Financial Services Bill

Lord Hodgson of Astley Abbotts Excerpts

Monday 11th June 2012 Lords Chamber

[Lord Hodgson of Astley Abbotts]

My Lords, when one is the 36th and last speaker in a debate of this length and quality, inevitably most of one’s foxes have been shot—in many cases, in fact, not so much shot as riddled. I do not want to trespass on the kindness of the House, especially at this late hour, by repeating familiar arguments.

I declare an interest: I am chairman of two firms that are regulated by the FSA, and until recently I was chair of a third. I want to make three points about the Bill: my gloss on the architecture; something about the philosophy and culture that are currently around in the Financial Services Authority and which I fear may be transmitted to the new bodies; and an area that has been less well covered today—the question of social impact investment, which is important for the future.

I first became involved in City regulation some 12 years ago. I was one of the first directors appointed by the Bank of England to the then new Securities and Investments Board. Experience has taught me since then, and I have served on regulatory boards since, that every crisis is always followed by cries to move the architecture around and change the bodies. Indeed, the SIB itself was the result of a crisis—a rather minor one by today’s standards—in that the Bank of England suddenly became enthusiastic when it found that, rather unpleasantly, its own pension fund had been adversely affected by the activities of a firm called Barlow Clowes. The Bank immediately agreed that there needed to be one central regulator, with subsidiary regulators that could carry on more specifically focused activities. In the end, there were three such: the Securities and Futures Authority, the Investment Management Regulatory Organisation and the Personal Investment Authority. In fact, this was a triple-peak regulatory system as opposed to a double-peak one.

Why did that system not prove successful? In a word, to follow what the noble Lord, Lord Desai, said: Barings. The overnight collapse of one of Britain’s most historic merchant banks caused ripples of concern. The need for reform was given further impetus by the view that the subordinate regulators were too introverted—my noble friend Baroness Noakes referred earlier to regulatory capture—and not sufficiently accountable. We have had echoes of that today, and no doubt we will continue to in our discussions about the Bill. It was felt that a unitary approach should overcome these problems, and the FSA was the result. Now, with the events of 2008, that in turn has proved to be found wanting, and we are now going back to a more diversified structure.

The danger of changing a structure in response to a specific crisis is that you create one that is too backward-looking. In essence, generals tend to fight the battles of the previous war. The three issues that I hope that we can explore in Committee are whether the structure permits or encourages peering into the fog of the future and taking preventive action; how the relationships between the FPC, the PRA and the SCA will be integrated and managed in a way that does not place a double or triple regulatory burden on the regulated firms; and, as many noble Lords have said, whether the system contains a sufficient element of accountability.

So much for structure. I turn to the second issue, regulatory focus and culture, which the noble Lord, Lord Eatwell, referred to in his opening remarks, and many other noble Lords have referred to subsequently. In my view, the relationship between the Financial Services Authority and regulated firms has deteriorated in recent years. At root, the authority has given undue weight to just one of its regulatory objectives—protecting consumers. That is a perfectly respectable objective but one to which the authority has given huge weight, and in consequence it has placed insufficient weight on its other objectives, especially the need to weigh the cost of regulation, encourage innovation and consider London’s competitive position. In short, the FSA has become process-driven and risk-averse.

That focus on process has led to a number of undesirable consequences. First, there has been an increasing reluctance by firms to maintain an open relationship with their regulator. Any admission of weakness, however slight, is seized upon by the regulator, and no credit is given to the firms for having identified the weakness in the first place. That is an unproductive way to behave.

Secondly, there has been a dramatic increase in Section 116 investigations. Section 166 of FiSMA permits the FSA to require a skilled person investigation. It is clear from debates at the FiSMA proceedings that this idea should be used sparingly, but investigations are increasingly being thrown around like confetti. It is not just the cost of the investigation or the diversion of management time; it is the feeling abroad in the City that Section 166 achieved very little other than providing the regulator with cover, so that if something subsequently goes wrong he can say, “We had a Section 166 investigation. What more could we do?”.

Thirdly, and finally, there is an abuse of power—and I use this phrase carefully—by the SIF committee. Where a person has a particularly influential position in the company, he or she requires specific approval by the FSA via the SIF committee. The SIF committee is a star chamber. It is as simple as that. Individuals can be left in regulatory limbo for months. I know of one man who has been in regulatory limbo for 11 months without recourse or redress and without being able to find out what he has been accused of because confidentiality is required by the FSA while the procedure investigation is going forward.

This is the philosophy that is prevalent in the regulator at present, and it is one that may be transmitted to the new organisations. Therefore I agree with my noble friends Lord Hunt and Lord Flight when they call for proportionality. Looking through the Bill, I see Clause 5 and the references there, but we will really need to bottom out the practical implications of the statement of intent and what they are going to mean on the ground in the operation of the City of London.

I now turn briefly to my third topic: social impact investment. It is something that the Government are very keen to encourage but about which the Bill is almost entirely silent. The social investment process poses particular challenges for all trustees, as well as for grant-giving foundations, especially those with a permanent endowment, but the real regulatory crunch and challenge that is relevant to this debate lies at the interface between the charity and its individual supporter or investor. The missing piece in the jigsaw at present is the ability to approach individuals about social impact investments without the need for a full Companies Act prospectus, the cost of which renders almost any scheme uneconomic. We are therefore in the counterproductive and counterintuitive position that an individual can give his or her money to a project and be certain that he or she will not get it back, but he or she cannot lend or invest it if there is any prospect of any return at all. That cannot be a sensible way of proceeding to try to encourage our fellow citizens to put money behind social impact projects that this country badly needs.

I hope that in Committee we can discuss how we can help the social impact butterfly out of its chrysalis. We will need to create an appropriate position for the regulator and perhaps establish a class of individual supporters or investors, perhaps by creating a self-certified social investor along the existing lines of the self-certified sophisticated investor. To be fair to my noble friend on the Front Bench, it is not up to the Treasury alone. Contributions will be required from other government departments—BIS, the Ministry of Justice and the Cabinet Office—as well as, as we have covered this evening, from the professions: actuaries, investment managers and accountants. In my view, it will probably take a generation for the social impact investment movement to reach its full potential, but we need to plan now, and financial regulation, more than any other sector, holds the key, so I hope my noble friend will be able to help us during the passage of the Bill to speed this process on its way.

I do not doubt that the events of 2008 showed weaknesses in the regulatory structure and that we will need to give the Bill very careful consideration and examination in Committee if we are to manage to create the delicate balances between risk and reward and in doing so avoid hamstringing the dynamism of the City of London.