Financial Markets: Stability

Baroness Penn Excerpts

Thursday 3rd November 2022 Lords Chamber

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

My Lords, I join all noble Lords in thanking the noble Lord, Lord Sharkey, for the opportunity to debate this important topic.

The central responsibility of any Government is to protect national security, and an essential pillar of that security is economic stability. That economic security and stability has real and profound impacts on people’s lives, as we have heard in today’s debate, from pensions and savings to mortgage costs and the broader cost of living.

The Motion that we are debating today speaks of the importance of stability in financial markets, and I agree with all noble Lords on the desirability of this. However, it is also important to recognise that many of those factors influencing stability can be beyond our control. There are global forces that can create volatility in the financial markets, as we saw in the past with the global financial crisis and more recently with the shocks of the global pandemic and the energy shock in the aftermath of Russia’s invasion of Ukraine. The role of government and the regulators is to ensure that we have a system that is resilient to those shocks. Since the financial crisis in 2008, that is what we have sought to build.

We created a new Financial Policy Committee to look at risks across our financial system, backed by the powers to tackle them. On the question the noble Lord, Lord Tunnicliffe, asked about whether the Treasury will take a view on financial stability risks in addition to the Financial Policy Committee, the Government remain committed to the Bank of England’s independence, so it is right that the FPC can independently assess the level of resilience required to promote UK financial stability.

We have also developed the UK resolution regime, which provides the financial authorities with powers to manage the failure of financial institutions in a way that protects depositors and maintains financial stability, while limiting the risks to public funds. We have implemented regulations to strengthen the resilience of the banking system, with the major UK banks now reporting core capital ratios three times higher than before the global financial crisis. There has also been a concerted international effort to strengthen the financial system and ensure that the authorities have the necessary tools in place to protect financial stability.

Recognising in particular the significance of the non-bank sector, over the last decade the Government and UK regulators have worked closely with our international partners through the Financial Stability Board to identify vulnerabilities and enhance the sector’s resilience. It is important to pursue this work through international fora due to the global nature of the financial system, and the Government, the Bank of England and UK regulators play an active role in this work. As a result, the system is much more resilient today than it was in 2008.

However, alongside the UK’s independent financial regulators, we continue to closely monitor any developments that could be relevant to UK financial stability. The Treasury, the Bank of England and the Financial Conduct Authority have well-established and mature systems for monitoring the health of our financial services firms and responding when incidents occur. We are also committed to maintaining and enhancing the UK’s position as a global financial services hub.

The noble Baroness, Lady Bennett, questioned what the financial sector delivers for the United Kingdom. She will probably be familiar with the statistics that financial and related professional services employ more than 2.3 million people across the UK, creating £1 in every £10 of the UK’s economic output and contributing nearly £100 billion in taxes to help fund vital public services. We plan to continue to strengthen that sector through the Financial Services and Markets Bill, which is currently in Committee in the House of Commons. We are all—

[Lord Liddle (Lab)]

The Minister has stressed, rightly, the importance to the prosperity of the City of London of financial regulation, and of a stable financial regulatory regime, which I certainly support. However, the Government are talking about taking powers to overrule regulators. Can the Minister confirm whether or not these powers will be included in the Bill when it gets to this House? Can she tell us how she thinks that will contribute to the independence and stability of the regime, which is so fundamental, as she admits?

[Baroness Penn (Con)]

I cannot confirm that, but I am sure that when that Bill comes to this House, we will spend sufficient time scrutinising its provisions and ensuring that they deliver the outcome that we all want—a stronger financial services sector—which is important not just for the City of London but for people’s everyday lives in the country.

[Baroness Bennett of Manor Castle (GP)]

The Minister referred to the amount of employment from the financial sector, which, by my figures, is about 7% of total paid employment, meaning that 93% of people are not working in the financial sector. If the Government are focusing their efforts on increasing the financial sector while failing to meet the needs of the sectors of the economy that provide 93% of jobs, are we not all losing out?

[Baroness Penn (Con)]

I do not believe that that characterisation is right. Ensuring that we have a strong financial services sector also benefits many other parts of our economy in terms of access to capital, and many other things. It does not need to be at the expense of the rest of our economy. It strengthens the rest of our economy.

[Lord Sikka (Lab)]

The Minister referred to £100 billion of tax from the finance industry. That is misleading, because it includes things such as the VAT collected by the finance industry, which is borne by customers; PAYE, which is borne by employees; and national insurance, part of which is also borne by employees. Surely that £100 billion number needs to be corrected.

[Baroness Penn (Con)]

No, it is correct. The noble Lord seems to know how it is composed, so we are transparent in how that number is reached. I would like to make a little progress.

[Baroness Bowles of Berkhamsted (LD)]

I am sorry, I know that the Minister keeps being interrupted, but maybe it should all come at once. She mentioned that the Bank of England had powers to intervene. I would be very interested to know what preventive powers she thinks the Bank of England could have used to intervene on LDI and leverage. It put it in its Financial Stability Report, but genuinely, I do not know what powers it has to intervene over something that is not covered by FiSMA. It is DWP and there is another regulator, yet it is causing a systemic glitch that could happen again.

[Baroness Penn (Con)]

The noble Baroness is right that there is more than one regulator at play in this space. That point was also made by the noble Lord, Lord Davies of Brixton. If the noble Baroness will forgive me, I will come on to some actions taken after the 2018 stress test shortly.

The noble Lord, Lord Tunnicliffe, asked what the forthcoming Bill will do to promote financial stability. Allowing us to tailor our financial services regulation to the UK’s situation and needs will mean that we can create the best regulation for our circumstances. In a world where financial services are evolving all the time, with new developments and technologies requiring regular changes, the measures in the Bill will mean that UK regulations can remain up to date and effective.

It is also the role of the Government to ensure that their own decisions lead to trust and confidence in our national finances. Our responsible approach to managing the economy meant that we went into Covid and the current economic crisis with strong public finances, allowing us to intervene to support people’s lives and livelihoods. In that context it is important to acknowledge that, while well intended, the recent growth plan had unintended consequences for economic volatility.

Mistakes were made, and we have taken steps to fix them. Most of the tax measures in the growth plan have been reversed and the associated volatility dissipated. However, we are still faced with a profound economic crisis, with global inflationary pressures driven by increased demand post Covid, elevated energy prices after Putin’s invasion, widespread labour shortages and, in response, central banks across many major economies raising interest rates.

My right honourable friend the Chancellor of the Exchequer has been clear that we will take the measures needed to restore confidence and trust in the UK’s public finances and to deal effectively with the economic shocks that are being felt across the globe. In doing so there will be difficult decisions to take, but I hope that I can reassure the noble Lord, Lord Tunnicliffe, and others, that in taking them, this Government will protect the needs of the most vulnerable.

Specifically on recent events, the FPC noted in its July Financial Stability Report that the worsening global economic outlook had caused markets to be volatile in recent months. Since July, global inflationary pressures have intensified further. Specifically on the intervention by the Bank of England, all noble Lords will be aware that in late September there was elevated uncertainty in the UK bond market that resulted in gilt yields rising rapidly and significantly. LDI funds, many of which held leveraged positions in the gilt market, faced significant margin calls as a result. In some cases, these calls exceeded the cash buffers that they held, forcing them to raise cash by selling gilts into a falling market. Large sales of gilts into an already illiquid market led to yields increasing even further, in turn triggering further margin calls and forcing further gilt sales to try to maintain solvency.

This would have led to a spiral of falling prices but increasing pressure to sell gilts, so, within its remit, on Wednesday 28 September, the Bank of England started temporary purchases of long-dated UK government bonds, with the aim of restoring orderly market conditions. In line with the Bank’s statutory financial stability objective, the purpose of these operations was to act as a backstop to restore orderly market conditions and reduce any risks from contagion to credit conditions for UK households and businesses while the appropriate adjustment takes place. This operation was fully indemnified by the Treasury.

It is worth remembering that the Bank’s intervention served to keep the gilt market stable so that funds had time to adjust their positions in line with the changed market conditions. The speed and scale of repricing far exceeded historical moves, and therefore fell outside the expectations of risk management plans or regulatory stress tests. Throughout the intervention, the Bank worked with LDI funds and pension schemes as they built their financial resilience ahead of it coming to an end. Market conditions have since improved. The Bank’s usage of the scheme, at under £20 billion, was significantly below the maximum size permitted under its maximum daily auction size and below the increase in the indemnity provided by the Treasury. This stress in the LDI sector highlights the necessity of ensuring that the appropriate risk oversight and mitigation systems are in place for market-based finance.

I shall try to address the question asked by the noble Baroness, Lady Bowles, and the noble Lord, Lord Tunnicliffe, about what has happened since the 2018 exercise that looked at this. Since then, the Bank of England has worked with other domestic regulators, including the Pensions Regulator and the FCA, on enhancing monitoring of the risks. That included working with the Pensions Regulator on a survey of DB pension schemes in 2019 and prompting work to improve pension liquidity risk management. As the FCA noted in its letter to the noble Lord, Lord Hollick, and my noble friend Lord Bridges in March this year, the FCA contacted the largest LDI fund managers to ask them what plans they had in place to deal with increased volatility. It also probed large managers on the speed with which they could call money from underlying pension funds in the event of stress.

In response to many noble Lords, including the noble Lords, Lord Sharkey, Lord Sikka and Lord Davies of Brixton, and the right reverend Prelate, the Government recognise that there will be lessons that need to be learned from the market volatility seen in recent weeks. The regulators are working with the industry to improve their resilience to market shocks, and it remains a focus of the Government and regulators to ensure that we have a robust regulatory system.

In addition to the ongoing monitoring of systemic risks by the FPC, His Majesty’s Treasury and UK financial regulators have been working internationally as part of the Financial Stability Board, as I previously noted, to develop global approaches to identify and address vulnerabilities in market-based finance. The noble Lord, Lord Sikka, asked why we take a different approach to the regulation of banks versus non-banks in the financial system. Part of that is the international nature of the non-banking part of our financial system.

The Bank of England has also committed to working with the Pensions Regulator and the Financial Conduct Authority to ensure that appropriate levels of resilience are in place to mitigate risks to UK financial stability. As the Pensions Regulator chief executive emphasised earlier this month, DB pension schemes were not and are not at risk of collapse due to rapid movements in the price of gilts, and savers should not make any hasty decisions about their pension pots.

I turn to pensions. As I have just stressed, defined-benefit pensions remain strong, and members of those schemes that were invested in LDI funds are not at risk of losing out as a result of either the aforementioned volatility or interventions made by the Bank. Indeed, the independent Pensions Regulator issued a statement on 12 October for trustees of defined-benefit and defined-contribution schemes and their advisers, which communicated its expectations on matters for trustees to consider in relation to managing schemes and supporting savers.

The noble Lords, Lord Sharkey, Lord Best and Lord Campbell-Savours, and my noble friend Lord Young of Cookham, rightly mentioned the housing market, and I want to respond directly. The fact is that interest and mortgage rates have been rising since last autumn in response to global trends. This is not a UK phenomenon, with the US Federal Reserve having raised its base rate since March 2022 and the ECB taking similar steps. In the UK, around 75% of residential mortgages are on a fixed rate and therefore, in the short term, shielded from rate rises. However, I know that, for those on variable rights and those who are seeing their own fixed-rate deals coming to an end in forthcoming months, there will be significant concern. Where mortgage holders fall into financial difficulty, FCA guidance requires firms to offer tailored forbearance options. While it is important to note that the pricing of mortgages is a commercial decision for lenders in which the Government do not intervene, the Government do offer support through Support for Mortgage Interest loans for those in receipt of income-related benefits and protection in court through the pre-action protocol.

Similarly, the setting of rates is a commercial decision for private landlords in which the Government do not intervene. However, we understand that many people will be worried about the impact of rising prices. My noble friend Lord Young of Cookham spoke more broadly about the reform needed in the private rented sector in order to provide more security to tenants in that sector. I agreed with much of what he had to say. Indeed, the Government’s programme of work to reform the private rented sector continues through, for example, our commitment to ban Section 21 no-fault evictions. We heard ideas from my noble friend Lord Young and the noble Lords, Lord Best and Lord Campbell-Savours, for other changes that we could potentially make in housing. I will take those back to the department and ensure that they are looked at carefully.

The noble Lord, Lord Sharkey, asked whether the local housing allowance would be uprated. He will know that, as part of our response to Covid, the rates of local housing allowance were increased significantly to the 30th percentile of the market, with 1.5 million households gaining just over £600 a year. We have maintained those rates at an elevated level last year and this year in order to ensure that claimants can continue to benefit from this. This is reviewed annually, and I will not comment further on the uprating of benefits.

More specifically, many noble Lords spoke about the difficulties that vulnerable people are facing this year with the rising cost of living. The Government absolutely recognise that and are focusing our support most heavily on those households. People are facing a difficult time. We have put in place an energy price guarantee and further support for those on income-related benefits, pensioners and those with disabilities. There is also discretionary support for local authorities to provide help in their local areas.

I am conscious of the time so I will begin to wrap up. Many noble Lords used this debate as an opportunity to look ahead to the Chancellor’s Autumn Statement. I welcomed the constructive efforts by the noble Lord, Lord Liddle, to make suggestions not just about areas of spending that should be prioritised but about ideas for tax reform to help to fund them, which always needs to come alongside. I will only say to him, on his suggestion for equalised pension tax reform, that we have heard in this Chamber in recent weeks about the challenges of keeping GPs and others in their roles because of the tax treatment of their public sector pensions, and the idea might perhaps be a bit more complicated than it may look at first sight.

[Lord Bilimoria (CB)]

My Lords—

[Baroness Penn (Con)]

I am afraid I am really short on time, so I will make some progress and finish.

As the Chancellor has said, and as I think the noble Lord, Lord Desai, and the noble Baroness, Lady Kramer, agree, stability is a pre-requisite for growth. It is vital for families across the country—from the jobs they depend on to mortgages they have to pay, and to savings for pensioners and businesses investing in the future—and vital for the Government’s ability to borrow and invest in our economy.

The Chancellor will deliver his Autumn Statement on 17 November. Many noble Lords have asked me to speculate on its contents. They will know that I cannot, but I can say at this stage that the Prime Minister and the Chancellor are clear that the priority will be to ensure economic stability by setting out a concrete plan to get debt falling in the medium term. However, they are also clear about their priorities when taking the difficult decisions that this will necessarily entail: to support the most vulnerable and to drive growth to ensure that we have a strong economy by building jobs for the future—and our resilience to future shocks, too.