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EU: Company Law

My Lords, I first declare an interest as a chairman and director of listed companies in the UK, the full details of which are set out in the Register of Lords’ Interests. I am also a former chairman of the audit firm, KPMG International. I congratulate the noble Lord, Lord Hodgson, on introducing this short debate on the eighth directive, which is of great importance and will be of significant impact if the implementation is not got right. I sought to try to understand why the eighth directive was what it is and why it came into being. I studied some of the various utterances of the commissioner, Frits Bolkestein, over the gestation time of this directive. Among the reasons that I could distil were, first, that it was a way of giving us better corporate governance within the European Union and more effective audit performance—which are to be applauded—and to make the EU a more competitive place in the capital markets, thus attracting more inward investment in capital markets. Another aspect was a need to avoid the extraterritoriality of Sarbanes-Oxley. Originally, this directive was postulated as a way of preventing Sarbanes-Oxley crossing the Atlantic. Sadly, it has failed, as we all know. We must learn lessons from Sarbanes-Oxley, as the noble Lord, Lord Hodgson, said—and I will come back to those in a moment. Was the directive a response to Sarbanes-Oxley as a way of imposing our own extraterritoriality within the EU or to deal with offshore centres—again, a matter of great interest to us—bringing them up to the same standards that we expect within the Union? A final reason was to regulate the EU market, thereby restoring investor confidence. All, or maybe some, of those reasons have merit and, therefore, I give this directive a cautious welcome. The high ideals of what it seeks to achieve are generally to be encouraged; but at this point it is important to pause for a moment to consider what happens when you get it wrong. You cannot look for a better case study in getting regulation wrong than what happened with Sarbanes-Oxley. Sarbanes and Oxley are eminent senators who put their Bill together in the United States as a knee-jerk reaction to financial scandals. It moved away from what we have known for years in this country of principles-based, light-touch regulation. The amount of time, money and effort that registrants on the US exchanges had to expend to comply with the initial approach of Sarbanes-Oxley, which was incredibly detailed and very rules-based, has driven capital seekers away from their marketplace in significant numbers. It is no accident that Hank Paulson at the US Treasury is putting great pressure on those who regulate to withdraw a lot of the detail to get the cost of compliance back down. The danger is that we do exactly the same with a directive like this. Let us look at what appeals in this directive. First, a single audit framework to create a competitive audit market across the EU is to be applauded. Secondly, if, in implementation, we can stick to principles-based standards and independence and get away from mandating rules, we will maintain a light touch in the regulation for which this country is well known and at which it has been successful. Essentially, when you distil what is in this directive, there is a lot that you could say is taking a UK template and applying it to the European Union. That is great if that is what we do. The notion of independent regulation based on the home country model, as it were, will minimise cost and it ought to drive improvements in audit quality. Finally, the requirements for transparency are to be encouraged. Given all those aspects of the directive that we see as positive, where are the problems? As with many great ideals, the devil is in the detail and I will give just a few examples—different from those given by the noble Lord, Lord Hodgson—where I think that there are significant difficulties in the detail. First, the application of the directive is far too wide. The Government must seek to exempt small and medium-size firms from the regulations. I speak with particular knowledge of the cost of compliance. The cost of compliance with this directive, if it applies in its totality, to small and medium-size firms will make them unable to engage in the market. Secondly, a number of the definitions within the directive are either far too wide or, at best, far too imprecise. I have seen three people look at article 23 which deals with the provision of non-audit services, and I have been given three different interpretations, ranging from a complete prohibition on an auditor doing anything at all for an audit client—the French model, which does not appeal to me—to something that says that it is only what we have in the UK and that there are certain things that an auditor should not do. We cannot allow that to be used within different member countries in different ways—and I shall return to that issue in a moment. Article 36, regarding the dismissal of auditors, is another example of an imprecise definition. What do ““proper grounds”” constitute? The article states that you can get rid of an auditor only if you have proper grounds. Does the fact that you disagree with him about his fee represent proper grounds? I can assure noble Lords that, in the eyes of many directors, it does. Finally, touching on the point made by the noble Lord, Lord Hodgson, mandatory audit committees are a bit silly. The one thing that works very well is ““comply or explain””. It works well in the UK and it will work well within the European Union. A final example is that we need to be wary of the notion of other member countries gold plating in a way that provides them with protection over their own affairs. I will give two examples. In France, the Code de déontologie, which is at variance with the eighth directive, actually extends extra-territorial service restrictions, adopting the French model of nothing other than audit services. I believe that the UK and the EU should challenge that. In Italy, mandatory audit rotation of firms, not partners, has been maintained. This has been proven not to improve quality; it has added cost and restricted competition within that market. There is no question about that. Italy is also trying to impose extra-territorial service restrictions. Again, I believe the Government should look at this closely. It is my understanding that the Department of Trade and Industry has consulted widely on this, so I do not suppose that any of my remarks will come as a great surprise to the Minister. I urge the Government to take heed of the responses, particularly those on the detail; otherwise, a great opportunity will be lost. In summary, as I said at the outset, I give this a cautious welcome.