Bank Recovery and Resolution Order 2016
Lord Young of Cookham
That the Grand Committee do consider the Bank Recovery and Resolution Order 2016.
Lord Young of Cookham (Con)
My Lords, since the financial crisis, the Government have implemented a significant programme of reforms to address the problems of the past and make the financial sector safer and more stable. In addition, the Government have implemented significant reforms to address the problem of “too big to fail” and ensure that the failure of a bank can be managed in a way that protects the wider economy and financial sector without relying on taxpayer bailouts. These orders concern two key planks of the reforms: macroprudential regulation, and resolution, which is the regime for managing the failure of banks and other financial firms. I will begin with the Bank of England Act 1998 (Macro-prudential Measures) Order 2016.
The Government have reformed our financial regulation so that risks to the whole system are identified and addressed. This element of regulation was not present in the previous system of regulation. The Financial Policy Committee addresses macroprudential risks through its powers to issue recommendations and directions. As noble Lords are no doubt aware, the UK housing market has gone through many cycles of boom and bust, often leading to wider economic problems when the market experiences a downturn. Mortgages are the single largest asset class held by UK banks. This makes them sensitive to the performance of the housing market. It also exposes them to direct risks when borrowers struggle to pay back their loans. Work by the Bank of England suggests that buy-to-let mortgage lending can amplify the housing cycle. As house prices go up, buy-to-let investors are incentivised to enter the market by the prospect of capital gains, and this pushes up prices for all home buyers. The Bank of England has asserted that as prices fall, buy-to-let investors are incentivised to sell their properties, which can exacerbate the downturn in the market.
The lessons of the recent financial crisis are still fresh in our memory and we know that the costs of financial instability are huge. That is why, in his Mansion House speech on 12 June 2014, the then Chancellor committed to ensuring that the FPC has,
“all the weapons it needs to guard against risks in the housing market”.
Following that statement, the FPC recommended that its powers of direction be expanded so that it could tackle effectively the systemic risks in the UK housing market. The Government agree with those recommendations and have already legislated to grant the requested powers regarding owner-occupied mortgages. The instrument we are discussing today will provide the requested powers over buy-to-let mortgages similar to those already provided with respect to owner-occupied mortgages. It will also allow the FPC to direct the financial regulators, the Prudential Regulation Authority and the Financial Conduct Authority, to require regulated lenders to place limits on buy-to-let mortgage lending in relation to loan-to-value ratios and interest coverage ratios. Both are commonly used measures of affordability employed by lenders when considering whether to extend a buy-to-let mortgage. This instrument is another step taken by the Government to ensure that the FPC has the powers it needs to address systemic risks and that our financial system is resilient and supports the wider economy.
I turn now to the Bank Recovery and Resolution Order 2016. The financial crisis demonstrated the need for an effective resolution regime to manage the failure of financial sector firms without relying on taxpayer bailouts. The UK’s special resolution regime provides the Bank of England, the Prudential Regulation Authority, the Financial Conduct Authority and the Treasury with the tools to protect financial stability by effectively resolving banks. The EU Bank Recovery and Resolution Directive established a common approach across the EU to the recovery and resolution of failing banks. It drew on key aspects of the UK’s existing resolution regime for managing bank failure.
Since the transposition of the BRRD in January 2015, industry and the regulators have had time to digest the new rules. They have identified a small number of areas where the UK’s special resolution regime could be improved. As such, this order makes changes to strengthen the UK’s special resolution regime to make it work more smoothly and effectively.
The Government have consulted extensively on the draft legislation, both through public consultation and through close engagement with the Banking Liaison Panel. These changes have the support of industry. The Government will also update the special resolution regime code of practice, a guidance document which sits alongside the legislative framework, to further clarify the measures introduced by the order.
The Bank Recovery and Resolution Order 2016 makes changes in three key areas. First, it makes amendments to allow the Bank of England or the Treasury to activate contractual default event provisions where it would assist a resolution. This will be necessary only for a narrow range of contracts, where the activation of default event provisions supports the Bank of England’s efforts to resolve a failing firm and maintain financial stability.
Secondly, the order introduces new stand-alone early intervention powers for the PRA and FCA. These powers could be used when an institution’s position was deteriorating to try to prevent it failing and requiring resolution. The stand-alone powers, which include the power to require the removal of senior management, clarify the scope of existing powers.
Thirdly, the order provides new backstop powers for the Bank of England to resolve branches of third-country institutions operating in the UK, independently of the third-country resolution authority. The circumstances in which these independent powers would be used are exceptional. The preference of the UK authorities is for co-operation between authorities.
The order also addresses a couple of other issues. First, it introduces powers to enable the bridge bank tool to be applied through a share transfer for building societies. The bridge bank tool allows the Bank of England to transfer the critical assets and liabilities of an institution in resolution to a bridge bank until they can be safely returned to the private sector. This amendment will ensure that the tool can be applied to building societies flexibly. Secondly, it introduces powers for the Treasury and the Bank of England to recover bail-in expenses.
As I said at the beginning, these changes will strengthen the UK’s resolution regime. I beg to move.
Lord Tunnicliffe (Lab)
My Lords, I shall speak to the two orders in the order which they appear on the Order Paper. I welcome the noble Lord, Lord Sharkey, to our deliberations. His presence swells by 50% the number normally involved and it is good to have him with us. That puts in context the question whether this exercise is worth while, because if Her Majesty’s Opposition were to contemplate voting down the order, there would be a constitutional crisis as if a bomb had dropped on the place. Frankly, not approving the order is not a serious option. I can assure the Minister that I have no intention of opposing it; indeed, I support it—with one area of exception.
So what do we usefully do on these occasions? The orders are peculiarly complex, because one has to understand resolution and bail-in, which are not popular subjects at GCSE. I put it to the Committee that we do four things: we put the orders in a political context; we probe the meaning to reveal any weaknesses; we try to secure assurances; and we try to influence future development and guidance. Other than the fact that I shall go on constantly about the clarity and accessibility of the orders, I wish to make no political points. My efforts will focus on the last three concepts.
I count in this order four significant areas. The first I will touch on is Article 29, which gives back to the Bank of England stock powers in the case of a UK branch of a third-country institution. I have no comments on that part of the order and am content. Similarly, Articles 21 and 22 provide for a tool to create a situation in which a building society can use the bridge bank tool. That is perfectly sensible.
I move now to the two most significant areas. Articles 31 and 32 give the PRA and the FCA powers to remove and replace directors and senior managers, and to appoint temporary managers. It is difficult to overstate how significant this power is. It has been implied, or even expressed in legislation, but the lawmakers are obviously not confident that it is clear enough, and I entirely support it being clarified. However, it does effectively mean that the board, chief executive or chairman of a privately owned bank that is trading could be removed by the PRA. That is a pretty dramatic thing to do. I do not think those powers exist anywhere else in what I will call “company law”, to use a very general term. Therefore, my first question on this area is: given the serious nature of Article 31 and 32 intervention powers, what procedures has the PRA set up to ensure that they are exercised in a fair and proportionate manner? It seems to me that the powers and how they are exercised need to be clearly understood. It would be useful on this occasion if the powers, how they are exercised, how they are accountable and how they can be challenged were placed on the record.
We come now to Article 15—the centre of the order. Article 15 speaks to the whole issue of bail-in, which is about “too big to fail” but also the crucial question of who pays. In 2008, the Labour Government decided that the big banks were too big to fail. That was a perfectly proper and courageous decision. I call it courageous because it was not at all clear that anybody had the authority to do anything at the time. If you read the accounts of the chaos at the time, particularly over that weekend, you will see, as is my recollection of events, that the UK led the world in stepping in to make sure that the banks did not collapse. The US had already set a precedent, having allowed Lehman’s to fail. The downside of this courageous decision was that the public purse paid. The essence of the bail-in is to ensure that shareholders and creditors pay first. It is an elegant but complicated concept. The key issue in a bail-in is how assets are swapped for equity during the resolution process. It is sufficiently important that it is not in fact handled by the PRA at this point but is handed over to the Resolution Directorate. Article 15 is about that concept.
Lord Sharkey (LD)
My Lords, I will address myself to the order that is 56 pages long. I agree with the points made by the noble Lord, Lord Tunnicliffe—and I thank him for sharing with me the letter of 24 November from the Minister—but unlike him I am not convinced that the order should progress as it stands. It was discussed in the Commons a week ago and there was concern there about Article 15.4, which amends Section 48Z of the Banking Act 2009. In particular there was concern about the insertion of new subsection 6(b). This subsection, as Lord Tunnicliffe has pointed out, would give wide, apparently unlimited discretion to the Bank or HMT to decide which instruments were to be bailed-in.
The 24 November letter addresses the question but does not seem to provide certainty. It simply notes:
“The exceptions in the amendment of section 48(z) will only apply to a narrow range of contracts where doing so would add to the authorities’ efforts to meet the special resolution objectives”.
The Minister repeated that earlier this afternoon. The Minister went on to say the following in his letter:
“The government will provide further guidance in Chapter 7 of the Special Resolution Regime Code of Practice on which type of contracts could include clauses that are activated by the use of a crisis prevention or management measure”.
This inevitably raises the question of why we are being asked to approve this order, or at least consider it here, without seeing the guidelines. Would not it be much more sensible to wait until we have the guidelines in front of us? They are the substance of this issue, and Parliament should have the opportunity to discuss them. Perhaps in the absence of them, the Minister can help us by characterising the type of contracts that will be affected.
Then there is the question of timing. When will the guidelines be published? If it is to be soon, why not withdraw parts of this order and re-present them with the guidelines? If it is not to be soon, does this not unnecessarily prolong market uncertainty?
There is another area in which further guidance is promised. The order provides the power for the Bank to resolve branches of third-country institutions operating in the United Kingdom independently of the third-country resolution authority. The Explanatory Memorandum to the order notes that respondents to the consultation were “broadly supportive” of this power, but some were concerned about the broad definition of the “business of the branch”. It goes on to say that further guidelines—again, guidelines—will be provided in the code on how the bank will judge whether,
“conditions for the use of these powers are satisfied for branches”.
Without these guidelines, this part of the order can only generate considerable uncertainty. Again, surely it would have been more sensible to debate the order with the guidelines. As things stand, Parliament is being asked to give the bank powers without having a clear view of how they will be exercised. The same questions of timing arise. If the guidelines are to be published soon, would not it be better to postpone discussion on parts of this order until they are published? If they are not to be published soon, does this not create unsatisfactory uncertainty in the market?
On the whole, I feel that the uncertainties generated by the absence of these two sets of guidelines make this order significantly flawed. It would be much better to withdraw it now and re-present it when we have the guidelines before us, or to withdraw Article 15 and Part 3 and re-present when the guidelines are available. I suggest that course of action to the Minister.
I have one final point. The order is very long. It is also very technical, as the Government explicitly acknowledged in the Commons. Consolidation would help Parliament to debate it more efficiently and to understand future references and amendments. In his 24 November letter, the Minister said that the Government have no plans to consolidate the legislation and points out that consolidated versions can be bought from commercial providers. The Explanatory Memorandum repeats that consolidated versions are commercially available but adds that,
“given the limited amount of Parliamentary time available, there are currently no plans to consolidate the legislation amended by this Order”.
Is there, in fact, a limited amount of parliamentary time available, in any non-trivial sense? The current schedules suggest not, at least not up until the end of March. In the interest of the sanity of current and future parliamentarians, will the Minister reconsider consolidation?
Lord Young of Cookham
My Lords, I am grateful to both noble Lords who have spoken in this debate. It is a complex subject and I am grateful for what the noble Lord, Lord Tunnicliffe, said about the meetings that we arranged. I certainly found that the learning curve in understanding this had a fairly steep gradient. I am also grateful for what the noble Lord said about officials at the Treasury and the Bank of England. To put the measure in context, the heavy lifting was done back in 2015 when the BRRD was transposed into legislation. Today, we are looking at relatively minor improvements to that broad structure in the light of a review that has taken place over the last two years. As I think I said, there has been broad approval for the proposals that we have in mind. I will go through the particular issues that the noble Lord raised, starting with the powers to suspend the board of directors. The position at the moment, as set out in the Explanatory Memorandum, is as follows:
“The Order also gives stand-alone powers to the PRA and the FCA to require the removal and replacement of directors and senior managers in accordance with Article 28 of the BRRD, and to appoint temporary managers in accordance with Article 29”.
So the regulators already have the power to undertake these early intervention measures. The stand-alone powers we are discussing this afternoon provide greater clarity on the scope of those powers.
As the noble Lord said, these are serious powers of intervention. He raised a number of questions about whether they would be exercised in a fair and proportionate manner. The new stand-alone early intervention powers are proposed with procedural safeguards for the firms, banks and individuals affected, and the powers may be exercised only if the conditions set out in Section 71D are satisfied. The PRA is required to give notice of its intentions to the firm, the directors and the senior executives who would be affected by the proposed use of these powers, and to give them time to make representations to the PRA. If, having considered any representations made to it, the PRA still decides to exercise these powers, the firm and any directors or senior executives affected have a right to have the decision reviewed by the Upper Tribunal, which will be completely independent of the regulators. The PRA’s general governance procedures should also ensure that these powers are exercised in a fair and proportionate manner.
In non-urgent cases, which in practice means in the vast majority of circumstances, decisions will be taken by the appropriate PRA decision-making committee, made up of at least three people. In urgent cases, if it is necessary to take a decision before a recommendation can be made to the appropriate decision-making committee, the PRA will require decisions to be made by at least two persons. In that case, the decision will be taken only if the two decision-makers are unanimous. At least one of the two individuals will not have been directly involved in establishing the evidence on which that decision is based.
Both the noble Lords, Lord Tunnicliffe and Lord Sharkey, raised issues about Article 15 and asked to which categories of contracts the amendment in Article 15 would apply. As I said when I introduced this debate, the amendment in Article 15 would apply only to a narrow range of contracts. To date, the Bank of England has identified two categories of contracts for which the amendment would be likely to apply. One category, mentioned by the noble Lord, Lord Tunnicliffe, is contractual bail-in instruments: debt instruments that qualify for the minimum requirement for own funds and eligible liabilities where the contract specifies that the instrument may be written down or converted to the extent required on the occurrence of a specified event, for example, when the bail-in tool is applied. I think that the noble Lord, Lord Tunnicliffe, accepted that that was a reasonable provision. With foreign law-governed debt instruments, it is necessary, for example, to ensure that the bail-in will take effect on a contractual basis because the application of the statutory bail-in power may not be enforceable on a cross-border basis.
The other category is certain service contracts specifying the terms on which services will continue to be provided following a resolution. These contracts therefore support operational continuity in an institution following resolution. Service contracts would also include certain contracts with financial market infrastructure, such as payment and settlement systems, where it is important to ensure that they continue to offer access to a firm after it has entered resolution.
Both noble Lords asked why Article 15 was not more specific about the categories. The answer is that resolution planning is an iterative process and banks are complex. It is possible that additional types of contracts could be identified at the advanced planning stage, where the Bank of England is preparing for the failure of a particular bank, so a broad formulation of the new power that Article 15 inserts into Section 48Z is appropriate.
Lord Young of Cookham
No, but hopefully, I will be updated very shortly on the update.
Resolution planning is a technical and iterative process and, as I said a moment ago, this may uncover further categories of contracts where the activation of default event provisions could aid the Bank of England’s efforts to resolve a firm.
I was asked by the noble Lord, Lord Tunnicliffe, whether the Article 15 exemption could be used on a contract-by-contract or category-by-category basis. In order to have full flexibility in resolution, the Bank of England will have discretion to specify contracts or to describe categories of contracts in the resolution instrument.
I was also asked what procedures would be used and who would be responsible for the Article 15 exceptions. As the UK’s resolution authority, the Bank of England will be responsible for deciding to which contracts the exemption in Article 15 applies. Before exercising its resolution powers, the Bank is required to consult the PRA, the FCA and the Treasury. The deputy governor for financial stability and the executive director for resolution have day-to-day responsibility for resolution matters within the Bank, which has established a resolution committee and a resolution advisory committee for the purpose of decision-making in its role as the resolution authority. The most important resolution decisions are reserved for and may be escalated to the governor, who may be advised by the Bank’s deputy governors.
I was asked how those who take the decisions will be accountable. As I said, the Bank is obliged to consult the PRA, the FCA and HMT but noble Lords will know that the Bank demonstrates its accountability to Parliament through the House of Commons Treasury Committee. The Bank of England and Financial Services Act 2016 provides that the National Audit Office may carry out examinations of the economy, efficiency and effectiveness with which the Bank has used its resources in discharging its functions. Those are two important areas of accountability.
Issues were raised about whether the details of governance will be in the public domain. The Bank of England’s governance arrangements on resolution were published in the Bank of England’s memorandum of understanding with the National Audit Office. Details on its governance arrangements are likely to be covered in the Bank of England’s statement on the operational independence of its resolution function, which it is required to publish by the Bank of England and Financial Services Act 2016. I will endeavour to find out what dates there are for that.
Moving on to the issues raised by Jon Cunliffe’s speech—whether the market is fully informed of the products being bought and sold, and making sure that it is—the Government and the regulators have consulted extensively with stakeholders as they develop the UK’s resolution regime. For example, the Bank of England’s Approach to Resolution document sets out how it expects to carry out the resolution of a failing firm in practice, using the powers available to it as the UK resolution authority. The Treasury’s code of practice document, issued in accordance with Sections 5 and 6 of the Banking Act 2009, provides further guidance on the UK’s resolution regime. The Banking Act 2009 also establishes the Banking Liaison Panel. This panel of industry bodies, law firms and regulators advises the Government on the UK’s resolution regime.
Are we planning to bring all the relevant legislation into a single document? Here we move on to more disappointing news. There are no plans to bring the different documents together. Each document serves a clear purpose. The Bank of England’s Approach to Resolution document sets out how the Bank expects to carry out the resolution of a failing firm in practice, using the powers available to it as the UK resolution authority. The Treasury’s code of practice is a statutory requirement, which provides further guidance on the legislative framework.
Lord Tunnicliffe
The Bank of England’s Approach to Resolution, from October 2014, is indeed the most readable of all the documents, but it is now clearly out of date. Is the Bank of England expected to produce an update?
Lord Young of Cookham
The noble Lord raises an important point, which I will of course pass on to the Bank of England. It is an independent body, but I am sure that it would like to respond to his point about updating the guidance, which, as he said, is now a little old.
Will the legislation be consolidated? Again, I am afraid, there is disappointing news. As a former Leader of the House, I can say that there was always enormous pressure on parliamentary counsel to draft legislation—it is a scarce commodity. Given the limited amount of parliamentary time available, there are currently no plans to consolidate the legislation. Stakeholders who are directly affected by the legislation and will therefore need a more granular understanding will be able to purchase consolidated versions of the legislation from commercial providers. In addition, HM Treasury’s special resolution regime code of practice will be updated to reflect the changes made by the order.
On the issue of third countries and the independent resolution powers, the powers that we are taking are in line with the Financial Stability Board’s “Key Attributes of Effective Resolution Regimes for Financial Institutions”. These key attributes recognise the need for resolution authorities to have, as a fallback option, the ability to take independent action with respect to local operations of foreign banks in certain circumstances, although, as I said at the beginning, every effort will be made for resolution by co-operation.
The noble Lord, Lord Sharkey, asked about the code of conduct. It will be published in the new year. I think that I covered the contracts under Article 15 in my introductory remarks.
The noble Lord, Lord Tunnicliffe, talked about the macroprudential issues and said that he would be happy to have a response to those in a letter, an offer that I gratefully accept. Now that the in-flight refuelling has arrived, I can say, on the macroprudential measures, that the FPC has included all previous recommendations and directions in the statements that follow its meetings. Implementation will depend on the specific direction and the regulators must consult on any rules that would implement these powers. The FPC may make recommendations regarding the timing of implementation. As I said when I introduced these instruments, we have already put on the statute book a similar regime for owner-occupiers, with whom I imagine the same sorts of issues have already arisen. Broadly, the same regime will apply for buy-to-let.
The noble Lord, Lord Tunnicliffe, asked about the cost. The cost reflects enhanced data collection, which is necessary for the regulators to monitor compliance with these powers and other prudential requirements.
I hope that I have covered most of the issues raised.
Lord Sharkey
When the Minister says that the guidelines on the definitions of the business of branches will be available in the new year, does he mean January or sometime in 2017? Also, I do not think that I heard him give a date for the guidelines for Article 15.
Lord Young of Cookham
At this stage I am not sure that I can take it any further than I did in my earlier remarks. However, I would like to make further inquiries and, if it is acceptable to the noble Lord, I will write to him when I have definitive information on those timelines.