Grand Committee
Arrangement of Business
The Deputy Chairman of Committees (Baroness Pitkeathley) (Lab)
My Lords, although we do not anticipate it this afternoon, your Lordships will know that, if there is a Division in the Chamber while we are sitting, the Committee will adjourn as soon as the Division Bells are rung and resume after 10 minutes.
Occupational Pension Schemes (Funding and Investment Strategy and Amendment) Regulations 2024
(8 months, 4 weeks ago)
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Viscount Younger of Leckie
That the Grand Committee do consider the Occupational Pension Schemes (Funding and Investment Strategy and Amendment) Regulations 2024.
Relevant document: 17th Report from the Secondary Legislation Scrutiny Committee
The Parliamentary Under-Secretary of State, Department for Work and Pensions (Viscount Younger of Leckie) (Con)
My Lords, these regulations were relaid before the House on 26 February. They bring in new measures that will support trustees and sponsoring employers of defined benefit occupational pension schemes to plan and manage their scheme’s funding over the longer term. The aim of the regulations is to achieve a fair and long-lasting balance between providing security for members of defined benefit schemes and affordability for the sponsoring employer.
I start by giving a bit of background. The UK has the third-largest pension system in the world, with assets of around £2 trillion held in both defined contribution and defined benefit schemes. The pensions sector is an integral part of the UK economy. I will focus on defined benefit pensions and these regulations. Over the last decade, across the Organization for Economic Cooperation and Development, the UK has seen the greatest improvement in defined benefit funding.
There are around 5,000 defined benefit schemes in the UK, and around 9 million people who depend on these pensions when they retire. Defined benefit pension schemes, often referred to as DB schemes, are a promise that scheme members will receive a guaranteed income in retirement, usually paid monthly, for the rest of the member’s life. Between them, UK DB schemes have around £1.4 trillion of assets under management.
Most DB schemes are closed either to new members or to new accruals. This means that they have an increasing number of members who are retired or close to retirement, and either a decreasing number of members or no members at all who will make contributions to the scheme. This is referred to as “maturing” and will change the funding requirements of the scheme. It is therefore extremely important that employers and trustees work together to manage maturing schemes to ensure they can continue to pay members’ pensions.
DB funding levels have improved in recent years through a combination of employers supporting schemes and, more recently, changes to interest rates. The Work and Pensions Committee report on its DB schemes inquiry, published today, recognises the new opportunities and challenges this brings. But financial markets and economic conditions are changeable and funding positions can quickly deteriorate. The Government will respond to the Work and Pensions Committee report in due course, but I reassure noble Lords that these regulations are designed to provide a solid foundation across current and future economic and market environments. This is good news for schemes, members and sponsoring employers, and for the UK economy.
The majority of DB schemes are well managed and supported by their sponsoring employers, but some schemes are not as well run, or are taking an inappropriate level of risk in their approach to investment and funding. This can lead to funding problems developing. Over a quarter of all DB schemes are in deficit on a technical provisions basis. This means that they have a deficit which will need to be repaired to ensure that members get their promised pensions when they are due to be paid—hence the regulations we are debating today.
The regulations build on the current funding regime for DB schemes, embed good practice and provide clearer funding standards. This will help ensure that all DB members have the best possible prospect of getting the benefits they have worked so hard to build paid in full when they fall due.
The consultation attached to these regulations built on extensive discussion, engagement and consultation with the pensions industry going back as far as 2017. This joined-up working is ongoing, with the development of the Pensions Regulator’s draft code of practice through to its most recent consultation on the statement of strategy. We had good engagement with the consultation: 92 responses from a wide variety of organisations across the pensions industry. The industry broadly welcomed the draft regulations but expressed some concerns that they were too prescriptive and could be improved for schemes open to new accrual. We listened, and the regulations before us today take account of that.
A key aspect of this work was the importance of balancing, on the one hand, clear standards for both open and maturing schemes that reflect the best practices that most schemes already follow and, on the other, ensuring that individual schemes have the flexibility to make funding decisions that best suit their own unique circumstances. Also, schemes must continue to be affordable for their sponsoring employers and to pay out all pensions as they fall due. Importantly, we aim to promote better collaboration between sponsors and trustees in the formulation of an overall journey plan. This includes an investment approach that reflects the scheme’s circumstances.
The Pension Schemes Act 2021 introduced new scheme funding requirements for DB schemes and requires DB scheme trustees to prepare a statement setting out the scheme’s funding and investment strategy, which must be submitted to the Pensions Regulator. These regulations are principle-based and set out detailed requirements for the funding and investment strategy. Better information and clearer funding standards will help address the problems the Pensions Regulator has faced in the past and will enable it to be more effective, efficient and proactive in carrying out its statutory functions.
As part of this strategy, all DB schemes will be required to set out their plans for how pension benefits will be paid over the long term. For example, this could be through buyout with an insurer, by entering a superfund or by running on with continued employer support. The strength of this employer support is fundamental. For the first time, these regulations introduce key principles for assessing the strength of the employer covenant. This is an assessment of the financial ability of the employer in relation to its legal requirements to support the scheme.
Schemes are required to have a clear plan along their glide path to maturity and low dependency, so as not to need further employer support by the time they are significantly mature. Schemes are required to reach low employer dependency in reasonably foreseeable circumstances. This embeds existing good practice that funding risks taken by a scheme before they reach maturity must be supportable by the employer, while providing explicitly for open schemes to support more risk, because there is more time for them to address any funding shortfalls.
The best possible protection for a DB member is to be supported by a strong and profitable employer. That is why we have made it clear that recovery plans are to be put in place as soon as the employer can reasonably afford, but this does not mean that the employer must put every free penny into the scheme to the detriment of its growth and other commitments. We believe that this sets an appropriate and sustainable balance while ensuring that schemes get a fair share of available resources.
The funding and investment strategy must be reviewed and, if necessary, revised, alongside each scheme valuation, which is usually every three years. When submitted to the Pensions Regulator, these valuations will be accompanied by a statement of strategy. This will articulate the trustees’ approach to long-term planning and management, as well as their assessment of the implementation of the funding strategy, key risks and mitigations and any lessons learned. Depending on circumstances, the Pensions Regulator now has the flexibility to ask for less detailed information from the schemes to improve long-term planning and avoid unnecessary burdens.
These regulations help drive the Government’s vision to encourage schemes to invest in ways that are productive for the UK economy. They make it clear that schemes have significant flexibility to choose investments while meeting the low-dependency principle. This will help support trustees in reacting to changing circumstances while investing in the best interests of their members.
The pensions industry has welcomed these revised regulations, which are explicitly more accommodating of risk taking, where supported by the employer covenant. They increase the scope for scheme-specific flexibility, including allowing open schemes to take account of new entrants and future accrual when determining when the scheme will reach significant maturity. The Pensions and Lifetime Savings Association recently commented that this is
“a significant set of ‘win’”
for its members.
I move on to the timing of these regulations. They will come into force on 6 April 2024 and a scheme must have a funding and investment strategy within 15 months of the effective date of the first actuarial valuation obtained on or after 22 September 2024. We intend that the Pensions Regulator’s funding code will be laid before Parliament this summer. The regulations, the code and guidance will work in partnership. These regulations will encourage the widespread adoption of existing good practice and help the regulator to intervene more effectively to protect members’ benefits.
I am confident that the Occupational Pension Schemes (Funding and Investment Strategy and Amendment) Regulations 2024 will support schemes and employers to make long-term plans and enable the Pensions Regulator to take effective action when needed. This will help ensure that scheme members get the retirement they have contributed towards and rightly expect. In my view, the provisions in these regulations are compatible with the European Convention on Human Rights. I commend the regulations to the Committee and beg to move.
Lord Palmer of Childs Hill (LD)
My Lords, I thank the noble Viscount very much for his normal exposition. I am sure that we will hear a lot more detail from other participants. I will confine myself to some questions rather than go through this large document, which the noble Viscount did not go through in great detail.
First, is there a disproportionate governance burden for small firms? I was worried about how small firms will be able to cope with these new regulations. Secondly, the resolutions will add to the duties of defined benefit schemes. Can the noble Viscount elaborate on how these duties will be dealt with? Thirdly, will the regulations help set out long-term objectives? I was a bit worried about comments that these schemes are all coming to an end and that we are just relying on people sitting in place on the schemes and very few new people, if any, coming in.
Is there a conflict—I could not answer this myself—between the beneficiaries and the employers? The noble Viscount used the phrase “fair balance”. I am not sure that this conflict shows a fair balance. On the duty of trustees to protect the interests of the beneficiaries, can we rely on all these trustees to do so, especially when the schemes are, in effect, stationary and being wound up? Also, there is the impact of the fund being hived off to insurance companies. These funds are hived off so often; will the beneficiaries’ interests really be protected? I think that will be their worry.
Finally, the noble Viscount talked about actuarial valuations. So often they mean that funds keep moneys in reserve, probably more than a commercial firm would have to. Can he comment on that? It is very nice and careful that they do so, but sometimes that might have a negative impact on the beneficiaries. I hope he can give me some answers to those numerous questions.
Baroness Drake (Lab)
I thank the Minister for the clarity of his presentation—this is a complex set of regulations—and for the briefing session that he arranged for Peers, where I was able to ask quite a lot of questions. I support these regulations but I want to take this opportunity to ask three questions.
The regulations were preceded by a government consultation on an original draft, which was amended post the LDI crisis and in the wake of the Mansion House productive finance proposals. Importantly, these regulations remove an uncertainty as to whether the DWP would qualify a trustee’s independence to make investment decisions as they make it clear that trustees will retain the power to decide how to invest the scheme’s assets. That is welcome; otherwise, it would have significantly weakened the trustee’s powers to protect scheme members. Is not intervening on a trustee’s independence to make investment decisions now settled policy? Also, is any consideration being given to granting additional powers to the Pensions Regulator to override investment decisions when it is oversighting a scheme’s funding and investment strategy?
Secondly, the regulations now allow greater flexibility in investments and risk-taking than was originally proposed in the first draft, were it supportable. The DWP has made amendments to avoid, to use the Government’s own phrase, things that “inadvertently drive reckless prudence” —that sounds like an oxymoron—“and inappropriate risk aversion”. As the Minister said, it is now explicit that open schemes can take account of new entrants and future accrual when determining when the scheme will reach significant maturity; this gives them greater scope for scheme-specific flexibility.
However, I note that these regulations also no longer require schemes of significant maturity that are making low-dependency investment allocation broadly to match cash flow from investment with schemes’ liabilities. The Government have made it clear that schemes can invest a reasonable amount in a wide range of assets beyond government and corporate bonds, even after significant maturity has been reached—for example, when the scheme’s years to duration of liabilities is around only five to 15. The DWP has explicitly removed the original draft Regulation 5(2)(a), which required in schemes of significant maturity that assets be invested in such a way that cash flow from investments broadly matched the payment of pensions under the scheme.
Why, when a scheme has reached significant maturity, would retaining the requirement that assets be invested in such a way that cash flow from the investments broadly matches the payment of pensions be considered “reckless prudence” or “inappropriate risk aversion”—the premise on which the original draft Regulation 5(2)(a) was withdrawn? When a scheme is in significant maturity, you need prudence and risk aversion because of the need for cash flow. In fact, in many closed DC schemes, the alignment of employers’ desire to remove DB liabilities and volatility from their balance sheets with trustees’ desire to protect benefits over the long term is increasingly leading to investments held broadly matching liabilities, as well as to consideration of a path to buy- out and buy-in for many schemes. It is rather rowing against what is happening in many instances. I fear that greater flexibility of access to surplus may not provide a sufficient incentive for schemes to change their course.
This is my third and final point. The requirement to assess the current and future development and resilience of the employer covenant is now on a legal basis and has to be embedded in the funding and investment strategy agreed by employers and trustees, which is welcome. It reflects the increasing importance given to covenants by trustees but the assessment of an employer covenant can be contested ground between employer and trustee, particularly where there is a question of whether there has been a material change to the strength of the employer covenant. Given this novel legal territory, which is of itself welcome, what powers does the regulator have to address such disagreements of view between the trustee and employer on the covenant, given that they have to agree them in order to proceed with a funding and investment strategy? How, if there are disagreements—and there could well be—will the regulator address those?
Lord Davies of Brixton (Lab)
I need to tell the Committee that I have an interest to declare: I am a fellow of the Institute of Actuaries. However, I should add—with some emphasis—that nothing of what I will say subsequently must be regarded as actuarial advice. It might sound like actuarial advice but I assure noble Lords that it is not. I speak from my experience as a scheme actuary having undertaken scheme valuations, including those under the TPR or previous iterations of where we are.
Unfortunately, I was unable to attend the briefing session due to other business in the House. It might have been better if I had attended because I have reservations about these regulations. They are going to go through and be implemented but, in expressing some doubts, I trust that it will affect the environment in which they are implemented.
In this context, we have to acknowledge the report published today by the House of Commons Work and Pensions Committee—Defined Benefit Pension Scheme, its third report of the 2023-24 Session—which comments in some detail on the role and functioning of the TPR. I want to take this opportunity to highlight some of the report, in which doubts are expressed about the way the TPR operates. For example, Mary Starks undertook an independent review of the TPR and said:
“TPR’s statutory objective to minimise calls on the PPF may drive it to be overly risk averse, particularly given the PPF’s strong funding position”.
I will return to that.
Other comments are that the TPR’s objectives have not changed to reflect the significant changes that there have been in the defined benefit landscape. The concept of excessive prudence is widely held within the pensions industry. The PLSA, the Pensions and Lifetime Savings Association, says that
“it would be helpful to give TPR a greater focus on member outcomes as a whole”,
while the Railways Pension Scheme trustee corporation suggested that an objective should be made explicitly to
“protect and promote the provision of past and future service benefits under occupational pension schemes of, or in respect of, members of such schemes”.
So there is a significant train of thought coming from the industry that the TPR has failed to acknowledge its role in pension provision.
A particular problem highlighted in the first comment is the position of the PPF, the Pension Protection Fund. In giving evidence to the Select Committee, its chief executive, Oliver Morley, said that the objective of the TPR to protect the PPF was
“looking a bit anachronistic now, given the scale of the reserves and the funding level”.
I am not asking the Committee to accept or endorse these comments at the moment but, at the very least, they emphasise that the role of the TPR is a matter of detailed discussion. The regulations before us are firmly within a concept of its role, which many commentators now say is outdated. I have held this view for some time; it is good to see that it is now accepted more widely.
This was the conclusion of the Select Committee:
“TPR’s approach to scheme funding has been driven by its objective to protect the PPF. We agree with those who told us that the objective now looks redundant, given the PPF has £12 billion in reserves”.
As I said, this is at the very least an issue that should be confronted, but it is not confronted by the regulations before us. The regulations are patently too prescriptive. The details that they require are not directed at the objective of protecting members’ benefits but are about establishing a system where box-ticking will take priority over the longer term and broader interests of scheme members.
I have also argued for some time that the TPR misunderstands its role. There is a sort of assumption in its thinking that the calculation of technical provisions represents the best valuation basis. New readers may well find that this is getting into deep water but the point is that the actuary who undertakes the valuation at the request of the trustees must comply with the appropriate professional standard: Technical Actuarial Standard 300. This is the latest version, coming into effect in April.
It is notable that these requirements, which any actuary valuing the solvency of a pension fund should follow, do not mention technical provisions. In essence, the technical provisions are there to trigger action by the regulator; they are not there to substitute for the scheme actuary’s solvency valuation. We have what is in effect a dual basis. The scheme actuary working for the trustees will advise what they believe to be the appropriate contribution rate. Parallel to that, there is the system of technical provisions that, if triggered, require a separate valuation to be undertaken to calculate the recovery plan.
They are quite separate operations but the TPR consistently confuses the two. The end result is that, by overemphasising the role of technical provisions, schemes are being forced into this problem of excessive care, or excessive protection, of the members. It is not at all clear to me that this bureaucratic overweight on the operation of pension schemes ultimately favours the members in any way. In effect, it forces schemes—LPI is just one example—to invest in gilts, which is bad for members; there is no question about that. It is good for the Pension Protection Fund, and good for a Government who are concerned about being held up as not caring about the protection of members, but members’ benefits are drawn from the scheme so the scheme should be funded in accordance with the actuarial solvency standards, as set out by the Financial Reporting Council.
Baroness Sherlock (Lab)
My Lords, I thank the Minister for his introduction to these regulations and all noble Lords who have spoken for their contributions. I should perhaps say that nothing in my speeches should ever be taken as actuarial advice or indeed advice of any kind, unless you have money to burn. As we have heard, these regulations implement significant changes to the DB scheme-specific funding requirements in association with the revised DB funding code. I will go through what I understand them to be doing—I invite the Minister to correct me if I have it wrong—and I have some questions.
The changes are driven by the recognition that most DB schemes are closed to future accruals and are maturing, which makes the longer-term strategic management of them important if members are to make sure they get their benefits in full when they fall due. The key principles underpinning the changes are a requirement for schemes to be in a state of low dependency on their sponsoring employer by the time they significantly mature, and better trustee engagement and better understanding and accountability between trustees and the regulator.
The regulations require trustees to agree a funding and investment strategy—an FIS—with the sponsoring employer, which will set out that longer-term funding objective and how it will be achieved over the lifespan of the scheme. Schedule 1 then sets out the matters and principles that trustees must have regard to in setting their FIS, and that they have to think about liquidity and unexpected requirements on the journey and after significant maturity, including the strength of the employer covenant, which I will come back to in a moment.
The trustees have to consult the employer on a statement of strategy on progress in achieving their FIS. In the absence of a Keeling schedule—I confess I am slightly obsessed with them—I went back to the Pensions Act 2004. Section 221B states that
“trustees or managers must, as soon as reasonably practicable after determining or revising the scheme’s funding and investment strategy, prepare a written statement of … the scheme’s funding and investment strategy, and … the supplementary matters set out in subsection (2)”.
Paragraphs (a) to (c) of Section 221B(2) say that the supplementary matters are: the extent to which trustees or managers think the funding and investment strategy is being successfully implemented, and if not, what they will do about it; the main risks faced by the scheme in implementing the funding investment strategy and what they are doing about the risks; and their reflections on past decisions and lessons learned. Paragraph (d) adds:
“such other matters as may be prescribed”.
These matters are now prescribed because they are defined by Schedule 2 to these regulations, which specifies the information to be covered in the strategy statement.
I assume this means that TPR will now have discretion on the level of detail it can request from a scheme in relation to the supplementary matters. Otherwise, without that discretion, it would have to rely on its existing powers and the setting of the clearer funding standards in these regulations. Is that a correct assumption? How will the DWP monitor whether the regulator is delivering that higher level of probability for which it is shooting? Are the Government leaving the door open to the prospect of increasing the regulator’s powers? That is an interesting one.
To return to the covenant, Regulation 7 puts the employer covenant assessment on a formal legal footing for the first time. The covenant now appears to be central to the new regulatory framework, rather than being left for the regulator to cover in the code. I presume the intention is for this to be an area of increased focus for trustees. This is welcome, given the increasing importance of covenant strength to the decisions made by trustees, although I suspect the law is catching up with trustee thinking as much as driving it.
However, getting access to enough information to assess the employer covenant is not always easy, and trustees and employers may not always align in their view of the strength of the covenant. The Minister mentioned that change can come quickly. We live in a world where changing markets and the impact of technology, mergers and acquisitions, leveraging and new creditors can all make a material difference to the strength of the covenant in pretty short order. The same forces can also reduce trustee confidence in the strength of the covenant in the longer term.
Regulation 7 requires trustees to assess the strength of the employer covenant, looking at current and future developments and the resilience of the business when they are setting or revising the FIS. As the Minister mentioned, funding deficits must be addressed
“as soon as the employer can reasonably afford”.
But we are also told that the impact on the sustainable growth of the business must be taken into account. Does that not put the trustee in the position of being faced with a push-me pull-you set of regulatory requirements, where the two are pulling in different directions?
Trustees will be required to seek more detailed information from the employer regarding its business. The regulator will provide updated guidance on the covenant, which will set out its expectations of both employers and trustees, and the regulations will clearly require trustees and employers to work more collaboratively in future. I have two questions about this, following the issue flagged up by my noble friend Lady Drake. Because placing the assessment of an employer covenant on a legal basis is novel, we need the Minister to make it clear how the regulator will resolve disagreements between trustees and employers on the current and future strength of the covenant, where that is inhibiting agreement on the FIS. If they cannot agree on the FIS because of different views on the strength of that, what will the regulator do about it? Secondly, will the regulator be able to impose its own view of the covenant on trustees?
Regulation 16 strengthens the requirements on the chair in respect of the strategy statement. It seems that the code has been drafted in a manner which assumes that chairs of trustees are appointed by the trustee board. I believe that there are still occupational schemes where the appointment of the chair is wholly the decision of the employer. Does this carry any implications for the requirements placed on chairs appointed in that way?
The costs incurred by trustees, which are funded by employers, will inevitably increase as a result of this. I am quite sure that the Minister will have read the 13th report of the Secondary Legislation Scrutiny Committee. I will not read it out in detail, but it points out the DWP’s assessment that about 16% of DB schemes had deficits in March 2023. It says:
“The Impact Assessment … claims that, as a result of these Regulations, DB schemes’ aggregate ‘deficit reduction contributions’ could be around £0.26 billion lower over the 10-year period compared to the current situation”.
It goes on to point out a range of issues around this, but what interests me is this:
“We note … that the IA states that it is based on data from March 2021, ‘therefore more recent market developments (particularly the rise in interest rates and gilt yields which impacted the estimated liabilities) are not captured in the modelling.’ In the light of market volatility, the House may wish to explore how robust DWP’s assumptions are about the potential benefits of these Regulations”.
I do not have a dog in this fight, but could the Minister put a response to that on the record? What assurances can he give the Committee in response to the concerns of the Secondary Legislation Scrutiny Committee?
Another point was made by that committee in its 17th report. I think the Minister indicated—or maybe he did not; I cannot remember—that this is a revised version of an instrument originally laid on 29 January. The DWP had to amend the content to amend the commencement date of one of the provisions to ensure that it aligned with the policy intention. Yet again, for the record I note a disappointment that once again we are having another instrument laid because of errors made in the original that needed to be corrected. It is becoming a bit of a pattern, I am afraid. But in this case, it provides us with an opportunity. In its 17th report, the SLSC said at paragraph 7:
“Our 13th Report of this session provided the House with extensive supplementary information on how the obligation is intended to work, and we are disappointed that DWP did not take this opportunity to improve its Explanatory Memorandum”.
Can the Minister explain to the Committee why the Government did not take that opportunity afforded to them by the need to reissue the instrument?
I have two quick points to make that were raised by other Members. First, on the Work and Pensions Select Committee report, the Minister said that the Government would respond to that in due course. I recognise that it has only just come out and they will not be able to. However, there is one point that would be helpful in particular—they will already have thought about this—which is that the committee raised the position of open schemes and relayed concerns that, despite some of the changes that had been made, some open schemes still thought that the new regime could require them to de-risk prematurely. Are the Government confident that they have landed in the right space on this?
Secondly, my noble friend Lady Drake asked a very important question about the regime governing investment by schemes that have reached significant maturity, essentially about whether they will no longer be required to balance cash from investments and liabilities going out. It would be very helpful if we could know about both of those.
I apologise to the Minister that I have, yet again, asked a number of questions, but I am grateful and look forward to his reply.
Viscount Younger of Leckie (Con)
My Lords, I thank all those who have spoken in this short debate. As usual, there were a number of specific and quite technical questions, notably from the noble Baroness, Lady Sherlock. I shall do my best to answer them. I think that some of them may be included in some of my rounding-up answers to other questions—but, as she will expect me to, I shall write a letter copying in all Peers if I fail to answer all of them.
Just on the question that the noble Baroness raised about the draft regulations, we outlined in the consultation response, as she alluded to, on 26 January 2024, that we would legislate for the regulations to come into force from April 2024, applying to scheme valuations from September 2024. That recognised feedback through the consultation about the need to give the pensions industry sufficient time to prepare before the requirements took effect. The regulations as drafted meant that one component of the reforms, the recovery plans, would come into effect on 6 April 2024 and not 22 September 2024. Since laying the regulations, we have recognised that this has the potential to cause confusion and additional administrative requirements for schemes. That is why we withdrew the regulations and relaid a revised version.
For clarity, we made two changes to the regulations. The first amendment was to ensure that the changes to recovery plans took effect only when the effective date of the actuarial valuation to which the recovery plan relates is on or after 22 September 2024. The second, in light of the first, is to clarify that changes which relate to actuarial valuations and reports also apply only on or after 22 September 2024. I reassure the noble Baroness that no other changes were made. These changes restate our intention to give sponsoring employers, scheme trustees and managers the same amount of time to prepare for the new requirements in the recovery plan.
I do not believe that I have an answer to the Explanatory Memorandum question, but I shall see whether I can address that before my remarks have concluded.
Baroness Sherlock (Lab)
I fully accept that some of these questions may have been technical and that the Minister may need to write but, in the case of one question that I asked, I would fully expect him to have come able to answer. The Secondary Legislation Scrutiny Committee took a lot of time taking these regulations apart. It made a number of recommendations and made comments about the Explanatory Memorandum. I fully accept the Minister’s explanation as to why the instrument was relaid—that makes absolute sense—but the committee explicitly asked why the DWP did not take advantage of the opportunity of having to relay the instrument to improve the Explanatory Memorandum. I know that he will have read the report, as I know he holds the committee in high regard, so I am sure that he came briefed and able to answer the question of why the department did not respond to that recommendation. Could he just answer that for us?
Viscount Younger of Leckie (Con)
Yes, I will do my best to do so. Regarding the Explanatory Memorandum, as outlined, because the changes here were focused on clarifying the date on which the regulations came into effect, the changes to the Explanatory Memorandum were limited to reflect the change. We shall note the feedback for future SIs. That is my answer but let me reflect on it; I might well be able to enhance it in the letter that I am clearly going to have to write.
Baroness Sherlock (Lab)
I will not interrupt further but, just to clarify the question, the point the committee was making was not that the Explanatory Memorandum needed to be changed to reflect the changes in the instrument itself. It was that, since the department was having to relay the whole thing, why not take the opportunity to do a better job of the EM? That is all.
Viscount Younger of Leckie (Con)
Absolutely. I think I have already indicated that lessons have been learned. From my point of view, I regret that we fell down on the Explanatory Memorandum and that we had to relay the regulations. Just for the record, I wanted to say that.
With that, I hope that we can take these regulations forward.
Renewable Transport Fuel Obligations (Amendment) Order 2024
(8 months, 4 weeks ago)
Grand CommitteeRead Full debate Read Hansard Text Read Debate Ministerial Extracts
Lord Davies of Gower
That the Grand Committee do consider the Renewable Transport Fuel Obligations (Amendment) Order 2024.
Relevant document: 16th Report from the Secondary Legislation Scrutiny Committee
The Parliamentary Under-Secretary of State, Department for Transport (Lord Davies of Gower) (Con)
My Lords, this order would amend the Renewable Transport Fuel Obligations Order 2007 so that recycled carbon fuels, known as RCFs, are eligible for support under the renewable transport fuel obligation—RTFO—scheme.
The RTFO scheme establishes targets to drive the supply of renewable fuels. It does this by placing obligations on suppliers of transport fuel to ensure that renewable fuels make up a proportion of their overall supply. The amount of renewable fuel that should be supplied is calculated as a percentage of the volume of relevant fossil fuel supplied in a calendar year.
This obligation is met by acquiring certificates which are issued for the supply of sustainable renewable fuels. These certificates can be redeemed at the end of an obligation period, as well as traded between parties. The value of these certificates therefore provides a revenue stream for producers of renewable fuels and demand for their products in the fuel market. While the RTFO has operated successfully since 2008, it is important that it continues to evolve as new technologies and opportunities for emissions-reducing fuels are developed.
We committed to supporting RCFs in the Government’s transport decarbonisation plan and this statutory instrument delivers on that goal. It is the product of two consultations with industry and in-depth working with industry experts and across government departments. The instrument will help to maximise the greenhouse gas savings that can be achieved under the RTFO by broadening the available feedstocks for eligible fuels and encouraging the development of a new industry.
So what are these new fuels? RCFs are fuels produced from fossil wastes that cannot be avoided, reused or recycled, and have the potential to reduce greenhouse gas emissions relative to petrol, diesel or kerosene. To date, the RTFO scheme has supported only fuels produced from renewable feedstocks, such as biomass and renewable energy. However, emerging technologies and production methods mean it is possible for fuels produced from fossil wastes to contribute to emissions reductions to a similar degree to renewable fuels.
For example, wastes such as municipal solid waste—black binbag waste to most of us—can be processed using advanced techniques to form alternatives to fossil diesel and jet fuel. These fuels can provide significant greenhouse gas emissions savings compared with their alternative end-of-life fate, such as incineration in energy- from-waste plants.
Recent amendments to the Energy Act via last year’s Energy Bill permit RCFs to be included in the RTFO as well as other renewable transport support schemes, such as the forthcoming mandate for sustainable aviation fuels, provided they cause or contribute to a reduction in carbon emissions. The amendment to the Energy Act recognised that RCFs can play an important role in decarbonising different transport modes, including harder to electrify vehicles such as heavy goods vehicles and airliners.
Turning to the specific content of this SI, it amends the RTFO order to add wastes of fossil origin as an eligible feedstock for fuel production. Importantly, it also designates RCFs as a “development fuel”. These development fuels can be used to fill a sub-target in the RTFO designed to encourage the supply of novel and strategically important emerging technologies for fuel production. As a development fuel, qualifying RCFs also need to meet additional eligibility criteria in the order ensuring that only fuels that comply with existing fuel standards can qualify. This mitigates any air quality or compatibility concerns, as the fuels will in essence be chemically comparable with transport fuels already in use today.
This order will also allow RCFs to claim one development fuel certificate per litre of fuel supplied, which is half that of similar eligible renewable fuels. This is in recognition that truly renewable fuels remain more valuable, while still rewarding emissions savings from RCFs. To ensure that we mitigate any unintended consequences, the order also introduces detailed sustainability criteria. These ensure that support is provided only to fuels that are produced from genuine non-recyclable wastes and that they provide a saving on carbon emissions of at least 50% compared to traditional fossil fuels such as petrol and diesel. These criteria ensure that the policy complements the waste hierarchy and avoids incentivising the creation of wastes while still delivering emissions savings compared to the alternative likely end-of-life fate for different waste streams.
Why we are supporting RCFs? We expect that RCFs will have an important part to play in meeting our future emission reductions targets. Renewable fuels already contribute one-third of transport emissions reductions from the current carbon budget. Widening eligibility to include RCFs will ensure that such fuels can continue to make that important contribution as part of the transition to the electrification of road vehicles. Advanced fuels such as RCFs can generate significantly lower emissions compared to traditional fossil fuels.
The UK is leading the way in developing many of these technologies, supported by grant funding from the Department for Transport via the Future Fuels for Flight and Freight competition and, more recently, the Advanced Fuels Fund. Introducing RCFs into the RTFO now sets a helpful precedent for the forthcoming mandate for sustainable aviation fuel, which the Government have committed to introduce on 1 January 2025 and which will operate in a similar way, but for the aviation sector. Including RCFs in both schemes is important, as production processes mean that many facilities will produce both road fuel and SAF at the same time. Supporting RCFs under the RTFO will also increase the range of feedstocks eligible for support and encourage the innovation needed to increase the deployment of low-carbon fuels in harder to decarbonise vehicles such as heavy goods vehicles and airliners.
A further benefit of supporting RCFs is to provide a productive alternative for difficult to manage wastes. Examples of RCF feedstocks include unrecyclable, often contaminated plastics such as black bin bag waste. These wastes are currently mostly incinerated or sent to landfill. Processing them into fuels offers a more sustainable method of waste management. RCF production also utilises many of the same processes and technologies needed to be developed in order to increase the efficiency and capability of chemical recycling. Providing extra investment into these processes will therefore lead to wider waste management benefits in future.
In conclusion, as I have said, fuels supplied under the RTFO scheme currently deliver about one-third of all domestic transport carbon savings under current carbon budgets. However, it is vital that we expand the range of feedstocks we use if we are to continue to grow their contribution and meet our net-zero goal. RCFs have the potential to deliver emissions savings across the transport sector, while also supporting the efficient handling of wastes, and provide an opportunity for a valuable emerging UK industry, something I think we should all support. I beg to move.
Lord Ravensdale (CB)
My Lords, I declare my interests as set out in the register, particularly as a chief engineer working for AtkinsRéalis, an engineering consultancy, and as a co-chair of Legislators for Nuclear.
I very much welcome this statutory instrument, not least because I put forward and agreed with the Government the amendment to the Energy Act 2023 which gave them the primary powers to undertake this change. As the Minister said, recycled carbon fuels can provide significant carbon savings compared with traditional fossil fuels such as petrol, diesel and kerosene, and will save large quantities of carbon for hard-to-abate sectors. They will also enable RCFs as key near-term components of sustainable aviation fuels in the SAF mandate. Clearly, how these carbon savings are to be determined will be a key point in the implementation of these regulations, so can the Minister perhaps expand to the Committee on the detail of how this carbon savings process will be undertaken?
Secondly, the other part to my amendments to the Energy Act 2023 related to nuclear-derived fuels and enabling these to obtain support under the RTFO. These powers will be important in the near term for plans for hydrogen-powered construction vehicles and for hydrogen-powered buses at Sizewell, and in the medium term for the SAF mandate, given the unique characteristics of nuclear plants and their ability to produce hydrogen and synthetic fuels economically and at large volumes, leveraging the heat that they generate as well as electricity to generate large volumes of sustainable aviation fuel. Can the Minister perhaps update the Committee on when we will see a similar statutory instrument for nuclear-derived fuels, and indeed on the timescales of those associated consultations?
Finally, I highlight the need for cross-departmental working in this area, particularly on sustainable aviation fuels, which I know is already happening. There is a need for ministerial sponsorship of a senior-level, cross-Whitehall discussion, including the relevant departments, including the DESNZ, the DfT and the Treasury, to initiate those activities and dialogue on policy, funding and collaborations needed to unlock this SAF opportunity from recycled carbon fuels and from nuclear-derived fuels. This would really help break down those silos and move this area forward. Can the Minister also please state what plans there are for such cross-departmental work in the future?
Baroness Randerson (LD)
My Lords, I thank the Minister for his introduction. The noble Lord has just referred to the significance of this instrument. It is a very modest little piece of secondary legislation, but it could well usher in a whole new era in relation to fuels. This is about recycled carbon fuels, which are potentially a useful extension to the RTFO order. It increases the range of fuels, as the Minister has said, which can be rewarded under the order, and will therefore increase potential total carbon savings.
At the heart of this is the fact that this is not zero carbon but lower carbon: up to 50% lower than traditional fossil fuels. Of course, we are with various techniques moving away from our traditional fossil fuels: therefore, one would say that perhaps 50% lower might be more modest as a percentage later on, as the move away from fossil fuels is generated. That is very important, because it is based on waste of fossil fuel origin, such as municipal solid waste. So, in terms of providing a new fuel, this is also solving an old problem, and is therefore very welcome.
Lord Tunnicliffe (Lab)
My Lords, I thank the Minister for his presentation of this statutory instrument. It is not an instrument that I have got on with very well. I decided to try to understand it, and that has absorbed a great deal of my time. As I tried to understand it, my old history teacher’s test came to mind: “You don’t understand it until you can explain it in your own words”. So I shall explain what I think it means, in my own words, and see whether the Minister agrees.
At one level, this is an elaborate and benign waste-management exercise. Let us look at the two comparisons here. A renewable transport fuel comes from taking CO2 out of the atmosphere and turning it into fuel using those wonderful devices called “plants”. We then turn the energy captured in those plants into fuel and burn it in vehicle engines and so forth, which releases the energy and the CO2 back into the atmosphere. The impact of the CO2 is neutral: in other words, the plants’ photosynthesis activity captures energy, essentially from the sun, and that energy is turned into fuel and then released.
A recycled carbon fuel takes carbon from beneath the earth, in the form of oil or carbon or whatever, and in this case turns it into something useful such as plastic, which then becomes waste. It is then, in this process, turned into fuel. That means, essentially, that it is burned. Energy is released and the CO2 is released into the atmosphere. The impact of CO2 is adverse, in the sense that carbon is taken from its fossil source and put into the atmosphere, which is a bad thing.
It is only if the feedstocks are not burned wastefully, through incineration or whatever, that there is a net benign effect: only if very strict controls are applied to the feedstock to make sure that it is inevitable that the feedstock is turned into free CO2, left to incineration et cetera—or it goes into landfill, which once again is an adverse outcome. Therefore, properly controlled, this policy is benign and has our support. So the Minister can stop his concerns; we are not going to try to vote this down, first because it is benign and, secondly, because we do not want a constitutional crisis.
Moving on, I have a few questions about this order. The emphasis in the literature seems to be on aviation fuel. Can the Minister give us some feel on the extent to which it will be a significant contribution to aviation fuel or where else it would be used in any significant amount? Indeed, will it be significant in any non-aviation applications? Next, is there an international dimension here in terms of the UK creating this instrument, which will stop the development of international agreements on this way of handling waste? Finally, is it within this instrument’s power for the Government to withdraw it, because it needs to meet two tests? The first is on the strict control of the feedstock while the second is about whether the financial incentives contained in the order actually work. If it is impossible to get a set of financial incentives that work, can the Government withdraw the instrument and its impact?
Lord Davies of Gower (Con)
My Lords, I thank all noble Lords for their consideration of this order. I will now attempt to respond to the specific points that they made.
Let me start by saying that the RTFO includes a range of strict eligibility criteria to ensure that all fuels supplied are sustainable and provide a minimum level of greenhouse gas savings. Although RCFs are a fossil fuel, and therefore emit fossil carbon when combusted, their carbon savings are determined by comparison to the counterfactual end-of-life fate of the waste feedstock. For instance, black binbag waste uses an assumption that the waste would otherwise be incinerated in an energy-from-waste plant and calculates the benefit seen by diverting that waste into fuel production. This still needs to provide an emissions saving of 50% compared to simply using fossil diesel.
Different counterfactuals can be considered, depending on the specific waste feedstock. This ensures that the use of these fuels delivers effective greenhouse gas savings. Converting residual non-recyclable waste plastic into recycled carbon fuels can encourage a more effective use of our waste, as it can achieve greater energy recovery than disposing of the waste via conventional means.
Any recycled fuel produced from plastics will have to meet the same fuel standards as all other fuels to gain support from the RTFO. We are aware that pyrolysis oil, which is an initial stage of chemical waste recycling, can be used as a fuel for some applications and can have negative air quality issues associated with its use. However, such fuel would not be eligible under the RTFO order proposed here, as it does not meet the relevant fuel standards outlined in the order. Pyrolysis oil created during RCF production would need to be further refined into a diesel fuel that complies with existing fuel standards to receive RTFO support. We are not aware of any evidence to suggest that this would alter the air quality performance of the final fuel compared to regular diesel.
I will now address one or two of the points that were made. The noble Lord, Lord Ravensdale, made a couple of points; in particular, he talked about nuclear-derived fuels. I can tell him that we received the primary powers required to support nuclear-derived fuels under the RTFO following Royal Assent of the Energy Act 2023. We continue to consider the inclusion of nuclear-derived fuels in the RTFO. We have confirmed that the forthcoming mandate for sustainable aviation fuels will support nuclear-derived fuels; it is on track to come into force on 1 January 2025.
On the issue of cross-departmental working, DESNZ, the DfT and the Treasury are absolutely aware of the need for it and are making great efforts to work together in order to take it forward.
Financial Services and Markets Act 2000 (Disapplication or Modification of Financial Regulator Rules in Individual Cases) Regulations 2024
(8 months, 4 weeks ago)
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Baroness Vere of Norbiton
That the Grand Committee do consider the Financial Services and Markets Act 2000 (Disapplication or Modification of Financial Regulator Rules in Individual Cases) Regulations 2024.
The Parliamentary Secretary, HM Treasury (Baroness Vere of Norbiton) (Con)
My Lords, these draft regulations make use of a provision in the Financial Services and Markets Act 2000 to enable the Prudential Regulation Authority to disapply or modify its rules for individual firms.
The ability of a regulator to flex the application of its rules for individual firms has been a long-standing feature of our approach to regulating financial services. This is a useful regulatory tool that can enable a regulator to take account of a firm’s specific circumstances in order to ensure that rules are applied in ways that achieve the best regulatory outcome. This flexibility has long been supported by regulators and the financial services industry.
Since it was introduced more than 20 years ago, the Financial Services and Markets Act 2000, known as FSMA, has included such a tool. Section 138A of FSMA enables either the Prudential Regulation Authority or the Financial Conduct Authority to disapply or modify its rules for an individual firm. Under Section 138A, the PRA or the FCA can disapply or modify a rule if a firm requests it or if the regulator has the consent of the firm.
As part of the work to adapt our regulatory regime for the UK’s new position outside the EU, this tool was reviewed. It was concluded that, while useful, Section 138A was not as effective as it could be. This is because it contains the test, which must be met before a regulator can permit a firm to disapply or modify rules, that the rules in question must be
“unduly burdensome or would not achieve the purpose for which the rules were made”.
This requirement does not always allow for rules to be flexed, even where appropriate disapplication or modification of rules would provide a better regulatory outcome.
The Government addressed this by introducing a new ability for regulators to flex their rules in a wider range of circumstances. This was legislated for through the Financial Services and Markets Act 2023 and is now set out in Section 138BA of FSMA. Under Section 138BA, the Treasury may specify regulator rules made under FSMA, which the relevant regulator can then permit a firm to disapply or modify. As with the existing rule-flexing tool in FSMA, a regulator can permit a firm to disapply or modify rules under Section 138BA only if the firm requests this or consents.
These regulations exercise, for the first time, the power approved by Parliament at Section 138BA of FSMA. The regulations do two things. First, they enable the PRA to permit a firm to disapply or modify any PRA rule in accordance with Section 138BA except for conduct rules and threshold conditions rules, which FSMA excludes from the scope of Section 138BA. After careful consideration, the Government have concluded that the PRA should have the ability to permit a firm to disapply or modify any PRA rule. This is because flexibility in the application of rules is particularly important for banks, large investment firms and insurers that are regulated by the PRA. These complex institutions, with highly specialised business models, often require a highly tailored approach to ensure that they are appropriately regulated.
Secondly, these regulations apply certain procedural safeguards to the PRA’s decisions under Section 138BA. When the PRA refuses a firm’s application or imposes conditions on a firm’s permission to disapply or modify rules, the PRA must issue a notice explaining its decision. When a permission to disapply or modify rules is given, the PRA must publish a decision notice so that it is public knowledge that a particular firm is subject to a tailored regulatory requirement. The regulations provide for an exception where the PRA is satisfied that publication is unnecessary or inappropriate, taking into account certain specified matters, for example whether publication would be detrimental to the stability of the UK financial system. If an affected firm is aggrieved by a PRA decision, it may appeal by referring the decision to the Upper Tribunal, which is the part of the Courts & Tribunals Service responsible for hearing appeals against decisions made by various public sector bodies, including the PRA and the FCA.
These regulations make use of an important regulatory tool recently approved by Parliament in FSMA 2023. They provide the PRA with a level of flexibility needed to ensure that the application of prudential rules to banks, large investment firms and insurers can be flexed, where appropriate, to ensure that regulation of these large and complex firms remains effective. They also ensure that the PRA, when taking these decisions, is appropriately accountable and transparent. I beg to move.
Lord Sharkey (LD)
My Lords, the Explanatory Memorandum and de minimis impact assessment for this SI contain a number of vague assertions. Nowhere is there to be found a plain English statement of the benefit brought about this SI, except in the vaguest and most general terms. In essence, as the Minister has explained, this SI does one important thing: it removes the two conditions, of which one must be fulfilled, for the PRA to allow modification or disapplication of the rules for individual firms.
This power to allow the modification or disapplication is, as the Minister has said, contained in Section 138A of FSMA. The two conditions to be granted a waiver are that the rule or rules in question are “unduly burdensome” and/or
“would not achieve the purpose for which the rules were made”.
The PRA appears to be the sole judge of whether either or both of these conditions may apply. There is no definition of “unduly burdensome” and no specified mechanism for deciding whether the rules are fit for purpose or not. The Explanatory Memorandum seems to suggest that such rulings may be challenged in the Upper Tribunal. Is there a body of case law from Upper Tribunal hearings that helps with the definition of “unduly burdensome” and how “fit for purpose” may be established?
Currently, waivers may be granted only if either of the two conditions applies, and the PRA appears to have discretion over whether they do or do not. This SI changes that; it inserts an additional and unconditional waiver mechanism which allows the PRA, as the Minister has said, practically unfettered discretion to modify or disapply rules for individual firms as it sees fit. What justification is there for allowing this unfettered discretion? What is really wrong with the current arrangements?
The EM and the IA both have a go at answering those questions. In paragraph 5.4, the EM states that
“section 138A of FSMA … does not, by itself, provide sufficient flexibility for a truly agile regulatory regime … This requirement”—
by which it means the two conditions—
“does not always allow for rules to be flexed, even where appropriate disapplication or modification of rules would provide a better regulatory outcome”.
The EM does not give any examples to show how dropping the two conditions may help in practice, and nor does it explain how a better regulatory outcome may be defined or by whom—I guess that that is the PRA again, at its absolute discretion.
The impact assessment tries to give a concrete example in the matching adjustment regime, widely criticised as being not fit for purpose and, therefore, a fairly obvious candidate for disapplication or, more likely, modification under the existing rules. This shows the weakness in the impact assessment’s case, which says rather limply:
“Without this SI, the PRA would find it much more difficult to allow firms to continue to use beneficial provisions like the Matching Adjustment”.
So it is clearly not impossible—it is simply saying that it is really difficult. Why is it much more difficult? Could the Minister explain the point about a possible difficulty in dealing with the matching adjustment using Section 138A rather than this new SI? Can she give perhaps more concrete examples of the dangers avoided in or the benefits arising from dropping the two existing FSMA conditions?
Lord Livermore (Lab)
My Lords, I am grateful to the Minister for introducing this SI, which delivers on one of the aims of the smarter regulatory framework, in that it will allow the Prudential Regulation Authority to disapply or modify the rules in the Financial Services and Markets Act in response to changing market conditions or emerging risks, and to facilitate innovation. We supported the principle behind this SI during the passage of the Act last year; as such, I have just a few questions.
First, can the Minister confirm how many times the existing power under Section 138A of FSMA has been used by the regulator in each of the past three years? Is there a forecast for how many times the new procedure is expected to be used in each of the next three years?
Secondly, the Explanatory Memorandum accompanying the SI notes that PRA decisions under this new mechanism will be challengeable in the Upper Tribunal, as the Minister noted. Is there any estimate of the potential caseload that may result from this new system? Can she confirm how long the Upper Tribunal is likely to take to determine challenges, and at what cost to applicants?
Thirdly, can the Minister confirm that, in considering an application to flex the rules, the regulator will remain bound by its objectives around financial and market stability? Finally, the impact assessment accompanying the SI talks of familiarisation costs for businesses. Are there any similar resourcing implications for the PRA? Are any additional positions needed at the regulator to deal with potential additional workload?
I am grateful to the Minister in advance for her answers. I take this opportunity to wish her and the noble Lord, Lord Sharkey, a happy Easter.
Baroness Vere of Norbiton (Con)
My Lords, I too wish all noble Lords a very happy Easter—there is one more day to go, I believe. I am grateful to both noble Lords for their contributions to this short debate. I have the answers to nearly but not quite all of their questions. I am disappointed in myself, but never mind; we will keep going.
I would like to go back to first principles. This was raised by the noble Lord, Lord Livermore, and to a certain extent by the noble Lord, Lord Sharkey. The PRA is governed by its core objectives, which are set out in law. There are two primary statutory objectives for the PRA: a general objective to promote the safety and soundness of PRA-authorised firms and an insurance objective to contribute to securing an appropriate degree of protection for those who are, or may become, insurance policyholders. Underlying that, FSMA also sets out two secondary statutory objectives for the PRA on effective competition, aligning to international standards and promoting growth in competitiveness. That is our starting point; that is the PRA’s job, per se. In taking a decision to disapply and modify rules, it must do so in that context.
The noble Lord, Lord Livermore, asked how many times Section 138A has been used in the last three years. I do not know, but I will write on that and explain what has happened to date. I will also write about the caseload and what we expect for the timeline in court. I do not anticipate that it will be enormous. With much of this regulatory behaviour, where there are disputes regulators will try to mediate wherever possible.
Turning to why the PRA would decide to disapply or modify rules, it is about getting greater flexibility to allow the system to work more effectively within the statutory objectives set out in FSMA. The provision does not direct a regulator as to how it should decide, because these are independent regulators. When this part of FSMA 2023 was debated, it attracted no debate at all, so I had therefore expected that noble Lords were very much onside with the powers we had given to the PRA, or potentially to the PRA, via this statutory instrument. It will be for the relevant regulator, in this case the PRA, to set out its policy for the disapplication or modification of rules. Noble Lords may have seen that it has already started to do this.
This goes back to the issue of transparency and ensuring that the public, and of course the industry too, are aware of what is going on. A whole series of industry consultations takes place whenever the use of 138BA is anticipated. Not only was the Section 138BA issue subject to consultations in 2020 and 2021, when we were developing and finalising our approach to the smarter regulatory framework, but, more recently, and more specifically, the PRA issued consultations on statements of policy. What happens is that the PRA says, “Okay, this is what we’re going to do. We’re going to put out a statement of policy”—for example, it has done it on Solvency II matching adjustments. The industry will then contribute to that, and it will go on to use whatever rules and regulations it now feels the industry agrees is appropriate.
So far, I think there have been two specific consultations and also a more general consultation by the PRA, basically saying, “Every time we do this, we will put out a statement of policy. Industry, do you think this is the right approach and the right thing to do?” So, I believe there is quite a lot of information being published around this. Obviously, it is not only for the industry to scrutinise that; it will be for others to scrutinise it as well, to ensure that we are not exposing our economy to detriment or, indeed, impacting our financial stability. That all seems fairly appropriate, straightforward and transparent.
The noble Lord, Lord Sharkey, asked about the Solvency II matching adjustment. It is our view, and I believe the view of the PRA, that it would not have been possible under 138A, because one of those two conditions would have had to have been met, and one could potentially say that it has not been. Is it unduly burdensome? I am not sure that it is, because it is more of an adjustment that annuity providers can use to secure more proportionate capital requirements. That is not a burdensome or non-burdensome issue; it is just that there is an opportunity to release capital by taking a sensible regulatory decision around matching.
The same goes for models as well. For example, in certain circumstances it may be the case that an institution’s model is better than the standard model that one tries to apply to the whole industry. If it can reassure the regulator that the model is robust, then, again, those might be the sorts of elements that one can put in to firm-specific changes to regulation. However, I fear that this will be returned to by the PRA over the coming years as we deal with assimilated law.
During the passage of FSMA 2023, we did say that we wanted agile regulators that are able to regulate and to change things according to risk. In this case, that will be by an individual organisation. But, as we go through and look at all the assimilated law that we dealt with under FSMA, some of it will then be able to fall away, because provision is available under 138BA that will be able to fill the regulatory gap that was previously occupied by that specific piece of regulation, but was then switched over to PRA rules and the way that it then chooses to put those into place. Again, this was the approach that was agreed during the passage of FSMA.
Sadly, I do not have anything on the PRA’s resources. I suspect that it has been gearing up for this for quite a long time; as I said, it has already started getting to work on consulting. Obviously, without the powers, it is unable to issue any firm-specific disapplications or modifications, but I will certainly write to the noble Lord if I get anything further on this matter. I have a few things to write on.
Lord Sharkey (LD)
I thank the Minister for her explanations. I have two or three points to make.
First, I am still rather puzzled about the matching adjustment, for two reasons. As the Minister will know, there is quite a lot of criticism of the matching adjustment. There is a sense in which it would be, I would have thought, relatively easy to categorise it as not quite fit for purpose; that is why I am puzzled that Section 138A had not been, or would not be used in the case of matching adjustments. Also, the de minimis assessment says that
“the PRA would find it much more difficult”;
it does not actually say that it would be impossible using Section 138A. If the Minister is going to write to us, perhaps she might expand on this point a little.
Secondly, I am curious about the body of case law from the Upper Tribunal. It would be interesting to know whether there is such a body and whether we can learn anything from it.
My third point is to do with publication. As I understand it, the current waivers issued by the PRA and the FCA are published in some detail. I was asking for some kind of commitment. Under new Section 138BA, the waivers will be published, I assume, but will they be published saying what the problem is, why this course of action has been chosen, what benefits are expected to arise, why the powers in Section 138A of FSMA were not seen as appropriate and why new Section 138BA was necessary? When the Minister writes, perhaps she might say something about this.
Baroness Vere of Norbiton (Con)
I can feel officials sending me things but I will write, because the noble Lord has asked some very good questions. We will write him a nice letter with some good explanations.
Accounting Standards (Prescribed Bodies) (United States of America and Japan) (Amendment) Regulations 2024
(8 months, 4 weeks ago)
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Lord Offord of Garvel
That the Grand Committee do consider the Accounting Standards (Prescribed Bodies) (United States of America and Japan) (Amendment) Regulations 2024.
The Parliamentary Under-Secretary of State, Department for Business and Trade (Lord Offord of Garvel) (Con)
My Lords, I beg to move that these regulations, which were laid before the House on 21 February 2024, be approved.
The Accounting Standards (Prescribed Bodies) (United States of America and Japan) Regulations 2015 provide a regulatory easement of the UK’s company reporting rules for US-listed or Japanese-listed parent companies that have chosen to re-domicile in the UK. The easement was originally introduced in 2012 and provides qualifying companies with extra time to transition from their national accounting practices to UK-recognised accounting standards. Following their UK incorporation, parent companies listed in the US or Japan may take up to four financial years to make the transition in order to prepare their group accounts in line with UK accounting principles.
At the original time of introduction in 2012, this was deemed especially helpful for companies using US and Japanese accounting standards that might otherwise have struggled to adapt to UK accounting standards when domiciling to the UK.
In 2023, the department published a post-implementation review of the 2015 regulations. The review took evidence from a small number of previously US-listed and Japanese-listed, now UK-domiciled, firms about their cost savings from the easement. The survey responses confirmed that the regulatory easement provided flexibility and enabled cost savings by the businesses using it. Businesses responding to the survey estimated that the regulations’ accounting conversion easement had reduced the scale of their conversion costs significantly. One company also said the regulations made possible the “most prudent and efficient” way for it to submit while listed in the US.
Although the post-implementation review found that the regulations were a helpful feature of the UK’s regulatory environment, it also identified a small risk of abuse of the easement. In particular, the review noted that more could be done to improve understanding that the easement was a transitional, time-limited concession, not a permanent exemption from the UK’s company reporting rules.
Having conducted the post-implementation review, the Government decided to extend the regulations, believing them to be a small, but useful, contribution to a pro-growth regulatory regime that supports inward investment. To give this decision effect, the Government laid the Accounting Standards (Prescribed Bodies) (United States of America and Japan) (Amendment) Regulations on 6 September 2023. These regulations extended the easement in recognition of its evident benefit to businesses that have used it so far. The easement would have expired without the regulations, with the result that newly domiciled US and Japanese companies would have been required to convert accounting practice immediately when they filed their first set of UK accounts.
When extending the regulations, the Government also took the opportunity to reduce the risk of the easement being misused or misunderstood by its beneficiaries. Specifically, regulation 4 of the 2023 regulations introduced an obligation on companies using the easement to include a note in their accounts stating when the easement ceases to apply. This additional requirement on companies was deemed a simple and proportionate mechanism to reduce the risk of abuse.
Regrettably, my department, the Department for Business and Trade, made a parliamentary procedural error in laying the latter provision by mistakenly using the negative resolution procedure rather than the correct affirmative resolution procedure. The new statutory instrument, which I beg to move today, is intended to correct the error. It removes regulation 4 of the 2023 amending regulations and substitutes a new regulation 5A in the 2015 regulations, doing this by the correct affirmative resolution procedure. The remainder of the 2023 amending regulations were made correctly, but the Government are grateful to the Joint Committee on Statutory Instruments for drawing their attention to the procedural error.
Driving growth in the UK economy requires attracting inward investment. These regulations are just one example of how we can make it easier for overseas companies to incorporate in the UK and create jobs in the UK economy. I beg to move.
Lord McNicol of West Kilbride (Lab)
I thank the Minister for introducing this statutory instrument, which remedies the Government’s mistake from last year. It is obviously a very short one and we on this side are not going to oppose it. I welcome any opportunity to speak in favour of regulations that seek to make businesses more likely to domicile in the UK. Making sure that Britain is open for business is vital and something that we want to push the Government to do in all areas.
As the Minister said, the 2023 post-implementation review found these regulations to be a positive although not decisive factor in encouraging companies to domicile here. The review also encouraged the Government to put forward Regulation 5A, which we now have an opportunity to welcome.
The Minister talked about abuse. What amount and type of abuse does he believe the regulation will counter? I could not quite understand that. What response has there been from the relevant UK companies to the regulations, given that they have already been introduced and implemented? Are those businesses satisfied with the level of clarity?
The Minister referred to the 2012 regulations but the draft instrument and the Explanatory Memorandum talk about the 2015 regulations, so I was not quite clear what he was referring to. Some clarity on that would be much appreciated.
Lord Offord of Garvel (Con)
I thank the noble Lord for his comments on this statutory instrument, and I welcome his enthusiasm for a pro-growth regulatory environment in the UK, which we have in common on both sides of the House. These regulations provide an easement of the UK’s company reporting rules, specifically to US and Japanese-listed parent companies.
I emphasise that this is a minority sport; not many companies participate in it, but where they do, among the major economies, there is perhaps more divergence in accounting standards in the US and Japan, because they are the biggest in the G7. That is why we have accommodated them with this legislation. I point out that this is a transitional concession simply to give companies more time and scope to convert their accounts to UK-recognised accounting principles. It is also designed to help safeguard the integrity of the UK’s accounting systems and reduce the risk of abuse.
On the concept of abuse, the post-implementation review found one instance in which a company was at risk of using regulations beyond the allotted four-year period. This is a minor risk, with only one instance, but the Government thought it prudent to address the concern while we have this opportunity.
The companies using this easement found it to be a small but useful intervention, citing cost savings of tens of thousands of pounds in some instances. For several larger companies, it amounted to millions of pounds.
The Government now propose to correct the procedural error made in laying Regulation 4 of the 2023 regulations by means of this affirmative statutory instrument. I therefore commend it to the Committee.
The Deputy Chairman of Committees (Baroness McIntosh of Hudnall) (Lab)
That completes the business before Grand Committee this afternoon. I wish a happy Easter to one and all.