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Public Bill Committee Debates

Draft Building Societies Act 1986 (Accounts, Audit and EEA State Amendments) Order 2008

The Committee consisted of the following Members:

Chairman: John Cummings
Blizzard, Mr. Bob (Waveney) (Lab)
Browne, Mr. Jeremy (Taunton) (LD)
Byers, Mr. Stephen (North Tyneside) (Lab)
Devine, Mr. Jim (Livingston) (Lab)
Donohoe, Mr. Brian H. (Central Ayrshire) (Lab)
Fraser, Christopher (South-West Norfolk) (Con)
Hall, Mr. Mike (Weaver Vale) (Lab)
Heppell, Mr. John (Nottingham, East) (Lab)
Hoban, Mr. Mark (Fareham) (Con)
Newmark, Mr. Brooks (Braintree) (Con)
Pritchard, Mark (The Wrekin) (Con)
Pugh, Dr. John (Southport) (LD)
Scott, Mr. Lee (Ilford, North) (Con)
Taylor, Ms Dari (Stockton, South) (Lab)
Ussher, Kitty (Economic Secretary to the Treasury)
Wright, Mr. Anthony (Great Yarmouth) (Lab)
Wright, David (Telford) (Lab)
Glenn McKee, Committee Clerk
† attended the Committee

Fifth Delegated Legislation Committee

Wednesday 4 June 2008

[Mr. John Cummings in the Chair]

Draft Building Societies Act 1986 (Accounts, Audit and EEA State Amendments) Order 2008

2.30 pm
The Economic Secretary to the Treasury (Kitty Ussher): I beg to move,
That the Committee has considered the draft Building Societies Act 1986 (Accounts, Audit and EEA State Amendments) Order 2008.
It is a pleasure, Mr. Cummings, to serve under your chairmanship, and to place the order before the Committee for debate.
The order will form part of the UK’s implementation of two EC directives—directive 2006/43 on the statutory audit directive, and directive 2006/46, which amends the EC accounting directives. Those directives have their genesis in the European Commission’s broader programme of company law reform, which is aimed at enhancing the credibility of financial statements and annual accounts published by European businesses, and, more importantly, in the need for accurate, reliable information in the aftermath of certain corporate financial scandals in the EU, such as the Parmalat scandal.
I should stress that UK legislation is already in place for a significant proportion of the areas covered by the directives. However, there are some areas where specific provision needs to be made in the legislative framework for UK entities. The directives, in so far as they relate to companies, are implemented by the Companies Act 2006 and by secondary legislation made by the Department for Business, Enterprise and Regulatory Reform. The Treasury has obviously been working closely with DBERR to implement the directives for those mutual societies for which the Treasury has policy responsibility, namely building societies and friendly societies. The order before the Committee concerns building societies only, because the other three orders that were required are subject to the negative resolution procedure. The building society order must be dealt with under the affirmative resolution procedure, because most of it will, if approved today, be made under a power in the Building Societies Act 1986, which requires prior approval by a resolution of each House. That power allows the Treasury to modify the 1986 Act to reflect changes in company law. The order has already been debated in the other place, which approved it on 20 May 2008.
The order makes amendments to the 1986 Act, to bring building societies legislation into line with companies legislation. In addition, the order amends the definition of “EEA state” in the 1986 Act. I will just run through—hoping to pre-empt any questions—the details of the order. First, relating to disclosures concerning off-balance sheet arrangements, the order includes a requirement for building societies to give certain information relating to such arrangements in the notes to their annual accounts. At present, that is not required by law.
Mr. Mark Hoban (Fareham) (Con): The Minister may have been about to deal with this, but to what extent do building societies, where they have off-balance sheet transactions, provide that disclosure at the moment?
Kitty Ussher: It would be good practice to do so, but it will not be required in law until we pass the order. It is obviously a good thing to do as—in the spirit of the hon. Gentleman’s question—it will increase transparency, and the information will be made available to a building society’s members and other interested parties, thereby helping them to make more informed decisions about the state of the building society’s business.
Secondly, the order will update the requirements on disclosure of auditor remuneration. Under the changes, building societies will have to specify separately in the notes to the accounts the fees paid to the statutory auditor for several categories of services, such as tax and internal audit services, in addition to the fees for the statutory audit. I am sure that all hon. Members will agree that that is an important amendment to the legislation. It will show at a glance what other services the auditor has performed for the client, and alert any interested stakeholders to any possible conflicts of interest.
Auditor independence and the security of auditors are paramount to the provision of reliable information. The order includes safeguards for auditor independence and security. It requires the auditor’s report to be signed by the senior statutory auditor in his own name, with provision for an exemption from the requirement on security grounds. It amends the rules on the removal and resignation of auditors.
Mr. Hoban: Why does the Minister believe that publishing the name of the auditor in the accounts will guarantee independence? Rules are already in place for independence and for the rotation of audit partners on a regular basis, certainly for those with listed clients. I am not sure what difference publishing the name will make.
Kitty Ussher: As a general rule, shareholders and other interested parties who have a relationship with a private sector company should be able to verify arrangements and satisfy themselves that that independence is also in place. I find that shining a light on things makes it more likely that nothing improper happens. I consider that good practice, and it is appropriate to legislate for it.
The order amends the rules on the removal and resignation of auditors, requiring the building society and the auditor to notify the audit authority of any removal or resignation and to give reasons. It also gives building society members and the Financial Services Authority a right to apply to the court for an order if an auditor was dismissed on improper grounds. These changes implement various requirements of the audit and accounts directives and bring building society law into line with company law wherever possible.
Finally, as I implied earlier, the order will amend the definition of an EEA state in the Building Societies Act 1986, simply because the current definition excludes Bulgaria and Romania, which became Community member states on 1 January 2007. The new definition includes all Community member states. I am sure that the Committee will agree that the proposed changes are both necessary and proportionate. They will help us further to enhance confidence in the financial statements and annual reports published by building societies, and engender good corporate governance standards. They will also help to protect the rights and independence of auditors to ensure that they are not unduly coerced into giving favourable or misleading reports. I commend the order to the Committee.
2.37 pm
Mr. Hoban: It is a pleasure to serve under your chairmanship, Mr. Cummings. We support the order, and I agree with the Minister that it is important to shine a light on these topics and to ensure that there is transparency in financial accounts.
One of the issues that slightly troubles me about the order is that some of the disclosure requirements are already in place—they have been in place for some time for listed companies. Some of the building societies are significant in size. As listed companies have had to disclose auditors’ remuneration by different categories for some time, I am intrigued to know why it has taken an EU directive to introduce this into the UK for building societies. Why did the Government not think it appropriate to do so in the past off their own bat, rather than relying on the EU?
Similarly, banks and other financial institutions have to make significant disclosures about off-balance sheet transactions. Anyone who has looked at Northern Rock’s accounts, for example, will have seen quite considerable disclosure. I am not entirely sure that disclosure has been helpful in the sense of giving a full picture of the structures underlying Northern Rock, and certainly some of the notes have given rise to confusion and debate in Parliament. However, those disclosure requirements are in place, and given the importance of building societies and the fact that under the Building Societies Act 1986 they were able to undertake Treasury transactions and deal with all sorts of derivatives, why has no thought been given to putting in place a requirement for building societies similar to that which exists for other deposit-taking institutions? I should be grateful for the Minister’s comments on that.
Secondly, the directive is clearly intended to harmonise rules on accounting and audit across the European Union. The regulatory impact assessment describes the policy objectives thus:
“To further enhance confidence in the financial statements and annual accounts published by mutual societies allowing members and stakeholders to make comparable assessments of different societies across borders by having access to complete and reliable information in relation to their financial arrangements and corporate governance.”
I can understand the need for harmonisation where there is significant cross-border interest, but it is not clear in the context of building societies and friendly societies how much genuine need there is for that degree of harmonisation. When thinking about harmonisation in future, this is an area where we need to understand whether there is a business need for harmonising the rules rather than simply doing something for the sake of tidiness and to pursue EU-wide objectives.
We are going to impose additional costs on building societies as a consequence of the order. I am intrigued to find out where the Minister or the Treasury would find an accountant for £50 an hour. When I finished working for PricewaterhouseCoopers, my services were charged at far more than £50 an hour. The explanatory notes state that the regulatory impact assessment is based on £50 an hour for an accountant. That is very good value, and I am sure that a lot of companies would like to know where they can find auditors at that rate. We are imposing extra costs in pursuit of harmonisation, but it is not clear what the value is in harmonising these accounts. I suspect that there is very little interest from members of building societies in looking at the results or accounts of building societies based here, in Estonia, Bulgaria or Romania.
2.41 pm
Dr. John Pugh (Southport) (LD): It is pleasure, as always, to serve under your chairmanship, Mr. Cummings.
I thought that this was a particularly timely statutory instrument because of the kerfuffle over Bradford and Bingley, but I have discovered subsequently that that is not a building society and that the difficulty that the Financial Services Authority has with it is not with its audited accounts, but with its presentation of its financial position. We have all read the order thoroughly from beginning to end, along with all the associated documents, and it is quite clear that it has been exhaustively and amicably consulted on with the building societies. It is almost nit-picking to criticise and pick holes in a statutory instrument that has been so well and thoroughly prepared. On looking through the legislation, it is almost a belt-and-braces job. It is perhaps done from the European point of view, but it is none the less done very thoroughly. Every smidgen of conflict of interest appears to have been sniffed out and anticipated so that auditing can be what we expect it to be: an objective account of the financial position of a building society without any dodgy, off-the-books accountancy.
There is a strong thrust in the statutory instrument to encourage transparency, which is to be applauded. It seems to me that no auditor should be able to masquerade under another guise and have a different relationship with a company so that it will not be subject to subsequent exposure or have an association with a company that is of some undeclared significance. It is with some hesitation, therefore, that I ask any questions at all, but I have two for the Minister that go to the heart of the matter. The first is in connection with article 4 on page 8, which states:
“The auditor of a building society must supply the directors of the society with such information as is necessary to enable the disclosure required by paragraph 1 to be made.”
That anticipates that the auditor might have some other financial relationship with the company and might be concerned not to disclose things as clearly as they might. I can see that there is a duty, but I could not find in the document any penalty attached to it. If by oversight, rather than by deliberate intent, the auditor should fail to do that, what would transpire? Would they be asked to do the work again or would there be a realistic penalty?
My second question relates to the removal and reservation of auditors. An auditor, perhaps through being too scrupulous, could be removed by a financial institution that was in trouble. Various people are allowed to appeal to a court, including the relevant authority. If that step is taken, it is clearly significant, and would have implications for the company and its standing. There does not seem to be any duty in the provisions to acquaint investors or members of the building society with that event. In a sense, it could take place in the background without their being aware of it. Is there, or ought there to be, some protection of their interests so that if there is a black cloud over the building society’s finances, the people who have their money in that building society can be alerted to it? With those two questions, I wave the SI cheerily on its way.
2.45 pm
Kitty Ussher: I should point out that both Bradford and Bingley and Northern Rock are banks and are in no way covered by the order, which is a quite specific tidying-up exercise, although an extremely useful one. I shall start by answering the question that the hon. Member for Fareham asked on why this needs to be done at an EU level. Company account and audit requirements have been co-ordinated at an EU level since the 1970s, and the latest changes are the product of conversations that took place following a number of corporate scandals in recent years. If one talks to any firm that operates cross-border or seeks to recruit from a cross-border talent pool, it will explain the benefits of a harmonised regime. “Harmonised” is a rather loaded word in many ways, but in this context it is an entirely sensible one to use.
There are, of course, compliance costs that we try to keep to a minimum, but at the same time there are clear benefits, although they are difficult to quantify. Indeed, PricewaterhouseCoopers, in the consultation, said that it was difficult to put a monetary value on it, but that it was very much of positive value to the companies, ensuring consistency, transparency and a level playing field, which justifies those costs.
Mr. Hoban: It is interesting that that organisation cannot monetise those benefits, because some of the benefits of increased transparency will enable those societies to reduce their cost of capital, which could be a monetised benefit that it did not pick up. However, as it used to employ me, I shall not be too critical of it. One of the other points that I wanted to make was that issues have arisen relating to corporate scandals, so why are we waiting for the EU to make those decisions rather than reacting ourselves? For example, it has long been a requirement of listed company accounts to disclose the various sources of remuneration for auditors by different categories of service. Why have we had to wait for the EU to act and why did we not act ourselves to ensure that best practice applies in the UK?
Kitty Ussher: The hon. Gentleman has got to the heart of the matter. Today is a tidying-up exercise that is the last stage of a rather long process that has taken place within a UK environment and at a European level. He will be aware of the entire company law reform process, which took the best part of a decade of working in consultation with firms and various representative groups and finally led to the Companies Act 2006. It is simply a matter of procedure that the European directives were implemented and agreed at the same time. It is up to the Treasury to implement legislation for the building society and mutual sector, whereas it is for DBERR—formerly the Department of Trade and Industry—to implement wider reforms to the Companies Act.
In a sense, two processes are being rolled into one, and we thought that it was better government to wait until the Companies Act had been implemented and then try to mirror the provisions in a way that met the EU requirements at the same time. We could have implemented it earlier or done something concurrently, but I think that it was better government to have an entirely consistent regime across the entire private sector.
Mr. Hoban: Without wishing to sound pedantic, disclosure of the different sources of auditors’ remuneration predates the Companies Act 2006. The regime was in place prior to that. We could have acted on that aspect sooner, in line with how such listed companies have been dealt with. I do not think that matters have anything to do with implementation of the seventh Council directive under the Companies Act 2006.
Kitty Ussher: The hon. Gentleman makes his point. We felt that we needed to react to the European directive when it had been implemented, and we are doing so as fast as we possibly can while consulting the industry, which is 100 per cent. in favour of it.
I thank the hon. Member for Southport for his general support. He asked what would happen if auditors did not fulfil their duty under the Act to provide information. The best way in which to answer that is to say that auditors are, of course, regulated by professional bodies and the act of not fulfilling the duty would be seen as an inappropriate lack of action and an offence under the guidelines for the regulated bodies. We expect the professional bodies to take the appropriate action, which would be reputational and could lead to a barring further down the line.
As for the duty to acquaint members with auditor problems, having set up the legislative framework, the incentives make it extremely clear that it would be a matter of public interest to make all interested parties, including members and the wider public, aware if there was a problem with a particular auditor. It would be good practice to publicise such matters appropriately. We are confident that that will work. If there are cases of such action not working, we shall watch out carefully for that. Having answered all the questions that have been put to me, I commend the order to the Committee.
Question put and agreed to.
Committee rose at nine minutes to Three o’clock.

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