Global Economy

Lord Eatwell Excerpts

Thursday 11th August 2011 Lords Chamber

[Lord Eatwell]

My Lords, I am most grateful to the noble Lord for repeating the Statement made by the Chancellor in the other place and for travelling back to the House to do so. We are living through a grave and difficult situation for the international economy; indeed, for the economy abroad and at home. Many noble Lords will feel that the current situation in the global economy is eerily reminiscent of the early days of the financial crisis in 2007-08. Then, as now, shocks to relatively small entities destabilised financial markets by undermining confidence in the authorities’ understanding of what was happening and hence their ability to do anything constructive. Small events then spread to even larger entities, so that even the most stable and secure institutions were affected. Then as now, fears were stoked up by the grandstanding of the ratings agencies. Then as now, funding dried up and the solvency of major institutions and sovereign states was questioned. Some of the actors have changed, but the play is the same, and those who will suffer—ordinary, hard-working people—remain the same too. As the crisis enters this new phase, are we better prepared? Have we learnt the lessons of the past three years? Does the Chancellor’s Statement represent a new understanding of what is happening?

The first lesson is simply to remember that the object of economic policy is the prosperity of our citizens, not the comfort of the financial markets. Stable financial markets are a means to an end, not an end in itself. That lesson was clearly learnt in the strategy devised by the G20 in 2009. It committed members to halve national deficits in five years by pursuing a concerted growth strategy. Unfortunately, the commitments made in 2009 were abandoned a year later. The growth strategy was abandoned in favour of austerity, imposed either by the markets, as in Greece, or by the Government, as in Britain.

The second lesson was the need for a clear analysis and understanding of what was happening in order to fashion an appropriate response and to generate confidence throughout the economy. Recent events in the United States and the eurozone suggest that this lesson has not been learnt. In the United States, the political wrangling of the past few months, and the intransigence and lack of flexibility of some senior policy-makers, resulted in a loss of confidence in the authorities' ability to deliver an economic recovery and even in their understanding of what needed to be done. None the less, at least output in the US has recovered to pre-crisis levels, while output in the UK is still 4 per cent below those levels. The Chancellor’s cheap jibe about US growth over the past two quarters is a fine example of statistical chicanery. Will the noble Lord explain why the US has got output back to pre-crisis levels but the UK has not?

In the eurozone, it should be clear to all that the institutions of monetary union are perfectly designed to transform economic difficulties into economic crises. The lack of a single eurobond market, backed by an effective treasury function and allied to fiscal transfers that occur as a matter of course in the US and the UK, results in a situation in which growth in weaker economic areas can result only in the accumulation of debt—and accumulation of debt results in the diversion of funding from the weak to the strong. It should be clear by now also that the main beneficiary of this flawed structure is Germany. We can imagine where the German exchange rate would be if it were the outcome of a deutschmark market rather than a euro market. Germany would be being priced out of world markets by its own exchange rate. What would happen to German export-led growth then? Does not the greatest beneficiary have the greatest responsibility to secure positive reform for every nation in the eurozone? Given the importance of the eurozone to the UK economy, we should do everything we can to assist in the creation of institutions necessary to run a successful monetary union. Here, I agree with the Chancellor's assessment of what reforms need to be made. The process will almost certainly require significant revision to European treaties. Will the Government lend their support to treaty revision?

The third lesson that is becoming clearer every day is that austerity alone does not work. The Chancellor has persistently argued that the Government’s austerity policy will, in and of itself, promote confidence in business to invest and in households to consume, thereby rebalancing the economy. Chart 2.7 of the Bank of England’s Inflation Report, published yesterday, shows clearly that the Government will meet their deficit targets only if firms and households start borrowing and spending again—if they borrow to replace government borrowing. However, that is not happening. The austerity policy is not working. Households are saving and companies are not investing. Financial institutions are deleveraging. Growth in manufacturing has ground to a halt and the balance of payments deficit is on the rise again. Real incomes are falling, squeezed by the rise in VAT and by an inflation rate that is twice as high as in France or Germany. The economy is dead in the water, yet the Chancellor’s Statement shows no recognition of what is happening out there in the real world. He repeats his obsession with deficit reduction at the cost of economic growth.

The central message of the Statement is that bond rates are low and the ratings agencies are appeased. But has anyone in the Government noticed that exactly the same was true in the Japanese economy 20 years ago, and has been for the past 20 years? Interest rates in Japan are significantly lower than in the UK, and have been for 20 years, and Japan’s AAA rating is secure. The result is 20 years of stagnation, “lost decades” as they are called, and the Japanese deficit has not fallen. We risk the same fate. Already, with prospective growth in the UK being downgraded by every respected economic agency, the deficit forecast is rising, not falling. The crisis in the financial markets has shifted from fears about deficits to fears about stagnation. The markets have realised that austerity will not fix deficits. Austerity reduces tax revenues and forces the Government into yet further expenditure cuts to hit its deficit targets.

There is no recognition of these dangers in the Statement, and they are dangers not only for Britain but for the global economy, as the obsession with austerity grips policy-makers around the world. Britain’s lead in this respect is doing great damage. What is needed now is a strategy for growth—in the United States; in the eurozone as a whole, not just in the northern states; and in the UK. The Chancellor recognises this and states that Britain needs a new model for growth. We on this side agree, but the plan for growth trumpeted by the Government—and who would not discount a plan that is described as “83 initiatives” rather than having clear content and direction?— was assessed by the independent Office for Budget Responsibility and its conclusion was that it would have no significant impact on growth at all.

What new measures do the Government have in mind to stimulate growth? Now is the time for the Government to back a real growth initiative, one based on investment in infrastructure, productive capacity, skills and new technologies. It should include an accelerated infrastructure programme, a national investment bank to mobilise funds lying idle in corporate balance sheets, and greater incentives for investment in and the expansion of new technologies. Without a commitment to economic growth, confidence will not return to industry or the consumer and deficit targets will not be met.

Policy-makers around the world, most especially the British Government, need to learn the bitter lessons of the last three years—that the object of economic policy is the prosperity of our citizens, not the comfort of financial markets; that a clear and consistent understanding of what is happening is necessary; and that austerity alone does not work. Simply repeating over and again that a policy is working does not make it true. The Government’s austerity policy is not working. It may delight the Chancellor’s friends in the ratings agencies, but it means prolonged stagnation for the British economy and economic misery for the British people. The Government need to face up to the reality of what is happening in the British economy and introduce a truly substantial growth strategy now.

Office for Budget Responsibility

Lord Eatwell Excerpts

Wednesday 6th July 2011 Lords Chamber

[Lord Sassoon]

My Lords, first, it is not our forecast. These are the forecasts of the independent Office for Budget Responsibility. Secondly, what is very heartening in the economy is the growth of manufacturing output and the growth of exports. Since last May, manufacturing output has been 4.2 per cent higher than in the same period in the previous year. Since last May, volumes of exports to the rest of the world have been nearly 13 per cent higher than in the same period a year earlier. The private sector has created 520,000 extra jobs in the past year and that is three-and-a-half times the number of jobs by which the public sector has contracted. I really do not think that noble Lords should get pessimistic. We always said that the recovery was going to be choppy but the manufacturing side of the economy is doing very well to rebalance, which is what the economy needs.

[Lord Eatwell]

My Lords, it is very helpful for the noble Lord to introduce the idea of rebalancing. Will he confirm that a vital component of the coalition’s policy to rebalance the economy is growth in business investment? Indeed, the OBR budget forecast contains a projected growth rate of 6.7 per cent for business investment. Will he confirm that latest figures show that business investment is not growing at all, but falling by more than 3 per cent a year?

[Lord Sassoon]

My Lords, I do not know where the noble Lord, Lord Eatwell, gets his figures from. Since last May, businesses have invested £91.4 billion across the economy and that is 9 per cent higher than in the same period in the previous year. That is very positive confirmation by business of what it sees as the prospects for this economy.

Monetary Policy Committee

Lord Eatwell Excerpts

Wednesday 6th July 2011 Lords Chamber

[Lord Sassoon]

I apologise to my noble friend for cutting him off earlier, but I am glad that he has got in now. It is certainly a bit of a puzzle that there is continued weakness in broad money growth at a time when nominal GDP is growing. I am no macroeconomist, but when I look at the tables I see that, among other things, the velocity of the circulation of broad money is increasing. I cannot see behind me to see whether my noble friend is nodding, but I think he is, so I am all right on that one. Any question of additional quantitative easing or withdrawal of quantitative easing will be decisions for the MPC whenever it sees fit.

[Lord Eatwell]

My Lords, would the Minister agree that increases in commodity prices and oil prices affect the economy of France, Germany and the United States just as much as they do of Britain? Why then is Britain’s inflation rate more than twice that of France, twice that of Germany and significantly greater than that of the United States?

[Lord Sassoon]

My Lords, the really important thing here is that the inflation expectations remain very low. All the range of forecasters is predicting that inflation will come down to the range of 2 per cent to 2.1 per cent in 2012 and beyond. That is the critical challenge for the MPC, in which it has the market’s confidence, and that is what underpins the very low interest rates that we continue to enjoy. We suffer, inherited from the last Government, a deficit the size of Portugal’s, but we have interest rates at the level of Germany’s.

Banking: Northern Rock

Lord Eatwell Excerpts

Thursday 30th June 2011 Lords Chamber

[Lord Sassoon]

My Lords, I am sorry if I cannot work up enough enthusiasm at 11am on a Thursday morning. The first thing to say is that not only has the foundation done good work in the north-east but its footprint covers Cumbria. We must not forget Cumbria. The previous Government agreed that Northern Rock would donate £15 million per annum to the foundation for a three-year period, 2008-10, and that commitment was honoured. Yes, the new agreement has an initial expiry date of December 2012, as I said, but it has the potential for a rolling one-year extension by mutual consent, to be agreed under certain terms. The door is open there, and it will be one of the things that I am sure prospective purchasers will want to take into account.

[Lord Eatwell]

My Lords, in the determination of best value for the taxpayer, how will the Government balance the short-run cash return from the sale with the long-run benefit to the taxpayer of there being a stable and successful mutual?

[Lord Sassoon]

The noble Lord makes a presumption there about the form of sale. We will be guided by the experts who have been appointed to conduct the sale, who will give advice on these matters to the Treasury.

Undertakings for Collective Investment in Transferable Securities Regulations 2011

Lord Eatwell Excerpts

Wednesday 29th June 2011 Lords Chamber

[Lord Sassoon]

That the draft regulations laid before the House on 10 June be approved.

Relevant document: 24th Report from the Joint Committee on Statutory Instruments, considered in Grand Committee on 27 June.

[Lord Eatwell]

My Lords, I wish to bring to the attention of the whole House some aspects of these regulations that are a source of grave concern. During the discussion on the regulations in Grand Committee on Monday, it became evident, to me at least, that the Government have seriously misjudged the regulations’ importance, notably in their potential impact on the savings of British families and on UK consumers of financial services in general.

These regulations are the latest stage in the programme to establish throughout Europe a single market in transferrable financial instruments, where Europe is defined as the EEA—the European economic area. The programme began in 1988. An important component of that process has been to give fund managers in non-member states the ability to passport their services into another member state. Today—29 June—this is done by complying with various requirements of the regulator in the jurisdiction in which the funds are to be marketed. For example, the FSA typically requires fund management companies to establish a legal presence in the UK that can be regulated and supervised by the FSA. As of this Friday—1 July, when these regulations come into force—that will no longer be the case. Instead, the so-called simplified notification procedure established by these regulations removes the rights of national regulators to vet funds before they are marketed. Thereby, British savers will be relying on the regulator in, say, Iceland, Romania or Malta to ensure that their savings are adequately protected.

This is a fundamental change. It is not, as the noble Lord, Lord Sassoon, argued in Grand Committee,

“a sensible piece of tidying-up”.—[Official Report, 27/6/11; col. GC 145]

In fact, the European authorities have recognised some of the potential dangers and, by means of the same regulations, have introduced two measures to attempt to protect consumers. First, there is to be a simplified prospectus—a key investor information document—and, secondly, there is to be improved supervisory co-operation across member states. Of course these are desirable measures, but it has for many years been a fundamental tenet of financial regulation in this country that caveat emptor is not a satisfactory doctrine in the complex world of financial instruments. However well informed the buyer might be, the seller always has the upper hand. Moreover, having sat on the boards of various national financial regulators of the past 20 years—I sit at present on the board of a regulator outwith the European Union—I assure noble Lords that exchange of information between regulators is often imperfect and sometimes downright misleading, particularly where sensitive national interests are involved.

In the Treasury's own assessment of the impact of the regulations, it is conceded that the new management company passport,

“may cause some operational and supervisory difficulties which could reduce consumer protection”.

Having apparently recognised the problem, the Government have decided to do nothing about it, over and above what they are required to do by the European regulations themselves. The safeguards built into the regulations are significantly inferior to those enjoyed by British consumers today; they will lose those safeguards on Friday.

I have just one question for the Minister: what additional measures of consumer protection will the Government introduce on Friday to compensate for the erosion of UK consumer protection by the regulations?

Undertakings for Collective Investment in Transferable Securities Regulations 2011

Lord Eatwell Excerpts

Monday 27th June 2011 Grand Committee

[The Commercial Secretary to the Treasury (Lord Sassoon)]

My Lords, these regulations transpose into UK law the updated fourth EU directive on Undertakings for Collective Investment in Transferable Securities—UCITS IV—and are supplemented by new FSA rules. I will give a little background on the UCITS framework before explaining why the Government are seeking to introduce the new regulations.

The UCITS directive sets out a common set of cross-EU rules for how eligible investment funds should be run. The rules emphasise transparency and consumer protection, which means that UCITS funds are designed particularly for retail investors. However, they are frequently used more widely, including by pension funds and insurance companies. UCITS funds account for roughly three-quarters of funds under management across Europe.

The UCITS framework is very important to the UK fund management industry and to investors. For investors, the directive ensures strong consumer protection—for example, through clarity in marketing—and integrates the EU market, which gives investors a wider and more diversified set of funds to select from. UCITS has been a key contributor to the growth of UK asset management firms. The directive brings down barriers, allowing them to market across the EU based on authorisation by the FSA. The UCITS brand is recognised worldwide and EU fund managers market it globally. There are now some £500 billion of UCITS assets under management in the UK. This is the third update to the UCITS directive since it was introduced in 1988. It is intended to ensure that the market can operate more efficiently, bringing further industry and consumer protection benefits.

UCITS IV addresses four widely recognised shortcomings. The first is the difficulty that fund management companies face in establishing UCITS funds in other member states. UCITS IV removes this barrier by streamlining the way UCITS funds are notified in other member states. Funds can access the market without delay once their fund manager has notified the domicile’s regulator.

The second shortcoming relates to investor disclosure. UCITS rightly emphasises clear and transparent disclosure to retail investors so that they can easily understand the information about the fund that they are considering investing in. In practice, the requirements have led to prospectuses that are too long and complex and do not allow investors to make effective comparisons between UCITS funds. UCITS IV improves investor disclosure, replacing the required prospectus required with key investor information that will be contained in a simple document and will give key facts to investors in a clear and understandable manner.

Thirdly, European funds are often not taking advantage of economies of scale and are generally smaller than their American counterparts. Again, this has led to increased costs for investors. The directive addresses this in two ways. For the first time, UCITS will allow master feeder structures to be marketed across Europe. For example, feeder funds in different domiciles across the EU will be able to invest in the same master fund located, for example, in the UK. This will allow a single portfolio of assets to be offered across jurisdictions and for different types of investor. The directive also introduces a framework to allow UCITS funds to merge across borders, again removing a barrier to the creation of larger funds.

The final criticism made of UCITS is that it prevents specialisation. All the most important activities associated with a fund’s management have to be located in one member state as only the fund can be passported. So, in practice, even though much of the investment management activity may be carried out in the UK, funds not based in the UK would have to establish extra fund management companies in the domiciles of each of their funds. That has pushed up the administrative costs that ultimately have to be borne by the investor, and prevents gains from scale and specialisation.

UCITS IV introduces an effective management company passport. This allows a management company to operate a fund in a different member state without the need to be established in the member state of the fund. To support this, UCITS IV requires improved co-operation between UCITS regulators, particularly when they are supervising a UCITS management company and fund established in different member states.

The new UCITS regime has been warmly welcomed by the UK industry, which considers it a further opportunity to grow, while serving investors better. The Government are taking all available means, within the current fiscal constraints, to maintain and build on the UK’s lead as a centre for asset management, and that includes capitalising on UCITS IV.

In particular, the Government want the UK to be a home for new master funds. To achieve that, we are working with industry to develop the most suitable vehicle to meet the real demand for a tax-transparent vehicle in Britain. This year’s Budget announced that the Government will legislate to introduce a tax transparent fund, from 2012. We are amending tax law to accommodate the conditions introduced by the management company passport, removing any risk that a foreign UCITS fund may become taxable in the UK as a result of having a manager resident in this country.

I hope that the Committee will support the making of these regulations today. I hope that this brief speech has reassured noble Lords that the regulations will bring considerable benefits to both the UK industry and consumers, and that they will therefore gain their support.

[Lord Eatwell]

My Lords, I do not like this legislation, because it is moving in exactly the wrong direction with respect to regulatory responsibility in a multijurisdictional context; namely, it is legislation that empowers the home regulator, not the host—and this when recent events, particularly in international banking, have shown beyond all reasonable doubt that power should be flowing in the opposite direction, towards the host regulator.

I understand that one of the ultimate objectives of the programme to create a single market in financial instruments in Europe is to make the home-host distinction irrelevant. That can be done only by the development of a regulatory regime in which the domain of the regulator is the domain of the market—that is, there is effectively a single regulator for the entire market space. However, that is not the case in the EU, or the EEA, and will not be in the foreseeable future; indeed, I rather suspect that the Government hope that it will not be the case. Therefore, the Government must face up to the fundamental weakness of home-based regulation—that it encourages regulatory arbitrage.

It may be argued that one of the purposes of these regulations is to encourage the adoption of common standards, to which the noble Lord referred, particularly in conduct of business regulation, and that that will tend to reduce the potential for arbitrage. We hope that that is true, but arbitrage will not be eliminated. For example, different enforcement standards can provide rich pickings for mobile and perhaps not entirely respectable firms. That is evident even in the much more coherent financial space that is the United States of America. It is far more likely in the somewhat less coherent European Union.

I was surprised that I could find nothing in the Treasury’s impact assessment that refers to the impact of regulatory arbitrage. Nor could I find any reference to the role of the new European Securities and Markets Authority, the successor to CESR, which might be seen as a medium-term solution to the single-regulator problem. What is the Treasury’s assessment of the impact of this legislation on regulatory arbitrage? Is the Treasury content that regulatory arbitrage is in the best interests of UK consumers? If not, what steps is the Treasury taking to discourage regulatory arbitrage, and more generally, what are the costs and benefits of such arbitrage for the UK, as will be encouraged by these regulations? What will be the role of ESMA in the definition of procedures to be followed in the UK both in the short and medium term?

A key element enhancing the likelihood of regulatory arbitrage is the simplified notification procedure to which the noble Lord referred. This removes the right of national regulators to vet funds before they are marketed. Is that not a regulatory weakness at a time when the need for the efficient and effective regulation of financial instruments has been clearly demonstrated? Why are we giving up our right to vet instruments marketed to UK consumers? The FSA or any successor organisation will now have a significantly diminished capacity to ensure that new fund managers seeking to enter the national market will conform to our standards.

This leads to the vexed question of consumer protection. The impact assessment, in considering the role of the Financial Ombudsman Service, states:

“We have also asked whether … FOS referral rights should be made available in: Scenario 3—a UK management company operating a UCITS authorised by a regulator in an EEA member State other than the UK, on a cross-border services basis”.

The assessment apparently asks the question, but unfortunately does not tell us the answer, so could the Minister tell us now? Will UK consumers have access to the FOS in such circumstances and, if so, what authority will the ombudsman have with respect to activities authorised in another jurisdiction? When answering these points, perhaps the Minister would like to consider whether his answer would be the same were the relevant authority to be, say, Romania or Malta. That is not a criticism of those states; rather, it is a reflection on their capacity to manage complex instruments. So the crucial question, as yet unanswered, is: what extra measures are Her Majesty’s Government taking to protect UK consumers once UCITS IV is agreed?

Finally, I turn to the question of the review of the impact of this legislation. The Explanatory Memorandum states that:

“The Treasury will review the operation and effect of the Regulations within five years”.

However, the European Commission plans to make further reforms regarding the roles and responsibilities of UCITS depositories and expects to publish proposals later this year. There are therefore no plans to have a post-implementation review until these further changes have been developed and proposed. Is that wise? Are we not likely to get into something of a muddle as to the impact of various changes layered upon one another over time? The changes about to be implemented have significant ramifications for the regulation of fund managers in national markets and on the options available to consumers. Would a review of the current changes not be in order sooner, regardless of other changes being proposed, to ensure that any problems are identified and addressed before they develop?

While this legislation will undoubtedly increase consumer choice by easing the market access of UCITS managers throughout the EEA, I cannot but feel, despite all the warm words on exchange of information between regulators and the introduction of the key investor information document, that it represents a significant diminution of consumer protection. That, to say the least, is unfortunate.

[Lord Sassoon]

My Lords, I thank the noble Lord, Lord Eatwell, for his contribution to the discussion, but I am sorry that he does not seem to see much of merit in what should be a sensible piece of tidying-up of a regime in Europe which has been in place since 1988. It has taken with it the interests of not only the industry but also the consumer groups as it has been developed successfully through three amendments—and now the fourth—to the directive. We have transposed the directive by way of copy-out without any gold-plating. It rather surprises me that the noble Lord takes this basic stance to a framework which has stood consumers across Europe very well for a considerable number of years and not to date raised any of the concerns that he suggests that this series of amendments might raise.

I shall go through those concerns. I hope that the noble Lord agrees that there is considerable work to be done to complete the single market, whether it is fund management, other parts of financial services or business services more generally. In areas of completing the single market, consumer protection has to be taken seriously but I would interpret that, as a starting position, as not wanting to help complete the single market. That is protectionist in its import if not in the intention, given how the noble Lord, Lord Eatwell, spells it out. That is an unfortunate starting point. We should be looking at ways to sensibly advance what is a well worked regime and to see how we can enable both consumers and the financial services industry to take advantage of sensible further development and the opening up of the single market.

On the noble Lord’s specific concerns, there are two aspects to the question of regulatory arbitrage. First, in the regime, the directive leaves little room for member states’ discretion. It is not that the UK will be transposing these rules in one way and other member states in a radically different way. I know that this is probably not the main thrust of the charge that the noble Lord made on this but it is important to be clear that it is not the rules themselves that will give any significant scope for regulatory arbitrage. Beyond that, it is of course important that we ensure in the UK that funds passported into the UK are suitably regulated. Broadly speaking, that is what has happened under UCITS to date. There are already a good number of funds passporting into the UK under the UCITS directive. The FSA has powers to regulate their marketing activities. This is not opening up some completely new avenue here.

[Lord Eatwell]

The noble Lord is quite wrong. It certainly is new. The whole point of the new regulation is that funds can be passported into the UK without the prior agreement of the FSA. That is entirely new.

[Lord Sassoon]

My Lords, it is completely possible—it is done widely now—to passport funds into the UK or other European member states. What is new is that, for example, there will not have to be a multiplicity of management companies set up, so that the passporting in will happen on a much more flexible basis. That is why in UCITS IV there is the introduction of enhanced supervisory co-operation measures between European regulators, precisely to take account of this point. The noble Lord may shake his head and tut-tut but this is what the directive introduces, precisely to address the sorts of concern that he has.

For example, if the FSA has concerns that an inwardly passporting fund is not being managed in accordance with the directive, it is laid out how it can raise the matter with the home state regulator, which must take appropriate action and inform the FSA of the outcome. While I accept that not all regulators will necessarily have the same capacity round Europe, the fact that the FSA or other host regulators will have those sorts of powers gives adequate protection given the sort of regime that we are talking about. We are not talking about bank capital or things that go to the heart of financial stability. Therefore, it is important that the proposed regime is proportionate. The points the noble Lord raises are very reasonable but they have been thought about and are accommodated in the regime.

Arrangements regarding access to the FOS and to compensation arrangements for foreign funds passported into the UK are covered by FSA rules. The FSA rules require that EEA UCITS management companies that passport into the UK in order to operate a UK-authorised UCITS fund will have to contribute to the FOS and FSCS levies so that they are treated equivalently to UK-authorised firms carrying on the same activity. If a claim arises against such an EEA firm under the FSCS rules, it will be met from the general levy on firms in the fund management subclass. We believe that that is appropriate and justifiable because of the need that the noble Lord properly identifies to protect eligible UK investors.

I hope that I have addressed the two main issues which the noble Lord raises on this regime. As I have said, the regulations will work alongside FSA rules to implement the fourth UCITS directive. If they are approved by this House, it is intended that they will come into force on 1 July 2011. The Government will in parallel continue to develop the tax and regulatory landscape to ensure that the industry is able to take full advantage of new opportunities provided by the directive, and to maintain—the noble Lord may not want to see this but the Government do—the UK’s position as a major centre of fund management activity in Europe.

[Lord Eatwell]

My Lords, I am very keen that the UK fund management industry should develop, grow and be successful; whether this piece of legislation will contribute to that only the future will tell. My main concern is consumer protection. I also asked when the regulations would be reviewed.

[Lord Sassoon]

The noble Lord is often one step ahead of me; I was coming to exactly that point. One of the best answers to the charges that the noble Lord puts is review. It should be good regulatory practice to review any regulation or directive of this kind. Indeed, the Commission is required to review the UCITS IV directive two years after its implementation. The Government will, of course, continue to monitor the UCITS framework and engage constructively with the European review. We do not anticipate the noble Lord’s worst fears being justified but if that is the case a review is indeed built into the structure to address anything that arises.

I hope that I have addressed the noble Lord’s concerns on the directive. Having heard that those concerns are already addressed in the directive, I hope that the Committee will support the making of these regulations.

Greece: Default Contingency

Lord Eatwell Excerpts

Monday 20th June 2011 Lords Chamber

[Lord Eatwell]

My Lords, I am most grateful to the noble Lord for repeating as a Statement the answer to an Urgent Question given by the Financial Secretary in another place. I must begin by congratulating him on the feat of speaking for a full four and a half minutes without referring for a moment to the substance of the Question asked. However, he still has some way to go before acquiring the skills of Mr Alan Greenspan, who famously qualified his speeches when chairman of the Federal Reserve by declaring that, “If anyone understood me, I misspoke”.

Of course, everyone will agree that we live in dangerous financial times and it is incumbent on all those in authority to take care when commenting on market-sensitive information, even to the extent of not answering legitimate parliamentary questions. However, the other fundamental aspect of these uncertain times is that it is important to plan for the worst, even as we hope that it will not happen. Assurance that the Government are indeed planning for the worst will enhance rather than reduce market confidence. Without going into any analytical detail, will the noble Lord tell us what is the Treasury’s current worst-case estimate of the potential exposure of UK financial institutions should there be a disorderly Greek default? Even if he will not answer that question, in the event of market disorder will the present Government stand behind UK financial institutions as the previous Government did? Any worst-case estimate should not, of course, refer just to direct exposure to Greek sovereign and private debt, as the noble Lord did just now, but to the exposure to other jurisdictions that might reasonably be assumed to suffer contagion from a Greek default. Just as the collapse of Lehman Brothers inflicted such a shock on the western financial system that the wholesale funding markets froze, pushing major banks into insolvency from which they had to be rescued by the state, so in similar fashion a default in Greece could produce knock-on effects. Of course, all these effects may already be priced into the market—we hope that they are—but we must plan for the worst.

As the noble Lord will be aware, Mr Michael Cohrs, a member of the new Financial Policy Committee of the Bank of England, has stated that what keeps him awake at night is the interconnectedness of the system, which could create ripple effects in financial markets throughout Europe and beyond. Without referring to any particular market or giving any other detail, what is the Treasury’s worst-case estimate of the scale of those ripple effects as they might impact the UK?

We also learnt from the Lehman collapse that the consequential fall in bank lending to households and industry—Lehman had been growing at more than 20 per cent a year and then ceased to grow at all—resulted in a fall in GDP from which the UK still has not recovered and, again in consequence, led to a sharp rise in the Government deficit. What contingency measures have the Government put in place to ensure that lending to industry and households will not be cut in the face of any market turmoil produced by a Greek default? Industry in particular needs to be confident that lending will be available at reasonable cost. Will the Minister guarantee that at the very least the lending targets of Project Merlin will be attained? If the eurozone economic problems put upward pressure on the UK deficit, will the Government revise their deficit reduction policy?

Finally, given the potential damage to the UK economy of financial disorder in the eurozone, does the Minister accept that it is very disturbing that Her Majesty’s Government seem to take pride in the fact that they are playing no part in the development of UK policies that will minimise future damage to the UK? Is it not time for the Government to be more proactive in Europe in pursuit of Britain’s best interests?

Regulatory and Banking Reform

Lord Eatwell Excerpts

Thursday 16th June 2011 Lords Chamber

[Lord Eatwell]

My Lords, I am most grateful to the noble Lord, Lord Sassoon, for repeating the Statement made by the Financial Secretary to the Treasury in another place. The Financial Secretary begins by commenting that the tripartite regulatory system failed. That is obviously true, and indeed a variety of other regulatory structures around the world also failed. In order to help us to establish a clear historical time line to understand what actually happened, will the noble Lord, Lord Sassoon, tell the House in which speeches prior to 2008 the Financial Secretary, the Chancellor or the noble Lord himself called for a tightening of regulation? Hindsight is a wonderful thing.

Continuing the theme of the rewriting of history, at the end of the Statement the Financial Secretary states that when the coalition Government came into office, questions were asked about the future of banking and regulation, but they had not been answered. I remind the noble Lord that domestically the most important road map for reform—the Turner review—was published in February 2009, and that the G20 conference that set the framework for international reform was held in September 2009. Far from there being no answers, most of the economic and financial analysis on which the Government’s proposals today are based was done before the election.

I turn to more substantial matters. The Statement fails to make it clear whether the financial policy committee will have any powers. What will it actually be able to do? Will it, for example, have the power to impose leverage collars or loan-to-value ratios to calm a bubble? Will it have the power to impose pro-cyclical levies on banks? Given that the committee will be the focus of macroprudential regulation, what will its relationship be to the more general formation of macroeconomic policy? It is now obvious to everyone that fiscal policy can be a source of macroprudential risk, so what role, if any, will the committee have in the formulation of fiscal policy, even, let us say, at an advisory level?

The Financial Secretary states very emphatically that the prudential regulatory authority will focus on microprudential regulation. Does not this division between microprudential and macroprudential issues repeat the institutional rigidities and errors of the past? Given that the regulation of individual firms will require macro issues to be taken into account, what exactly is the difference between the risks that create macroprudential problems and those that create microprudential problems, and how will anyone know in advance of a crisis which is which?

The Financial Secretary states that the financial conduct authority will have new powers to ban the sale of toxic products. This really is very odd. Since in the recent crisis the toxicity of products was related to the macroprudential risks they created, how is this power invested in the arm’s-length FCA to be related to the management of macro risk by the Bank of England?

I now turn to the future structure of the banking industry and the work programme of the Independent Commission on Banking, as covered in the Statement. First, we on this side heartily endorse the principles for reform set out in the Financial Secretary’s Statement. We would, however, add a further principle: that the failure of a bank should not destabilise the real economy.

Secondly, the Statement endorses in principle the ICB proposition that there should be a ring-fence around high street banks. That sounds sensible and clear until one asks: what exactly is a high street bank? Does the Financial Secretary refer to banks that base their business only on high street deposits—the deposits of households and firms? Or, would it be acceptable for high street banks to have interbank lending, repos and other wholesale funds on the liability side of their balance sheet, given that it was the failure of these markets in commercial paper that was a major factor in the financial crisis? Will that ring-fencing apply to all banks offering retail services in the UK, whether they are British companies, subsidiaries of foreign companies or branches of foreign companies? Will it also apply to banks passported into the UK from other EU jurisdictions?

We welcome the possibility that Northern Rock may be returned to the private sector as a mutual. I echo the question asked by the noble Lord, Lord Lawson, on Monday: in the model chosen for the privatisation of Northern Rock what weight will be given to the implications for future financial stability? Would not mutualisation be an important buttress of stability?

In the Statement the Financial Secretary also voices his support for the Basel III accord. As the noble Lord will be aware, at the centre of that accord is the increase in the minimum capital that banks are required to hold relative to risk-weighted assets. Is the noble Lord aware that the capitalisation of the banks in Ireland prior to the crisis exceeded the new limits proposed in Basel III? Why are the Government supporting such a feeble standard?

We welcome the publication of the White Paper and the draft Bill, and indeed the Government’s agreement to pre-legislative scrutiny. We also note that many of the institutional structures to be given legal legitimacy by the Bill are already in place. There was a reference to the financial policy committee meeting today. Given that the Financial Services and Markets Bill, the predecessor of the Financial Services and Markets Act, underwent major changes, including institutional changes after the pre-legislative scrutiny by the committee chaired by the noble Lord, Lord Burns, is not the establishment of these structures, prior even to a Second Reading in another place, somewhat premature?

Banking: Government Shares

Lord Eatwell Excerpts

Monday 13th June 2011 Lords Chamber

[Lord Sassoon]

My Lords, I am grateful to my noble friend as she enables me to point to the mandate which UK Financial Investments was given by the previous Government. It was that in creating and protecting value for the taxpayer it must have due regard to both financial stability and competition. At all stages, whether it is the involvement of the Independent Commission on Banking or the mandate of UKFI, competition is at the centre.

[Lord Eatwell]

My Lords, the noble Lord has mentioned Project Merlin on a number of occasions. Will he explain to the House why the lending targets set for the banks under Project Merlin and announced to this House have now been reduced by a good 10 per cent? Why are the Government fiddling the figures?

[Lord Sassoon]

Number one, this is a Question about the disposal of bank shares; number two, I would not believe everything that you read on the front page of the Financial Times every day.

Consumer Insurance (Disclosure and Representations) Bill [HL]

Lord Eatwell Excerpts

Monday 13th June 2011 Grand Committee

[Lord Eatwell]

My Lords, I express my gratitude to the Minister and his team and to Mr David Hertzell of the Law Commission for their briefing on the Bill, which was very helpful indeed.

In debates on measures brought before Parliament, the claim is often made—and perhaps even sometimes believed—that the consequences will be wide-ranging. In the case of this Bill, it is likely that the claim will indeed be true—and perhaps not only in the United Kingdom. For the Bill proposes a fundamental change in the structure of the insurance contract from a requirement that the purchaser discloses everything that will be material to the insurer’s decision to insure to a requirement in Clause 2(2) that the purchaser,

“take reasonable care not to make a misrepresentation to the insurer”.

In effect, the purchaser must answer carefully the question posed by the insurer. That is a dramatic shift of responsibility. Even though it is claimed that the Bill essentially clarifies what is accepted practice under the FSA’s insurance regulation and the various provisions of the Financial Ombudsman’s scheme, it seems that the Bill goes further than mere clarification.

One of the fundamental principles of insurance is that which is referred to as “uberrimae fidei”, or “utmost good faith”. That principle is fundamental to insurance law throughout common-law jurisdictions. A quick internet search revealed exactly the same principle as cited in the UK also cited in India, Ireland, Australia and the United States. Yet the Bill makes it clear in Clause 2(5)(a) that,

“any rule of law to the effect that a consumer insurance contract is one of utmost good faith is modified to the extent required by the provisions of this Act”.

Given that this legislation makes such a fundamental change to the principle if not to the practice of consumer insurance, it would be helpful if the Minister would clarify a number of points. First, have I interpreted correctly the shift in the onus of good faith? Is it indeed the case that the Bill characterises the information on which an insurance contract is based as deriving from the responsibility of the insurer to ask the questions and from the requirement that the consumer answer the questions with “reasonable care”, as under Clause 3? Also, is it indeed the case that there is no onus on the consumer to provide information that is not asked for—that is, there is no requirement to answer questions that are not asked, however relevant the information may be to the insurer?

As a supplementary point, what is the position if the consumer thinks that unasked-for information might be relevant to the contract but, not being asked, either concludes that the insurer believes the information to be not relevant or believes that it is not his or her responsibility to supply the information? In other words, will Clause 3(1) result in the addition of catch-all questions to insurance contracts, such as, “Is there any other information that might be relevant?”, hence substantially negating the declared intention of this Bill? Would that question be “clear and specific”? Is such a question permissible?

As a further supplementary, what questions are not permissible? As the noble Lord will be aware, the European Union seems likely to rule questions associated with gender as being out of order in motor insurance. Is this likely to become a general rule? Are questions about race permissible when they are relevant, as in the health issues associated with, say, sickle cell anaemia?

Secondly, why is there no responsibility on the insurer not merely to be clear and specific in questioning but also to demonstrate the relevance of questions asked? If questions that are indeed relevant when embodied in the insurer’s statistical analysis do not appear relevant to the consumer and their relevance is not demonstrated, the consumer may be led into treating the exercise more casually than is appropriate. This may be particularly true in medical insurance, in which the relevance of important issues may be very obscure to the consumer.

As I understand it, Clause 4(1)(b) establishes appropriate materiality in legal terms, but to the lay man, and indeed to the consumer, that clause is completely obscure. I imagine that if I asked any non-lawyer in this Room to explain how that clause established materiality, they would be hard pressed to do so. Since this is consumer legislation, should not the wording be clear and specific and not as obscure as Clause 4(1)(b)? I believe that the clause needs to be rewritten.

Thirdly, given that the insurers are now no longer protected by the catch-all requirement that the consumer must provide everything that would be material to the insurer’s decision to insure, it might be expected that the questions asked in proposal forms would become far more wide-ranging and comprehensive than has previously been the case. The very complexity of questions required to cover every eventuality might well create problems in and of itself. Are there to be guidelines to insurance companies defining the character and range of questions to be asked? Will the ABI, for example, provide such guidelines?

Fourthly, it is a familiar problem in credit analysis that a consumer’s credit rating is inappropriate because information has been logged wrongly or analysis has been faulty, or for a number of other reasons. In these circumstances, consumers have access to their credit ratings and a right of appeal. Is a similar facility available to consumers of insurance products and, if it exists, will the availability of this facility and its importance be widely publicised subsequent to the passage of this Bill? Will the facility be available, or is it available on the internet? In this context, are consumers deemed to know to what they have access? I know that this is a common outcome of business law, but it would be entirely inappropriate in consumer law.

Fifthly, how are all these matters to be played out in the process of renewal of an insurance contract referred to in Clause 2(3)? What if the request “to confirm or amend”, based on the original questions asked, does not in fact cover relevant changed circumstances? Is the consumer required to volunteer such information and how, under the terms of the Bill, is he or she to determine what is relevant? Would the insurer be allowed to ask the catch-all question, “Provide all other information that might be relevant at this stage”? If so, once again the Bill is otiose. It is particularly unclear in Clause 2(3), which therefore requires redrafting. It says that an insurance contract renewal is in fact a new contract. Renewal is not a concept known to insurance law. Should not the clause be redrafted to make that clear? What estimate has the Treasury made of the increase in the cost of insurance consequent on this legislation?

Before ending, I shall turn to the questions raised by paragraph (a) of Clause l, which seeks to define “consumer”, and by Clause 6, which is on warranties and representations. It may be—I have been unable to find out—that the concept of the consumer is defined in other relevant legislation, but as drafted in this Bill the definition is unreasonably vague. For example, taking out insurance against debilitating illness is typically motivated by the economic well-being of the sufferer and could not be said to be unrelated to the individual’s trade, business or profession. That would be especially the case if the physical or mental capacity that is insured is a necessary component of the performance of the profession. For example, for a ballet dancer, the body is the tool of his or her profession; it is the instrument of his or her art. Would any general health insurance taken out by a ballet dancer be insurance contracted by a consumer or not? Another, less exotic, example of the ambiguity of this definition of a consumer comes to mind. If I insure my BlackBerry, am I a consumer or not? The expression “wholly or mainly” is far too vague for me to know and, by the way, is unknown to insurance law.

On a related point, why was the legislation not extended to cover small businesses or even the micro-businesses to which the noble Lord, Lord Sassoon, referred, which at present suffer the same disadvantage as consumers? Indeed, the boundary between a consumer and a small business is often very vague—take my BlackBerry example. The clause requires further attention. It is not satisfactory as it stands.

On the question of insurance warrants, Clause 6(2) makes a valuable amendment to the law on misrepresentation, but this does not eliminate the generally destructive power of a warrant related to a condition of insurance. Given the drafting of Clause 3, which refers to “reasonable care”, and the remedies outlined in Schedule 1, would it not be appropriate to eliminate the role of warrants entirely from consumer insurance?

This is an important Bill, which is designed to pursue a worthy purpose. It is entirely supported by this side. However, it is not clear that the present drafting is sufficient to bear the weight of the major philosophical and practical change that is embedded within it. We will have the opportunity to pursue these matters at a later stage. In the mean time, answers to the questions that I have posed will greatly facilitate preparation of any necessary amendments.

I nearly forgot: as far as the Committee stage is concerned, I understand that under the rules governing Law Commission Bills it is possible to take evidence in Committee. Given that and given the defects in the drafting of the Bill as presently tabled, are the Government intending to call expert witnesses in Committee?

[Lord Sassoon]

My Lords, I start my response to what has been a helpful discussion by thanking the noble Lords who have taken the trouble to contribute this afternoon. The points have been wide-ranging and constructive. I am grateful to the noble Lord, Lord Eatwell, for his faith that I can respond so quickly to the huge number of very detailed points that he raised in his constructive intervention. He may forgive me in advance if I do not manage to cover all the details. Of course, I will write to the noble Lord and copy that to others who have taken part in the debate this afternoon.

[Lord Eatwell]

My Lords, I entirely understand the noble Lord’s position and am quite happy to receive written answers to my questions.

[Lord Sassoon]

I am grateful for that, because some of this has been a touch technical and some rather fundamental. I will talk about the process in a moment, as my noble friend Lord Higgins asked about the procedure for Law Commission Bills. The fact that it is a Law Commission Bill and has, as my noble friend pointed out, been the subject of a big report subsequently consulted on by the commission means that we can be fairly confident that all the fundamentals of the law have been considered in great detail. Otherwise, this Bill would not be going through this procedure. This is the first Bill to go through the Law Commission procedure since the procedure was made permanent last year. I am pleased that, as my noble friend Lord Higgins recognised, this innovation has allowed for parliamentary time to be found for this legislation, which would clearly otherwise have been difficult.

On what happens next, the important thing is that this is not in any sense a fast-track procedure, because the Bill will follow the usual parliamentary process but for two exceptions. First, the substantive Second Reading debate is held in Committee—that is what we are doing this afternoon—rather than on the Floor of the House. Secondly, the Committee stage will be, as the noble Lord, Lord Eatwell, said, taken by a Special Public Bill Committee, which is indeed empowered to take evidence from witnesses as well as to conduct the usual clause-by-clause examination of the Bill. I have no present intention to suggest from the Government’s side that we should call witnesses, but that is allowed for in the procedures. For the benefit of my noble friend, I draw the Committee’s attention to paragraph 8.44 of the Companion to Standing Orders, which says:

“The House agreed in 2008, on a trial basis, that second reading debates on certain Law Commission bills should be held in the Moses Room … The Committee debates the bill, and reports to the House that it has considered the bill. The second reading motion is then normally taken without debate in the House, though it remains possible, in the event of opposition, for amendments to be tabled or a vote to take place on the motion. Law Commission bills are normally committed to a special public bill committee”.

I hope that that is as clear as it can be. I do not know whether that allows for speakers lists, gaps and things this afternoon, but I am grateful that my noble friend got to his feet and contributed to the discussions in his usual lively way.

As I said in opening, we believe that this Bill is necessary in order for the law to catch up with best practice. It will also ensure that the legal duty of consumers is reasonable and clear. In answer to the questions asked by the noble Lord, Lord Eatwell, in this area, I am not sure whether it is right to look on it in the context of shifting the onus of good faith. It is clear that it is up to the insurer to ask the questions and to the consumer to answer them, with the potential consequences of misrepresentation in the way that I outlined in opening. The effect of this is to shift the burden between the insurer and the consumer in the consumer’s favour as against the law as it stands in the 1906 Act. That is entirely appropriate.

It is worth reiterating in this context—I think that this is the point on which my noble friend Lady Kramer asked for confirmation—that any information that the consumer misrepresented or failed to disclose must be proven to have been relevant to the content and/or the price of a policy before the insurer is entitled to a remedy. There is a shift in the legal position, but it is a shift towards a position that is in line with industry best practice and the standards that are currently imposed by the Financial Ombudsman Service.

I am particularly grateful to my noble friend Lady Kramer for drawing attention to a shocking but classic case of the sort that this Bill is intended to obviate and to ensure does not happen in future. The case that she put forward was interesting because it was a question not of unreasonable loss to the consumer—as I understand it, after a two-and-a-half-year struggle, the FOS found in favour of the insurer—but, as was explained to us, of the very real distress and the time and effort that had to go into getting to the right answer. That should be eliminated in similar situations as a result of this legislation.

As I said in opening, the industry will benefit, as we anticipate a reduction in the costs of handing complaints internally and with the ombudsman. In that context, I can confirm to my noble friend Lady Noakes that we will be mindful of the burdens of implementation on the industry. She rightly and helpfully pointed out the various other initiatives that will bite on training, information and standards of scripts, whether in relation to the retail distribution review or simplified advice. Her points are well taken.

My noble friend Lord Higgins referred to paragraph 10.30 of the Law Commission’s report, which discusses the pros and cons of giving legal effect to industry guidance. My noble friend quoted from paragraph 10.30, but the report discusses the issue at some length in paragraphs 10.32 to 10.43. The Law Commission decided not to include such a provision for the reasons set out in paragraph 10.38, principally because the role of guidance is different from that of legislation. I think that the discussion is extensive in the Law Commission’s report.

[Lord Sassoon]

Good. I, too, am grateful that we have nailed that one.

On the other questions raised by the noble Lord, Lord Eatwell, there is first this difficult issue about permissible questions and specifically questions of gender and race. They are made particularly difficult by the recent judgment of the court in relation to motor insurance. This issue is dealt with elsewhere and not in the Bill, which is solely focused on the transmission of information in the context of underwriting risk. It is not part of the scope of the Bill to discuss questions of discrimination or equalities legislation—nor should it be.

On the definition of consumers and micro-businesses, we discussed informally last week what would happen with respect to the insurance of the foot of a ballet dancer or a footballer. Maybe we could call this the “David Beckham’s foot” question. The Explanatory Notes on Clause 1 define a consumer as,

“an ‘individual’ who is acting wholly or mainly for non-business purposes. Thus the consumer must be a natural person, rather than a legal person (such as a company or corporation). The definition expressly provides for mixed use contracts”—

for example, the insurance for a personal car that is sometimes used for business travel to be defined as a consumer insurance contract. It means that the Bill will not apply to individuals purchasing insurance that is mainly for purposes related to their trade, business or profession, which would clearly be the case in some of the examples that have been discussed.

Lastly, on the cost of insurance, HM Treasury has not made an estimate of the impact of the Bill on insurance premiums. However, we have estimated that the net impact will be savings for the industry—that is, when we take account of the initial training costs and the savings as a result of fewer FOS complaints among other factors. On the basis that the industry should have net savings from this Bill being enacted, there is absolutely no reason to believe that there should be any additional cost passed on to consumers. In relation to the overall cost of insurance, these are relatively small marginal costs but ones that would impact favourably—that is, downwards—on insurance costs.

[Lord Eatwell]

I should perhaps explain the point about cost. Given that the catch-all clause from the Marine Insurance Act 1906 is removed, necessarily the range of risks to which the insurance company is exposed will be greater. Given that, it is likely that the premium charge will be greater. That was the point that I was making.

[Lord Sassoon]

My Lords, I do not believe that the range of risk will be any greater. Under this Bill, the range of risk to which the insurers are exposed will be brought in line with the current industry best practice and the standards to which insurers are held under FSA rules and by the FOS. There is no extension of the range of liabilities; there is merely—this is an important “merely”—an alignment, a clarification and an important legal codification of where the duties lie at the point at which the insurance contract is taken out. There is also clarification of the remedies—the remedies that are already applied by the FOS—should a misrepresentation occur. So, yes, the position under the law will change from that of the 1906 Act, but in substance the Bill will put insurers in a position that they are already in under current practice. Therefore, I would not accept that there is a greater range of liabilities and costs to which the insurer is liable; if anything, as I have said, there will be a modest saving because of the clarity that the new architecture will bring.

I have gone on at some length in response to the important questions that have been raised. I will sweep up anything else that I have not had the chance to cover and get back to noble Lords in good time ahead of the Special Public Bill Committee. I hope that I have, nevertheless, responded to as many points as I can this afternoon. I look forward to further discussion in the Special Public Bill Committee in due course.