Banking support

Written evidence from HM Treasury

PAC Hearings on 2 and 8 February 2011

At the PAC hearings on the "Asset Protection Scheme (APS)" and "Maintaining the Financial Stability of UK Banks" on 2 and 8 February respectively, I committed to provide you with further information on:

· HM Treasury’s engagement with the audit profession since the financial crisis;

· The application of section 122 of the Lisbon Treaty and the UK’s financial obligations to the Eurozone;

· Information on how many taxpayers in the 50% tax rate work in financial services; and

· Any enforcement action taken by the authorities against Royal Bank of Scotland (RBS) employee

Audit

Turning first to engagement with the auditing profession; whilst the banking crisis was not primarily a matter of a particular audit that went wrong, as the Treasury Select Committee concluded, it did bring to light deficiencies in the audit framework.

Alongside the Department for Business, Innovation and Skills (BIS), who take the lead in Government on the implementation of standards relating to accountancy and audit, the Treasury has been working closely with the Bank of England, the Financial Reporting Council (FRC) and the Financial Services Authority (FSA) to improve the audit framework. The particular focus has been on:

· Better reporting by the audit committees;

· More disclosures around the "going concern" judgement;

· Investigating the scope for assurance on narrative reporting;

· Enhancing auditor scepticism; and

· Improved processes and standards for supervisor and auditor dialogue.

Some examples of ongoing work in this area may be helpful. They include:

· FRC-led work on encouraging sufficient professional scepticism into auditors’ work. The FRC’s Audit Inspection Unit, in their 2009-10 Annual Report [1] led to the UK Auditing Practices Board publishing a Discussion Paper in August 2010: "Auditor scepticism: raising the bar"; [2]

· The Bank of England and the FSA have been working together to introduce changes to the British Bankers Association Code. Credit institutions will meet regularly with the FSA to discuss relevant disclosure points and related matters for each reporting methodology. There is also a proposal for greater disclosure of changes in accounting methodology, and, for some financial instruments, greater disclosure around: accounting judgements relating to market conditions; complex fair values and complex products; and risks arising from off balance sheet arrangements; and

· Work to follow up the ongoing House of Lords Economic Affairs Committee’s inquiry into audit, to promote dialogue between auditors and prudential supervisors, which was provided for in the 1987 Banking Act, but weakened in the Financial Services and Markets Act 2000. BIS and Treasury officials have been working with the FSA and FRC on this, and feedback on their joint consultation "Enhancing the auditor’ contribution to prudential regulation", [3] is expected soon.

The Treasury, along with BIS, has also been working with European institutions and internationally. For example:

· In the UK’s response to the European Commission’s Green Paper on Corporate Governance in Financial Institutions, we highlighted the potential benefit of measures to improve the frequency and quality of reporting by auditors, and of the need for greater contact between external auditors and national supervisory authorities;

· The UK’s response to the European Commission’s Green Paper on Audit sets out the Government’s view that audit has an important role to play within the broader corporate governance and regulation regime, and highlights the importance of delivering improvements through: enhancing audit quality through improving auditor scepticism; enhancing the content of the report of the audit committee in relation to listed companies; and through exposing the expectation gap in audit; and

· Support for the work of the International Accounting Standards Board (IASB) which has taken significant steps to improve financial instrument accounting, through a portmanteau standard known as IFRS 9 – Financial Instruments. The first phase of these changes was published in November 2009 and addresses the appropriate accounting treatment for, for example, off balance sheet transactions.

Assistance under the Lisbon Treaty

At the Maintaining Financial Stability hearing, the Committee raised some questions about the UK’s financial obligations towards the Eurozone, and whether and how Article 122 of the Lisbon Treaty applies to this.

The European Financial Stabilisation Mechanism (EFSM) was established by EcoFin Council on 9 May 2010. EcoFin Council agreed that up to €60 billion would be available from the EFSM. The EFSM had been established under Article 122 (2) of the Lisbon Treaty, which forsees the possibility of granting Union financial assistance to a Member State in difficulties or seriously threatened with "severe difficulties [...] or exceptional occurrences beyond its control", EcoFin Council decided, given the circumstances at that time, that these criteria now applied.

The EFSM is financed by the European Commission raising funds on capital markets, guaranteed by the EU Budget. There is no direct impact on the EU Budget from any such borrowing by the Commission. Only in the unlikely event that a beneficiary Member State defaults on loan repayments would the EU budget would be affected.

In those circumstances, Member States would be liable for a share based on their contribution to the EU Budget at that time. Contributions to the EU Budget vary over time, mainly driven by the Member States’ share in national income. As an illustrative example, based on contributions to the 2010 EU Budget the UK’s share is approximately 14%. Therefore the contingent liability to the UK from the EFSM loan to Ireland would be around 0.15 billion.

The December European Council agreed that a permanent mechanism to safeguard the financial stability of the euro area as a whole (European Stability Mechanism (ESM) will be established by "the Member States of the euro area" from 2013. The UK will not be part of the ESM, which will replace both the EFSM and the EFSF.

The December European Council also agreed that "as [the ESMJ is designed to safeguard the financial stability of the euro area as a whole ]...Article 122(2) TFEU will no longer be needed for such purposes".

50% Rate Taxpayers

Turning next to the Committee’s questions on the proportion of taxpayers within the 50% tax rate band who work in financial services firms; there are estimated to be 275,000 taxpayers in this band in 2010-11, and of these, around 63,000 are classified as working in the financial intermediation sector. The definition of financial intermediation used here includes those working in banks, insurance and pension funding (excluding compulsory social security contributions) and in activities auxiliary to the financial intermediation sector. [4]

FSA Enforcement

Finally, at the Asset Protection Scheme hearing, the Committee asked about any enforcement action taken against individuals in RBS as a result of the bank’s failure.

The FSA carried out an enforcement investigation into Johnny Cameron, former Executive Director of RBS and former Chairman of Global Markets. The FSA did not find any incidences of regulatory breaches against Cameron and he did not make any admissions. However, on the basis of information available, the FSA believes that Cameron would not meet its current standards for approval for a "significant influence function". Cameron agreed that he would not:

· Perform any significant influence function in relation to any regulated activity; or

· Undertake any further full time employment in the financial services industry.

More broadly, the Government has welcomed the proposal by the FSA to produce a publishable report on the events that led to the failure of RBS. The FSA is aiming to deliver a publishable report to the Government and the Treasury Select Committee by the end of March.

In order to publish such a report, the FSA considers that it would need permission from RBS and perhaps other individuals, to use confidential information provided by them in the course of the supervisory investigations now concluded, as well as those to whom the information relates. The FSA is conducting the discussions with RBS and, where necessary, other individuals, to secure the necessary permissions.

February 2011