Local Audit and Accountability Bill [HL]

Lord Smith of Leigh Excerpts

Monday 17th June 2013 Grand Committee

[Lord McKenzie of Luton]

My Lords, at the start of our proceedings, for the record I should declare that I am a member of the Institute of Chartered Accountants in England and Wales, although I am not sure it is an interest.

In moving Amendment 1, I shall speak also to Amendment 13. Amendment 1 focuses on the desirability of retaining capacity for national or central procurement of auditor appointments in future, in addition to the arrangements for smaller authorities. The amendment requires the actual arrangements to be in place, but not necessarily activated before the Audit Commission is abolished. We have tabled a further amendment, which we can debate on Wednesday, which is a more enabling and flexible approach, adapting the proposition in the Bill for smaller authorities. As we are in Grand Committee, we will, obviously, not be voting on these amendments, but they give us the opportunity for a serious debate on one of the central issues arising from this Bill.

By the time the key provisions of this Bill come into force, it is to be expected that all of the audit contracts for principal local bodies will be undertaken by private sector firms under arrangements entered into with the Audit Commission. This will comprise some 800 principal authorities, including local authorities, NHS bodies, police authorities, national parks authorities, et cetera. Perhaps the Minister might arrange for us to have a comprehensive list at some stage. These arrangements run through and cover audits for periods to March 2017. The contracts—I believe that there are 10 of them—can be extended through to periods to March 2020 at the discretion of CLG, but decisions to extend would effectively have to be taken by the beginning of the year 2016-17 if an EU-compliant procurement process is to be undertaken. If these contracts are not extended under the Bill, the local public bodies would go their own way and make their separate appointments, although there is flexibility for authorities to jointly procure, together with other bodies.

It seems very clear that procuring centrally on this basis is driven by significant savings in audit fees; 40% is the quoted figure, which I understand is accepted by the Government. These benefits can be extended should contracts be extended. This is a very substantial saving to local government, in particular at a time when budgets are under the severest pressure and likely to remain so as a result of the spending review.

Noble Lords will have seen the outcome of some modelling undertaken by the Audit Commission for the LGA, which looked at six potential procurement options ranging from local choice to central procurement. It summarised the outcome in its briefing to us; indeed, that briefing showed that of the six choices, from local choice through to central procurement, the central procurement was clearly the least-cost option. The conclusion reached was that central procurement could save the public purse some £200 million over five years.

We should not overlook the fact that along with central procurement comes the management of the contracts and, in particular, the arrangements concerning auditors selling other services to their audit clients. Perhaps the Minister will tell us what safeguards will be in place when local appointments hold sway. How will it be assured that such practices will not impede independence requirements? We hear that appointment of local auditors is part of the localism agenda and that local bodies should be able to choose auditors who better suit their needs. However, this seems largely to overlook the fact that audit is, quite properly, a heavily regulated activity. Who can act, supervision of the firms, a code of audit practice and the accounting requirements are, and will continue to be, set nationally. Those matters are not, by and large, optional, nor should they be. What will happen to audit fees when there is local procurement depends on a number of factors and will be made more complicated by the fact that local procurement is invariably a few years distant.

We can see the Government’s perspective on this at paragraph 103 of the impact assessment. It states:

“While local bodies may not realise the whole of this saving”—

that is, the 40% achieved on outsourcing and central procurement—

“when they procure their auditors themselves, there should be plenty of scope to negotiate fees well below … the 2009/10 [levels]”.

That means that the Government think that audit fees will rise as a result of local procurement.

Clearly, much depends on how the audit market develops over the next few years. The outsourcing by the commission did not do much to widen participation levels in the local authority and health sectors. The outsourcing of the in-house commission practice went to only seven firms—most to the big four plus Grant Thornton. Research shows that market concentration in audit services leads to higher audit fees. There is a credible argument that individual procurement would act against market concentration but the major providers in the market are large, economically powerful entities with resources to invest to tackle new opportunities. One of the risks is that the larger authorities will fare well in this because they will be more attractive clients to the big firms. Smaller authorities will in practice have less choice, may be junior partners in joint appointments, or may miss out on the services of the larger firms or be unable to afford them.

The market will be affected by developments in the EU and, quite possibly, by the deliberations of the UK competition authorities to which the big four have been referred. Procurement could be more costly. Given that those principal bodies are likely to award contracts for five years, it is estimated that more than 90% of them will have to follow EU procurement rules, and EU thresholds will apply to the total value of the contract awarded. For audit work this is €130,000. Pricing will be affected by other factors, especially as the commission will no longer be providing cover for limitation of auditor liability.

The Government will doubtless say that authorities can group together, as indeed they can, but there is no clear framework to support this. Indeed, there is no explanation, for example, of what happens if there is joint provision but a conflict develops between one of the authorities and the firm involved.

It is clear that there is great uncertainty about how the local procurement plans will work out, and that is why it must make sense to retain the option to undertake central procurement should the Government’s assessment be unduly optimistic. We have not been prescriptive about how that capacity might be provided—there are clearly a number of options—but it would be imprudent not to keep the opportunity in reserve.

Amendment 13 is a very narrow amendment. Clause 4 sets out the general requirements for audit and yet refers to the accounts of a relevant authority and the imperative for them to be audited in accordance with the provisions of the Bill. The clause requires the auditor to have been appointed by the particular authority in question. However, if the auditor for the relevant authority has been appointed by the Audit Commission under a contract which may not expire until 2017 or even 2020, these provisions would not seem to apply. I wonder whether that is the intention. The new regulatory regime is due to commence, as I understand it, in 2015-16. What will be the situation if there is a joint appointment or a framework agreement is operated? How can that requirement be met? I beg to move.

[Lord Smith of Leigh]

My Lords, I first declare my interest. I am leader of Wigan Council and the chairman of the Greater Manchester Combined Authority—which I notice is covered in Schedule 2. I am also a vice-president of the LGA. I apologise to noble Lords for missing the Second Reading. Unfortunately it clashed with the annual meeting of my council. As I am the executive leader of the council and had to choose which meeting to go to, I think that I probably made the right choice.

I want to speak in support of my colleague Lord McKenzie of Luton and particularly to expand on what he rather dismissively described as his Amendment 13, which removes those three little words. What puzzles me is that the Government are—I believe rightly—encouraging a lot of joint working with local authorities to deliver lots of services, in many cases allowing joint appointments for senior officers, particularly for smaller authorities. As we know, in many cases it is a financial necessity to do this. As we have discovered in Greater Manchester, which is working on the community budgets pilot, joint working is essential if we are to deliver the Government’s agenda of reforming public services. We are working with 10 authorities in Greater Manchester. The three boroughs in London and so on are also good examples of places working very closely together. However, if joint work is going on, where is the audit taking place? The sensible thing would be to have a joint audit—to have someone who can audit all of the activity in a simple and straightforward way.

Given my noble friend’s knowledge of the accountancy profession he addressed the power of large audit firms and the way in which that might operate unfairly in the market. One way of reducing that power would be to allow local authorities to procure jointly. That would give them greater power in the market, enable them to get larger contracts and—one hopes, with the economies of scale—help them to get reductions in fees. I think that Amendment 13 is important and I hope the Minister responds to it.

[Lord Palmer of Childs Hill]

My Lords, I also must declare that I am a member of the Institute of Chartered Accountants in England and Wales. I am also chairman of a local authority audit committee at the London Borough of Barnet, and am a councillor in that borough. I also thank the Local Government Association for its very informative description of the various options available. I have been quite nervous about centralising the acquisition of external auditors. I feel that the role of the internal audits tends not to be recognised by external auditors who, from my research, seem to do a lot of substantive work which in many ways shows that they are not relying on the work in internal audit that the local authorities are paying for. That is what is happening at the moment.

As much as I would like there to be local acquisition of external auditors, I am happy to go along with making this option available. I believe that the way that the centralised body performs will depend on how the local authorities react and whether they are getting a good deal. I also believe that the wording in the amendment is right. The danger of not permitting this centralised option is that local authorities, and the auditors themselves, will cherry pick the audits they want, and that the local authorities will cherry pick the auditors they want. That arrangement could be too cosy. This issue arises and has become imperative because of the ending of the Audit Commission. We are examining what can be done due to that change in circumstances. The comment about taking out only one or two words was absolutely right. Without removing the word “authority”, Amendment 1 will not carry the same weight. From our Benches I support both amendments in this group.