Public Limited Companies (Financial Regulation)

Part of the debate – in Westminster Hall at 4:48 pm on 13th March 2003.

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Photo of Ruth Kelly Ruth Kelly Financial Secretary, HM Treasury 4:48 pm, 13th March 2003

I start by congratulating the Treasury Select Committee on its report, and its Chairman, my hon. Friend Mr. McFall, on the way he which he introduced this important debate—and, indeed, on securing it. He asked whether we would stand firm on our proposals, and I assure hon. Members that we will. There is no room for complacency on this issue.

I certainly take issue with the comments of Mr. Djanogly, which I thought were extraordinary. The United Kingdom must remain at the forefront of international best practice in auditing and accounting standards and corporate governance. Indeed, our commitment to those issues is widely recognised internationally. It is also widely seen as one of the strengths of the United Kingdom system—one that enhances the efficiency of capital markets.

I welcome the commitment that my hon. Friend Mr. Beard and Norman Lamb have shown on this issue. We must give it priority, which is why my right hon. Friends the Chancellor of the Exchequer and the Secretary of State for Trade and Industry set up the co-ordinating group on audit and accounting issues, which I chaired with the Under-Secretary of State for Trade and Industry, my hon. Friend Miss Johnson, who has responsibility for competition, consumers and markets. Our final report was published on 29 January, and we had valuable input from a wide range of sources, including the Treasury Committee report on the financial regulation of plcs.

Good systems of financial reporting and audit regulation are vital to underpinning confidence in the efficient and effective operation of capital markets. Establishing those conditions requires us to have timely, true and fair financial reporting, underpinned by high accounting and audit standards; effective arrangements for the enforcement of those standards; the independent audit of financial statements; effective corporate governance arrangements; and independent and transparent regulation of the accountancy profession.

As Mr. Flight noted, standards and regulation, although important, can never be a complete defence against individuals who are determined to do wrong. Nor can they wholly protect us against a culture of corporate greed and loose ethics. A zero-failure regime is not a desirable option, but we owe it to savers, investors, employees and all the honest business people whose reputations have been tarnished by these scandals to ensure that our defences are as robust as they can sensibly be.

The package of reforms announced on 29 January will raise standards of corporate governance for listed companies, strengthen our accountancy and audit professions and provide for a more effective system to regulate the profession. Taken together, those reforms are comprehensive and mutually reinforcing. The package is tough where it must be, but measured and proportionate throughout. We have sought to achieve better regulation, not just more regulation. Our approach will ensure that our corporate governance structures remain among the best in the world, and that must be in the interests of the millions of pensioners, savers and businesses that depend on them.

Let me turn now to some of the specific points that were raised. I should probably start with the Higgs report, because that is where the interest of most hon. Members seemed to lie. The first line of responsibility for ensuring honesty and probity must rest with companies and their boards of directors. In the light of the report's proposals on the role and effectiveness of non-executive directors, the combined code on corporate governance will be strengthened to provide that at least half the board, including the chairman, should be independent. Similarly, all the members of the audit and remuneration committees, and a majority of the nomination committee, should be independent. Furthermore, the definition of an independent director should be strengthened and clarified, the separation of the roles of chairman and chief executive should be reinforced, and new descriptions should be given to the roles of the board, the chairman and non-executives.

Derek Higgs's report also contains proposals to improve the way in which top-level appointments are handled. They should promote meritocracy through an open, fair and rigorous appointments process, rather than encourage appointment through personal contacts and friendships. As part of the follow-up, a group led by Laura Tyson of the London business school will study ways of bringing candidates from the non-commercial sector to greater prominence. It will report to my right hon. Friend the Secretary of State for Trade and Industry in May.

There has been a good deal of comment about the Higgs proposals. The Financial Reporting Council is currently consulting on revisions to the combined code. It has stated that the consultation is intended not to reopen debate about the substance of the recommended changes but to get the detail right and to examine the best way of implementing the changes.

I note the comments of the hon. Members for Bury St. Edmunds (Mr. Ruffley) and for Arundel and South Downs about the consultation process, but I urge Members to remember that Derek Higgs consulted extensively. He undertook a great many interviews and a great deal of research, all of which has been published on the web. He sounded out the main representative organisations, including the CBI, about his proposals. His recommendations on the combined code are not drawn out of thin air.

I am confident that the Financial Reporting Council will still consider all responses received from business, investors and others, but the issues should be considered carefully rather than through megaphone diplomacy. That is exactly what the FRC will do. The consultation runs through until mid-April and the FRC, as an independent body, is fully responsible for that consultation.

I completely agree with the comments of my hon. Friend the Member for Dumbarton, the Chairman of the Treasury Committee, who said that the proposals represent the opportunity to change voluntarily. The Higgs proposals are intended to be a statement of best practice, based on the principle of comply or explain. They are not rigid rules. Indeed, they are specifically designed to leave room for judgment, and we believe that such judgment is best exercised by shareholders. In laying out his approach, he has deliberately avoided the rule-based approach of the United States. I believe that that is a great merit of our current system, and one that will continue. We may not have seen an Enron in the United Kingdom, but we have not been immune to numerous home-grown cases of corporate scandal or destruction either. There is no ground for complacency in that regard.

Certain myths have sprung up in relation to the Higgs proposals. One is that somehow the role of senior non-executive director is a new role, but that is not the case at all. The role of senior non-executive director is embedded in the current combined code. It works very well already in many large companies. The intention of the proposals is not to undermine in any way the spirit of a unitary board. The role of chairman rightly remains central, both in managing the board and in the relations with shareholders. Derek Higgs's proposals would complement that role with better communication to the non-executive directors of shareholder views. That opinion was forcefully expressed by shareholders to the Government, and to Derek Higgs when he carried out his review.

The hon. Member for Arundel and South Downs asked how the proposals should apply to smaller companies. In his review, Derek Higgs specifically considered whether there should be a difference in best practice rules between large and small companies. The view that came loud and clear from small companies was that they did not wish that to be the case. They did not wish to be considered in any way as having a second-tier system of corporate governance.

All publicly listed companies have responsibilities to their shareholders. As a matter of principle, Higgs was wary of promoting different sets of standards. That does not mean that he assumed that in all cases all principles would necessarily be appropriate. In fact, he specifically recognised that many small companies may wish to explain rather than to comply. There are no deadlines for the implementation of his proposals; it is up to the individual company to explain to its shareholders the principles that it decides to follow. That comment was reflected in the debate on Higgs that took place after the statement by my right hon. Friend the Secretary of State for Trade and Industry earlier this year. She said:

"Let me stress and develop . . . the need to avoid one size fits all."

She explained that the proposals did not apply to alternative investment market listed companies. She added that

"the circumstances of companies, especially smaller companies, that fall within the scope of the combined code will be different. It is important for the FRC to reflect that in the wording of the revised code and explain why we rely on comply or explain."—[Hansard, 29 January 2003; Vol. 398, c. 887.]

The report of the co-ordinating group on auditing and accounting emphasised the importance of the audit committee in overseeing the financial reporting of the audit processes of listed companies. We believe that effective audit committees are central to restoring confidence in capital markets and that their role and membership need to be strengthened. In that respect, we welcome the work of the FRC group, chaired by Sir Robert Smith. The group has developed the existing combined code guidance for audit committees.

The Financial Reporting Council's proposed revisions to the combined code will also implement the recommendations of the Smith group that the audit committee should consist of entirely independent members, at least one of which should have relevant financial experience, monitor the auditor's performance, especially on independence and objectivity, and develop and implement policy on the purchase of non-audit services from the auditor, with reference to tough new ethical guidance. Following well established practice, listed companies will be required either to comply with those provisions or to explain to their shareholders why they are not doing so. The comply or explain approach is one of the great strengths of the UK system.

A second major aspect of the reforms concerns tougher measures to underpin auditor independence. Following the recommendations of the co-ordinating group, the Government have announced that, as well as an enhanced role for audit committees and a tightening of the provision of non-audit services by auditors, the professional bodies have already changed their regulations so that the lead audit partner must be rotated within five years, and partners and senior employees of audit firms will not be able to take up employment with the company that they audit within two years of leaving the audit firm.