Financial Services and Markets Act 2000 (Ring-fenced Bodies, Core Activities, Excluded Activities and Prohibitions) (Amendment) Order 2016
Lord Young of Cookham
That the Grand Committee do consider the Financial Services and Markets Act 2000 (Ring-fenced Bodies, Core Activities, Excluded Activities and Prohibitions) (Amendment) Order 2016
Lord Young of Cookham (Con)
My Lords, from 1 January 2019 the ring-fencing regime will require structural separation of core retail banking on the one hand from investment banking on the other for UK banks with retail deposits of more than £25 billion. Ring-fencing was the central recommendation of the Independent Commission on Banking chaired by Sir John Vickers, which the Government accepted and legislated for in the Financial Services (Banking Reform) Act 2013. It will support financial stability by insulating retail ring-fenced banks’ core services whose continuous provision is essential to the economy—that is, retail and small business deposits and payments services—from shocks originating elsewhere in the global financial system. It means that banks which provide those essential services become simpler and more resolvable so that core services can keep running even if a ring-fenced bank or its group fails. In doing so, ring-fencing reduces the perceived subsidy that comes from the presumption that the Government will bail out failing banks. Details of the regime are set out in secondary legislation passed in 2014 and it is some of those details that this order amends.
There are 18 different amendments in the order which achieve three purposes. First, to address issues in the secondary legislation that could inhibit the successful implementation of the regime; secondly, to ensure that ring-fenced banks are able to continue recognisable retail banking activities; and thirdly, to close holes that we have discovered in the ring-fence. Together with the PRA, we will constantly patrol the ring-fence for any flaws in the regime and will step in to close them when they are identified.
To assist the Committee, as I note each of the amendments, I will identify the part of the order where each can be found. Unfortunately, as the order is laid out in line with the elements of the existing secondary legislation it is amending rather than thematic, and as some amendments require changes to more than one part of the legislation, my description may involve some skipping around. I am of course happy to provide a more detailed explanation of any aspect of this order.
The first category of amendments tackles issues in the regulations that could work against the successful implementation of the regime. Article 2 of the order, after necessary changes to some definitions, withdraws the requirement for banks’ larger customers to complete a burdensome qualifying declaration and removes the requirement for banks to issue information to customers who are unaffected by the regime. Article 3(3) on page 4 also falls into this category by allowing in certain circumstances the securitisation of assets acquired in a resolution scenario and providing for the treatment of assets held by the banking group before ring-fencing comes into effect. Sticking with the theme of addressing issues that could threaten implementation, the elements of Article 3(6) found at the top of page 7 make it much easier for the PRA to assess compliance with the rules relating to the selling of simple derivatives, while Article 3(7) ensures consistency with the pensions regulations. Finally in this category, Article 3(10), right at the end of the order, addresses what happens when an organisation unexpectedly becomes a relevant financial institution while a ring-fenced bank is exposed to it.
The second set of amendments addresses issues with the regulations that might prevent ring-fenced banks carrying out activities we would certainly expect a retail bank to conduct. Amendments found in Article 3(4) on page 5 ensure that ring-fenced banks can continue being members of payment systems and central counterparties, and that they can hedge risks within the ring-fence. Articles 3(7) and 3(8) on page 7 ensure that ring-fenced banks can manage their liquidity risk. Similarly, amendments found in Articles 3(9) and 3(10) on page 8 ensure that ring-fenced banks can continue lending working capital to small businesses, acting as trustees, providing consultative services, and providing loans to infrastructure projects. The final set of amendments closes holes we have discovered in the ring-fence. Article 3(2) on page 4 expands the list of globally systemic insurers to which ring-fenced banks may not be exposed. Article 3(6) on page 6 tightens the risk calculation that constrains ring-fenced banks’ issuance of simple derivatives.
There are some things these amendments do not do. They do not alter the location of the ring-fence: core activities must be ring-fenced and investment banking activity must be outside the fence. They do not alter the height of the ring-fence: the same degree of operational and financial independence must be observed between the ring-fenced bank and the rest of its group, and they do not alter the timetable for ring-fencing banks. Banks in scope must be ring-fenced 27 months from now and, together with the PRA and the FCA, we are monitoring their progress closely. I beg to move.
Lord Tunnicliffe (Lab)
My Lords, I thank the Minister for introducing the final statutory instrument of the day. The order makes a number of changes to the ring-fence regime which is due to come into force on 1 January 2019. As a result of the structural changes that the banks have begun to implement in advance of the regime, the Treasury has suggested that a number of technical issues have become apparent which if not rectified could undermine its effectiveness.
I want to say at the outset that the Opposition have no intention of opposing any of the measures proposed in this statutory instrument and any moves to fix errors prior to the commencement of the regime are welcome. However, there are a number of questions that I want to put to the Minister in order to clarify the intent and purpose of some of the changes outlined in the order. Before turning to the specifics, I want to address a broader issue which I hope sincerely the Minister will take back to those of his colleagues in the Treasury who prepare explanatory material for future statutory instruments. At the most basic level, the order relates to the forthcoming introduction of the ring-fencing regime, but the underlying objective of the instrument and of the Financial Services (Banking Reform) Act 2013 which it amends is to ensure the reduction of risk from the banking sector.
The Minister referred to 18 amendments—there are in fact more when you take into account the multiple changes being made on some points. They are being introduced because at present there are shortfalls in the ring-fencing regime standards. They are minor alterations, but as I understand it the regime would have a severe impact on the operation of the sector if left unamended, so these changes are quite important. I presume that the decisions have been made as a result of detailed examination and consultation, and I would ask the Minister why such information has not been provided with the order. The noble Lord is an experienced parliamentarian and will know that by convention we will not oppose these measures. It is therefore vital that we have a full assurance that the changes do not increase risk and are necessary not only for the banking sector but for the public good. As Her Majesty’s Opposition, we cannot provide the necessary scrutiny if Explanatory Memorandums are as scarce in detail as the one in question today.
The Minister’s speech has illustrated beautifully why I never read such orders. They are, frankly, impossible to read, especially when they amend other orders; it is bad enough when they just amend a Bill. We in the Opposition are totally dependent on the clarity of Explanatory Memorandums in order to apply scrutiny, but I must say that the memorandum for this order hits something of a new low. During the development of this legislation, which I have lived with all the way through—largely because I did not duck at times—we have had very good support from the Treasury. It produced excellent briefing notes to go with the original Act and the various amendments to it, and its helpfulness continues to this day—I think that it was Tom Etheridge whom I spoke to yesterday morning. Although Treasury officials have helped me go through the memorandum, it is unfortunate that it should be so difficult to understand. In terms of confusion my favourite is paragraph 7.22. I shall not read it out because I am sure that the Minister has it in front with him or has read it with the same energy as I have. I could not understand it because it does two quite different things in the same paragraph, and indeed in the same sentence.
I failed my 11-plus and attended a secondary technical school, but I remember my English teacher telling me not to put more than one idea in a sentence, and ideally not more than one idea in a paragraph. Perhaps if I had gone to a grammar school I would have a more nuanced approach whereby you mix them all up like a soup. To illustrate the limitations of paragraph 7.22, if you delete in the second line,
“and strengthen the UK’s resolution toolkit”,
and then in the fourth line delete,
“acquired in a resolution scenario”,
and reread it, the paragraph makes sense. It states:
“RFBs are currently prohibited from securitising assets that they haven’t created themselves”.
That is simply not true because there are no RFBs. What it really means is that the order as presently drafted makes that prohibition. As I have amended the paragraph, it goes on to say:
“To aid transition to the ring-fencing regime … this Order amends the EAPO to allow an RFB to securitise assets … transferred in a ring-fencing transfer scheme”.
A ring-fenced transfer scheme is a scheme which is proposed by a bank for how it will divide itself up and is approved by a court. That is an absolutely essential part of the process of creating the ring-fence so it is reasonable that that exception should be made. The paragraph goes on to say in lovely language,
“or acquired by itself or a member of the wider banking group at least two years before becoming an RFB. In all cases this is limited to assets that an RFB is permitted to hold”.
What that actually means is that any assets acquired after 1 January 2017 cannot come under this prohibition in order to create a two-year buffer before 1 January 2019 when the ring-fence comes into effect. Once again, that is a perfectly reasonable thing to do. As I have amended this paragraph, it is all about how to get into the ring-fence situation in order to modify the prohibition for that transition to take place. That is an important idea. I think that I understand it, but if I do not I am sure that the Minister will tell me so. If I have understood it correctly, it is a perfectly reasonable concept.
A second meaning arises if I delete in the second line of the paragraph,
“aid transition to the ring-fencing regime and”,
and then in the third line, I delete from “transferred” to the end of that sentence. It would then read:
“To … strengthen the UK’s resolution toolkit, this Order amends the EAPO to allow an RFB to securitise assets acquired in a resolution scenario”.
This once again is a very powerful and crucial idea. I have been unfortunate enough to have studied the resolution regime as part of my duties in picking up this brief. It is an exciting process when a bank goes bust. My understanding is that there would probably be 60 hours in which to work over a weekend. It is crucial that the resolution authority is able, if it believes it to be the right course of action, to break up the bank and transfer the good bits to another ring-fenced body, and for that ring-fenced body to be able to take those assets as if they were its own. I think that is what this paragraph means given what I believe are two different senses.
If I have made a mistake, perhaps the Minister will write a letter. I am sympathetic to that. But the point I am making is that this paragraph and many other paragraphs in the document could have been written at greater length for bears of little brain like myself so that we could tread through this order. It is very big and I think it contains 20-odd changes that are crucial to the regime. One important duty of the Opposition is for at least one person in it to understand the order in totality and to have tested it to see whether it makes sense and is consistent.
As I have said, this is a wider issue than just the order in front of us. I hope that the Minister will convey the concerns I have raised so that all sides of the House can engage in more informed and fruitful discussions. Once again, I thank the Treasury, which was happy to take the time to take me through the order.
On two specific points, the first concerns the removal of the “qualifying declaration” which large corporate customers are required to submit before the bank can move their account to the non-ring-fenced body, and its replacement with a requirement on the bank to reach a determination as to whether a customer is eligible to be moved to the non-ring-fenced body. From my reading of the instrument—I encourage the Minister to correct me if I am wrong—this is the only alteration that constitutes an actual policy shift as opposed to a technical amendment. I would be grateful if the Minister could go into more detail about why this decision was made and the implications that this will have on both the companies and the banking sector. I am happy for the Minister to write to me on this, but I tried quite hard to understand the paragraph in the draft Explanatory Memorandum that covered this point. While I think I understood it in part, I do not understand it fully.
The second point, which relates to the removal of the qualifying declaration, concerns the impact assessment or the lack thereof. Paragraph 10.2 of the Explanatory Memorandum states that,
“these amendments respond to technical issues”,
and that therefore there will be,
“no new impact on business, charities or voluntary bodies”.
Yet only two paragraphs later the memorandum reveals that:
“The Treasury is preparing a validation impact assessment in relation to the removal of the qualifying declaration process”.
Surely it would have been wise to produce an assessment before the policy was introduced, or at least before the order was laid. The Government have until January 2019 to get this right, so why is it being rushed through and the correct assessment procedure not being followed? Can the Minister say when the validation impact assessment will be published? Such a document might also provide more understanding of the motivation of that part of the order.
I spent about 10 hours trying to understand the order and at points one has to stand back and say, “Why bother?”. We had a lovely illustration today of the other end of the spectrum, where my noble friend Lord McAvoy was able to say, “Fine—get on with it”. He put it in proper lordly terms, but frankly he did not say any more than that. That was a class of statutory instrument I would describe as trivial—I do not mean that in a rude sense but in a technical sense. In mathematics, when you have a line sometimes you put “trivial” at the end, which means that the reason for it is self-evident; the reason for that order was self-evident, and fair enough. There are some totally political orders which we do not vote against because of our convention, but we want to stand up, make big speeches and get on the record that we do not like what something is doing, which is important. Some orders are a mixture of technical and political, but some, which I hope this order is, are wholly technical. What, then, is the role of the Opposition? It seems to be to make sure that the drafting of the order and the thinking behind it have full depth—that it fits together and goes with the grain of the order. For that, we need fully to understand it.
There are two ways through this dilemma. One is for the Treasury to write better Explanatory Memorandums; we know it can because of some of the excellent stuff it produced in generating the legislation. The other is probably for us in particular to become aware of orders rather earlier; I have put action in hand for that. When we have conversations with the Minister and officials about something of this depth and length, we can use a more informal process to slog through the detail and make sure that we understand it.
As far as I am able to understand the order, I thoroughly approve of it. I have been through the changes, which all seem necessary and reasonable. I have a slight problem with the definition in relation to notification of a big company compared with a little company, but, that aside, we are content with the general policy, which we have supported through its many stages. This seems to be a sensible set of corrections. If the Government have another swathe of amendments to bring to us—many would be critical of that, but I know that they would be reacting to responses from industry and their own work—I would want on that occasion to try to understand more before we reached this stage, so that we could perhaps make this stage a mere formality.
Lord Young of Cookham
My Lords, I have taken many statutory instruments through another place, but this is the first SI that I have taken through your Lordships’ House. I am enormously impressed by the detailed consideration which the noble Lord has given to it; it will certainly put me on my guard for any future SIs that I may take through. I am grateful to him for the Opposition’s support for the order before us. The noble Lord has a background in this subject, having been closely involved with the primary legislation.
Let me try to deal with some of the issues that the noble Lord raised. On consultation, the amendments were the subject of a short, technical review—because they are mainly technical changes—with the affected banking groups and their representative body, the British Bankers’ Association. Such a review was proportionate for the amendments, given their technical nature. They have also been drafted in consultation with the PRA and the Financial Conduct Authority.
The noble Lord asked about the impact of the order on risk. Some amendments ensure that ring-fenced banks are able to deliver economic services, as it was always the intention that they should. Some of the activities help ring-fenced banks manage their risk; for example, ensuring they can hedge risks within the sub-group. Other activities permitted by the amendments and the ring-fencing legislation more broadly carry risk, but with this order we are not shifting the ring-fence to include any new types of business but only ensuring that ring-fenced banks are able to deliver the service that they are meant to.
I take the noble Lord’s point on the Explanatory Memorandum. He wants an Explanatory Memorandum for the Explanatory Memorandum, because he found it difficult to follow. I will take that point on board and see whether in future we can do better and make sure that an Explanatory Memorandum lives up to its name.
On securitisation, the bit of the Explanatory Memorandum that the noble Lord focused on, his understanding is correct. Ring-fenced banks are allowed to securitise the assets that they created—this was a recommendation of the Independent Commission on Banking. Ring-fenced banks normally may not securitise assets originating outside the ring-fence. The order makes two changes: first, to what assets ring-fenced banks may securitise after 2019; secondly, to provide for what happens to assets already on their books before ring-fencing comes into existence.
The first change provides an exception to the prohibition on securitising acquired assets for assets obtained following the resolution of a failed firm. Successful resolution is important to ensure that failing firms do not harm the economy or taxpayers. This amendment maximises the resolution options available to the regulators by increasing the chance of finding a suitable private sector purchaser for the failed bank’s assets.
The second change introduces provisions to deal with banks’ existing assets. The current regulations fail to provide for the treatment of both assets created by the banking group before the ring-fence is established and assets acquired by the banking group in the past. The order makes it clear that when ring-fenced banks are created, they may securitise the assets already held by the banking group and those transferred through the ring-fenced transfer scheme. However, to stop banking groups spending the next two years acquiring assets for the ring-fenced banks to securitise, ring-fenced banks will be able to securitise assets held by the banking group only if they were acquired more than two years before the ring-fenced bank was established; for most banks this means 1 January 2017, which will be shortly after this order comes into force.
On the changes to the qualifying declaration, this should simplify matters for businesses. Completing qualifying declarations is likely to require banks’ customers to devote senior staff time to completing the declaration and may require engagement of legal advice, accountants and auditors to sign off the evidence the business provides. This cost to non-bank businesses will be considerably higher than to banks completing due diligence. With the changes, non-bank businesses will not have to undertake the regime that was set out initially. We believe that around 34,000 medium and large businesses will benefit from this change.
On the impact this will have, these amendments are, as I said, mainly technical changes to the ring-fencing regulation. The amendment with the most significant impact is the one I just referred to: the removal of the qualifying declaration process. This will remove a burden on banks and their medium and large business clients during the transition. The Regulatory Policy Committee rules say that the deregulatory nature of this change means that we do not need to prepare a regulatory impact assessment. But we do need to prepare, on a longer timescale, a “validation” impact assessment so the RPC can confirm the deregulatory effect of removing the qualifying declaration process. We do not normally publish these validation impact assessments but in this case I will be happy to, once it has been validated.
Finally, the noble Lord suggested a process of interaction between Opposition Members or other noble Lords and the Treasury to get a better understanding of the regulations that are brought forward. I will take that helpful suggestion away and see how the Government can best respond to it.