Taxation: Avoidance
Lord Eatwell Excerpts(13 years, 1 month ago)
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Lord Eatwell
My Lords, the issues raised by the noble Lords, Lord Dykes and Lord Phillips, have recently been the subject of two important reports. First, the report of the Public Accounts Committee into tax disputes, published on 20 December last year, revealed what can only be described as a scandal. It demonstrated a quite extraordinarily cosy relationship between HMRC and major companies, particularly international companies, in the determination of tax liabilities. It also demonstrated a failure to follow proper procedures in the resolution of tax disputes, and a consistent bias towards the favourable treatment of large companies compared with small companies and the ordinary taxpayer.
Everyone in this country who is settling their tax assessment this month, knowing that they will incur a fine and interest charges if they do not pay up on 31 January on the dot, will be astonished to discover that large companies may be given 10 years to settle their tax obligations. They will also be furious that up to £20 million in interest has been lost because of HMRC errors, while, for reasons that are still not clear, the department decided it would not reopen negotiations with the relevant company—a decision that it appears was taken without legal advice. The PAC report says that,
“the Department did not even take the most basic step of making its own note of meetings with the company concerned, relying instead on the record kept by the company”.
To compound this record of complacency and connivance, the department failed to be open with the PAC investigation and was,
“less than clear and consistent in the evidence”,
given to the PAC and to the Treasury Select Committee in another place.
It is important to remember that HMRC is, quite rightly, a non-ministerial department, thereby removing Ministers from any suspicion of involvement in individual taxpayers’ affairs, but this scandal goes beyond matters that can be remedied at arm's length by more effective management and the appointment of extra Revenue commissioners. It strikes at the very heart of the fair and impartial management of the tax system. It reveals systemic failures that have resulted in unfair and partial treatment verging on favouritism, and it demands the exercise of ministerial responsibility, for it undermines public confidence in the probity of government and the integrity of the Revenue.
If the failings exposed by the PAC were an isolated set of events—an aberration—the measures taken so far by HMRC to put its house in order just might be regarded as sufficient. Regrettably, this is not the case. As we have heard from the noble Lords opposite, it is a widely held view that tax avoidance is rife in this country, and that wealthy individuals and large companies that can afford sophisticated tax advisers can avoid attacks by abusive means.
The term “abusive means” has been defined by Mr Graham Aaronson QC as,
“contrived and artificial schemes which are widely regarded as an intolerable attack on the integrity of the UK’s tax regime”.
This quotation is taken from a report entitled A Study to Consider whether a General Anti-Avoidance Rule should be Introduced into the UK Tax System, published in November last year, which was authored by Mr Aaronson and commissioned, to give them due credit, by Her Majesty’s Government. I applaud the initiative. Mr Aaronson concludes that a general anti-avoidance rule should be introduced, and proposes practical means by which this might be done. In his report, he argues that certainty in the tax system makes an important positive contribution to the economic and business environment. The presence of tax loopholes, and their exploitation by the unscrupulous, undermines that certainty. Moreover, competitive pressure forces firms to adopt more and more elaborate tax avoidance measures.
Competitive advantage can be gained by companies that go down the tax-abusive route, and hence firms that attempt to take a high moral stand, as the noble Lord, Lord Phillips, points out, are placed at a competitive disadvantage and may be eliminated from the marketplace. All must join the race to the bottom. Tax avoidance by businesses therefore undermines certainty, forces firms to adopt the tax-avoidance policies of the lowest common denominator, undermines any perception of fairness in the tax system and imposes a dead-weight loss on the economy by spawning a socially useless tax avoidance industry. It is damaging not just to the Revenue, but to the performance of the economy as a whole.
The source of this pernicious burden on our economy, the foundation of the tax avoidance industry, is the complexity of the tax system. It is complexity that by its very nature creates the exceptions and loopholes that can be legally exploited by the enthusiastic, well resourced tax avoider. If we are to tackle the disease rather than the symptoms, complexity should be the target. An important reason for the complexity of the tax system is that Governments attempt to manipulate behaviour via tax allowances and reliefs to incentivise people to behave in a particular way—to invest in new businesses or to undertake more R&D, or to recycle waste, or whatever. What is remarkable is that years of academic study have demonstrated that very few of these incentives actually work. Tax allowances to stimulate investment, for example, do not tend to result in more investment. Instead, they are a subsidy to investment that would have taken place anyway.
Another important source of complexity is a government belief that it is appropriate to differentiate between revenues from different sources, so that benefit deemed to derive from capital gains, or, more scandalously, from carried interest, is taxed differently from benefit derived from income. The treatment of interest on debt as a cost, and hence being tax deductible, is a major factor distorting the funding of business in this country. All this is a rich source of tax avoidance. Then of course there are the tax benefits handed out to specific social groups with the most powerful lobbying voices—the non-doms come immediately to mind.
Whether it derives from good intentions, perceived policy objectives, or mere cowardice and/or patronage in the face of the powerful and well funded, complexity is the fundamental source of avoidance. Without tackling complexity, the avoidance industry will never be significantly reduced. I therefore applaud the establishment by the Government of the Office of Tax Simplification and look forward, in hope rather than expectation, to its efforts bearing fruit. In the mean time, while we wait for the simplified promised land, Mr Aaronson concludes that all current approaches to curb tax avoidance,
“are not capable of dealing with some of the most egregious tax avoidance schemes”.
He might have added, if he had had the PAC report before him, that all attempts to limit tax avoidance are undermined if there exists the cosy relationship between the HMRC and big business identified in the PAC report.
With the PAC report and Mr Aaronson's report before him, the Minister must address a number of questions. First, when did Ministers first know of the matters identified in the PAC report? Were they fully informed, or have they made further investigations? What have their investigations, if any, revealed about further abuse and, if so, what sort of abuses? What action do the Government intend to take to correct the systemic deficiencies in the HMRC? Is it not time for a full investigation into the practices and substance of the taxation of large companies, in order to re-establish public confidence in the probity of government and of the Revenue? Secondly, do the Government accept the conclusions of Mr Aaronson's report? When do they intend to introduce a general anti-avoidance rule, with the institutional support outlined by Mr Aaronson? Thirdly, when can we expect a report from the Office of Tax Simplification that deals specifically with business taxation and tax avoidance?
Confidence in the tax system is, as noble Lords opposite have said, fundamental to our democracy. If confidence in the fairness and probity of the state is lost, effective revenue raising is undermined—colourful examples, perhaps from the Mediterranean, can be imagined. The issues identified in the Public Accounts Committee report and in Mr Aaronson’s report demand an urgent response. I hope we will hear from the Minister today the concrete steps that the Government intend to take to curb abusive behaviour towards the tax system. If practical steps are not forthcoming, the Government will have some explaining to do to this House and to the British people.
Lord Phillips of Sudbury
The noble Lord raised some extremely pertinent points about HMRC, but does he agree that the Government reducing the staffing at HMRC over the next few years by 12,000 is scarcely likely to increase the effectiveness of tax collection?
Lord Sassoon
My Lords, as I am sure my noble friend would recognise, all government departments are having to tighten their belts; otherwise, the deficit is not going to be tackled. I hope to reassure him by explaining where HMRC is focusing its efforts. The recruitment of over 1,200 staff in new posts to tackle non-compliance is significantly upping HMRC’s efforts in this area and will bring in significant additional revenue in each tax year, so the answer to his question is yes.
The customer relationship model that HMRC uses has considerably improved its ability to identify risk and to handle these issues. The report by the National Audit Office on HMRC’s 2010-11 accounts, which underlay one of the reports referred to by the noble Lord, Lord Eatwell, noted that HMRC’s high-risk corporate programme has brought in a yield of over £9 billion and that it contributed to reduced avoidance activity by major companies. The investment is there. On another point made by my noble friend Lord Dykes, we do not forget the cash economy in those efforts.
I am grateful to the noble Lord, Lord Eatwell, for drawing attention to the question of the general anti-avoidance rule, the GAAR. We are exploring that option to see whether such a rule could help to deter and counter tax avoidance in a fair way. Attention has been drawn to the work of Graham Aaronson and his colleagues and their report. We received the report in November last year. We will be considering it and are actively discussing its implications with businesses and tax professionals. We will respond to the report at the Budget and set out our plans if appropriate. We have said clearly that we would not introduce a GAAR without a further formal round of public consultation, so that is very much work in progress.
I am also grateful to the noble Lord, Lord Eatwell, for applauding the introduction and the work of the Office of Tax Simplification. The complexity of the tax system has been much remarked on, and I can echo many of the remarks made by noble Lords on that. The OTS has started its work and published recommendations on tax relief, avoidance legislation and IR35, as well as an interim report on small business tax. More is coming down the pipeline and this ongoing work will be an important part of what we all want to see: a simpler tax system that is easier for individuals to comply with. I may disagree with the emphasis of my noble friend Lord Phillips of Sudbury on some things, but I certainly agree that this is fundamentally about individuals doing what they are required by the law to do.
Another critical component of preventing avoidance is the way in which HMRC engages with the largest taxpayers proactively to identify and tackle avoidance. We do not have the time to go into the detail of this but, in response to some of the somewhat one-sided interpretation and selective quoting of the recent Public Accounts Committee report, I draw the attention of the House to HMRC’s detailed rebuttal on many factual points in the conclusion of that report. In brief, to be clear, this effort with large businesses is not in any way HMRC being soft on large business or on those with complex tax affairs. HMRC treats all taxpayers even-handedly and does not allow them to settle for anything less than the full amount due. It is through its engaged and intelligent approach to tax avoidance that the additional revenue to which I have already referred is coming in.
Lord Eatwell
The noble Lord referred to erroneous statements in the PAC report. Did they include the observation that senior HMRC officials had had lunch and dinner with the companies that then had a reduced tax burden?
Lord Sassoon
My Lords, the substance of the issues to which HMRC takes exception is to do with the size of unresolved tax bills and some of the details of cases in which errors were found that HMRC disputes. That is the substance, rather than the question of who met whom with what refreshments laid on. We should stick to the substance.
Other noble Lords have been scrupulous in keeping to their time. I am conscious that, with the interventions, I risk going over my time, so I will press on. I want to answer just one more question, raised by my noble friend Lord Dykes, about the tax treatment of overseas companies. I just confirm that we are reforming the controlled foreign company rules very much to protect against the artificial diversion of profits to low-tax jurisdictions, just as our general reforms are being made to make the UK a good place for global corporates to have their headquarters. Having said that this is a matter for individuals, I will not comment on the affairs of any individuals.
In conclusion, I have very briefly explained our strategy for tackling tax avoidance to ensure that everyone pays their fair share. This is an important topic and I am glad that we have had this debate. The Government are taking real, decisive, concrete action to close the tax gap. We are making good progress, but there is much more to do. We will ensure that every sector of society pulls in the same direction to tackle the deficit and the woeful economic legacy left to us by our predecessors.
Taxation: Inheritance Tax
Lord Eatwell Excerpts(13 years, 2 months ago)
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Lord Sassoon
My Lords, I hear clearly what my noble friend says and I am sure that the Ministry of Justice will want to move faster, but I am just giving what the backstop date is.
Lord Eatwell
I think that everyone is in agreement that the structure of inheritance tax at the moment is unsatisfactory, as illustrated by the data that the Minister presented in his Answer. It has stimulated a large avoidance industry and it contains perverse incentives. In the spirit of the season, may I offer the Minister the gift of a constructive proposal? We should cease to levy inheritance tax on estates and instead should levy it on recipients. That would significantly reduce avoidance and would incentivise the wider distribution of wealth.
Lord Sassoon
My Lords, as I said, we have no plans to review the law, but we are always interested in constructive suggestions, wherever they come from.
Economy: Private Capital Investment
Lord Eatwell Excerpts(13 years, 2 months ago)
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Lord Sassoon
My Lords, we are very interested in anything that keeps credit flowing. However, although my noble friend is very good at reminding us of that issue, we are getting a bit far away from fiscal measures.
Lord Eatwell
My Lords, I am sure that the Minister will agree with the noble Lord, Lord Empey, that, however low interest rates may be and whatever fiscal incentives may be in place, ultimately investment is determined by business confidence. Is he aware that the Institute of Chartered Accountants in England and Wales produces an index of business confidence? In its latest report, it says:
“The Confidence Index has suffered its largest quarterly decline since the survey began”.
The survey began in 2004. Is it not clear that the destruction of business confidence is the main outcome of the Government’s economic policies?
Public Service Pensions
Lord Eatwell Excerpts(13 years, 2 months ago)
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Lord Eatwell
My Lords, it is important to remember that what we are discussing is the reduction in the lifetime living standards of a significant proportion of the people of this country. We are discussing the fact that the real incomes of public service workers will, in retirement, be significantly lower than they had every right to expect when they took up their positions in the public service. When the noble Lord speaks of “reform” of public service pensions, he means reduction of public service pensions, and when he speaks of saving,
“the taxpayer tens of billions over the decades to come”,
he means reducing the incomes of pensioners by tens of billions over the decades to come.
Noble Lords will be aware of the difficult choices that we all face over the question of pensions. The excellent report a few years ago by the noble Lord, Lord Turner, and the recent study by my noble friend Lord Hutton have spelt out the consequences of lower birth rates and greater longevity for the provision of pensions. Given that the standard of living of everyone depends on the goods and services produced by the working population, the smaller the working population is in relationship to the whole the more difficult it becomes to provide for the non-working pensioners. The choices that need to be made when facing such a major, secular shift in demography and in the economy should have been the subject of bipartisan national debate. They should have been approached with the clear understanding that what is under consideration is the decision to reduce lifetime living standards.
In his report, oft cited by the Government, my noble friend Lord Hutton stressed the need to approach these issues in a careful and balanced way, with particular care for the impact of any increased contributions on lower-paid public service workers, and the need to sustain high-quality, reliable pensions provision. Having people retire into poverty, dependent on state benefits in their old age, cannot be an answer under any circumstances. In taking up my noble friend’s points, the Government failed on both counts by seeking to impose a steep rise in contributions and a permanent switch in indexation from RPI to CPI, neither of which measures formed part of my noble friend’s recommendations.
The consequence of this arbitrary and authoritarian approach to reducing the lifetime incomes of some of the lowest-paid people in the country was 10 months of stalemated negotiations and then strike action, in many cases by people who had never dreamed that they would ever go on strike. The strike on 30 November, a strike that could and should have been avoided, seems to have brought the Government to their senses. We on this side of the House are pleased that the people who rely on public services, as well as millions of public sector workers, can approach the holiday season knowing that proper negotiations are taking place at last and that a solution that is fair to pensioners and fair to taxpayers may be on the horizon.
We are pleased that the Government have at last recognised the need to protect the lowest-paid from unaffordable increases in contributions, the need to reassure older employees worried about how long they will have to work and the need to ensure that people who dedicate their working lives to our public services can expect a decent income in retirement. It is important that, in any proper national consideration of how best to tackle the changing demographic factors behind pensions provision, the Government should provide the fullest and clearest information on what is proposed and on the consequences for public service workers at all levels of income.
For each of the four schemes under consideration, what are the new proposals for contribution increases? What is the timetable according to which they will be introduced? How do the Government intend to ensure that the new contributions are affordable for lower-paid workers, including part-time workers? What assessment have the Government made of the impact that their proposed changes might have on the number of public service workers opting out of the scheme, of the impact that this may have on future pensioner poverty and of consequential demands on state benefits? In taking steps to increase the pension age, what allowance do the Government intend to make for those in physically demanding jobs where the current retirement age from that particular line of work may indeed be appropriate?
Most importantly, the Government must now realise that a pensions agreement in the public services should be for the long term and should be part of the fundamental relationship between Government and people, whichever party is in power. How will the Government make good on their promise to deliver a deal that is secure and sustainable for the next 25 years? Will they learn from their errors of the past year and understand at last that a properly informed public debate, and an appropriately negotiated agreement with strong bipartisan support, is the only way to achieve a fair and lasting agreement?
Consumer Insurance (Disclosure and Representations) Bill [HL]
Lord Eatwell Excerpts(13 years, 2 months ago)
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The Commercial Secretary to the Treasury (Lord Sassoon)
My Lords, I beg to move Amendment 1, which leaves out Clause 2(5). This subsection was added to the Bill following acceptance of an amendment in Committee. I will also speak to Amendment 2, which proposes an alternative and—I hope that the House will agree—improved approach to addressing the Committee’s concerns about renewal of insurance contracts. Having considered the amendment accepted by the Committee, we felt it was necessary to come forward with alternative drafting to achieve what noble Lords had in mind through the original amendment.
Taken together, these two amendments will mean that insurance companies are expected to have to show that they told their policyholder that answering questions on renewal was important. However, they also avoid some unintended consequences of including this requirement in its current form as part of Clause 2.
These amendments address something which the Bill Committee touched on extensively in its deliberations. There was much discussion of the implications of the Bill for consumers renewing insurance. Renewal involves entering into a new contract and consumers are therefore under the same obligation as when first purchasing their policy—that is, they must take reasonable care to answer the insurer’s questions, or the insurer may be entitled to refuse a later claim. Noble Lords were concerned that consumers might not recognise the significance of questions asked on renewal, as they may not understand that it is a new contract, and as a result might not take sufficient care to answer these questions.
The Government agree that insurers should take measures to ensure that their consumers are aware of the importance of responding to questions which they are asked at renewal. However, as I mentioned, to ensure that the effect of this change to the Bill reflects the wishes of noble Lords, we felt that it was necessary to come forward with alternative drafting. There are some relatively small drafting points.
The inserted text splits subsections of the current clause which need to run together, and the phrase “make clear” may be a difficult standard. However, most importantly, it leaves no remedy for an insurer who has not included the right wording, even if the consumer’s failure to reply was a deliberate or reckless misrepresentation. I am sure that the Committee did not intend to give consumers a “get out of jail free card” in circumstances where they knowingly and deliberately deceived their insurer. The amendment therefore removes the drafting accepted in Committee stage and substitutes an alternative in Clause 3. That explicitly adds to the list of factors that a court may take into account, when determining whether a consumer acted reasonably, whether the insurer communicated the importance of answering questions on renewal. Both the Association of British Insurers and the Investment and Life Assurers Group agree that that is a more suitable approach.
There are many ways in which an insurer may communicate the importance of answering questions at renewal. The Committee discussed whether wording which explicitly told the consumer that they were entering into a new contract would achieve that. That is indeed one way in which an insurer may communicate the importance of answering questions as required by the amendment.
It might be helpful if I set out for noble Lords current market practice at renewal and the effects of the amendment in this context. An insurer will often send the consumer a letter to say that their insurance is up for renewal. Market best practice is usually to send a list of the facts that the consumer told them the last time. The consumer is asked to read and consider the list, and to contact the insurer if the facts have changed.
In motor insurance, it is common practice for insurers to renew the policy even if the consumer fails to reply. It is now a criminal offence for a motorist to allow their car insurance to lapse without notifying the Driver and Vehicle Licensing Agency and we therefore welcome any practice which makes renewal a simple process for the consumer. If nothing has changed, there is no need for the consumer to reply, but if something has changed and the consumer fails to respond, this is capable of being a misrepresentation. As my noble friend Lady O’Cathain stated during the last Committee sitting, it may be that nothing has changed in relation to your car insurance. Alternatively, you may have been convicted of a new driving offence which you should tell your insurer about. As a result of this amendment, the insurer should clearly communicate the importance of mentioning such changes. If the letter is poorly laid out or in very small print, or if it fails to tell the consumer that failing to mention changes may lead to claims being refused, then a consumer may act reasonably in overlooking it.
In circumstances where the consumer fails to respond because they did not understand the implications, the insurer would be expected to show that they told the consumer how important it was to respond to the questions at renewal time. The insurer would know that it could not just point to the consumer’s oversight. This last important point was teased out in Committee and was, I believe, noble Lords’ real intention. I believe that the amendment addresses the concerns raised by noble Lords during those discussions.
Lord Eatwell
My Lords, as I have stated throughout our proceedings, we on this side of the House fully support the Bill as a measure which makes a major improvement to the relationship between insurer and insured in consumer insurance. We have sought to improve the Bill, making clear elements of the drafting which were unclear or which, on careful examination, did not correspond to the declared intentions of the Law Commission and therefore required amendment. Accordingly, in Committee I proposed the amendment to which the noble Lord has referred and which in due course the Committee passed almost unanimously, the only dissenting voice being that of the Minister himself.
Before dealing with the substance of the Minister’s amendments, I first ask him whether he consulted the Companion before tabling them. Paragraph 8.133 states that,
“an issue which has been debated and voted on in committee can be reopened, provided that the relevant amendment is more than cosmetically different from that moved in committee”.
When we look for the meaning of “cosmetically different”, earlier in the same paragraph it is stated that amendments must not be identical or of identical effect. Consequently, the Minister cannot argue that this amendment has identical effect. If he does, he must withdraw the amendment.
Lord Sassoon
I wonder whether it would be helpful at this stage to confirm that the government amendments have been drafted in full recognition of what the Companion says. As I tried to explain in setting out the rationale for the amendment, I do not believe that it has the same effect because it provides greater clarity and, I believe, delivers what, in Committee, noble Lords wanted to achieve. My understanding of the process is that, if there had been a problem with the technical raising of the amendment, the Public Bill Office would have raised questions on it. Therefore, I believe that both in substance and in form the right things have been done.
Lord Eatwell
I think that the noble Lord is contradicting himself. He said that it was what noble Lords wanted to achieve when they voted on the amendment in Committee, yet he says that it is not identical in effect. That does not seem consistent. However, let us move on.
Turning to the substance of the amendment, I accept that its placement in the Bill is superior to that which I proposed in Committee, and for that I am grateful. However, the intention of the Committee was that insurers would be required to make clear to consumers that when a policy was renewed, it would in fact be a new policy, and consequently the importance of questions asked would be of the same order as when new business was written. As many noble Lords argued in Committee, they were not aware of this—indeed, I believe that the Minister himself admitted that he was not aware of it—and they could well understand a consumer failing to be aware of it too. This lack of awareness might result in the consumer taking insufficient care in answering questions posed by the insurer.
The Government’s amendment does not refer explicitly to the fact that a renewal is a new contract and hence this is not of identical effect. Instead, it proposes the vague test of,
“how clearly the insurer communicated the importance of answering those questions (or the possible consequences of failing to do so)”.
That is a very vague rendition of what was intended by the amendment in Committee. Instead of being explicit, the matter is now to be left to the courts to decide. However, I note that the Minister stated that explicitly telling the consumer that they were entering into a new contract would be “one way” in which the insurer could communicate the importance of the questions asked at renewal. I fully expect that the ABI and the ILAG will draw this passage in Hansard to the attention of their members and that it will form a background to any subsequent court proceedings. On that basis, I shall raise no objection to the government amendment.
Finally, I would be grateful if the Minister would clear up the matter raised in Committee by the noble Lord, Lord Goodhart, and not subsequently resolved. That is the relationship between Clause 5(1) and Clause 5(3). As the noble Lord, who is in his place, pointed out, they seem to duplicate one another and hence, potentially, they are a source of confusion. As we still have a chance to sort this out at Third Reading, perhaps the Government could enlighten us about the reasoning behind this dual oddity of drafting.
Independent Commission on Banking
Lord Eatwell Excerpts(13 years, 2 months ago)
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Lord Eatwell
My Lords, I am most grateful to the noble Lord for repeating the Statement made by the Chancellor of the Exchequer in another place. However, I regret that effective scrutiny by this House has been limited by the Government providing the 80-page response only half an hour before the noble Lord got to his feet.
As the Statement makes clear, banking policy in this country has two potentially conflicting goals: first, to ensure that a stable domestic financial system supports the real economy with a steady and reliable flow of appropriately priced credit, together with other domestic and international banking services; and secondly, there is the goal to sustain the City of London and other UK centres as the world’s premier offshore financial centre, providing a wide range of financial services that transform and repackage saving flows from all around the world. This was the core conflict highlighted by the Independent Commission on Banking—the trading activities of the offshore centre can inflict instability and contagion on the domestic economy. The proposal of the ring-fence that the Government are endorsing today is a response to that core conflict. It is an inadequate response, but perhaps something is better than nothing.
Why is it an inadequate response? Noble Lords may be surprised to learn that more than three years on and contrary to the assertions of the ICB in its final report, nothing in these policy proposals would have prevented the collapse of Northern Rock. The reason is that there are two serious flaws in the ICB approach. First, there is the belief, echoed by the noble Lord, that moving to a 10 per cent capital to risk-weighted assets ratio will provide the resilience to the banking sector required to head off a serious crisis. This belief is a fantasy without empirical foundation. For example, Allied Irish Bank had capital in excess of the maximum now being proposed by the Government prior to its collapse. It was not enough. In a real financial crisis, no feasible capital ratio will be enough. While on the subject of risk-weighted assets, do the Government intend to maintain the Basel II approach that leaves the calculation of these risk-weights to the banks themselves? With respect to other primary loss-absorbing capacity, what is the Government’s view of the buoyancy of the market for these instruments on which they put so much weight and which do not at present exist?
Secondly, the report maintains the outdated and indeed discredited approach of focusing on the asset position of the banks and has very little to say about the liabilities side of the balance sheet. Hence, the ring-fencing proposals are all about what is done with depositors’ assets and the capital needs are related to that dubious measure of risk-weighted assets. But in the case of Northern Rock, the collapse was entirely attributable to what was happening on the liabilities side of the balance sheet. It was the inability to turn over short-term funding that resulted in the taxpayer needing to provide a £30 billion rescue. The ICB’s claim that current liquidity proposals could have prevented this is, I believe, wishful thinking. By the way, in the glance that I have been able to give the Government’s response, I would suggest that the illustrative diagrams of balance sheets on page 28 are profoundly misleading as the boxes do not represent the proportions of liabilities and assets as they are presumed to do. I shall return to the issue of the liabilities side of the balance sheet later. For the moment, I give one cheer to the Government’s endorsement of the ICB’s approach. At least it is better than nothing. Ring-fencing is the right thing to do even if they put the fence in the wrong place.
Crucial to the entire approach will of course be the construction and policing of the ring-fence. Can the noble Lord tell the House whether the Government have accepted all—I stress, all—of the ICB’s proposals on the construction of the ring-fence? In particular, the Government seem to suggest that ring-fenced banks will be permitted to hedge risks to which they are exposed in derivative markets. If they are allowed to hedge, how is the line to be drawn between hedging and speculation, and who is to draw that line? A major hole in the ring-fence as it now stands—or perhaps it is a flexible thing as it now waves in the wind—is that banking activity for large companies can take place either within or without the ring-fence. This means that organisations that produce well over half the UK’s GDP will have banking services outside the ring-fence. In that case, will not banking operations outside the ring-fence be too big to fail, because they could bring down major British companies, and will not the exposure of the taxpayer that the ring-fence is supposed to eliminate be almost as great as it ever was?
More generally, it is a well known outcome of regulatory activities that they stimulate a creative response from the banks, creative in the sense that they work out ways to circumvent and/or evade the regulations. Hence there will be a need to keep the operations of the ring-fence under continuous review. How do the Government intend to do that? The response states:
“The Government believes that the location of the ring-fence should be flexible”.
What does this mean—it sounds like a fine opportunity for lobbying to me—and who will determine the location of this “flexible” fence? Would it not be appropriate to keep the ICB in being and charge it with the task of reviewing regularly the performance of the ring-fence?
One of the declared objectives of the ring-fence, which the noble Lord repeated, is to protect the assets of depositors from the casino operations of the investment banking divisions of the banks. Where a ring-fenced bank is the wholly owned subsidiary of a bank holding company and that holding company fails, perhaps due to casino-style activities, will its creditors have access to the assets of the ring-fenced bank? If not, why not? If so, what is the value of the ring-fence?
I turn to the liabilities side of the balance sheet. Am I right in saying that the Government have no intention of limiting the wholesale funding of the balance sheet other than through the imposition of a leverage collar that fails to discriminate between deposits and wholesale funding? Why are the Government therefore intent on penalising banks that have a strong deposit base—banks that proved to be the most resilient during the financial crisis? Of course, the FSA’s proposals on liquidity and a leverage collar will improve the situation, but surely they are not enough. Why do the Government not take note of the research that demonstrates that deposits by families and firms are “sticky”, while wholesale deposits embody greater risk? On the other hand, what is to be the role of the interbank market within the ring-fence?
On competition, the noble Lord made it clear that the higher levels of capital and loss absorbency will apply just to UK banks. What of the branches of non-UK banks operating in the UK, such as Deutsche Bank? What is the Government’s assessment of the competitive impact on UK banks of branches of European or other banks operating in the UK not being required, as the response states, to have the same levels of loss absorbency?
On timing, the ICB said that the ring-fence should be in place as soon as possible and well before the Basel III deadline. The Statement refers to compliance with the legislation on ring-fencing being as soon as “practically possible”. Who is to determine what is practically possible and what are the criteria for that determination?
What do the Government expect to be the impact of these recommendations on the supply of credit? Given the abject failure of the Government’s Project Merlin and the desperate need to increase lending at reasonable rates to UK SMEs, the Bank of England’s executive director for financial stability has suggested that the ratio of capital requirements to risk-weighted assets should be lowered, not raised as the ICB and the Government recommend. Do the Government agree with the ICB or with the executive director of the Bank of England?
I welcome the Government’s announcement on the Royal Bank of Scotland. These are changes that we on this side have urged for some time. This is a taxpayer-owned bank and it should pursue the taxpayer interest.
I therefore give one cheer for a faltering step in the right direction. We will seek significantly to improve the approach when the Government bring forward their legislative proposals.
Economy: Deficit Reduction
Lord Eatwell Excerpts(13 years, 2 months ago)
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Lord Eatwell
My Lords, the Minister has made it clear to the House today that the Government’s deficit reduction strategy is based on sand. It is always five years ahead. He has told us today that the target is to balance the budget by 2017; next year it will be 2018, the year after that 2019 and, like old age, it will simply retreat before us. Given that the Government’s strategy has been pushed off track and is failing to meet its deficit targets, why in the autumn Statement did they not cut expenditure more and raise taxes more to put the deficit reduction strategy back on track?
Lord Sassoon
My Lords, first, the deficit reduction strategy, as the OBR confirms, is absolutely on track. If the noble Lord is suggesting that we should cut expenditure and raise taxes, is that the policy of his party?
Sovereign Credit Ratings: EUC Report
Lord Eatwell Excerpts(13 years, 3 months ago)
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Lord Eatwell
My Lords, a great strength of this report, on which my noble friend Lord Harrison is to be congratulated, is that it distinguishes clearly between the role that rating agencies play in the markets for private securities and the role that they play in the sovereign debt markets. In private markets, rating agencies provide a relatively simple rating for what are often mathematically very complicated financial instruments. Without this sort of interpretation, the markets in complex products could not operate. The role of the rating agencies is to provide confidence to the buyers. Unfortunately, in the recent past that confidence was seriously misplaced, as my noble friends Lord Foulkes and Lord Monks both commented.
However, as the report makes clear, and as the noble Lord, Lord Kerr, pointed out, the task of rating agencies in respect of sovereign debt is quite different. Sovereign debt instruments are typically fairly simple; they are standard bonds of fixed duration. In this instance, the necessary rating skills are quite different from those needed in unpicking a complex statistical model. First, they consist of a devotion to whatever is the conventional economic wisdom of the time. It is convention, not good economics, that matters and often drives markets. Secondly, the sovereign appraisal should include an assessment of the political and economic controversy within and between sovereign states. Here, political fashion inevitably plays a role in determining whether any given package of economic policies is deemed sound or not. As we in this country know to our cost, the current fashion is for austerity—today’s cure for all economic ills.
It is not at all obvious, as the report acknowledges, that the rating agencies have any particular superiority in evaluating sovereign risks over any intelligent investor, as my noble friend Lord Myners emphasised. If the role of rating agencies is so straightforward, why are they of any importance at all in the discussion of sovereign debt? Neither the report nor, disappointingly, the Government’s response addresses this core question. If, as the report’s title suggests, rating agencies are but the messenger, what is the origin of the message that they bear? To put it another way, if they are but the symptom—distressing and perhaps worth treating in itself, but not fundamental—what is the nature of the disease? It is in the light of that more basic issue that we should judge the Government’s response.
The basic issue has two dimensions: the development of the international bond market over the past three or four decades and the particular design of the sovereign bond market in the eurozone. The current structure and scale of international bond markets are a relatively recent phenomenon. For example, today the annual value of cross-border transactions in UK sovereign bonds comfortably exceeds 1,000 per cent of UK GDP. In 1971, the comparable value was nil. A similar explosion of cross-border activity is to be found in the sovereign bond markets of all G7 countries other than Japan. Into this environment of huge cross-border flows is thrust the eurozone, an economic entity larger than the United States of America. The sheer scale of the eurozone economy ensures that any significant bond fund manager anywhere in the world who is seeking to diversify exposure must have major holdings of US dollar bonds and sovereign bonds denominated in euros. However, whereas exposure to the dollar may be obtained by investing in US treasuries, exposure to the euro may be obtained by investing in any of the various eurozone sovereign bonds. Investors have a choice as to which euro sovereign to hold—a choice that is likely to be informed by their estimate of risk and return, and influenced to a greater or lesser degree by the rating agencies. This is a perfect structure for costless speculation and costless hedging, leading to huge flows between euro sovereigns and exposing any given sovereign to almost unlimited speculative pressure via naked trades. This is the disease.
Let me put the matter another way. The state of California, comprising 13 per cent of the US economy, is bankrupt. This has no impact on the US bond market. Greece, comprising 2 per cent of the eurozone economy, is similarly compromised, with disastrous destabilising consequences for the eurozone as a whole. It is against this background of a huge international bond market and a serious design flaw in the eurozone that the Government’s response to the report should be judged.
Do the Government’s proposals, such as they are, help to suppress the symptoms, or do they provide a guide to tackling the disease? The Government rather downplay the report’s criticism of the rating agencies’ performance prior to the sovereign crisis in the eurozone. The report is forthright:
“The valid charge against the rating agencies … is ... that they failed … to identify risks in some Member States”.
The Government’s response ignores this conclusion altogether and focuses instead on the need to share “factually correct information”. Can the Minister explain why the Government do not share the committee’s views on the failings of the rating agencies prior to the crisis?
On the symptoms, the Government are surely right to support measures to reduce hard-wiring of ratings into legislation rules and guidance. Yet the Government’s statement that they believe that,
“the more sophisticated use of ratings by investors should be encouraged”,
is surely one of the more vacuous platitudes of recent times. The Government’s support for greater transparency in the methodologies of the rating agencies, mentioned by the noble Lord, Lord Vallance, is likely to make matters worse rather than better, by increasing volatility as traders, knowing the methodologies, anticipate ratings changes.
In contrast to the noble Baroness, Lady Noakes, the Government express enthusiasm for greater regulation of the ratings agencies. As was pointed out, the Government signed up to this at the G20. Will the Minister tell us what regulatory steps the Government propose and explain how these steps will enhance the smooth operation of sovereign bond markets? What is most striking about the Government’s response is that it makes no attempt whatever to locate the role of the rating agencies in the context of the overall operation of the eurozone sovereign debt market. That, after all, was the topic of the report. Mr Cameron and Mr Osborne have repeatedly urged the eurozone Governments towards action, without spelling out exactly what action they propose. Perhaps the Minister will help fill the void in government thinking this evening by telling us what steps the Government propose should be taken to stabilise the eurozone bond market and where the rating agencies fit in to the Government’s plans.
Economy: Monetary and Fiscal Policy
Lord Eatwell Excerpts(13 years, 3 months ago)
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Lord Sassoon
The debt is going up. Far be it from me to criticise my noble friend, who quite rightly makes this point. If the deficit was running at the level that we inherited from the previous Government, of 11.1 per cent a year—the highest deficit level in our history—it would not take very many years before our debt got up to the level of the Italian and the Greek debt. That is why we will continue to keep our deficit policy on track and keep our interest rates low. I entirely agree with my noble friend that we must be reminded about the level of debt as well.
Lord Eatwell
My Lords, in his first Answer to my noble friend, the Minister said that the Monetary Policy Committee takes account of growth and inflation, but its statutory responsibility is to take account only of inflation. When did the Treasury change the policy?
Lord Sassoon
My Lords, I will let the noble Lord, Lord Eatwell, read the actual words in Hansard tomorrow. [Interruption.] No, I am not changing anything. The MPC has to take account of the prospects for growth and inflation when it is judging how to set the direction of monetary policy. Its target is an inflation target, but it needs to take account of a wealth of other factors when making its decision, so that is what it does.
Devolved Administrations: Financial Flexibility
Lord Eatwell Excerpts(13 years, 3 months ago)
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Lord Sassoon
My Lords, a lot of factors have to be taken into account in setting expenditure for the devolved Administrations, not least our favourite Barnett formula, but the fact remains that expenditure on a head-count basis in Wales will, in the present period, be some 12 per cent higher than the per head expenditure in the United Kingdom.
Lord Eatwell
My Lords, was the Welsh Assembly consulted before this decision was made?
Lord Sassoon
My Lords, the United Kingdom Parliament—this House and another place—was not consulted before an awful lot of spending decisions were taken. That is the way that Governments make spending decisions.