Bank of England Act 1998 (Macro-prudential Measures) (Amendment) Order 2021

Lord Agnew of Oulton Excerpts

Thursday 8th July 2021 Grand Committee

Moved by

[Lord Agnew of Oulton]

That the Grand Committee do consider the Bank of England Act 1998 (Macro-prudential Measures) (Amendment) Order 2021.

[The Minister of State, Cabinet Office and the Treasury (Lord Agnew of Oulton) (Con)]

My Lords, since the financial crisis, the Government have implemented significant reforms to address the problems of the past and make the financial sector safer and more stable. A key element of these reforms was establishing the Financial Policy Committee, which is responsible for identifying, monitoring and addressing risks to the financial system as a whole. The FPC addresses macro-prudential risks through its powers to issue recommendations and, importantly, directions to the Prudential Regulation Authority and the Financial Conduct Authority.

Successive Governments have legislated to provide the FPC with the powers of direction that it needs to address risks to financial stability. Through these existing powers, the FPC can ensure that firms are not allowed to take on excessive levels of leverage, effectively tackle systemic risks in the UK housing market, and vary firms’ capital requirements against exposures to specific sectors over time. This instrument amends the existing powers of direction granted to the FPC by Parliament to ensure that they continue to operate effectively given changes that have been made to the wider prudential regime since they were first introduced.

The Financial Services Act 2021 represents a major milestone in shaping a regulatory framework for UK financial services outside the EU. It enhances the competitiveness of the sector and ensures that it continues to deliver for UK consumers and businesses. The Act extended the powers for the PRA to make rules which apply to holding companies for the purposes of prudential regulation. Accordingly, the Act granted the FPC the ability to make directions or recommendations that relate to holding companies, ensuring a coherent regime under which holding companies become responsible for meeting prudential requirements. Consistent with these changes, this instrument amends the FPC’s existing powers of direction, where necessary, so that they can also be applied in relation to holding companies.

In addition, the Government have stated their intention to move the detail of the leverage ratio framework exclusively into rules made by the PRA using powers introduced by the Financial Services Act 2021. The leverage ratio is intended to be a broadly risk-insensitive measure of a bank or investment firm’s level of leverage. This instrument therefore amends the FPC’s powers of direction over the leverage ratio so that the method for measuring a bank’s exposures when calculating the leverage ratio is defined by reference to rules made by the PRA. This method will be subject to any specifications made by the FPC when it issues a direction in relation to leverage. For example, the FPC currently recommends that the PRA excludes central bank reserves from banks’ exposures for leverage purposes to ensure that macroprudential policy does not impede the smooth transition of monetary policy. Under this instrument, the FPC would instead be able to direct the PRA to make such an exclusion.

This House may wish to be aware that the FPC and the PRA recently published a consultation on proposed changes to the UK leverage framework. This followed the FPC’s comprehensive review of the framework in light of revised international standards, and its ongoing commitment to review its policy approach. The UK remains committed to the implementation of the Basel 3 standards, of which the leverage ratio is a key part, alongside other major jurisdictions.

It is important to emphasise that the FPC’s proposed leverage ratio framework delivers a level of resilience at least as great as that required by international standards, providing a vital backstop to secure the resilience of the banking system. The framework will continue to require that the vast majority of the UK leverage ratio be met with the highest quality of capital. However, I should make it clear that the changes introduced by this instrument are to ensure that the FPC can continue to make effective use of the existing powers of direction over the leverage ratio that have already been granted to it by Parliament. It is for the FPC, which is independent of government, to decide which of its levers, including its powers of recommendation and direction, would be most effective and appropriate to implement measures such as the proposed changes to the leverage ratio framework.

The Treasury has worked closely with the Bank of England to prepare this instrument. In accordance with our statutory obligations, officials have consulted the FPC, which agreed with the approach being taken. We have engaged with the financial services industry on the contents of the instrument.

This instrument is necessary to ensure that the FPC’s existing macroprudential tools continue to operate effectively given changes that have been made to the wider prudential regime since they were first introduced. I beg to move.

--- Later in debate ---

[Lord Agnew of Oulton (Con)]

My Lords, I thank the noble Lord, Lord Tunnicliffe, and the noble Baroness, Lady Bowles, for their thoughtful contributions. It is the Government’s view that this instrument is necessary to ensure that the FPC’s existing macroprudential tools continue to operate effectively, given changes that have been made to the wider prudential regime since they were first introduced. On the question from the noble Lord and the noble Baroness about the leverage ratio, it is for the FPC, which is independent of government, to decide which of its levers, including the powers of recommendation and direction, would be most effective and appropriate to implement measures such as the leverage ratio. It is important to point out that the ratio itself increased from 3% to 3.25% in 2016 and banks are today reporting core capital ratios almost three times higher than before the 2008 global financial crisis.

To expand on the comments of the Economic Secretary, since 2016 the Financial Policy Committee has used its powers of recommendation to implement a leverage ratio, which excludes central bank reserves, and the FPC’s current consultation proposes to maintain that policy. The changes in this SI will instead allow it to direct the PRA to implement such changes to the framework, appropriately reflecting that the PRA will become responsible for defining the total exposure measure on an ongoing basis. On the noble Lord’s question about how the Government foresee capital requirements changing now that we are outside the EU, the UK remains committed to maintaining the highest international standards, including the Basel standards. This has not changed now that we have left the EU. However, I should note that the capital requirements in relation to the implementation of Basel 3 and 3.1 standards and the prudential regime for investment firms are set by the regulators and therefore independent of government.

The Government believe that delegating responsibilities to expert and independent regulators remains appropriate. The regulators have the expertise to set rules in the complex and technical area of financial regulation. They do so in an agile way which corresponds to the changing context. The PRA will decide exactly how these Basel 3 standards will be implemented, subject to any recommendations or directions made by the FPC based on the specificities of the UK market, in line with statutory objectives and accountability frame- works set out in the recently passed Financial Services Act. The PRA’s recent consultation on Basel 3 implementation set out several areas where it proposed to tailor the implementation of the outstanding Basel 3 standards to better reflect the UK context.

The noble Lord requested a timeline for ongoing prudential regulation. Last year, the Treasury and regulators published their intention to implement the outstanding Basel 3 reforms and the investment firms prudential regime for 1 January 2022. To enable this, Her Majesty’s Treasury intends, in the near term, to lay an affirmative SI which revokes the relevant aspects of the onshore to capital requirements regulation, therefore allowing the PRA to make rules that fill the space of those revocations and, in so doing, implement the outstanding Basel 3 standards. The Treasury will also, later in the year, lay an affirmative SI which makes consequential amendments needed as a result of the aforementioned revocations.

I want to highlight the Regulatory Initiatives Grid, the third edition of which was published in May of this year and includes the proposed timeline for other prudential reforms, such as the implementation of Basel 3.1. The grid adds to the extensive co-ordination mechanisms already in place between HMT and regulators, giving firms a clear picture of upcoming regulatory initiatives, including consultations, so they are better placed to plan for them. In relation to consultation exercises and draft rules to emerge since the passing of the Financial Services Act 2021, I can confirm that the PRA sent its consultation and its draft rules on Basel 3 implementation, shortly after their publication, to the Treasury Select Committee, the Lords Economic Affairs Committee and the Lords EU Services Sub-Committee. The PRA intends to follow a similar process when it publishes its subsequent policy statement and near-final rules.

The FCA has also engaged with parliamentary colleagues on its two consultations and policy statement on the investment firms prudential regime. Indeed, the first IFPR consultation was discussed by Parliament during the passage of the Financial Services Act and the FCA has notified the Treasury Select Committee of all the IFPR publications to date. I am confident the FCA will follow a similar process for future consultations, policy statements and final rules. As set out in their letters to parliamentarians during the passage of the Financial Services Act, both regulators are happy to hear views and discuss ongoing work in more detail with MPs, Peers and parliamentary committees wherever this is helpful.

Finally, the noble Lord also asked for an update on the ongoing future regulatory framework review. The FRF review aims to build on the strengths of the UK’s existing framework as set out in FSMA to ensure that it is fit for the future. The review considers whether changes are required to the regulator’s statutory objectives and principles, how we ensure that accountability and scrutiny arrangements with the Treasury, Parliament and stakeholders are appropriate, given the regulator’s new responsibilities, and how we return responsibility for designing and implementing the specific requirements that apply to firms in certain areas of retained EU law to the regulators within a framework set by government and Parliament. An initial consultation exploring these key issues and a proposed approach was published in October 2020 and closed in February 2021. The Government are considering the 120 responses received ahead of a second consultation in the autumn.

On the question asked by the noble Baroness, Lady Bowles, about the plans for the UK framework to take a different approach to Basel, the design of the leverage ratio framework is a matter for the FPC and the PRA, which are independent of government. The UK’s proposed leverage ratio delivers a level of resilience at least as great as that required by international standards. Interested parties are able to respond to the ongoing consultation that I referred to, which is being carried out by the FPC.

I hope that the Committee has found today sitting informative and that it will join me in supporting this order, which I commend to the Committee.

Motion agreed.