Financial Services and Markets Bill

Baroness Penn Excerpts

Committee stage
Tuesday 21st March 2023 Grand Committee

[Lord Tunnicliffe (Lab)]

My Lords, I thank His Majesty’s Treasury for sharing its policy on the Edinburgh reforms last month. This Government, following their initial floating of the HMT intervention powers, have given parliamentarians serious cause for concern regarding their judgment. We should be slow to trust that they have the judgment and operational competence to implement the changes in the Edinburgh reforms safely and effectively. Could the Minister give an indication of the Government’s intentions and/or direction of travel concerning both ring-fencing and the senior managers and certification regime?

We heard from the Bank of England governor this week that the Government’s version of Solvency II reform increases risks for insurance firms by 200% more than the Bank’s preferred option. I think we are vindicated in our general concern about the Government’s gung-ho approach to financial stability. Sweeping changes to ring-fencing and the senior managers and certification regime are too important to be left to statutory instrument. The amendments from the noble Baroness, Lady Kramer, are sensible safeguards that the Government should consider thoroughly.

We have seen chaos in two banks this week—Silicon Valley Bank and Credit Suisse. What is the Government’s assessment of whether other systemically important banks are safe and sound? Did we see SVB and Credit Suisse coming? Did the regulators? What are they proactively doing to protect UK consumers and investors?

My view on Amendment 216 is not yet fully formed; I want further discussions with colleagues. I agree with the general view on Amendments 241C and 241D that the issue is really about scrutiny and accountability. In my view, it is impossible to argue that a relaxation of either ring-fencing or the senior managers and certification regime is other than very significant. The present method of accountability through an affirmative instrument is clearly insufficient and I commend the device of the noble Baroness, Lady Kramer, which she has included in these two amendments. The Government should support them.

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

My Lords, I will speak first to Amendment 216, which pertains to the Government’s announced reforms to Solvency II, made possible through the Bill’s revocation of retained EU law.

The Government are reforming Solvency II, the rules for prudential regulation of the insurance industry currently set by the EU, to reflect the UK insurance market’s unique features. These reforms will provide incentives for insurers to increase investment in long-term productive assets by more than £100 billion. They will also benefit consumers by increasing insurers’ ability to provide a broader range of more affordable products.

The Government have committed to make changes to the matching adjustment, an accounting mechanism whereby insurers can match their long-term liabilities with long-term assets and hold less money to pay out claims. These reforms will incentivise firms to invest significantly more in long-term productive assets such as infrastructure. This investment will support growth across the UK and the Government’s climate change objectives.

The noble Baroness’s amendment would instead result in a stricter treatment for some assets than under current rules. I reassure noble Lords that the Government’s reforms to Solvency II strike a careful balance between boosting growth across the economy and maintaining high standards of policyholder protection. Insurers will still be required to hold extra capital to safeguard against unexpected shocks, they will still have to adhere to high standards of risk management, and they will still be subject to comprehensive supervision from the PRA, our world-class independent regulator.

The noble Baroness, Lady Kramer, asked whether we would replicate the Canadian Government’s position with regard to pensions and insurance firms in this context. She referred to statements in the Budget about pension funds—although I think they were focused more on defined contribution pension funds than defined benefit pension funds. I do not know the detail of the specific Canadian regime, but the reforms proposed here do not pose risks to financial stability. As I said, each insurer must still hold enough capital to survive a 1-in-200-year shock over one year. Insurers will still have to adhere to the high standards of risk management. The Government and the PRA have announced a series of additional supervisory measures that the PRA will take forward to ensure that policyholders remain protected. For example, the PRA will now require insurers to take part in regular stress-testing exercises.

[Lord Eatwell (Lab)]

May I comment on the issue of stress tests, which the Minister also raised during Questions this afternoon? You can stress test only risks that you know are there. It depends on the underlying model that you create to examine in your stress tests. Thus stress tests did not pick up the LDI problem at all because it was not there in the models that were used. In financial services, risks appear in entirely unexpected places, and relying on stress tests is, and has been demonstrated to be, a very weak answer. She should reconsider her reliance on this argument.

[Baroness Bennett of Manor Castle (GP)]

Since it is related, I also question the readiness for a 1-in-200-year shock. We have seen very similar kinds of mathematical approaches, if you like, taken to issues such as flood risk and other climate risks, and they have been found to be very ineffective in dealing with problems. They only increase the failure to understand risks.

[Baroness Penn (Con)]

I would point to stress tests as one of the tools that the Bank of England, including the FCA and the PRA, has in its toolbox for securing financial stability. It is not the only tool that it uses. The noble Lord is right that it tests against certain scenarios, which are updated each year to take into account the changing picture around the world and look at different risks, but it can test for only the risks that we have thought about. It is a tool in the toolbox, not a solution to everything.

The noble Lord mentioned LDI. The picture there is mixed. It was identified as a source of risk by the Financial Policy Committee but the extent of movement in gilt prices that it was then stress-tested against was far greater in the scenario that we saw unfold. It may be a good example of the benefits of being able to horizon-scan and look for risk—risk was identified—but also of the limits of some of that work. I completely acknowledge that. The same applies to the point made by the noble Baroness, Lady Bennett.

Amendments 241C and 241D relate to important regulatory reforms introduced following the global financial crisis and the recommendations by the Parliamentary Commission on Banking Standards. I pay tribute to the important work of that commission and to its members who are here today. It has had a lasting legacy in improving the safety and soundness of the UK’s financial system.

Amendment 241C relates to the ring-fencing regime, which, as we have heard, is a major post-crisis reform separating retail activities from investment banking activities in large banking groups. As required by the Financial Services (Banking Reform) Act 2013, the Treasury appointed an independent panel, chaired by Sir Keith Skeoch, to review the ring-fencing regime. The legislation required this review to take place after the regime had been in operation for two years; that review concluded in March 2022. I say to my noble friend Lord Trenchard that the Skeoch review looked at the questions about the effectiveness of the ring-fencing regime, and it is in the context of that review that we are discussing the way forward.

In December, as part of the Edinburgh reforms, the Chancellor announced a series of changes to the ring-fencing regime. These broadly follow the recommendations made by the independent review. It concluded that the financial regulatory landscape has changed significantly since the last financial crisis—a point made by my noble friend Lady Noakes. UK banks are much better capitalised and a bank resolution regime has been introduced to ensure that bank failures can be managed in an orderly way in future, minimising risks to depositors and public funds.

In the light of these considerations, the independent review concluded that changes could be made in the short term to improve the functionality of the regime. Crucially, the panel stressed that these could be made while maintaining financial stability safeguards. The panel also recommended that, over the longer term, the Government should review the practicalities of aligning the ring-fencing and resolution regimes. I assure noble Lords that the Government remain firmly committed to the objectives of the ring-fencing regime: to protect core banking services, such as retail deposits, from risks elsewhere in the financial system while minimising risks to taxpayers in the case of a bank failure. As recent events have shown, it is critical that the Government and regulators have the necessary powers to act decisively in pursuit of these objectives.

In response to the review, the Government have announced their intention to consult later this year on a series of near-term reforms to the ring-fencing regime to implement the independent review’s recommendations. The proposed reforms will make the regime more adaptable, simpler and better placed to serve customers, while maintaining important protections for depositors and financial stability. Alongside this, and in response to the review’s longer-term recommendations, the Government recently published a call for evidence that explores how better to align the ring-fencing regime with the resolution regime. I assure all noble Lords that, in the context of that longer-term call for evidence, no decisions have been made on the longer-term future of ring-fencing. The call for evidence is seeking views on a wide range of options including the possibility of disapplying the regime where banks are deemed resolvable, which was one of the Skeoch review’s recommendations. It also seeks views on retaining or further alternative options for reforming the regime.

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[Lord Tunnicliffe (Lab)]

My Lords, on the digital pound, we support the Bank of England’s work exploring the potential benefits of a safe and stable central bank digital currency, but the Government’s overall approach to crypto remains unclear.

With the collapse of FTX, it is clear that crypto can pose a real threat to normal people in the real economy and therefore may pose a systemic risk in future. The approach HMT has taken to the digital pound is a welcome contrast to this Administration’s eagerness to lean into a crypto Wild West in the recent past. We need to get serious about attracting innovative fintech companies to the UK by safely harnessing the potential of new technologies. How will the Government do this?

On the amendments in general, the issue of accountability has come up once again. The concept of using primary legislation to have a check on these ideas is clearly practical and therefore very attractive, but it will have problems. If the Government would only embrace our concerns about accountability and come forward with a proper and comprehensive accountability structure, perhaps we would be able to develop a more sophisticated approach than the rather raw power of primary legislation. However, as a fallback it is very attractive.

[Baroness Penn (Con)]

My Lords, the Government have been transparent about their plans to enable the use of digital identities in the private sector, including in financial services, and we are committed to ensuring the scalability, flexibility and inclusivity of secure digital identities.

The Government initiated their digital identity programme following industry calls for the Government to take the lead in developing common standards for digital identity across the whole economy. We continue to believe that a whole-economy approach is the right way forward, and we are working with stakeholders to deliver this at pace.

For example, the UK digital identity and attributes trust framework has already enabled right to work, right to rent and criminal record-checking processes to be digitised, making these checks quicker and more secure. In addition, measures in the Government’s Data Protection and Digital Information (No. 2) Bill, which was introduced to Parliament on 8 March, go further by securing the reliability of digital identity services across the economy for those businesses and consumers who wish to use them. The Government also recognise that greater clarity with respect to how digital identity services certified against the digital identity and attributes trust framework support requirements under the Money Laundering Regulations will be key for market uptake. As set out in the Government’s 2022 Money Laundering Regulations review response, we have committed to considering this too.

I hope that I have reassured my noble friend Lord Holmes that the Government remain committed to enabling the use of secure, reusable digital identity products across the UK economy and that Amendment 218 is therefore not necessary.

Turning to Amendments 220 and 221, also from my noble friend, the Centre for Data Ethics and Innovation guidance has not been designed to form the basis of regulatory requirements relevant to financial services and is unlikely to address AI risks specific to that sector. Appropriating CDEI guidance for the basis of regulation that is aimed at the wider governance of AI through non-regulatory tools and industry-led techniques is therefore likely to lead to unintended consequences; however, I appreciate my noble friend’s point that he used the CDEI for illustrative purposes.

I assure my noble friend that the newly created Department for Science, Innovation and Technology is already developing a cross-economy, pro-innovation framework for AI regulation, underpinned by a number of cross-sectoral principles to strengthen the current patchwork approach to regulating AI directly. Further proposals for the new regulatory framework will be published in a White Paper in the coming weeks. Through our proposals for a new AI regulatory framework, we are building the foundations for an adaptable approach that can be adjusted to respond quickly to emerging developments. The vast majority of industry stakeholders we have engaged with agree that this strikes the right balance between supporting innovation in AI while addressing the risks.

Furthermore, the FCA, the PRA and the Bank of England recently published a discussion paper on how regulation can support the safe and responsible adoption of AI in financial services. Therefore, to avoid unintended complications with the use of digital identities and artificial intelligence in the financial services sector, I hope that my noble friend will not press his amendments.

Finally, I turn to the important topic of central bank digital currencies and Amendments 241F and 241FD, both ably introduced by my noble friend Lord Forsyth. The Government have been clear that they consider that Parliament will have a vital role to play in the future of any digital pound. As I set out to my noble friend Lord Bridges in a previous debate in the Chamber, when we discussed the findings of the report to which my noble friend referred, the Government expect to fully engage Parliament, including through any possible legislation, in an open and transparent manner to ensure that there is full and proper scrutiny of any proposals over the coming years. As the joint Treasury and Bank of England consultation paper published on 7 February set out, the legal basis for the digital pound will be determined alongside consideration of its design; this is the subject of ongoing work.

[Lord Forsyth of Drumlean (Con)]

Could my noble friend the Minister just define what “vital” means? Does it mean primary legislation?

[Baroness Penn (Con)]

As I said, the approach we take will be determined alongside the consideration of any design of a central bank digital currency. The decision to move ahead with a CBDC has not yet been taken; however, we do believe that it is likely to be needed in future. Although it is too early to commit to build the infrastructure for one, we are convinced that further preparatory work is justified. Therefore, that definition will become clearer as the design of the approach also becomes clearer—but the commitment at the outset to parliamentary engagement is there.

[Lord Vaux of Harrowden (CB)]

The Minister just made a statement that it is likely to be needed in future. Can I ask a very simple question: why? Why is a CBDC likely to be needed in future? That seems a fairly bald statement.

[Baroness Penn (Con)]

My Lords, we may not wish to repeat the debate that we had in the Chamber earlier this year, but I was going to address my noble friend’s question about retail versus wholesale and the point from the noble Lord, Lord Vaux, about the use case for a CBDC.

The noble Lord, Lord Eatwell, made one of the points in relation to a CBDC. We want to ensure that central bank money, which is currently available to the public only as cash, remains useful and accessible to the public in an ever more digitalised economy. We have heard about access to cash in our debates earlier in Committee.

[The Deputy Chairman of Committees (Baroness McIntosh of Hudnall) (Lab)]

My Lords, I am sorry to interrupt the Minister but there is a Division in the Chamber. The Committee will adjourn for 10 minutes, after which we will resume and allow the Minister to finish what she had to say.

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[Baroness Penn (Con)]

My Lords, I was explaining why we think that the UK may need a digital pound in future. The central point is that we want central bank money, which is currently available to the public only as cash, to remain as useful and accessible as ever in an ever more digitalised economy.

I was going to address my noble friend Lord Holmes’s question about whether the work we are taking forward is focused on a wholesale or retail central bank currency. The proposal being considered is potentially to introduce a retail CBDC at some point in the future. With regard to a wholesale CBDC, banks have access to electronic central bank money in the form of reserves; we are open to exploring innovative ways in which wholesale firms could use reserves. There is a programme for reform under way on electronic central bank money in the form of reserves that will bring similar benefits to those that we see for CBDCs in the retail space.

[Lord Forsyth of Drumlean (Con)]

Is there going to be a limit on the amount that people can hold in this retail central bank digital currency? Does the Minister accept that, if there is no limit, that will have major implications for financial stability?

[Baroness Penn (Con)]

These are some of the questions that we want to consider through the consultation that is currently open and any further work. That consultation recognises the financial stability implications of developing such a proposal; we will want to consider them as we take this work forward.

[Lord Tunnicliffe (Lab)]

I hope that the Minister anticipates consultation and research. To me, “consultation” means coming back to the industry. The industry comes from a perfectly respectable position but it is one position. We need basic research, modelling and all the various techniques to explore the potential risks.

[Baroness Penn (Con)]

The noble Lord is right that the public consultation phases of this work are one element of the work that will be done by the Treasury and the Bank of England in developing this concept. There are many other strands of work that will also be undertaken. As we discussed in the previous debate, any such project would be a significant infrastructure project with significant financial implications so we would need an appropriate approach acknowledging that.

We are at an early stage of this work. As I said, we have not taken the decision to go ahead with a CBDC but we think that there is sufficient evidence to justify further exploratory work. At this stage, it would be premature to include any provision in the Bill. I reiterate my previous statement that the Government expect to keep Parliament fully engaged in this work as it progresses. I therefore hope that my noble friend Lord Holmes will withdraw his Amendment 218.

[Lord Tunnicliffe (Lab)]

That word, “engaged”, flummoxes us all. We do not see a mechanism in our system. Will the Minister write to us and spell out what “engaged” means?

[Baroness Penn (Con)]

I can look to write to noble Lords on this question but I am not sure that I would be able to add more to my response at this stage, which is that the Government expect to fully engage Parliament, including through any possible legislation, in an open and transparent manner to ensure that there is full and proper scrutiny of any proposals over the coming years. As the joint consultation paper set out, the legal basis for the digital pound will be determined alongside consideration of its design; that is subject to ongoing work. If I wrote to noble Lords at this stage, I think I would be saying exactly that but, if there is anything further to add, I would be happy to do so.

[Lord Sharkey (LD)]

I just want to make sure that I understand exactly what the Minister is saying. If the Government decide to bring in the digital pound, will they commit to bringing it in via legislation?

[Baroness Penn (Con)]

I am afraid that I have gone as far as I can in detailing the approach that we would take to Parliament. We expect to engage Parliament fully. However, the legal basis for the digital pound will be determined alongside consideration of its design. Work is not yet at the stage where we can provide that further clarity.

[Lord Holmes of Richmond (Con)]

I thank all noble Lords who have participated in this debate and my noble friend the Minister for her response. At this stage, I beg leave to withdraw the amendment.

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[Lord Tunnicliffe (Lab)]

There is no official Labour Party position on this, but I feel enormous sympathy for the position of the noble Earl, Lord Attlee. I hope the Minister will take this away, not as a legislative proposal but as a problem to be solved, and ensure that it is considered at a very senior level in the Treasury.

[Baroness Penn (Con)]

My Lords, before I speak to his Amendments 223 and 241FB, I first thank my noble friend Lord Attlee for his engagement and for bringing to my attention the specific example he has raised today as context for his amendments. I commend his staunch support for Ukraine, and the Government remain fully committed to supporting Ukraine in the face of the relentless Russian bombardment.

I reiterate to the Committee that the money laundering regulations are a vital part of the UK’s comprehensive economic crime response. The regulations are designed to combat illicit finance but should not be barriers to legitimate customers, including those connected with the export of military equipment to the Ukrainian defence forces.

As the Prime Minister has set out, the Government are fully committed to helping Ukraine emerge from the war with a modernised economy that is resilient to Russian threats. Of course it is important that those contributing towards this are not prevented unnecessarily from carrying out their business, but this needs to be balanced with the existing controls which protect this country, and international partners, from risks of money laundering.

It is important that we do not take steps that might allow the money laundering regulations to be circumvented by bad actors, even in circumstances such as this. It is therefore right that financial services firms continue to be empowered to carry out their own, risk-based due diligence when financing the export of armoured vehicles or military equipment, or individuals who are engaged in the international defence industry.

The money laundering regulations are purposefully not prescriptive and are designed to allow firms to make their own decisions about how to comply, balancing their understanding of the risk with proportionality. The Government do not and will not involve themselves in commercial decisions of individual firms but we can be clear that, where all the correct licences are in place, the money laundering regulations should not be a barrier to the financing of legitimate export activity.

[Earl Attlee (Con)]

I am sorry to interrupt my noble friend, but I would like to make it clear that Peter does not need any financing. The other cases that I have come across in the aerospace and defence sector are very well financed; that is why their businesses are not very attractive to the banks, which can withdraw financial services because there is no money in it. Peter does not need finance; all he needs is the bank to process the money, but the bank has a real difficulty processing money from Ukrainian businessmen.

[Baroness Penn (Con)]

My Lords, I was making the point that there is a wider context here that there should be no barrier to the financing of legitimate export activity.

Turning to the point made by my noble friends Lord Attlee and Lord Trenchard, the government process for the granting of export control licences focuses on the end use of goods rather than the source of funds paying for them. It is therefore distinct from the due diligence checks that a bank would carry out before conducting the transaction. I assure noble Lords that, through the Government’s engagement with my noble friend on this, we have engaged with the Export Control Joint Unit, the Financial Conduct Authority and other partners on this issue. While I appreciate the frustrations of individual cases, we are not aware of a systemic issue. The Government will continue to monitor reports of similar problems; if we identify a systemic problem, we will act to address it.

I turn to the solutions suggested by my noble friend. The noble Lord, Lord Eatwell, and my noble friend Lady Noakes are right that our obligations around anti-money laundering regulations stem from our international obligations to the Financial Action Task Force. The approach set out in these proposals would very likely be in contravention of those obligations. My noble friend Lady Noakes is right that the current version of our anti-money laundering regulations reflects our membership of the EU, which is consistent with those obligations from the Financial Action Task Force, but in some areas goes beyond them.

I turn to Amendment 238, tabled by my noble friend Lord Holmes of Richmond. The Government undertook a review of the money laundering regulations, which was published last year. This was a comprehensive assessment of the effectiveness of their implementation and whether they had led to unintended consequences for businesses or consumers. It explicitly assessed whether aspects of the money laundering regulations remain appropriate and proportionate in light of the UK’s exit from the EU and the additional flexibilities that affords us. It identified a number of areas for reform to make the regulations more proportionate and reduce unnecessary burdens on legitimate customers, which we will take forward through future updates to the regulations. These reforms will further tailor the regime to the UK’s risk profile, following the removal of specific European requirements from the money laundering regulations last year.

While the Government remain committed to ensuring the proportionality and effectiveness of anti-money laundering regulations and the regime around it, and monitor the effects on financial inclusion, the review required by Amendment 238 would largely repeat the exercise conducted last year, of which we are still to implement the full results.

My noble friend referred to the previous group on digital identity. He is absolutely right; we recognise that greater clarity on how digital identity services are certified against the Government’s digital identity and attributes trust framework would support requirements under money laundering regulations that will be key for market uptake, so we see the opportunity there and the role for government in providing assurance on that process of uptake as a potential technical solution to make some of these processes easier. As set out in our 2022 money laundering regulations review response, we have committed to consider this fact too.

For the reasons I have set out, I hope that my noble friend Lord Attlee can withdraw his amendment and that my noble friend Lord Holmes will not move his when reached.

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[Lord Sharkey (LD)]

My Lords, I agree with everything that the noble Lord, Lord Eatwell, has said. We are happy to support this amendment. I simply have two questions and one observation about it.

The amendment says that we must include “green infrastructure”. Is there a practical, generally agreed working definition of what that actually means? I also notice that, in carrying out the review, the Treasury must consult a list of organisations. The final group of organisations is “relevant financial services stakeholders”. Is the intention also to include professional advisers? They would be a vital addition; perhaps that should be made explicit as we go forward.

My observation is that proposed new subsection (3)(c), which talks about

“establishing frameworks to enable DB pension funds to invest in firms and infrastructure alongside the British Business Bank”,

is an extremely good idea. We should make sure that this happens as soon as we can.

[Baroness Penn (Con)]

My Lords, the Government remain fully committed to the objective of unlocking pensions capital for long-term, productive investment, where it is in the best interests of members. High-growth sectors developing cutting-edge technologies need access to finance to start, scale and stay in the UK. The Government are clear that developing the next generation of globally competitive companies in the UK will require unlocking defined contribution pension fund investment into the UK’s most innovative firms.

That is why, in the Spring Budget last week, the Chancellor committed the Government to working with industry and regulators to bring forward an ambitious package of measures by this autumn. He also set out a number of initial measures to signal the Government’s clear ambition in this area. They included increasing support for the UK’s most innovative companies by extending the British Patient Capital programme by a further 10 years until 2033-34 and increasing its focus on R&D-intensive industries, providing at least £3 billion in investment; spurring on the creation of new vehicles for investment into science and tech companies tailored to the needs of UK defined contribution pension schemes by inviting industry to provide feedback on the design of a new long-term investment for technology and science initiative; and leading by example by pursuing the accelerated transfer of the £364 billion Local Government Pension Scheme assets into pools to support increased investment in innovative companies and other productive assets. The Government will shortly come forward with a consultation on this issue.