Financial Services (Banking Reform) Bill

Debate between Lord McFall of Alcluith and Lord Flight

Monday 9th December 2013 Lords Chamber

[Lord McFall of Alcluith (Lab)]

My Lords, I support the amendment. In evidence from business people to the Treasury Committee and the parliamentary commission it was said that good and firm regulation is a competition issue. Given that we aspire for London to be maintained as a global centre for financial products, it is important to recognise that dirty money comes in and out. The example was given of HSBC. It acquired a Mexican bank in 2001 in America. From day one the board was told by the compliance officer that no decent compliance functions were available. Notwithstanding that, the situation continued for six or seven years in which drug money was laundered, people died in Mexico as a result, and HSBC was fined almost $4 billion by the US authorities. If that can happen to a UK-based bank, it can be happening elsewhere. It is important that we ensure that regulation in this country is firm.

Mention was made of General Abacha. In 2006 there was an investigation by the FSA that did not go anywhere because the regulator did not have authority. It is therefore important that in this legislation we underline the regulator’s authority. The regulator did not have authority because there was a tension—and there will still be a tension, despite the new architecture—between the financial stability of companies and conduct of business. If we are to make London an attractive global centre, we have to understand the elephant in the room—money-laundering. I am afraid that, if we do not give the regulator an express duty and authority on money-laundering, we could find the problems that happened with Nigeria in 2006 and elsewhere being replicated. That case has still not been investigated authoritatively enough. Having this anti-money-laundering element in the Bill would be extremely important, and I support the amendment.

[Lord Flight]

My Lords, perhaps I may make the point that I made last time this matter came up for debate—a point that is staring at us. The problem is with parts of the world where corruption, drugs and political corruption are rife. Much more demanding anti-money-laundering requirements are needed when accounts are opened for individuals or organisations from such parts of the world.

We already have a factfile that grades different countries around the world according to the extent of their corruption—so there is, if you like, a textbook. If those standards were required, it would, apart from anything else, discourage banks from potentially getting involved. Also, rather than imposing greater demands on everybody—I do not think anyone is suggesting that the average Mr and Mrs Brown from Dorking is engaged in money-laundering—much more demanding standards would be applied when dealing with organisations and individuals from parts of the world where there are the real money-laundering problems.

Financial Services (Banking Reform) Bill

Debate between Lord McFall of Alcluith and Lord Flight

Wednesday 23rd October 2013 Lords Chamber

[Lord McFall of Alcluith (Lab)]

My Lords, I support the noble Lord’s amendment enthusiastically because the auditors were the weak link in the financial crisis. In terms of profits, the banks booked expected profits and then found out they were not there. So the question is: where were the auditors in that situation?

I was chair in 2007 when the Treasury Committee looked at Northern Rock. There were no meetings between the regulators and the auditors. The auditors of Northern Rock received more income from consultancy for Northern Rock than they did from audits. If I remember correctly, the auditors wrote 10 letters on behalf of Northern Rock, from which they gained £800,000. That is £80,000 a letter: not bad for a day’s work. Again, if I remember correctly, there were about seven meetings between the regulators and Northern Rock. At the time the mentality in the Financial Services Authority was the bigger the bank, the bigger the risk; the smaller the bank, the smaller the risk. Of these seven meetings, four were conducted by phone. Three were face-to-face, with no minutes taken. If you were the secretary of your local community council or your golf club and came up with such practice, you probably would not be the secretary at the end of the year. The regulator, however, kept on swanning along. That practice was a terrible practice—the voice of the auditor was missing.

The Treasury Committee report was clear. We said that within the limits of what they are required to do, perhaps the auditors did an adequate job. However, if they did an adequate job in terms of what they were required to do, the question remains: what is the point of an audit? That question continues to haunt the audit profession and it has not started to answer it.

The Government say there is talk about a code of practice, but in 2011 in a letter to the Economic Affairs Committee, Andrew Bailey of the Bank of England was very clear that,

“the working relationship between external auditor and the prudential supervisors had broken down in the period prior to the financial crises”.

So the code of practice does not work. The aim of this amendment is to ensure that there is a statutory basis so that no one can come along in future and say “That aspect was overlooked”. There has to be a serious duty on individuals to look at that.

From an accounting and disclosure perspective, RBS, Halifax and Northern Rock went down because of factors such as huge wholesale funding and property exposures. It was clear from the accounts two to three years previously exactly what the risks were, but nobody took heed. That is why the voice of the auditors has to be that much stronger. At the time, RBS shareholders approved the ABN AMRO deal by 95% to 5%, but that was just months before it collapsed.

When he was on the Economic Affairs Committee the noble Lord, Lord Lawson, asked John Connolly of Deloitte a pertinent question about auditing. The answer was that perhaps Deloitte would have had a different interpretation of “going concern” if it had realised that the Government were not standing behind the banks at the time. How flexible and flimsy is this focus on auditing from the auditors themselves?

There is a long way to go on audit, not just with regard to a statutory basis. There has to be a look at what auditing uncovers and what information it gives. I suggest that the Government look at three key features of an early warning system, having said that the auditors knew what the risks were before. First, there has to be a duty on auditors to raise these issues early with the supervisor. They knew what lay ahead if the reckless approach continued. Secondly, and very importantly, the auditors need to become more professional and sift large numbers of high-impact, low-probability events so that the regulator can understand what the risks are. Remember that the regulator was operating on the basis of business models—the profit and loss accounts of companies—which had nothing to do with the regulator, so they never looked at that. That is why we ended up with such huge scandals as PPI, interest rate swaps and whatever else. Business models are crucial to the regulator, as they should be to the auditors, so it is crucial to sift that large number of high-impact, low-probability events.

Given the point I made earlier about nobody taking heed, there needs to be an increase in credibility to ensure that all stakeholders pay attention to what auditors are saying. In terms of auditors and auditing and the link between auditors and the regulator, there has to be a less compliance-driven and more comprehensive approach. There has to be an enhanced role for the auditor as an independent expert to check and challenge all the trivial and complex issues that banks present. There has to be clear and unequivocal communication from the auditor to the company, and it is important that the regulator is aware of that information. From the auditors there has to be an insight into the company’s risk management system. More than anything, there has to be a universally consistent interpretation and application of standards. Given that we have to increase the confidence of the stakeholders by auditors, financial reporting needs to ensure that investors understand what is happening in a company.

The Government’s response to the commission’s report is totally inadequate. They said that they are,

“not convinced of the need to define the frequency of this dialogue in statute”.

The Bank of England has also said:

“The PRA has published a code of practice on the relationship between an external auditor and the supervisor”.

That code of practice, by the way, was ignored and jettisoned in the past. The FSA, given its culpability in Northern Rock, Halifax and the Royal Bank of Scotland, has the cheek to say that it supports an open dialogue with external auditors.

Andrew Bailey’s letter states quite clearly that the code of practice does not work. The empirical evidence states quite clearly that the auditors and regulators did not do their job in the past. If all we have is an exhortation to the financial community, auditors and regulators, to do things better, we will be back here in a few years. I therefore ask the Minister and the Government to look at this issue very seriously, and if they cannot give us a full answer today, to ensure that when we come back on Report and have had adequate time to look and present our amendments on that, at least we can have a positive way forward.

[Lord Flight (Con)]

My Lords, I strongly support these two amendments and the points made by the noble Lords, Lord Lawson and Lord McFall. I will add only the point that IFRS renders accounts virtually impenetrable, and fund managers have to convert them into a more understandable form of accounting to understand what on earth is going on within the organisation. I have been critical of IFRS for more than 10 years. The point was made to me initially that this was not a matter for Parliament but for the profession. It is of crucial importance to Parliament, because if it leads to things such as the banking mess, the nation at large is responsible. Secondly, as the noble Lord, Lord Lawson, pointed out, not only did it exaggerate profits in good times and create fictitious profits on the back of which excessive bonuses were paid, but it also exaggerates the other way in bad times, and therefore arguably can lead to an underappreciation of a bank’s strength. I had thought that France and Germany had some sympathy with this view and, notwithstanding other criticisms, I had been hopeful that the EU was looking to address this issue. I am disappointed that, to date, nothing seems to have happened.

I also make the point that, going back 20 years, Switzerland actually put a legal obligation on the auditors to do the compliance regulatory checking. The auditors were then liable if they had not done their job properly. I think it is a pity that Switzerland changed from that practice because I thought that it worked extremely well. I am not necessarily recommending it for this country but it was a novel idea, and the auditors ought to know what is going on within a bank if they have done their duty in auditing that bank properly. Switzerland has since changed its approach. Indeed, it was after it did so that Switzerland, too, encountered problems.

When the crisis broke in 2007-08, I asked myself: where were the auditors? Since then, candidly, there has been justified criticism of the regulators, but the issue of what the auditors were doing and why, and why bank accounts were so unsatisfactory, has not been adequately examined. I believe that the Treasury Select Committee has looked at this, but I am not sure whether it has done so in any detail. It is still quite an important issue and I believe that this Government should exercise pressure to effect reform of IFRS. In addition to the havoc it caused in the banking industry, it has also been significantly responsible for massive damage to our pension systems by overestimating the liabilities, especially when bond interest rates are artificially low. That has led to massive closure of justifiable defined benefit schemes. It really is a problem and it needs addressing.

Financial Services Bill

Debate between Lord McFall of Alcluith and Lord Flight

Wednesday 18th July 2012 Lords Chamber

[Lord McFall of Alcluith]

My Lords, I agree not with the pious nature of the amendment of the noble Lord, Lord Flight, but with the realism of my noble friend Lord Peston. I chaired a workplace retirement income commission last year for the National Association of Pension Funds. We have seen a flight from defined benefit schemes to defined contribution schemes. As a result, we invited a Harvard professor to examine and explain the defined contribution scheme. He told us that he was unable to understand his own defined contribution scheme, never mind anyone else’s. Therefore, while financial education may be good, it is not the whole show.

[Lord Flight]

My Lords, although I acknowledge the issue, I do not believe it is that difficult. I observe that my own parents learnt basic accounting some 90 years ago at ordinary grammar schools in London as part of the general certificate. That stood them in pretty good stead. Even in my time, when I was doing basic economics, what I learnt was pretty fundamental to understanding what equity was, what debt was, and so forth. The courses that are up and running are pretty effective—for example in my own school, of which I have been a governor for many years—although I do not say that they are perfect. One of the problems is that since the Second World War, money has almost been thought of as dirty within the educational world. This is something to shy away from. One of the crucial things is for the schools themselves to have staff who can be taught to teach and be enthusiastic about the subject.

Financial Services Bill

Debate between Lord McFall of Alcluith and Lord Flight

Tuesday 26th June 2012 Lords Chamber

[Lord McFall of Alcluith]

The rules do not include wrong policy and I never suggested that they did, but what I am saying is if there is a charged atmosphere in Parliament and there could be a scapegoat, perhaps the governor or a future governor would leave as a result of that. We must be mindful of that situation and I gave a parallel, if not an exact one, of what happened a few weeks ago on that particular issue. We also have the governor now being appointed for eight years. That was adopted after being suggested by the Treasury Committee and no one has commented on it in this Chamber. I think it is something which needs much more reflection from the Government.

The noble Lord, Lord Burns, spoke about the chairmanship of the court. I would suggest to the noble Baroness, Lady Wheatcroft, that this is a big challenge to the Bank of England, which at the moment is not perceived to have that challenge. That aspect of challenge is really important. I could give noble Lords an example from my time on the Treasury Committee. No names, but I was approached by the representatives of a number of non-executives during the financial crisis and asked if I would see them. They wanted to tell me about the situation on the board of their company and explain why no change was affected by them; my answer was, “Absolutely not. You’re on your own. If you’re a non-executive and you cannot challenge, you should not be on the board. You should leave the board as a result of that”. The aspect of challenge still resonates and we need that. It is the issue that the noble Baroness, Lady Kramer, was pointing to and the Minister needs to reflect on it.

The noble Lord, Lord Flight—if I can wake him up, no, I do not think I can—made the point about Mervyn King and economics teaching. He made the distinction that it was the economics teaching that was bad and not the present governor’s teaching—

[Lord Flight]

The former—

[Lord McFall of Alcluith]

Yes, the former, exactly. Economics has lost its way on this issue. I would point the noble Lords to a good letter in the Financial Times yesterday that said economists are there for the well-being of society and that they forgot that. There needs to be a fundamental rethink of the economics curriculum. When Alan Greenspan appeared before the Senate, he said the intellectual edifice that was built up has now crumbled as a result of that.

Other noble Lords have made the point that Amendment 5 is going too far, but we need reflection on it and I can understand where people are coming from. The noble Baroness, Lady Kramer, raised the issue of Parliament’s involvement and pre-appointment consultation. I think the Government can do something in terms of pre-appointment consultation, whether it is overt or covert. I would suggest that if they do not want any further annoyance at the other end of this building, they should reflect on that issue and come back with something in terms of pre-appointment. It can be done, it is feasible.

--- Later in debate ---

[Lord McFall of Alcluith]

My Lords, I beg to move this amendment in the name of the noble Baroness, Lady Noakes, and myself. It is quite a simple amendment. The principle behind it is that the external members of both the Monetary Policy Committee and the Financial Policy Committee should be in the majority, to counter groupthink within the Bank itself. The Treasury Select Committee had taken evidence on this and was very clear on it, as was the Joint Committee on the draft Bill, which recommended that there should be a majority of non-executives on the MPC. Both the Government and the Bank of England disagreed. The Bank of England said very clearly,

“Decisions about the relative numbers of internal and external members of the MPC and FPC are ultimately for Parliament.”.

If those decisions are for Parliament and there is a cross-party consensus on that, Parliament’s will should be observed in this case. The Bank made the point that,

“diluting internal membership to the point where the Committees could not be presented as distinctively Bank Committees would undermine the Government's purpose of asking the Bank to undertake these activities in the first place”.

If the Government feel, as they have said, that increasing the number of external members on the Monetary Policy Committee would make it unwieldy, given that that would take the number to 11, there is a simpler way of doing that. That is to ensure that there are two fewer members of the internal executive on the committee, which would result in the MPC’s internal members numbering four and its external members numbering five. When we talk about external members, I am very much aware of the experience that I had and that you can get groupthink with external members as well.

The concept of diversity is really important and, as was mentioned in other debates in the Chamber today, we should be ensuring that there is representation of women on the committee. The MPC and the FPC have exclusively all-male boards. There are women who were at senior level at the Financial Services Authority and who have now left—for example, Margaret Cole, who was the managing director of its conduct business unit. She made a great contribution in ensuring that the industry listened to the Financial Services Authority, and she made a lot of real improvements on insider dealing. Sally Dewar left the authority too. These women have left, so that needs to be taken into consideration here as well.

One concept that has not been addressed in the financial services industry overall has been the consumer. I battled for years to get a consumer representative on the Financial Services Authority, and we eventually got one on it. Let us think on a wider front and keep in mind the words of the former Monetary Policy Committee member Professor Charles Goodhart, who said, as someone echoed today, that if you are excluding 50% of the population then you do not have the best talent pool. Let us have external members, eliminate groupthink and let the will of Parliament prevail.

[Lord Flight]

My Lords, my two amendments follow those in the name of the noble Lord, Lord McFall, and are essentially probing. They up the stakes from having six members appointed by the Chancellor of the Exchequer to having eight and require that all members of the FPC are,

“sufficiently independent of the Bank of England”.

To me, the issue is this: the FPC will be crucial. Its job is to detect things going wrong in the financial system and to direct institutions to put things right if they are in trouble. My view is that if the FPC is just part of the Bank of England, it runs the risk of being overdominated by what I will call the Bank of England establishment. It is important that FPC members are independent and, if they can be persuaded, may be people with central bank experience from other economies, who are the sort of people who will be good at the job for which they are chosen.

That gives rise to another issue which I have only just appreciated. The wording is slightly ambiguous. The implication is that members of the FPC must be directors of the Bank of England, members of the court. That seems to be slightly questionable. I am not sure that all members of the Monetary Policy Committee are members of the court. The FPC is parallel to the MPC in its role, and it would not be satisfactory if the Court of the Bank of England got to such a size that it was unwieldy. I question, therefore, and think it might be worth considering, whether there should be the requirement that FPC members are directors of the Bank of England. That does not seem to add anything.

However, the main point is to achieve a body of people that delivers the job it is there to do. It is not directly relevant, but I am mindful that the one banking system that entirely escaped all the troubles of 2007-09 was that of the Lebanon. The governor of the Central Bank of Lebanon, who is a very wise old bird and has seen many things before, spotted the trouble coming in terms of mortgage instruments and kept the banks of the Lebanon out of it all in good time. We want an FPC that, whatever the next problem is that faces us, will be capable of steering in that sort of direction. The wider the experience it has, the better.