Local Audit (Delegation of Functions) and Statutory Audit (Delegation of Functions) Order 2014

Lord McKenzie of Luton Excerpts

Wednesday 16th July 2014 Grand Committee

[Baroness Williams of Trafford (Con)]

My Lords, this order is one of a number of statutory instruments that will put in place new arrangements for the audit of relevant authorities as set out in the Local Audit and Accountability Act 2014. I do not wish to take up your Lordships’ valuable time by repeating in this debate the arguments that were put forward during the passage of the 2014 Act supporting the abolition of the Audit Commission. However, it remains the view of the Government that the arrangements that we are putting in place, including this order, will create a more efficient audit system, giving greater responsibility to local bodies whilst providing greater opportunities for local people to hold those bodies to account. They will also save £730 million over the five years between 2012 and 2017 and an estimated £1.2 billion over 10 years.

On the specifics of the instrument being considered here today, the order delegates certain of the Secretary of State’s powers in relation to the eligibility and regulation of local auditors to the Financial Reporting Council, which is the independent regulator responsible for the oversight and development of corporate governance standards. Let me provide a little context on its background. The Financial Reporting Council is a company limited by guarantee that is partly funded by the Government. You might also wish to know that its board of directors is appointed by the Secretary of State for Business, Innovation and Skills, and it already carries out delegated functions, similar to those that I will shortly outline, for statutory—that is, company—audits. The functions that this order delegates to the Financial Reporting Council include: authorising professional accountancy bodies to act as recognised supervisory bodies for local audit; authorising professional accountancy bodies to offer a local audit qualification; undertaking significant public interest disciplinary cases and, where appropriate, imposing a range of sanctions on those auditors found to have committed misconduct; carrying out an additional level of oversight and monitoring of audits of significant local public bodies, defined by regulations as “major local audits”; and reporting to Parliament annually in relation to inspections. The order closely follows the existing delegation order for statutory—that is, company—audit approved by Parliament in 2012 and, in article 10, makes a small amendment to that order to ensure that the same minimum consultation period applies to Financial Reporting Council consultations whether the consultation relates to company audit or local audit.

How does the order fit into the new audit framework? These arrangements will simplify the rules that currently apply to auditors by removing unnecessary duplication from the system. At present, audit firms have to work under two regulatory systems—one set by the Audit Commission and the other by the Companies Act 2006. The new audit framework largely replicates the Companies Act regulatory regime, with which auditors are already familiar, to cover local audit. That is not to say that we are removing necessary safeguards or compromising the quality of local audit; the work of the auditors will not change. The National Audit Office will set out what auditors should do to fulfil their statutory duties and, as set out in this order, where appropriate the Financial Reporting Council and professional accountancy bodies will monitor the quality of audit, as they already do for the private sector.

Through this order, the Financial Reporting Council will take on the responsibility for authorising professional accountancy bodies to act as recognised supervisory bodies. These bodies will, in turn, have responsibility for deciding which firms are eligible to undertake local public audit and for monitoring compliance with the rules and practices that they have established, and also with auditing standards. The Financial Reporting Council will also have responsibility for the recognition and supervision of audit qualifications that are not recognised by the Companies Act 2006. In approving an additional qualification, the Financial Reporting Council will need to assess whether it meets the minimum requirements as set out in the Local Audit (Professional Qualifications and Major Local Audit) Regulations 2014—SI 2014/1627—which were laid on 27 June and are subject to the negative procedure.

The monitoring of major local audits will be covered by the Financial Reporting Council. The Secretary of State has specified in the regulations that I have just mentioned which relevant authorities will have their audits defined as major local audits. Briefly, the conditions are that an audit of relevant authorities with either total income or total expenditure above £500 million, or an audit of relevant authorities with local government pension funds with assets in excess of £1 billion or more than 20,000 members, will be considered to be a major local audit. The Financial Reporting Council will also, subject to consultation, be able to give a direction to a relevant authority specifying that its audit will be a major audit.

Why do we need this order? Without the order, the Secretary of State would retain oversight of the whole regulatory framework for local auditors, thus continuing an anomalous position and a dual regulatory regime. As I said earlier, the powers being delegated to the Financial Reporting Council here largely mirror those delegated by the Secretary of State for the Department for Business, Innovation and Skills to the Financial Reporting Council for oversight of the regulation of statutory—that is, company—audit.

Before the introduction into Parliament of the measures included in the 2014 Act, we consulted widely both on the broad policy approach and also in more depth on the proposed framework, through the publication of a draft Bill. Noble Lords may also recall that a parliamentary pre-legislative scrutiny committee provided detailed scrutiny of what is now the Act while it was in draft form. During the Bill’s passage through Parliament, we also provided draft regulations on several of its key provisions to the parliamentary Bill Committee, and last autumn we undertook an interactive public consultation exercise. Over 130 replies to the consultation were received in total, of which 62 commented on the regulatory framework, including the main audit firms which currently carry out local audits and which have been engaged throughout this process.

Nearly 80% of the relevant replies were in favour of the approach proposed for the regulatory framework. This reflects the work that we undertook before consulting, in having regard to the existing statutory framework and engaging with key stakeholders through a working group to make sure the proposals reflect their views. It was found that 71% viewed the Local Audit (Professional Qualifications and Major Local Audit) Regulations as providing an appropriate framework to allow a body to develop a suitable qualification for local audit, and 63% agreed that the proposed thresholds were appropriate to capture the audits of significant local bodies.

Following comments made during the consultation about the role of the Financial Reporting Council, we made minor changes to the order being discussed here today. It now includes a requirement that the Financial Reporting Council consults any bodies whose audits it decides should be subject to additional monitoring by being treated as a major local audit, even though it would fall outside the conditions described as defining a major local audit in the regulations I have just mentioned.

I commend the order to the Committee.

[Lord McKenzie of Luton (Lab)]

My Lords, I thank the Minister for her very full introduction to this order. As has been explained, it puts in place elements of the regulatory framework for the local audit regime. This involves delegating certain of the Secretary of State’s powers to the Financial Reporting Council. As would have been apparent from the debate in another place, we do not oppose this order. As has been said, it is about removing duplication and an attempt to replicate the Companies Act regime for local audit. However, I have one or two questions.

The Audit Commission is to be abolished in 2015. What arrangements are in hand for the management of the audit contracts that were outsourced and are not due to come to an end, I think, until 2017? Has a decision been taken on whether or not they are to be extended? I think there was the option of extending them for a further three years. Paragraph 7.1 of the Explanatory Memorandum makes reference to an “open and competitive market”. Could we therefore have an update on how many different firms are currently undertaking local audit work and how many were eligible to bid under the Audit Commission’s final transfer? Perhaps we could also have an update on the ultimate disposition of those audit contracts—I think some of them were bundled on a regional basis—and how they were transferred, and whether any of those arrangements have had to be unpicked and retendered for one reason or another.

As the noble Baroness explained, the FRC will have responsibility for monitoring “major local audits”. This term has been defined in the recent set of negative regulations, which have been referred to. Can we be told how many major local audits there are expected to be? Reference has been made to the consultation exercise from last autumn and comments received from the LGA about the Financial Reporting Council being involved in local authority audit policy. Would the Minister care to comment on that?

On the Government’s suggested savings, can we be told how much will be saved as a result of the audit arrangements already contracted out by the Audit Commission? I think that was a bone of contention when we debated the Bill.

Subject to the answers to those questions, as I said, we have no difficulty with this order and I am happy to support it.

[Baroness Williams of Trafford]

I thank the noble Lord for being the only person present for the beginning of the debate, and for the points he has raised.

He asked how many local bodies will be undertaking major local audits. We estimate that there will be around 100 to 150. He also asked whether there would be an extension to the existing audit contracts that are in place, to allow for the transition phase. We have asked the LGA to set up a company which will manage existing audit contracts, running to 2017, so I hope he is satisfied by that. We will make a decision on whether or not to extend those contracts in due course.

I think I have answered both his questions. Was there another one?

[Lord McKenzie of Luton]

I think there were one or two. There was one about the savings. I think the figure of £730 million was referred to. I was trying to understand how much of that, if any, relates to the work that was already done by the Audit Commission outsourcing its contracts in 2013 and perhaps 2014 as well. I was also interested in getting an update on how those contracts were actually dealt with when the Audit Commission contracted them out. I do not think they were all done in one contract; I think they were done in a series of regional contracts but I do not have in my mind the totality of how that all worked. Have any of those contractual arrangements had to be unpicked? I think the arrangement was that they were contracts between the audit companies and the Audit Commission.

I am certainly grateful for the update about the LGA being the entity that will monitor and manage those outstanding contracts, and that there is not yet a decision on whether or not they will be extended. If the Minister were able to pick up some of those other points, that would be helpful.

[Baroness Williams of Trafford]

I apologise to the noble Lord. On the £730 million-worth of savings that we have estimated over the next five years and the point that the noble Lord raised about the previous period, we estimate that there were about £200 million-worth of savings. I will write to the noble Lord with an update on who has the contracts and how they are located.

I have a correction. The LGA will set up a separate company, and we are working together for it to do so.

[Lord McKenzie of Luton]

To be clear, is that separate company going to manage the existing contracts as well as possibly looking to amalgamate or centralise contracted audits in the future, or is it just one of those functions?

[Baroness Williams of Trafford]

I understand that a transitional body will be in place to run the contracts at this stage. If the noble Lord is not entirely satisfied with those slightly hurried answers, I am happy to write to him.

[Lord McKenzie of Luton]

I would be very grateful.

Motion agreed.