EU: Financial Regulation (EUC Report)
Lord Harrison
That this House takes note of the Report of the European Union Committee on The post-crisis EU financial regulatory framework: do the pieces fit? (5th Report, Session 2014–15, HL Paper 103)
Lord Harrison (Lab)
My Lords, in the welcome presence of the noble Lord, Lord Boswell, I am delighted to introduce the EU Committee report, The Post-crisis EU Financial Regulatory Framework: Do the Pieces Fit. The report was the product of the work of the EU Economic and Financial Affairs Sub-Committee, which I had the honour of chairing for five years, up until the general election. I now speak as a former chair, having been succeeded by the noble Baroness, Lady Falkner of Margravine, who I am also very pleased to see here today. I wish her every success in her new role, in particular given the interesting times we continue to live in.
Indeed, it was precisely those interesting times that prompted the sub-committee to undertake this inquiry. Following the outbreak of the financial crisis, the European Commission introduced no fewer than 41 legislative proposals—and the alphabet soup of acronyms that followed—resulting in a radical transformation of the European Union financial sector regulatory framework. Rules, supervision and institutional structures have all been affected and EU law has significantly increased, both in breadth and depth. The sub-committee decided to launch an overview of these significant reforms. Were they necessary and proportionate? What went right and wrong in responding to the crisis? How did the European Union institutions perform and did the reforms have the desired effect?
We took evidence over a period of several months from key witnesses, including: our own Government; Michel Barnier, the then Commission vice-president responsible for the internal market and services; two deputy governors of the Bank of England; the Financial Conduct Authority and the PRA; and two of the new European supervisory bodies, known as ESAs—the European Banking Authority and the European Securities and Markets Authority, or ESMA. We were ably assisted in our work by Professor Niamh Moloney, Professor of Law at the London School of Economics, who acted as specialist adviser for the inquiry. We are grateful to Professor Moloney and to all our witnesses. I am also personally grateful to Katie Kochmann, our policy adviser, and Stuart Stoner, our clerk whose sharp intelligence and unstinting industry have been rewarded with a deserved promotion to the Select Committee.
We began by assessing the objectives behind the proposals. These included: restoring and deepening the single market in financial services; establishing a banking union; building a more resilient and stable financial system; enhancing transparency, responsibility and consumer protection; and improving the efficiency of the European Union financial system.
We assessed the performance of the European Union institutions. We found that they were placed under considerable strain by the crisis. However, given the magnitude of the task they faced in responding to a once-in-a-generation crisis, we found that they performed well. Nevertheless, the sheer scale of the legislative reforms inevitably meant that the resulting framework contained passing weaknesses. In particular, the expected high standards of consultation and impact assessments were not always maintained. Can the Minister ensure that these will be restored to the premier position they deserve when discussing any of the new financial changes that will happen?
A principal focus of our work was an assessment of the new European supervisory authorities. They have endured a baptism of fire since their inception in 2011. I was very pleased that, six months later, we produced our first report—I think we were the first institution to do any analysis of their role. They have been responsible for much good work yet they are hampered by several fundamental weaknesses, including a lack of authority, insufficient independence, marginal influence over the shaping of primary legislation and insufficient flexibility in the correction and tidying up of the legislative errors that inevitably happen. Above all, they suffer from inadequate funding and resources—something we found in our 2011 report. In our view, the powers and authority of these agencies needed to be enhanced. I would be interested in the Minister’s view on how that can be achieved.
There are some oft-cited cases of flawed legislative reforms, including the alternative investment fund managers directive—the AIFMD—and the bank remuneration provisions in the capital requirements directive IV as well as the contentious plans for a financial transaction tax. The sub-committee expressed grave concerns about the latter proposal throughout my time in the chair, which included two sharp and critical reports, yet discussions continue on this doubtful project. They rumble on. Will the Minister update the House on what is happening with the financial transaction tax?
Yet these cases were exceptions. We found that the bulk of the new regulatory framework was necessary and proportionate and, significantly, would have been introduced and implemented by the United Kingdom in some form, even if action had not been taken at European Union level. This was particularly so because so much legislation derived from G20-driven international standards on financial sector regulation, where the then Prime Minister Mr Brown must be given his proper credit.
That being said, we found that not enough consideration was given to the general, overall effect on the financial sector of such a huge programme of reform. In short, the cumulative impact of the reforms was not always fully calibrated or appreciated. Many of the reforms were understandably designed to strengthen the resilience and transparency of the financial sector, yet a by-product of this focus was a belated recognition of the importance of the growth agenda. In this important discussion, I hope the Minister will fully take on board the importance not just of completing the financial services single market agenda but of the single market as a whole. Will he update us on President Juncker’s €300 billion financial injection, much of it private money, in order to get the economy of the European Union going again?
In the light of our concerns, I am pleased at the approach taken by the new Commission. First Vice-President Frans Timmermans has placed great store by the Commission’s better regulation agenda, including enhanced impact assessments, better stakeholder consultation and a recognition that the Commission should be judged by the quality of its output, not its sheer quantity. Likewise, the new Commissioner for Financial Stability, Financial Services and Capital Markets Union, the noble Lord, Lord Hill of Oareford, has made a commitment to review the cumulative effect of these various reforms. In addition, his commitment to such proposals as capital markets union as a tool for growth and investment also bodes well. We were very pleased to complete our capital markets union report before the end of my chairmanship. I hope that it will be discussed in this Chamber at a later date.
Our report was entitled The Post-Crisis EU Financial Regulatory Framework but, as noble Lords are well aware, the crisis continues to deepen in Greece. The robustness of the new framework, including key measures such as the single supervisory mechanism and the single resolution mechanism for EU credit institutions, is likely to be tested like never before, and the first few weeks seem to have done so.
Meanwhile, we have our own concerns here in the United Kingdom. Our report stressed that the implications of these reforms for the United Kingdom are immense, given that we have the largest financial sector in the European Union. We expressed concern that the UK’s influence over the European Union financial services agenda had diminished, despite the appointment of the noble Lord, Lord Hill, and stressed that the Government and other UK authorities, including the City of London, needed to take urgent steps to correct this, and to enhance the UK’s engagement with our European partners.
We also stressed the need to convey the message to all in Europe that the prosperity of the City of London, and the financial services industry that it hosts, is in the interests not only of the United Kingdom but of the European Union as a whole. Again, I hope that the Minister can give us an assurance that these points will be borne in mind as negotiations on the question of UK membership of the EU progress in the coming months.
I was very pleased to attend, again with our clerk Stuart Stoner, the parliamentary conference of the IMF in April, and Madame Lagarde was very pleased to receive from my hot sweaty hands a copy of this report, which she promised to read. This again demonstrates that we can have an influence by doing the studied work that is typical of this House, and I thank colleagues not just of the committee that I have left but those over the five years that I sat on it and had the pleasure of chairing it. I thank them for all their help and hope that the noble Baroness, Lady Falkner of Margravine, will enjoy her period in the chair in the coming five years, which will be testing indeed.
The Earl of Caithness (Con)
My Lords, the noble Lord, Lord Harrison, paid a fitting tribute to the staff of the committee, to the participants and to the quality of our witnesses, and I can do no more than say amen to what he said. I pay particular tribute to the noble Lord himself. He chaired the committee wonderfully well for the two years that I have so far sat on it. It is a very diverse committee—on the one hand there were some very strong Europhiles while on the other there were people who wanted to get out of the EU, and still do—yet, thanks to his guidance, we always managed to produce a unanimous report. That is a tribute to his skill. We will miss him but are also delighted that the noble Baroness, Lady Falkner, has taken on a pretty warm seat.
The EU has done a formidable amount of work since the crisis of 2008, with a large number of directives and regulations in a short time. It is probably unique in the EU’s history. Our report poses the question: do the pieces fit? Yes, they fit pretty roughly, but you would expect that from western European countries and the Commission. A more pertinent question is: do they solve the problem? That is more difficult to answer, because obviously a lot of stuff is yet to be implemented and the jury is still out. Still, I shall offer my initial opinions, which I have to tell your Lordships have hardened quite considerably since we produced the report.
Sovereign debt is not mentioned in our report but the European Systemic Risk Board has just reported after three years’ work on the question of sovereign debt. It has said that the favourable regulatory treatment of institutions that buy the debt leads to a continued high-risk strategy. Its recommendation is to do nothing.
The worldwide banking system remains flawed. Unlike companies, banks rely almost entirely on borrowed funds, including money from depositors. That allows them to take bigger risks, and they will crash the economy again—it is only a question of when. It is a greater risk for us in Europe because of the euro, which has a systemic hole in the middle of its heart: member states do not control the currency in which they issue debt.
On banking union, as we mention in paragraph 22 of our report, it was a big mistake that the third leg of the stool, the deposit guarantee mechanism, was dropped. That three-legged stool, which had a bit of strength and balance, is now a wobbly two-legged stool.
It is also interesting to note that some of the Governments that helped solve the 2008 crisis are now in deep trouble themselves and need helping out of the mess that they have got into. Looking back, like many people I was rightly angry at the way that some of the bankers had behaved—but they were a small minority. They took us right to the brink, and caused and are still causing a huge amount of pain. Undoubtedly, however, there has been more regulation than was necessary in those areas that needed attention. The solution to the crisis, which rightly started out at an international level, was expanded considerably at the EU level. Some politicians fed the flames of the anger I have described. Doubtless we all recall the words of President Sarkozy of France at Davos in 2011, and what he said pleased the press and the anti-bank movement a lot.
Bankers were blamed for everything, and when the witch-hunt has started, it is very dangerous to behave or even look like a witch. The result was that the repercussions went way beyond the banks, and most financial service industry and even non-financial firms were caught up in the “Barnier Bible”, Commissioner Barnier’s 41 pieces of legislation. As the noble Lord, Lord Harrison, said, some of the resulting legislation was ill-conceived and due to political pressure; we mention that in paragraph 5 of our summary.
Once the ball was rolling, there was no stopping it. However, I find some comfort in noticing the difference between Commissioner Barnier’s approach and that of the Commissioner my noble friend Lord Hill, whose stated objective is to have the minimum amount of regulation. Let us remind ourselves that 400 of Commissioner Barnier’s regulations have yet to pass into law. Let us also not forget that prior to the financial crisis and the introduction of all these heavy regulations, the City of London was a big contributor to the tax receipts of HM Treasury and the Government. The new rules have substantially reduced the profit of the financial institutions and hence their ability to pay tax.
In the committee we discussed an ongoing concern: namely, what is the UK’s input into all of this? It is hard to judge, but we are reassured by the Government that HMT was fully involved. My experience is that it tends to be more involved than it is given credit for, but I remain sceptical. Even this morning, evidence was taken from the Financial Secretary, David Gauke. It was on a different subject, but he said that there is no Government involvement at all—and that is with the own resources of the European budget. That is a serious concern, and it shocked all of us in the committee that he was so blunt about it.
However, if the UK had serious input into regulations and directives such as MiFID and AIFMD, why are they so burdensome on the industry with no good effect? In our recommendation in paragraph 164 we deal with proportionality for smaller firms, some financial service providers and non-financial firms. While it is perfectly true that having one regulator for the whole of European business is of huge benefit for our global investment firms, the smaller national firms are being severely compromised by the increase in regulation and the cost involved.
I gave an example of a firm in the debate on the Queen’s Speech when I spoke on 4 June in col. 612. I now add that that firm has had a fourfold increase in compliance administration personnel in the last four years and that its annual spend on insurance and regulation this year is up 40% on 2013. With all the extra regulations to come, there is a continued state of change, challenge and fear for small companies.
Were the Government aware of the consequences of these regulations? Does my noble friend Lord Ashton agree that that business could not set up today because of the costs and extra regulatory burden, and that we are already witnessing an amalgamation of firms into even larger companies in order to stay in business? The consequent lack of choice and diversity is bad for the market and for Europe in general. The implications are more severe for the UK than for other member states—as the noble Lord, Lord Harrison, rightly reminded us, we are the financial centre of Europe, and if we suffer, so does the rest of Europe. What discussions have Her Majesty’s Government had with the Commission to correct these excessive burdens?
I, too, must touch on chapter 3 of our report, which deals with the European supervisory authorities. In response to our report, the Government stated that the ESAs will need to continue to ensure that their rules are proportionate and do not overburden industry and regulators with unnecessary guidelines and standards. Who is doing that? Who is keeping a check on the regulators at European level? There is also concern at national level that our regulators are vying with each other to show their virility. Issuing the biggest ever fine is undoubtedly good news for their reputation and pleases those who are against the financial services industry. We need to keep a very careful eye on this. How is my noble friend controlling our national regulators?
Misconduct can be handled in a number of ways, and we have seen some horrific displays of misconduct in financial services. My noble friend will be aware that the Fair and Effective Markets Review, launched by my right honourable friend the Chancellor of the Exchequer and the Governor of the Bank of England in June 2014, has just reported. This is an important area. An effective market and an effective form of behaviour can reduce the amount of regulation. What are the Government doing to encourage the Bank of England and the FCA to promote their report globally, so that there is an international agreement? When are the report’s recommendations for the UK going to be implemented?
I was very fortunate to serve on the committee at a time of such an interesting revolution in the way the financial services industry in both Europe and the world has changed. As I said at the beginning of my speech, my thoughts have hardened: too much has happened in too big an area, and although the consequent fallout has yet to be fully felt, when it is, we will be all the poorer for it.
Lord Flight (Con)
My Lords, I have much enjoyed the four years I have spent on the committee. As the noble Earl, Lord Caithness, pointed out, there was a wide range of views but we never had any problem in reaching compromise and agreement. The quality of the reports we produced and the use to which they were put were significant: they have had an impact not just in this country but throughout the EU. I thank the noble Lord, Lord Harrison, for the civilised, human and excellent way he chaired the committee, and our excellent clerk, Stuart Stoner, and the rest of the staff.
The committee was really one of the only places where European law and directives got any sort of scrutiny at all in this country. It was hard work grinding through it all—nearly every week, yet another provision had to be addressed and the Government advised about it. It was indeed a never-ending stream.
I learned a lot from my membership of the committee. In particular, I well remember a visit to Frankfurt and Berlin. I was very keen to ascertain Germany’s position on the basic argument that if the euro is not to fall apart, Europe needs to come together politically and economically, and it needs a system of transfer payments from the more successful and more competitive economies to the less successful economies. However, the universal answer that came from Germany was “Not a pfennig”. There was an absolute “no” to any form of transfer payments to the less successful parts of the EU. I am afraid that, to me, that means that the euro will not be able to succeed as a currency and will go the way of the last European currency, which was in place from 1863 to 1893.
A second point about Germany that I found quite extraordinary was the failure to understand that if you take austerity measures which grind an economy into the dirt—leading, for example, to a collapse of 25% of GNP, as in the case of Greece—you are likely to get a nasty political reaction. Of course, the Treaty of Versailles after the First World War did just that to Germany, and Germany had a most unfortunate political reaction in its turn. However, the Germans seemed not to understand that point at all.
Turning to the report, I think we can say that it is a very professional, thorough and useful chronicle of EU regulatory initiatives and policy since 2008. As the noble Lord, Lord Harrison, pointed out, there was what I would call some polite criticism of a fair amount of what we felt to be overkill and perhaps wrong, but the report certainly refers to the main flawed items at that time. The great objection to AIFMD was that it was introduced to attack hedge funds but ended up embracing perfectly straightforward investment trusts and virtually anything other than a UCITS, imposing a huge and expensive body of work and reports that nobody reads. The bank remuneration arrangements simply serve to raise fixed salary costs to banks, which is hardly desirable, and we have not yet lost the threat of a financial transaction tax.
Although I agree with the report that much of the regulation would have been enacted in the UK anyway and that it was not specifically an EU initiative, I do not really agree that all the new regulations that have been introduced are needed or proportionate or that they achieve anything very much. I think that there has been a misguided and often wrong reaction to the financial crisis, particularly in Europe, where most of the problems have been about the euro, in contrast to the specific banking problems that this country experienced.
I like to try to step back and look at the enormous increase in regulation in recent years and to ask what it is contributing. We have gone down a route of extraordinary micromanagement and prescriptive regulation, the costs of which—ultimately passed on to ordinary savers and companies—are enormous. We have three layers of initiative: the international and US layer and the EU layer, and our own UK gold-plating of much that comes from both those sources.
Professor Gower would turn in his grave if he could see what has happened to the very sensible regulation which he introduced. His basic principle was about principle and about encouraging integrity. The plethora of overprescriptive regulation serves almost to remove the whole fundamental issue of requiring principled conduct and integrity. It is all about thousands of different rules and asking whether they have been complied with correctly. We now have a plethora of new bodies, with people not understanding what most of them are about. We have the FATF, FATCA, the FSB, the FSE, the ESAs, ESMA, MONEYVAL, the EBA and the JMLSG, to mention just a few. In 2001, the FSA had a staff of just 600; today, the FCA has 4,000 staff and the PRA more than 1,000. Coming down the pipeline are 420 pieces of EU level 2 legislation to be introduced. Within the financial services industry there are about an extra 100,000 people working as compliance employees. The FCA now has 16 handbooks of rules with 4 million words and, as I have said, huge costs are imposed, ultimately on the customers of the industry and often to little point.
To my mind, it was a mistake for the UK to surrender sovereignty in financial services to the EU. Of the 20 main measures of the last decade, I think that approximately half would have happened anyway and half very much reflect specific EU policies and objectives. There is a big issue that, although 28 EU countries—maybe it is more than that now—control the legislation, 22 of those countries have no skin in the game.
I have talked about the problems of the AIFMD. Another area that needs to be mentioned is MiFID II, which is now imposing upon what we used to call stockbroker private client activities some, I think, quite ridiculous requirements. Just yesterday, I heard of a case where an individual went along wanting a significant amount of wealth to be managed and was given 120 pages to digest and six different forms to sign—he ended up walking away saying, “You must be mad if you want me to try to digest all this and sign anything”. Also, unless older clients specifically say that they require a bold investment approach, they are put under what is viewed as a more cautious approach for older people, and that means a significant amount of government bonds—arguably government bonds are about the highest risk investment category for the next five years, as and when interest rates return to normal.
The latest issue, and since our report, is the EU fourth AML directive. I wonder whether Members of this House are aware that everybody now will become a politically exposed person. If you are a PEP, your bank has to monitor every transaction over your account and, if anything looks to be slightly out of the normal, report it as a potential source of corruption. The cost of doing this sort of thing is absolutely enormous. That is why banks are increasingly sacking their PEP clients. But PEPs are not just Members of the other place and of the House of Lords—they are their spouses, their children and their parents, if alive. It is a completely and utterly ridiculous system that has been brought in, particularly when I think that the power of Back-Bench Members of Parliament and working Peers to engage in corruption is virtually non-existent anyway —so watch out.
It is now also very difficult to do business with many emerging economies. If those emerging economies do not meet the required FATF standards, the bank of an exporter cannot accept payment from the bank of the company in the emerging economy to which they are exporting without an enormous process of assessment as to whether that bank is a proper institution. It is becoming more difficult as a result to export to many emerging economies.
I wish my noble friend Lord Hill success with his capital markets directive. That has been one of the really positive initiatives in recent times. But even with that there is a problem, in that the principle of the EU is that financial products and investment funds should not be marketed to ordinary citizens, because it does not think that they can understand them adequately, other than USIT funds. For example, it is making it very difficult to promote debt funds to attract investors, where SMEs in particular very much need additional finance. ESMA is trying to regulate 95% of market-making activities, which will purely clutter up the market.
However, there are even bigger, wider issues. The single market is in many ways about protection; it is about keeping out of the EU market other than EU-based products and institutions. It is no wonder that a lot of large players rather like the system, because if you are part of a cartel in a protected market, what could be better? You certainly do not want the competition of institutions from America or Hong Kong.
Those who like a command economy, having failed to achieve that in government, have moved to the regulatory sector, where they have had a heyday in introducing command economy measures. It is not just in financial services; there are now more people working in DfID than there are farmers left in this country.
I understand that part of the Government’s renegotiation agenda is to seek to acquire for the UK a veto over directives relating to the financial services industry, just as France has such a veto in relation to its biggest industry, agriculture, and Germany in relation to engineering.
Lord Liddle (Lab)
It is not the case that France has a veto in relation to the common agricultural policy, as I think the noble Lord well knows. All the decisions on the reform of the common agricultural policy have been taken by majority voting in the Council of Ministers. Of course, the council tries to take into account the views of member states which have particular interests. Surely he would acknowledge that, in the case of financial services, that is what has happened with Britain: our interests have been taken into account by the council.
Lord Flight
I would have thought that what I have just said demonstrates that what I call sensible interests, including our interests, have often been overridden. With regard to agriculture, while I am well aware that the overall reforms of the system have been pan-EU, I think that France still has some protective vetoes. We will see whether this is correct, and what the negotiations are able to achieve.
I am critical also of the UK. There has been a lot UK gold-plating of what has come to the UK both internationally and from Europe. The introduction of RDR has simply removed financial advice being available to 70% of the country’s population, as a result of which the Government are struggling with providing guidance on pension fund services and leaving people hanging in mid-air as to who they might approach to manage their pension assets.
There is the need for an independent new appraisal of what regulation in the EU and even internationally is good and useful for markets and for clients, and what is unnecessary, harmful, and incurs a cost and adds no benefit. I would like to think that the UK will give an EU lead to reform of regulatory overkill and I wish the noble Lord, Lord Hill, enormous good fortune in his commitment to review the cumulative effects of the various regulatory reforms.
Lord Liddle
Does the noble Lord accept that the Commission has just produced precisely what he is asking for? Commissioner Timmermans has put forward a whole set of propositions on regulatory reform and on reviewing existing legislation to make sure that unnecessary regulation is cut back. The noble Lord, Lord Flight, appears to be making statements without full regard to what is happening currently in Brussels.
Lord Flight
I am aware of what is happening in Brussels but I specifically said that I wanted to see the UK more active in terms of a programme of regulatory rationalisation and review. The key point I am seeking to make is that when I stand back, I perceive what I believe to have been enormous overkill, often not addressing the right areas, since the 2008 financial crisis.
Lord Davies of Oldham (Lab)
My Lords, the House has long appreciated the chairmanship by my noble friend Lord Harrison of this committee and the series of reports which have been of great use to noble Lords in informing us on crucial economic issues. I thought that I had a straightforward job this evening, which was to welcome certain parts of the full report—I have some reservations, of course—and to congratulate my noble friend on his chairmanship and on producing it. Now I am absolutely astounded as to how on earth he manages to sustain calmness in a committee which it seems has at least one representative, and probably two, who ought to have written a minority report saying that they would never have started from here and they largely do not agree with anything to do with regulation. In fact, they do not even think that the financial crisis was caused in this manner and therefore a totally different subject ought to have been tackled. I am afraid that the House can scarcely be expected to indulge in such a wide-ranging debate, and indeed I have not come armed to tackle that position—except to say to the noble Lord, Lord Flight, and to a certain extent the noble Earl, Lord Caithness, that they must recognise that this report is on the post-crisis EU regulatory framework. What crisis do they think the report is referring to?
Surely we are dealing with the financial crisis which affected the whole of the western world and caused repercussions much wider than that. It is only right that the European Community, in the same way as successive British Governments, should have set about the task of bringing in regulation against circumstances which the noble Lord, Lord Flight, must recognise. The morality that he thinks is held in a handshake of agreement between gentlemen in the City just does not hold in the present day. In fact, the attitude where such trust was held at the time clearly led to circumstances in which people could betray it in such a way that whole economies in Europe and, I might add, most of the western world and the United States, crashed in the face of banks going down. That is the measure of the crisis, so it is not surprising that my noble friend Lord Harrison chaired a committee report on financial regulation. I do not think that the Minister should be asked to respond to a widespread debate on whether regulation is needed at all. I would have thought that we have enough evidence in that respect.
That is why the committee has examined the European supervisory agencies which oversee the regulatory framework and has found a great deal of their work to be satisfactory, but has also made it clear—not just on this occasion but in the past as well—that these bodies will need considerable resources to carry out their tasks properly. That is a recommendation in the report. I do not know whether the two noble Lords have dissented from that position, but the nature of their contributions to the debate suggest that they actually have. However, the report from the committee addresses itself to that issue, and that is what is before the House today.
We know, as my noble friend Lord Harrison said, that there are areas of proper disagreement. We recognise that the financial transaction tax is an issue of considerable disagreement both in our economic, financial and political circles and, of course, in certain parts of Europe. Certainly, the current proposal is not acceptable to many. As my noble friend Lord Harrison indicated, the committee wondered what progress had been made on the financial transaction tax. We are not quite sure where the discussions on that very significant issue are. There is clearly a considerable body of opinion, not just in Europe or in the United Kingdom. My own party has a real interest in a financial transaction tax. The United States, too, is interested in the way in which Governments can receive necessary resources from a very wealthy section of their economy which, of course, looks as if it could afford further levels of taxation.
We have a real interest in these European issues. If one thing stands out from the crisis facing Greece at present it is the question of financial regulation. That has an impact on the UK, too. We cannot shy away from the issue. We had a Statement earlier this week showing the Government’s proper concern about the situation in Greece. Why was that Statement made? It was because the UK has a very real interest in the success or failure of economies in Europe. If the Greek crisis goes to its worst position, we are conscious of the fact that there will be an impact on the British economy. As for our citizens, it must be recognised that we are effectively sending out emergency messages to so many of our people who either live in Greece or may be travelling to Greece on holiday. They are at risk because of the crisis. That is why we need to look at these issues, and why we should be grateful to my noble friend Lord Harrison and his committee.
We do not need to get sidetracked today into whether there needs to be regulation from Europe on the financial sector. The report also emphasised the fact that we have a prominent figure who is central to the success of European initiatives in this respect. I am referring to the noble Lord, Lord Hill, whom we all valued for his contribution here as Leader of the House. He is in the Commission, involved in the crucial area of financial and economic matters. Of course, therefore, we hope that he will be able to use influence to give guidance in circumstances where we all recognise that a great deal needs to be traded.
There is a whole other dimension to the report on which there may be some disagreement, but I hope that the Minister will address himself to it. The report says:
“One of the overriding concerns of our witnesses was that the legislative framework had been focused too much on stability rather than growth”.
I am not surprised that there is an emphasis on stability when absolute chaos descended upon us all for a number of months during the financial crisis. It is also clear that we will need action and regulation that promote growth, too. That was put to the committee. I hope that the Minister will address that matter as well. In addition, there was the issue of the capital markets union. We hope that there will be a constructive response to the ideas implicit in that.
The wider issue is quite clear: in the coming months and years we need to ensure that the United Kingdom’s voice is used essentially to help to create a post-crisis framework that guarantees, as far as we are able, that nothing like the circumstances that we went through in the last decade affects our country, Europe and the wider world again. We have to be a constructive and active member of negotiations.
I recognise that the Minister will not accept every point in the report. Nevertheless, the Government’s response to the report is extraordinarily welcoming. In fact, I have great difficulty recalling a report where so many commendations were made on the salient conclusions reached by it. Yet, here we are being sidetracked into a debate as if the report has no real credibility at all. I think that it does and that the Government recognise that it does. I therefore hope that the Minister will respond to the salient and constructive points in the report, rather than being sidetracked into what I regard as a minority viewpoint expressed by noble Lords. They certainly have every entitlement to their views, but this is not the occasion on which they should have been expressed in quite that manner.
Lord Ashton of Hyde (Con)
My Lords, I thank the noble Lord, Lord Harrison, for his five years chairing the committee and for producing the report. I also thank the other committee members for their preparation of this comprehensive report. Of course, I thank all noble Lords for their contributions.
The UK is home to some of the world’s most successful and competitive financial firms, benefiting businesses and working people across the country. It is therefore right that we remain focused on the legislation that provides the framework within which businesses and customers operate. It must provide the foundations to ensure that the financial services industry plays a leading role in creating jobs and generating growth, delivering for customers at every stage of their lives, but it must also provide the foundations to ensure that the sector remains strong and stable.
We are emerging from the worst economic crisis in living memory—a point well made by the noble Lord, Lord Davies of Oldham. It is important to remember that context when considering the significant volume of EU financial services legislation since the crisis. I particularly draw the attention of my noble friends Lord Caithness and Lord Flight to this. In making their criticisms they have to bear in mind the situation pertaining and which we are addressing, and the chaos and misery that it caused to many people in the European Union. It was crucial that we acted quickly and decisively to shore up the financial system and then put in place measures that aim to ensure that we never face such a situation again.
There have been benefits: an increase in transparency; a more level playing field across the EU for financial actors; the tools to end the adverse relationship between sovereign countries and bank, to ensure that taxpayers are never again in line to bail out banks; and a more stable financial system. However, the speed of action and complexity of issues means that there will be some unintended consequences.
I shall now address some of the points that the noble Lord, Lord Harrison, made. He asked for the latest on the so-called Juncker plan, also known as the European fund for strategic investments. I can report that the 25-26 June European Council approved the fund and called for its rapid implementation.
The noble Lord, Lord Harrison, also mentioned the committee’s finding that the UK’s influence in Europe was diminishing. We continue to be an active and influential member of the EU and have many examples to prove that from building a coalition to deliver the first ever reduction in the EU’s budget to delivering fundamental reform of the common fisheries policy. We are at the heart of the debate on interests that matter most to the UK but I accept what the report said. The Government will definitely consider those views addressed in it.
Both the noble Lord, Lord Harrison, and the noble Lord, Lord Davies of Oldham, asked for an update on the financial transaction tax, which has many problems as far as the UK is concerned. The UK believes that the Commission’s proposal is unlawfully extraterritorial. We also believe that the proposal is technically flawed. Following this lack of agreement, the 11 participating member states have committed to finalising a watered-down first stage of the tax covering shares and some derivatives by the end of this year. The Chancellor will not hesitate to challenge in court the final FTT directive if our legal concerns are not addressed.
My noble friend Lord Flight talked about gold-plating. I draw his attention to the bit in the report which said that arguments about gold-plating in the UK are “finely balanced”. He also mentioned the fourth anti-money laundering directive. We have been in regular discussions with the private sector to take its concerns into account both throughout the year and prior to making any amendments to the regulations. This directive has been agreed by all EU member states and was published in the EU Official Journal in June 2015. The Government are required to transpose this directive into UK law and we intend to run a full consultation prior to the next set of amendments that are due to come into force by June 2017 at the latest.
Finally, my noble friend Lord Flight mentioned politically exposed persons for UK purposes. The revised global standards, to which the UK is fully committed, require that they be treated as politically exposed persons on a risk-sensitive basis. The revised standards require that for all foreign PEPs enhanced due diligence is required. Domestic PEPs will be subject to enhanced due diligence and ongoing monitoring when the business relationship is assessed as high-risk. The Government seek a risk-based approach to the application of this requirement in negotiating the fourth anti-money laundering directive.
I turn to the report and again thank the noble Lord, Lord Harrison, and the committee for their work, which I believe constitutes a useful and valuable contribution to the debate on financial services regulation within the EU. The Government agree with the committee’s recommendations on the need for reviewing the financial regulatory framework following the upheaval in recent years. Under First Vice-President Timmermans’ Better Regulation Package, as mentioned by my noble friend Lord Caithness, the Commission has moved to strengthen its programme that assesses the existing stock of EU legislation to make it more effective and efficient. The Government also strongly welcome the plans of the noble Lord, Lord Hill, to undertake an assessment of the cumulative impact of financial services legislation.
The Government also agree with the committee’s calls for improvements to the Commission’s approach to impact assessments, which was the first question of the noble Lord, Lord Harrison. We particularly welcome Vice-President Timmermans’ proposals to lighten the regulatory burdens for small and medium-sized enterprises. I say to my noble friend Lord Caithness that the Government acknowledge the important role that small businesses have in supporting the economic recovery. We are committed to creating the best possible environment for a sustainable private sector. This includes our approach to EU legislative proposals, where there is a commitment to the “Think Small First” principle when preparing initiatives, including lighter regimes for SMEs in new legislation and exemptions for microenterprises. Vice-President Timmermans’ proposals on better regulation include guidelines for mandatory SME and competitiveness tests in all impact assessments, and we particularly welcome these proposals. These are welcome steps in the right direction. The Commission must now deliver on its proposals to improve the process of EU lawmaking.
My noble friend Lord Flight mentioned the alternative investment fund managers directive. The Government recognise that this has imposed new costs on the alternatives sector, particularly managers above the AIFMD threshold. This underlines the need for better impact assessments and improvements to the better regulation agenda.
Turning to the European supervisory authorities—ESAs—it is clear that they are an important part of the European regulatory framework. They have been tasked with a significant workload and they have performed well under difficult circumstances. We fully agree with the report in these respects. Given the large amount of secondary legislation the ESAs have had to deliver since their inception, it is understandable that they have been focused on the creation of the single rulebook, but we believe that, as the flow of post-crisis legislation slows, they should focus on delivering other parts of their mandate, such as pushing for greater convergence in supervision, ensuring consistency and raising standards. They have a crucial role to play as system managers and in improving supervisory standards across the single market.
However, one area where the Government disagree with the conclusions of the report is on additional funding for the European supervisory authorities. The report recommends that additional funding should be given to the ESAs to fulfil their mandate. The Government believe that, at a time when Governments across the Union are tightening their belts, it is not appropriate for the ESAs to seek large increases in their funding. The Government are convinced that, through proper prioritisation of their work, the ESAs can deliver against their existing mandate with their existing funding.
The Government join the committee in welcoming the work of the Financial Stability Board on tackling “too big to fail”. It is clear there have been positive developments in the EU and internationally. The stabilisation of the banks through the implementation of capital requirements under Basel III through the EU’s fourth capital requirements directive is one good example.
I also ask noble Lords to note the publication of the final report of the Fair and Effective Markets Review, which was mentioned by my noble friend Lord Caithness. The review, established by the Chancellor, made far-reaching recommendations to improve the fairness and effectiveness of wholesale fixed-income, currency and commodity markets. Given the global nature of these markets, we will be taking forward several of these recommendations internationally, including with the Financial Stability Board and the International Organization of Securities Commissions. The review warmly welcomes the Bank for International Settlements’ work to create a single global FX code. The review has worked with colleagues from other central banks to develop a work programme that will deliver a robust set of standards. It has recommended that once the global standards are in place, the UK backs these standards with a new regulatory regime for FX spot markets. Given that the same standards should be upheld in all jurisdictions, this should not affect the UK’s competitiveness.
Indeed, ensuring global regulatory consistency is essential in stopping the build-up of risk from the variation of reform, regulatory arbitrage and market fragmentation, and the UK continues to play a significant role in the international push for a stable, safe and globally regulated financial system. But we also need a smart regulatory approach which also recognises that in some cases member states can be best placed to determine what regulation is appropriate for their markets.
The Government understand that the euro area is moving towards greater integration, and that this has implications for the UK. The committee’s report rightly notes the risks to the UK of further eurozone integration. We have consistently recognised the wish of euro area member states to achieve closer economic and fiscal integration to strengthen the single currency. The crisis unfolding in Greece has underlined the desire—and, indeed, the need—for collective action across the euro area in times of difficulty.
A stable and growing eurozone is in the interests of all EU member states, including the UK. At the same time, the Government have been clear that we will not be part of this closer integration. We have, however, been closely involved in the negotiations, particularly over banking union, to protect UK interests. The UK continues to be an active and influential member of the EU and the Government continue to be at the heart of the debate, working closely with other member states, including euro area member states, on the key issues of the day—improving Europe’s competitiveness, the single market and trade.
The report states that while the UK’s expertise in financial services is respected, the UK’s influence over the legislative process is diminishing. While I appreciate that there is always more that can be done and welcome the constructive recommendations in this area from the committee, the Government have secured positive outcomes for the UK, at times having to fight hard for them. For example, the Government have successfully worked with our European partners to introduce tools for resolving EU banks that are credible, workable and closely aligned with existing UK legislation, through the bank resolution and recovery directive. We have also secured flexibility for the UK to implement its macroprudential regime, within the scope of the capital requirements directive IV proposal, and exempted British pensions from new rules on disclosure for investment products. Where the Government thought that EU legislation was at odds with the treaties, we have challenged it in the courts as we have on short-selling, the financial transaction tax, location policy and the bonus cap.
There are some questions I am afraid I did not manage to get hold of but I remember one in particular from my noble friend Lord Caithness. He asked: what am I doing to control the regulators? The answer is that the European supervisory authorities are held to account through their respective boards of supervisors, where the FCA and the Bank of England are represented. Domestically, the FCA and the Bank are held to account by the Treasury Select Committee, Her Majesty’s Treasury and Parliament. Regulators need to be independent to serve as a second pair of eyes for the single market.
As the Prime Minister has set out, and as the noble Lord, Lord Davies, mentioned, we need to make the EU a source of growth, jobs, innovation and success, rather than stagnation. We strongly support Mr Juncker’s vision of a well-regulated and integrated capital markets union of all 28 member states which maximises the benefits of capital markets and non-bank financing for the real economy. We fully agree with the committee that the concept of capital markets union should be welcomed. It is a project to which the UK is fully committed. But if the single market is to continue to be a driver of growth, European legislation must focus on finding the right balance between enhancing the EU’s competitiveness in an increasingly global environment, promoting growth, maintaining stability and protecting consumers. We need strong regulatory standards applied internationally but this also means proportionate and consistent legislation that continues to decrease barriers between member states and recognises that, in some cases, the responsibility for regulating markets best falls to member states themselves.
I therefore repeat my thanks for noble Lords’ comments and the committee’s review of the regulatory framework since the financial crisis. The Government can safely say that by far the majority of its recommendations were accepted. I counted at least 23 out of 33 recommendations that were accepted without any qualification; even some of the others were accepted with some qualification. Generally speaking, the Government accept the review and warmly welcome it, as I warmly welcome the insights of noble Lords this afternoon.
Lord Harrison
My Lords, in concluding the debate I remind my colleague the noble Earl, Lord Caithness, of something he said to us when we embarked upon this report: that he hoped it would become a textbook for those who seek to discuss these matters in future. I believe that we have achieved that. I thank my noble friend Lord Flight for his comments and for the PEP talk that he gave us in the midst of them.
I thank my own Front-Bencher, my noble friend Lord Davies of Oldham, who has wielded this responsibility over many years, for sympathising with me over the sometimes choppy waters that we on the committee experienced in dealing with financial affairs. However, we were always united in having the proper and right approach. I hope the noble Baroness, Lady Falkner, during her reign of the tricky committee that is the financial services committee, also experiences the calm that has been displayed here this evening in helping the UK resolve some of the really challenging and important points that are being made to us about the future.