Amendments of the Law (Resolution of Silicon Valley Bank UK Limited) (No. 2) Order 2023

Thursday 15th June 2023 Grand Committee

Considered in Grand Committee

13:00

Moved by

[Baroness Penn]

That the Grand Committee do consider the Amendments of the Law (Resolution of Silicon Valley Bank UK Limited) (No. 2) Order 2023.

[The Parliamentary Secretary, HM Treasury (Baroness Penn) (Con)]

My Lords, as the Committee will be aware, Silicon Valley Bank UK Ltd—SVB UK—was sold on Monday 13 March to HSBC. The aim of this sale was to ensure that customers of SVB UK could access their deposits and banking services as normal; to limit risks to our tech and life sciences sector; and to safeguard some of the UK’s most promising companies.

We have achieved these outcomes—the best possible—in short order, without any taxpayer money or government guarantees. There has been no bailout, with SVB UK sold to a private sector purchaser. This solution is a win for taxpayers, customers and the banking system. The IMF has said that the UK’s response to SVB UK restored market confidence and contributed to the UK’s upgraded growth forecast. It now expects the UK to avoid a recession this year.

On Monday 13 March, the Economic Secretary to the Treasury laid in both Houses a statutory instrument, using the powers under the Banking Act 2009, to facilitate the sale of SVB UK to HSBC. That instrument has now been approved by both Houses. It granted HSBC’s ring-fenced bank an exemption so that it could provide liquidity on non-arm’s-length terms to SVB UK on an ongoing basis. This was needed to facilitate the sale of SVB UK to HSBC, because it ensured that HSBC was able to provide the necessary funds—over £2 billion in the immediate days after—to its new subsidiary. The exemption also ensures that HSBC UK can provide liquidity to SVB UK as needed.

The Economic Secretary to the Treasury has now laid this second statutory instrument, which we are debating today, to provide an ongoing exemption from ring-fencing requirements for SVB UK, beyond the existing four-year transition period. This exemption is subject to conditions relating to the size of SVB UK’s core deposits, and the type of business it can undertake.

The first condition is intended to ensure that SVB UK, or its subsidiaries, will not be able to hold core deposits—typically, retail and SME deposits—above the existing core deposits threshold in the ring-fencing regime; that is, £25 billion. The threshold is used to determine whether a bank becomes subject to the ring-fencing regime. The second and third conditions are intended to ensure that SVB UK, or its subsidiaries, will be allowed to undertake only new business activities similar to SVB UK’s existing business at the time of the acquisition by HSBC.

These conditions are intended to ensure that the exemptions from the regime are limited to what was needed to facilitate the sale of SVB UK. Together, they minimise risks to financial stability and limit any competitive distortion.

Indeed, Sam Woods, deputy governor for prudential regulation and chief executive of the Prudential Regulation Authority, has confirmed the PRA’s support for the provisions in this instrument in a letter which the EST has laid in the Libraries of both Houses and which I sent to those who spoke in the debate on the first SI relating to SVB. It states that

“the statutory instrument and its conditions supports the PRA’s primary statutory objective of safety and soundness, and limits competitive distortion”.

The letter also confirms that the PRA has a range of tools to ensure the effective supervision of HSBC and SVB UK.

This amendment, along with the previous exemption, was crucial to the purchase of SVB UK by HSBC and protected taxpayers and depositors. The UK has a world-leading tech sector, with a dynamic start-up and scale-up ecosystem, and the Government are pleased that a private sector purchaser was found. I hope noble Lords will join me in supporting this legislation. I beg to move.

[Lord Davies of Brixton (Lab)]

My Lords, I support the order, but it raises some issues that bear significant further thought. The exemption from the ring-fencing requirement is clearly an issue, so it was discussed in the Chamber earlier in the week. The Government have said that ring-fencing is a key part of their package of banking reforms designed to increase the stability of the UK financial system and prevent the costs of failing banks falling on taxpayers—this was following the financial crisis. Clearly, it is important, and any decision to have some exemption needs careful consideration. I shall not deal with the issue in detail; I heard what the noble Baroness, Lady Kramer, said about it in the Chamber earlier in the week, so I can say in anticipation that I very much agree with her remarks.

I want to say something about the resolution process and what we learned about it during this episode. The Bank of England is responsible for taking action to manage the failure of financial institutions—the process known as resolution. The Bank said that the financial system needs an effective resolution framework, and that was one of the key lessons from the global financial crisis of 2008. Resolution reduces the risk to depositors, the financial system as a whole and the public finances which could arise following the failure of a bank. The object of resolution is to reduce the risk of bank failure as well as to limit its impact when it occurs. To be effective, a resolution authority needs powers that ensure that any losses will fall on a failed bank’s investors but without risk to financial stability or to the broader economy.

To achieve those objectives, the Bank has powers that affect the contractual rights of counterparties and investors in the failed firm, so there have to be statutory safeguards for creditors and counterparties. The requirement in general is that shareholders and creditors must absorb losses before public funds can be used. The Bank has a range of powers to enforce insolvency, which was the initial expectation in this case, or to transfer all or part of a firm’s business either to a private sector purchaser or to a temporary bridge bank established by the Bank pending a sale or transfer.

At the point of failure, Silicon Valley Bank UK had a total balance sheet size of about £8.8 billion and a deposit base of approximately £6.7 billion—that is, assets greater than liabilities to depositors. In that sense, it was solvent. However, the scale of the deterioration of liquidity and confidence meant that the Bank and the Prudential Regulatory Authority—PRA—concluded that the position was not recoverable. It is what the Governor of the Bank of England has described as “banking 101”.

Having consulted the Treasury, the PRA and the Financial Conduct Authority—the FCA—the Bank of England decided ultimately to use its resolution powers to transfer the bank to a private purchaser. My question for the Minister is: what lessons have the Government learned from this episode about the resolution process? The process is relatively new and untested, which means that each example must be explored in detail. The idea of testing the resolution regime is of course problematic; you would not want to test your home insurance by burning down your house, so we have to learn where we can.

Now, getting to the crux of what I am talking about, the example was discussed at the meeting that the House’s Economic Affairs Select Committee had with the Governor of the Bank of England on Tuesday, which I attended. Unfortunately, we do not yet have the official transcript, so I cannot quote what the governor said, but I can give the Committee my impressions of what issues need to be explored based on what was said at the meeting.

The first issue is whether the resolution regime worked. Was there a clear and predictable set of rules upon which depositors could rely or was it, in practice, totally ad hoc? It may be that what worked was the right approach in the circumstances, but we need to be clear about that. The governor appeared simply to rule out certain approaches—for example, a bridge bank—largely, it would seem, because of the impact on the public purse. Manifestly, the wish to avoid splitting the assets and liabilities led to the decision to break the ring-fence.

Another thing that was clear is that resolution is inevitably an intensely political process. When the bank said it consulted HMT, it certainly was not just officials. Certainly, the Chancellor but also the Prime Minister were involved in what in banking terms does not really count as a large institution but that on the face of it had wider financial implications. I do not want to downplay the significance of the event. It appeared that at one stage of the process it was suggested that a failure to resolve the matter satisfactorily would “really set back curing disease”—so no pressure.

Finally, the underlying question is whether we are heading in the direction that means that it will, in practice, never be acceptable to impose losses on uninsured deposits. We must remember that in this case the deposits were generally commercial, not personal, deposits. These issues are being discussed, and there is ongoing discussion about a digital currency, but it would be best if they were discussed clearly, openly and together.

[Baroness Kramer (LD)]

My Lords, I am delighted to follow the noble Lord, Lord Davies of Brixton. I am very glad that he has had an expanded discussion of resolution. I will refer to that very briefly in what I have to say.

I have a lot of questions for the Minister on this area. She will not be surprised by them because I and others had questions in March when we debated the SI that provided the temporary exclusion of HSBC from the ring-fencing provisions. This time we are looking at a permanent exclusion.

First, let us look at this permanent exclusion. A few moments ago, the Minister said that there are constraints and conditions. Indeed, when we discussed the first SI she led us to believe, I do not think with any ill intent, that when we saw the SI including the permanent exclusion we would find constraints and conditions on either the activities of Silicon Valley Bank UK or the ability of HSBC to transfer unlimited funds to it, in a way that would give us reassurance that this was a very limited busting of the ring-fence, not something with fundamental implications.

I am struggling to understand that because the Minister made it clear just now that Silicon Valley Bank UK could not expand into being a major retail bank. None of us ever thought that HSBC, as a major retail player, would be setting up Silicon Valley Bank UK to be a major retail bank. So long as Silicon Valley Bank UK does not become a retail bank, I cannot see how the PRA is in any way able to limit its activities. Presumably it would limit those activities under Section 55M of FiSMA—“Imposition of requirements by PRA”—and those would not apply if it was not engaged in regulated activities. I am struggling to understand quite how the role of the PRA would work to limit the range of activities carried out by Silicon Valley Bank UK.

Secondly, let us look at those activities. If anybody wants to know what they are, I suggest that they take a look at the Silicon Valley Bank UK website; they will see that it is heavily engaged in supporting both venture capital and private equity. That takes us into that investment banking, high-risk activity that has, since the changes post the crisis in 2007, been separated out from retail banking. We also know, just from discussions, that it is heavily involved in a range of derivatives.

13:15

Nearly all the kinds of activity that one would associate with an investment bank that sits outside the ring-fence are indeed already encompassed by Silicon Valley Bank UK. I am struggling to understand what the various constraints are that the Minister was talking about and how they apply—unless, as I say, Silicon Valley Bank has suddenly turned into a major retail player, which would not be logical and is not, I am sure, HSBC’s purpose. If the Minister could provide some clarification on that, I would be most grateful. I was looking to find the constraints within the SI itself. I may have misread the various clauses but I cannot see them.

My argument has always been that ring-fencing was an extremely significant decision by Parliament to provide a fundamental safeguard following the lessons learned from the financial crash of 2007-08, building on the work of the Parliamentary Commission on Banking Standards and its recommendations. The ring-fence had multiple roles; one was to separate the culture of retail banking from investment banking because their relationship with each other was clearly unhealthy. We saw retail banks trying to achieve far greater profits; that is how we ended up with mis-selling in a whole variety of areas and on a very large scale, and it is the reason why we saw HBOS lower its credit standards and begin to fund itself short in order to generate greater profits. We saw a lot of unfortunate behaviour within the retail sector because of this cross-contamination with the investment part of banking.

On the investment side, we also saw a very cavalier attitude towards risk-taking by quite a number of banks, which is how we ended up with the CDOs. They had that cavalier attitude because they knew that they could fund themselves, not by having to go to knowledgeable investors but because they had access to the funds in the current accounts of ordinary folk and retail depositors.

The decision was that the two had to be separated, so I am very concerned about an undermining of the ring-fence. As far as I can see, there is nothing to constrain HSBC from deciding that it wishes to use those retail funds that it has within its organisation to flow into Silicon Valley Bank UK to use for activities such as venture capital, private investment or exotic derivatives. That is exactly the issue that concerned the House the last time that we met to discuss this. At one level, even if you think it is a good thing that we should not have a ring-fence, it will give HSBC a very significant advantage over its various competitors. It is inevitable that those competitors would use pressure and precedent to make sure that they also get similar opportunities and a level playing field.

The sense is that the decision to provide this regime for our largest bank is effectively the death knell for most ring-fencing for major banks in the UK. I admit that there is a process that must be followed—we have the Edinburgh reforms—but the Government have always been very clear that they will come in through statutory instruments and regulation, not through Parliament.

I go back to Section 55M of FSMA, on the imposition of requirements by the PRA. Can the Minister explain how the application of Section 55M requires any kind of primary legislation, as I cannot see that it does? Even if the regulator said that it would try to limit the breach to just HSBC and Silicon Valley Bank UK, that is a decision by the regulator, not Parliament. The regulator could change its mind, go the other way and say, “No, we’re entirely comfortable with the idea of removing the ring-fence”. Essentially, we take the decision away from Parliament if we rely on Section 55M of FSMA as the control factor in whether the ring-fence remains in place. Perhaps the Minister can help me work through that. I am just trying to understand how the notion that primary legislation is required fundamentally to change the ring-fence remains intact now that this is in place.

I will talk for a moment or two about resolution. The Government put forward the argument—the Minister used it on Report of the Financial Services and Markets Bill—that the resolution plans for banks if they fail are an effective substitute for ring-fencing. I argue that they cannot be. We have had dramatic evidence of that over the past several months. Credit Suisse had in place a resolution plan in case it failed, but the Swiss regulators—I stress again that I do not think they are fools or inadequate in any way; they are excellent—made the determination that if they pursued the resolution plan, they would create an economic crisis for Switzerland, so they set it aside.

In the United States, the three regional banks that collapsed did not have resolution plans because the US had adjusted, after a lot of industry lobbying, the benchmark at which banks started to have to have them in place and these smaller regional banks had become exempted. However, under US banking regulation there is an option in these cases for the regulator to impose a resolution plan, even if one is not written and in place when the failure happens. In the cases of the three regional banks, the US made that same determination that it should not impose resolution because it would create too much risk to the economy. Instead, it found other ways to come to the rescue of the three banks that failed.

We now know from absolute experience that resolution, which may apply in some limited circumstances and may sometimes be exercisable, will be available only in relatively limited circumstances. That underscores the fundamental necessity not to harm the ring-fence, which has held the ground over the past several years and looks to be our best and primary hope of preventing the kind of mismanagement, misbehaviour and risk-taking that led to the 2007-08 crash.

I hope the Minister will help me through this, as I struggle to see where there are now realistic, meaningful limitations on HSBC’s ability fundamentally to avoid the application of the ring-fence to its activities, provided that it routes the funds through Silicon Valley Bank UK and also does not turn it into a retail bank, which I am sure is far from its intention.

[Lord Livermore (Lab)]

My Lords, in our debates on Report of the Financial Services and Markets Bill we discussed at great length the wider issues around ring-fencing. I said then that we fully support the steps taken by the Treasury, the Bank and the regulators in relation to Silicon Valley Bank UK. The system worked at pace to ensure that SVB UK could continue its operations.

Silicon Valley Bank UK serves a high concentration of life sciences and tech companies in this country, and those firms play an indispensable role in driving growth and innovation across our economy. We therefore recognise that granting an exemption to the ring-fencing regime for HSBC was necessary to guarantee the sale of SVB UK in exceptional circumstances.

However, I have three questions for the Minister. First, although it is welcome news that SVB UK will continue lending, it is clear that tech and life sciences firms need more options. What plans do the Government have to ensure that SVB UK is not the only way that such firms can access capital?

Secondly, the three conditions on SVB UK that have made this ring-fencing exemption possible appear to be sensible, but are there are any circumstances that could lead to additional conditions being imposed or to a reopening of the exemption in future?

Finally, the Government previously indicated that if parliamentary committees were to undertake an inquiry on SVB UK’s collapse or on wider issues with the banking sector, they would co-operate with that inquiry. Has there been any interaction on this matter, beyond March’s exchange of correspondence with the Commons Treasury Select Committee?

[Baroness Penn (Con)]

My Lords, I thank all noble Lords for their contributions. Although I think we all agree that the outcome reached with regard to Silicon Valley Bank UK was a good one, there are important questions about the process by which it was achieved and its implications.

The noble Lord, Lord Davies of Brixton, asked about lessons learned and, specifically, whether the regime worked as expected or as provided for when it was designed. Under the special resolution regime, various tools and powers are available to the Bank, the PRA and HMT to stabilise a failing institution. To deploy them, the authorities must be satisfied that: the bank is failing or likely to fail, by considering a number of factors, such as the value of assets and the ability to meet liabilities, as the noble Lord mentioned; outside the stabilisation powers, action will not be taken to prevent the bank failing; the exercise of the power is necessary, having regard to the public interest; and the objectives of the regime would not be better met by winding up the bank. Any use of the power that would entail risks to public funds must also be approved by His Majesty’s Treasury.

In the case of SVB UK, we can say that the powers were indeed used in a way provided for by the Banking Act 2009. The Bank of England, as the resolution authority, determined that the use of the private sector purchaser tool produced the best outcome, having regard to the special resolution objectives. In particular, it ensured that SVB UK’s customers were fully protected. As the noble Lord noted, the Treasury was consulted by the Bank of England before the private sector purchaser tool was exercised, as is also required by the Banking Act.

As I said, the authorities have a range of tools and options to choose from when deciding how best to manage a failing financial firm and contingency plan for a range of different scenarios. In choosing between the resolution tools set out in the Banking Act 2009, the Bank of England and the Treasury work closely together. The Bank is the UK’s resolution authority and is responsible for executing all stabilisation options provided for under the special resolution regime, with the exception of the temporary public ownership option, which is the responsibility of the Treasury.

13:30

Although we reached a good outcome in this instance, the noble Lord, Lord Davies of Brixton, is right that it is important that we reflect on what happened and look at whether any lessons can be learned and how improvements can be made in the future. I confirm to the Committee that the Treasury and the Bank of England are working together to ensure that we reflect properly on the events in this case and how best to draw on those lessons learned.

The noble Lord, Lord Livermore, asked about engagement with Select Committees in this case. We will absolutely co-operate with the Treasury Select Committee’s inquiry on this matter. We have not had any exchanges with it since March, but we stand ready to discuss the issues further with it as needed. That will also form part of the lessons-learned exercise that will be undertaken between the Treasury and the Bank; Parliament will also have a role to play in scrutinising what happened.

The noble Baroness, Lady Kramer, asked a series of questions on the operation of this exemption and on its implications more widely. She asked where the limitations on the exemption to the ring-fence for SVB UK are in this SI. They are in Article 2(2), which sets out the limit to the core deposits that SVB UK can take and defines the permitted business as

“any business which is closely connected with, directly relates to, or is of a similar nature to, the products and services offered by way of business by Silicon Valley Bank UK Limited as at 13th March 2023”—

the date on which the sale took place. The noble Baroness asked—

[Baroness Kramer (LD)]

Just for clarification: HSBC could pass as many billions as it wishes through to Silicon Valley Bank UK to use for venture capital, private equity, structured derivatives and whatever other products Silicon Valley Bank provided to its customers on the date of its purchase—is that correct? So there is no constraint on the amount or where within that pool of activities the funding can go. It would be helpful for us to understand that.

[Baroness Penn (Con)]

If I might press on, I shall address at least part of the noble Baroness’s subsequent questions. Just to correct a perception: as the governor outlined to the Economic Affairs Committee yesterday, SVB UK typically provides corporate start-up banking services rather than investment banking. I think that difference is important in this context.

[Baroness Kramer (LD)]

I want to pick up on that “typically”. As far as I can see, there is nothing in this which says that the proportionality of commercial banking deposits with regard to the other activities has to stay constant. Carrying out one transaction in an area would bring it within the scope of future activities, would it not?

[Baroness Penn (Con)]

To answer the noble Baroness’s question about whether SVB UK will be permitted to use unlimited amounts of retail funding from HSBC’s ring-fenced bank, the ring-fencing exemptions are subject to conditions that restrict the amount of SVB UK’s core deposits and the type of business that it can operate, as I have set out and as is in the SI. In addition, the PRA has granted HSBC UK and SVB UK temporary waivers to remove constraints in the PRA Rulebook relating to the capital requirements regulation—CRR—on the intragroup lending and funding from HSBC to SVB UK. These waivers, along with the modification to the regime the Government made in the first SI, allowed HSBC to provide emergency liquidity to SVB UK.

As is usual practice with PRA waivers, they are time-limited. One of the waivers expires on 17 September 2023 and the other on 17 June. Whether these waivers are extended or modified is a matter for the independent regulator. The waivers are part of the range of tools that the PRA can use to ensure the effective supervision of HSBC UK and SVB UK. If these waivers lapse, the constraints in the PRA Rulebook regarding intragroup lending and funding from HSBC to SVB UK will come into effect, which would mean that SVB UK would not be able to be funded to an unlimited extent from HSBC UK’s retail deposits.

The noble Baroness, Lady Kramer, said that she took no comfort from either the provisions in this SI or the PRA’s wider supervisory and regulatory powers. What I would say is that the PRA has confirmed its support for provisions in this instrument. Sam Woods has stated that the SI and its conditions support the PRA’s primary statutory objective of safety and soundness and limits competitive distortion. He outlined that the PRA has a range of tools that it can and will draw on to ensure the effective supervision of HSBC and SVB UK and ensure the protection of retail deposits. It will continue to supervise both HSBC UK and SVB UK in line with its usual supervisory approach.

The noble Baroness asked me about Section 55M of FiSMA. I suggest that I should perhaps write to the noble Baroness and the Committee on this point. I have the outlines of an answer, but I think that it might be better delivered in writing for complete clarity. To come back to her point, more broadly, about parliamentary scrutiny or control over the process around the ring-fence and changes to it, the actions in this case are entirely in line with powers granted to the regulators in terms of operating the resolution regime. What we should not do is to think that the powers used under the special resolution regime are indicative of the Government’s or regulators’ approach to reforming the ring-fence more broadly. Any fundamental reforms to that ring-fencing regime would require changes to primary legislation. There is nothing in this process that has changed that.

To turn to the question from the noble Lord, Lord Livermore, on lending to the sector, or sectors, that formed a large part of the customer base for SVB UK, he is absolutely right that it is essential that tech and life science firms have access to the capital that they need to start up and scale up. We support that through the British Business Bank, which has several programmes tailored specifically to the needs of the UK’s life science and technology companies, including the £200 million Life Sciences Investment Programme and the £375 million Future Fund Breakthrough programme, which is specifically aimed at increasing the supply of growth-stage venture capital to UK-based companies working in capital and R&D-intensive areas, such as quantum AI, life sciences and clean tech. There is the National Security Strategic Investment Fund, which invests commercially in advanced technology firms and aims to accelerate the adoption of the Government’s future national security and defence capabilities.

Further to that, at the Budget, the Government extended the British Patient Capital programme by a further 10 years. Alongside that, the Government launched the long-term investment for technology and science initiative to aim to spur the creation of new vehicles for investment into science and tech companies, tailored to the needs of UK defined contribution pension schemes. The contribution of pension scheme capital in this area is something that we discussed quite a bit yesterday, and the Government have further intentions to take forward action in this area.

[Lord Davies of Brixton (Lab)]

Do we have a date for that?

[Baroness Penn (Con)]

I believe that at the Spring Budget the Chancellor said that he would report back in the autumn on the further work undertaken in that area—so quite soon, I would say.

I shall read through the transcript of this debate and look to ensure that where I have not fully answered the questions raised I write to noble Lords. Although it has been a short debate, it is an important area and I want to make sure that we get all the facts clearly on the record.

Motion agreed.