NON-EXECUTIVE DIRECTORS

HC Deb 19 February 1987 vol 110 cc1125-44

Mr. Nelson

I beg to move amendment No. 57, in page 68, line 36, leave out clause 91.

Mr. Deputy Speaker

With this it will be convenient to take the following amendments: No. 58, in page 69, line 5, leave out clause 92.

No. 61, in schedule 3, page 80, line 31, at end insert—

'Composition of hoard of directors

2A. In the case of an institution incorporated in the United Kingdom the directors include such number (if any) of directors without executive responsibility for the management of its business as the Bank considers appropriate having regard to the circumstances of the institution and the nature and scale of its operations'.

No. 62, in page 81, line 19, leave out second 'and' insert '(7A)'.

No. 62A, in page 81, line 22, at end insert 'and in determining whether those systems are adequate the Bank shall have regard to the functions and responsibilities in respect of them of any such directors of the institution as are mentioned in paragraph 2A above.'.

No. 63, in page 81, line 22, at end insert 'and in determining whether those systems are adequate the Bank shall have regard to the functions and responsibilities in respect of them of any such directors of the instil ution as are mentioned in paragraph 2A above and the formal working relationships established between such directors and the auditor or auditors'.

Mr. Nelson

Amendments Nos. 57 and 58 seek to take out of the Bill those amendments which were passed during the Committee stage which provided for the statutory requirement that there should be a minimum number of non-executive directors on the board of the United Kingdom registered banks and that they should form themselves into a majority composition of audit committees with specific remits of considering the financial control structures, the scope of remuneration of auditors, and the compliance of the bank concerned with the probative provisions of this legislation.

In Committee the Economic Secretary expressed some support for the sentiments behind the representations that were made at that time and, indeed, for much of the intention of those amendments. At the same time the Bank of England itself issued a circular to banks, seeking their comments on its proposals for audit committees, involving inevitably a substantial representation of non-executive directors. Ernst and Whinney, in its interesting guide to directors entitled "Bank Audit Committees — A Guide for Directors", said: A recent study of quoted companies by the Bank of England has shown that on average one in three directors is now non-executive and of 60 per cent. of the companies examined, the board included three or more non-executive directors. It was always recognised that the best practices of many joint stock banks would not be affected by the amendments. We were seeking to ensure that, in the medium-sized and smaller banks, and in some more questionable banking concerns, there was a genuine independent and non-executive element which would act as a check not just on the credit analysis and policies arid on the audit and accounting requirements but also on the extent to which the bank complied with the probing provisions of the legislation.

With the background of the Johnson Matthey bank collapse, it is fair to point out that if that representation had been there, and if the right questions had been asked at the time, we might not have had the problems which subsequently arose. As we are in the business of depositor protection with this legislation, I believe — I am delighted that the Committee concurred at the time—that there was and remains a strong case to be made for non-executive directors in the banking sector, apart from the arguments that could be strongly adduced for their election elsewhere in the commercial sector.

I should like to pay tribute to my hon. Friends the Members for Harrow, East (Mr. Dykes) and for Suffolk, South (Mr. Yeo) for their support in drafting the amendments and also for their resolute support in Committees. Standing Committee can play a useful role on non-party matters, admittedly at the margins, in tightening up the provisions of the legislation and enhancing them as we have done.

My hon. Friend the Economic Secretary was good enough to point out in Committee that, while he was unable to accept the amendments as tabled, he would try to import the concept of non-executive directors and seek on Report to go beyond that in regard to their responsibilities. He pointed out—and I accepted then and subsequently—that clauses 91 and 92 would be an improper and impracticable burden to place on the banking sector, and particularly on small banks where it might not be appropriate to have such a large minimum number of non-executive directors. He referred to subsidiary banks where the holding banks might already have non-executive director representation.

For some small, authorised institutions, which, although banks, are largely inactive, and are not trading substantially, it would be a costly and not very effective means of securing a check on the audit activities and the directorial responsibilities of the boards. For that reason I discussed with my hon. Friend the Economic Secretary ways in which his supportive sentiments and the intention of the Committee might be satisfied. The result of those discussions is the amendments which have been tabled.

The amendments seek to provide a presumption that there shall be non-executive directors on the boards of banks but that the Governor of the Bank of England shall retain the discretion to waive that requirement, or vary it, according to the circumstances of individual banks. Amendment No. 61 will meet that need and add to schedule 3 a specific provision on the composition of boards of directors which can mean nothing other than that they shall have non-executive directors. I think I am right in saying that it will for the first time import into company law the concept of non-executive directors. While it is not a departure from the unitary board system and the individual and collective responsibility of all directors for the operations of the company, it will for the first time recognise and identify in law non-executive directors in the banking system. To that extent, it will be a useful paving amendment which may be built on in other parts of company law.

Many people may reasonably say that it is not sufficient to have non-executive directors and to let them organically determine in each bank or collectively what function they will have. Hon. Members will be aware that the character and the role of non-executive directors can vary enormously between companies or between banks. There is little one can do about non-executive directorships being appointments of patronage of the chairman, the chief executive or a controlling shareholder. Inevitably there will be an element of jobs for the boys in the appointment of non-executive directors of banks, or former employees may stay on in a sinecure capacity. However, they will have a non-executive function in that they will not be involved in the day-to-day business of the company.

An inevitable problem is that non-executive directors will go along to a large extent with the views, policies and practices of the rest of the executive board. On the other hand, hon. Members will be aware of many companies, particularly public companies, where the non-executive directors guard their independence and their objectivity zealously and where the executive members of the board and members of the company have a keen interest in maintaining the objectivity, independence and impartiality of the non-executive directors. Executive directors benefit from the non-executive directors asking the right questions at the right time, and indeed asking difficult questions at a difficult time. In that way one can perhaps stave off problems that might otherwise arise. Most companies which use the practice have done so to their advantage.

To try to answer the question as to how the role of non-executive directors of banks should evolve, amendment No. 62A was tabled. It attaches to a later part of schedule 3 additional words which will ensure that non-executive directors have specific responsibility for the accounting activities of boards of directors. While they may involve different means of fulfilling that responsibility in each bank, the significant point about amendment No. 62A is that it refers back to paragraph 2A in amendment No. 61, which directly links the responsibilities of the non-executive directors for audit and accounting to their identity and to the presumption that they must be on the boards referred to in paragraph 2A of schedule 3.

That linkage is a very important adjunct to the initial amendment. The result is that amendment No. 62A can mean nothing other than that the non-executive directors are expected to form themselves into an audit committee. I understand that it is difficult and impractical to import audit committees into law at the moment. My hon. Friend the Member for Kensington (Sir B. Rhys Williams), who has been such a champion of this cause over many years, and I have sought to do this—he through his Bills and I in the amendments moved in Committee. To the extent that it is practical in law, I think it is provided in amendment 62A.

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However, there is a problem with this. Much will depend on how the banks, and the Bank of England in particular, respond to the rather wide phraseology of the two amendments, particularly No. 62A. The amendments would have the effect of taking out the advances already made in Committee and substituting these changes, but first I want to be satisfied—and I sincerely hope that my hon. Friend the Economic Secretary may be able to satisfy me—that the Bank of England itself accepts an obligation, apart from the circular which it has already issued, to follow through on the content of these amendments and to insist that where there are non-executive directors, and in many boards where there are not, there will be audit committees and they will have defined minimum remits to fulfil and a certain degree of accountability, as well as some penalty that they can impose if what they recommend is not followed. Some discussions may already have taken place, and I hope that my hon. Friend will be able to give us as full an assurance as possible concerning the intentions of the Bank of England in this respect.

If that can be done, and if I and other hon. Members can be satisfied that the Bank of England really intends to use the provisions to ensure a much wider representation of non-executive directors and that they do a job of work within the banks, the House and our Committee will have achieved something and it will be an important landmark and an important marker for the future.

Mr. Dykes

I wish to be as brief as possible in following my hon. Friend the Member for Chichester (Mr. Nelson) with a few remarks about this cluster of amendments in his name and the names of my hon. Friend the Member for Suffolk, South (Mr. Yeo) and myself. I fully endorse what my hon. Friend said. He was remarkably skilful in keeping his speech slightly shorter than it might have been, bearing in mind that he is the principal sponsor, and quite a number of other points could have been made. I understand the reason for that and, perhaps rather agreeably for Thursday night, we have reached these important amendments somewhat earlier than might have been expected when the Committee stage began.

What has resulted from the discussions in Committee, from subsequent discussions that may have taken place informally and from the amendments on the Amendment Paper, represents what we as sponsors would suggest is the best balance of all the complex considerations in a very important piece of reform. Without getting too carried away, and with no disrespect to the Government's other changes in the Bill, which have commanded widespread support, we suggest that this is perhaps the most important part of the Bill in terms of additions to it.

The history of the Bill, as was explained on Second Reading and in Committee, stemmed from a series of unfortunate accidents in respect of one institution. It was therefore very much a repitition of the 1979 Act, but with the abolition of the two entities, which were banks or quasi-banks, making them into one in terms of any supervision or surveillance that was being constructed or repeated from the previous statute. This and the other three or four significant changes made by the Government, are the important changes to the Bill.

In putting forward these amendments tonight, we very much hope that the Government and my hon. Friend the Minister will be able to accept what has been suggested by way of a compromise. As my hon. Friend the Member for Chichester said, we do this without in any way yielding or ceding the basic elements of the strategy that was being constructed all the way through my hon. Friend's speech in Committee when the then new clauses 10 and 11 were being promoted by him and others, including myself, because of the current circumstances and difficulties and the need to increase the supervision of institutions where the public's wealth, welfare, financial interest and, indeed, moral interest to some extent, are involved.

This is also carrying out an essential reform, whatever way it may work out in detail, depending on the decision of the House tonight and the Government's reaction to these amendments, which represent something of a compromise on our part. It is a significant reform, going back to what my hon. Friend the Member for Kensington (Sir B. Rhys Williams) has been trying to do over many years, earning the plaudits and the tributes of Members of the House and people outside in so doing, in respect of companies in general. For the moment I think that we can with justification concede that there is a significant difference with financial institutions and banks and other corporate entities may be left for another day, depending on the experience of this legislation if these amendments are accepted by the House.

During the debates on these issues in Committee I was struck by the fact that my hon. Friend the Minister was in difficulties. We recognised that and could understand and sympathise with him, but unless I misrepresent him —it is always easy to do this when one is guessing—he was nevertheless anxious to try to help if possible. However, we have to admit to ourselves as well as to the House that the dropping of what are now clauses 91 and 92, as amended in Committee in favour of what we now deem to be something that might have a better chance of getting through the House, is a major step for us as sponsors of the amendments.

We hope that this will be an inducement to the House to look favourably upon our compromise suggestions and also that it will generate the support of the Government. We are attempting to meet my hon. Friend the Minister's objections and worries in Committee that we were perhaps in phraseological terms trying to overdo things and construct too tight a legislative provision, but none the less to achieve our objectives in this legislative attempt to get non-executive directors inserted for the first time into bank boards.

My hon. Friend the Member for Chichester referred to the lapsing of the specific reference to audit committees. I agree strongly with him that our substitute suggestion, amendment No. 62A, is a helpful way of our putting this forward to the House and trying to meet the Minister's worry that, textually, we were overdoing it, exaggerating and perhaps creating difficulties. Perhaps we can all agree —I say this tentatively—that the essential requirements and objectives of the original amendments in Committee can be met without too tight a legislative and textual end result in the actual words.

This would fit in very well with what was said in the Bank of England's consultative paper, which appeared perhaps somewhat miraculously, and certainly very interestingly in terms of its timing, when the Committee stage was drawing to an end. In its document the Bank of England endorsed in strong terms the idea, referred to indirectly and perhaps somewhat vaguely, for obvious reasons, in amendment No. 62A, but none the less with great emphasis, that the audit committee should have specific and clear duties, and that even if these duties were not put into legislation at this stage — although by implication the Bank of England's presenting letter had legislation in mind as a background possibility —depending on how these were to function first in a non-legislative form, perhaps later they would come into the legislation. I see that as the implication of this whole exercise even if, for obvious reasons, certain people, including the Bank of England, will wish to deny that now.

I refer very quickly to page 10 of the consultative paper and the references to what the members of audit committees should do. I hope that, under our suggested compromise amendments, my hon. Friend the Minister can react to these ideas yet again to reassure us that that is the whole direction of the Government's thinking and policy in line with the Bank of England's ideas and suggestions, even if there is no specific legislative reference now, and I say that with great emphasis.

Page 10, paragraph 5.5, of the document relates to the functions of committee members. With heavy emphasis, the Bank of England document states: The directors appointed to the audit committee should be able and willing to accept the related responsibilitis and should have relevant experience and skills. All members of the committee, including its chairman, should be independent of financial management and of any responsibility for the accounting, internal control and auditing functions in the bank and be free from any relationship that could interfere, or be seen to interfere, with their objectivity and the exercise of their individual independent judgment.

I shall not continue to quote from paragraphs 5.6 and 5.7 because I do not want to weary the House. However, if hon. Members read those paragraphs they will acquaint themselves with the Bank of England's suggestions. The Bank of England's suggestions felicitously fit in with our "compromise" amendments and the suggestions to which my hon. Friend the Member for Chichester referred, which are revealed in the booklet circulated by Ernst and Whinney. Unless I have overlooked something in my mail recently, I believe that that booklet is the only publication that hon. Members have received from any firm of accountants. I hope that I shall not be regarded as vulgarly promoting one particular firm. I do not know that firm personally, although I believe that it is famous.

My hon. Friend the Member for Richmond and Barnes (Mr. Hanley) is familiar with, and I believe is a distinguished member of, the accounting profession. I believe that he has declared his interest in this matter, although not of course meaning in Ernst and Whinney. My hon. Friend will agree that Ernst and Whinney's document "Bank Audit Committees—A Guide for Directors" implies that there is ground for legislation on these matters. Although the debate is still raging, Ernst and Whinney sets out in helpful, precise, elaborate detail those functions which the firm believes audit committees and their members should perform. I refer to the helpful suggestions made in the Ernst and Whinney document on pages 11, 12 and 13. On pages 14 and 15 Ernst and Whinney describe the comprehensive management functions that should be found in any corporate organisation, including banks. Within that list of functions, reference is made to audit committee functions.

Progress is thus being made. The suggestions made by the Bank of England and Ernst and Whinney are encapsulated in the amendments. However, as my hon. Friend the Member for Chichester said, giving up the purposes of clauses 91 and 92 is a big step. I do not know whether we will have the agreement of the House in this matter, and the amendments do not have the effect of the amendments that were originally proposed in Committee. It is incumbent upon the Government—I shall be interested to learn the reaction of the Opposition if they choose to intervene in the debate—to tell us their views on these matters and the way in which they can accommodate the amendments.

I want to make a point that relates to the atmospherics that were evident in Committee. I want also to echo what was said by my hon. Friend the Member for Chichester and pay tribute to the way in which my hon. Friend the Economic Secretary has tried to be helpful. This has been appreciated. None the less, in Committee we were struck by the paradoxes that we have to face. On occasions when there is no party political implication and we are debating legislation that does not raise a party battle, but arises from a consensus in that an emergency has produced a need to update legislation, to tighten supervision and to abolish the distinction between licensed deposit takers and banks—without the conventional political dog fighting that sometimes prevails—there is none the less a reluctance by civil servants to accept changes in legislation. Civil servants, rather than Ministers, are reluctant to make changes that will reinforce and improve legislation. I believe that these changes would not cause any intrinsic difficulty for the Government, and that point transcends the political nature of the party in government.

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I do not believe that other European legislatures have the built-in automatic difficulties that face any Government here. I hope that I shall not annoy any of my colleagues by making that point. However, it is a pity that a macho stance must be adopted in Committee. I trust that I shall not annoy my hon. Friend the Economic Secretary when I say that there is an idea that if a concession is made, that will produce a tearful reaction. I do not mean that literally, but metaphorically. That reaction is often unnecessary. If a general feeling wells up in Committee or on Second Reading that an addition, a reinforcement, a piece of legislative material or an amendment can be brought in significantly to improve a measure, or a marginal part of a measure, there is an over-reaction.

Why is that so? We could have a great deal of philosophical discussion about that, but not tonight. However, it is a pity that that repetitive over-reaction element in legislative debate occurs in Committee. That is less important as a consideration and as a point of hesitation about the meaningfulness of our debates on the Floor of the House. It is much more obvious then that party political dog fights will occur. However, that is not necessary in Committee, particularly when we are discussing banking measures.

I hope that I have not been too long-winded. I have made that point deliberately at some length and have probably risked the wrath of hon. Members in so doing. I hold this institution very dear and believe that by and large it does a good job in promoting legislation, but all too often in debate there is a reluctance to change legislation. Perhaps, to make ourselves feel better, we can point the finger for that reluctance at the civil servants rather than at Ministers.

Mr. Tim Yeo (Suffolk, South)

My hon. Friend the Member for Harrow, East (Mr. Dykes) raised an interesting point at the end of his speech. If time permitted I would like to pursue that, but as it does not I will merely say that, broadly speaking, I concur with him.

I pay tribute to my hon. Friend the Member for Chichester (Mr. Nelson) and to my hon. Friend the Member for Harrow, East. They tabled amendments on this matter in Committee and voted for them. That action distinguished them from other hon. Members. My hon. Friend the Member for Chichester has led with great skill and determination the campaign to make the changes in the Bill. I am glad that since the Committee stage was concluded he has been able to negotiate an acceptable compromise, although naturally I am disappointed that we do not have in the Bill the specific clauses that were agreed in Committee. Nevertheless, we have taken a considerable step forward.

It is especially appropriate at a time when self-regulation is under a certain amount of criticism that we should be strengthening and making specific reference to the role on non-executive directors. Only recently in the banking world self-regulation has shown that it can operate successfully and swiftly. In the aftermath of the Guinness affair, top management has been replaced in what was considered to be one of the most powerful merchant banks. That occurred with a swiftness which could not have been achieved under a different system. Perhaps that will lead in due course to the consideration of non-executive directors in stockbroking firms. Again, recent events may suggest that that would be a desirable innovation.

It is very important, in consideration of the amendments, that we should not overstate the implications of the amendments or the Bill. Nothing that we can do through legislation will eliminate incompetence, imprudence and fraud. Those are facts of life. They are regrettable, but they exist. However, we can establish a good supervisory system and regulatory framework that will detect those abuses quickly.

The innovative nature of today's financial markets is such that new instruments will always be devised, the use of which will test the technical skill of the regulators by seeing that banking in particular is conducted in a proper fashion. We only have to note the enormous growth in the swaps market and the acknowledgment in the document produced jointly by the Bank of England and the federal authorities in America that they are so far unable to produce an acceptable definition of the weight to attach to certain instruments, including some of the new swaps, to see the truth of that. That is an example of a difficulty that will always exist about trying to regulate the banking business.

It comes back to the probity, integrity and independence of the board of directors. The provisions in this group of amendments greatly strengthen both the independence and, I hope, the probity of those directors. The role of good non-executive directors will be crucial in ensuring that banks will conduct their business properly. The establishment of audit committees would also make a substantial contribution.

When the matter of non-executive directors was raised in Standing Committee, the Minister said that there might be some problem about definition because we were introducing into law a concept that was not previously recognised. To illustrate that, I shall cite a conversation that I had with the chairman of one of the big four clearing banks. It was a private conversation, so I shall not identify him. I asked him how he saw his role and he said he regarded it as being that of a full-time non-executive. On initial reflection, that concept presents a paradox. He went on to explain that he believed his job was to represent the outside interests of the bank—the interests of the depositors and the shareholders as opposed, perhaps, to the interests of the management.

When someone in a prominent position in banking describes himself as a full-time non-executive, one is forcefully reminded of the problems of definition, because I rather suspect that those of us who have put our name to these amendments look upon a non-executive as someone who, by definition, is not full-time. Of course he may be paid for his non-executive duties and it is proper that he should be, but his full-time work or most of his work is done away from the institution in which he is a non-executive director. I should be interested to hear whether my hon. Friend the Minister has had any more thoughts about a definition in the period since the Committee concluded its debates.

I echo a good point made by my hon. Friend the Member for Chichester (Mr. Nelson). I hope that, since we have had to give up a specific reference to a minimum number of non-executive directors being appointed and a specific reference to audit committees—because neither of those will now appear in the Bill—the Minister and the Bank of England will make clear publicly that they regard the inclusion of such directors as a matter of the greatest importance for informing their judgment about the suitability of an authorised or potentially authorised institution to be a bank. A public statement of the bank's policy and of the Government's policy about those points would be of immense value. I hope that the statement will refer not only to the matter about the number of non-executive directors, but that it will also make specific reference to the role that they could play in relation to audit committees.

Mr. Cash

I congratulate my hon. Friends on their speeches. Those congratulations are more than justified, given the circumstances in which the amendments were moved in Committee and the way in which my hon. Friends have persevered to achieve as much as they have. As my hon. Friend the Member for Suffolk, South (Mr. Yeo) said, they have not got everything that they wanted. However, that in no way diminishes the importance of the step that has been taken.

I have and will continue to have some reservations about creating what could turn out to be a rather top-heavy audit provision in relation to either banking legislation or companies legislation generally, of which banking is a part. The boards of directors of banks are governed by the Companies Acts every bit as much as directors in other companies. In the field of the non-executive director, our minds are drawn to the question of independence. That goes back to the matter that we discussed during the passage of the Financial Services Act 1986, the importance of which has become a feature of discussions in Parliament over the last few years.

Against the background of the scandals and the misfeasance that have occurred recently, some of which were serious and some of which must not be exaggerated, the notion of independence, of a watchdog, a non-executive director, is increasingly becoming a matter of policy. However, at the moment it has not been explained as such by or on behalf of the Government. The notion is becoming increasingly accepted and those of us who serve on committees and who have maintained an active interest in financial services, in banking and in the troubles that have occurred in the field of company law, are increasingly driven to the view that the independent watchdog, the non-executive director, has the function of maintaining a fiduciary relationship with the members of the company. That role is of paramount importance.

I think that section 235 of the Companies Act 1985 has provisions which require that employees should be fully informed and involved in the policy making of a company. In banks and in other companies there are also people who are called shareholders, and they have a vast interest in what is done in their name. The object of the audit committee proposal and the idea of a non-executive director are to enhance the role of fiduciary relationship which, I regret to say—I know that hon. Members will agree—has been under a considerable strain recently in certain quarters.

It seems to me that we need not merely a total and thorough investigation of the financial aspects of banking or of companies. That is well exemplified in this interesting paper produced by Ernst and Whinney and entitled "Bank Audit Committees—A Guide for Directors". We also need an opportunity to look at the role of the board and the manner in which it exercises its fiduciary relationship. In addition to the provisions in the Bill, I should like to see provisions that are more explicitly defined and aimed at directing shareholders.

There should be a shareholders' committee to complement the role of the non-executive director. That would enable a balance to be struck between institutional investors and the small shareholder. It is a fact of present day life that in wider share ownership, the explosion in the ownership of shares throughout Britain—whether in banking or in other fields such as British Telecom or British Gas—a gap has emerged which needs to be filled. It could be filled by a shareholders' committee along the lines suggested in my Protection of Shareholders Bill and some redefinition of the role of auditor, accountant, solicitor and company secretary. That is a perfectly reasonable proposition and would provide a means whereby non-executive directors and the audit committee, which I hope will eventually come into being, will be supplemented so that they know that when things go wrong they will have an opportunity, either individually or jointly, to turn to that committee. After all, the committee would represent the members of a company, whether they be institutional investors or small shareholders, and they have an absolute right to know what is going on. If there are breaches of criminal law, fiduciary relationship, companies or banking legislation, they have the right to be informed about what is happening. I make no apology if that is regarded as a novel idea; it complements the arrangements that my hon. Friends have introduced, and on which I congratulate them. They have taken a great step forward.

Mr. Dykes

I am sorry to come back to a point that puzzled me earlier. I am not clear why my hon. Friend was so adamantly against the new clauses that we introduced in Committee and which, I am glad to see, he is now supporting. Perhaps he could explain that to the House.

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Mr. Cash

Yes, I can do so easily, although adamant is not the word that I would have used. I was not persuaded at that time of their value. However, having heard the brilliant speech of my hon. Friend the Member for Harrow, East (Mr. Dykes), who could fail to be converted by the logic and emotion with which he addressed the House for about 20 minutes? Therefore, in the light of what has been discussed, I hope that what has been put forward is accepted. I want to take this opportunity to congratulate my hon. Friend the Member for Kensington (Sir B. Rhys Williams) on his determined campaign since 1969, and thank him for all that he has done in this area.

Mr. Hanley

I, too, congratulate my hon. Friend the Member for Kensington (Sir B. Rhys Williams) on his almost unique campaign. It is 17 years since he first introduced his Bill on audit committees. He has introduced such a Bill every year in this House, and when he was in the European Parliament he took every opportunity to try to introduce it there also. Few people have such determination for a cause that seems unattractive at first sight, at least on voting intentions, but which is nevertheless right. I have spoken to his Bills and been a supporter of them since I came to Parliament. Therefore, when my hon. Friend the Member for Chichester (Mr. Nelson) sought to table new clauses 10 and 11 for the Committee stage, I leapt up to support them. It was with great frustration that I found that I was not a member of the Committee. However, I added my name to those amendments because I believed that they were the right way forward.

I was surprised when, through the courage of those who stuck to their convictions, those clauses became part of the Bill on Report. I was not only surprised but, in a way, I was awed because, for the first time in a substantive statute, my hon. Friend the Member for Kensington had seen the birth of the child that he had gestated 17 long years ago. I believe that that is longer than whales, elephants, human beings or any known living creature.

However, there was no doubt that my hon. Friend the Economic Secretary had to take advice and to suggest, perhaps in a mood of compromise, clauses that would go some way towards meeting the national mood of greater control over corporate institutions, while seeking a successful and practical method of achieving that.

I have already declared my interest as the parliamentary adviser to the Institute of Chartered Accountants in England and Wales. On behalf of all accountants, I thank the many members of the Committee who have paid the most marvellous advertising service to the firm of Ernst and Whinney for its excellent booklet. If any firm has been rewarded for its skill and effort in producing such information, Ernst and Whinney has tonight.

I should mention my hon. Friend the Member for Stafford (Mr. Cash). I may be wrong in this detail, but I believe that his grandfather was a founding father of the Institute of Chartered Accountants, and must have known the founding father of Ernst and Whinney. One can imagine those two august gentleman, in Victorian days, meeting at the origins of the institute. Little would they have realised that the grandson of one—

Mr. Cash

The great grandson.

Mr. Hanley

Little would they have realised that the great grandson of one would advertise the eventual product of the other in this House.

The Institute of Chartered Accountants believes that, although those clauses were supportive of the underlying philosophy of the initiatives, they were not practical and would not achieve their objectives. The issues raised by both clauses were considered widely by member firms in the institute and also by the committees of the institute that deal with such matters. In the light of the recently issued Bank of England consultative paper on the role of audit committees, which has already been referred to, and in the light of the response of the Department of Trade and Industry's consultative documents on the implementation of the eighth directive, these matters were given a fair airing.

It was thought that the institute should submit its advice to the Treasury. It did so in October 1985 and in February of this year when it sent a letter to the Treasury stating that the mandatory requirement for three directors could be over-onerous on certain banks, for the simple reason that the size of the bank was in no way taken into consideration in the drafting of the original clause. One could possibly agree to a mandatory requirement for banks above a certain size, but one should allow banks under a certain size to appoint just one non-executive director to the board. The requirements created by the original new clause 10, that all authorised institutions had to retain at least three non- executive directors who would be wholly independent, took no account not only of the size, but of other factors and of the special situations of groups in which there might he a number of authorised institutions.

The institute considered that the appointment of non-executive directors should take account of the size of the bank. It also considered that the Bank of England should establish with the prospective authorised institutions, when authorisation was sought, the development and size of that authorised institution at that time. For those reasons, the imposition of the statutory minimum of three non-executive directors appeared inappropriate. There has been some discussion in the City as to where one could find the appropriate individuals to fill the places that would he created by the statute.

In any event, the institute pointed out to the Treasury that it saw good reason for the retention of a least one non-executive director in all authorised institutions. Indeed, that is the essence of the amendments that have been moved by my hon. Friend the Member for Chichester (Mr. Nelson).

The institute felt that the function and the role of the non-executive director required careful definition. The criteria expressed in the clauses appeared to restrict it, and the Bill already gave the Bank of England the right to establish that the directors of the institutions were fit and proper persons before granting authorisation. Therefore, the institute felt that it would probably be appropriate to leave with the Bank of England the responsibility for determining the suitability, or otherwise, of the proposed non-executive directors. That is what the institute recommended earlier this month, and I am glad that the compromise amendments have been tailored accordingly. I am also glad that the institute's advice was properly taken into account.

Although the original amendments will not see the light of day in the Bill as it passes to another place, this is a momentous occasion. My hon. Friend the Member for Kensington should regard this as a red letter day, not only in his life but in the life of regulation over institutions—in this case over banks, hut perhaps, in future, over companies. However, it is a shame—I am sure that my hon. Friend did not expect this—that the first gleam of light in the history of audit committees and statutes should be at the hands of the Treasury and not those of the Department of Trade and Industry.

It is remarkable that the Treasury should be so understanding of the need for this type of supervisory body. Perhaps the Department of Trade and Industry, which often prides itself as the Department of innovation, will look to the Treasury, which it often regards as a body of people who do not have the vision of technical innovation and advance which it sponsors, and learn from this Treasury legislation. I hope that the Treasury, in its rules and guidance, will set out the detailed provisions that my hon. Friend the Member for Kensington has mentioned on many occasions.

Audit committees are required by companies quoted on the New York stock exchange. Therefore, over many years, they have served not only the institutions that they have helped hut, more important, the shareholders in them. The practicalities of audit committees are proven. In the United States, they have lasted for many years. The fact that these new clauses will lead to this type of audit committee is an important moment in the life of the House.

Mr. Nelson

My hon. Friend made an interesting and important point—it was referred to in Committee—about listing requirements on the New York stock exchange. I shall be interested in his views, not only as an hon. Member but in his advisory capacity to the institute—this matter goes slightly beyond the remit of the Bill—about whether he and the institute would favour such a requirement here. If, in the near future, this provision is not extended in company law more generally, many people will consider that there is an urgent and compelling case for the stock exchange to provide a similar listing requirement.

Mr. Hanley

My hon. Friend spoke forcefully in Committee about the advantages and, indeed, the disadvantages of audit committees. The point that he raised is relevant to these amendments. What will be the influence of the amendments upon other financial institutions? The Institute of Chartered Accountants in England and Wales has not this year stated an official view on the point, but in the past it has issued documentation setting out the role of audit committees, their advantages and disadvantages, and how major companies can set them up.

It is interesting that, in the thousandth edition of the official journal of the Institute of Chartered Accountants, named Accountancy, the editorial should be a cry for audit committees for major companies. Indeed, not long after, my hon. Friend the Member for Kensington introduced his annual Bill, to the general acclaim of those who arc fully conversant with the need for accountability in the City, and it was welcomed by many chartered accountants. It will be difficult for some authorised institutions to find an audit committee of, let us say, three, four or five people.

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The amendments are practical. Because the Bank of England is obliged to satisfy itself that an institution's board has sufficient non-executive representation according to its size, with suitably defined roles, before it can be authorised, the right compromise has been reached. I am certain that the Institute of Chartered Accountants is happy with the final result and would offer its congratulations not only to the founding father of the audit committee, my hon. Friend the Member for Kensington, but to my hon. Friend the Economic Secretary. With his usual wisdom, my hon. Friend the Economic Secretary has found a compromise that will be practical, helpful and, ultimately, of benefit to those who invest in banks, and surely that must be the vast majority of the nation.

Sir Brandon Rhys Williams (Kensington)

The clauses may prove to be an important aspect of the Bill. Therefore, the House is justified in giving the matter a few more minutes. I take the opportunity of thanking my hon. Friends, in particular my hon. Friend the Member for Richmond and Barnes (Mr. Hanley), for their kind references to my long-standing campaign to improve the ways in which the executives of companies can be supervised in the course of their work.

I must correct one point that my hon. Friend the Member for Richmond and Barnes mentioned. I do not think that I introduced the expression "audit committee" into my series of proposals until as recently as 1976. With my first Bill I tried to bring into statute the expression "management audit". The management audit was to be instituted by a shareholders' committee, as I envisaged it, very much along the lines of the Bill that my hon. Friend the Member for Stafford (Mr. Cash) has just brought in, which certainly deserves consideration by the House.

Self-regulation is part of Government policy. We must look to the Government to come forward with specific measures to enhance the way in which self-regulation works in banks and in public companies generally. Obviously, self-regulation is a matter for shareholders' natural prudence; but there is a special reason why it goes a little wider than simply protecting the shareholders' interests, and that is the enormous privilege of limited liability. If shareholders are able to rely on that serious concession, they have a duty to see that companies, or banks, as in this case, are managed in a competent and efficient manner. It is a matter of public interest and shareholders' duty.

How do shareholders exercise supervision? Over the past century or more, businesses have become so complex and so large that it is not possible for shareholders to get an accurate concept of what is being done by the executives who are appointed to make use of their assets. Different solutions have been found in various countries over the course of time. The German solution of setting up a separate supervisory board to watch, on a permanent basis, what the executive board is doing, obviously has many advantages, but that is not the way in which this country has developed its company law. While the Germans were evolving a concept of the supervisory board, we were placing more reliance on auditors. In the 19th century, it first became obligatory for companies to have an independent audit.

We have retained the concept of the unitary board, but, for some reason, in British company practice, it does not seem to be operating as well as we should like. In the United States and Canada, the concept of the unitary board has been retained, but there has been a significant development there that we have not yet followed. Of course, American banks are closely controlled by all kinds of provisions that have not been introduced here—I do not for one moment suggest that they should be—but the practice in America has been to develop the audit committee. It is a pity that we have not moved much faster in that direction. I blame the DTI for its immobilism in respect of the concept of the audit committee. Year upon year, it comes to the House to amend our company law and to add enormously to the scope of it, to add to the power of inspectors, panels, boards, the police and whoever else can bring pressure to bear on companies from outside. That is not self-regulation—one may call it what one will—but outside pressures on companies are not proving to be effective. Thus, we find ourselves in a highly unsatisfactory situation. It is not possible to open the newspapers without reading about some new, unwelcome or unsavoury development in companies and banks.

This is the Department of Trade and Industry's silly triumph. It has resisted the concept of self-regulation, although that is the direction in which we ought to go. I am extremely glad that hon. Members on both sides of the House share my opinion about that. British practice in the supervision of the executives of major companies is too loose and, as one would expect, the executive elements become either too enthusiastic and go much too far or they become sluggish, inefficient and resistant to change and fail to take advantage of new opportunities.

In the case of the scandals that have upset us with regard to the banks—in particular Johnson Matthey, Morgan Grenfell and others, very fine and reputable institutions where things went rapidly wrong—one has to ask what the auditors and the directors were doing by allowing those situations to develop and become so disastrously out of hand. In those cases, I do not believe that the auditors or the directors were necessarily to blame. What is wrong is the system, and that is what we are dealing with in these clauses.

We must freshen up our ideas about the responsibilities of auditors and the way that we call upon them to work, and we must also freshen up our ideas about the responsibilities of directors.

I strongly recommend anybody who is interested in the subject to take the trouble to read the speeches that were made on the last morning in Standing Committee when my hon. Friends—in particular my hon. Friend the Member for Chichester (Mr. Nelson)—forced the Committee to take note of their views on the way in which the Banking Bill should be amended. The debate contained many important comments that well deserve study, and I hope that they will indeed be widely studied. My hon. Friends deserve well of their House for the courage and persistence in insisting that the Committee should take note of their views.

Over the last 100 years there has been a change in the concept of the director in British company law. If one goes back to the 1856 Act—one of the first really important measures that this House introduced in regard to company law—it was then axiomatic that the directors were all independent. The idea of their taking executive responsibilities is virtually excluded by the terms of that Act, because that was not the practice in those days. It is only in the Board of Trade Order 1906 that one finds the concept of the managing director beginning to be accepted. The managing director is really a one-man committee of the supervisory board that is running the business.

From there we have moved on and have now reached the stage where hon. Members say that to introduce into company law the idea of the non-executive director, or the independent director, would be an innovation. But the independent director is not an innovation; he is a relic, who is gradually disappearing. When one examines what those who claim to be non-executive directors are doing, one finds that they may be full-time officers of the company, or that they are serving the executives or the business in various functions and are not acting in a supervisory capacity at all. Because they are so involved in the management of the business they are unable to exercise supervisory functions. Therefore, the supervisory role of the directors is going by default.

I do not accept the idea—which I am afraid emanates from the Department of Trade and industry—that if we refer to non-executive directors or independent directors this will be a catastrophic change and a great new intrusion into company law. It is quite the reverse. It is simply holding from further decline the status of the supervisory director.

How are we, then, to proceed, and in particular how should we proceed with regard to banks? I pay a considerable and warm tribute to the Bank of England for producing its consultative paper last month on the role of audit committees in banks. It is an excellent document. It does not mention my 1985 Bill; it refers only to my 1983 Bill, which shows just how little effect Back Benchers can have, even on those who are most supposed to know the views of this House. But never mind. I pay tribute to this excellent paper. However, it is simply a matter of exhortation.

The bank is asking the various institutions in the City to do what they think is right and to appoint an audit committee. I am afraid that if we rely on exhortation, the consequence normally is that all right-minded people who are efficient and run decently managed companies will do what they have been asked to—if they are not doing it already, while those whom one most wishes to correct, because their conduct is open to question, will find ways to use the audit committee in a manner that is perfunctory — or they may even refuse to appoint an audit committee at all. Therefore, my hon. Friend the Members for Chichester, for Harrow, East (Mr. Dykes) and for Suffolk, South were right when they suggested that the appointment of an audit committee should be mandatory.

I recognise, however, that it is difficult to legislate when there is such a wide variety of institutions, some of which are outside the scope of British company law. Even if we want changes to the law that will catch companies as a whole on a very wide scale, the House has to recognise that banks are a special case and that it is advisable to let the Bank of England exert the pressure which, in another kind of institution, it would perhaps have been better for shareholders to exert on their own behalf.

I believe that independent directors are very important and necessary in banks and that audit committees are appropriate. We must hope that they will become a regular and established feature of the management of banks. Therefore, I accept the compromise amendments that have been worked out and that have been moved by my hon. Friend the Member for Chichester and others. They barely meet the case, but they do meet it for the present, and I am willing to support them. However, I should like to make two comments.

First, the method of conducting the business of an audit committee ought to be spelt out somewhere. There is a wealth of literature on the subject that is based on American and Canadian examples. The way in which audit committees have matured in the last 10 or 15 years in the United States provides us with an example of how audit committees should be operated. If we do not give clear guidance about what the audit committees should be doing, there will be perfunctory or inadequate performance that amounts to nothing, and it will waste the time of the people involved. The Bank of England should issue a further code of practice on what constitutes model rules for the functioning of an audit committee.

Secondly, I am concerned that amendment No. 62A as it stands does not place sufficient, or indeed any, emphasis on the appoinment of an audit committee as a desirable practice. We know what the Bank of England has in mind, but if the clause stands as it does at present it will not place emphasis on the appointment of an audit committee— hence my amendment No. 63, which I beg to move. If, therefore, an institution were aggrieved by a bank decision that it did not meet the minimum criteria — in which case it is permitted under clause 25 to appeal to a tribunal—there would be no reason for the tribunal to support the bank's opinion. Surely it would be best to allude to the relationship formally established with the auditors by the independent directors in the relevant schedule to the Bill.

I ask my hon. Friend the Economic Secretary whether he will at least agree to say specifically that the Bank of England will be acting properly if it follows up the consultation paper on the role of the audit committees in banks by insisting, where it sees fit, that the appointment of a properly constituted audit committee should be part of the minimum criteria.

I would be satisfied if the Economic Secretary agreed to that, because I believe that it would give sufficient guidance to people who might be appointed to an appeal tribunal some time in the future, to show that that was what the House intended, even though it did not appear in the actual text. Better still, I should like my hon. Friend to accept my amendment No. 63, which I believe is fully in line with the Government's policy.

Mr. Ian Stewart

I greatly respect the efforts of my hon. Friend the Member for Kensington (Sir. B. Rhys Williams) who, over the years, has advanced the virtues of non-executive directors and audit committees. I believe that he has undoubtedly played a significant part in encouraging the use of audit committees and in drawing attention to the importance of having non-executive directors in companies and, in this context, in banks.

Before I deal with the points of substance, I should like to reply to my hon. Friend the Member for Harrow, East (Mr. Dykes) and other hon. Friends who have suggested that they have not got what they wanted, but that the Bill is not a bad compromise. It is not a compromise as it would not be practicable — I repeat what I said in Committee — to introduce the type of measures in the new clauses introduced in Committee, because they have wider implications for company law. In the absence of a clear definition of the responsibilities and functions of non-executive directors and audit committees, there are areas of doubt and dispute that could cause significant problems.

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I do not wish to labour the point, but if definitions of the specific responsibilities were attached to nonexcecutive directors they would cut across the general legal position of companies and their boards. Therefore, that would have implications for other areas of company law. Directors could evade performance of their duties by claiming to be non-executive directors. A whole range of issues germane to company law make it impossible to introduce workable provisions of the type that my hon. Friend's clauses seek to provide.

There is no resistance on the part of officials or myself to such changes, but Ministers have a responsibility to ensure that legislation that is passed by this House is workable. It was on that basis alone that I differed with my hon. Friends in Committee when I said that, rather than introduce my hon. Friend's specific proposals, I thought it would be better to introduce provisions on Report that would have the same effect.

I say that by way of explanation because I am glad that my hon. Friend the Member for Chichester (Mr. Nelson) said that he is willing, provided he is given a number of assurances, to withdraw the clauses and substitute the provisions that we have discussed and which I believe meet his needs.

I strongly support the general purpose of the original clauses and the purpose of the amendments now put forward. In Committee there was unanimity in the belief that it was desirable to move in that direction. The only difference between my hon. Friends and myself was a difference of method. In Committee I gave an undertaking to introduce measures, if they could be properly defined, along the lines which are now introduced in the Bill. Therefore, my suggestions in Committee about what should be done have not changed.

I wish to draw particular attention to the significance of the Bank of England paper on audit committees. That paper has been referred to by a number of my hon. Friends. I regard it as a positive statement and that view is shared by the Bank of England. I am aware that it was circulated to members of the Committee and I have placed a copy in the Library so that it is more widely available.

I asked the Bank of England to take account of the comments made in Committee when this subject was debated because I thought that it should be aware of the specific points made and I hoped that it would endorse the proposals. I have a response from the Deputy Governor of the Bank of England in which he states: The Governor and I have been following with interest the debate in Standing Committee on the role of non-executive directors and audit committees. While welcoming the principles which lie behind the new clauses which the Committee added to the Bill, we entirely share the reservations about their practical effect which you expressed; and I am pleased to learn that it is intended to introduce alternative provisions on Report which will emphasise the importance of non-executive directors, whilst giving the Bank discretion as to the requirement for them in individual cases. As my hon. Friends will recall, that discretion was on several grounds: the matter of size is relevant, but there is also a question of company structure, such as subsidiaries and parent companies. The Bank of England must take those matters into account.

The Deputy Governor then referred to the consultative paper and continued: As you will have noticed, the tone of the paper is direct. The Bank is committed to seeing that all major banking groups establish an audit committee and that in all cases, unless there are sound reasons to the contrary, at least one non-executive director is appointed who can undertake some of the audit committee functions. The Deputy Governor asked me to draw that to the attention of the House in this debate and I am glad to do so. It reinforces the provisions now being proposed to be introduced into the Bill. They will be the peg on which the bank can hang its requirements, as part of its prudential supervision, that non-executive directors should be the presumption and that wherever practicable they should be involved in audit committees.

On page 80, the third heading under schedule 3 reads: Business to be conducted in prudent manner. Under that heading, the bank has power to apply to individual institutions the requirements which it deems to be necessary for the prudent management of business of a bank or institution of that kind. If we couple that with the clear firm statement of the Deputy Governor, I can assure my hon. Friends that that means that banks of a certain size will be required, as part of what they need to do to satisfy the supervisor, to have audit committees and non-executive directors.

The importance of that is considerable. It will greatly strengthen the stability of financial institutions. I noted what my hon. Friends said about the implications for going wider into the company sector at large. Obviously, that goes beyond my responsibilities. I can ensure only that the Bill for which I am responsible has the appropriate provisions. Therefore, I hope that the amendments of my hon. Friend the Member for Chichester will be accepted.

My hon. Friend the Member for Kensington said he thought that it would be helpful if model rules were produced by the Bank of England, and I shall draw that to the attention of the Bank of England. The consultative paper is designed to answer several specific questions—for example, questions of size. I would not expect such rules to be available now, but after that consultative process is completed, the Bank, in that area as in all other areas where it requires certain criteria to be met for prudential purposes, will undoubtedly make it clear generally to the institutions what it expects.

My hon. Friend went on to say that, because there was no specific reference to audit committees, the bank could be disregarded in trying to impose non-executive directors and audit committees. Given that it is the intention of the bank to have such provisions, it could not be overruled. It is the Bank of England, as the supervisory authority under this legislation, which will determine, after consultation, the basis of prudent management financial institutions which take deposits. Subject to reservations on the grounds of size or structure, it will require these provisions, and would not regard the requirement that business should be conducted in a prudent manner as being satisfied unless such conditions were met.

My hon. Friend the Member for Kensington asked whether that could be set aside, for example, by the tribunal. The Bank of England certainly would be acting reasonably in insisting on that. It is not the job of the tribunal to second-guess the bank in its judgment on general supervisory requirements. I can give my hon. Friend a full assurance on those points.

I welcome the introduction into statute for the first time of a reference to non-executive directors, as defined in the amendment. This is an important development. It is not necessarily the most important matter that has arisen during consideration of the Bill. Whether or not these provisions were inserted into the Bill, that would have been the requirement in practice as a result of the supervisor's actions. Nevertheless, I welcome the amendment, because it emphasises an important development which is particularly relevant to financial institutions. I shall not try to go wider than that and say what relevance it may have to companies more generally. I note in passing that there are many companies, even quoted companies. The difficulty of recruiting suitable non-executive directors of the right calibre in setting up equivalent provisions for non-deposit-taking companies throughout the economy is a pretty daunting task. Nevertheless, in the case of deposit-taking institutions, this development will be important. Therefore, I hope that the amendments of my hon. Friend the Member for Chichester will commend themselves to the House.

Amendment agreed to.