Top10,
Thank goodness your father in law has never worked with children. He could potentially be still a risk to your children, I don't care how old he is now. Its what he has done previously that is what matters here. He has shown no remorse for his actions at all has he?. That is in itself telling and points to no contact.
He won't accept any rules your H sets, FIL has no idea of boundaries at all. What if FIL breaks the rules or tries to circumnavigate these?. He has proved as much by his inappropriate actions towards his children when younger.
FIL tried something on which was inappropriate with both of his children at the time; his wife, their mother never suspected anything untoward. She likely had no idea her husband was this way inclined and indeed divorced him for other reasons.
Her reaction as per your comment is somewhat disturbing:-
" DH and his sister have approached their mum about their feelings. Their mum completely denies that it is possible that they really felt like that as children, let alone that it was FIL's fault. I suspect that it came as a shock to her what DH and his sister were saying and to acknowledge for a second that it might be true would make her feel very guilty as a mother (why didn't she know? what shoud she have done? etc...)"
It is also quite telling in its own way (and its quite a common reaction as well for children not to be believed and for their feelings to be denied). She did not fully believe them did she, she did not want to believe that her H was capable of doing such things and her reaction is very sad.
As for his father too touching his half sister on the thigh - that was abuse no two ways about it. How can that be otherwise, she certainly did not consent and that poor girl must have been both confused and scared witless.
All this is making you and your DH very uncomfortable now but attempting to bury it, go into disbelief or denial (your H has certainly done that as have you to a lesser extent) and not inform the authorities is not helping anyone, least of all yourselves. Do not make any allowances at all for FIL, he has got away with an awful lot but he should not get away with it now. Sexual abuse and inappropriate touching which is incestuous does happen within families; far more than people realise. It is truly a taboo subject.
How much do you actually know about this FIL in terms of background?. I am referring to his childhood, adolescence and early adulthood here. His past in terms of relationships is not great, you may well find that his early years were also very troubled (he may have been in trouble with the law for instance or showed cruelty to animals from a young age). He may well have been abused himself as a child and was himself a victim of incest but it is no justification or excuse for his future actions.
I do feel for you both actually; you've got to make some tough decisions here but your main priorities are still yourselves and your children. Not this FIL person, at the end of the day he really does not figure or should not figure. Your H's parents divorced so he is really out of your lives now on a day to day basis at least. I think your H is being far too nice and reasonable here to the man who sexually assaulted him, he needs really to talk to a counsellor (BACP are helpful) about all this and the buried issues it has pushed now to the forefront of your relationship.
Your H's primary loyalty is or should be to you his wife and his children.
From what you write about him as well FIL is a real nasty piece of work as well, a toxic and manipulative individual. I think he will tie you both up in knots if you meet him, do not think he cannot manipulate you. Abusers are not stupid at all, they are highly manipulative and plausible individuals (to those in the outside world). He has been allowed to get away with a great deal to date. His sexual assault on your H should have been reported to the authorities; if he had done this to someone else what would have happened then?. That person would certainly have reported your FIL to the police and rightly so. Your H's shame (a misplaced feeling totally) and yes, embarrassment at being assualted stopped him from shopping his Dad. He has probably wondered on many occasions since why on earth he could not or was not able to stop his Dad doing what he did. Your H likely blames himself for being assaulted by his Dad. It may have happened some years ago now but I would still urge you to press charges against this individual. You can still make a complaint and you would be listened to. How else would he be stopped and or properly face the consequences of his actions otherwise?.
Your H should consider too talking to an incest survivors group.
I do not wish to further upset you here but your FIL may well have kept diaries detailing his abuses. A gruesome thought but one that cannot be fully discounted.
Sexual abusers come in all shapes and sizes.
Abuse is about power and control as well.
If you truly want a workable solution to protect your children he has no contact whatsoever with them. Do the right thing by both yourselves and your child. You will both be forever wondering otherwise and figuratively speaking looking over your shoulder. If he met them you could be wondering if he was having any inappropriate thoughts about them. What if he had a camera with him at say Christmas in a restaurant and wanted to take photographs of your children?.