Financial Services and Markets Act 2000 (Regulated Activities) (Amendment) Order 2015
(9 years, 10 months ago)
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Lord Newby
That the Grand Committee do consider the Financial Services and Markets Act 2000 (Regulated Activities) (Amendment) Order 2015.
Relevant document: 20th Report from the Joint Committee on Statutory Instruments
Lord Newby (LD)
My Lords, the financial services industry matters greatly to our economy, which is why the Government have taken wide-ranging action to ensure the integrity and stability of financial services in the UK. A framework of legislation for financial market benchmarks was introduced in response to the LIBOR scandal, when the Government took action to criminalise the manipulation of LIBOR and to create further supervisory requirements on administrators and submitters to LIBOR.
Last June the Chancellor announced the establishment of the Fair and Effective Markets Review, which reinforces the Government’s determination to ensure confidence in the fairness and effectiveness of UK wholesale financial market activity. The review is chaired by Minouche Shafik, Deputy Governor of the Bank of England, with Charles Roxburgh, director-general of financial services at HM Treasury, and Martin Wheatley, CEO of the Financial Conduct Authority, as co-chairs. The chairs are supported by a secretariat drawn from those three authorities. The review will report this June.
In addition, the Chancellor announced that the Fair and Effective Markets Review would make early recommendations on which further major financial benchmarks ought to be brought into the UK criminal and regulatory regime originally put in place for LIBOR. Given the widespread use of benchmarks in financial contracts, it is vital that consumers and markets are confident that benchmarks are credible and trustworthy.
In August the review recommended to the Treasury that seven additional benchmarks should be named in legislation. The review considered a wide range of benchmarks in fixed-income, currency and commodity markets—FICC—selecting a recommended list to target those benchmarks where the regulator currently has fewer powers and where manipulation of a benchmark would have the greatest impact on financial markets.
In drawing up its recommended list, the review sought to identify benchmarks that are major FICC benchmarks, those where the main benchmark administration activities are located in the UK, and those based on transactions in financial instruments that are not covered comprehensively by existing market abuse regulation. The Government opened a four-week consultation on these recommendations and held round-table discussions with participants from all sectors of the market. Overall, respondents agreed that the seven benchmarks recommended by the review should be brought into the UK regulatory regime.
Following that consultation, the Government announced in December that they agreed with the review’s recommendations in full. The changes set out in this draft order therefore extend the criminal and civil regulatory regime to cover those further seven major financial benchmarks. These changes will extend the legislation covering LIBOR to the following seven major benchmarks: the WM/Reuters 4 pm London Fix, which is the dominant global foreign exchange benchmark; the Sterling Overnight Index Average—SONIA—and the Repurchase Overnight Index Average, or RONIA, which both serve as reference rates for overnight index swaps; ISDAfix, which is the principal global benchmark for swap rates and spreads for interest rate swap transactions; the London Gold Fixing, soon to be known as the LBMA Gold Price, and the LBMA Silver Price, which determine the price of gold and silver in the London market; and the ICE Brent Index, which acts as the crude oil market’s principal financial benchmark.
Lord Soley (Lab)
I apologise to the Committee and to the Minister for being two minutes late for his opening statement, having been in the Chamber for the Recall of MPs Bill. I then heard the call of the noble Lord, Lord Newby, so I thought that I had better do that instead.
There are just a couple of points that I want to make on this very welcome SI; I have no problems with the thrust of it. The last bullet point in paragraph 7 of the Explanatory Memorandum refers to the European Union introducing powers in 2017. When the European Union brings in those rules in 2017, will we then have totally new legislation to address that? As I understand it—the Minister will correct me if I am wrong—the European Union has not decided on the content of the laws that it wishes to apply but, clearly, if we do not apply it then we will find ourselves with a different set of regulations from those that apply in European Union states. I am not sure whether they will apply to all states, but certainly they will apply to many. I want to be clear about whether we will bring in that regulation here and adjust to whatever the European Union decides after 2017, in which case we will then have to come back to the Floor of one House or the other to pass new legislation.
My understanding is that any criminal charges relating to a breach of the European Union regulations would not apply in the United Kingdom. Any breach of any European Union rule could be a criminal act, as it is here under Part 7 of the Financial Services Act. If that is to be the case, would we make our criminal offence the same as it would be in the European Union? The Minister might need to think about that, but one can see the dangers in that we would have a criminal code operating in new European Union legislation that was different from the criminal code that might apply here in the UK.
The only other matter I wanted to raise is not minor in content but is very brief. It is about where this SI applies to small businesses under Section 11. I recognise that it is very unlikely to have a big impact on small businesses of any type, but it could. I want to make sure that the Government have consulted with not only the British Chambers of Commerce but the Federation of Small Businesses. Is the FSB aware of this? Has it said that it is relaxed about it, from its members’ point of view?
Lord Tunnicliffe (Lab)
My Lords, I thank the Minister for presenting this order and explaining it to us. I also thank my noble friend Lord Soley for coming along to swell our numbers. We have had so many interesting debates just between the two of us that three is difficult to cope with.
As usual on these exciting Treasury SIs, which I am asked by my party to handle, I studied the paperwork with great care. The superficial presentation of the order seems to take seven indices and put them into the LIBOR legislation. I remember that to some extent from our time discussing the Bill, but I had a further look into it. The essence of the legislation is summarised in the August 2014 report by the Fair and Effective Markets Review, which led to this recommendation. It seems to me that the process in fact bears on submittance. On page 5 of the report there is a list of submitters’ responsibilities. The responsibilities of benchmark administrators are overwhelmingly to look at submitters and make sure that they are right. I am very happy to be corrected by the Minister if I have got that wrong.
Since we are using this LIBOR framework—or LIBOR-type acts—as a vehicle for this order, I first ask the Minister how well the FCA has performed its LIBOR role over the couple of years that it has been in place. I made the point about the division between administrators and submitters because if I have read the paperwork properly—I would be only too pleased to be corrected—only two of these indices, SONIA and RONIA, have submitters at all. The full effect of the primary legislation makes sense for those. Can I ask the Minister whether these are here for completeness, or has there been malpractice in these indices? Obviously you cannot prove negatives, but has any known malpractice taken place in the creation and management of these indices in recent times?
Moving on to the other five indices, looking first at ISDAFIX, as I understand it the objective is to make it mechanical. The report I referred to says:
“Where practicable, IBA plans to transition the calculation methodology from this polled submission model to an algorithm-based approach, using tradeable quotes from regulated trading venues as the input for the rate”.
That is the end of the important part of the quote. More recently, the impact assessment says:
“ISDAFIX will be transitioned to a different methodology before April 2015”.
That would create a situation where, as far as I can see, there would be just an administrator. It would be valuable if the Minister could confirm that. Can he also confirm that the transition to the algorithm-based methodology will be completed by April 2015? If that deadline is missed, what is the Government’s intention? Will they use this to supervise the old system, or will they delay the introduction of the new system?
I understand from the paperwork that the gold fixing system is once again in transition. Will the transition to the new gold fixing methodology be completed by 1 April? If not, what will happen?
I was fascinated to read that the WM/Reuters London 4 pm Closing Spot Rate is once again, as far as I can see, mechanical—that is, it is a derivation from publicly available information, or at least market-recorded information, which implies that it is a mechanical index. I am somewhat confused at this when in recent years, and indeed months, we have had scandals in the foreign exchange market. Perhaps these are markets that fall out of the control that the order seeks to relate to. If not, and the order does not relate to those scandals, what are the Government doing to ensure that those markets where we have had problems in the recent past are properly under control?
If I am right in my understanding—I could have great humiliation in a few moments when the Minister explains to me that I am completely wrong—five out of the seven indices seem to be administrator-only. That raises the interesting question: what happens if there is an error? Surprisingly to me, not being a person of the City, there were no civil actions, as far as I know, as a result of the original LIBOR scandal. Looking at it from a distance, one felt that some parties may have been disadvantaged and there would be efforts by them to secure damages from the people who created that disadvantage. The only way there could be a problem with the administrator-only indices would be if there were errors. If there were, though, would the administrators have a commercial liability? If they did, who would pay? The administrators per se, as far as I can see, are not businesses of great substance; they are businesses created for the relatively modest task of administration.
I have a couple of other points. The UK is forging ahead of the EU in this area. I have no criticism of that; it makes perfect sense. My noble friend has asked how the thing will eventually come together, and I look forward to the response to that. However, have any other countries initiated legislation in these areas, and how does that legislation interface with the orders that we are looking at today?
My other question is: why seven? Were other indices considered? None is mentioned in the report, but do we know of other indices that were considered, what were they and why were they not included?
Lord Newby
My Lords, I am grateful to both noble Lords who have participated in this debate, particularly to the noble Lord, Lord Soley, for breaking up our traditional duet. He asked about the relationship between this order and the developing EU plans to do roughly the same thing. Negotiations are going on at EU level in which the UK is actively participating. The aim is that the EU regulation, when it comes forward, will be compatible with these measures. When it comes in, it will replace this order automatically because it will have legal force. However, the aim—there is no reason to think that this will not be possible—is that the EU measure does not require us to make any substantial change to the way that we run this regime. It will come in and supersede what we are doing, but only, as it were, in a legal sense rather than in a practical sense. That is the plan. We do not envisage that we will need to make any significant changes in the way that the administration or the procedures work as a result of that measure coming in.
Lord Soley
How will this measure come off the statute book? Is it because it is identical to another? I understand that this measure will have to come off the statute book.
Lord Newby
I will write to the noble Lord if I am wrong, but I believe that if an EU regulation is passed which covers the same area as existing domestic legislation, it automatically supersedes it under the terms of the 1974 legislation.
As regards criminal charges and the criminal system, the relevant criminal code dealing with any charges will depend on which country the offences are committed in, so if an offence is committed in Germany it will obviously be dealt with under its criminal code, just as an offence committed in this country will be dealt with under our criminal code.
The noble Lord, Lord Soley, asked about consultation with the FSB. I suspect that there was no consultation with the FSB because the kind of businesses we are talking about here are not typical small businesses. I would be extremely surprised if any business that was going to be significantly involved with these indices were a member of the FSB. However, as I said, consultation was undertaken with those stakeholders which are most closely involved at present.
The noble Lord, Lord Tunnicliffe, asked a number of questions. He asked how the implementation of the equivalent LIBOR order had been carried out. That order came in in April 2013, but applies only to activity undertaken after 2013. The criminal cases taken in respect of manipulating LIBOR relate to an earlier period. The charge was conspiracy to defraud and there has already been one guilty plea. We have not taken any cases under this legislation yet as it relates to the recent period. We hope that since it came in there has not been the kind of malfeasance that would require us to use it. The other legislation was used for earlier offences.
On malpractice in relation to other benchmarks, the two benchmarks against which malpractice has occurred are the gold fix, where Barclays got into difficulty due to manipulation, and there was a case involving WM/Reuters in November last year. We are not aware of systematic problems going forward because the new regulatory regime is stronger than it was in the past. However, some problems have arisen with some of those benchmark areas.
The noble Lord asked about the ISDAFIX and whether the change of administrator would be in place in April this year, to which the answer is yes. On Gold Fixing and the change in the administrator, live testing of the new arrangements is imminent and, again, we expect it to be in place before April. He suggested that in future, because of the nature of the benchmark, administration has changed, and it will be virtually impossible for it to be manipulated—certainly not manipulated in the way in which it was in the past. Sadly, it is not quite as straightforward as that. The main change in the methodology is that, in the past, the indices were based on quotes, but in the future they will be based on trades. It is possible that trades could be made with manipulative intent. You could be making real trades with a view to manipulating the index. There is rather more to the system than just a passive, administrative procedure. If somebody wants to manipulate the index they will still be able to do it in theory, although it will be more difficult. That is leaving aside all the rules to try to stop them, but in theory it could be manipulated by trades with manipulative intent.
Lord Tunnicliffe
Am I right that in five of the seven indices the manipulation that happened in LIBOR, which was essentially submitters manipulating the index for their fellow bankers, and so on, would not take place? If someone tried to manipulate the benchmark, particularly in the five I mentioned, he would have to go to the market and alter things happening there. It would be a much more exposed position and probably a rather more expensive one.
Lord Newby
The noble Lord is absolutely right. The point I was seeking to make was that it is not impossible to do it but the costs of doing it are potentially greater.
Lord Newby
Probably more than a case of champagne.
The noble Lord asked what happens if there are errors and who would pay up. If there were an error in the way in which the system worked, the administrators would pay up. That is obviously different from what happens if damages are caused because somebody is manipulating the exchange. If the exchange itself causes errors to be made or makes errors, the exchange will be liable for those errors.
With regard to what is happening elsewhere, we are not aware of any other European country that is planning to do this. They are awaiting EU legislation. Of course London is a global centre for these types of index, which is why it is more important here than in some other financial centres in the EU.
Finally, the noble Lord asked why we went for these seven rather than going beyond. The view was that these were the seven most systemically important indices. We consulted on the scope and whether we should go further and the view taken was that these were the key ones and we should stop at seven. That was thought to be a proportionate response. I hope that I have answered the questions asked by noble Lords and that the Committee will feel able to support the order.