Treasury Committee

Oral evidence: Appointment of Sir Winfried Bischoff to the Financial Reporting Council

Wednesday 7 May 2014

Ordered by the House of Commons to be published on 7 May 2014

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Members present: Mr Andrew Tyrie (Chair), Mark Garnier, Mr Andrew Love, Mr Pat McFadden, John Mann, Mr Brooks Newmark, Jesse Norman, Teresa Pearce, Mr David Ruffley and John Thurso.

Questions 1-31

Witness: Sir Winfried Bishoff, Chairman of the Financial Reporting Committee gave evidence. 

Chair: You have an audience, Sir Win. They are still coming in.

Sir Winfried Bischoff: Probably for the next one.

Chair: It is possible people are keeping their seats warm for the next session, but we are very pleased also to be seeing you.

Sir Winfried Bischoff: Thank you.

Chair: You are leading off today. I would like to begin by asking you why you applied for this job.

Sir Winfried Bischoff: When I thought about it, one of my concerns and interests has always been the importance of a financial centre, any financial centre—I lived in Hong Kong for quite some time and in New York—and the importance of London as a global financial centre. Good regulation and strong regulation is very positive for a financial centre because ultimately that leads to greater investment. It seemed to me that the Financial Reporting Council, both in relation to the way that it looked at governance as well as accounting and accounting standards, auditing and so on, was just such a body that we need in this country. Therefore, it was of interest to me. It was as simple as that.

Chair: You are certainly well qualified to fill the position, which we have to say has not always been the case in respect of some of the witnesses we have had this year in various other inquiries. I would like to ask a set of specific questions on which I gave you a moment’s notice this morning or just before lunch. Do you support the recommendations of the Banking Commission with respect to the role of the audit and the role of the regulatory accounts?

Sir Winfried Bischoff: In looking at the recommendations of the PCBS, obviously there were a number and one of them was in relation to regulatory audit. Certainly, as far as the FRC is concerned, I know that it is very happy to work together with the PRA in relation to that and to help the PRA set the standards that may be necessary for a regulatory audit.

Chair: Which would be published?

Sir Winfried Bischoff: This would be published.

Chair: You think that would add something, as we did? Is there any aspect of our recommendation on that with which you have reservations?

Sir Winfried Bischoff: No, I do not have a reservation.

Chair: Then you had better help us implement this.

Sir Winfried Bischoff: I have very great sympathy with it. As for the continued publication, however, of audits, I would see the two as going together, but not necessarily in the same document. I would see audit as being an important part, but the regulatory audit being supplemental and being important in relation to financial companies and banks.

Chair: Rather than going through all these recommendations one by one, and there are five, having given you a moment’s notice to reflect on it, are there any that you would like to single out as something on which you have any reservations and, if so, what are they?

Sir Winfried Bischoff: No, I do not have any reservations. As you know, I have views on expected loss and your recommendation on that is something that I very much endorse. I happen to think the prudence aspect is very good. It may take some time to get done, but I think it will be done. I think that is very positive.

Chair: The banking industry is not so enthusiastic in places.

Sir Winfried Bischoff: Not all in the banking industry, but I think a number of my former colleagues in the banking industry would be in favour of it.

Chair: They are not very keen on it when they are in the job, but once they leave it is amazing how quickly they become converted to this piece of common sense.

Sir Winfried Bischoff: Yes.

Chair: Is that what you are telling me? Yes.

Sir Winfried Bischoff: I think that is right. I think there are some of my generation who, in fact, of course, were brought up with expected loss who would still be in favour of it. Perhaps it is generational.

Chair: Well, that was very helpful.

Jesse Norman: Sir Win, can I ask you about the levels of concentration in the auditing sector in the UK? Is that a source of concern to you, with the big four exercising the kind of dominance they do at the moment?

Sir Winfried Bischoff: In ideal circumstances one would have more, a big six or something like that, particularly as it concerns rotation of auditors because obviously the choice is then less. There have been recommendations made in relation to rotation of auditors that I think are very useful. Of course, the concentration is largely at the FTSE 100 end rather than at the FTSE 350 end, but there is a very great concentration on that. It appears to be quite difficult to find, among the next group of auditors, those who feel—this is not just objective but also subjective—that they have the competence to do the audit, for example, on very complicated, complex, global companies. I would like there to be more, but I think those are the facts: we only have four at the moment.

Jesse Norman: One of the arguments that is made, obviously, is that you can only audit a very large global multinational if you have similar scale.

Sir Winfried Bischoff: Yes.

Jesse Norman: Of course, that has not historically been true. Auditing firms have audited local firms and they have had to deal with each other, and sometimes that cross-cutting interrogation can be helpful.

Sir Winfried Bischoff: It can be.

Jesse Norman: I wonder whether or not you think there might be scope for the FRC to try to take a role in promoting competition in the industry.

Sir Winfried Bischoff: I think it is one of the things that obviously has been suggested at various times. It is not our remit and we are not looking for it. It falls elsewhere. I happen to believe that competition, as in very many walks of life, is good.

Jesse Norman: Yes. You would prefer more competition if it could be arranged, if action could be taken?

Sir Winfried Bischoff: If it could be done and if those who provided the competition had equivalent competence.

Jesse Norman: Why do you think it is that those slightly smaller firms are not breaking through? How have the big four managed to erect such impregnable barriers to entry at the top end of the market?

Sir Winfried Bischoff: Do you know, I think it is not necessarily just at the auditing firms. I am not a defender of auditing firms but, in looking at it from the corporates’ point of view who hire, you do tend to look at people who have the resources. Somehow or other the resources of the smaller firms have been concentrated not on the very largest. They have chosen their business model as concentrating on the medium-sized companies or perhaps medium-sized FTSE type of companies; 250 and 350, that kind of thing.

Jesse Norman: Yes. Do you think the big four are too big to fail? They are essentially outside the scope of genuine interrogation because anything that caused one of them to fail, whether competitive or regulatory, would be such a monstrous disaster.

Sir Winfried Bischoff: I do not think they are too big to fail. I suspect that, if there were a major problem, one would need to be more thoughtful than perhaps we were with Andersen, when the whole firm failed. If there were a problem, perhaps a part of it may fail—one would hope not—but I do not think the whole firm is in danger of being too big to fail.

Jesse Norman: Because further consolidation would be disastrous?

Sir Winfried Bischoff: Yes, it would be disastrous, yes.

Jesse Norman: Okay. That is very, very helpful. Thank you. I think that is all from me.

Mr Ruffley: Could I ask, Sir Win, what steps have been taken since the crash to improve audit quality? Can you just list them?

Sir Winfried Bischoff: A number of steps have been taken. One obviously is the most recent step and that is audit quality reviews, which are undertaken by the FRC. We are having a thematic review, for example, on banking audits, and the inquiry into the firms and giving ratings to the auditing firms in relation to their clients. Quite a lot has been undertaken in relation to the standards. The FRC has a very active dialogue with the firms and we point out to the firms where, in fact, they are deficient. There are three standards at the moment of relative satisfaction or deficiency. That may be increased to four.

Mr Ruffley: Are you going to turn those into league tables and put them on your website?

Sir Winfried Bischoff: We are giving consideration to that; yes, absolutely.

Mr Ruffley: There are at least three big criticisms of the auditing firms, those who audited banks’ statements. I will pick three and you tell me whether or not you think this problem has been fixed. One comment was to the effect that a lot of bank auditors thought the regulator was a kind of backstop against bank failure and, therefore, there was a bit of moral hazard going on. Do you think that is still true, that bank auditors perhaps rely too much on the regulator looking at the state of a bank?

Sir Winfried Bischoff: Whether that was ever true I just do not know. It certainly is not true any longer because I think it is very clear that the regulator has a role to play, but he is not the auditor. In fact, some of the recommendations and improvements that we have made include a more qualitative narrative that the auditor has to produce in relation to risk and so on. No, I do not think what you describe is the case. If it were the case, I do not think it is the case any longer.

Mr Ruffley: Fine. Another point raised was that auditors did not want to qualify accounts because, if they did, it might lead to a run on the bank. Has that problem been solved?

Sir Winfried Bischoff: On that one, I do not know enough about whether the major auditing firms would ever have thought that. I am just not aware of it.

Mr Ruffley: My final point is there was a suspicion at least that there was too cosy a relationship between one of the big four consultancies who were offering not just audit services but also management consultants and other advisory services and that this might have led to a conflict of interest when auditors came to audit a bank. Has that been fixed?

Sir Winfried Bischoff: Of course, what has been fixed and what is public is the proportion or the amount of consulting services that are being undertaken. I think it is ultimately up to the audit committees of banks also to make sure that there is not this apparent conflict between consulting services and auditing services. I certainly know that audit committees, not just in banks, are very much more conscious of that.

John Mann: Are you not an odd choice to be chairing this body seeing as you had such a key role at Citigroup?

Sir Winfried Bischoff: I suspect the choice was not made by me. It was made by somebody else and the interview committee and those who appointed me will have borne in mind my role at Citi, which obviously was after the events happened, and my role in Schroders and at Lloyds and on a number of commercial and non-banking companies in the United States, Europe, the UK and the Far East.

John Mann: But Citigroup was one of the biggest disasters in the financial crisis. It was one of the most heavily criticised and Lloyds itself, when you moved on to Lloyds, was found guilty of various improprieties and fined for them. How can you be credible as chairman of this new body?

Sir Winfried Bischoff: As you know, at Citigroup I was appointed interim CEO in November 2007, after, in fact, the disasters happened. I was chairman then for another 15 months until 2009. At Lloyds, I was asked to become chairman in September 2009 and since that time Lloyds has been recapitalised. The taxpayers are beginning to get back their money at a profit. I believe the performance of Lloyds, under the management team that I assembled, was very good. Ultimately, the judgment was not made by me, Mr Mann; it was made by others.

John Mann: I appreciate the judgment is not made by you, but isn’t the problem that you are one of the “insiders’ insiders”? You were there in the middle of it. Vast numbers of people lost their jobs in those two companies and in the wider world— people’s standards of living were down and businesses were going under—and yet you emerge responsible for overseeing corporate governance in the sector. How can that be right?

Sir Winfried Bischoff: I totally disagree with you in relation to Lloyds. I was not responsible for the actions that were being taken there. However, I was a senior member of the management team, but not chairman or chief executive at Citi. If there is a criticism that you are levelling that I was around when Citi got itself into trouble, I think that was true. I was not the most senior executive, nor was I chairman. At Lloyds, I simply was not around when some of the actions were taken that caused job losses and caused losses.

John Mann: My final question: as the regulator, this industry has been a disaster in terms of its behaviour. Shouldn’t people be brought in from outside? Has the country not had enough of the City looking after the City insiders? Your appointment just exemplifies what is wrong with the culture in financial institutions and banking in this country and worldwide.

Sir Winfried Bischoff: I am not the only one, of course. The Financial Reporting Council has a board and has committees. If there is a problem with bankers, I am the only banker on those bodies.[1] The other members are lawyers, industrialists, asset managers and insurance people. There is a broad range of people involved. I do not make all the decisions. I happen to believe we have an outstanding management team, with Stephen Haddrill as chief executive. I will be a voice. Obviously, I will be an important voice, but I have a board that I am answerable to and I have an executive team with which I will be working.

John Thurso: One of the critical responsibilities of the FRC is over the whole area of corporate governance and the Combined Code—it is now called something else, the Code of Corporate Governance or whatever it is—it is your responsibility.

Sir Winfried Bischoff: Yes.

John Thurso: What importance would you give to that side of the work? Can you talk me through how you would like to see that develop?

Sir Winfried Bischoff: I think the corporate governance side is something that I think the broader range of shareholders very much welcomes. As you know, the FRC and the UK have been very good at getting the “comply or explain” principle adopted in quite a number of other countries, which I think is very positive. I think governance also means that you do something that is concise and fit for purpose in terms of much more narrative, which we are asking for. On governance in terms of remuneration, we have, in fact, got proposals out in relation to remuneration that focus on the long-term interests of the company rather than on hiring, retaining and incentivising individuals. There are a number of areas in relation to that. In some of the auditing, we are asking the auditors to be somewhat more discursive in relation to risks and so on. It is a broad area, much to be done on that. There is one other thing and that is the Stewardship Code, and that is how asset managers and those institutions who invest in the company describe their activities, particularly to their investors.

John Thurso: Can I ask you about one area, but I think it is a pretty important area and one that the Parliamentary Commission on Banking Standards focused on quite a lot, namely the composition of boards? If you do not have strong and skilled challenge within the boards and get into group-think, a lot of us believe that is where a lot of the problem comes. Among the recommendations, we certainly said that we should look at the way in which board members are selected. For example, there was a recommendation that non-executive vacancies should be looked at and advertised publicly, things like that. Not so much on the specific but on the generality of the need to get boards that have a wide degree of experience and a strong internal challenge, how will you be looking at what the Parliamentary Commission said and taking that forward?

Sir Winfried Bischoff: We agree with that recommendation. We agree very strongly that boards ought to have a wide knowledge base; a specific knowledge base, not for all members but in my view a strong majority of people who understand the industry in which they operate; there should be diversity in relation obviously to gender; and experience is important. We very much welcome those observations. The PCBS made another observation about who should be leading that, and it should be the nominations committee as a whole rather than the chairman.

Chair: Thank you very much indeed for coming to see us this afternoon, Sir Win. I expect there will be more work and more exchanges between us in the future, but for the time being we are very grateful to you for giving evidence.

Sir Winfried Bischoff: Thank you very much.

              Oral evidence: Appointment of Sir Winfried Bischoff to the Financial Reporting Council: HC 1243                            6