Statutory Auditors (Amendment of Companies Act 2006 and Delegation of Functions etc.) Order 2012

Lord Flight Excerpts

Monday 25th June 2012 Grand Committee

[The Parliamentary Under-Secretary of State, Department for Business, Innovation and Skills (Baroness Wilcox)]

My Lords, the purpose of this order, which amends the Companies Act 2006, is to implement the legislative changes required to support the reforms to the Financial Reporting Council—the FRC—from 2 July 2012, announced by the Government in March.

The FRC is the UK’s independent regulator, promoting high quality corporate governance and financial reporting to foster investment. It discharges its responsibilities by setting codes and standards and monitoring the conduct of market participants in specific areas to ensure that they comply with the relevant regulatory requirements.

Noble Lords may remember that the House of Lords Economic Affairs Select Committee criticised the number of organisations engaged in the oversight of accounting and auditing in its report published on 30 March 2011. In addition, the Government’s The Plan for Growth report, published in March 2011, highlighted concern that the FRC’s structure might lead to a duplication of effort. This would potentially cause overregulation but also increase the risk that major weaknesses were not addressed.

The FRC is highly regarded but its structure is complicated and hard to understand. Its seven operating bodies, with separate boards and secretariats, restrict its ability to respond to issues that cut across structural divisions. For example, no single operating body has a remit sufficient to tackle broad questions around the handling of risk, the future of audit and corporate reporting. Following the 2008 financial crisis, such issues had to be addressed by the main board, making use of its ability to bring together the high levels of expertise across the operating bodies. Furthermore, the FRC’s effectiveness is constrained by its current powers regarding the accountancy and auditing profession that it oversees. The FRC is being restructured to ensure that it is best placed to meet the challenges created by the global financial crisis, but the board does not have the powers to achieve the necessary change on its own.

The Government and the FRC issued a joint consultation document on 18 October 2011 on the proposed reforms to the FRC’s structure and powers. A summary of responses was published on 27 March 2012. A total of 75 responses was received from stakeholders. There was a wide range of views, some supportive of the proposals and others challenging the case for reform. All views were considered carefully and taken into account in the joint government and FRC response. The FRC’s reforms will give greater clarity to the boundaries between the professional bodies and the FRC and enhance the FRC’s independence from the professional bodies in its role as the UK’s lead audit regulator.

The final-stage impact assessment, published alongside the Government’s and FRC’s finalised proposals, identified direct savings to business in the order of £0.4 million a year. These largely resulted from the ability to settle disciplinary cases without a public hearing, subject to the necessary publicity.

The order will delegate statutory powers to the FRC board rather than its operating bodies as at present, with the exception of the Financial Reporting Review Panel powers, which move to the new Conduct Committee; provide the FRC board with powers to determine and require, rather than request, that recognised supervisory bodies impose sanctions in respect of poor quality audit in certain circumstances; permit certain disciplinary cases to be concluded without a public hearing where the auditor concerned agrees, although they remain subject to appropriate publicity; and provide the FRC board with powers to impose directions and financial penalties on the recognised supervisory bodies and recognised qualifying bodies for shortcomings in discharging their regulatory responsibilities.

These changes, taken as a whole, will enhance the Financial Reporting Council’s effectiveness as part of the wider UK regulatory framework and ensure that the United Kingdom has a powerful, joined-up voice on the international stage. I therefore commend this order to the House. I beg to move.

[Lord Flight]

My Lords, I would like to put on record that this is important legislation. In effect, it sets up a full-scale regulator of the accounting profession comparable to the FSA in the financial services industry. To some extent, I am slightly surprised that this is only an amendment to the Companies Act as it contains many important changes. However, I welcome the order and its economies. I am glad that there was full consultation and I am curious to know the reaction of the institute and of the profession generally.

One or two important matters follow from the order. First, who appoints the senior executives of this new regulator? I have the highest regard for Stephen Haddrill, the present chief executive, but I do not know whether it is a self-appointed body or whether there is any accountability to Parliament or the Treasury Select Committee.

My first question at the time of the banking crash was: where were the auditors? The only point of an audit is to show whether institutions are in either good or bad order. Sets of banks’ accounts running to 500 pages were totally impenetrable and impossible to understand and, as far as I am aware, in no case were the auditors whistleblowers. I do not know whether this enhanced FRC will have the powers to change that situation, but some form of review of what happened to the auditors during the banking crash could be of some use.

My other point—the committee of the noble Lord, Lord MacGregor, also made this point—is that the FRSA’s accounting standards have been a disaster. They have, in essence, painted an over-rosy picture in good times and an over-negative picture in bad ones. There is a widespread view that they need changing and that they are particularly unsuitable for banks. Every time this matter is raised, nothing ever happens and it is not clear where responsibility lies. However, I imagine that it will be a duty of the greatly enhanced FRC to consider the matter and make recommendations, not only to the profession but to the Houses of Parliament as well.

We have an important new body. It was necessary and timely to tidy it up in the way that it has been, but on those two points there is some unfinished business.

--- Later in debate ---

[Lord Flight]

Perhaps I may just correct myself. I think that I said FRSA when I meant IFRS. I apologise.

[Baroness Wilcox]

I thank noble Lords very much for the exchanges that we have had. I thank the noble Baroness, Lady Hogg, for being here today—I am delighted about that. She seems to have answered several questions for me, which is an enormous help. Of course, there are many questions to answer. This is a very big and wide area, and it affects so many different organisations that it is right that I should receive more questions than I can answer at the moment. However, I shall endeavour to answer some of them. In talking about appointment issues and so on, the noble Baroness, Lady Hogg, has more than likely provided answers but I shall try to respond to some of the questions from my noble friend Lord Flight.

I think that he asked who appoints the senior executives—a point that I think the noble Baroness, Lady Hogg, answered. The FRC is a company overseen by its board and it will appoint its senior executives in line with the best human resources practices. The additional points made by the noble Baroness were very useful and she gave a better answer than mine.

The Accounting Standards Board sets standards for financial reporting and has regard to best practice. This includes reference to international developments—the IFRS—as well as responding to developments and thinking in the United Kingdom. The use of international accounting standards is subject to EU approval, as always. The adoption of international standards, and amendments to those standards, follows consultation with the member states, and the FRC and the UK work closely with the EU and the IASB to influence these wherever they can.

My noble friend Lord Flight asked who the FRC will be accountable to following the reforms. The FRC will continue to be accountable to government and ultimately to Parliament in relation to the exercise of its statutory powers, and it will also be accountable to the key stakeholders, including the investor community, which relies on the quality of corporate governance and reporting in the United Kingdom. The FRC will report annually to the Secretary of State on the exercise of its powers.

My noble friend Lord Flight and the noble Lord, Lord Young, asked where the auditors were during the financial crisis. When considering financial institutions, it is important to note that the primary regulator of those institutions which was most prominent during the financial crisis was the Financial Services Authority and not the FRC. The FRC works closely with the Financial Services Authority with a view to ensuring that regulatory action is taken where appropriate. We believe that the changes to the FRC’s structure will enable it to bring its full resources to address any emerging problem much more quickly and effectively than was done at that time.

The financial crisis has been looked at, as we heard, by the House of Lords Economic Affairs Committee. Although it raised a number of issues relating to auditing, some of which are addressed by these measures, the Government do not take the view that these issues were at the heart of the crisis. The “going concern” issues mentioned by the noble Baroness, Lady Hogg, are important, but there were also failures of prudential regulation. If I have missed anything from those questions, it will of course be picked up by the sturdy band behind me, who have been frantically trying to answer all these questions.

Thankfully, the noble Lord, Lord Young, welcomed this measure before setting off with a flurry of questions, all of them right and relevant. I shall try to answer a few for the moment and then, if it is all right, I will reply in writing. Why is the FRC jettisoning the tried and tested ASB/APB brands, and what effect will this have on the FRC’s capability to influence at an international level? International influencing is a central objective of the FRC. The Government and the FRC recognise the contribution that the FRC’s standard-setting bodies have made, while remaining convinced that the changes proposed are needed to strengthen the UK voice. In the new structure the FRC should be better equipped to tackle the most strategic issues and to provide high-quality thought leadership, as well as continuing to develop excellent technical solutions. Standard-setting is increasingly debated in the United Kingdom, in the European Union and internationally in fora that cover a wide range of issues. The FRC needs to exert influence accordingly in these areas. The FRC board has the experience, the seniority and hopefully, through the new structure that we propose, the authority to do that.

On the question from the noble Lord, Lord Young, on auditors’ independence, the Government and the FRC acted in the wake of the crisis to improve transparency. Furthermore, proposals are now being considered in Europe on this very question. The noble Lord also asked about reporting on corporate governance. The FRC is required to make an annual report on its activities, and that report is laid in Parliament.