International Accounting Standards (Delegation of Functions) (EU Exit) Regulations 2021

Lord Callanan Excerpts

Tuesday 27th April 2021 Grand Committee

Moved by

[Lord Callanan]

That the Grand Committee do consider the International Accounting Standards (Delegation of Functions) (EU Exit) Regulations 2021.

Relevant document: 46th Report from the Secondary Legislation Scrutiny Committee

[The Parliamentary Under-Secretary of State, Department for Business, Energy and Industrial Strategy (Lord Callanan) (Con)]

My Lords, these regulations, which were laid before the House on 1 February, aim to address matters relating to company reporting arising from the UK’s exit from the EU. I shall refer to these regulations as the delegation SI.

International financial reporting standards—IFRS—are a set of international accounting standards used in over 125 countries around the world, including Australia, Canada and across the EU. In a world with growing economic interconnectivity, accounts prepared in accordance with high-quality international accounting standards provide the consistency and reassurance that investors require to confidently invest in capital markets. The Government are committed to IFRS as standards that drive improvements in the quality and comparability of financial reporting, facilitate investment across borders and build links for investors and regulators between capital markets. The UK is the largest single user of IFRS, with over 15,000 economically significant UK companies now using the standards. This includes all publicly traded companies, which are required to use them to prepare their consolidated accounts.

Legislation made in 2019 provided post-transition period continuity for IFRS by transferring all existing EU-adopted IFRS into UK law to form “UK-adopted international accounting standards”. I shall refer to these regulations as the principal regulations. The principal regulations also provided a mechanism for IFRS to be adopted for use in the UK after the end of the transition period. This action meant that the Secretary of State has been able to adopt crucial amendments to IFRS for use in the UK, including amendments relating to the ongoing interest rate benchmark reform. This was, however, intended only as an interim measure. The principal regulations also provided for the delegation of the adoption functions to an expert body.

The purpose of the delegation SI is straightforward. In line with the intent of the principal regulations, it will delegate decision-making powers on the adoption of IFRS to the recently established UK Endorsement Board. The board will have two primary responsibilities: it will be responsible for the analysis and adoption of IFRS for use in the UK, and for influencing the development of IFRS by the International Accounting Standards Board.

To adopt a standard, the endorsement board will need to be satisfied, first, that its application is likely to be conducive to the UK’s long-term public good; secondly, that the standard meets the criteria of understandability, relevance and comparability; and thirdly, that its application would not be contrary to the principle that accounts provide a “true and fair” view. In addition, decisions on the adoption of IFRS can be taken only following consultation with stakeholders with an interest in the quality and availability of accounts.

I turn to the endorsement board’s influencing work. While it is beneficial for the UK to maintain alignment with international standards, it is also important that those standards work for the United Kingdom. That is why influencing the development of IFRS by the International Accounting Standards Board is one of the board’s key responsibilities. Effectively performed, this will mean that UK interests are addressed during the development process and final standards reflect the needs of UK stakeholders.

These are substantial responsibilities, but the endorsement board has been equipped to meet those needs. Clearly, the calibre and expertise of those involved in the decision-making process is vital. The appointed board, led by Pauline Wallace, is talented, experienced and diverse. Its membership includes preparers of accounts, members of accounting firms and academics and investors; an economist will also be recruited over the coming months.

Further, we recognise that the board’s decision-making, although independent, cannot overlook the regulatory context. As such, those in attendance at endorsement board meetings will also include representatives from the relevant government departments, the FCA and the Bank of England. These observers will be involved in discussions but not the final decision-making stage, in order to maintain the board’s independence.

The endorsement board’s terms of reference were adopted at its first meeting in March and are available on the board’s website. The terms of reference are structured around guiding principles of accountability, independence, transparency and thought leadership. They provide for an active and transparent adoption process that is receptive to the views of stakeholders and reflects the long-term public interest. In drafting the terms of reference and the establishment of the endorsement board, we involved a broad range of stakeholders with an interest in IFRS, including regulators, at each stage of development. We are grateful for their insight and commitment.

I now move to the oversight of the endorsement board. The board is an independent unincorporated association supported by a subsidiary of the FRC via a service-level agreement. This agreement will include support in the areas of HR, finance and IT equipment to enable the board to carry out its work.

I have already stressed that the endorsement board’s decision-making will be independent. However, this does not mean that it should be beyond the reach of those with wider responsibilities for the integrity of company reporting. As such, a key principle of the adoption process will be transparency, with both the discussions and the outcome of adoption decisions being made publicly available.

The endorsement board will be accountable to the Secretary of State for how it performs its delegated functions, and the Secretary of State will, in turn, lay the endorsement board’s annual report before Parliament. The board will also report, in a publicly available document, on its governance and due processes to the FRC. I should add that the Secretary of State will also retain the ability to make regulations to amend or withdraw the delegation if it appears to the Secretary of State that the delegation is no longer in the public interest.

With the appointment of an interim chair, board members, the recruitment of a secretariat and adoption of the terms of reference, we have completed important steps to establish the endorsement board. The cost of this has been approximately £2 million over the past two years and we expect future ongoing costs of £2.9 million per year. These ongoing costs will be funded using the FRC’s levy on preparers of accounts. This will put the cost of the endorsement board to those who benefit most from IFRS.

In conclusion, I hope noble Lords will agree that delegating statutory powers to the UK Endorsement Board will support the UK’s long-term public interest and maintain high standards of UK company reporting. I commend the regulations to the Committee and ask it to support and accept them. I beg to move.

--- Later in debate ---

[Lord Callanan (Con)]

My Lords, I thank noble Lords for their insightful contributions to this debate. The many points raised have demonstrated the need for the measures contained in the delegation SI and the support that they will give to users and preparers of accounts. Businesses up and down the UK continue to face uncertain trading conditions, particularly in light of the Covid-19 pandemic. The delegation SI provides reassurance for UK-registered companies using IFRS, on a mandatory or voluntary basis, that the Government remain committed to these global standards and their role in the UK’s company reporting framework. Further, we will use the strengths of the UK’s accounting and finance sectors to contribute to the future development of IFRS and to ensure that UK company interests are taken into account. I believe that the board will develop a reputation as a major voice on the global accounting stage.

I will now deal with some of the points raised in debate. The noble Lord, Lord Davies of Brixton, asked a question on parliamentary accountability. As I set out in my opening speech, Parliament will have oversight of the Endorsement Board’s activities and the board will be required to report on its technical decision-making to the Secretary of State on at least an annual basis. The Secretary of State will, in turn, be required to lay that report before Parliament. The Secretary of State must also, separately, lay a report each year on the carrying out of responsibilities related to the adoption of international accounting standards.

The statutory criteria for the Endorsement Board means that it must consider the long-term public good when deciding to adopt a standard, together with the costs and benefits, and any effects on the economy. The whole point of the UKEB is for the UK to decide on its adoption for use in the United Kingdom. While the UK was a member of the EU, the European Commission decided on adoption; now, the UK can make its own decisions on what standards are used.

The key advantages of IFRS are the high-quality, transparency and comparability that the standards bring to financial statements. They are now in use in over 125 countries, including the majority of the G20 states, all EEA member states and 93 major securities exchanges around the world. If the UK is to continue attracting international investment, it is in our interests to maintain alignment with these international standards. This was recognised by Parliament when continued use of IFRS in the UK was approved in 2019. A dedicated and independent Endorsement Board is more easily able to recruit the expertise needed for decision-making and influencing the future direction of IFRS. It is also better placed to conduct the outreach required to assess the impacts of adoption in the UK. A separate board is also consistent with the approach taken by many other countries that use IFRS, including Australia and Canada.

My noble friend Lady Neville-Rolfe referred to the Sarbanes-Oxley regime on internal controls in the US. I understand that this has had some benefit in terms of fewer US companies having to restate their accounts, but I respect my noble friend’s knowledge of potential negative impacts. The Government’s current audit reform and corporate governance White Paper includes proportionate proposals on internal controls. I would be very happy for my officials to brief my noble friend on the White Paper as a whole; I know that she has already had some meetings on it.

The regulations set out what is meant by long-term public good. They particularly require regard to be paid to the following matters: whether the use of the standard is likely to improve the quality of financial reporting; the costs and benefits likely to result from the use of the standard; and whether the use of the standard is likely to have an adverse effect on the economy of the United Kingdom, including on economic growth. The board will be required to consult with those representatives of users and preparers of accounts before adopting a standard, including smaller business where that is relevant.

Regarding the points made by the noble Lord, Lord Sikka, the Endorsement Board will be bound by the same assessment criteria that Parliament approved for the Secretary of State. These are based on established principles for financial reporting, including that the standards are not contrary to the principle to provide a true and fair view of an undertaking’s financial position, and that they are conducive to the long-term public good. There is also an obligation to consult persons representative of those with an interest in the quality and availability of accounts.

It is true that the IFRS Foundation is registered as an overseas company incorporated in Delaware, where it is classified as a not-for-profit, tax-exempt organisation. In the UK, the foundation’s tax is calculated on the basis of notional trade, where publications revenue is offset by the costs of developing the published materials. This was agreed with the UK authorities in 2006 and is set out in the foundation’s latest annual report. The terms of reference require meetings and decisions to be held in public. Its initial meetings have been held in public and are available to view on its website. The key advantages of IFRS are the high quality, transparency and comparability they bring to financial statements; they are prepared following extensive consultation and consideration.

Regulated entities are required to prepare separate accounts for investors and the market at large. These are separate from those produced for the regulator, which is considering the entity’s solvency and liquidity position to understand the impact on the system as a whole, and the two have two separate purposes. Accounts prepared under IFRS are general purpose accounts designed to meet the needs of a wide range of investors, finance providers and stakeholders. The proposals in this SI do not change the existing capital maintenance and distributable profits regime in the Companies Act. As I said earlier, the international standards are used in more than 125 countries, including Australia and Canada and across the EU.

Moving on to the points made by the noble Baroness, Lady Bowles, the conditions of the EU withdrawal Act do not provide the powers to create a new statutory body to endorse IFRS. The Endorsement Board is therefore an unincorporated association, comprising the chairman and the board members. Resources and funding are provided by the existing body, the Financial Reporting Council. The Endorsement Board has been designed to be accountable and open to scrutiny by government and stakeholders, and there are statutory requirements for reporting to the Secretary of State, to the FRC and to Parliament.

IFRS are not incompatible with the requirement to show a true and fair view in UK company law. Section 393 of the Companies Act 2006 sets out the overriding requirement that directors must not approve accounts unless satisfied that they give a true and fair view of a company’s financial position, notwithstanding the accounting standards used in their preparation. Additionally, the legal criteria for adopting a new or amended IFRS for use in the UK already includes a provision that a standard cannot be adopted if it would be contrary to the requirement for accounts to provide a true and fair view of the undertaking’s financial performance and position. Accounts prepared under IFRS are general purpose accounts, designed to meet the needs of a wide range of investors, finance providers and stakeholders and, as I said earlier, the proposals in this SI do not change the existing capital maintenance and distributable profits regime in the Companies Act.

The Endorsement Board secretariat has commenced some of the foundational work that will be needed to inform the assessment of IFRS 17. This includes conducting a survey of insurance companies and establishing an insurance technical advisory group. The work is expected to escalate in the coming months and will include outreach with representatives from stakeholder groups across the UK’s insurance sector, including preparers of financial statements and investors. As the recent announcement of the board members demonstrated, membership is representative of areas with an interest in the quality and availability of accounts. This naturally includes representatives with experience in the biggest accounting firms, as their expertise and insight will be invaluable. However, as the board composition demonstrates, those with experience in smaller firms are also valued as board members, and no one on the board has an existing role at any of the big four accounting firms.

Pauline has over 30 years’ experience in the development of accounting standards and I am delighted that she is the inaugural chair of the Endorsement Board. Her experience and technical knowledge of the standards has been invaluable during the work so far and there is no question in my mind that she is the right person to lead the board. She retired from PwC in 2013 and in my view this provides a sufficient gap between the end of Pauline’s employment by a big four firm and appointment as chair of the UK’s Endorsement Board, without any danger of being unduly influenced by the policies of a former employer. In addition, the terms of appointment for members of the board require it to comply with the terms of reference. The Secretary of State could take action if the terms of reference were being disregarded, including the ultimate ability to revoke the delegation.

Moving on to the comments of the noble Lord, Lord Lennie, the terms of reference are already published on the UKEB website, and these are intended to be finalised after the completion of the parliamentary debates. All board members are, of course, required to act independently and in the UK’s long-term public good, including not showing preference to special interests. The Endorsement Board has been developed with Sir John Kingman’s review of the FRC in mind, and we envisage ARGA’s role in relation to the board to be similar to the FRC’s role.

To close, I reiterate that the action taken by these regulations represents the best way forward for adoption of IFRS in the UK’s long-term public interest. The endorsement board is ready, now is the time for it to take on its functions, and I commend this statutory instrument to the Committee.

Motion agreed.