Financial Services (Banking Reform) Bill

Lord Higgins Excerpts

Wednesday 23rd October 2013 Lords Chamber

[Lord Phillips of Sudbury]

My Lords, I, too, support the amendment. I moved Amendment 91B at the close of our second day in Committee, which overlapped to a considerable extent with this amendment. In my amendment, I also talked about looking at the cultural as well as economic effects of this mass of gambling, as it is, within the financial markets. I hope that the Government will smile upon this; it may be that if it comes back on Report I will try to amalgamate my amendment and this one.

[Lord Higgins (Con)]

My Lords, I also support my noble friend’s amendment, but with some qualifications and a request for some clarification. The amendment simply refers to “proprietary trading by banks”; that does not distinguish between one part of a ring-fenced bank and another. The arguments on this issue are so clear that we should take a perfectly clear view that there ought to be no proprietary trading whatever by any ring-fenced bank.

There is also no real need to wait three years for such an inquiry. My noble friend referred to the Volcker rule in America; not all of us in this Chamber have Paul Volcker as a personal friend, but I have great respect for him. He is absolutely right that this should not be carrying on in the United States. Although it may be that there has been a decrease for the moment, over a period of three years the situation might change somewhat. Therefore, we could take a clearer view on this between now and Report than is set out in the amendment. As my noble friend has pointed out, this is effectively the banks’ carrying out risky trading on their own behalf—in the past, not infrequently, it was risky trading on their own behalf with clients’ money—and this, again, is a crucial point. Perhaps we should clarify that aspect of the matter, but I have not the slightest doubt that this is a move in the right direction and I hope that we can make rapid progress on it.

[Lord Turnbull]

I reassure the noble Lord, Lord Higgins, that it is certainly not intended, while this activity might remain within a banking group, that it should be done, under the plan, by a ring-fenced bank. One of the reasons why we took the view that we should wait and see is that the dividing line between a proprietary trade and a trade on behalf of a customer is not straightforward, which is why it is very difficult in the US. For example, if I lend the noble Lord money he may seek some kind of hedge which I would provide. That might mean that my position as the bank is no longer what I really want it to be. As a bank, I would look around to see what my colleagues have done during the course of the day, and we would then add up all the positions that we have taken. We may well find that that position is not where we really want to be, so on the following day the bank goes out and undertakes a trade which gets it back to the degree of hedged position that it wants. Was that a proprietary trade or was it a trade that was a consequence of serving a customer? That is why this is actually very difficult and why we are wise to wait and see whether workable definitions could be found of what constitutes real proprietary trading and of what constitutes trading in response to a customer. This measured amendment enables us to do precisely that.

[Lord Deighton]

My Lords, the ICB considered in detail the case for a ban on proprietary trading in the UK, but decided in favour of ring-fencing. The PCBS heard evidence from a wide range of sources that prop trading does not appear to play a large role in the UK at the moment—as my noble friend Lord Lawson pointed out—nor did it play a significant role in the financial crisis. The noble Lord, Lord Turnbull, has already addressed the question of my noble friend Lord Higgins, but it should of course be noted that the ring-fenced banks will be banned from proprietary trading as well as from market-making and other forms of trading activity that would expose them to risks from global financial markets. Therefore, from a prudential perspective, much of the risk posed by prop trading can be addressed by a suitably robust ring-fence which is, of course, the thrust of our legislation. This was the point made by the PRA in response to questions from the PCBS.

It is also worth noting that the evidence heard by the PCBS also suggests that prop trading is not necessarily the sole avenue for the cultural contamination of banks. For example, the PCBS highlighted in its excellent report the serious failings in culture and standards at HBOS, a bank which did not engage in any prop trading at all. Indeed, it is perfectly possible to run an integrated securities business with full integrity in a way that manages any potential conflicts of interest quite satisfactorily, so they do not necessarily follow. It is far from clear, therefore, that prop trading is the real problem facing the UK financial system, or that structural solutions address cultural problems. In light of that, and of observations about the practical difficulties of a ban on prop trading, as it is being attempted in the US through the Volcker rule, the PCBS did not recommend a ban on prop trading.

It is not wholly clear what further evidence would support a different conclusion to that reached by the PCBS in its own assessment, so it is unclear what a further review into proprietary trading within such a short period of the PCBS’s own report would add. Still less is there a need for such a review to be followed immediately by an independent review of the same question. Of course, we have no issue with reviews as a matter of principle: we are just not sure that, in this case, legislating for one in advance really does much for us.

As the findings of the PCBS do not suggest that prop trading presents a serious prudential risk at this time, I do not think we need to legislate for the regulator to carry out a further review. The absolutely valid point made by my noble friend Lord Lawson was that this could change in the future. That is what we are trying to address. Should that happen, the PRA has made it clear that it already has the powers it needs to bear down on prop trading where it endangers the safety and soundness of a firm or where the risk incurred is not consistent with the publicly stated risk appetite of a bank.

Moreover, monitoring and reviewing all risks to a bank constitutes an essential part of the PRA’s work. The PRA’s approach is to insist that firms adopt and follow a risk appetite that is consistent with the PRA’s statutory objective to promote the safety and soundness of firms that it regulates. This will include regular monitoring and review of all risks, not limited just to those associated with prop trading. Therefore, to require the PRA by legislation to undertake such a review seems unnecessary. Should we legislate for a review of how reference rates are set, for example? Should we legislate for a review of mis-selling practices? Why, therefore, should we do it for prop trading? It is not apparent to me what problem a review would solve. While I think that reviews can play a useful role, in this case we are not sure that it is justified in advance.

We need to give the regulator the space to allocate its resources in a way that is appropriate and proportionate when considering all the different risks to the UK financial system, not only focusing on one particular risk. Our more widely framed reporting requirements allow for this. For all of these reasons, I do not think that a review on the particular issue of prop trading is necessary. The regulators are already subject to extensive reporting requirements. I expect the PRA to make the Treasury, and Parliament, aware of any emerging risks it identifies, whether through prop trading or anything else. The deputy governor for financial stability has already written to the chair of the Treasury Committee, offering to discuss arrangements for reporting. I therefore ask the noble Lord to withdraw his amendment.

[Lord Higgins]

My Lords, the Minister says that we do not want to have the regulator wasting resources. However, if we ban an activity, it would not waste resources. I am also not absolutely clear—I thought I was—that we are going to say that proprietary trading by a ring-fenced bank is absolutely banned. If that is so, ought we not to make it absolutely clear in the Bill?

On the point made by the noble Lord, Lord Turnbull, we have to distinguish between proprietary trading and other activities such as hedging as there may be a case for the bank operating on behalf of its clients by hedging for a foreign exchange risk or whatever. However, that is not at all the same as what is normally meant, certainly by Paul Volcker, whereby banks use a client’s money to take on particularly risky investments which have nothing to do with the client.

[Lord Deighton]

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

--- Later in debate ---

[Lord Higgins]

My Lords, we have had a fascinating debate within a debate between the noble Viscount and my noble friend Lord Lawson. I merely make one or two points. It seems to me that there is a case for a remuneration code. In a way we could let the amendment end after subsections (1) and (2) and leave it to the FCA and PRA to take a view. It raises the question of whether, after they have done so, the code they come up with ought then to be considered further in this House. I leave that on one side.

As far as culture is concerned, what my former constituents regard as unfortunate is the whole culture of bonuses. I think that they take very strongly the view that the people concerned should be paid a rate for the job and then get on with it. Rather than specify, as this amendment does, that a proportion must be in the form of remuneration which is variable, I think they would rather the opposite—or at any rate, that the proportion which is variable should be limited.

There are, of course, very real practical problems concerning remuneration in a company which is clearly going on the rocks, when one needs to recruit someone to sort it out. That is a particular case. More generally, we could usefully consider the points made by the noble Lord, Lord Turnbull. The argument for his attitude, if I understand it correctly, on variable remuneration is, “If it is variable, we can claw it back at some later stage”, but that may be a long while after the actual events have taken place. There is also the problem of companies being not just too big to fail but, as has been said on previous occasions, too big to manage. Part of that problem is that we are looking at remuneration for banks which are in that situation. What has become clear in recent events is that people have been paid very large sums when the organisation they are asking to manage is not capable of being managed at the size that it is. Be that as it may, there is a case for a remuneration code, but we should probably leave it to the bodies concerned, which are suggested in this amendment.

[Lord Newby (LD)]

My Lords, we have had an extremely wide-ranging debate on many aspects of bankers’ remuneration. I remind the House of the two specific amendments in front of us. The first imposes a duty on regulators to prepare an additional code on remuneration in relation to senior managers of banks, while the second proposes additional powers for regulators to claw back deferred remuneration of employees of banks that require state aid.

The statutory requirement on regulators to prepare another remuneration code aims to implement a set of remuneration reforms similar to those recommended by the Parliamentary Commission on Banking Standards. I will explain why the existing remuneration code, current rule-making powers and further regulatory action in response to the parliamentary commission provide a clear basis for the implementation of these proposed reforms.

The existing remuneration code addresses the commission’s objectives for regulating remuneration in a way that combines a concrete legal basis with a rigorous system for application. The remuneration code is made under the rule-making powers given to the regulators in the Financial Services and Markets Act 2000, including Section 137H, which extends the provision which may be included in remuneration rules. Any breaches of the regulator’s rules, including breaches of the remuneration code, can be punished with serious sanctions. The code reflects the Financial Stability Board’s principles and standards for sound compensation practices, and European legislation under CRD IV. So this is a code established under statute and therefore might not in any way be thought to be ephemeral.

The content of the existing code already goes a long way to addressing the content proposed in the amendment and, where that is not the case, the regulators have indicated their intention to consult further on any necessary changes. So, for using profits to calculate pay, the existing code states that firms must assess current and future risks, and the need for consistency with the timing and likelihood of the future revenues. This clearly requires firms to calculate profit-based remuneration carefully with regard to risks to the bank. On the balancing of risk and reward, the code makes extensive reference to the close relationship that remuneration and risk considerations must have. Reward calculation based on profit and non-financial metrics must encourage effective risk management and not constitute a risk itself.

On pay deferral, the code specifically requires that at least 60% of variable remuneration above £500,000 or to a director of a significantly-sized firm is deferred over a period of not less than three to five years. On top of the existing requirement, the regulators have said in their response to the PCBS that they will consider adding to their code requirements on deferral. In this area, the existing code is already rigorous and set to become even more so. Regarding the issue of variable pay for non-executive directors, the PRA has stated clearly in its response to the PCBS that there is currently a presumption that this practice should not take place and that this will continue to be the case.

The FCA is conducting a thematic review of sales-related incentives and assessing what action would most effectively prevent those presenting conduct and stability risks. This could include further high-level remuneration principles for staff not subject to the full remuneration code. Additionally, the PRA and FCA have stated that they will update the remuneration code following consultation next year. This review will take into account the PCBS recommendations, including those on a greater use of instruments such as bail-in bonds to tackle the practice of compensating recruits on change of employment and greater and more granular disclosure by remuneration committees in banks’ annual reports.

Therefore, to specify in primary legislation exactly what the code should cover on top of the rigorous current approach seems unnecessarily rigid. The exact content of the code will need to be updated from time to time, including in the light of international best practice. Ensuring that the regulators have the necessary powers and authority to undertake such changes in a timely manner is crucial—and that is already achieved in FiSMA. Overprescribing in primary legislation risks adding an unwieldy layer to what is already an effective process.

I believe we have already given the regulators the necessary powers to apply rules to manage financial stability risk and promote responsible behaviour in banks. The existing code is based on internationally agreed principles and is responsive enough to incorporate new provisions when called for. Indeed, nowhere is this clearer than in how the PRA and FCA revisions of the code, and the FCA thematic review, will take account of the parliamentary commission’s recommendations.

On the subject of the clawback of deferred remuneration at banks in receipt of state aid, I should begin by being clear that the Government perhaps more than that of any other country, recognise the consequences of bailing out financial institutions. We have been clear that individuals must be held accountable for misconduct and that there should be no rewards for failure. The Government agree that there should be specific powers available for the regulator in relation to remuneration at banks where they require state assistance. The ability to reduce or revoke deferred remuneration when a bank requires state aid would further strengthen accountability and complement the extensive reforms which the Government have undertaken to remove the implicit taxpayer guarantee.

However, regulators already have the power to require the cancellation of deferred remuneration and loss of office payments where a bank requires state-aid support under their existing powers. In the PRA code, specific provision is made for the reduction of deferred remuneration where a bank suffers subsequent poor performance. Additionally, the reforms introduced under the EU capital requirements directive IV have reinforced existing rules on pay at banks in receipt of state support so that: bonuses are strictly limited where inconsistent with the maintenance of a sound capital base and timely exit from government support; regulators will be able to require banks to restructure remuneration in a way that is aligned with sound risk management and long-term growth; and directors should not receive a bonus unless justified.

The Government sought to build on these measures to strengthen further the accountability of individuals who are responsible for an institution which requires government intervention by requesting the PRA to consider the PCBS recommendations on this issue. In response, the PRA has stated that following consultations next year revisions to its code will strengthen and broaden the circumstances in which unvested awards can be reduced and vested awards clawed back. The PRA is also considering to whom these rules should apply and whether further powers are desirable in this regard.

However, extending these powers to cover the removal of pension benefits which have not yet become payable, but which the individual concerned has a contractual right to receive, is difficult. That would restrict the rights of the individual concerned under the European Convention on Human Rights to the “peaceful enjoyment” of his or her possessions. The Government do not consider that this would be appropriate. The PRA will consult further on these issues early next year, including on the details of how the powers should be drafted and the population of staff to whom it should apply.

The noble Lord, Lord Turnbull, specifically asked to whom the remuneration code applies. The code currently applies—and will continue to apply—to around 2,700 firms, including all banks, building societies and capital adequacy directive investment firms. That includes broker-dealers and asset managers—such as most hedge fund managers and all USIT investment firms—as well as some firms which engage in corporate finance, venture capital and the provision of financial advice, brokers, multilateral trading facilities and others. In terms of who is covered within those firms, the code defines “Remuneration Code Staff” to include,

“senior management, risk takers, staff engaged in control functions and any employee receiving total remuneration that takes them into the same remuneration bracket as senior management and risk takers, whose professional activities have a material impact on the firm’s risk profile”.

Some of the principles in the code must be applied to the whole firm, including those on guaranteed variable remuneration and the more general principles around risk management et cetera.

The right reverend Prelate talked about the culture in the banking sector and changes that he is seeing in Birmingham, which he hopes are the start of a process. I think we would all agree that that is desirable. In some of the big banks at least, there has undoubtedly been a noticeable change in culture in recent months and years. The right reverend Prelate and a number of other noble Lords talked about the overall level of remuneration. That is a matter for the bank’s shareholders but the Government and my colleague in another place, Vince Cable, have strengthened the powers of shareholders to require boards to explain and get approval for what they plan to do on remuneration. That has considerably increased transparency and, I hope, might have a moderating influence.

The noble Lord, Lord McFall, asked whether the regulator would have access to Barclays management information, to know how it makes its money. I think we talked a bit about this in an earlier debate. The PRA has access under Section 165 of FiSMA to require banks to provide it with all the information or documents that it reasonably requires for its function. That is a very broad power and would cover the information referred to.

The nub of our argument, as the noble Lord, Lord Turnbull, rightly pointed out in his opening speech, is that we have a code. It is operating with increased rigour and will be amended next year to take account in detail of what the parliamentary commission has said. That being the case, we do not need any further provision.