Session 2010-11
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General Committee Debates
European Committee Debates

Audit Policy

The Committee consisted of the following Members:

Chair: Andrew Rosindell 

Banks, Gordon (Ochil and South Perthshire) (Lab) 

Cunningham, Tony (Workington) (Lab) 

Davey, Mr Edward (Parliamentary Under-Secretary of State for Business, Innovation and Skills)  

Hopkins, Kelvin (Luton North) (Lab) 

Jones, Andrew (Harrogate and Knaresborough) (Con) 

Kelly, Chris (Dudley South) (Con) 

Lord, Jonathan (Woking) (Con) 

Murray, Ian (Edinburgh South) (Lab) 

Ruddock, Joan (Lewisham, Deptford) (Lab) 

Simpson, David (Upper Bann) (DUP) 

Smith, Miss Chloe (Norwich North) (Con) 

Wheeler, Heather (South Derbyshire) (Con) 

Zahawi, Nadhim (Stratford-on-Avon) (Con) 

James Rhys, Committee Clerk

† attended the Committee

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European Committee C 

Tuesday 1 March 2011  

[Andrew Rosindell in the Chair] 

Audit Policy

[Relevant Document: European Scrutiny Committee, 12th report of Session 2010-11, HC 428-xi, chapter 1.]  

4.30 pm 

The Chair:  Does a member of the European Scrutiny Committee wish to make a brief explanatory statement about the decision to refer the documents to the Committee? 

Kelvin Hopkins (Luton North) (Lab):  Thank you, Mr Rosindell. It is a pleasure to sit under your chairmanship this afternoon. It may be helpful to the Committee if I take a few minutes to explain the background to document No. 15274/10 and why the European Scrutiny Committee recommended it for debate. 

The Commission believes that the measures adopted in the aftermath of the financial crisis have paid limited attention to how the audit function could be improved, and that some of the failings in the auditing of banks and others raise questions about the adequacy of the present legislative framework. It has therefore sought in document No. 15274/10 to open a debate on that issue, as part of a wider consideration of matters relating to the financial sector. 

The Commission identifies seven headings for discussion: the role of the auditor; the governance and independence of audit firms; the supervision of auditors; the configuration of the audit market; the creation of a single market for the provision of audit services; the simplification of rules for small and medium-sized enterprises, or SMEs, and practitioners, or SMPs; and international co-operation for the supervision of global audit networks. It also looks in more detail at a number of specific issues relating to the role of the auditor, governance, supervision and market structure. 

In their initial explanatory memorandum, the Government said that, in their response to the Commission’s consultation, they would indicate that they are wary of large, risky changes which may impose large costs and have uncertain effects, and that they would suggest more targeted proposals likely to result in a less concentrated audit market, to improve information about risks in company accounts, and to reduce unnecessary burdens on business. 

The Government subsequently provided a copy of that response at the request of the European Scrutiny Committee, and the main points are summarised in an annex to the Committee’s report of 15 December 2010. The Committee also noted in that report that the document before the Committee addressed a subject of some considerable public interest, and that, although its tone is in the main balanced and sensible, the UK clearly had a number of reservations over some of the measures proposed. It therefore considered that it should be debated in European Committee. 

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4.32 pm 

The Parliamentary Under-Secretary of State for Business, Innovation and Skills (Mr Edward Davey):  I thank the hon. Member for Luton North and the European Scrutiny Committee for giving us a chance to debate these important issues in this House. I had the pleasure of attending a Select Committee in the other place to give evidence on these matters. It is good that this House has the chance to debate them, too. Perhaps it would be helpful if I set out some of the context to this debate, and the UK approach to engaging with the EU. 

In October 2010, the European Commission published its Green Paper, “Audit Policy: Lessons from the Crisis”, as part of its commitment to improving corporate governance in the aftermath of the financial crisis. In the wake of that crisis, and as part of its effort to learn the lessons from it and to reform the financial sector, the Commission wants to determine whether the role of auditors can be enhanced to warn of or mitigate financial risks that arise in future. In particular, the Commission wants to know whether audits give the right information to all financial actors, whether there are issues around the independence of audit firms, whether there are risks linked to a concentrated market, whether supervision at a European level might be useful and how best the specific needs of small and medium-sized businesses can be met. 

The aim of the green paper is not to make prescriptive recommendations, but to launch a wide debate on the issues. The Green Paper looks at whether the role of auditors can be enhanced to mitigate any new financial risk in future; the independence of auditors; the reliance that stakeholders can place on audited financial statements; and the nature of the expectation gap, which arises when people expect to get more assurance out of an audit than is, or can be, provided; the concentration in the audit market and what the effects would be of the disappearance from the audit market of a major player; the role played by audit supervisors; the potential for an internal market for audit within the EU; the specific needs of small businesses in relation to audit; and the global context and how to co-ordinate the EU’s efforts at a global level. The green paper is one element in a broad range of EU initiatives to improve corporate governance in the wake of the financial crisis. 

The Commission has indicated that it will consider what proposals it can make during 2011. How is the UK engaging with the EU on that? As I say, the Government welcome the opportunity for the UK to contribute to the debate on the value, role and future of audit and the audit market, with the aims of improving corporate governance and stability, and furthering UK objectives. The UK approach to engagement on the green paper is clear. We are pushing for practical ways to increase the range of suppliers of major audits in the UK; better communication about audit between the board and shareholders; effective contingency plans for regulators and major audit firms, co-ordinated globally; clarity about non-audit services, an area where the UK ethical guidelines for auditors are at the cutting edge; and a reduction in unnecessary burdens, which could be brought about by the EU making audits voluntary for some unlisted companies outside the regulated sectors. 

Those measures need to be implemented within a coherent European, and indeed international, framework. However, our response to the Commission emphasises

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that member states have different law and governance structures, ownership structures, and business practices, so we have been clear that the detailed measures and oversight needed to achieve those outcomes should be set at a national, not European, level. 

What are we doing domestically? In the UK, the Government have overseen the development of new, more effective ways of ensuring that the regulators work with auditors to improve the effectiveness of bank audits, and have been seeing how auditors can contribute to the work of the regulators. There have been revised ethical guidelines from the Auditing Practices Board to enhance the independence of auditors, and a consultation on the operating and financial review, on which we will make proposals around the time of this year’s Budget. We also have contingency planning, to ensure that we can mitigate the wider consequences for business in the event of the disappearance of a major audit firm. 

Our response to the green paper promotes to the Commission some of the ideas that the Government have developed that we believe would make audit and the audit market more effective throughout the EU. We are also making it clear to the Commission that it is important for the UK to retain nationally the flexibility to apply the improvements that we are suggesting in a way that works with our wider national framework. 

We have treated the green paper as an opportunity to promote an evidence-based view of the role and function of audit, and to shape the debate at European level. We are engaging with the EU early to ensure that we achieve the best deal possible for the UK as the Commission’s intentions emerge. I hope that the Committee will support the Government’s position of applying a unified UK approach to working with the European Commission to deliver a strong, principles-based framework for audit as part of the corporate governance regime. I should be happy to take Members’ questions. 

The Chair:  We have until 5.30 pm for questions to the Minister. I remind Members that questions should be brief. It is open to a Member, at my discretion, to ask related supplementary questions. 

Gordon Banks (Ochil and South Perthshire) (Lab):  On a point of order, Mr Rosindell. May I seek your guidance on whether it would be appropriate for me to make a statement, rather than asking a question? 

The Chair:  Would you like to make your statement now, instead of after the questions? 

Gordon Banks:  Yes. 

The Chair:  You can speak now, and you are also allowed to speak after the question period. 

Gordon Banks:  Thank you, Mr Rosindell. It is good to serve under your chairmanship and to have had your guidance. 

The near-collapse of the world’s financial system has given us all cause for thought. We Opposition Members welcome this opportunity to discuss the green paper. This will be the second time that auditors and regulation have come under intense scrutiny in recent years, the

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first being in 2001, after the collapse of Enron. This time round, quite rightly, the first reaction of Governments across Europe has been to consider how to stabilise the financial system, but as the green paper highlights, there is a real need to look at how systems of auditing can be improved. As the paper states, 

“Robust audit is key to re-establishing trust and market confidence”. 

Without improved reporting, financial decisions for investors are very difficult. 

Many people across the world will wonder why the banks failed shortly after receiving clean audit reports. The question that is being asked, and has been asked, is whether the recent crisis occurred as a result of the failures of audits and auditors, or through poor decisions made by the banks, which were less than transparent. I am not quite sure that we will ever get to the bottom of that question. 

I would like to turn to what we are doing here in the UK. The Minister will certainly be aware of the audit firm governance code for England and Wales, which was introduced by the previous Government in January 2010. What feedback has his Department received from the industry regarding the effectiveness or otherwise of the code? 

I congratulate the Minister on recognising that the green paper contains a number of potentially significant recommendations, a fact that was acknowledged by the European Scrutiny Committee last December. The Opposition are pleased to debate the document this afternoon. 

As the paper states, there is a gap between what auditors do and what members of the public and shareholders expect them to do. What steps might the Minister’s Department take to better educate shareholders or those looking to invest about the role of auditors? It is important to get across the message that an audit report should never be treated as gospel by people when making investment decisions. I agree with the Minister that the expectation gap will probably never be closed completely, as he stated in his Department’s response, but I am sure that it can be narrowed, or we can die trying. The green paper talks about the possibility of greater powers for audit firms through the extension of the auditors’ mandate. There may be a case for granting such powers to narrow the expectation gap. Perhaps such issues may be fleshed out further by the Commission in its final report. 

The Minister will be aware that there is already talk of expanding the role of auditors, for example, to monitor firms’ corporate social and environmental responsibilities or to allow them access to more forward-looking information to tackle the perceived image that auditors’ information is often too little, too late. I know from my own constituency mailbag that constituents have asked for firms to be required to publish their levels of carbon emissions, and I know that that issue is being explored by the Minister’s colleagues in the Department of Energy and Climate Change. Will he outline whether his Department has engaged with DECC with regard to that issue and how it might apply to the audit process? 

The Minister also alluded in his response to the paper that he may be supportive of proposals to include the degree of aggression used in firms’ accounting choices,

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the risk position of the firm and the key judgments taken in audit committee reports. Will he expand on that? 

While there may be a need for additional powers for auditors, there may also be a case for reforming existing powers. The green paper suggests that the reasonable assurance approach used by auditors may no longer be fit for purpose because of how it is being adopted, not because of the framework of its expectations. That may of course be linked to the need for audit firms to apply high levels of professional scepticism, even to their own work. 

Another issue explored in the green paper is the gap between the number of larger firms and the smaller number of audit firms that are equipped with the resources to carry out an effective audit of those large firms. What is the Minister’s Department doing to support UK-based audit firms that want to expand to ensure that they have the ability to audit larger companies, where the more lucrative audit contracts reside? There may be a need to move away from the dominance by the big four of Deloitte and Touche, Ernst and Young, PwC and KPMG, which will create greater choice for clients and perhaps remove a potential future headache or two for the Minister. He outlined in his response to the green paper that the Government will suggest more targeted proposals that are likely, over a period, using the Minister’s words, to nudge the audit market towards being less concentrated. Perhaps I could gently nudge the Minister today to give us a time scale on when those proposals are likely to be made. He also mentions in his statement that big-four-only clauses are a matter for the competition authorities. Would he be prepared to refer such issues to the Competition Commission or other relevant body, or is that a matter for his colleagues in the Treasury? 

I turn to UK-based audit firms. The green paper suggests that there may be an opportunity for the creation of a European passport to allow UK auditors to provide services on an EU-wide basis. The Minister has said he would be able to support that proposal. Further to that, it would be useful if he could tell us whether the EU is engaging the United States and other non-European nations about the development of international standards on auditing. 

Another vital area raised in the green paper is the independence of audit firms. At present, a company’s shareholders appoint its auditors, which creates a distortion in the system, as the green paper has outlined. Will the Minister tell the Committee what discussions the Department has had with regulators, particularly in the financial sector, about placing restrictions on certain firms or individuals conducting audits that may be in the public interest? 

The green paper also states: 

“Situations where a company has appointed the same audit firm for decades seem incompatible with desirable standards of independence.” 

I note the additional costs associated with mandatory rotation outlined by the Minister in his response, but will he say whether he might support proposals requiring a firm publicly to justify its decision to reappoint its current auditor? As the Minister has admitted, there is a very low audit firm switching rate in the UK—about 4% on average for all listed companies. 

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On the issue of fees for audit services, the Minister will be aware that audit firms in the UK are subject to a voluntary code of practice on profitability. What discussions has his Department had with the industry about enshrining that code of practice in law to ensure that we have total transparency throughout the industry over profits, or does the Minister believe that the voluntary code works well? 

The Minister will be aware that in France auditors are required publicly to justify their audit opinion, together with their report on the annual accounts. In France, listed companies are required to appoint two different audit firms, which jointly share the work and sign the audit report. I appreciate that joint audits are entirely legal in the UK, and not mandatory, but will the Minister tell the Committee whether the Government intend to follow suit on either of those arrangements for any specific type or size of organisation? 

I note that the Government support increased co-operation between national regulators, and the establishment of a closer working relationship between auditors and financial service regulators. However, the Government’s response is light on detail in that area, and I would be grateful if the Minister expanded on how exactly they intend to achieve those aims. 

There have already been discussions about the creation of a new European supervisory authority, but that would be subject to the constraints of the EU budget. Will the Minister tell the Committee whether the UK’s team in Brussels has discussed the establishment of such a European supervisory authority, and what benefits that may deliver, if any—those may be the pertinent words? I understand that the Financial Reporting Council and the Financial Services Authority published a discussion paper on those issues last June. Will the Minister confirm whether his Department contributed to that discussion, and whether he is aware of any outcomes from the document? 

Although there are calls for increased coherence and co-operation between European neighbours on audit matters, we still have split responsibility for audits in the UK. For example, the Secretary of State for Business, Innovation and Skills has responsibility for audit policy, but the Chancellor has responsibility for policy on the audit of banks and other regulated institutions, such as building societies. Will the Minister tell the Committee whether the Government have any plans to consolidate audit policy into one Department, or will we have to wait until the Secretary of State makes another slip-up and has his responsibility taken away from him? 

The Minister made reference in his statement to the fact that the UK has successfully introduced audit exemptions for small companies without ill effect. He will be aware that that was an initiative pioneered by the previous Labour Government. As someone who has started a small business, I welcome that initiative. Although the Government talk a good game on removing regulation, they have not delivered. May I be so bold as to ask the Minister to outline even one regulation removed by his Department to support SMEs? If he intends to take forward any proposals from the EU green paper, will he tell us which regulations he intends to remove? 

There is also the issue of who audits the auditors. The green paper has suggested that it is worth exploring whether the financial statements of auditors should be audited. Given the potential conflict for an auditor of

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being audited by a competitor, does the Minister think that there may be a role for statutory bodies, such as the National Audit Office or similar organisations at a European level? 

Finally, the Government talk a lot about banking reform and delivering a network where no player is too big to fail. However, will the Minister be storing up another set of woes for himself by allowing the development of a small number of audit firms that are too big to fail, as that failure would impact upon the practical ability of institutions such as our banks to function normally? We know only too well, to our cost, the impact that befalls the UK economy when our banks do not perform in what we consider a normal way. 

The Chair:  Does the Minister wish to respond to the Opposition spokesman’s remarks now, or to do so in the general debate that will take place after questions? 

Mr Davey:  I am happy to respond now. 

I thank the hon. Member for Ochil and South Perthshire for his questions—I counted 16. I am not sure that I got every one, but it was like a Gatling gun at times, so I hope that I managed to pick them up. We will see whether I manage to answer all of them. His first question was whether or not we had received feedback from the governance code that was introduced last year by the previous Government. The feedback is practical and is being implemented by major firms, so that looks like quite a positive response. I hope that he welcomes that. 

The hon. Gentleman wanted to know whether we are going to educate shareholders and investors in the expectation gap with respect to audit. It is an important question that goes to the heart of this debate. People think that, just because a set of accounts has been audited that, inevitably, everything is fine. Clearly, that is not the case; it has never been the case. We can look at the theory of audit, and I am sure that the hon. Gentleman has read his Mautz and Sharaf, from 1961, the seminal work which assures us that audit works in a normal environment, when the wider economy is not collapsing and when the directors of the company are not collaborating in fraud. In those circumstances, audit is not going to work and we saw, with the economic crisis, as the economy was collapsing around the world, clearly, accounts and reports that had been audited a few months earlier were not audited with the expectation of that economic and financial crisis. That goes to the heart of the problem and of this debate and he was right to focus on it. 

Can we better educate shareholders and investors? I am not sure that it is the Government’s job directly to go around educating every single investor and shareholder about every single risk that they could possibly face, but our response to the Green Paper and how we want to reform auditing practice in this country does address that, through the emphasis that we are putting on the role of the audit committee report. 

We want to see better communication between the audit committee and the board. The audit committee is responsible to the board, but that report, which goes to investors, shareholders and outside analysts, if improved, could make a significant difference, not just in dealing with the expectation gap, but in understanding how a set of accounts have been put together. The auditor

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would audit the report of the audit committee to say whether it was a fair and reasonable report. We would like—we are discussing this with the Financial Reporting Council and others—the audit committee report to deal with the appointment of the auditor, how that process works, how often and how long that auditor has been auditing that firm’s accounts and how aggressive, to use the phrase he picked up from our written response, were the accounting judgments that were made. If that sort of information was very clearly disclosed and those sorts of judgments were more transparent, that would play a really big role in this area. 

That is linked to one of his later questions about concentration. The hon. Gentleman is right to say that many people are worried about concentration in the audit market—about the fact that 99 of the 100 top companies in the FTSE 100 are audited by just the big four. Some of this can be overplayed—people give the idea that if one of those firms fails, it would be calamitous, but I do not subscribe to that. I think that the audit market or the corporate market could certainly withstand one of those firms going bust: they are not too big to fail. If we look at the evidence when Arthur Andersen collapsed in the United States, it did not impact directly on the share price, or, indeed, on the share price of Arthur Andersen’s clients. That is evidence that if one of the big four were to collapse, it would not be a systemic disaster. Nevertheless, we should be concerned about concentration in that market, particularly on competition grounds. 

The hon. Gentleman asked about how we would address that matter. The points I made about the audit committee report begin to address that in terms of demand. Investors and shareholders have limited information about the appointment of the auditor—although, of course, they technically appoint the auditor, as he will be aware. If the audit committee report included the sort of information I have been describing to the Committee, shareholders might ask rather more searching questions about the process for appointing an auditor. That approach—greater transparency to create the demand for thinking about the appointment of the auditor—is better than the one proposed by the EU Commission’s Green Paper and, indeed, by some commentators, who want us to take a more regulatory approach. So, focus on the demand side is a key part of dealing with concentration. 

There is an issue on the supply side. I do not favour some of the more dramatic options that are sometimes discussed—the break-up of the big four and such things—but I think the Commission is interested in the idea that we could change the rules, so that people who are not qualified auditors can own audit companies. That would enable more capital to come into the market and would help if there was a crisis and a need for recapitalising a failing audit company. Such an approach could also help some of the mid-cap audit companies grow, so that they are able to challenge the big four. There are supply-side and demand-side policies we could adopt to deal with concentration. 

The hon. Gentleman asked about how we have been engaging with DECC in respect of its obligations under the Climate Change Act 2008. I can tell him that I have met Ministers and officials in DECC and other Departments. We are very much studying in detail the best way to report on greenhouse gas emissions and over what population of businesses any regulations in

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that area should apply to. He asked—I think it was his sixth question—whether we will tackle what are known as the big four-only clauses, which apply when banks say to a company that they will only lend the money if that company is audited by one of the big four. For the record, I should say that that situation is anecdotal. He will be aware that we have made it clear that that is an issue for the competition authorities and that the Office of Fair Trading is independent, and rightly so. He will therefore understand why we do not want to tell the OFT what to do in that regard. 

The hon. Gentleman was concerned about whether we should go down the mandatory rotation of auditors route. I think I made it clear that we do not favour that approach. He also wanted to know whether we should put the code of practice on governance into law or whether we should leave it as a voluntary code. We favour keeping it as a voluntary code, because it is working incredibly well and we do not think that legislation or regulation is needed. He wondered whether we should copy the French and have joint audits, and rightly said that joint audits are legal in this country. It is up to companies and, indeed, their owners to decide whether joint audits are necessary. We do not intend to make that a requirement. 

The hon. Gentleman asked about our views on the European supervisory authority for auditors—the proposal that is being mooted in the Green Paper—and I can confirm that we do not support such a body. We believe that there is a role for greater co-ordination between national supervisory bodies for auditors. The idea of a college of national supervisors coming together for greater co-ordination and co-operation makes sense, but there is no need for an EU institution or body in the way that the Green Paper suggests. 

The hon. Gentleman said that he was disappointed that we were not deregulating in this area. We are very much engaging in considering areas in which to deregulate. He should hold his breath for just a few weeks longer to see the result of our work, because we certainly are considering whether the accounting and audit regulation for SMEs can be reduced to support the sector. He wanted to know how we are engaging in some of these debates at the European level. UK officials are discussing with EC officials how best to improve the coherence of auditor regulation. That is very much an active thing for us. Officials from the Treasury and BIS regularly interact on these issues, as I do with my counterparts in other Departments, and we engage with the Financial Services Authority and the Bank of England. 

It is possible that I have missed one or two points. In fact, I have just received inspiration. We are always grateful for such inspiration. The hon. Gentleman asked whether auditors’ own accounts will be audited. If the auditor is a partnership or a company, its accounts are subject to audit, unless it falls within the small-size exemption. If I have not fully responded to any question and if he comes back to me, I am sure that I can give him the answer in writing, but with those remarks, I have tried to respond to his scattergun but well-made set of questions. 

Kelvin Hopkins (Luton North) (Lab)  rose—  

The Chair:  I call Kelvin MacKenzie. 

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Kelvin Hopkins:  It is not the first time that that mistake has been made, Mr Rosindell, but our politics are somewhat different and I am not a journalist. 

May I suggest to the Minister that the financial crisis represented, among other things, a pretty grotesque failure of audit? In his and the Government’s view, were auditors asleep on the job, were they out of their depth, under-resourced and lacking in capability, or were they just too close to the institutions and companies that they were supposed to audit? I wonder which of those things is significant, or are they all significant? What needs to be done? 

Mr Davey:  I am grateful to the hon. Gentleman for that question, but I disagree with the assumption behind it. He seeks to suggest, if I understand him rightly, that the financial crisis that we witnessed was the fault of the auditors. [ Interruption. ] He seems to put quite a lot of blame on the auditors. He asks whether they were asleep on the job or too cosy with the companies that they were auditing. From my reading of the situation—not just from reading the great book, “The Storm”, written by my right hon. Friend the Secretary of State for Business, Innovation and Skills—the key blame does not lie at the door of the auditors. There were many other factors. 

As I said, in my analysis, the theory of audit tells us that, when an economy is in collapse, people are unable to rely on audit. So the theory of audit makes it clear that, in the circumstances that we saw, we should not expect audit to perform its normal function. One must go back and realise that not enough people appreciated the expectation gap. People are unfairly blaming auditors, but that is not to say that we cannot improve the quality of audit and try to make the audit market in the UK, the EU and across the world function better. That is what we intend to do, and as the Ministry responsible for audit, we are spending time on engaging in this issue with officials from across the Government. 

The hon. Gentleman invited me to choose from a list and say what was the failure of auditors. I am afraid that I disagree with him on all those points. For example, he suggested that auditors might have been too close to the companies that they were auditing. Ethical standards are overseen by the profession through the Auditing Practices Board, and we have high ethical standards in this country. I have seen no evidence to suggest that the independence of auditors has been seriously questioned. That has been our response to the Commission’s Green Paper. The policy concern—this should concern us all, although we must get it in perspective—is a concentration in this market. 

Kelvin Hopkins:  I take note of what the Minister says; but before the crisis, many people would have said that our banks were the safest. They were regarded with great respect as secure institutions, where nothing could possibly go wrong. Should the auditors not have spotted that some assets being bought and sold were worthless and that the mountain of electronic paper that was floating about the world would cause massive problems? Some countries did not get involved in the feeding frenzy on those alleged assets and were protected from the crisis as a result. The auditors must have some responsibility for not spotting that those things were worthless. 

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Mr Davey:  The hon. Gentleman refers to an issue that is regularly raised: should auditors have qualified the accounts and reports of the companies that they were auditing, whether they were banks or non-financial corporates? The extraordinary uncertainty and difficulty that we saw in the financial crisis made it very difficult for them to do that. The idea that they could have anticipated what happened is unrealistic, because the crisis was unique, unprecedented and very different from that of the 1920s and ’30s, as I am sure that he is aware. 

The hon. Gentleman says that they should have qualified the reports in the run-up to the crisis, but he is misunderstanding what the theory of audit tells us. Auditors do a clear and distinct task. There job is not to foresee the future. They do not have a crystal ball. They are dealing with the set of accounts that are in front of them and the evidence that they see. To suggest that they can second-guess the things that he is discussing is wrong. 

I am surprised that the hon. Gentleman focuses on that, rather than on the role of the relationship between the regulators and the auditors, which is where a lot of improvement could be made. The regulatory regime that we saw in this country, and in some others, was shown to be not fit for purpose. The need for proper prudential regulation of the macro picture is where there was a fault. Going by some of the views that I have heard him express over the years, I would have thought that he expected that. The regulators are supposed to take a system-wide approach, whereas the auditors are asked to look at the narrow set of accounts in front of them. If we want to attribute blame, we should ask questions about the financial regulatory regimes. I am delighted to say that the Government have asked those questions and are reforming that regime. 

Kelvin Hopkins:  The Minister has moved on to my next question, which is on regulation. We had some significant failures of financial regulation under the previous two Governments. I make no apology for what went wrong under the previous Labour Government, as well as under the previous Conservative Government. I understood him to say that further deregulation is proposed. Is that not the wrong direction? Should we not be modernising and making regulation more effective, as he suggested? 

Mr Davey:  I focused my remarks about deregulation on SMEs. If we are going to blame, I am sure that one sector of the economy that was not to blame for bringing on the crisis would be SMEs. I hope that the hon. Gentleman accepts that deregulating SMEs is a good thing for growth and job creation, which is what we want to do. 

Kelvin Hopkins:  I am concerned. Lots of questions are asked in the Green Paper, including whether there is a conflict in the auditor being appointed and remunerated by the audited entity. In a sense, the Green Paper asks the question as well, then discusses it. Is there not an inherent problem in auditors being employed to audit companies that are the clients and eventually pay the bill? Auditors do not have sufficient independence when auditing. 

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Mr Davey:  I think that I answered the question on independence a little earlier, but let me make it absolutely clear. A company’s management and executives do not appoint the auditors; the shareholders do. Some people might say that, in reality and practice, the shareholders do not appoint, although they are responsible in law, and the reality is that the management propose and the annual general meeting accepts without further question. However, to deal with the underlying issue, the shareholders are the legal appointers of the auditors, and our proposed reforms, advocated by me today and in our response to the Green Paper, will improve disclosure and transparency in the process gone through by the management in suggesting an auditor for the shareholders to confirm the appointment of. By going down that route and providing more information to shareholders about the process, we can address the hon. Gentleman’s concerns. We can also, over time, possibly deal with some of the concentration in the market. 

I was surprised to learn—my officials will correct me if I get the figure wrong—that the average period for which an auditor has been auditing one of the FTSE 100 firms at the moment is 48 years. I am getting the nod; it is 48 years, which might surprise hon. Members—it surprised me—because that suggests a lack of turnover in auditors for FTSE 100 companies in this country. Therefore, if we ask an audit committee to say in its report to the board and shareholders how long the auditor has audited the company’s books, such information will be vital for the shareholders to get hold of and to start asking questions. Our approach is the right way. It is non-regulatory; it is about disclosure and empowering shareholders, who are the legal appointers of the auditors. 

Kelvin Hopkins:  I now have a different question. I was pleased to hear the Minister emphasise that dealing with any auditing problem and improving the auditing regime should be focused at member state level, rather than having a Europe-wide audit system. That is sensible. Given Britain’s dominant role in finance, we have expertise that is perhaps not shared by some of the other countries. Are we not in the lead in auditing ourselves? 

Mr Davey:  I am grateful to the hon. Gentleman for pointing that out to the Committee, for the record. Whether our debates are on audit, corporate governance or more generally on potential shortcomings and how to improve them, it is always important to say for the record that we have some of the best quality corporate governance and auditing in the world. He would be quite right to say that ours are some of the world’s leading companies. For that reason, if we can avoid the traps and dangers of having some sort of major EU supervisory body, which brings with it cost, delay and unnecessary interference, we could see the Green Paper as an opportunity. 

The Green Paper makes some points about it being easier for professional auditors to operate in all EU member states. Anglo-American audit companies operate in many member states. Indeed, they do so throughout the world and many of them are global in their reach. In many respects, audit markets are already global, but there are inevitably some restrictions in different parts of the EU. Getting a passport for professional services is part of the deregulation that we have been advocating in the single market, so that the service directive is

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properly enforced and there is better mutual recognition for professional qualifications. That is where we need to go. It will spread best practice throughout the EU, and British firms will be well placed to take advantage. 

Kelvin Hopkins:  I am glad that the Minister has said positive things about Britain, but I am worried about his reference to America. I remember Mr Madoff and the Ponzi scheme, which cost many people vast millions of dollars. I hope that that will not be possible in Britain, because of greater professionalism and greater honesty in such matters. Is there not something to be said for Britain providing advice and assistance to other member states, whose audit system are not as efficient, as modern or as effective as ours? Have we a role to play in advising and spreading our expertise? 

Mr Davey:  That is exactly what the Government hope to do by leading some of the debate and responding positively to the Commission’s Green Paper. We want to make it clear that we strongly disagree with the idea that we should have a new supervisory body. We are working with some of the ideas that we can welcome in the Green Paper and arguing for our general approach. Surprisingly, we think that it is good for UK plc, which is why we are taking such an approach, which is operating in some member states, and it would be good for the EU’s economy if it were operating more widely. I do not want to act in a patronising way with Britain lecturing other countries. That would be the wrong approach; but, by working with our EU partners and the Commission, we can make some real, positive achievements. 

We wrote the Green Paper response to meet the sort of concerns expressed by the hon. Gentleman. It is worth pointing out that the UK professional oversight body is an absolute key, central player on the European group of audit oversight bodies. It is not just at Government level, but within the professions that we punch above our weight. 

5.18 pm 

Mr Davey:  I beg to move, 

That the Committee takes note of European Union Document No. 15274/10 and Addendum, relating to a Commission Green Paper: Audit Policy—Lessons from the Crisis; and supports the Government's approach to work closely with the European Commission to deliver an effective framework for audit as part of a corporate governance regime and to promote national solutions to these issues, where appropriate, rather than seeking legislation at EU level.  

I thank members of the Committee for their questions. The Green Paper presents a real opportunity for the UK to gain EU-wide recognition of the benefits of our audit framework and to shape the debate at the European level. 

5.19 pm 

Gordon Banks:  I presented my mixture of statements and questions in my earlier contribution, and I am grateful to the Minister for his response. I will trawl through Hansard tomorrow—that might be a joke—and, if he has forgotten to answer any question, get back to him. 

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5.20 pm 

Kelvin Hopkins:  I will speak briefly. I hope that the Minister does not object to the fact that I have asked a number of pressing questions. It is important that we raise issues if we are concerned about them, to ensure that in future we do not get into the difficulties that we have had in recent years in international finance. I am not an accountant or an auditor; I have a modest appreciation of economics, but that is a different field. I have friends who have worked in this field at the highest level, so I have some insight into what goes on, and I want to ensure that we do not simply nod things through without anyone asking questions. That is always the danger in these Committees. 

I have taken it on myself to ask all those questions because I am genuinely interested and genuinely concerned. I have some modest local knowledge—as we all have, no doubt—about how audit works. I am vice-chair of governors of a large sixth-form college, where we have an internal and an external audit. It is important for someone who does not have financial expertise, which governors typically do not, to consult professional advisers to ensure that things do not go wrong. At that modest level, our auditors are aware of the assets when they look at the balance sheet and have buildings and so on in front of them. It is not simply a question of ticking them off, having a gin and tonic and going home; they do a professional job and I am always impressed with them. We also have two or three accountants on our governing body, who are important as well. Someone once suggested to me that the reason why we have so many accountants in Britain is that we are so bad at maths that we have accountants to do our sums for us, but that is another story. 

Again, I am pleased that the Minister has said that at member state level, particularly in Britain, we will focus on what we can do to ensure that our audit system is fit for purpose for the long term and that we do not have difficulties. Perhaps we can help other countries to improve their systems as well where necessary, not in any patronising way, as the Minister says, but by offering professional services, as we would do in other respects. 

I hope that the Minister does not object to the fact that I have asked all my questions. I am a relatively innocent Back Bencher, and I wanted some answers to gain an assurance about what the Government are doing in these matters. With those few words, I shall conclude. 

The Chair:  We are all grateful to the hon. Member for Luton North for his well-informed questions this afternoon. 

5.22 pm 

Mr Davey:  The debate has been slightly shorter than the questions. I confirm to the hon. Member for Luton North that I welcome his questions and found them extremely helpful. I am glad that the European Scrutiny Committee wanted this debate. 

I must say in passing that the subject of Europe often creates a lot of divisions between parties and that we all take very entrenched positions, but here is a European issue that is not dividing anyone. Whatever political party we come from, we accept that this is not a matter for major European competence creep, that we do not need a new body at European level and that we need to

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argue strongly for the national approach, which we have done. It is important sometimes to focus on such consensus, to inform some of our other debates on Europe that are less consensual. 

The hon. Member for Luton North has done the Committee a service by asking some of his questions, because I have found that this is quite a complicated issue. He is modest about his knowledge, but I have heard him speak eloquently on the economy a number of times. He and I ought to be modest, however, about our knowledge of detailed auditing practice and theory. I had to bone up a little for this debate and for my work as the Minister responsible, and in doing so, I realised that this country should be proud of its record. We have a huge amount to contribute not just to Europe but globally. Working with the FRC, we have been trying to engender an informed debate in the country. I attended a meeting this morning where a panel of investors, auditors and corporates discussed some of our proposals and some of the FRC’s proposals. Such debate is critical to ensuring that our country remains at the leading edge in this area. 

Yes, the economic and financial crises posed difficult questions, but I take some comfort from how the corporate

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sector—not just large corporates, but medium ones as well—managed to survive in an incredibly difficult environment. There were huge difficulties in the financial sector, but through efficient capital markets, governance and assurances such as auditing, corporates that were experiencing historic problems were able to refinance and get the capital to keep going, and we did not have a meltdown of corporate Britain like the meltdown of financial Britain. Rather than rushing to judgment and saying that corporate governance and audit need dramatic reform, we should reach a completely different conclusion and say that they stood the test. Yes, they can be improved and we can learn lessons, but we do not need to rip them up and start again. 

I thank members of the Committee for their contributions to the debate. As we try to promote not just the UK’s interests but what I believe are the EU’s interests, we go into that debate with support from across the House. 

Question put and agreed to.  

5.26 pm 

Committee rose.