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Companies Act 1985 (Operating and Financial Review) (Repeal) Regulations 2005




 
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Eleventh Standing Committee on Delegated Legislation

The Committee consisted of the following Members:

Chairman:

†Mrs. Joan Humble

†Blunt, Mr. Crispin (Reigate) (Con)
†Davey, Mr. Edward (Kingston and Surbiton) (LD)
†Dhanda, Mr. Parmjit (Gloucester) (Lab)
†Djanogly, Mr. Jonathan (Huntingdon) (Con)
†Fraser, Mr. Christopher (South-West Norfolk) (Con)
†Goodwill, Mr. Robert (Scarborough and Whitby) (Con)
†Hepburn, Mr. Stephen (Jarrow) (Lab)
†Heyes, David (Ashton-under-Lyne) (Lab)
†Khabra, Mr. Piara S. (Ealing, Southall) (Lab)
†Marris, Rob (Wolverhampton, South-West) (Lab)
†Michael, Alun (Minister for Industry and the Regions)
†Penrose, John
(Weston-super-Mare) (Con)
†Reid, Mr. Alan (Argyll and Bute) (LD)
†Simon, Mr. Siôn (Birmingham, Erdington) (Lab)
†Strang, Dr. Gavin (Edinburgh, East) (Lab)
†Todd, Mr. Mark (South Derbyshire) (Lab)
†Truswell, Mr. Paul (Pudsey) (Lab)
Alan Sandall, Committee Clerk

† attended the Committee


The following also attended, pursuant to Standing Order No. 118(2):

Duncan, Mr. Alan (Rutland and Melton) (Con)

 
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Thursday 16 March 2006

[Mrs. Joan Humble in the Chair]

Companies Act 1985 (Operating and Financial Review) (Repeal) Regulations 2005

2.30 pm

Mr. Edward Davey (Kingston and Surbiton) (LD): I beg to move,

    That the Committee has considered the Companies Act 1985 (Operating and Financial Review) (Repeal) Regulations 2005 (S.I. 2005, No. 3442).

May I first say that it is a privilege to serve under your chairmanship, Mrs. Humble. Our proceedings may be interrupted at an early stage by a Division in the House, but I shall try to make some initial progress.

My hon. Friends and I prayed against this statutory instrument because we felt that—

2.31 pm

Sitting suspended for a Division in the House.

2.45 pm

On resuming—

Mr. Davey: It is nice to be back again, Mrs. Humble. As I was saying, my hon. Friends and I prayed against this statutory instrument because we supported the Government’s original measure, and we are surprised that they now want to repeal it. We want to object in the strongest possible terms to their proposal to go back on their original policy, and I want to go into some detail as to why we think that the Government’s original position was correct.

There are three reasons why it is astonishing that we are here. The first is that the operating and financial review, and the regulations bringing that system in, have been widely consulted on over a period of years, and as a form of corporate reporting the system has been around on a voluntary basis for a number of years. It has been known about and finessed over some time. Secondly, the regulation was brought in less than a year ago, so this U-turn is probably something of a record. The primary legislation to support and strengthen it was published less than a month before the Chancellor announced that he intended to repeal it, and at the same time the Chancellor said that he would not proceed with that primary legislation.

Thirdly, and even more astonishing, is the fact that, after the Chancellor’s announcement on 28 November at the Confederation of British Industry conference that he wanted to repeal the regulation, the Government have been forced into consultation on whether it should be repealed. That has happened because Friends of the Earth, in an extraordinarily brilliant legal argument, persuaded the Government
 
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that they would lose in legal proceedings, had the Friends of the Earth action gone to court. The Government therefore decided that they would accede to the request by Friends of the Earth, and consult on whether the regulation should be repealed.

The consultation is ongoing. It was announced in an answer to my hon. Friend the Member for North Norfolk (Norman Lamb), in which the Minister who is here today said:

    “The Government have decided to widen their current consultation on company narrative reporting requirements.”

Later on in the explanation of what they were going to consult on, the Minister said:

    “The Government will also consider in light of responses to this consultation whether existing business reporting requirements should be amended by regulations under secondary legislation as an interim measure before the new Bill comes into force.”—[Official Report, 1 Feb 2006; Vol. 442, c. 550W.]

—in other words, the statutory instrument that was introduced last year.

So my question to you, Mrs. Humble, is whether the Committee should even be sitting. There is an ongoing consultation that does not even finish until 24 March, and that may decide that the legislation should stay as it is, but the Committee is being asked to say whether we should repeal it. It is the world turned upside down—an absurd, farcical situation. Is it right, Mrs. Humble, given the Government’s code of practice on consultation, that the Committee be asked to repeal a statutory instrument when the Government are consulting on whether it is still needed? Could I have your opinion?

The Chairman: If the hon. Gentleman is asking that question on a point of order, I would say that it is not a point of order. It is a matter for argument.

The Minister for Industry and the Regions (Alun Michael): Perhaps I can be of assistance. There is a piece of legislation which is currently being debated in the other place—the Company Law Reform Bill. When, as I hope, that Bill goes on to the statute book, we shall place reporting requirements on companies. Between now and then, the requirements are set out in statutory instruments under existing legislation, so obviously it makes sense for us to be as coherent as possible on those requirements, and not to place a greater burden on companies than might be in the legislation at the end of the day.

We therefore have to look now at the requirements in respect of reporting on 2005–06. Companies need certainty. There will be the issue of the requirements for 2006–07. Both those have to be dealt with through this channel, although we expect that the legislation will provide for the new requirements from 2007 onwards. That may look a little piecemeal to the hon. Gentleman, but it is a sensible and coherent way of ensuring that companies know exactly what is required of them.

Mr. Davey: By the time we finish our debate, it will be absolutely clear that the Government’s position has no coherence—neither in respect of how they have approached this whole process, nor in how they are behaving now.


 
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I want to ask the Minister about what will be an important point for those who read this debate. Is he saying that, irrespective of the consultation, there will be no obligation in the fiscal year 2005-06 for quoted companies to produce an operating and financial review in their accounts, but that, following the consultation, that might be the case for the 2006–07 financial year?

Alun Michael: The consultation is about the appropriate business reporting requirements for the future, not about the operating and financial review regulations, which we repealed in November.

Mr. Davey: With respect, I thought that this Committee was repealing them. The Chancellor of the Exchequer made an announcement on 28 November. I do not believe that even he has the power to repeal them with a CBI announcement. This House, not a ministerial statement, has the power to decide.

Alun Michael: I am not sure whether the hon. Gentleman genuinely misunderstands or is being obtuse. We are dealing with the specific statutory instrument, through which we account to the House; that is why we are debating it today under normal procedures. The consultation is about the reporting requirements going forward and whether amendments should be made to the requirements in the Company Law Reform Bill, which, as I said, is being considered in another place. I quote directly from what was said:

    “The Government will also consider in light of responses to this consultation whether existing business reporting requirements should be amended by regulations under secondary legislation as an interim measure before the new Bill comes into force.”—[Official Report, 1 February 2006; Vol. 442, c. 550W.]

I just made precisely that point to the hon. Gentleman—the Bill is before Parliament. Only when the Bill is fully in force and on the statute book will its requirements be placed on companies. In the meantime, it is obviously sensible not to place greater requirements on companies than are placed on them by legislation.

Mr. Davey: I very much doubt whether that was the understanding of Friends of the Earth of the legal position when it decided not to go ahead with its action in respect of its concern that the Chancellor made the 28 November announcement without consultation. The Minister is tying himself into huge amounts of knots. If he is trying to pretend that the operating and financial review and that form of narrative reporting are different—completely separate—from the consultation that he is talking about, he is living in cloud cuckoo land.

Mr. Jonathan Djanogly (Huntingdon) (Con): First, the provisions of the Company Law Reform Bill relate to the implementation of the OFR. The Minister did not make that clear. Secondly, it has become clear from consulting on what should be the component parts of the business review that we should look again at the OFR to see which elements should be taken out and stuck into the business review. The Minister was not clear on that either.


 
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Mr. Davey: The hon. Gentleman is absolutely right. The Minister is trying to give the Committee the impression that this is a planned, well-thought-through, strategic process—but it is a complete and utter shambles.

Dr. Gavin Strang (Edinburgh, East) (Lab): I hesitate to intervene before the Minister has had a chance to set things out, but it might be helpful to make matters clear even before he speaks. Does the hon. Gentleman agree that new primary legislation will provide an opportunity for further consideration of the important issues before us today, and that the eventual outcome may be something that many people, including Friends of the Earth, were uneasy about as a general statement, but which, when it comes to making the law, is rather different? In a sense, there will be opportunities, following the primary legislation, to ensure that we have a regulatory framework that goes in the direction that hon. Members on both sides of the House want to see.

Mr. Davey: I am grateful for that intervention. There is no dispute that the Company Law Reform Bill [Lords] will bring in a legislative framework for operating and financial reviews, but we already have a framework. It was passed by the Government less than a year ago, and the Committee is being asked to get rid of it. In the process of bringing the matter to the Committee, the Government announced that they would consult on such issues. That is my concern. It is a complete dog’s breakfast, and I am sure that the right hon. Gentleman realises it.

Mr. Djanogly: The right hon. Member for Edinburgh, East (Dr. Strang) said that the Company Law Reform Bill [Lords] would provide an opportunity to discuss the matter. He may or may not be aware that it is being discussed. The Lords Committee is now dealing with the relevant clause, and it has not done as he suggested. Perhaps he is saying that we should wait for the Bill to come to the Commons. The reality is that the Government have been caught on the hop, and they do not know where they are.

Mr. Davey: I entirely concur.

Rob Marris (Wolverhampton, South-West) (Lab): Is it not the case that, before the regulations are passed, a company has, for the year 1 April 2005 to 31 March 2006, to produce both a business review and an operating and financial review? The effect of the statutory instrument before us would be to drop the requirement for an operating and financial review for that financial year, and maintain the requirement for a business review, which has a lot of overlap with the OFR; and in future years it will be up to Parliament, under the Company Law Reform Bill [Lords], to decide what kind of review-type reporting is required. This is an interim measure, is it not, for the financial year just about to end?

Mr. Davey: The hon. Gentleman is right to an extent, but we do not know exactly what will be the results of the ongoing consultation. If we knew that, it
 
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would be helpful. Let us be clear about what caused that consultation. The Government were under judicial challenge and were forced into consulting. The statement that the Minister made on 1 February was not volunteered; he was dragged into making it by Friends of the Earth.

Alun Michael: It is clear that the hon. Gentleman is trying to score points, otherwise he would be accurate in what he says. There is an existing consultation about what the requirements of the Company Law Reform Bill [Lords] should be. In the statement that I made on 1 February, I indicated the extent to which the nature of consultation would be expanded and clarified. I point out to the hon. Gentleman that the words I cited earlier were from my statement. I said:

    “The Government will also consider in light of responses to this consultation whether existing business reporting requirements should be amended by regulations under secondary legislation as an interim measure before the new Bill comes into force. For the avoidance of doubt, however, no such changes would apply to financial reporting periods which had commenced before any new regulations had been passed. This is to ensure that companies have certainty as to their current legal reporting obligations and have adequate time to prepare for any changes.”—[Official Report, 1 February 2006; Vol. 442, c. 551W.]

My hon. Friend the Member for Wolverhampton, South-West (Rob Marris) set out the position clearly. The hon. Member for Kingston and Surbiton (Mr. Davey) should stop trying to muddle people.

Mr. Davey: That certainly was not the intention or the effect; when people read the record of our proceedings, they will make their own judgments about that exchange. In order to move the debate on and not get stuck in the mud on that point, I shall give an overview of why we disagree with the Government’s proposal to repeal the regulations.

First, we think that it is a bad policy decision. We agreed with the Government when they first introduced the framework, because we agreed that there was a strong case for better narrative reporting in company accounts. There are various reasons for that. Extra information helps investors and shareholders; it is a good aspect of excellent corporate governance; and it helps companies because it makes them focus not just on their investor communications but on other aspects of their businesses. It is also important because of provisions in the OFR framework for reporting on environmental impacts, community issues and employee relations. There is a set of reasons why the Government were right, and we shall come back to that.

Our second reason for thinking that the Government are wrong to repeal it is that we do not believe that they have made a case for deregulation. The Chancellor was clear that this was supposed to be a major measure, taking burdens away from business. However, the cost estimates that we have seen suggest that it is relatively minor, and at the margins of what is going on in respect of improvements in narrative reporting. If that is set against the benefits, the case is not made. In addition, the fact that, from the
 
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perspective of many businesses, investors and other groups, it is not a welcome move suggests that the Government have a weak case.

Thirdly, we think that it is a wrong move because of all the uncertainty that has been created. The Minister can refer to his written answer as much as he likes. I referred to it at the start of my remarks, and that has not provided any clarity.

Let us talk about the context of the measure. We need to be clear about what the operating financial review was trying to do and how we got from the point at which it was promulgated to today. It is a form of non-financial reporting. Most OFRs cover everything from the nature of the business in which companies are involved to their objectives and strategies and the key drivers of their performance. Often, they discuss the capital structure of a company in order to make the less numerate among us more aware of what the financial tables are telling us. They cover human resource issues and research and development and, in particular, they look forward to future investments and prospects and discuss aspects of corporate social responsibility.

There is a good case for such reporting, as I said earlier, not least because the more information they have, the more willing potential investors are to invest in a company. That is not surprising. There is also evidence that better corporate governance and better narrative reporting can reduce the cost to companies of capital and improve their share prices. There are good, commercial reasons for companies to go down that path, and many do so voluntarily. We believe that many would like a push to go further along it.

There is another way in which OFRs can be helpful. While companies are, first and foremost, the property of their shareholders, they also have a major impact on our society and our environment. It is only right that the information should be provided by corporations, particularly the very large ones that we are considering, so that society can see what is going on and make judgments. There are strong reasons for going down that route. Of course, there are many forms of non-financial reporting. The OFR is one form, and it has been developed in a particular way. It has really got going since the early 1990s, because a key decision was made by the Financial Reporting Council and the Stock Exchange in 1993, when they recommended to major companies that OFRs should appear in annual reports—on a voluntary basis, of course.

That approach began a debate that went on throughout the 1990s and led to the corporate governance debate. An independent company law review took place between 1998 and 2000, followed by the Government’s White Paper “Modernising Company Law” in 2002, followed by a working group under Rosemary Radcliffe, which developed the proposal for consultation. Then there was formal consultation, followed by more consultation to develop the whole policy. In other words, it took a long process—many experiments, many pilots and much work by many people—to develop the idea, and the Department of Trade and Industry was an enthusiast:
 
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it really liked it and pushed for it. When the former Secretary of State for Trade and Industry announced that the Government were pushing that, she said:

    “The OFR will improve the quality of the reporting and complete the corporate jigsaw to give investors a clearer picture”.

She continued:

    “It will also help the owners of the business better understand their organisations and think about how people perceive them . . . Shareholder engagement is a success when there is an informed, healthy, open dialogue between investors and business . . . While prepared for shareholders, the OFR will also be useful to other vital stakeholders such as employees, customers and environmental groups”.

The right hon. Lady was ecstatic. Indeed, the DTI’s annual reports for 2004 said that the OFRs were at the heart of the Government’s policy for corporate law reform. The DTI was very much in tune with many other people, including ourselves, in pushing the idea forward.

Had the Government been pushing the idea by themselves, one might have said that it was right that they could change their minds—even though it is a major U-turn. But let us remember that many outside players were involved in the process—including a lot of the accounting and management institutes such as the Accounting Standards Board. Many individual quoted companies have been parlaying their employees to go into that area to develop their own OFRs. There is a whole world of auditors out there who have been preparing for that policy initiative. A lot of people have been involved.

At the same time—and this might come to the heart of some of the debate—there have been other developments in the world of non-financial accounting. The EU accounts modernisation directive was adopted in June 2003, and it had many similar aims to the OFR. That is at the heart of the Government’s defence. I assume that they will say that it does not matter that we are getting rid of the operating and financial review because the requirements of that directive—in particular, the business review— mean that a lot of the directives will be achieved.

To a certain extent and at certain levels, the Government are right. I say that happily to the Minister—he can pocket that early on. However, there are some significant differences. The business review applies to many more firms—to large and medium-sized firms—whereas the OFR applies only to the quoted companies, of which there are nearly 1,300. There is a different group of firms.

The information required by the OFR is far more demanding—not just in relation to environmental and community issues but in particular in relation to the forward-looking nature of non-financial accounting. The OFR is far more demanding in terms of the specifics that companies must put into their annual reports, possibly most significantly, on the level of audit of that information. The audit requirement is much stronger in the OFR

There is no doubt that the OFR adds more than the EU directive business review. Significantly for the debate in which many of us are engaged, the Government knew when they were developing the
 
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OFR that the directive was in place. It was not news to them—they were developing the OFR at the same time. In fact, they were building on the OFR deliberately. When they consulted with UK businesses, those businesses knew about the directive, and knew that the OFR was extra, with additional requirements. As far as we can see from the people who applied to the consultation, no one said that we should stick to the directive. Many people were keen on the extra non-financial accounting requirements that the OFR would bring.

So let us be clear. The Government may say that the business review is sufficient, but when developing the OFR, they felt it was not.

Mr. Alan Reid (Argyll and Bute) (LD): My hon. Friend is quite right. He is making a powerful case, and the Government agree with him. When the legislation went through last February, the then Minister for Industry and the Regions said that:

    “The information that will be disclosed in the OFR has often not been well captured in traditional financial statements”.—[Official Report, Second Standing Committee on Delegated Legislation 3 February 2005; c. 3.]

So the Government agree that traditional financial statements are inadequate.

Mr. Davey: My hon. Friend is right. That is why the whole business world—and the auditing and accounting world—was absolutely astonished when on 28 November, the Chancellor of the Exchequer got up at the CBI and announced that he was going to get rid of the OFR requirements. The interesting thing is that a number of the Chancellor’s own colleagues were pretty stunned by that.

Because of the excellent work of Friends of the Earth, again, we know the story of how that situation came about. It appears that a high-ranking Treasury official in the enterprise unit, who was named in the newspapers, had a meeting in the summer with representatives of a fund management group called Hermes. They were talking about general things and having a nice little chat, when a gentleman suggested to the high official that if the Government wanted a big win to make them popular with big business, they could get rid of the OFR regulation.

The Treasury official went away and wrote a memo, of which I have a copy, on 29 September. The memo was actually quite balanced. It talked about the consultation on the OFR and said that there had been concerns, but that DTI had addressed them. It said that there was a good political case, but it also said:

    “We think it would be useful to work with DTI”.

It appears that not much work was done with DTI. The note to the Chancellor concluded:

    “Are you content for us to engage with DTI on this issue?”

One would think that the Chancellor would have been content, but another internal memo to the Chancellor, dated 23 November, said:

    “Urgent. Action required this week . . . It is anticipated that a number of Ministers will have concerns about this proposal, given their departments’ specific interests in the initiative.”

That was on 23 November. The Chancellor made his speech on 28 November. In other words, the Treasury acted unilaterally, without proper discussion with DTI
 
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or the Department for Environment, Food and Rural Affairs. It railroaded the plans through without consulting political colleagues in Whitehall. That is an astonishing way to run a Government.

The Treasury memo goes on:

    “While Alan Johnson was not the Secretary of State for Trade and Industry when the OFR was introduced, he may raise concerns. The DTI has spent some years bringing the OFR to fruition and have put it at the heart of their corporate governance strategy.”

It was not at the heart of DTI’s annual report, but it seems that DTI was not allowed more than a few days to respond to the Chancellor’s initiative. That is shambolic government. It is a dreadful way to govern. It raises serious questions about the Chancellor of the Exchequer, and I feel sorry for the Minister and his colleagues, because they have been put in an impossible situation. All Committee members can feel sympathy for him. It will be very interesting to see how he will eat DTI’s words of just a few months ago.

I come to the case that all the memos make: the case for repealing. Let us argue about that as well.

 
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