Financial Services (Banking Reform) Bill

Debate between Lord Deighton and Lord Lawson of Blaby

Monday 9th December 2013 Lords Chamber

[Lord Deighton]

My Lords, these amendments require the PRA to review proprietary trading by UK banks and PRA-regulated investment companies and prepare a report to the Treasury. That will be followed by an independent review of the issue. The PRA must consider in its report the extent to which regulated firms engage in proprietary trading. It will then have to assess whether that risks their safety and soundness.

As the Parliamentary Commission on Banking Standards showed, proprietary trading can take many forms. That is why we are requiring the PRA to look into what particular risks different forms of proprietary trading can pose to the safety of the firm.

To help to give a full picture to the Treasury and to Parliament, the PRA must also report on steps it has taken to deal with risks from proprietary trading and whether it encountered any difficulties when it tried to tackle those risks. Building on that, the PRA must then give an assessment of whether it believes the tools it has to tackle proprietary trading are appropriate, given the risks that may exist at that time and in future. It must also consider whether restrictions imposed on proprietary trading in other countries have been effective. The experience of the United States in relation to the Volcker rule, which banned proprietary trading by banks, will be particularly relevant.

That review will take place within a year of the ring-fence coming into force. The Government have committed to ring-fencing being implemented in 2019, so this will take place in 2020. In Committee, there was some discussion about the appropriate timing of the review. The Government returned to the original PCBS recommendation, which said that the review must include,

“an assessment of the impact of the ring-fencing rules on proprietary trading by banks”.

To do that, the ring-fence must be in place for at least some time to consider such issues. While the ring-fence and proprietary trading are in many ways distinct issues, they will of course interact. Therefore we think it is right to allow the PRA to consider the impact of risks from proprietary trading on ring-fenced banks and whether the safeguards in place are sufficient for the particular requirements for the safety of ring-fenced banks. I know that members of the PCBS have been very concerned about that in the past, and I want to make sure that this review looks at this important area.

Following the PRA’s report to the Treasury and to Parliament, the Treasury will set up an independent review panel. The first task for that panel will be to consider the evidence that the PRA gathered and come to a view on its findings. It will then have to make recommendations about whether future measures to deal with risks from proprietary trading are necessary. The independent review will be able to make any recommendations in relation to proprietary trading that it considers appropriate. It will not be constrained, and like the PRA review, will be able to consider the experience other countries have had with restrictions on proprietary trading, such as in the US with the Volcker rule. By the time of the review, I imagine that a wealth of information and views will be available to help the independent panel come to its conclusions. The independent review panel must make its recommendations in a report to the Treasury and to Parliament.

As I have said previously, the PCBS heard in evidence that proprietary trading does not currently pose a large risk for the UK financial system, but it can do little harm to keep this area under review, should risks emerge in the future.

As noble Lords have seen when we debated other parts of the Bill, and, indeed, through this Government’s willingness to set up and listen to the ICB in the first place, we are in favour of independent reviews. Therefore we are persuaded that proprietary trading is an area where an independent review in future can add value. These reports will give a future Parliament all the information it needs to assess whether future safeguards are necessary. I beg to move.

[Lord Lawson of Blaby]

My Lords, once again I would like to thank the Government and, in particular, my noble friend Lord Deighton, for moving this amendment. It is in response to a strong recommendation that was encapsulated in a specific report on this subject among the five reports from the Parliamentary Commission on Banking Standards.

Just as in the previous amendment, which concerned the review of the ring-fence, initially the Government were prepared to look at it only from the point of view of whether an individual banking institution had been gaming the ring-fence. They have now agreed to look at the system as a whole, and I am grateful for that. Again, initially the Government said, “No way should there by a review of proprietary trading”, but they have now come round to saying, “Yes, the parliamentary commission was right and there should be a review”. I am extremely grateful to my noble friend for that. He said that there is no risk at the moment. That is because proprietary trading has, for the time being, stopped to all intents and purposes. Yet at its peak it was for many banks up to 30% of their total business. One must imagine that that is quite likely to occur again in future. I do not know whether it will but it is clearly possible. But if I might say so to my noble friend, it is not simply a question of risk—although risk is obviously an important factor.

There was an important debate on Thursday last week on the five reports of the Parliamentary Commission on Banking Standards. Unfortunately, I was unable to attend but I read the Hansard report. It was introduced by a magisterial speech by the most reverend Primate the Archbishop of Canterbury and there were a number of good speeches—it read very well. In particular, I was impressed by the speech by my noble friend Lord Deighton, in which he gave us a little autobiographical counter. He spoke a little bit about his own experience as a banker. One thing I noted in particular. He said he was always conscious of the importance in banking of, “putting the customer first”. That is a very important aspect of banking culture. Indeed, banking culture was one of the most important things that the parliamentary commission was set up to look into.

However, in proprietary trading there is of course no question of putting the customer first—because there is no customer. It is the bank trading on its own behalf. That involves a totally different culture and mindset. If you want to preserve in banking—as I think we should—the culture that my noble friend believes in, as he said on Thursday, then you should ban proprietary trading by banks altogether. It is fine for hedge funds. It is an excellent activity for them and they can do it very well. I am not suggesting that it should be made an illegal activity, but banks should not do it. Most of us on the commission—though clearly not all—came to that conclusion. We called for a review because we were unsure about the practicalities. There is some difficulty in defining the sort of proprietary trading that should be banned for banks because there is a need for market-making. The line between market-making and proprietary trading is very clear in the minds of those doing it, but whether it is clear in law is another matter. We thought it useful to look at the American experience.

Finally on this, I say to my noble friend that we should look at the American experience but not too much at the American legislation. The complexity and detail of the American legislation was simply appalling. It is a problem across the legislative system that they have in the United States. My noble friend quite rightly referred to the Volcker rule because Paul Volcker insists that there should be a ban—for cultural reasons, above all. He also told us, when he gave evidence to the commission, that the legislation introduced in Congress was certainly not the sort he had in mind.

Having said that, I wish the Government well in this. It will be an important review, for the reasons that I have outlined. I commend the Government for repenting, if slightly belatedly—but as the right reverend Prelates on the Bishops’ Benches will know, better “the sinner that repenteth”, et cetera. Thank you very much.

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[Lord Deighton]

We now turn to the proposal to put in the Bill new requirements on regulators to meet the auditors of banks. This issue has been subject to extensive debate. The Government have been clear throughout that the regulators should carry the full responsibility for managing an effective relationship with the auditors of banks they supervise, and be held to account for how well they deliver it.

The reasons for this are strong. Before the crisis, regulators neglected their engagement with auditors while the auditors themselves signed off on the accounts of banks which we now know were, in some cases, in dire straits. The Government took action. There is now a requirement in the Financial Services and Markets Act for the PRA to lay its code of practice on auditor engagement before Parliament, meaning that the regulators will be held accountable for how well they deliver on the requirement to engage with the auditors of banks.

However, it has become clear how strongly the PCBS valued the opportunity to go further and specify the number of meetings in statute, to ensure auditors’ insights are used. For those reasons the PCBS is clear that, over time, this dialogue between auditors and regulators must not be allowed to lapse. The proposed amendment therefore includes two provisions to ensure that this crucial dialogue is preserved.

First, the regulators must disclose in their annual report the number of meetings they have held with the auditors. This allows Parliament to hold the regulators to account for the frequency of meetings. Secondly, the regulators must meet at least once per year with the auditors of firms that the PRA, the leading prudential regulator, considers to be important to the stability of the United Kingdom economy. This is a minimum requirement. The Government believe that it is right to place the duty on the regulator to determine how many more meetings are required with the auditors of firms of particular types, consistent with its risk-based, judgment-led approach. This allows the regulators to focus their resources where the risks are highest.

Some noble Lords may argue that the minimum requirement should be higher. The Government do not agree. The Government have said that the regulators must meet with any firm that may be important to the financial system at least once per year, but within this group, there will be firms of major and firms of minor significance.

For firms of major significance, once may be too little; for firms of minor significance, once may be sufficient. For example, under the PRA’s current code, for banks that could have the most significant impact on financial stability, the PRA code mandates at least three meetings a year. For other firms whose failure could still materially impact the UK financial system, the PRA code mandates at least one bilateral a year. The FCA meets at least twice per year with the auditors of the most significant banks and at least once per year with those in the next largest category.

The Government believe that it is right that Parliament does not seek to specify this level of detail in legislation. To do so would risk misaligning the PRA’s resources with the risks the financial system faces. The Government therefore believe that this amendment arrives at a suitable compromise between the desire to specify in the Bill a minimum number of meetings, to prevent meetings between auditors and regulators from lapsing entirely, and an approach that requires regulators to take responsibility for pursuing proportionate and high-quality engagement, and enhanced mechanisms for accountability. I commend these amendments to the House.

[Lord Lawson of Blaby]

My Lords, once again, I am extremely grateful to my noble friend Lord Deighton and his colleagues in the Treasury for agreeing to bring forward this amendment. As he pointed out, it is in response to a recommendation of the Parliamentary Commission on Banking Standards. Hitherto the Treasury has been reluctant to accept this, but it has now done so and it is in the Bill. Incidentally, this was also a recommendation of your Lordships’ Economic Affairs Committee, in its report on the auditors a little while back. This provision is needed in the Bill because we have been here before. The Banking Act 1987—I introduced the Bill that led to that—enabled these meetings to take place, and for a number of years they did. However, in the run-up to the great banking crisis and meltdown they had ceased. That is why we on the commission felt that this time it was necessary to have this provision in the Bill, and I am grateful to my noble friend for that.

I know that the hour is getting late but I should mention another matter that relates to a recommendation of the commission. There was lamentable failure of these meetings to take place and the fact that the auditors were in front of the crisis—the dog that never barked—was partly because of the lack of meetings and was largely the fault of the regulators at the time. It was their responsibility above all to seek such meetings. However, there was also the lamentable inadequacy of the accounting system at the time, IFRS. It is probably an inadequate system in general but it is particularly flawed when it comes to the auditing of banks. That is increasingly recognised within the accountancy profession. It is too late for me to go into the details, and I have explained the specific failings in previous debates and I will not go over the ground again.

When the commission addressed this issue it said that since we cannot change IFRS because the “I” represents an international agreement—although it is, in fact, a European agreement because the Americans have made it clear that they do not want to have any part of it—the PRA must require the major systemic banks to produce a second set of accounts that satisfies the needs of prudential regulation and supervision. That involves a small extra cost to achieve a considerable objective.

When this matter was discussed in Committee, my noble friend Lord Deighton said that there was no need to put such a provision in the Bill because the PRA had the power to do so—and I very much hope that it will do so. It is up to the Treasury Committee in another place to keep the PRA up to the mark. I hope that the present chairman of that committee will do that. Andrew Tyrie, the Member of Parliament for Chichester, outstandingly chaired the work of the Parliamentary Commission on Banking Standards and he secured its important and unanimous report. However, I was slightly alarmed in Committee when the Minister said that the regulators already have power,

“to make rules requiring banks to prepare additional accounts, to the extent that this is permissible under EU law”.—[Official Report, 23/10/13; col. 1022.]

While I thank him for the amendment, I must ask him: if the PRA wishes a systemically important bank to present a set of accounts in a way that it feels is necessary for proper prudential supervision, what will it be prevented from doing under EU law? The House needs to know that.

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[Lord Deighton]

With respect to the question asked by my noble friend Lord Lawson about what constraints the EU law would put on the PRA getting the information in the form that it requests, this is merely tying it into what comes out of the capital requirement directive IV, just to make sure that it is consistent. I am not aware of a particular constraint, but I am aware that there will be additional disclosure responsibilities that come along with that. We really just want to integrate it, but I do not believe that it is a constraint; it should actually help with disclosure.

[Lord Lawson of Blaby]

I am most grateful, but will my noble friend agree to look further into this and, if there is a constraint, to write to me?

[Lord Deighton]

Of course, I would happy with that undertaking. I fully accept the observation from the noble Lord, Lord McFall, that an audit needs to have the context of the business model behind it to have a proper understanding of where the business is going. We will certainly encourage the regulator to ensure that the dialogue with the auditor takes into account what is really happening in the business and does not just look at the numbers in isolation.

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[Lord Deighton]

That the Bill do now pass.

[Lord Lawson of Blaby]

My Lords, it is incumbent on us to respond to the very kind words of my noble friend Lord Deighton. As he said, the Bill has been completely transformed. I have been a Member of this House for a very long time now but I cannot recall a Bill—let alone a Bill as important as this one—to have been so totally transformed for the better. It is not only a great deal bigger but also a great deal better as a result of its passage through your Lordships’ House. I am extremely grateful and the nation will be extremely grateful.

There has been a lot of nonsense talked about the excessive size of the banking sector in this country. Some people have been even as foolish as to talk about a monocrop economy. The fact of the matter is that banking accounts for a little over 5% of this country’s GDP; it is nothing like a monocrop economy. However, it is a supremely important sector and one in which we are world class.

There is a size problem—I have not got time to go into it now and it would not be proper to do so—with individual institutions. As the former Governor of the Bank of England said, if an institution is too big to fail, it is too big. The size of the sector is a great strength of this country. As the present governor, Mr Carney, said recently, it is a great strength of the United Kingdom that we are prominent and world class in this growing and supremely important industry. We want it to grow further, which I hope it will. It is our great strength. It is what economists call the law of comparative advantage—you should do what you are best at—and this is a sector in which we are very good. However, if it is going to get bigger and bigger, which I think it will and should, it has to be both clean and robust. The purpose of the Parliamentary Commission on Banking Standards was to try to ensure that it would be both clean and robust. That is what the Bill is about.

I say again how grateful I am to the Government, and particularly to my noble friend Lord Deighton, for having implemented so many of the recommendations of the parliamentary commission to ensure that the Bill leaves this House in an infinitely better state than when it arrived here.

Financial Services (Banking Reform) Bill

Debate between Lord Deighton and Lord Lawson of Blaby

Wednesday 27th November 2013 Lords Chamber

[Lord Lawson of Blaby (Con)]

My Lords, I support strongly what the most reverend Primate the Archbishop of Canterbury and the noble Lord, Lord Eatwell, have said. I speak in support of them because this is a particularly important issue.

In constructing a safe banking system, a number of things are taken into account, including risk-weighted assets and other matters of that kind, but there is no doubt that the leverage ratio is the single most important element in having a strong and robust banking system. This amendment is not about what number it should be. I mention en passant that the Government say that we must not interfere with what the Vickers committee recommended, yet when the Vickers committee recommended a number which they did not like they disagreed with it. Nevertheless, that is water under the bridge.

The review is quite unnecessary—although it will probably not do any harm—because the issue of the leverage ratio is peculiarly simple. Who will be responsible for setting the leverage ratio, the Treasury or the Financial Policy Committee of the Bank of England? The amendment is important because it would give the Minister the opportunity to make a clear statement. There has been movement since Committee. The Governor of the Bank of England, Mr Carney, gave evidence to the Treasury Committee in another place only yesterday saying that his understanding was that it would be the responsibility of the Financial Policy Committee of the Bank of England. We would like to have that explicitly stated by my noble friend here today.

[The Commercial Secretary to the Treasury (Lord Deighton) (Con)]

My Lords, the amendment would require the Government to make an order giving the FPC a power to direct the PRA to set a leverage ratio within six months of Royal Assent. It is absolutely the case that it will be the FPC which exercises these powers. It has never been the intention that the Treasury would have those powers. For those who are not so familiar with the context, I shall have another go at being less confusing about the background, because it is important to understand why the review is necessary to get to that end case and what the current situation is.

There was a lot of concern around the idea that the Chancellor has the power to set a leverage ratio, which I think was in part a result of some confusion about how the law currently stands and works—which in turn is partly because of the various domestic and international reforms running to different timescales. We are in a process of change and a lot is moving around.

I tried last time to clarify the current powers of the regulator and the future powers of the FPC during Committee. I thought that I nearly succeeded, because I think that the noble Lord, Lord Lawson, is on record as saying that he was encouraged to some extent. That was a ringing endorsement compared to how I did on some of the other amendments, so I thought that I had done quite well.

The Government have sought to provide further clarity on this point through the recent exchange of letters with the Governor of the Bank of England. I will return to that. I hope that, with that explanation and a description of the steps that the Government will take to clarify matters further, I can satisfy your Lordships that their concerns about what I agree is a very important issue will be addressed.

First, I shall try to explain the current state of the law. Then I will explain our proposals in that context, because I think that that will give noble Lords the full picture.

Under current law, three bodies are concerned with the leverage ratio: the Treasury, the FPC and the PRA. Of course, the last two are part of the Bank of England group. Of those three, one has the direct power to set a minimum leverage ratio now. That is the PRA. Let me make it absolutely clear: it can do that not just on a firm-specific basis but on a system-wide basis. It can do that now; it has that power. It can set the leverage ratio directly, as it did back in June, or on the basis of a recommendation from the FPC. When I replied to the noble Lord, Lord Turnbull, I talked about the June action of the PRA as the killer fact; it was obviously not as emphatic as I hoped.

Under FiSMA, the FPC has two sorts of powers. First, there is a wide power of recommendation on any issue with regard to financial stability, which it makes to the PRA to exercise under its powers on a “comply or explain” basis. For that to work, the PRA must have powers to apply rules across the whole sector, which, as I have just explained, it does. It is envisaged that that is how most of the FPC’s decisions will be enacted. Secondly, the FPC has a narrow set of macro-prudential tools, which are powers to direct the PRA to act. There are currently two powers of direction. Currently, they are a counter-cyclical capital buffer and sectoral capital requirements. The Government also committed—this was the original situation—to giving the FPC a third direction tool to vary the minimum leverage ratio once the minimum was set in 2017.

For the avoidance of doubt, the Treasury plays no role here. If the PRA wants to set a leverage ratio either under its own initiative or under the recommendation of the FPC, it does not have to ask the Treasury, and the Treasury has no veto. The Treasury is the only body of the three that does not have the power or influence to set the leverage ratio. So the debate is essentially about how and when the Treasury grants the FPC that specific power of direction over the PRA, rather than the PRA retaining some discretion in the matter.

That being established, let me turn to the Government’s recent exchange of letters with the Bank of England. The Government have already committed to give the FPC the power of direction to vary the leverage ratio through time in 2018, subject to a review in 2017, but, given progress internationally—all the transformational change that we just discussed—there is a case for such powers being given earlier, or specified in a different form. To settle this debate, the Chancellor asked the governor, who is the chair of the FPC, to review the matter and make a recommendation to him that he could take to Parliament. The Government believe that that is the right approach to granting the FPC additional powers of direction, for a number of reasons.

First, there is an existing process for the FPC being granted such powers, established under the Financial Services Act, which many in this House and the other place, including the chair of the PCBS, helped to design. These are prescribed by the Treasury by order under Section 9L of the Bank of England Act 1998. Before making an order, the Treasury must consult the FPC and make an order in Parliament. This is subject to the affirmative resolution procedure, so must be approved by each House of Parliament.

To fulfil their duty of proper consultation before bringing a proposal under the Act, the Government believe that it is appropriate and necessary that the Bank furnish them with the relevant information from the planned review of the leverage ratio. As noble Lords can see from the governor’s response to the Chancellor, he is more than happy to go along with that process, given the things that are going on this year. Secondly, as a matter of policy, there are a number of outstanding technical issues that will need to be settled before the Chancellor can bring fully fleshed-out proposals back to Parliament.

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[Lord Deighton]

My Lords, we are considering a proposal to mandate the regulators to meet the auditors of all the banks they supervise at least twice a year. Strengthening the quality of engagement between auditors and supervisors is an objective that the Government share. I think that there is absolutely no disagreement between us about how important that is and how it has not always worked well in the past. I listened to the concerns of the noble Lord, Lord Lawson, that voluntary commitments for regulators and auditors to meet regularly could easily fall into abeyance. However, some lessons have been learnt from the financial crisis, and the Government have taken meaningful steps to ensure that the new regulator does not slip into the habit of neglecting engagement with auditors.

FiSMA now includes new Section 339A, which requires the PRA to have arrangements for sharing information and opinions with auditors of PRA-authorised firms, and to publish a code of practice to set out the way in which it will comply with this obligation. This code of practice sets out in detail the principles governing the relationship between the regulators and bank auditors and must be laid before Parliament whenever it is changed. This change to the law has greatly improved the regulators’ engagement with auditors since the crisis, so the Government have taken action here. The Government believe that the action they have taken in this respect is in line with changes to ensure that the regulators now follow a judgment-led approach to supervision that ensures regulators are clear in their purpose and direct resources to the most important cases.

One of the criticisms of the old FSA was that its approach did not focus on the most significant issues and too much resource was taken up by inflexible processes. Operationally, this new legal framework forces regulators to be more diligent and allows them to be held accountable. The essential strength of the new legal framework is that it demands diligence from the regulators through parliamentary review and encourages proportionality by allowing them to specify where they will focus their resources. The result has been that the PRA will meet with firms which have the potential to cause major economic disruption in the case of failure at least three to four times per year. The FCA will meet with the auditors of those firms at least twice a year. This is exactly what we want—prioritised, high-quality engagement where it matters.

The Government therefore remain unconvinced of the value of changing the frequency of this dialogue in statute without some reference to proportionality. Two meetings a year with the auditors of important firms is too little, while the same number for very small firms may be too many. The Government favour the current legal framework with its provisions for diligence and prioritised application of resources. Of course, there may be refinements that can be made in the law to ensure that the requirements on regulators are always express.

[Lord Lawson of Blaby]

For clarification, if my noble friend reads the amendment, he will see that it does not say that the meetings should be held twice a year but that they should be held at least twice a year, so there is flexibility there. I hope that he will take this back and bring forward something better than he has said so far—interesting though that is—at Third Reading, because he has not addressed the critical point of the need to have a statutory requirement for these meetings to take place. He can decide what the right periodicity is; what I am anxious about is that there should be this statutory requirement.

[Lord Deighton]

I was just getting to that. The Government believe that there is a superior approach to strengthening the law in this area by clarifying the requirements on regulators to meet auditors enough times to accomplish their objectives. I think we agree that the periodicity should not be the constraint, although perhaps we could deal with that by a requirement to disclose the frequency of meetings with certain types of firm to ensure accountability. Such an approach would, in the view of the Government, be superior and retain proportionality and the judgment-based approach while increasing accountability. If the noble Lord will withdraw his amendment I will be willing to return to it at Third Reading, subject to further consideration of these issues.

[Lord Deighton]

That is what I am saying, yes.

[Lord Lawson of Blaby]

In answer to the useful point of clarification by my noble friend Lord Higgins, will this measure definitely be on the face of the Bill?

[Lord Deighton]

Yes.

[Lord Lawson of Blaby]

Given that undertaking, for which I am extremely grateful, I beg leave to withdraw the amendment.

Financial Services (Banking Reform) Bill

Debate between Lord Deighton and Lord Lawson of Blaby

Tuesday 26th November 2013 Lords Chamber

[Lord Newby]

My Lords, we now move to a group of government amendments which pertain to the scope of the offence relating to a decision that results in bank failure. This offence was introduced through amendments to the Bill in response to a recommendation by the PCBS. As tabled in advance of the debates in Committee, and building on the FiSMA definition of “bank”, the offence would have applied to retail banks and building societies. This meant that all deposit takers except credit unions were covered.

As discussed in earlier debates on the scope of the senior managers regime, the Committee debate on 15 October has prompted the Government to reconsider this position. In the light of the persuasive arguments put forward in that debate, we are amending these clauses so that the offence may be committed not only by senior managers of a bank, but by senior managers of relevant authorised persons. “Relevant authorised person” is defined by government Amendment 106 to include banks and those investment firms that are regulated by the PRA as well as the FCA. These are known as systemic investment firms, because their large size means they have a significant impact on the wider financial sector. Smaller investment firms will continue not to be covered by the offence. This is because, like credit unions, they do not represent a significant risk to taxpayer funds, or to financial stability, and their failure is very unlikely to lead to serious harm to customers.

The Government shared this definition with the members of the former PCBS and are hopeful that the scope now captures those firms that the PCBS had in mind. I hope that these amendments fully meet the House’s concerns on the matter.

The other amendments in this group make consequential amendments to Clauses 27 to 28 which are necessary to give effect to this change, and improve the drafting of the existing provisions. There was also some debate in Committee over whether the cross-heading as tabled properly represented the offence. In the light of this, I have asked the House printers to amend the heading so it now reads, “Offence relating to a decision causing a financial institution to fail”. I trust that this addresses the concerns raised. I beg to move.

[Lord Lawson of Blaby]

I make one point of clarification on what my noble friend said. I apologise for my cold. It is absolutely necessary that the definition of “bank” should be extended in the way that the noble Lord has said. I am very pleased with that. He gave us a reason that these investment banks, or these investment institutions, might be a potential liability for the taxpayer. I hope he will withdraw that. It is very important that there is no taxpayer liability there. The reason we wanted it expanded is that we were concerned about banking standards, which was what this commission was all about: banking standards and culture. That is why it is necessary that there should be this regime for these banks, not because there might be a taxpayer risk or bailout.

Financial Services (Banking Reform) Bill

Debate between Lord Deighton and Lord Lawson of Blaby

Wednesday 23rd October 2013 Lords Chamber

[The Commercial Secretary to the Treasury (Lord Deighton) (Con)]

My Lords, these two amendments concern the role of auditing in banks. Many excellent points have been made about the historical challenges and weaknesses and to some of the problems they have created. However, not all of these have specifically addressed the amendments themselves.

Amendment 92 seeks to strengthen quality engagement between auditors and supervisors. We agree we want to accomplish that and the noble Lord, Lord Eatwell, made the same point. The question is about the most effective way to ensure it is consistently brought about and the difference between us is about how we accomplish that. It may appear attractive to require greater engagement in statute as a guard against complacency in the future, but the clause risks weakening the auditor dialogue and perpetuating the tick-box approach that was found wanting in the last financial crisis. That was one of the most important lessons about regulation we learnt from that crisis. The FSA was widely criticised for measuring adherence to its rules—like how many times you met the auditor—but not coming to an informed judgment about the risks in individual companies and the wider market. That is where the focus of our regulation needs to be.

I may have been in the private sector too long, but solving a major problem by legislating for a number of meetings has never been the best way to get quality outcomes to serious problems. The FSA was criticised, beforehand, for not engaging enough with the auditors of the banks they supervised. The then statutory requirement for regulators to meet with auditors at least once per year simply became another process and the wider purpose of the meetings was not properly developed. The whole point of the Financial Services Act 2012 was to make sure such failing was addressed and that the regulators follow a judgment-led approach to supervision. This means that all enforcement activities must enhance the regulators’ understanding of the business and the wider market to better enable them to detect risks before problems become serious.

FSMA now includes a new Section 339A—which deals with the powers to which my noble friend referred—requiring the PRA to have arrangements for sharing information and opinions with auditors of PRA-authorised persons, and to publish a code of practice setting out the way in which it will comply with this obligation. This code of practice, which we have talked about, sets out the principles governing the relationship between the regulators and bank auditors. The code has been laid before Parliament, so provision has already been made, both in and under FSMA, for a regular dialogue between the regulator and the auditor. These requirements mark a change in focus away from process—stipulating the number of meetings—to actual outcomes: getting them to do the job properly. This requires regulators to consider serious engagement with auditors and subjects their stated approach to scrutiny so we can see if they are complying with the code of conduct: it does not just fall away. This process is not only more rigorous in the short term, but gives the opportunity for parliamentary scrutiny when the codes of practice are laid before Parliament and provides a check on potential complacency in the future.

My noble friend Lord Lawson referred to the need to make sure the dialogue was at least quarterly: the PRA code says that it should be. Most noble Lords will not be familiar with the details of the code of practice, but for the major firms—the ones that are perceived to represent the greatest risk to the stability of the financial system—at least three or four meetings per year are encouraged. This is a risk-based approach and the meetings are: at least one routine bilateral meeting between the lead audit partner and the supervisor; one routine trilateral meeting between the lead audit partner, supervisor and the chair of the firm’s audit committee; and one bilateral meeting between the lead audit partner and supervisor in the lead-up to and during the annual audit of accounts.

Conversely, the amendment’s legal requirement for more regulator meetings with auditors would just follow in the footsteps of the tick-box policy from before the crisis. I am really talking about the smaller, much lower-risk firms, where the guidance is, generally speaking, for at least one meeting a year. Having two meetings a year would simply increase the workload of regulators and take them away from exercising judgment and away from prioritising the most concerning engagements. They would simply be setting up meetings, irrespective of individual circumstances, just because they needed to fulfil a rigid requirement. In our view, such rigidity would weaken engagement and impair the regulators’ ability to adapt their approach as circumstances change.

Because of all that, the Government remain unconvinced of the need to define the frequency of this dialogue in statute, as the PRA code already specifies this and invites scrutiny. My noble friend Lady Noakes put it very well when she spoke about how the world has moved on and how this now operates.

In relation to the second amendment, the Government have been clear that the crisis highlighted deficiencies in accounting standards and the fact that there was room for improvement. We all agree with that, and that is what we said in our response to the final banking standards report. The regulators must have the information they need to do the job of safeguarding financial stability, and in some instances that may require disclosure of financial information on a basis different from that used by other audited bodies. In response to the noble Lord, Lord Hollick, the PRA will have access to management accounts, for example.

In response to the banking standards report, the Government asked the PRA, working with other authorities and the FPC, to undertake a broad-based review of this subject. That review will take account of the nature and scope of information required to create a separate set of accounts, the costs and benefits of the initiative, and international requirements. From 2014, the new Capital Requirements Directive IV will require banks to disclose supplementary information which goes beyond the international financial reporting standards. Therefore, it is not yet clear whether we need an additional, separate set of accounts in the light of the extensive prudential and other regulatory reporting requirements that are being imposed through the CRD IV framework.

However, I can assure noble Lords that, whatever the outcome of this review, the powers that have been given to the regulators under the Financial Services and Markets Act, as amended in 2012—this, again, goes back to my noble friend asking about the existing powers—are already sufficient to permit the regulators to do everything that this amendment gives them the power to do. Their current powers would permit the regulators to make rules requiring banks to prepare additional accounts, to the extent that this is permissible under EU law, to specify the principles that should govern the preparation of such information and to make it public. To the extent that the amendment merely gives the regulators the powers they already have and does not require anything else of them, it is unnecessary. I therefore ask the noble Lord to withdraw the amendment.

[Lord Lawson of Blaby]

My Lords, I have listened to what the Minister has said. On the second of his two points, I think that he is very close to the position that I and other noble Lords who have spoken are in concerning the IFRS accounts and their defects. He is very much closer than he is on the first one, and he is very close to what I was trying to say. He said that the Government are going to see whether they can get an improvement. He referred to CRD IV, which goes some of the way but is not entirely satisfactory. The only way that we will get accounts in a form that is satisfactory for the regulators and the supervisory requirements is if they ask for that. He is absolutely right that they can do that now. In practice, they could have done it before the 2008 crash, but they did not. That is the problem. Those of us who support the amendments are saying: once bitten, twice shy. It could have been done before; it can be done now. But it was not done before. Therefore there should be a statutory duty, which would make it more likely that it will be done. How can that be objectionable?

On the first issue the principle is the same: once bitten, twice shy. The idea that this is simply a bit of box-ticking is an insult to the intelligence of this House. As we say in the amendment, the meetings should take place more than once a year—and they will be nothing to do with box-ticking. They will be meetings of the kind that the supervisor and the regulator find most useful. Those people will use their discretion; there is no box to be ticked at all. That idea is—if I may say so, with great respect to my noble friend the Minister—a total absurdity.

It is perfectly true that under the code of practice and so on, such meetings could take place anyway. But that was also the case before: not only could such meetings have taken place, but the Banking Act 1987, which was then in force—that part was not repealed— encouraged them to do so. However, although meetings did take place to begin with, towards the end they did not happen. That is why it makes sense to make it a statutory duty for those meetings to happen. They will not take the form of box-ticking; they will take the form that the regulators and the supervisors find most useful. We leave that to their discretion, but we do not wish to leave to their discretion—this is, in effect, the Government’s position—whether the meetings take place at all. We may wish to discuss this further, but for the present I beg leave to withdraw the amendment.

--- Later in debate ---

[Lord Deighton]

I apologise to the noble Lord. I was so excited about the first question that I forgot about the second one. It is consistent with what I have already said that the FPC intends to address this recommendation in that timescale, but a full assessment will depend on the definition of leverage agreed internationally, so it all rather depends. In terms of who is going to implement it, as I said, the regulators already have the power to do so. In June this year, they changed the ratios on our key eight institutions to protect them in the mean time, so they have these powers and they have exercised them. I think that is a killer fact.

[Lord Lawson of Blaby]

My Lords, in some ways this has been a rather puzzling debate. I warmly endorse what the noble Lord, Lord Eatwell, said. This is one of the most important—if not the most important—issue that we have to discuss in the course of this extremely long Bill. For that reason alone, I think it likely that we will wish to come back to it at Report. Meanwhile, I am encouraged to some extent by what my noble friend the Minister said. However, he seemed to be saying at least two completely different things, if not three. One was that we would have to have the leverage ratio—we are all in agreement that we have to have a leverage ratio—that was internationally agreed. Then he said that we would also have discretion, with the FPC, to decide the leverage ratio, and therefore that there was no need for the amendment because the provision was already there.

First, I am not convinced that it is already there. I shall read very carefully what the Minister said. When my right honourable friend the Chancellor responded to the recommendation of the Parliamentary Commission on Banking Standards, he said nothing of the sort. Nor did he say whether he disagreed with it. He said the first part of what my noble friend said: namely, that we have to accept the international standard.

There are only two major global financial centres: New York and London. It is important that we do what is right for our financial centre—and the United States takes the same view. We should not rely on international agreements. Too often it is the lowest common dominator that is agreed. The United States is going its own way, particularly with large banks. It realises that it is a major global financial centre and that New York is so important to the American economy that they have to get it right.

In the United Kingdom, the banking and financial sector is even more important to the British economy. In relative terms, it is five times as important to our economy as the American banking and financial sector is to theirs. Therefore, it is all the more important, if we are to have a strong and successful financial centre and a strong and successful economy in this country, to do what is right.

It is quite clear that that means that we should have a leverage ratio that may be the same as what is agreed internationally—if it is agreed internationally—but may well be a more prudent one. It certainly would not be a less prudent one, but it may be in the interests of the City of London and the British economy that it should be more prudent.

The amendment states that the decision should be taken by the Financial Policy Committee of the Bank of England. In a sense, my noble friend agreed with that when he said that the duty was already there and that we had given it to the committee. If that is so, it is good news. However, I suspect that it is not entirely the case. Therefore, it is very likely—in fact, more than likely—that we will come back to this very important issue on Report. In the mean time, I beg leave to withdraw the amendment.

--- Later in debate ---

[Lord Deighton]

I was trying to be clear but I shall reinforce my comments. I think this issue was covered on the first day in Committee when we dealt with the details of ring-fencing. It is clear that proprietary trading for ring-fenced banks is not allowed; it is an excluded activity, as defined. As my noble friend implies, there are some exceptions to that which are predominantly related to a bank’s own hedging activities to deal with its own surplus liquidity. My noble friend’s phrasing was accurate and the issue is included in the Bill.

[Lord Lawson of Blaby]

My Lords, I think that there has been a slight misunderstanding. My noble friend the Minister said that we have gone down the ring-fencing route instead. That is a different matter altogether. The idea of ring-fencing is to put a sharp barrier between the commercial banking operations of a universal bank—the lending to individuals and to small businesses and, indeed, medium-sized businesses—and the investment banking activities. There should be a line between them. There is also the great question, which we debated earlier, as to whether there should be a total separation. This is about whether a universal bank—I agree with my noble friend that it would not be done in the ring-fenced part—should be permitted to engage in proprietary trading at all.

It is all very well to say that there may be cultural contamination as a result of proprietary trading but that, as there are other forms of cultural contamination as well, we should not bother about this one. I do not buy that. If we can significantly reduce the amount of cultural contamination by making proprietary trading by banks illegal, that is a plus. There may still be other problems with the banking culture, but at least we would have solved an important part of it.

My noble friend the Minister also seemed to say that there was no need to review this issue. There is a need to review it for the very reason that the noble Lord, Lord Turnbull, pointed out. The overwhelming weight of evidence received by the commission in conducting its inquiry was that it would be a very good idea for banks not to engage in proprietary trading for some of the reasons that I and other noble Lords have given in this short debate. However, as the noble Lord, Lord Turnbull, identified, the problem was how precisely you define proprietary trading and distinguish between it and market-making and some of the other activities referred to.

I have known Paul Volcker for 30 years. He is a very wise old bird. I am not suggesting that my noble friend the Minister is not wise, but of all the people I have known in the financial sector Paul Volcker is among the wisest, if not the wisest. If he thinks that this measure is desirable and workable, that carries a great deal of weight with me. He said that if a chief executive of a bank did not know whether or not he was engaging in proprietary trading he ought to be fired. At one level that is a perfectly good answer. Nevertheless, there is a complicated issue of definition. That is why we have said that we should see how things develop over the next three years and see whether there is a workable system in the United States or whether those who say that it is completely impossible to have a satisfactory definition because it will not work are right. We will find that out and then we will take action accordingly.

It is nice to hear mention of the notion that the PRA can bear down on proprietary trading as it implies an acceptance that there is, or could be, a problem. However, that is not the same thing as saying very clearly that no bank should be doing this, even if it is not a ring-fenced bank. At present, the Bill does not go far enough in that regard. This is something to which we will almost certainly wish to return on Report. I beg leave to withdraw the amendment.

Financial Services (Banking Reform) Bill

Debate between Lord Deighton and Lord Lawson of Blaby

Wednesday 23rd October 2013 Lords Chamber

[The Commercial Secretary to the Treasury (Lord Deighton) (Con)]

My Lords, the intention of the amendment is to transfer into HM Treasury the function of managing the Government’s shareholdings, in particular in RBS and Lloyds. As my noble friend Lord Lawson has pointed out, the Chancellor of the Exchequer, in his Mansion House speech in June, has already made it clear that he rejects this particular PCBS recommendation.

As has been pointed out in a number comments already, UKFI was not a creature set up by this Government; it was set up by the previous Government when they made the initial capital injections into RBS, Lloyds, Northern Rock and Bradford and Bingley, with the idea of being able to manage these investments on an arm’s-length commercial basis. So that was the genesis.

This group works closely with the management of RBS and Lloyds to assure itself of their approach to the strategy and to hold management to account for their performance. RBS and Lloyds are led by their management and board in the interests of all shareholders, including the taxpayer. So, while it may be possible to imagine different arrangements to fulfil these objectives—you can make the arguments and the pros and cons of the different ways of doing it—the current ones work well, as my noble friend Lord Garel-Jones has said, and it would not make sense to change them at this stage. So, just as my noble friend Lord Lawson said it is a simple amendment, there is a simple reason to reject it—it does not make any practical sense. UKFI is working fine and the time and effort it would take to pull it back into the Treasury and to reorient all that work there would distract our efforts on the important work that is currently going on.

My noble friend Lord Lawson referred to the review at RBS in particular, which we are two-thirds of the way through, and the bad bank/good bank option. I am afraid I am going to disappoint my noble friend. I am not going to tell him what the result is but it will be ready this autumn and we will announce the outcome and the rationale behind it. The matter is being pursued with great urgency and the last thing we want to do at the moment is to destabilise the arrangements for conducting that important analysis, which is really the most important thing.

I reiterate that UKFI is staffed by some very good top people. I have worked with them and I have seen the work that they do. Frankly, we have been able to recruit top-class people to do this work on our behalf. I can assure the Committee that the Government continue to value the role that they play. It was demonstrated again, as my noble friend pointed out, by the role they played in advising the Chancellor on the successful divestment of 15.5% of the Government’s shareholding in Lloyds at 75p per share. They will carry on looking at the full range of options for RBS and managing the timing of the subsequent tranches of the sale of Lloyds back into private ownership.

I am grateful to the PCBS and the noble Lord for raising these issues, but the Government consider that UKFI has a vital role to play which it is performing well. I therefore cannot support the amendment and I urge the noble Lord to withdraw it.

[Lord Lawson of Blaby]

My noble friend will not be surprised to hear that I am wholly unconvinced by his reply; nevertheless I shall please him by withdrawing the amendment.

Financial Services (Banking Reform) Bill

Debate between Lord Deighton and Lord Lawson of Blaby

Tuesday 8th October 2013 Lords Chamber

[Lord Deighton]

My Lords, these amendments streamline the procedure for the group restructuring powers—the so-called electrification powers. In another place, following the recommendations of the PCBS, the Government introduced amendments adding new Sections 142K to 142V. These sections give the regulator the power to require a banking group to restructure if the regulator believes this necessary to ensure the objectives of the ring-fence. As the PCBS recommended, the regulator will have the power to require the group to divest completely either its ring-fenced bank or its non-ring-fenced bank, or transfer specific business units out of the group. These extensive powers may be exercised if the regulator believes that the group’s ring-fenced bank is insufficiently independent or if the group’s conduct is such as to threaten the regulator’s ability to meet its statutory objectives. The amendments made in the Commons thus provide for the power to require the separation of an individual banking group that the PCBS recommended.

However, some concerns were expressed both in the other place and in this House that the procedure for the regulator to exercise its group restructuring powers was too complicated and drawn out. It was argued that the number of steps involved and the length of time required from start to finish created a process that was so cumbersome as to be difficult for the regulator to use in practice, and that this risked undermining the group restructuring powers as a deterrent against attempts by banks to subvert or game the ring-fence.

The Government took these concerns very seriously. As noble Lords will recall, I committed at Second Reading to bringing forward amendments to simplify and streamline the process for exercising the group restructuring powers. These amendments do exactly that. Amendments 7, 9, 11 and 12 replace the requirements for three preliminary notices with just one so that if the regulator is considering exercising its powers it need notify the target group only once, stating its reasons for considering requiring restructuring and the action it is proposing to take.

Amendment 8 removes the requirement for the Treasury to consent to a preliminary notice. Previously, Treasury consent was required for each of the original three preliminary notices. Under this amendment, the regulator need give the Treasury only a copy of a preliminary notice. Treasury consent will be required only later in the process for the issue of a warning notice.

Amendment 15 clarifies that any notice of a decision by the regulator not to exercise its powers must be given in writing. Amendment 16 provides that a copy of such a notice be given to the Treasury.

Amendment 17 shortens the warning notice period from 12 to 18 months to three to six months. This period is intended to give a bank about which the regulator has concerns, and to which it has issued a preliminary notice, an opportunity to address the problems identified by the regulator of its own accord. The Government still believe that it is right to give a bank the chance to tackle any problems, but agree that the period originally provided for was too long.

Amendments 13, 18 to 20 and 38 are consequential on the other amendments being made to these sections. Amendments 21 and 22 remove the requirement that the regulator must allow at least five years for any restructuring or divestment to be completed. Now it will be up to the regulator to set whatever deadline it considers appropriate.

These changes will bring the procedure for using the group restructuring powers into line with that proposed by the PCBS. One point on which we continue to differ from the PCBS is the inclusion in the procedure for requiring the restructuring of an external review, which Amendments 10, 14 and 116 would have inserted, and which we have already debated.

As for the total time involved to require the separation of a group, following the Government’s amendments, the minimum total time will be slightly shorter under the Government’s provisions than under the PCBS’s. Under the Government’s amendments, the minimum time from the regulator’s first notice of its intention to require restructuring to the actual imposition of a requirement to separate will be approximately four months, compared to approximately five months under the PCBS’s amendment. These amendments will therefore make the group restructuring powers—the “electrification” powers—an effective reinforcement to the ring-fence.

Some will argue that the Government should have gone further and should also legislate for the option of full separation across the entire UK banking industry. The Government do not agree with this suggestion. To provide for a targeted deterrent against members of an individual banking group that seeks to game or evade the ring-fence is a sensible reinforcement for the ring-fence. To legislate for industry-wide separation, however, would not be a sanction; it would be to abandon that policy. The logic of requiring all banks to separate would have to be that the ring-fence had failed to achieve its objectives of delivering greater financial stability while preserving the legitimate economic benefits of universal banking. It could in no way be described as a deterrent.

[Lord Lawson of Blaby]

My noble friend has talked about the great advantages of universal banking that need to be preserved. Will he explain to the House what these unique advantages are?

[Lord Deighton]

The first point that I would make in response is that it was the position of the ICB, which did an enormous amount of work on this, that the ring-fence was not in any sense a compromise but was in fact superior to full separation because of some of the synergies available in the universal bank. The essence of the argument is that the other parts of the bank that may not get into financial trouble actually provide benefits of diversification and scale that can protect the ring-fenced entity from any of the problems that they may have. It is essentially the diversification and scale advantages that universal banking may bring.

I have some sympathy with my noble friend’s underlying suggestion; in much of the discussion so far we have talked about how ingenious bankers are but, given what they have done to their organisations and the industry over the past five years, you have to question exactly how ingenious they are on a consistent basis.

To come back to the point, others are of course perfectly entitled to the view that the ring-fence will fail—we have heard that point of view from many Members here—and a future Government would be entirely within their rights to propose an alternative policy to ring-fencing. However, the only proper way to legislate would be for the Government to conduct research and analysis to match the calibre of the Vickers commission in support of full separation. I note that the PCBS produced no such evidence. Let it build a consensus around its conclusions, and let it come to Parliament with new legislation to be subjected to the full scrutiny and debate that such a step would require.

Monetary Policy Committee: Inflation

Debate between Lord Deighton and Lord Lawson of Blaby

Wednesday 13th February 2013 Lords Chamber

[Lord Deighton]

I do not really want to get into a semantic argument about the definition of flexibility, and I do not know whether it appears in the original Act. However, to my simple understanding, the remit and the MPC’s behaviour clearly demonstrate significant flexibility, which is what you would expect in a policy tool to cope with our difficult and challenging economic circumstances.

[Lord Lawson of Blaby]

I support my noble friend the Minister in everything that he said and I greatly look forward to the court case which the noble Lord, Lord Peston, is about to bring against the Bank of England. I am sure that that will give us great entertainment value. Is my noble friend aware that to jettison the inflation target at this time or at any other time would mean a loss of financial market credibility and a loss of political credibility for no gain whatever?

[Lord Deighton]

I thank my noble friend for his expert endorsement. He is absolutely right: our inflation target has served this economy extremely well. The Chancellor and the incoming governor as well as the existing governor have been clear that it would take a very high hurdle to climb over to find a better structure than the one that we currently have.