Lord Young of Norwood Green
Main Page: Lord Young of Norwood Green (Labour - Life peer)Auditors: EAC Report
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Lord Young of Norwood Green
My Lords, I enter this debate with great trepidation, not being a financial expert by any means. I do not envy the Minister her task in trying to sum up. I am only going to touch on a few points. I did not read all of the report and did not have a single malt, but I certainly had a good look at it and at the government response. I think we should congratulate the committee on doing a good job. I am indebted to the noble Lord, Lord MacGregor, for the history. I was fascinated by Deloitte’s involvement as the first auditor of the Great Western Railway. Knowing Brunel’s propensity for raising cash from investors and very rarely giving them any return, I can see that it is a historic problem.
Some key points have arisen during this debate, which focused on the banking crisis. Time and time again, although not everybody seems to agree, the question of whether there should be a dialogue between auditors and regulators was raised. The noble Lord, Lord Stewartby, drew to our attention the subtle distinction between regulators and supervisors. I am sure the Minister will deal with that. It seems to me that that is part of solving this difficult problem.
Then we got to the nature of the audit and the IFRS and GAAP approaches. We had a debate between box ticking and prudence, and it seemed that most noble Lords erred on the side of prudence. I think it was the noble Lord, Lord MacGregor, who talked about professional scepticism and the feeling that it is important that auditors exercise their judgment.
I was also interested in what the noble Lord, Lord Lawson, said when he asserted that there has been a decline in moral standards in the City of London. In fact, he talked about moral bankruptcy. What we saw in 2007 and 2008 was quite clearly the product of a catastrophic failure of governance and the failure of regulators to understand the nature of the systemic risk in the financial system. It may be that we should be taking the opportunity to reassert the existence of the fiduciary duty on those who are responsible for managing the assets of savers and investors to act in their interests, exercise good judgment and be accountable for that judgment.
There has been a lot of discussion about the dominance of the big four, but no one has come up with a solution to that particular problem yet. I was exercised again by the noble Lord, Lord Stewartby, reminding us first of all of this 48-year relationship in what I would describe, in a variation on the word oligopoly, as a “quadropoly” and secondly that there seemed to be a “unification of outlook”—I hope I have not paraphrased him—and a “suspension of critical faculties”. None of the people involved seemed to have recognised the risk. He talked about the Queen’s comment that no one saw this train crash coming. Then he referred to the slicing and dicing of products, these financial derivatives that were so complicated yet nevertheless managed to achieve an AAA rating when we knew they were rotten at their core.
Clearly there is a need, as I think both the noble Lord, Lord Northbrook, and my noble friend Lord McFall of Alcluith said, for auditors and indeed management to be trained to recognise risk. That is something else I hope the Minister will address. On the question of risk and risk committees, that seemed to be one of the important recommendations, although the report seemed to refer just to banking and finance companies. I was thinking about that and reflecting that there were other companies that took substantial risks, which resulted in the Government footing some of the bill. The one that came to mind was Southern Cross, which became so leveraged that it could not sustain itself, and I recalled the impact the foundering of those care homes had on society as a whole. When it comes to big companies and risk committees, it seems to me that it is not just the banking and finance sectors that should be required to submit to them.
I am also indebted to, I think, the noble Lord, Lord Shipley, for reminding us of the human consequences of the Northern Rock crisis, which he saw every time he looked out of his window in Newcastle; and not just for shareholders, but for the employees who suffered as a result. It seems to me that a risk committee and auditors being involved in that is fundamental.
I am not sure how we are to resolve the dominance of the big four. I hope that the noble Lord, Lord Northbrook, is wrong that the Competition Commission will not be able to shed any light on that. We had the noble Baroness, Lady Hogg, suggesting—and she was not the only one—that now the Audit Commission is going this should present an opportunity for other auditing companies to emerge. Somebody else suggested that the FSA reports would be a good vehicle to assist in this process. I do not feel competent to comment on that but no doubt the Minister will, although she was given a get-out clause there when the noble Lord, Lord Lawson, said that she could deal with his seven recommendations by letter. I felt the Minister should be eternally grateful for that because they got more and more complex towards the end.
I think it was the noble Lord, Lord Lawson, who made the point that no auditors have been sued as a result of the banking crisis. Amazingly, nobody seemed to take any responsibility. There must be something wrong if everybody apparently was exercising their responsibilities and yet we had this financial crisis. As the noble Lord said, nobody at this point in time is willing to accept responsibility. We know that there is plenty of work to be done. When I look through the government response, I do not think that they have got it right in all cases. I gave the example of the question of risk. It is important that all companies should have that. The relationship between the auditors and the risk committee will be important. I look forward to the Minister’s response and once again thank the committee for its work.
The Parliamentary Under-Secretary of State, Department for Business, Innovation and Skills (Baroness Wilcox)
My Lords, I thank my noble friend Lord MacGregor of Pulham Market for calling this debate. We have heard some well informed and constructive contributions from the House. It has been a particular master class for me, and certainly for my civil servants behind us because they have had evidence today of what a Lords Select Committee can do with a subject all by itself. At the moment, every time we can show how well a Lords committee does, we should do so.
Of course, I will not be responding to the noble Lord, Lord Hollick, who asked my permission to be able to speak and to leave. He therefore knows that I will be writing to him rather than answering his questions while I am on my feet. As we have already heard, my noble friend Lord Lawson decided to let me off the hook today and gave us those seven biblical recommendations that he left us to reflect upon. We will, of course, write to him. As for the rest of the questions from your Lordships, I hope that I will be able to answer a goodly few of them along the way. Of course, I will write to anybody to whom I have not been able to immediately respond.
I start by paying tribute to the Economic Affairs Committee’s chairman, and to the report and recommendations, some of which have already resulted in action. One of the recommendations in the report was that the audit market should be investigated by the competition authorities. As my noble friends Lord MacGregor and Lord Stewartby, and the noble Lord, Lord Currie, noted, within two months the Office of Fair Trading had announced its provisional decision to refer the market for the audit of large companies to the Competition Commission, which plans to publish its provisional findings by the end of November. I emphasise what an important development the Government consider this investigation by the competition authorities to be.
The Select Committee report made several other recommendations. I recognise that the committee expressed disappointment with some of the elements of the Government’s response to its report. It might help if I start by covering two issues where I know that the committee continues to have concerns. The first is the issue of international financial reporting standards—IFRS. Under EU law, listed companies in the European Union are obliged to prepare their consolidated accounts in accordance with IFRS. My ministerial colleague, Norman Lamb, replied to a letter from my noble friend Lord MacGregor on this issue last week; I think that he is coming out with a Statement fairly soon. In line with the conclusions of the G20 last November, we continue to support the aim of a single international system of standards. These will develop with time and aim to address issues, on an international basis, as they arise. The Financial Reporting Council—FRC—is engaged in that process, as are the Government when revised standards come to be adopted in the European Union.
The other area where the committee expressed concern was the need for discussions between auditors of financial institutions and the prudential regulator. The Government continue to support the code of practice that now requires discussions twice a year, with one discussion including the relevant bank. The code of practice appears to be working. For this reason, and in accordance with better regulation, we will not be introducing a statutory requirement. The Government, the Bank of England, the FSA and the FRC all support this. However, we will be watching the issue closely.
My noble friend Lord MacGregor asked what the FSA code of practice requires. The code of practice now requires discussion about each of the banks between the relevant auditor and the prudential regulator twice a year, with one of those meetings including the bank itself. These discussions are happening and the code, as I say, appears to be working. My noble friend Lord Stewartby asked why auditors did not recognise the risks. The banking crisis had a range of causes. More or better assurance alone would not have stopped it, but we have certainly learnt lessons.
The systemic problems that caused the banking crisis have been well rehearsed and include a failure of credit judgment, a failure on the part of central banks to recognise asset bubbles, weaknesses in regulation and deficiencies on the part of credit rating agencies. Audit has never had a financial stability role, and is only one element of the regulatory framework that ensures that we have working capital markets. The issue of systemic risk falls to the regulator, as well as to the boards of companies, rather than to the auditors. In terms of the audit of banks, the Government are committed to the objective of improving bank corporate governance, and will continue to work closely with the European Union and internationally to increase transparency and accountability in a proportionate manner.
I now turn to some other recommendations of the committee, where the Government and the FRC have taken action. On the long tenures of some auditors of large companies, BIS and the FRC consulted separately last year as to how discussions between auditors and audit committees about the appointment of auditors might be improved. Amendments to the FRC’s corporate governance code and audit committee guidance will follow this year. This will include a new requirement for auditor retendering by FTSE 350 companies, on a “comply or explain” basis, every 10 years. My department will publish a summary of responses to the consultation on narrative reporting shortly and we will set out the Government’s position as regards wider assurances of corporate reporting beyond the audit of accounts.
My noble friend Lord MacGregor asked whether the Government are proposing to encourage company boards to form risk committees. Well, the Government are reviewing the structure of the corporate reporting framework. We propose splitting the current single corporate report into two documents: a strategic report and the annual directors’ statement. The strategic report, as its name implies, is strategic. It will allow companies to tell their story, describing their business model, the strategy to deliver this and the risks to this strategy through the directors’ remuneration. It is not the Government’s intention to create legislation to mandate that companies have specific risk commitments.
My noble friend Lord Hodgson asked why we need to change the current narrative framework. The results from the August 2010 BIS consultations, “The future of narrative reporting” and “A long-term focus for corporate Britain”, demonstrated a consensus among respondents that change to the current narrative reporting framework was required. They struggled to glean the key messages from the mass of data presented. We propose to divide the current annual report into two documents. The first is called strategic, as I have already mentioned, and the second—the annual directors’ statement—will contain information that is used by some, but not everyone. Our proposals will, I hope, help companies and investors concentrate on strategic issues for the business, and encourage more integrated reporting, giving a clear line of sight from the company’s results through to its business model, strategies and risks.
On the abolition of the Audit Commission, the Audit Commission announced the award of contracts to outsource its audit work to private-sector providers last week. This was very good news in terms of concentration in the audit market. Grant Thornton, from outside the big four, has been awarded the largest share of new work of any of the recipients. These contracts were awarded on the basis of cost and quality criteria, and demonstrate the confidence we can have in auditors outside the big four.
The noble Lord, Lord Currie, spoke of the need to promote the use of middle-tier audit firms by large companies. At present, under the EU directive, statutory auditors have to be majority-owned by qualified auditors. We are continuing to support an exploration of the likely demand for and consequences of alternative structures, and this might help smaller firms grow. It might also help recapitalise an audit firm in the event of its failure. We recognise that other member states have differing views on this and are continuing to discuss this issue with the presidency and the Commission.
My noble friend Lord Hodgson asked whether the Government are enabling non-big four firms to win public sector work. The answer is yes. The Government are committed to improving value for money from public procurement. We are centralising within Whitehall the procurement of common goods and services, including for audit and assurance. Central government purchases from small and medium-sized companies doubled to £6 billion in the past year as the coalition has pursued its pledge to realign its spending away from multinationals. The shift will see almost 14 per cent of Whitehall’s £44 billion budget secured by SMEs this year, up from 6.5 per cent in 2010.
The noble Lord, Lord Northbrook, asked whether proportionate liability or a statutory cap on auditor liability could serve to encourage more audit firms to bid for large company audits. The Government have no plans to do that. The Companies Act 2006 already allows for contractual limitation of liability, and some auditors’ liability agreements have been signed. The committee supported the exemption of more SMEs from audit. My department’s consultation closed in December, and we will be setting out our response to the findings in the spring. In Europe, we are making the case for raising the exemption thresholds. The committee expressed concern about fragmentation between regulators of audit, accounting and corporate reporting. In October, BIS and the FRC consulted on changes to streamline the internal structure of the FRC and improve its regulatory efficiency and effectiveness. My colleague Norman Lamb intends to make a Statement on this in the other place shortly. On non-audit services, my department has now amended regulations on disclosure of auditor remuneration to bring them into line with the revised ethical standards.
The noble Lord, Lord Shipley, talked of the conflict of interest if one company provides audit and other services and my noble friend Lord Hodgson said that he did not see a problem with it—I thought I would put both those pieces in. In answer to the noble Lord, Lord Shipley, as the committee heard during its inquiry, the standards were revised following the financial crisis. The disclosure framework is now in line with the categorisation of non-audit services in the standards. It also reflects the concerns the committee raised about internal audit services and tax advisory services, in particular, where the regulations ensure separate disclosure will be made. Shareholders can then question the audit committee on the discussions it had with the auditor on those services and the safeguards to the auditor’s independence.
On accounting standards for SMEs, the FRC is continuing to consult on how UK GAAP should be developed, including how it should apply to medium-sized companies. I recognise that I have not covered all of the committee’s recommendations. There were a number of others which the committee suggested should be taken forward as part of the Competition Commission’s investigation and there are others that the commission has voluntarily included within the scope of its investigation.
My noble friend Lord MacGregor spoke about living wills. The FRC has begun work with the six largest audit firms to develop a framework. It will be a sort of “how to” guide by a firm for regulators who might have to dismantle or separate various parts in an orderly fashion.
I would like to answer one of the questions from the noble Lord, Lord Young, because questions from the speaker for the Opposition always come at the very end and rarely get answers. The noble Lord asked about conversations between auditors, banks and regulators. That has been well received in the UK and by banking regulators overseas, which are looking at—or already are—implementing similar approaches in their jurisdiction. I will write answers to the rest of the questions that he asked.
The committee made some proposals that are now reflected in the European Commission’s proposals and which we welcome. These include removing the audit firm ownership rules from the directive, making big four-only clauses ineffective and making audit reports more informative.
As far as the Government are concerned, this has been a very useful debate and I am sure everyone else in this Room has enjoyed every single moment of the two and a half or three hours that we have been doing this. It has been a useful debate on an important subject and I thank noble Lords very much.
Lord Young of Norwood Green
Before the noble Baroness sits down, there was just one area I wanted her to elaborate on. Paragraph 184 is very emphatic. It says:
“We believe that every bank should have a properly constituted and effective Risk Committee of the Board”.
I do not want to go on to quote the rest of the paragraph but that is very firm. Despite the banking crisis and the concern expressed—almost unanimously, or at least by almost every contributor—the Government’s response was that it is “desirable” for banks and other institutions but not absolutely mandatory. It then goes on to say:
“There is a strong presumption that banks and insurers that are included in the FTSE 100 are examples of types of firm that should have separate risk committees”.
In the light of what has happened and the strength of that recommendation, I would like to understand exactly why the Government felt they should not go further than they have done in their response.