Committee (2nd Day)
My Lords, as usual, if there is a Division in the Chamber while we are sitting, the Committee will adjourn as soon as the Division Bells are rung and will resume after 10 minutes.
Clause 7 : Appointment of local auditor
14ZA*: Clause 7, page 5, line 29, leave out subsection (1) and insert—
“(1) Unless regulations that apply to a relevant authority have been made by the Secretary of State under subsection (9), a relevant authority shall appoint an auditor (a “local auditor”) to audit its accounts for a financial year not later than 31 December in the preceding financial year in accordance with subsections (2) to (8).”
In speaking to Amendment 14ZA, I shall speak also to Amendment 14ZC. These amendments take us back to the debate at the start of our proceedings on Monday. When speaking to Amendment 1, I indicated that we had tabled a further amendment covering the same essential point: that of retaining the capability of enabling national or central procurement. These two amendments adopt an equivalent formulation to that provided for in Clause 5 relating to smaller authorities. It provides the Secretary of State with the opportunity to specify a person to appoint auditors for relevant authorities, and potentially provides relevant authorities with the opportunity to opt into or out of such arrangements. Absent the activation of such a capacity, the provisions on a local appointment would run. The amendment is not prescriptive of the person or persons whom the Secretary of State can designate to undertake these appointments.
I do not propose to restate in detail the arguments in favour of retaining a bulk purchase capacity. These were well aired on Monday and, I believe, well supported. In fact, I think it is fair to say that they found favour with the Minister, who said:
“It has been made clear that there is some appetite for developing this national procurement arrangement. If such arrangements for this national procurement maintained choice for local bodies—which is effectively what I have said—and allowed them to take part or appoint locally then we would be willing consider the scope for allowing it under the Bill”.—[Official Report, 17/6/13; col. GC5.]
We entirely accept that the Government would need to be assured about how such arrangements would work and be effective. However, these amendments offer a framework for this, and indeed the framework on which the Government are themselves seeking to rely in relation to smaller authorities. I look forward to a favourable reply, again, from the Minister.
I will wait for the noble Earl, Lord Lytton, and the noble Lord, Lord Tope, to speak to their amendments, the thrust of which I understand. However, for the idea to be credible it would presumably require the other body appointed to be subject to the rigours of this Bill. I am sure that was the intention. I beg to move.
My Lords, I shall speak to Amendment 14ZAA and its co-runner Amendment 14BZA, both of which are in my name and that of the noble Lord, Lord Tope.
The principle behind these two amendments is relatively simple; they seek to allow for a measure of delegation of the duty to appoint an auditor so that the actual procurement of auditors and their formal appointment can be made by another body on behalf of the authority. The issue arises by virtue of Clause 7(1), which states:
“A relevant authority must appoint an auditor”.
This, if taken literally, could be taken to mean the direct appointment of a named auditor in person on an exclusive and non-transferrable basis. I am sure that it is not intended to be quite as tight as that. It is certainly felt by the LGA, and others who have briefed me on this matter, that this might prevent any appointment as authorised proxy by an external person or body.
In reality, a firm is appointed to the task and nominates one of its number, often a partner or director, to head up a small team to handle the matter. The appointment of an auditor, to use that singular term of art, and as a specific named individual, is in any event customarily carried out per pro the authority by this means. For instance, most small charities and similar bodies appoint a firm rather than an individual. In the realms of a collective appointment via a national or sector-led service, this becomes more important. A large consultancy firm bidding for a sector-led contract will ultimately make an appointment itself of the named auditor as overseer and signatory to the auditor’s report
The gist of Amendment 14ZAA is quite simply to provide for the procurement of an auditor by way of a duly authorised proxy, including a large firm, a sector body or other similar large concern dealing with possibly several authorities. It does not make this mandatory, simply an option.
Amendment 14BZA follows from this. If the procurement is by way of another body charged with meeting the requirements of the Bill and thus delegated from the authority, it is unnecessary, or should be unnecessary, to have an audit panel, because the oversight of the auditor is carried out in accordance with the relevant rules of engagement via the proxy. The authority always remains responsible for whatever measures it has put in place. The appointed procurer of the audit service must observe all the criteria in the Bill for that activity.
The LGA, as I said, provided a useful brief on this and it is worth picking out a few salient points. The amendments would be consonant with the authorities’ need to have flexibility to procure their audit nationally, or in some form of grouped manner. It would make collaborative audit procurement more attractive and produce, as we heard on the previous day of this Committee, the potential for significant savings. That would be to the direct benefit of local finance. Some of the reasons why this is so have already been rehearsed, including the Audit Commission’s own modelling and its calculated saving of between £205 million and £250 million over a five-year period.
The Government’s own impact assessment does not refute this. Indeed, it concedes that local appointment may not procure the level of savings secured by the Audit Commission during its last procurement round. It seems obvious to me that each authority procuring its own auditors on a recurring basis replicates a cost base. There is an opportunity to save money here.
I will not go into the other details that have been discussed before, save to say that I agree that local appointment does not necessarily increase competition or cut costs. I have no proof of this, but my hunch is probably that not many firms would undertake a municipal audit in the first place. In reality one is probably looking at one of the larger firms, a point that we have heard before. I register the point made by the Minister on Monday. A paraphrase of her words is that there will be no recreation of the Audit Commission by the back door, but if the reality of this Bill’s proposals is to create some form of suboptimal procurement with waste by duplication, I have to say that I am against that as a principle. I hope the Minister will feel that subject to any safeguards that might be necessary to eliminate the risk of a “son of” Audit Commission coming about, the principle is acceptable, in which case we can work out the detail as we go forward. I beg to move.
My Lords, I will speak to these amendments, although sitting next to me is my noble friend Lord Tope, in whose name Amendment 14ZA stands. I hope the noble Lord, Lord McKenzie, will confirm that we have already dealt with the collaborative basis and the fact of buying centrally. Even I was a late adherent to this, but I think we agree that in one form or another that is the way to go forward, however it can be arranged, although there were numerous alternatives. As the noble Earl, Lord Lytton, has said, there are going to be significant savings, which is something that we cannot ignore.
I have one question about a sentence in Amendment 14ZA on the appointment of a new auditor, or the re-appointment of an existing auditor, to,
“audit its accounts for a financial year not later than 31 December in the preceding financial year”.
Both the Bill and the amendment say that that appointment should be made not later than 31 December in the preceding year. I cannot work this out in practical terms. Let us say that KPMG is the auditor of a local authority or group of local authorities; it has not finished its accounts and the accounts will not be signed off until, at the earliest, the end of January the following year. That company could be under notice, according to the amendments, that it may not be, or could not be, the auditor for the ensuing year. While KMPG is finishing off its audit—the accounts will not have been finished and signed off by the relevant person in the local authority, who in my local authority is me, so I am told; I have done it three years in a row—a new auditor, PricewaterhouseCoopers, perhaps, will have been appointed.
I worry about how that will affect the mindset of the auditor who is being replaced. Enshrining within the Bill that the auditor has to be appointed by 31 December within that year will cause moral, and sometimes practical, difficulties. Perhaps the Minister will take this issue back and consider whether the wording should be “could be appointed by 31 December” or “as soon as possible by that date”. I worry how the changeover, if there be a changeover, will affect the performance of the outgoing auditor.
My Lords, I thank both noble Lords for these amendments, which take up the points that we made on Monday about the possibility of a centralised audit process for both larger and smaller authorities. As I understand it, the larger authorities will be run, more or less, by the LGA and the smaller authorities by the NALC. I made it quite clear that we were content to have discussions with the LGA and the NALC, to whom we are talking already, on the strict understanding that there could not be, in either case, mandatory schemes. The amendments brought forward today by the noble Lord, Lord McKenzie, and the noble Earl, Lord Lytton, are flexible enough to take account of that. As I said on Monday, we are willing to continue the discussions that are already taking place. I am sure that we can come back to this issue at a later stage if anyone feels that they are not going in the right direction.
Amendment 14BZA would specifically exclude bodies that opted into such an arrangement from the need to have an auditor panel. We agree with that. If there is a centralised system it is plainly not sensible for those who are being helped by it to have their own audit panel. However, it is essential that if they are appointing their own auditor, independently or in conjunction perhaps, with another authority, they have to have an audit panel. We have discussed the make-up of an audit panel and its independent membership, and they would be required to do that.
The noble Lord, Lord Palmer, raised the question of the date of appointment of auditors. The reason behind the auditor needing to be appointed by 31 December is to ensure that if for some reason the local authority fails to make an appointment, there is time for the Secretary of State in particular to take action under Clause 12, which allows him either to direct a body to appoint or make an appointment on behalf of the authority. We will discuss this later, but it will certainly apply to health authorities, and I understand that the situation is similar in local authorities. I hear very clearly what the noble Lord says about the auditors possibly lacking the enthusiasm to carry on if they are about to be replaced, but I think the audit bodies are pretty professional, and they would need to continue.
We will discuss the appointment of auditors when we reach the amendments that are a couple of groups further on, but I think those are the main points that have been raised. As I said, I hope that we shall be able to return to this matter at the next stage with some further ideas on how the centralised but not mandatory system might work.
I hope that with those explanations, and if I have covered the points that were made, the noble Lord will withdraw his amendment.
My Lords, again, I am grateful to the Minister for a very clear steer on where the Government are on this. I hope that by the time we get to Report we can make progress on seeing how it is working out in practice, particularly if there is a provision in the legislation to take it forward once the Bill is enacted.
The noble Lord, Lord Palmer, made an interesting point about the handover arrangements between auditors. I am sure that it does happen. I read the other day that Land Securities changed auditors for the first time in 60-odd years. I think that PricewaterhouseCoopers went out, but I cannot remember who went in. However, it does happen, and I think that the professional arrangements of the bodies that supervise these organisations include a code of conduct that covers that. I beg leave to withdraw the amendment.
Amendment 14ZA withdrawn.
14ZAA*: Clause 7, page 5, line 31, at end insert—
“(1A) A relevant authority may appoint another body to procure the appointment of auditors for purposes of meeting the requirements of this part of the Bill.”
First, I thank the Minister very much for her comments. Secondly, as I understood her, Amendment 14BZA might be acceptable with modifications. I appreciate that, but obviously, pending such modification, I shall not move that amendment at this juncture. I hope that at some juncture the noble Lord, Lord Palmer of Childs Hill, will explain to a mere ignoramus like me what the arrangements are when one auditor hands over to another. It is certainly something that I had not considered at all.
Amendment 14ZAA not moved.
14ZB*: Clause 7, page 5, line 38, leave out subsection (3)
My Lords, this amendment addresses the question of the appointment of local auditors, covered by Clause 7. The procedure requires the local authority to appoint an auditor. Clause 7(2) provides that an auditor may be appointed,
“to audit its accounts for more than one financial year”.
Clause 7(2)(b) states that,
“the authority must make a further appointment of a local auditor at least once every 5 years”.
The amendment would remove the following subsection, which states that the paragraph to which I have just referred,
“does not prevent the relevant authority from re-appointing a local auditor”.
The object of my amendment is to ensure that there is a change after a five-year period. In my submission, it is possible for the auditor and the local authority to have too cosy a relationship. As I read it, there is nothing in the procedure for appointments set out in Clause 8 even for a tendering process to be entered into by the local authority, although I may be incorrect in that regard.
Clause 8 provides that:
“A relevant authority must consult and take into account the advice of its auditor panel on the selection and appointment of a local auditor”.
If a panel did not recommend a competitive tendering process, or even if it did, as long as the local authority had regard to that it would not necessarily follow that there would be such a process.
I agree that five years is a sensible sort of period for a firm to be engaged. However, it seems unfortunate, to put it mildly, that people could be reappointed for a substantial period of five years and then be reappointed with, or particularly without, a tendering process. That would be an invidious and unfortunate position to have arrived at. We are aware, of course, that the market for the larger authorities is likely to be dominated by a handful of firms. That was one of the reservations expressed on Second Reading and during our previous day in Committee, and I think that most of us, possibly including the Minister herself, are not entirely comfortable with that. To see such a process as a repeat appointment, particularly in the context of these large national outfits, is anti-competitive, if I might put it in that way. It also raises an issue about the kind of relationship that might develop when a firm is anxious to retain the contract.
For those reasons, in my submission it would be better to require not simply a reappointment process but a process that excluded the original firm. There might have to be a backstop position in case nobody else presented. That matter might require, for example, the agreement of the panel and the authority or even, potentially, of the Minister or the department. I suppose one might need that safeguard, but the important principle is that there should not be indefinite appointments of the kind that, as I see it, the Bill would facilitate. I beg to move.
I find it somewhat surprising that there is this perceived idea of auditors being too cosy with their client, a local authority, because all the probity and requirements of audit mean that they would be being professionally negligent if they did not do the job they are supposed to be doing. I really do not think that this is quite as much of an issue as the noble Lord, Lord Beecham, is suggesting.
My Lords, I am struggling to understand the implications of what the noble Lord, Lord Beecham, is proposing. I think we all share his concern—I accept that it might not always be a widespread concern—that sometimes, maybe after five years, it could become too cosy. I hope we would all accept that a tendering process after five years is certainly desirable; whether it should be mandatory is something that we can debate. However, in such a tendering process, would the existing auditor be precluded from taking part in that process, or, if it was to take part in it and was clearly to submit the best value tender, would the authority then be prevented from reappointing it on that basis? That is the point I struggle to understand.
My Lords, I thank the noble Lord, Lord Beecham, for raising this interesting point, but I am bound to say that I have the same scepticism about this as the noble Baroness, Lady Eaton, and my noble friend Lord Tope. It is scepticism about whether it is necessary.
The Bill currently requires local authorities or local bodies to make a new appointment every five years, as the noble Lord said. In most cases, this will require them to go through a full EU tendering process. We expect that most authorities would have that as a requirement, if not in their code of procedure then in their code of conduct. They will also have to go through the process with the independent auditor panel, which will have to manage the tendering process so that it is both independent and transparent. The independent auditor panel will also look regularly at the quality of the audit from the auditors currently doing the job. If they are not doing the job, it will not recommend that they are allowed to proceed. The Financial Reporting Council has ethical standards as well, and will require that key audit staff are rotated on a regular basis. The Government believe that the requirements for a maximum five-year term and the rotation of key staff provide sufficient assurances, along with the other measures on auditor appointment and removal, to safeguard auditor independence and the local bodies’ independence of view in taking on their auditors.
I know that there have been wider discussions about, for example, a recent Competition Commission report on the need for mandatory auditor rotation. However, we understand that the evidence that mandatory rotation supports improved auditor independence and auditor quality is inconclusive. Bearing in mind what my noble friend Lord Tope and the noble Baroness, Lady Eaton, said, sometimes there is benefit in the continuation of an auditor, not on a cosy basis but because of the mere fact that, particularly with bigger authorities, you have somebody who understands the processes and what has been happening during the past five years. In any event, I think it would be wrong to exclude them from being able to tender, to bring down the barricade and say, “No, you can’t do that”.
There is sufficient professional involvement to ensure that auditors are not reappointed where they are unsuitable, where they have not done the job properly or where the local body thinks that they could do with a change of auditor and makes that clear. I do not think we need to make it mandatory that they cannot go beyond five years; that would be too draconian. I am satisfied that we have the processes in place to ensure that a full appointments system takes place every five years. If the current auditors were seen to be the most successful, they should be able to be reappointed.
I hope that that explanation will satisfy the noble Lord, Lord Beecham, and that he will be able to withdraw the amendment.
My Lords, as the noble Baroness knows, I am not easily satisfied, and I am not completely satisfied by her reply, although I am grateful. In particular, there is still an issue about market share and the domination by large firms, which I fear will not be addressed by allowing the system outlined in the Bill. However, having heard the debate, of course I beg leave to withdraw the amendment.
Amendment 14ZB withdrawn.
Amendment 14ZC not moved.
Clause 7 agreed.
Schedule 3: Further provisions about appointment of local auditors
14ZD*: Schedule 3, page 39, line 5, after “may” insert “after consultation with the relevant authorities and representatives of local government”
My Lords, this is a very straightforward amendment, which is intended to ensure that the Secretary of State will consult before producing regulations under paragraph 4 of Schedule 3. Perhaps the Minister will take the opportunity to share with us what the broad content of the regulations will cover, or say when we might expect to receive a draft. I beg to move.
Here I am acting as the Minister, jumping to my fifth subject today, although I am happy to do so. As has just been explained, Amendment 14ZD would require the Secretary of State to consult relevant authorities and representatives of local government before exercising powers as set out in Schedule 3 to make further provision about the appointment of an auditor to certain bodies.
We are sympathetic to the concerns behind the amendment, which we understand are to ensure that bodies are suitably consulted before further provision is made on auditor appointment. Perhaps it would be helpful if I clarify the scope and purpose of this power, which I understand to be the purpose of this probing amendment. The power is limited to bodies not covered by paragraphs 1 to 3 of Schedule 3. It therefore does not apply to local authorities, police bodies, or the GLA.
Schedule 3 already makes provision in relation to these bodies to ensure that the appointment process reflects their specific governance arrangements. In the case of local authorities, it prevents the delegation of the appointment decision below full council. This ensures that the appointment of the auditor is made in a transparent manner and with proper accountability. The power at paragraph 4 is simply intended to allow the Secretary of State to make similar minor provisions for other bodies covered by the Bill to support accountability. This might mean preventing the delegation of the appointment decision for other bodies as set out, as the noble Lord will know, in Schedule 2.
As set out in the statement of intent that the Government laid earlier this week, we will work with delivery partners and interested parties to consider what specific provisions are needed. With these reassurances on the scope and purpose of the clause, and on our intent to consult affected bodies, I hope that this provides sufficient additional information for the noble Lord to be able to withdraw his amendment.
I am grateful to the noble Lord for that response. I certainly intend to withdraw the amendment. However, perhaps he could be a little more specific about the other bodies covered by this. I am not sure that I fully grasped his point about particular bodies. Does he have an example?
Schedule 2 sets out a range of other bodies. The minor bodies that are set out range from waste management boards to drainage boards to parish councils and to others but do not include the major local authorities or the GLA et cetera. Schedule 4 relates to Schedule 2. I hope that is clear.
Amendment 14ZD withdrawn.
Schedule 3 agreed.
Clause 8 : Procedure for appointment
14ZE*: Clause 8, page 6, line 26, at end insert “and the appointment process”
My Lords, the procedure for the appointment of auditors provided for in Clause 8 seems overly bureaucratic, but if that is the Government’s approach, I suppose this amendment simply adds to that bureaucracy. Amendment 14ZF would require that the term of the appointment be part of the notification. Indeed, it might specifically cover the point probed by my noble friend Lord Beecham as to whether it is a reappointment.
Amendment 14ZE would require that the appointment process be set down. Transparency on this matter is for the Government, not unreasonably, of high importance, and we agree. The process will have an impact on competition and pricing, so making the interviewing process clear, assuming there was one, and what firms were involved would be an indication of the relevant authority’s commitment to these issues. It might also provide an indication of the commitment to trying to open up the market, an indicator of whether local or regional firms have been included.
Doubtless the Minister will tell us that this amendment is unnecessary and will flow from the process set down. That is fine, but it would be good to have an idea of the Government’s expectations over these areas.
My Lords, the noble Lord, Lord McKenzie, began by describing this process as overly bureaucratic, but then I think he went on to say that, since it is overbureaucratic, let us have an amendment that makes it even more bureaucratic. That is not the most compelling argument that I have ever heard from the noble Lord, Lord McKenzie, as I suspect he knows very well.
The amendment certainly seems to describe what is good practice and what I hope would happen in practice. I am moderately confident that that is what would happen, certainly with any good authority. Whether we need to have an even more bureaucratic process to enshrine all this in legislation, I am very doubtful, and whichever Minister is replying they will no doubt tell us that we do not want to make it too bureaucratic.
Perhaps I may just ask whether it would remain open to authorities to combine in placing audit contracts. The Audit Commission identified substantial savings having been made by central commissioning, and it anticipated that if extended to the remaining 30% of contracts, a significant further saving of some £400 million over five years could be made. I am not necessarily saying that that is the way to go but, under the provisions of the Bill and this whole appointment process, would it still be open for such an approach to be adopted by authorities coming together, for example, in a particular region or a particular class of authority, obviously with the support of their independent panels? Would it still be open to them to move in that direction, getting a sort of bulk purchase by agreement rather than it being imposed externally? It would be helpful to have some assurance on that.
My Lords, I am happy to give that assurance. That is entirely acceptable and to be expected within the Bill. Often small authorities in particular will find it convenient and useful to combine how they approach this matter. However, as the noble Lord has just said, this is by voluntary co-operation rather than by imposition from the centre.
I have to reprimand the noble Lord, Lord Tope, for making exactly the first point that I was going to make, thus cutting down on what I have to say.
The Government understand and support the intentions behind the amendment—to ensure that there is transparency over the appointment of the auditor—but they are not convinced that this is the sort of thing that needs to be in the Bill. The Bill already includes a requirement for the notice to include the advice of the auditor panel, which is required to advise on the selection and appointment of the auditor. This might cover issues such as the length of the appointment and the process for appointment. Under the Bill, auditor panels must have regard to guidance issued by the Secretary of State on their functions. We expect that such statutory guidance, or wider guidance on best practice, might cover the sorts of issues that should be included in any advice from the panel.
With those reassurances, I hope that the noble Lord will be willing to withdraw the amendment.
I am grateful to the Minister. I certainly do not intend to press the amendment. I say to the noble Lord, Lord Tope, that I did not honestly expect the Minister to rush to accept the wording; it was a mechanism to open up a debate, particularly about the process and there being transparency in the extent to which other firms are invited in—in a beauty parade or whatever the mechanism is. That may be some measure of the determination of the local authority, if it has one, to broaden and open up the market. However, I entirely accept that that will be the expectation and that it will be set down in some of the guidance that will flow from this Bill. Accordingly, I beg leave to withdraw the amendment.
Amendment 14ZE withdrawn.
Amendment 14ZF not moved.
Clause 8 agreed.
Clause 9 : Requirement to have auditor panel
14ZG*: Clause 9, page 7, line 7, leave out subsection (1) and insert—
“(1) Each relevant authority shall have an audit committee to exercise the functions conferred on audit committees by or under this Act.”
My Lords, this group of amendments would in essence delete the requirement to have an auditor panel and require that each relevant authority had an audit committee. The audit committee would undertake the role envisaged for the audit panel under the Bill. Other amendments in the group are consequential, substituting “audit committee” for “audit panel”, although I acknowledge that more of these would be necessary in practice. Our following amendment, Amendment 14BB, would require that any audit committee must have a majority of independent members and be chaired by an independent member.
The role of audit committees in the public and private sectors is well understood. It would be good to hear from the noble Lord, Lord Palmer of Childs Hill, who has particular experience in chairing his local audit committee. In the private sector, the audit committee has become one of the main pillars of corporate governance. Its aim is enhancing confidence in the integrity of processes and procedures relating to internal control and corporate reporting, and it has a key role in providing oversight of the work of the external auditor.
Equally, in the public sector, audit committees are an essential element of good governance. They help to raise the profile of internal control, risk management and financial reporting, as well as providing a forum for the discussion of issues raised by internal and external auditors. They can enhance public trust and confidence in the financial governance of an organisation.
The CIPFA guidance is that audit committees should be chaired independently of executive and scrutiny functions. CIPFA has issued non-statutory guidance that draws on best practice, including that issued by the FRC. That practice makes clear that audit committees should consider the effectiveness of the auditor’s risk-management arrangements, the control environment, and associated anti-fraud and anti-corruption arrangements. They should seek assurances that action is being taken on risk-related issues identified by auditors and inspectors. They should be satisfied that the authority’s assurance statements properly reflect the risk environment and any actions required to improve it. They should approve internal audit strategy, and plan and monitor performance. They should review summary internal audit reports and receive the annual report of the head of internal audit. They should consider the reports of external audit and inspection agencies. They should ensure that there are effective relationships between external and internal audit, inspection agencies and other relevant bodies, and that the value of the audit process is actively promoted. They should also review the financial statements, external auditor’s opinion and reports to members, and monitor management action in response to the issues raised by external audit.
We will discuss the matter of audit committees for health bodies in our debate on a subsequent amendment, but the Government’s intent, in paragraph 32 of the Explanatory Notes to the Bill, seems to be that the existing audit committees of health service bodies, which already satisfy the independence requirements, will be the auditor panels for a health service body; so we are half way there. Audit committees in local government are not currently mandatory, although most authorities have one, or an equivalent.
This would seem an ideal opportunity to rationalise matters by requiring all local authorities, certainly principal ones, to have independent audit committees and to subsume the proposed narrower role of audit panels within this. Although the Bill allows for an audit committee to act as a local audit panel, the position could end up with an authority that has an auditor panel and an audit committee, just an auditor panel, or an audit committee that is properly constituted. This is a recipe for overlap and confusion. Has the time not come when we should require principal bodies at least to have a proper audit committee independently organised, following CIPFA guidance? I beg to move.
It is not often that I agree with much of what the noble Lord, Lord McKenzie, says in this context, but I fully agree with much of what he has said about the role of the audit committee. Having chaired the audit committee of a large metropolitan authority myself, I see great value in it. The proposal for an audit panel in addition is really a sledgehammer to crack a nut. It adds again to the bureaucracy.
I have slight concerns about the requirement for a majority of independent members. I see fully the value in the noble Lord’s suggestion of an independent chairman, but it is extremely difficult in many authorities to find suitably knowledgeable and qualified people to take these roles. I know that under the old standards regime, finding suitable people to chair those bodies was quite difficult. In some cases, they had the desire to take over the world and gradually grew, like Topsy, the role of that body. If we could have independent chairmen, that would satisfy what is perceived as the body’s independence. I certainly do not see the need for an additional body in the audit panel to decide who should audit the authority. There are many checks and balances already within local authorities on probity issues, as I said earlier, so this is an unnecessarily bureaucratic step. The audit committee could happily perform that role.
My Lords, the noble Lord, Lord McKenzie, has raised a very important and useful issue. We will discuss in relation to a later amendment the actual composition of a committee or panel and the number of independent members on it. I would guess that most principal authorities have an audit committee. I do not know, but it had not occurred to me that they would not until now. In many cases, as in my own authority and as that of my noble friend Lord Palmer of Child’s Hill, that committee is chaired by a member of the opposition. That is very much not the same as an independent chairman. Nevertheless, it is a good practice that is followed by many authorities. In my case, it is a Liberal Democrat authority, while in my noble friend Lord Palmer’s case it is a Conservative-controlled authority. It is therefore a useful extension to have a panel or committee chaired by an independent member.
There is room now for further discussion and consideration about whether we really need to have completely separate and independent auditor panels, as proposed in the Bill, or whether there is some way of meeting that through the existing audit committees and amending that practice. Rather than reinventing something that in most cases is working quite well in practice, I would rather see us adapting it. It can certainly be adapted without too much difficulty to meet the Government’s requirements through the Bill, which I think we all broadly support. We are all trying to achieve the same ends, so having poked a little fun at the noble Lord, Lord McKenzie, for the previous amendment, I thank him sincerely for raising a very important issue with this series of amendments.
My Lords, I endorse what the noble Lord, Lord Tope, has just said about the principle, which my noble friend also referred to, of combining these two roles. It does not seem at all necessary to have panels on the one hand and a committee on the other. As the noble Lord has reminded us, most authorities have established audit committees. I ought to declare an interest again as a member of Newcastle City Council and as an elected member serving on the audit committee, which is independently chaired and has a majority. It works very well and it seems to make absolute sense that that body should also have oversight of these appointments.
Perhaps I may refer to the noble Baroness’s observations. Although technically the noble Lord, Lord Tope, is right that it is not for this amendment, as the remarks have just been made I shall endeavour to rebut the thrust of the argument. This is really a matter of perception. It is important that the public are convinced that in the matter of the propriety and regularity of an authority’s financial transactions, the oversight of the process—not just the appointment process, but the whole job of audit—is carried out without the conflict that might arise from, for example, a controlling group in an authority having a majority of members on a committee.
Whereas of course in many cases there will be a mix of members, in some councils the political position is that there is no opposition, or there is insufficient opposition to be represented on the committee. It is desirable that we should go that further step, to which we will no doubt address our minds shortly. The cardinal point is that the Government are right that there should be audit committees, but they should do the whole job, including the appointment process. I very much welcome my noble friend’s amendment.
My Lords, I have an amendment coming up, Amendment 14BBA, but had I known how the discussion on this amendment moved by the noble Lord, Lord McKenzie, would proceed, I would have asked for it to be grouped with these amendments, so it is possibly better that I make my comments now and consolidate the entire process somewhat. Otherwise, I fear that Amendment 14BB will have stolen a large part of my thunder, apart from anything else.
I queried the majority of independent members issue on Second Reading. I am mindful of what the Minister said on Monday: that the panel would not need to be large but that independence was important. I can certainly relate to the question of whether you have a committee and a panel as a term of art, with the duplication that that involves, to which I referred earlier. I think that the principle of an independent chairman is a given, but it appears to me from my much lesser knowledge of these procedures than that of other noble Lords that some councils might have few politically independent members. I do not know how many would have none at all, but there must be some. Even political independence, it seems to me, is no guarantee of freedom from bias, if that is the point that the Bill is intended to address. The subtitle of my amendment would be, “Precisely what do we mean by independent in this context?”. That ought to be explained.
Picking up on the point made by the noble Baroness, Lady Eaton, it seems to me that objectivity and competence, rather than independence, would be a better test for this purpose. I am bound to admit that I am at a loss to know which would be the more readily capable of definition and, if necessary, enforcement, so to some extent I can see it from the Government’s side. I think we are all agreed that we are trying to get a true and fair picture of an authority’s financial affairs. Up to a point, that works back to the basis of oversight from within the council.
Apart from asking the Minister whether she can enlighten the Committee on the question of independence, I remind your Lordships, who all know it far better than I do, of the veritable layer cake of qualifications and eligibility criteria that already applies to audit and to auditors, to which the Bill in this respect risks adding further complexity. I relate to the points made by the noble Baroness, Lady Eaton, about the independence and objectivity of auditors as professional people embedded in their culture, training and ability to retain their professional status. As a member of another profession altogether, I very much relate to that. Ultimately, it is the auditor who is doing the scrutiny, not the committee or panel. They are there simply to select—if selection be needed; we will get to that later. If the auditor is given the proper tools and the freedom to act and attacks it with the independence of mind necessary, that is the fundamental safeguard sought by the Bill.
My Lords, I declare an interest myself, as leader of a local authority, and apologise for not being able to take part in these proceedings before. I shall make a very small point, which need not be clarified now but perhaps could be before Report.
I have a great deal of sympathy with the tenor of comments being made universally around the Committee about the risks of overlapping. I strongly follow the noble Earl’s comments about the importance of the integrity and role of audit as it is practised by local authority officers at the moment. I was going to raise my query later, but I shall follow the noble Earl, because it affects independence, which is the subject of this amendment. Paragraph 2(2)(b) of Schedule 4 would not disqualify somebody from being a member if,
“the panel member has not been an officer or employee of an entity connected with the authority within that period”—
that is, for five years.
The only thing that needs to be made clear and perhaps can be made clear on Report is whether that means the authority or the individual. Let us posit a case of somebody who has been an officer of a body and has gained a great deal of lifetime experience, and has retired early, perhaps eight years ago—we do not want any age complication, so let us just say that he no longer works for that authority. After his departure, some years later, that body becomes a connected authority, whereas he has had no connection with it for some time. His experience might be useful, and one does not want to exclude potential individuals by idle wording. I take it that the Bill means that somebody who has been working for, or connected with, the authority in the past five years should be excluded. However, the way in which it is written could mean that if you have worked at any time for a body that becomes connected in the previous five years, you would be excluded. I think that the second category might be considered, as somebody could be useful in pursuing this role.
My Lords, the definition of independence is set out in Schedule 4, which says that a person is independent if they are not a member or officer of the authority and have not been within the past five years, or a “relative or close friend” of such a person. Questions of objectivity and competence, particularly competence, are, apart from qualifications in accountancy, a little more subjective. Professional competence is defined by qualifications rather than by other things.
The intention here is to allow flexibility rather than to be too prescriptive. I am told that 80% of local authorities already have audit committees; 31% have at least one independent member and 15% have more than two independent members. If panels can be constituted from members of the audit committee, that is fine, provided that they are independently chaired and have an independent majority. There could be two independent members of the local audit committee, plus one other, to make the specific appointment for external audit. I assume we all accept that there is a difference between the continuing internal audit process and the appointment of external auditors. We are trying not to be too prescriptive on this, but that is the distinction that we are drawing.
There are concerns that audit committees will get in a muddle about having audit panels alongside them, but that is not at all necessary, particularly in larger authorities. We are not convinced that we need to make audit committees a statutory requirement in local government, although, of course, practice is such that the overwhelming majority of large and small local authorities have audit committees. Local authority audit committees may wish to set up a small auditor panel, which may be connected with the audit committee, provided that it has an independent chair and an independent majority. There can be important links between the role of a panel and the audit committee, but their specific roles are distinct.
We do not think that there is a wider case for imposing statutory majority independent audit committees on local government for internal audit, for some of the reasons mentioned, but for a panel that appoints the external auditors that case should stand. Under the accounts and audit regulations, local authorities are already required to ensure that a committee, or a meeting of the whole body, reviews arrangements for the internal control and effectiveness of internal audit, approves the annual governance statement and considers and approves the statement of accounts. That is what the audit committees in most local authorities already do, usually led by back-bench councillors and, as noble Lords have said, very often by opposition councillors. However, the Government are not prescriptive about the precise structure that local bodies use to meet these requirements. Based on these existing functions, guidance from the Chartered Institute of Public Finance and Accountancy suggests that members of audit committees should be independent of the executive but need not be fully independent of the council.
The Bill therefore includes the flexibility for bodies to retain their existing councillor-led audit committees by setting up a separate independent panel. Where an authority wishes its audit committee to advise on auditor appointment and independence, it is right that that committee has a majority of independent members. A general requirement for majority independent audit committees, without any flexibility, would be more prescriptive and possibly even bureaucratic. It would require local authorities to significantly restructure their existing audit committees, even though they might be functioning well with respect to their current, non-appointment-related roles. In the light of these reassurances and the flexibility that the Bill continues to provide to local bodies, I hope that the noble Lord will be willing to withdraw his amendment.
Perhaps at the same time it might be appropriate if I reply to the noble Earl, Lord Lytton, on his amendment, which would remove the requirement for a relevant authority’s auditor panel to consist of a majority of independent members. The amendment would mean that a panel would need to have only an independent chair. We understand that the amendment might be related to concerns that we avoid any undue burdens on local bodies. There might also be concerns that some authorities would struggle to find enough skilled and fully independent members to form a majority. Given the noble Earl’s interests in the smaller bodies sector, I understand that he might have particular concerns about ensuring that requirements are proportionate for smaller bodies that choose not to take part in central procurement arrangements.
As we discussed earlier this week, protecting the independence of the auditor is critical to ensuring the quality and integrity of audit. The pre-legislative scrutiny committee endorsed the need for a properly independent panel to oversee auditor appointment. In the companies sector, guidance from the Financial Reporting Council recommends that audit committees consist of independent non-executives. It is right that panels advising on auditor appointment should be majority independent.
The Bill meets these aims while minimising additional bureaucracy and burdens for local bodies. There is no requirement for panels to be large. If, for example, a panel consisted of three members, which is the recommended minimum size of audit committees in Treasury guidance, only two independents would be needed to form a majority. The Bill also allows bodies to share panels to further minimise any burden.
On the possible concerns about smaller authorities, I agree with the general principle that arrangements need to be proportionate. In most cases, I expect that such bodies will participate in central procurement arrangements, so they will not need to have a panel. Where a smaller authority decides not to participate in such arrangements and makes its own appointment, it is right that a majority panel should oversee auditor independence. As I have said, the Bill therefore provides flexibility to allow authorities to minimise any burden. A smaller body might, for example, choose to share an auditor panel with a larger neighbouring authority where they would otherwise struggle to find independent members. With those reassurances, I hope that we have satisfied the noble Earl’s concerns and that he will not press his amendment.
My Lords, I do not wish to detain the Committee. I just hope to have a response in writing before Report. My point about paragraph 2(2)(b) to Schedule 4 was simply whether it meant that,
“the panel member has not been an officer or employee”,
within the past five years,
“of an entity connected with the authority within”,
the past five years, rather than, as it reads,
“the panel member has not been an officer or employee of an entity connected with the authority within”,
the past five years: namely, that he could never have worked for that authority at any time in his life. That is the point that I was hoping to clarify, but it can be clarified in writing.
Perhaps I may raise one small issue about the independent members of an audit panel. I do not see, unless I have missed it, how the process is expected to take place, and I have some concerns about the clarity of the job description and expectations. In some local authorities, particularly in the appointment of people such as coroners, these have not always been as transparent as they should be. It would be helpful if we knew what process is expected for authorities to achieve the genuine independence and quality suitable for the needs of the panel.
Perhaps I may add some more questions. I am sorry that they come so late. While paragraph 2 of Schedule 4 deals with a number of issues, it helpfully defines what is meant by a “relative”. Although seven categories of relative are referred to at page 40 of the Bill, there is no definition of the words “close friend”, which appear in paragraph 2(2)(c). Is it possible to define what is meant by “close friend”? If it is not, I suggest that the words should be taken out of the Bill, because this could lead to a ridiculous situation.
What is the rationale for dealing with health service bodies in a different way under paragraph 3 of Schedule 4? It seems to be a parallel process, and I wonder why it is regarded as separate. Why is the process not the same for the two bodies? In particular—I should know, but I do not—what are the current audit arrangements in health service bodies? We know what they are in councils—they either do or do not have an audit committee—but I do not know whether, at the moment, health bodies have audit committees as such. If they have, just as many of those who argued for the panel concept to be incorporated in the audit committee would argue for the same in health. At least my noble friend and I think that these two bodies are one more than is necessary, and if that is true for local government it is also true for health bodies. I am slightly puzzled by the potential parallel structure here.
My Lords, we will move on to the question of health bodies in our discussion of further amendments, and I hope that the noble Lord will allow us to return to the issue when we deal with them.
In answer to the noble Lord, Lord True, the Bill would not prevent someone who had worked for the local authority but had finished working for the local authority more than five years ago acting as an independent member of the panel. That is certainly my reading, and I state that as the Government’s clear understanding of the position.
On the question of a close friend—I appreciate that the noble Lord, Lord Beecham, is querying this—I am told that the phrase is already in the Localism Act. It is, to some extent, a matter of perception, but we all understand, from having dealt with local authorities over a long period, that this is one of the areas where one needs to make sure that panels look independent and are assured to be independent. Where someone seems like a close friend, it is clear that we will give guidance that that sort of person ought not to be appointed to a panel in that area.
There is more on the definitions in the letter of intent that was circulated on Monday, which I hope noble Lords have seen, and there will be more in the guidance provided to local bodies. I hope that provides sufficient reassurance for the amendment to be withdrawn.
My Lords, I am slightly confused, because the group of amendments with which we are dealing is about the relationship between audit committees and auditor panels. The noble Lord, Lord McKenzie, as the mover of the amendments, will comment on that in a moment. However, I am quite sure that we will return to this issue, if only to seek clarification about the distinction and whether the two bodies should be, or have to be, separate. My noble friend Lord Wallace seemed almost to be saying that the auditor panel could in effect be a subcommittee of the audit committee. I do not think that that was quite what he meant, but maybe it was. We still need to clarify that role.
My confusion started when my noble friend went on to reply to Amendment 14BBA, which is not only in the name of the noble Earl, Lord Lytton, but in mine. That amendment has not been moved yet, so I am not quite sure whether we are dealing with it. If we are, and for the sake of preventing us from dealing with it later on—if and when it ever gets moved—perhaps I might say that the noble Earl is vastly more expert than me on the case of small bodies, such as parish councils and the like. However, the amendment comes from the Local Government Association, which represents primarily the larger authorities that do have these concerns. Personally, I have no great problem with majority independent members, but the LGA is concerned about it on a number of grounds.
First, the LGA quite rightly makes the point about the professional integrity of auditors, which the noble Baroness, Lady Eaton, has already made, as has the noble Lord, Lord True, and others, and which I think we all accept. They are already fully regulated, quite rightly and properly, and therefore the perception of independence is, in a sense, already covered to a considerable extent by the regulation.
Secondly, there is the rather more important, practical problem of whether in some areas it will be possible to find a significant number of truly independent people. That does not mean somebody elected to the council as being independent of a political party; it means somebody who is truly independent of the council in a way that is defined in the schedule. In some areas, it may not be possible to find sufficient people of relevant experience. That does not mean that they have a professional qualification necessarily, but that they have relevant experience and are also able and willing to put in the necessary time to serve on this. That may be less of a concern in some London boroughs that many of us know. However, I can well see that in more rural areas or smaller district councils, it may well be quite a significant difficulty. That is part of the concern that the LGA was raising and which we need to include in this debate, whichever amendment we are debating at this moment.
Since we are not sure which amendment it is, perhaps the Committee will forgive me if I say just a word, having come in late on this section. I hope it will. I want to pick up on what the noble Lord, Lord Beecham, said about close friends. I feel that whatever legislation these Houses of Parliament pass should not be capable of ridicule. That must surely be paramount in people’s minds. Can one imagine the situation in which people vehemently deny that they are a close friend: “I am not a close friend, let me on it.”? It is quite nonsense. The idea of having to justify not being a close friend is capable of being ridiculed.
We are not putting these words into the Bill; we are trying to say that the relationship of someone in this position should not be such that they could influence the person on the panel. Imagine a court trying to decide whether this person was a close friend when they were denying it. Mr Saatchi and his wife might have problems saying whether they were close friends, given that he put his hands around her throat—he has been cautioned, so I think I can say that. It really is a worry. As I say, I understand what the Bill is trying to do and it is absolutely right to do so. However, to pick up on what the noble Lord, Lord Beecham, has said, the words are unfortunate.
My Lords, I thank all noble Lords who have contributed to what was a wide-ranging debate in the event. I also thank the Minister for his reply, but I am bound to say that I do not feel reassured by it. There are two sorts of issues flowing through this debate. One is whether, as the amendment proposes, the audit committee could not take unto itself the role of the auditor panel. Then there is the separate but obviously related issue of composition, whether it is of the audit committee or the auditor panel, and whether that should be independent as defined, quite apart from the definition.
The noble Lord, Lord Wallace, asserted that 80% of local authorities have audit committees. I accept that. I know that it is not currently mandatory, but it is certainly encouraged and there has been a substantial development of them. Their role is not limited to internal audit, controls and processes. That is part of their role, but the CIPFA guidance makes clear that part of their role is reviewing the financial statements, the external auditor’s opinion, and reports to members, so they should already have an engagement with the external auditors and be able to take a view on how they should proceed.
If that is right and if the audit committee’s role is wider than that perceived for the audit panel, why not have the audit committee able to undertake that role? Why confuse the matter with a separate body? If, along the way, that makes it a statutory requirement to have an audit committee, what on earth is wrong with that? That is good governance. It is mandatory, I think, in the private sector but not currently in the local government sector. We have a chance to rationalise something here for good governance and remove the possibility of confusion about which the noble Baroness, Lady Eaton—and pretty much every noble Lord who has spoken—was concerned by having the two bodies.
The amendment argues for one body to be the audit committee, which can encompass its existing role under the CIPFA guidance and the role required of the auditor panel. It seems to me to be entirely logical and straightforward.
When we are talking about independence in this context, we are talking about the independence of the members from the local authority involved. That is the independence judgment to be made. We will come to broader issues of independence. We have to question whether the definition of independence in that context is right, but that is another matter. It is argued that it would be difficult to get enough members. I am unsure about that. Were the noble Lord, Lord Shipley, in his place, I think he would strongly assert that it is not a problem. It would be good to have more evidence on that.
In a sense, the question of whether there should be a majority of independent members—I am with my noble friend Lord Beecham on that—is a separate matter. If there is agreement that there should be an independent chair and just one body, which should be the audit committee, we are well along the way to getting something that could change the Bill to make it more fit for purpose. The prospect of having those two bodies running at the same time seems horrendous. The overlaps and bureaucracy involved in that just do not seem to me to be worth while. There is a very easy solution for the Government, which is to have audit committees across the piece, certainly for all principal local authorities, as most do at the moment.
We will return to this issue as we move towards Report. I urge the Government to reflect. I think there is a chance of improving the Bill that in no way diminishes what the Government seek to do by their proposition of auditor panels. For the time being, I beg leave to withdraw the amendment.
Amendment 14ZG withdrawn.
Amendments 14A to 14BA not moved.
Clause 9 agreed.
Schedule 4 : Further provisions about auditor panels
14BB*: Schedule 4, page 40, line 6, leave out sub-paragraph (1) and insert—
“(1) A relevant authority, other than a health service body, shall determine the membership of its audit committee, provided the committee—
(a) consist of a majority of independent members (or wholly of independent members), and(b) must be chaired by an independent member;subject to sub-paragraphs (1A) and (1B).
(1A) An individual shall be ineligible to act as a member of an audit committee if that individual has any disqualifying interest.
(1B) The Secretary of State may by regulation determine interests that would disqualify an individual under sub-paragraph (1A).”
My Lords, the purpose of this amendment is to introduce arrangements to prevent individuals with a disqualifying interest from sitting on an audit committee. In this context, the term “audit committee” is being used but, if we reverted to the context in the Bill, it would be the “auditor panel”. We have just discussed the fact that there is a requirement for the auditor panel, or auditor committee, to be independently chaired and, as we have also discussed, for there to be a majority of independent members.
However, as the Bill is currently drafted, whether somebody is independent for the purpose of being able to serve is determined broadly by whether they have been a member, officer or employee of the authority, a connected entity or, indeed, a close friend, whatever that may mean. These relationships which preclude someone from serving on the committee or panel do not appear to encompass a person with a significant business relationship with the relevant authority. This might be someone who is a major supplier to the authority—a significant landlord, for example—or a major client of one of the audit firms being considered for appointment.
We have not attempted here to define these disqualifying attributes exhaustively because it seems to me that that is a job for parliamentary counsel. However, another issue is raised about the obligation, if any, on audit panel or audit committee members, whether or not they are members of the authority, to declare any interest which, if prejudicial, would require them to withdraw from any meeting if they were a member of the authority. Obviously that could upset the balance of dependent and/or independent members. It may be that this is all closed off through other regulations but perhaps the Minister will put it on the record.
In summary, the question is whether a business relationship between an individual and a local authority could be deemed to make them not independent of the authority and how that is encompassed within the Bill? Also, what guides the activities of such members when they serve on one of these bodies and might have a conflict of interest arising from something that is on the agenda of the meeting? I beg to move.
My Lords, we are, in a sense, continuing the previous debate. Before I directly address the amendment in terms of defining “independent”, I shall speak with another hat on. As noble Lords will know, I speak for the Cabinet Office on issues of civil society and I am struck by the fact that the largest single part of the population that is becoming more active in all civil society activities is the fit retired. There is a very large and growing element there and it is precisely the area from which local bodies are likely to find the independent members that they are looking for. Looking around this room, I note that many of us would fit into that category but, unfortunately, we are not retired. Therefore we have less time than we would otherwise like to have. The noble Lord, Lord Tope, is particularly fit, although I like to think that I am fitter than he is.
We are happy to look into the question of how one defines “close friend” and of course we will have discussions on a range of these issues between Committee and Report. However, I reiterate that a third of audit committees already have independent members and 15% have two independent members. We see the independent panels which will appoint external auditors as not having the heavy weight of work that audit committees have but as fulfilling a rather more distinctive function.
The proposal in the amendment for mandatory audit committees is addressed more directly in other amendments but, as I understand it, this specific amendment is intended to ensure that, as well as being independent of the authority, members of an auditor panel or audit committee do not have wider conflicts of interest that might compromise their independence. I agree that potential conflicts of interest should of course be taken into account in appointing members of auditor panels. However, the Bill already includes a duty for relevant authorities to have regard to guidance issued by the Secretary of State in relation to their independent auditor panels.
We intend that such guidance will cover exactly these sorts of issues, such as how auditor panels will operate and who should sit on them. We intend to work closely with the sector and interested parties on developing such guidance and identifying what wider interests should be considered in appointing members of a panel. I hope these reassurances are sufficient for the noble Lord to withdraw his amendment, or perhaps to ask for further discussion between the Committee and Report stages.
My Lords, I should apologise to the Committee. It was probably my fault that we got confused. I was following my noble friend Lord Lytton and my eyes went to page 40, and we therefore drifted on to the next group.
Perhaps I may ask a brief question. The noble Lord, Lord Beecham, raised the question of a “close friend”—it is good to know that the noble Lord has many close friends—and he is right to be concerned about the definition. Where is the question of political friendship dealt with in this? While it is good practice in local authorities, including my own, to have an opposition chairman—we are conscious of the political issue—is the situation of independents having close political associations but not close personal ones dealt with, in this or other legislation, in a way which would enable the work of panels not to be distorted by political considerations? In some authorities which are perhaps not as well governed as others, those kinds of considerations can be just as important as personal friendships.
My Lords, we are willing to look at that as well and I will write to the noble Lord. After all, we are talking about panels that may consist of two independents and one member of the audit committee. We are not talking about a vast number of people to be found outside. However, my understanding is that “independent” will exclude close political friendship. My experience of close political friendship also tends to mean close personal friendship, but we could discuss that in the bar or on another occasion.
My Lords, perhaps I can come back on that because I am probably the only person in your Lordships’ House who is a chairman of an audit committee. The present situation in many audit committees, of which mine is one, where the chairman is a member of an opposition party, which I am, gives an incredible independence. You are not part of the ruling party and when we were in power we did the same the other way round.
As the noble Lord mentioned, we already have two independent members, which is very good. However, the trouble is that if you appoint an independent chairman or chairwoman of the committee, that person could well have a political affiliation. Therefore, when the controlling party in that local authority was looking for an independent chair of that committee or panel, not unnaturally it would look to people whom they know or know of. The current situation where the person is of an opposition party, where that is relevant, seems to get over that point because that person is not a close political friend. I just wanted to pick up that point from my personal experience as something to think about that when we are considering this point.
My Lords, I think that we are trying to achieve the same thing here and therefore further discussion will be helpful. I pick up on the Minister’s example of an auditor panel that has two independent members, in the terms defined thus far, and a member from the audit commission. Whether they are friends by any definition, they could easily be members of the same political party. In a slightly different context, we said earlier that all of us are concerned that that should not happen in terms of elected members, with a majority party having a majority on the committee or sometimes even all the places on the committee. If we are talking about a small auditor panel, with the three members suggested, it is possible—this is not in the realms of fantasy in some areas of the country—that all three could be members of a political party. That does not necessarily imply a conspiracy or corruption; that is merely how it is in that area.
Thanks to the noble Lord, Lord True, we have moved to an area to which we may have to give greater thought if we are to achieve the objectives we all share.
My Lords, I am grateful to the Minister for that response and for the undertaking to look at this again. The points that have been made around the Committee today emphasise that there is less clarity than there should be on how this is all meant to operate and some of the nuances that could flow from just a strict reading of the legislation as it is.
I understand the point about making a judgment about whether someone was independent from an authority because of a business relationship. As the Minister said, you would seek to deal with that through guidance and it would be an issue as to whether they should be appointed to serve on the committee or the panel. In a sense, we are differentiating between someone who is not independent in that category and someone who is a relative, where they are not precluded from being appointed to the panel or committee. However, there cannot be too many of them or the requirement for a majority to be independent would break down. I am not quite sure of the logic in that. However, rather than stretch the debate this afternoon, I ask the Minister to look at that as part of the broader discussion. Maybe we could have a meeting of all noble Lords who have contributed before we get to Report because it would be difficult to repeat this discussion at Report without some interim deliberations. Having said that, I beg leave to withdraw the amendment.
Amendment 14BB withdrawn.
14BBA*: Schedule 4, page 40, line 8, leave out paragraph (a)
My Lords, I am going to be incredibly brief and thank the Minister for his reply in the previous debate, as well as for his comments on the bit that I did not actually ask about, which were very informative. Secondly, I apologise to the noble Lord, Lord Tope, for lifting this amendment from where it was and sticking it three groups further forward. Thirdly, I apologise to the Committee for my confusion on the definition of independence. I see that the jury is out on that. On that basis, I do not propose to move the amendment.
Amendment 14BBA not moved.
14BC*: Schedule 4, page 41, line 5, after “may” insert “, after consultation with representatives of health service bodies,”
My Lords, this amendment touches on something that my noble friend began to address in an earlier debate. It addresses paragraph 3 of Schedule 4, and the making of regulations about a health service bodies auditor panel. These regulations would enable the Secretary of State to determine whether any of the members of the health service bodies auditor panel must be independent and, if so, what proportion must be independent, as well as the definition of independent.
A health service body means a clinical commissioning group and special trustees for a hospital. These powers are subject to the negative procedure. The amendment would require there to be consultation with representatives of health service bodies before regulations are produced. This seems to be a significant paragraph to be dealt with by the negative procedure, particularly given the prescriptive nature of the constitution of auditor panels for other relevant authorities.
The Explanatory Note to the Bill, to which I referred earlier, states:
“The intention is that these panels will be the existing audit committees of health service bodies which will meet the independence requirements of best practice for central government audit committees”.
I took the opportunity to raise this in advance with the Bill team, and I had a helpful reply, which I have not had a chance to get my mind fully around yet. Perhaps the Minister might take the opportunity to put something on the record. If I understand the position, it is accepted that the audit committees of health service bodies, as currently constituted, which they are required to have under legislation, will serve as the auditor panels. In a sense, we have achieved for health service bodies what we have been seeking to achieve for local authorities. Therefore, it should not be too great a step to complete the journey. I should be grateful if the Minister would put something on the record generally about why there is this differentiation between health service bodies and local authorities. I beg to move.
My Lords, the direct answer to the noble Lord is that there are different arrangements in the various bits of legislation. As he has said, the clinical commissioning groups have governance arrangements that say that their audit committees can carry out this duty. That is how it has been set up in the health service. The composition of the clinical commissioning groups and local authorities’ arrangements are different. I want to make it clear that where local authorities have audit committees with independent members on them, it is possible for them to appoint the panel from the audit committee as long as they use the independent members. The arrangements are not and do not have to be totally different from those available as regards the health service.
I have pages of response to a question that the noble Lord has not asked. Is he reasonably happy that I have addressed the amendment? If not, I will give him the reams of pages that I have in response.
I shall ponder that response but I think that I would hang on to the basic point. It seems to me that the regulations that will flow from this provision will be, as has been said, a creation of the audit committees as the auditor panels. There will be only one body for health service bodies, which, in a sense, is the clarification that I was seeking as to what would flow from the broad powers set out in that paragraph. Obviously, there is a broader issue to which we will return about why that cannot be replicated for local authorities.
I am struggling to remember the question that I should have asked. Perhaps in the interim, I should beg leave to withdraw the amendment.
Amendment 14BC withdrawn.
Schedule 4 agreed.
Clause 10: Functions of auditor panel
Amendment 14BD not moved.
14BE*: Clause 10, page 7, line 14, leave out “must” and insert “may”
My Lords, I shall speak also to the other amendments in this group. The amendment would remove the requirement on the auditor panel to advise on the maintenance of an independent relationship with the local auditor. Indeed, it makes it discretionary. When I prepared for this debate, I could not for the life of me immediately recall why we tabled it. Obviously, the circumstances where a relevant authority ends up with an auditor panel and an audit committee, as we have discussed, would give rise to overlap and confusion, and possibly conflicting advice.
However, on reflection, we tabled it as a probe to establish a definition of “an independent relationship”. The Bill defines who is independent in establishing eligibility to serve on an audit panel and/or committee, but this definition does not appear to help in defining the parameters of an independent relationship between the relevant authority and its auditor. Is it proposed that guidance will be available, or is it expected that audit panels or audit committees will work that out for themselves? This issue is of particular relevance to the provision of other services by audit firms and how this is to be managed.
Amendment 14BJ would make a minor wording adjustment to advice related to liability limitation agreements. By referring to proposals for an authority to enter into such an agreement, it implies not that the proposal must have originated from the relevant authority but that it is more likely to have come from the audit firm.
Amendment 14BK would remove subsection (7), which seems superfluous. If subsection (6) requires the panel to advise on proposals for liability limitation agreements, why must there be the extra stricture for it to respond to requests for advice? It is not clear to me. I beg to move.
My Lords, perhaps I may first deal with the description of “independent” which, I understand, will be a matter of consultation. There will be consultation on what “independent” means in health bodies and how it should be defined. We all need to be clear about what “independent” means, a point raised by the noble Lord, Lord Palmer, and others. This is in relation to health bodies, not local government bodies, but that consultation will be carried out. I hope that that is helpful.
On the main question about the auditor panel’s duty to advise on a proposal for an audit authority to enter into a liability limitation agreement, Amendment 14BJ would require that the panel should advise where there is a proposal for the authority to enter into such an agreement, rather than a proposal by the authority to do so. Amendment 14BK would remove the requirement that a panel must give advice on such a proposal if the authority asks for it. Amendment 14BE would require that an auditor panel “may” advise on auditor independence whereas the Bill currently states that a panel “must” advise on it.
The intention behind the amendments, to remind the noble Lord, relates to separate amendments that we had proposed to allow for a central body to appoint auditors on behalf of any relevant authority which had opted in to this structure. Where such arrangements applied, it would not be necessary for—I am sorry, something seems to have gone seriously wrong with my notes.
I will reply on the basis of the independent relationship but I am afraid that I am going to have to ask the noble Lord to come back on Report on this so that can I fulfil his right to a proper reply.
As to advising on the maintenance of the independent relationship, it is important that the panel maintains an ongoing oversight of the auditor’s relationship with the relevant local body. As in the company sector, this might include, for example, an annual assessment of the independence and objectivity of the auditor and setting policies for the provision of non-audit services.
The noble Lord asked about limited liability agreements. I ask him to raise the issue again. I shall certainly write to give him an answer. I apologise.
I am grateful to the Minister for that response and am happy to follow up on those points. They were quite narrow points concerning the wording; they were not substantive points of principle. I am happy to send the noble Baroness an e-mail or drop her a line. I am sure that we can deal with that before we get to Report.
In relation to the definition of an “independent relationship” with a local auditor, I obviously accept the importance of the maintenance of such a relationship—I think that we would broadly understand what that means—but, as I said, I could not find a definition of it anywhere in the Bill. I think that the noble Baroness said that, certainly in relation to health bodies, that issue was going to be the subject of consultation, and presumably that would give some guidance on the definitions that would apply for the purposes of local authorities. If there is anything further that on reflection the noble Baroness wishes to follow up on, perhaps she can write to me. Accordingly, I beg leave to withdraw the amendment.
Amendment 14BE withdrawn.
Amendments 14BF to 14BR not moved.
Clause 10 agreed.
Clause 11 : Relationship with relevant authority
14BS*: Clause 11, page 8, line 23, leave out “other than a health service body”
My Lords, I need not speak at length on this because I made a relatively lengthy intervention at Second Reading setting out the reasons for my concern about the need to be assured of proper public accountability for the actions of NHS bodies. I think that public accountability is important, and there is material in the Bill about what should be done with reports, but it is essential that a body cannot just receive a report and sit on it.
Reference has been made to a case in which a primary care trust lost £28 million. At Second Reading, I described to noble Lords what happened. A supervisory body called in an auditor but the audit report was not ultimately published. Instead, a commentary was published with various recommendations—some good and some bad—but it was written on the basis that, as no one had really lost any money, we could all proceed and other bodies would make up the money. It was entirely unsatisfactory.
Since speaking at Second Reading, I have been contacted by the leader of another local authority, who thought that I was rather mild in what I said and felt that I should probably have named some names in connection with this affair. I have reflected on that. I think that my decision not to do that at Second Reading was right, and I maintain that position. Since Second Reading, I am very grateful to have had the opportunity to meet with my noble friend Lady Hanham and with officials from the Department of Health. My noble friend had very kindly drawn the attention of her colleagues in the Department of Health to this issue.
We have a fast-evolving world in health and local government, and these worlds are now encouraged to overlap. Indeed, my own authority, along with another local authority, is currently negotiating with clinical commissioning groups and, we hope, a foundation trust to set up an integrated commissioning organisation. That is the way in which the Government wish everyone to go within eight years. Alongside that, other elements of the health service will continue.
I believe that we now have the very odd situation where there is one strand of law which is semi-engaged in this legislation and which derives from the National Health Service Act 2006, as amended in 2012, and a whole strand of local authority-related legislation concerning audit and accountability. As the two empires come together, so should those two worlds come together. In my judgment, they need not necessarily be identical, but the noble Lord, Lord McKenzie, made a fair point when he said that the clinical commissioning group is being treated very differently in this Act from the way in which local authorities are treated. I do not make a case for identity but I do for accountability.
Local authorities have a public responsibility to ensure that what is done in their area is done for the good of their local populations, and that it is done effectively and openly, as we would expect it to be done ourselves. I made the point at Second Reading that there were various issues relating not only to audit but to scrutiny and its important role. I would like to think that while it may not be possible to achieve it in the short term, as I understand it from my discussions so far with my noble friend, in the time that this Bill is before Parliament—perhaps even when it is in the other place—it might be possible to think with a little more foresight about how we are going to adjust to this world and ensure full accountability. It is simply not acceptable that a body existing in an area and other parts of the health service, as happened in the case that I reported to noble Lords at Second Reading, should simply refuse to respond to questions from a public authority about the use of resources, certainly considering the scale involved.
We have to find a method somehow, whether or not it is through guidance—and there is existing guidance—although I would perhaps prefer it to be stronger than that. This Bill should provide us with opportunities, as local accountability is not just about local authorities and neither is this legislation. I am encouraged by what my noble friend has said so far. We may be able to find some improved structures, which may be simplified in some respects, as other noble Lords have said in Committee. They should be structures which ensure proper behaviour in the first place, effective independent audit and effective and open accountability. All those strands need to be addressed. If an internal audit document is published with a commentary and then scrutiny is refused, it is not a satisfactory outcome where there is evidence of large-scale ineptitude. That is a kind way of putting it regarding the use of £28 million of public resources. I am sure that there are other examples.
I am not going to repeat all the circumstances of the case but I urge the Committee to see those great public entities of local government and the National Health Service as two great elements of the state, providing vital services to our country and overlapping in many ways. We should therefore find the opportunity to construct an architecture that meets those three strands: effective and proper governance; effective and ultimately independent audit, although internal audit is vital in all those things and I do not denigrate it; and the strand of openness and, ultimately, scrutiny. This is really a probing amendment although my noble friend encouraged me to think that were this to be laid, she might perhaps be able to give some encouragement to me and to the Committee that the Government would be prepared to look at these matters in the months ahead. I beg to move.
My Lords, I thank my noble friend for having introduced this amendment because it opens up the relationship that exists between local authorities and health authorities, particularly in relation to what is required of scrutiny. As my noble friend has said, the primary care trusts and the clinical commissioning groups have now come into being, while the local authorities still have a health scrutiny role since that changeover. If I may, I will refer to the duties in the health scrutiny regulations as I go through what I have got to say.
Failure to comply with a duty under the health regulations will place the relevant body in breach of its statutory duty and render it at risk of a legal challenge. The regulations provide that the local authority can require attendance of a member or employee of a relevant health service provider or commissioner to answer such questions as appear to the authority to be necessary for discharging its health scrutiny functions. It is the duty of that member or employee to comply. The regulations also require a health service commissioner or provider to provide a local authority with such information about the planning, provision and operation of health services in the area of the authority as the authority reasonably requires in order to discharge its health scrutiny functions. To focus particularly on attendance, if a local authority was to require the attendance of members of a clinical commissioning group, it could do so under the health scrutiny regulations.
On employers’ actions, we would expect employers to take the appropriate steps to ensure that the relevant member or employee complied with the local authority’s requirements. It would be highly unlikely that an NHS body, as a public authority, would refuse to take action to ensure that its members or employees complied with a request from a local authority. I think that these provisions are part and parcel of the health service legislation which recently passed through Parliament. The emphasis put on this since the noble Lord’s problem arose may have changed.
Any refusal would not be in line with the duty of co-operation that applies as between the National Health Service and local authorities. Section 82 of the National Health Service Act 2006 imposes a duty of co-operation between National Health Service bodies and local authorities and requires them, in exercising their respective functions, to co-operate with one another in order to secure and advance the health and welfare of the people of England and Wales.
As regards the attendance of particular individuals, identification of the appropriate member or employee to attend may depend on the type of scrutiny review being undertaken and its aims. To take a theoretical case, where the local authority has required attendance of a particular individual—let us say the accountable officer of a clinical commissioning group—and it is not practical for that individual to attend, or if that individual is not the most suitable person to attend, we would expect the clinical commissioning group to suggest another relevant individual. In such situations, both the local authority and the commissioning group or provider, as the case may be, will be expected to co-operate with each other to agree on a suitable person for attendance and, in doing so, to act reasonably.
Therefore, in the interpretation of the health scrutiny regulations and on the basis of the duty of co-operation contained in the National Health Service Act 2006, there are existing principles that guide how the National Health Service and local authorities conduct themselves in relation to the discharge of the local authority’s health scrutiny function.
We share my noble friend’s desire to ensure that everything works as it should in the future and, although we feel that the duties and powers already in place are correct, we believe that we can take further action to ensure that the responsibilities on NHS organisations and local authorities are clear. We shall shortly be publishing updated guidance to support the health scrutiny regulations and to emphasise these responsibilities. If my noble friend would find it helpful, I know that the Department of Health would be happy to work with him on the development of this guidance.
I appreciate that this was very much an individual case to which my noble friend brought our attention, but it flows widely across the health scrutiny role. I hope that I have reassured my noble friend that there are requirements on people to come, that the health authority can require them to come and that they are truly expected to appear. I know that that was not the situation that he described but the regulations are there. If my noble friend is willing to give his experience and help to the Department of Health, I know that it will be very willing to take it up. With that, I hope that he may feel that he has enough to enable him to withdraw the amendment.
My Lords, I am very grateful for what my noble friend has said. Certainly, I would be extremely interested in seeing this guidance in draft. I am sure that the leaders of the other five local authorities involved might also be interested as well, and perhaps other people in the local government world. I do not know whether it might be possible to extend that offer but, as far as I am concerned, I accept the courteous proposal and am very grateful for it.
As for the individual case, my noble friend referred to the 2006 legislation. The blunt truth is that the body concerned was happy to volunteer one individual, but the unfortunate thing was that that individual was not involved at all. Those who were involved—some of whom no longer worked for the body and therefore could not be volunteered by the body—need to be accountable. Others declined to be presented. Effectively, the authority was told that it could have this individual, but those who had actually given the instructions and done things were not available.
I would have to examine very carefully the wording of the guidance and the regulations to ensure that that situation could not be replicated. What we do not want is a kind of legalese compliance—that of saying, “We sent someone along who stonewalled at the scrutiny committee, but you have to be satisfied with that, not act unreasonably and not want to actually hear from the people who were involved”. That is a very important rider. It is very easy to say that the body can do something, but scrutiny must go to the individual. It is no good the Government saying, “You can talk to the Chancellor of the Exchequer”, when it is actually the Minister of Defence whom you want to talk to. That is an issue that I would want to elucidate in the discussions that my noble friend has kindly offered with officials.
I am very grateful for what she said and for the earlier discussion. With a warning that I will be coming to look in those corners, I beg leave to withdraw the amendment.
Amendment 14BS withdrawn.
Clause 11 agreed.
Clause 12 : Failure to appoint local auditor
Amendment 14C not moved.
Clause 12 agreed.
Clause 13 : Failure of clinical commissioning group to appoint local auditor
14D*: Clause 13, page 9, line 31, leave out “25 March” and insert “31 December”
My Lords, this was a very straightforward amendment, which probes the difference between deadlines in relation to the appointment of auditors to health bodies and local authorities. One is set at 25 March and the other, as we touched on earlier—or the noble Lord, Lord Palmer, did—at 31 December. Perhaps the Minister can just give us an explanation for that difference in approach.
My Lords, this goes back to what we were discussing when we were talking about local authorities. If the clinical commissioning group has not appointed an auditor by December and has no reasonable expectation of employing one by the end of March, the Commissioning Board will have to notify the Secretary of State and he, NHS England or the commissioning group will have to ensure that an auditor is appointed. There is no question that the clinical commissioning group should not have an auditor in place at the beginning of the financial year.
Perhaps I may ask the Minister for clarification. The Bill states:
“by the end of 25 March in the financial year preceding the financial year to which the accounts to be audited relate”.
So, if the relevant year is to 31 December 2012, as I understand it, the auditor will have to be in place by 25 March 2011 because that is the financial year preceding the financial year to which the accounts to be audited relate. Is that right? I would have thought it should be in the financial year to which the accounts to be audited relate, not the preceding year. This is bringing the date incredibly far forward and I wonder whether I have misunderstood it. Perhaps my noble friend the Minister can elucidate.
My Lords, I have misled the Committee, for which I apologise. As the noble Lord said, it is the preceding year. If the clinical commissioning group fails to appoint an auditor in the preceding year at the end of March, the Commissioning Board will have to notify the Secretary of State. This gives time for an auditor to put in place the provisions for the following year. The Secretary of State has to be notified by the commissioning board by 25 March that the clinical commissioning group has failed to appoint an auditor. The provisions are intended to ensure that a clinical commissioning group has a local auditor in place in a way that is consistent with their respective roles. I agree with the noble Lord that nine months seems a long time to get someone in place.
I thank the Minister. I am going to have to read the record on that. The potential discrepancy that I was probing was the difference between using the 25 March and the financial year preceding it. As I understand it, if the financial year ends 31 December 2014, it would be the 25 March 2013 that would count. However, the difference is between the 25 March for the clinical commissioning groups and 31 December for the relevant authority’s appointment date. Why is it 31 December in the preceding year for the relevant authority and 25 March for clinical commissioning groups? I am happy to receive a follow-up letter if that is easier. I beg leave to withdraw the amendment.
Amendment 14D withdrawn.
Clause 13 agreed.
Debate on whether Clause 14 should stand part of the Bill.
My Lords, in seeking that Clause 14 should not stand part of the Bill, I should say that this is a probing measure to seek government assurances about the appropriateness of facilitating the limitation of local auditor liability arrangements. The impact assessment and other documentation records that the Audit Commission currently provides an indemnity to audit firms for certain aspects of their work. This is, presumably, their statutory audit function. It also appears that it covers irrecoverable legal costs. We are told that the indemnity has been used only twice over the past five years and that auditors have faced legal action four times over a five-year period. Perhaps the Minister will let us know the amounts involved in the use of the indemnity and how much was paid.
What benefits ensue from limited liability arrangements which relieve auditors of liability in respect of negligence, default or breach of trust when conducting an audit? What are the benefits of that? The limitation of auditors’ liability has been permitted under the Companies Acts since 2008, although reports suggest that there has been little take-up. I am indebted in this regard to a Mr James Herbert, who is a corporate partner in a law firm who wrote an interesting article in Accountancy Age back in 2009. I took the opportunity of speaking to him to see whether the view he expressed then had changed. It had not.
Part of the reason for little take-up of those arrangements is attributed to issues with the SEC prohibiting UK companies registered with them from entering into those arrangements. Under the Companies Acts, any limitation must be fair and reasonable. A separate agreement is reached for each year and each agreement must be approved by shareholders. On the face of it, there is no reason why auditors should be protected from the consequences of their negligence or default in the public or private sectors. However, one of the public policy objectives was to enhance competition in the UK audit market and to address concerns about auditor concentration. As we have discussed before, the big four have deep pockets, are better able to bear the risks and have more clout with professional indemnity insurers. There are concerns that the smaller and mid-tier firms have been least able to benefit from the agreements.
Another reason for allowing such agreements might be its impact on the price of an audit. If the risk on the audit firm is less, the cost of the audit should go down. However, it is difficult to gauge whether there will be any real downward pressure on fees in the public sector, particularly given the infrequent calls on the commission’s indemnity. We can see some merit in allowing limitation of liability agreements if tightly regulated and if they can be demonstrated to help to open up the markets and put downward pressure on fees. However, we are sceptical that they will deliver that outcome. Perhaps the Minister can say when we might see a draft of the proposed regulations referred to in Clause 14 or what else might be provided in the key elements in the regulations. How do the Government propose to monitor and assess the effects of the clause?
I emphasise that in my discussions with that particular lawyer, it appeared that limitation of liability agreements have simply not taken off, certainly not in the private sector, so one wonders about the merits of introducing them to the public sector.
We might wish to return to the matter on Report, but it seems to me that, at the very least, there may be an argument for a sunset clause on the provisions, or at least a very clear process of assessment so that one can see whether what should be the benefits—downward pressure on audit fees and an opening up of the market to smaller firms—is actually achieved. We remain sceptical.
We have already mentioned that the number of accountancy firms capable of carrying out these audits is quite small—five to seven, probably. The maximum would be 13, and most of those would probably not achieve those audits. All of those in the top echelon of firms of audits are now limited liability partnerships. The days of my times in practice when we were personally liable have, for the large firms that we are considering, long departed.
I ask my noble friend: if there is a liability, where should it rest? Should it rest at the end with the Government as a short-stop? Should we say, at the end of the day, if things go sour, the Government will pick up the liability? Bearing in mind that no partner of one of those firms would be personally liable, and that they are firms of great size with considerable power, I wonder whether they should not bear that liability.
We had the example within the corporate sector of Arthur Andersen, which messed up on an audit—not a local authority audit but a public audit—and that ended with the demise of that firm. Are we trying to say that, in terms of local or public health authorities, these firms should have this protection, or are we saying that these are the professionals and they must do their audits, work correctly and cover themselves? We are not talking about anyone being responsible for fraud or errors within local authorities or the health service; we are talking about them not having carried out their work properly to an extent where they can cover themselves. I ask the Minister to reconsider whether the liability should ultimately rest with the Government, or whether it should rest with these five to seven very large limited liability concerns.
My Lords, perhaps I can pick up the questions as I go along. However, it would probably be helpful if I gave the justification for the clause and then we could look at the impact.
As in the companies sector, auditors appointed under the Bill will, by agreement with the audited authority, be able to limit the extent of their liability to the body in relation to negligence or breach of duty or trust. This clause gives the Secretary of State powers to place restrictions on such agreements to ensure that they are reasonable and proportionate.
The decision to allow liability limitation agreements in the companies sector was made following extensive consultation. Such agreements aim to ensure that auditors are not held liable for consequences beyond their control and responsibility. Under the joint and several liability principle in UK law, auditors may be held liable for damages beyond that for which they are directly responsible. The Financial Reporting Council has welcomed provision for such agreements.
Clause 14 mirrors the Companies Act 2006 by providing that any such “liability limitation agreement” must comply with certain conditions. The purpose of this clause is to ensure that the agreements do not unreasonably limit the auditor’s liability and are entered into transparently. Without such a provision, there would be no limits on an auditor limiting their liability and nothing to stop them removing all liability completely. As I said, it is right that auditors are held responsible for their actions in a fair way.
Subsection (2) requires that:
“A liability limitation agreement must comply with regulations made by the Secretary of State”.
Such regulations may address the duration of an agreement or the amount to which it may limit the auditor’s liability, or require it to contain, or not contain, certain provisions. Under subsection (5), regulations may provide that any limited liability agreement not complying with regulations is void or has effect only in so far as it complies with them. In the interests of transparency, subsection (6) allows the Secretary of State to make regulations requiring the disclosure of any such agreement. Subsection (7) excludes compliant agreements from wider provisions in the Unfair Contract Terms Act 1977, which set out similar but more general provision and conditions around limitation of liability.
With regard to the amounts of money involved, perhaps I may write to the noble Lord. I think that the amounts are very small but I will provide them to the noble Lord. As the Bill proceeds, there will be further details on the various matters that have been raised. We will, as with all new legislation, be undertaking a review of monitoring to see what the situation is.
With regard to the point raised by the noble Lord, Lord Palmer, about who should pick up the liability, the Bill includes provisions that enable auditors to recover the costs of their time in exercising their functions from the body being audited. It does not replicate the Audit Commission’s indemnity scheme, which covers the costs of auditors taking or defending legal action. We believe that it is appropriate for private companies to bear the risks and costs of that. We do not believe that it would unduly deter auditors from exercising their functions. The Audit Commission has rarely indemnified its suppliers. On the noble Lord’s question as to whether the Government should pick up liability, the answer would be no. With that, I urge that the clause remains part of the Bill.
My Lords, I am grateful to the Minister for that response. I think that we understand a bit better that the regulations will broadly follow the Companies Acts requirements and what flows from that. I found her response confusing in some respects. We are talking about something that is not beyond the control of the auditors. These arrangements are predicated on a breach in respect of any negligence, default, breach of duty or breach of trust occurring in the course of the audit of accounts, so it is a failure of an audit firm which triggers them. The noble Lord, Lord Palmer, raised a very important point. If there is a breach or damages and if that is not to be visited on the auditor, or what is to be visited on them is restricted, who bears the cost of the rest? I do not think we understand that from the Minister’s response.
I thought that the public policy issue about this was partly to do with making sure that another big four company did not go under. The ramifications of those four big beasts going down to three would be significant over a whole range of areas, as we learnt from the demise of Arthur Andersen because of Enron. I thought that a key point was to make it easier for smaller firms to enter the market because their risks were, in a sense, capped. There is no great evidence to suggest that that has happened in the private sector. We do not yet know whether it will happen in the public sector, but if it does not, that raises the question: why have these agreements in the first place? All they do is to protect audit firms. Why? These are sophisticated organisations. They have excellent training programmes, generally recruit very good staff and have been around the block a few times. If they mess up, should they not bear the consequences? If not, the question of the noble Lord, Lord Palmer, is absolutely right: who should? Part of the rationale may be that it would produce downward pressure on audit fees, but that is difficult to justify, particularly if the use of the commission’s indemnity was pretty restricted.
We may return to that issue, perhaps in terms of a sunset clause, if these things are to continue. I hope that the same arrangements as in the private sector, where I think they have to be annual contracts, will persist in the public sector in so far as they are used at all. I hope that guidance is given to firms when faced with such a request from their auditors as to how they should respond. We have probably taken this as far as we can this afternoon, but for us it is an outstanding issue to which, one way or another, we will wish to return.
Clause 14 agreed.
Clause 15 agreed.
Clause 16: Resignation and removal of local auditor
14E*: Clause 16, page 12, line 5, at end insert—
“( ) the right of the local auditor to make representations to the authority’s auditor panel or supervisory body”
My Lords, Clause 16 concerns the resignation and removal of the local auditor, and the amendment refers in particular to circumstances relating to the removal of a local auditor, although on reflection it could refer equally well to circumstances in which a local auditor resigns.
The purpose is to ensure that the procedure specifically encompasses the right of a local auditor to make representations to the auditor panel or supervisory body, or the audit committee, if that is what is in place, and that might encompass a right to make representation to members. The removal or resignation of an auditor is a serious business. Under the Companies Act 2006, an extensive process is set down where somebody is removed or resigns. These include, in the first case, the right to make representations to members when removed and a statement of circumstances when resigning. It is these Companies Act processes which the Government are seeking to import into the Bill, and we support that.
Under the current regime, there is no need for regulation on the removal or resignation of local public auditors because it is the Audit Commission that appoints and removes them. However, a change in auditor could be straightforward—arising, say, from a new potential conflict of interest—or it might be indicative of a fundamental difference of view as to the accounts, where an auditor feels that they can no longer carry out the audit effectively because of concerns over the governance of the body or a fundamental breakdown in the relationship. Ensuring that there is a right for auditors to make their case at an appropriate level is therefore very important.
The Bill includes, at Clause 16, regulation-making powers which cover a range of issues. Doubtless, the Minister will say that they are broad enough to cover the thrust of this amendment. So be it, but perhaps we can hear from the Minister what the plans are in respect of resignation and removal to cover circumstances where the appointment has been made by the local body, jointly with another body, or in transition by the Audit Commission. I beg to move.
My Lords, the noble Lord makes an extremely important point which in certain circumstances could touch on issues of public accountability, although referred to on another matter. It may well be that he could be satisfied in that Clause 16(3)(d), at the top of page 12, allows a regulation-making power in relation to,
“the role of the relevant authority’s auditor panel or … supervisory body”.
On this issue of a right of audience, or a right to make representations, my noble friend might well be able in discussion to consider including the point which the noble Lord has raised. It is a significant one and he is right to refer to Companies Act procedures. Perhaps it could be clarified whether it is potentially encompassed in that area, which might help some of us on the Committee.
My Lords, Amendment 14E would add to the regulation-making powers under Clause 16(1)(b), which relate to the circumstances of an auditor being removed, as the noble Lord said, by a local public body before their term of office expires. It would enable regulations giving local auditors the right to make representations to the authority’s auditor panel or to the auditors’ “recognised supervisory body” in those circumstances. The noble Lord asked what would happen if it was the Audit Commission; as we have already said, that commission will have an interim body between it being abolished in 2015 and when this changes. That will be a responsible transfer, which is the main thing.
We are sympathetic to the intention of this amendment, which is to ensure proper scrutiny of the removal of an auditor. However, as the noble Lord suspected, we consider this amendment to be unnecessary. Subsection (3)(c) already provides a regulation-making power about,
“the steps that may be taken by the local auditor in connection with the local auditor’s removal from that office”.
As set out in our consultation paper on the draft Bill last year, we intend by regulations to enable the auditor to respond to a relevant authority’s notice of intention to remove them, with that response to be considered by the relevant authority’s auditor panel. So the auditor panel now has a role in overseeing that in an independent way.
The auditor panel would then be required to advise the authority on the proposal to remove the auditor. In light of the auditor’s response, we intend that the authority’s final decision to remove the auditor would be subject to that advice. As with appointment, we intend that where a body does not follow the audit panel’s advice it would need to publish the reasons for not doing so. We also intend to require that the recognised supervisory body is notified of a removal. Therefore, we do not consider that it is necessary to include this additional wording in the Bill. We think that there are enough safeguards in it. With that explanation, I hope that the noble Lord will feel able to withdraw his amendment.
I thank the Minister for that reply. I did not assume that she would accept the wording, but I wanted to get something on the record. I am grateful to the noble Lord, Lord True, for his acknowledgment of this issue. The Minister has dealt with it wholly satisfactorily. I beg leave to withdraw.
Amendment 14E withdrawn.
Clause 16 agreed.
Committee adjourned at 6.16 pm.