Financial Services Bill

Lord Lawson of Blaby Excerpts

Monday 15th October 2012 Lords Chamber

[Baroness Wheatcroft]

This is a simple amendment which I believe could have significant effect. Your Lordships will recall that just before our major banks admitted catastrophic losses resulting in multibillion-pound bailouts and the Government becoming a major shareholder in Lloyds and Royal Bank of Scotland those banks were each given clean audit reports. The annual reports which the auditors signed off were packed full of numbers and told us nothing. The auditors received huge rewards for their efforts, yet within months of them signing off those accounts without any qualification the taxpayer was having to fork out £65 billion—that is £1,000 for every citizen in the country.

In February 2007 Northern Rock, which had a hugely risky business model, was given a clean audit report for its 2006 accounts. Within months it was clamouring at the door of the Bank of England for support as the queues mounted outside its branches. In February 2008 Lloyds and RBS each produced accounts for the preceding year. To judge from the unqualified audit reports each received, these were businesses which would happily carry on trading, yet just months later the Government were having to orchestrate a massive rescue package. Audit fees for those accounts were more than £13 million at Lloyds and £17 million at RBS. For what?

Audit is a profession in which the UK has played a dominant role but the profession’s role in the financial crisis does it no credit. The Economic Affairs Committee of this House has done some admirable work looking at the role of auditors but now we need action.

I do not believe that the auditors who signed off those bank accounts could have been entirely sanguine about what they were doing. They must have been aware of the perilous exposures that were building up, not just in derivatives but in loan books which were loaded with extraordinarily generous loans made against a ragbag of properties and businesses. Some of those still sit on the books at valuations which might be deemed “optimistic” at the very least. Yet such is the narrow interpretation placed on the duty of auditors that they were able to give those banks what is seen as a clean bill of health just as disaster was about to fall. Shareholders took comfort from those audit reports, only to see their investments shattered. The Economic Affairs Committee concluded that while the auditors may have carried out their duties properly in the strict legal sense, they had not in the wider sense, and that wider sense is surely crucial.

This amendment would change the requirement of an audit report for banks. It may be that other sectors would benefit from such a change but this is the Financial Services Bill and, as we have learnt, banks are not as other businesses. The amendment would require auditors to provide a narrative report on the risks they perceive in the bank they have audited. How different might those Lloyds and RBS reports have looked had this been the case then?

The Minister may feel that the content of annual reports is a matter for the Financial Reporting Council but this need not always be the case. This month the FRC has launched a consultation on guidance for the audit of financial instruments. I commend it to your Lordships as an exercise in overdosing on acronyms. Whether or not it would improve the audit of financial instruments, I do not feel qualified to judge, but it will certainly take a long time to wend its way through the FRC process. The Government can and regularly have intervened through the Companies Act to determine the shape of annual reports. Only recently the Business Secretary has decided to change the way in which remuneration is reported in annual reports. If there is a belief that the demands made on auditors and banks need to be strengthened, then the Government can use this legislation and provide the change that is required.

I have no illusions that asking auditors to report on perceived risks will go down well with everyone in the profession but some would welcome the wider remit. They would have to exercise judgment over what constituted genuine risks and they would be doing a service to shareholders as well as the wider community. Those familiar with company prospectuses will know that the list of risk factors can be comprehensive, bordering on the ludicrous, but it is not beyond the auditing profession, perhaps working with the Financial Reporting Council, to come up with ground rules that would make this a useful exercise. If all banks had to have such a narrative report, it would give auditors the opportunity to do their job properly. It would stop them being prone to any bullying tactics from executives. It would give shareholders and the community a better picture of what is truly going on in their financial institutions. I beg to move.

[Lord Lawson of Blaby]

My Lords, I would like to support very strongly the amendment moved by my noble friend Lady Wheatcroft. I shall speak briefly but my brevity does not indicate that this is not an important issue. It is a very important issue indeed. We are debating in the shadow of the worst banking crisis of our lifetimes and possibly the worst banking crisis there has ever been. As my noble friend pointed out, the Economic Affairs Committee of this House produced a report called Auditors: Market Concentration and Their Role which was published in March 2011. It was extremely critical and rightly critical of auditors in the context of the banking collapse that we have seen. This was, as is common with reports of Select Committees of this House, a unanimous report, but unanimity can be got in various different ways. This was unanimity where everybody of all parties who sat on that committee and heard the evidence was totally committed to what the report said. My noble friend Lady Wheatcroft mentioned one thing from the report. Let me quote one other thing from paragraph 204. It states:

“There was no single cause of the banking meltdown of 2008-09. First and foremost, the banks have themselves to blame. … But we conclude that the complacency of bank auditors was a significant contributory factor”.

This has to be addressed. How will we prevent—as far as we can—this sort of thing happening again?

In discussion of an earlier amendment, the noble Lord, Lord McFall, referred to the banking commission of which I, too, am a member. It is quite possible, such is the importance of this, that the banking commission will decide to look into the question of bank audits and auditors, and indeed auditing standards and IFRS, which leave a lot to be desired and are probably a step in the wrong direction. However, we must do what we can in the Bill to rectify the position.

I say en passant that what concerned me a great deal when the big four auditors gave evidence to us was the extent to which they seemed to think that they had simply to satisfy the management of the banks at the time, when under law their duty was to the shareholders. Furthermore, the putting in place of a proper system of audit for business and industry as a whole, but particularly for the banks, is a public duty; auditors had a duty to the wider public to do a good job, quite apart from their duty to shareholders of the banks—and they failed lamentably.

What can we do about this? I do not think that my noble friend Lady Wheatcroft would say that her amendment is the complete answer. Of course it is not: a lot more has to be done. However, it is very important that the Bill addresses this question, and I believe very firmly that the amendment before the House tonight is an important part of the answer, even though it is not the whole answer. I strongly support my noble friend’s amendment.

[Lord Oakeshott of Seagrove Bay]

My Lords, I, too, am delighted to support the amendment moved by my noble friend Lady Wheatcroft. With her characteristic delicacy and discretion, she did not mention the name of the auditors in question—but I will. I believe that Deloitte has very serious questions still to answer about its audit of RBS, particularly towards the end. There were some unhealthily close relationships between Deloitte’s auditors and the senior management of RBS. I also believe that PWC has very serious questions to answer about its final audit of Northern Rock before it went bust. I am sure that the Minister will remember that in this House, I moved an amendment calling for a special audit of Northern Rock, organised by the Bank of England. The amendment was agreed, but not approved in the other place. My noble friend has put her finger on a very important question and I very much hope that the Government will take it seriously.

--- Later in debate ---

[The Commercial Secretary to the Treasury (Lord Sassoon)]

My Lords, the question of the audit of banks is indeed an important one, and one which has recurred in policy debates over the past 20 years. I looked back to see what the Banking Act 1987 had to say on the topic and what Lord Justice Bingham had to say when he looked into the BCCI collapse. Various changes were made at that time and since in FiSMA but it is important that we learn lessons from the recent banking disasters, and I address the particularities of this amendment from a position of agreeing with the considerable concern around this issue. However, I do not believe that the amendment before us completely achieves what we are trying to do.

Clearly auditors are uniquely placed to identify and flag to the PRA current and potential risks in a firm. We would also expect the PRA to share relevant information with auditors, for example where it views a firm’s approach to asset valuation or provisioning to be significantly out of line with its peers. It is worth pointing out that there are areas in which the present regulator, the FSA, believes that auditors should be looking at particular issues and reporting on them and it can require that to be done in rules under Part 22 of FiSMA. So, for example, under the client asset rules, auditors are required to report on whether investment firms have properly segregated their client assets.

I do however have some difficulty with this particular amendment. My noble friend Lady Wheatcroft says that if only provision like this had been in place before or at the time of the crisis the auditors might have given a lot more help which might have prevented some of the disasters. On the other hand my noble friend Lord Lawson of Blaby quotes from your Lordships’ committee’s report which talks of the complacency of bank auditors at the time. Taking as read for the moment that the complacency thesis is the right one, I wonder if that complacency would have run through what was required to be done under a particular provision like this one in the amendment. I think that we are on to something important here but I am not convinced that this quite hits the sweet spot that the Committee is aiming for and that requiring auditors to provide this general narrative report will achieve what we want. Risk assessment is a highly-specialised process and it goes to the heart of the job of the prudential regulator. What I think we want of auditors is to see if there is something more that they can do which supports the prudential judgment rather than cuts across it.

[Lord Lawson of Blaby]

I am most grateful to my noble friend. Of course this is not the whole answer; I made that clear in my remarks. However, does he not think that this amendment would have been helpful and that it is therefore worthy of support from the Government?

[Lord Sassoon]

For the reasons that I have given, I am not absolutely convinced that it would have been helpful against the background of complacency of the bank auditors at the time of the crisis. Having said that, I agree with the Committee that there is something here that we need to look at further, so I want to see whether the Bill can and should go further to require the regulator to make the most of the expertise that auditors can undoubtedly offer. I am happy to take this issue away and consider whether there is an amendment that I can bring back at Report that recognises the important role of auditors without cutting across the role of the regulator in the way that I believe this particular amendment may do. I will look at it and come back to the House with something that addresses this area. On that basis I hope—