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Local Audit (Appointing Person) Regulations 2015

Volume 759: debated on Tuesday 27 January 2015

Motion to Consider

Moved by

That the Grand Committee do consider the Local Audit (Appointing Person) Regulations 2015.

Relevant document: 17th Report from the Joint Committee on Statutory Instruments

These regulations are among a number necessary for local public audit in the new regime introduced by the Local Audit and Accountability Act 2014. That Act abolishes the Audit Commission and gives greater responsibility for auditor appointment to local public bodies. I will not take up the Committee’s valuable time by repeating the arguments put forward during the passage of the 2014 Act in this debate. There was broad support across the House for making the collective procurement of audit services available to local public bodies, and these regulations deliver on the commitment that we made then.

We recently updated our impact assessment: this is saving £759 million over the five years between 2012 and 2017—the duration of the outsourced audit contracts—and an estimated £1.35 billion over 10 years. As a direct result of this work being done by the private sector, the cost of external audit for local bodies will reduce by £30 million per annum.

Before getting into the detail of these regulations, I will explain the background. From 2017, a local public body will have to appoint its own auditor unless it chooses to opt in to the collective procurement arrangements we are providing for with these regulations. The Local Audit and Accountability Act 2014 already allows local public bodies to get together to jointly procure audit services. During its passage through Parliament, we amended the Bill to make broader collective procurement arrangements available in light of an appetite in the sector for this. In particular, the noble Baroness, Lady Hanham, worked with the noble Earl, Lord Lytton, to address and resolve concerns so that legislative provisions for collective procurement for smaller authorities would be suitable for the needs of that sector.

I will deal with the appointing person regulations first. As I said, we made provision for collective audit procurement in the Local Audit and Accountability Act in response to demand within the sector. We also consulted on a draft of these regulations. Responses were broadly content with these provisions, including those that we asked specific questions about: that the decision by local bodies to opt in must be taken at full council, and that the maximum period of the appointing body’s responsibility should be set at five years.

This is a lengthy set of regulations, so noble Lords will understand if I do not discuss them in detail. They make the collective procurement of audit services available to the sector while meeting objectives of accountability, transparency, continued auditor independence and audit quality. To achieve this, they: provide for the Secretary of State to specify an appointing body in a transparent manner; allow more than one appointing body to be specified, enabling specialisation in audit procurement for different groups of authorities; set out how authorities can opt in to, and later opt out from, the appointing body’s arrangements; require the appointing body to consult authorities on audit fee scales; define the appointing body’s roles in relation to auditor appointment, resignation or removal; require the appointing body to monitor auditor independence and compliance with contractual obligations, and deal with any disputes or complaints relating to audit work or audit contracts; and provide that an authority which has opted in to these arrangements will not be required to have an independent auditor panel. The regulations also provide that the appointing body’s services will be available as an additional option to the Secretary of State if an authority which has not opted in to collective procurement arrangements also fails to appoint its own auditor.

The smaller authorities regulations have a similar objective to the set of regulations I have just spoken about, but for smaller local public bodies. They provide for the collective procurement of audit services for smaller bodies, with the same guiding principles as for principal authorities. Those are transparency and accountability in decisions taken about how a body’s auditor is appointed, and continued effective, independent assessment of the accounts of authorities subject to that audit.

As with an appointing body for principal authorities, the body’s remit is clearly defined and will be focused on achieving good value for money in audit procurements. If it does not, smaller authorities are unlikely to use its services.

A key difference is provided in these regulations between the collective procurement arrangements for larger and smaller authorities. Principal authorities must choose to opt in to take advantage of their appointing body’s arrangements. Smaller authorities, however, must actively opt out of their appointing body’s arrangements if they prefer to appoint their own auditors. There are very many smaller authorities—nearly 10,000 in total—and we expect that the majority will want to remain opted in. It is more cost-effective and efficient therefore to opt them in as a default, but a smaller authority will be free to opt out if it chooses.

These regulations also make some audit provisions specific to smaller local public bodies. Authorities with a turnover above £25,000 but below £6.5 million must appoint an auditor, or have an auditor appointed to them, to provide a limited assurance on a financial statement. The regulations also provide that bodies with a turnover of under £25,000 are not normally subject to audit engagement but must comply with enhanced transparency requirements. We have taken a risk-based approach to the exemption for the smallest bodies: the exemption will not apply when such a body is new or where it is subject to a report in the public interest, or an item in its accounts has been declared unlawful. We have consulted the National Audit Office on this approach and it is content.

We undertook two rounds of consultation on these regulations. The first, in the autumn of 2013, was on an initial draft. Again, respondents were broadly content with their provisions, including: that a smaller authority should not be forcibly opted out by the appointing body; that the appointing body should publish a list of appointing bodies; that the Secretary of State should have the power to opt in a smaller authority which has failed to appoint an auditor; and that below-£25,000 authorities should not be exempt from a limited assurance audit if they are newly formed or have had an item in their accounts declared unlawful, or if they have been the subject of a public interest report in the previous year.

We undertook a second round of consultation in the summer of 2014. In particular, we asked whether the draft regulations met the objectives of transparency, quality and cost-effectiveness. Most expressing a preference agreed. However, chief among the concerns was that the regulations are complex and that many smaller authorities may remain unaware of the new requirements.

We recognise the complexity of these regulations and the challenge to many smaller authorities of interpreting their effect. Therefore, we have redrafted them to simplify and clarify them where we can. We are publishing a brief and accessible guide to the audit and transparency requirements applicable to smaller authorities, which we have shared with this Committee in draft. Again, this guide reflects considerable consultation with the sector.

In summary, the regulations provide for the Secretary of State to specify an appointing body for smaller authorities in a transparent manner. They set out how smaller authorities can opt out of, or later opt in to, the appointing body’s arrangements. They require the appointing body to consult representatives of smaller authorities on audit fee scales. They define the appointing body’s roles in relation to auditor appointment, resignation or removal, monitoring auditor independence and compliance with contractual obligations, and dealing with any disputes or complaints relating to audit work or audit contracts. The regulations set out that an authority opted in to these arrangements will not be required to have an independent auditor panel. They also require a smaller authority whose turnover is below £25,000 and is thus exempt from the requirement for limited assurance audit to self-certify by letting the appointing body know this and by publishing the fact.

These regulations were debated in another place last Wednesday and several issues were raised. While it is for the sectors concerned to set up audit procurement bodies, the Minister confirmed that the body for smaller authorities was to be in place later this year, and the Local Government Association was well engaged on the question of a body for larger authorities.

The Minister was also able to confirm that concerns expressed by the Institute of Chartered Accountants in England and Wales about the status of the limited assurance audit work carried out on smaller authorities were being addressed. Departmental officials have been engaging with the institute and with audit firms themselves. Audit firms are positive about the limited assurance work; many are already undertaking it. I understand that officials will next be meeting the institute to discuss their concerns on 2 February. With that, I commend the regulations to the Committee.

My Lords, I thank my noble friend the Minister for that detailed exposition. I need to declare—especially given her last comment—that I am a chartered accountant and that I was, until May, the chairman of a local authority audit committee. I think that is probably enough in that respect.

I see my role as being to pick holes, if there are any, in what I see in front of me. The main thing that I am looking at is the draft guide which my noble friend referred to. On page 3 of that guide, there is the comment that the annual accounts are subject to a limited assurance review. Within audit committees, internal audit teams have a way of classifying the work of each department or service area, and when they audit that service area, they deem its performance to have been satisfactory, limited or poor respectively. It is generally done with a traffic lights system. The term “limited assurance” has a specific connotation within the audit field, and by referring in the guide to a limited assurance review there is the complication that it will be viewed as part of what I call the traffic lights system in local authorities. It is a slightly careless use of words that are used within the realm of audit. Could my noble friend think about that and the confusion that it might cause?

There seems to be a very light mention within the paper of internal audits, which I mentioned in an earlier discussion on the Bill. Good local authorities rely very much on their internal audit teams. External auditors also rely on the internal audit to a large degree, although it depends very much on the firm and the internal audit. The idea is that you do not do the job if it has already been done. However, internal audit is hardly mentioned. It is mentioned on page 5 of the paper that there should be an internal control, but there does not then seem to be a relationship in terms of what regard external auditors can take of that internal audit. If we are aiming to drive down costs for local authorities and the like, there ought to be an acknowledgment of what good internal audits can achieve. I did this when I was chairman of an audit committee—internal audits tore the living daylights out of service areas, and if they did not perform better, they had to come back and explain why. That is what internal audits do, but there does not seem to be much mention of it here.

Annual appointments are complicated, as very few accountancy firms are deemed by the Institute of Chartered Accountants in England and Wales—I presume this is the case in Scotland as well—to have the stature, knowledge and capability of doing this. I cannot remember what the figure was—I am sure other noble Lords will—but it was no more than eight, and probably about five. There were about 10 firms that had the capability but only about eight were deemed to be able to do it. So there will be a very limited market for these firms. I do not know whether the Minister has inquired with the professional bodies as to whether they see any problem.

My last comment on this is about very small authorities. My understanding of the paper is that very small authorities—those with a turnover under £25,000—will not need to appoint an external auditor, unless someone raises a query. In practice, if a small authority that needs a set of accounts, and thus an audit, has a turnover of £25,000 or less, and somebody raises an accounting query, that local authority or body will then have to appoint an external auditor to deal with that query from a member of the public. I may have this wrong, and my noble friend will correct me, but my reading says that that is what needs to happen. Therefore, in practical terms, if Mr or Mrs Vexatious raises a problem with the accounts of a local body with a turnover of £25,000 or less, it has to appoint an external—not internal—auditor, whose fees will start, say, at £1,000 and may be a lot more. My noble friend should know that that is impractical. I hope that these points are addressed before the regulations are put on a firm basis.

My Lords, I declare an interest as a member of Newcastle City Council and of its independently chaired audit committee.

My noble friend Lord McKenzie and I whiled away a happy hour or three, as I recall, on these issues when the Bill was going through. Some of the reservations that we had then would apply also to the proposals before us, and my noble friend will enlarge on them. I concur with some of the questions raised by the noble Lord, Lord Palmer. In particular, he is right in his recollection that there are, apparently, eight firms—a couple of which are actually connected to the big five; so there is generally little choice in this field. One of the questions is whether that is acceptable to the Government or whether there should not be an attempt to encourage other, perhaps smaller, firms to develop an expertise, make more of an impact on the market and recognise that, in fact, the high cost of employing the major firms—the Deloittes, the PwCs and so on—is justified in the context of even a joint appointment. The fact that there is a joint appointment will not necessarily reduce the cost of an individual audit exercise, although perhaps the Government have done some work on that and can enlighten us.

One of the points that I, and I think my noble friend, raised was the desirability of positively promoting a change of auditor after a period of time, because there is a danger that the auditor and the local authority get too close together. The Minister has a long experience—although not quite as long as mine—in local government and as a council leader, and will therefore be familiar with these issues. A turnover is desirable, and perhaps the noble Baroness can indicate whether the Government might be prepared to facilitate that in this context.

One of the other issues facing all local authorities is, given the effective demise of the Audit Commission, the difficulty of comparing what goes on within one’s own authority with other authorities. The Audit Commission had its virtues and some problems from time to time, but at least it often provided information across the piece that one could look at and with which one could compare what one’s own authority was doing. I know that that is the view not just of political members of the audit committee in Newcastle but very much of the independent chair and independent members, and they miss such a basis for comparison. Given what I guess is the slightly smaller degree of experience in these matters among the smaller councils that we are talking about, have the Government any proposals to remedy this information gap? While all authorities can benefit from that kind of comparative information, it is probably more important, in some respects, for smaller authorities—particularly if independent members serve on them. It would be very much welcome to hear the Government’s position on that process.

The Audit Commission is not officially dead and buried but that part of its work regarding local authorities is effectively gone as far as local authorities are concerned. That is unfortunate and we have to live with it—at any rate, for the time being—but, given these new proposals, I hope that something will be done to assist members of smaller authorities, their officers, in so far as they have any, and those who ultimately do their accounts to be able to look at what comparable authorities are doing. That would certainly be a much more useful process for the audit committee’s oversight, or that of the local authority, of what is going on in their local patch.

My Lords, I thank the Minister for introducing these two sets of regulations. As she will have gathered from the debate in the other place, although we have some questions of detail, we will not seek to oppose these regulations.

I agree with much of what the noble Lord, Lord Palmer, and my noble friend Lord Beecham said, and I will come on to some of those points in a moment. However, on the issue of internal audit, I had no doubt that the noble Lord would raise it because he was very strong on this issue when we were discussing the Bill. My question is how under this regime the strength of internal audit is going to be reflected in the setting of fees. That was not clear from my reading of the regulations.

We are pleased that during the passage of the Local Audit and Accountability Bill, which is now an Act, the Government accepted the argument in favour of preserving some opportunity for ongoing collective procurement of audit services for those who wished to avail themselves of the opportunity, which is what these regulations cover. Although we were not supportive of retaining the Audit Commission with all its former powers, its precipitate demise forgoes the opportunity; we should have used it in some of the roles that are promulgated in these regulations. It is a pity that that decision was taken without thinking through the consequences.

The LGA has created Public Sector Audit Appointments Ltd which is due to manage ongoing audit arrangements. Until April 2015, it is the responsibility of the Audit Commission. It will use staff transferred from the commission, so we are getting rid of the commission and transferring some of the staff into this new body to carry out some of the activities that it was already carrying out in managing those existing contracts. How many staff are to be transferred under these arrangements and what are the expected ongoing annual costs of the new entity through to 2017?

My noble friend Lord Beecham touched upon the best value profiles and the ability of individual authorities to benchmark themselves against others. I understand from what I have read that the profiles will not be preserved in their previous form and therefore will not be available under the new regime.

Both the appointing person regulations and the smaller authorities regulations provide for the Secretary of State to specify the person or persons to appoint a person to appoint a local auditor. For principal authorities and smaller authorities the Secretary of State can specify different persons in relation to different classes of authorities. Will the Minister say a little more about what the Government have in mind in terms of these appointments, whether they will seek to appoint for different classes of authority, what experience they will look for in the person they appoint, how they propose to monitor the performance of such persons and by reference to what criteria?

The noble Baroness referred to the LGA. I do not know whether it is proposed that the existing LGA entity will become involved, whether there will be a new entity, or whether that will be part of the provision. Is it the intention that Public Sector Audit Appointments Ltd will be an appointee? It is noted that no appointment can be made for a financial year before 1 April 2017, but does this imply that the existing contracts will not be extended beyond their current term? I think that they can be extended to 2020. What is the earliest date that the run-on of existing arrangements can be triggered? If there is a desire to run them on to 2020, what is the earliest date when the decision is needed in respect of that?

The noble Lord, Lord Palmer, and my noble friend Lord Beecham touched on capacity. When outsourcing its audit contracts to the private sector the Audit Commission sought, although with limited success, some diversity of providers. My recollection is that most of the contracts went to the big four accounting firms. I think there were a few others, and Grant Thornton featured among them. I cannot remember how many other firms were sought, but there were precious few.

I think that it was the fifth firm. I cannot remember whether there were any beyond that, but there may have been changes in the interim.

What requirements, if any, will be placed upon appointed persons in this regard to seek to bring diversity of providers to the market? The regulations cover the obligation of appointing persons to oversee issues of independence. Generally, this should cover the independence of the auditor from the authority being audited as well as the independence of the auditor from the appointing person. As the Minister said, there has been extensive consultation around these proposals, but significant and authoritative concerns still appear to have been raised in some quarters. I refer first to comments made by the Audit Commission, which chime with those made by the noble Lord, Lord Palmer. How does the Minister respond to the comments made by the Audit Commission in its letter to all noble Lords written in September 2014? I refer to two paragraphs in particular. The first says:

“Currently all local authorities have their financial documents subjected to review by an external auditor. This is at no cost to most councils spending less than £25,000 a year and has a maximum cost to them of £100 a year. Under the current government’s proposals, external checks will not happen routinely for local authorities spending less than £25,000 a year. However these bodies will have to appoint an auditor for when local people wish to contact one with formal questions or objections. Additionally, these parishes and other bodies will have to publish specified information on their website or, if they don’t have one, on the website of the district council. This will inevitably cost more than the current arrangements”.

That is precisely the point the noble Lord made. The commission goes on to say:

“The regulations making provision for all procurement possibilities (exempt opted-out authorities, exempt opted-in authorities, non-exempt opted-in authorities, and non-exempt opted-out authorities) are close to impenetrable. Administering these complex new arrangements will also require any collective procurement body to hold and keep up to date large amounts of information about all 10,000 or so small bodies across the country. This will include contact details, whether they want to be part of the body or not, all the audit appointments the body has made, and all the bodies where auditors have used their statutory powers. This will add to its costs and therefore increase audit fees”.

How do the Government respond to that?

Moving on briefly to the position of the Institute of Chartered Accountants in England and Wales, I should declare my interest as a fellow of the institute, although it is a long time since I practised to earn a crust. A key part of the new arrangements will be the NAO’s proposed Code of Audit Practice. The Minister will be aware of the responses to the draft code as well as the smaller authorities regulations, in particular that of the ICAEW. Although broadly supportive of the code, the institute has expressed some reservations about smaller authority assurance arrangements. It expresses these in two paragraphs in particular, and as an aside I should say that it also refers to the issue of value for money in arrangements going forward:

“We have noted the statement in paragraph 3.6”—

of the consultation document—

“‘should evidence of poor value for money become apparent during the course of the audit, the auditor should consider the implications of this for their work.’ It would be helpful to clarify that this does not require auditors to search for evidence of poor value for money, but rather consider the underlying arrangements where a significant situation might arise which identifies that value for money is not being achieved”.

Is that right and are the Government happy that that is the position?

I now move on to small authority assurance engagements, to which the noble Lord, Lord Palmer, also referred. The institute states:

“As you know, ICAEW has had significant concerns about the government’s proposals in relation to smaller authority assurance engagements. In particular, our concerns have centred around the mis- understanding of the difference between ‘audit’ and ‘assurance’ engagements”.

It goes on to say:

“ICAEW would not be supportive of a change to the definition of audit as suggested by DCLG and we would strongly urge the NAO to also reject moves to create such confusion and to create a new definition. Indeed, as indicated in our response to government on the smaller bodies’ regulations … we would not recommend that any ICAEW member firm take this work on if significant changes to the regulations are not made and that the definitions of audit and limited assurance continue to be mis-interpreted”.

That is pretty strong language, and stronger than I have read in any representations that it has made before. The Minister said that the Government are still in discussion about that, but can she say something more about whether there is any movement or convergence of views on that with the institute? If the institute is advising its members not to engage, that is a very serious blow indeed. If these issues with the ICAEW have not been resolved, and the institute maintains its stance on discouraging member firms from taking on assignments, there is a major problem. Obviously, there is a little time before we get to 2017, but it would be good to know that there was some progress on that matter.

I have one or two further minor points for the Minister. An opted-in authority will not be required to have an auditor panel, but if it does, that panel must not be consulted on opted-in matters related to the audit or the auditor appointment. Why is that provision there? It is not apparent to me as it stands. For smaller authorities, the exercise of the public right to question and object must in future take place within the 30-day inspection period rather than in the period after it. What is the purpose of that change?

I have one final point. Under the transparency code for smaller authorities, there has to be an explanation of any differences between balances carried forward and total cash and short-term investments. How is that supposed to help? As it stands, it could be interpreted in myriad different ways. These regulations are exceptionally complex. We would not seek to stand in their way, and guidance will obviously help, but we hope that the complexity will not defer the opportunity to use this approach, which is an important strand of our discussions on the Bill.

I thank all noble Lords who have contributed to this debate. Like them, I declare an interest in local government, but I do not declare an interest as an accountant—although I declare an interest as being married to one.

The noble Lord, Lord McKenzie, is quite correct that this is a complex area. The more we look into it, the more we realise how complex it is. I will go through the various points that noble Lords made.

I wonder whether my noble friend Lord Palmer is the same Lord Palmer who was on Barnet Council.

I conducted a peer review on Barnet Council some time ago and I wondered whether that was indeed my noble friend.

Marvellous, so our paths have crossed. My noble friend asked about the draft guidance on the limited assurance review and whether it was understood by the accountancy profession. It is well understood by the audit and accountancy professions because it is already in use. It is about European standards and defined in the guide, so I hope I can give him comfort on that.

My noble friend also made a point about internal audit and about there not being enough detail in the guide. It may be helpful if I point out that these regulations and the guide are about external auditors and do not really focus on internal audit. However, that is not to say that we do not agree entirely that internal audit is extremely important.

My noble friend also made a point about vexatious queries and how time-consuming and money-consuming they can be for smaller authorities, asking how the regulations guard against such costs. The regulations allow for the auditors to ignore obviously vexatious claimants.

The point is that a very small local authority would not have an auditor and would have to appoint someone if an action took place. If an auditor was in situ, I am sure that they would behave very responsibly—I have seen them do so—but my point concerns when you have to appoint one. I am sorry for interrupting my noble friend.

I totally understand where my noble friend is coming from. If you are a small authority—for example, a parish council—and someone makes a vexatious claim against you, I am making the assumption, although I stand to be corrected if I am wrong, that the appointing body could do that for you. I understand that that is correct. Therefore, the body appointed by the Secretary of State could do that for you—it could take on the role that a larger authority would avail itself of. I hope that that helps my noble friend.

Both my noble friend Lord Palmer and the noble Lord, Lord Beecham, talked about the limited audit market. The Government’s view is that the repackaging of the audit contracts by a sector-led body could in fact open up the market. That is the hope. It may be helpful for noble Lords to know that we are working with the sector to encourage new entrants.

The noble Lord, Lord Beecham, talked about the turnover of auditors. The NAO will have a key role in complaints, similar to that of the current Audit Commission. I am happy to share with him the letter from Kris Hopkins MP and Andy Sawford MP on this very point if that would be helpful.

The noble Lord, Lord McKenzie, asked about the number of staff to be transferred and the cost of the transfer. If it is okay with him, I will write to him about that. He also talked about the specification and who the Government will appoint as the specified persons. Much will depend on what is put forward by the sector, but it is open to the sector to bring forward specialised bodies. In terms of extending the current contracts, as the noble Lord pointed out, we will run them until 2017. We can extend them to 2020, and we will make that decision in the summer of 2015.

The noble Lord also asked about the independence of the auditor from the appointing person. That is a very good point. The auditors’ own codes and proper practices remain in place under the new regime.

The noble Lord also mentioned the concerns raised by the Audit Commission, which we do not agree with because we are of the view that the new system is cheaper. It is true that smaller authorities may pay more due to no longer being cross-subsidised by larger authorities, as is currently the case, but I assume that, in pooling arrangements, they will try to make those processes more efficient.

In terms of the limited assurance engagement, the limited assurance order is already under way. This will not change. Officials understand that firms are eager to engage with limited assurance contracts and will be meeting them on 2 February.

The noble Lord, Lord McKenzie, mentioned that the arrangements are very complex to maintain for smaller authorities. Smaller authorities will all have to self-certify income, and this information will be held on a spreadsheet just as the Audit Commission holds it, so it is not as complicated as it may first seem. The new regime for smaller authorities is proportionate to their size and the amount of public money that they handle.

I hope I have covered most points. If I have not, I shall write to noble Lords. On that note, I commend the order to the Committee.

Motion agreed.