Bank of England Act 1998 (Macro-prudential Measures) Order 2013
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Lord Newby
That the draft orders laid before the House on 24 and 28 January be approved.
Relevant documents: 18th and 19th Report from the Joint Committee on Statutory Instruments, 26th Report from the Secondary Legislation Scrutiny Committee, considered in Grand Committee on 26 February
Financial Services and Markets Act 2000 (Regulated Activities) (Amendment) Order 2013
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Lord Newby
That the Grand Committee do report to the House that it has considered the Financial Services and Markets Act 2000 (Regulated Activities) (Amendment) Order 2013
Relevant documents: 19th Report from the Joint Committee on Statutory Instruments, 27th Report from the Secondary Legislation Scrutiny Committee.
Lord Newby
My Lords, the Government have been clear that the attempted manipulation of the London interbank offered rate is completely unacceptable and has no place in the UK’s financial services industry. That is why we moved quickly after the initial revelations emerged to ask Martin Wheatley, the chief executive-designate of the new Financial Conduct Authority, to consider what immediate reforms could be made. The Wheatley review, which was published in September, provides a 10-point plan to reform LIBOR, including recommendations to both government and market participants. The Government welcomed and endorsed the Wheatley review’s recommendations, and have asked all institutions to which they are addressed to implement them without delay.
The Government believe that the banks and the British Bankers’ Association have to take responsibility for their failings and act on Mr Wheatley’s recommendations, including the removal and replacement of the BBA as operational LIBOR administrator. HM Treasury and the BBA have been working together and have made significant progress in laying the foundations for this unprecedented process. The noble Baroness, Lady Hogg, is now leading an independent committee that will recommend an appropriate successor. This builds on the legislative changes that we have already made. Following the Wheatley review, we introduced the following amendments to the Financial Services Act, which are relevant to today’s debate, to enable benchmark activities to be brought within the scope of statutory regulation under FiSMA, and to create a new, distinct criminal offence for making false or misleading submissions in connection with the determination of benchmarks.
Following a period of consultation at the end of last year, the two draft orders that underpin these changes, which we are debating today, were laid before Parliament. Last week they were approved by the other place. The Government plan to bring both orders into force at the beginning of April. This will continue the Government’s approach of taking decisive action to reform LIBOR.
The first statutory instrument amends the Financial Services and Markets Act 2000 (Regulated Activities) Order, to denote that submitting to and administering a benchmark are both regulated activities. The draft order specifies LIBOR as the relevant benchmark. The regulation of these activities will enhance and strengthen the FCA’s ability to make rules on benchmark-setting, as well as its ability to supervise directly and take regulatory action against those involved in benchmark-setting processes. It will also implement a key recommendation of the Wheatley review. Under this order, the banks that submit to LIBOR and the successor to the BBA will be regulated by the FCA.
The draft order provides certain exemptions to these activities to cover information that was not created specifically for the benchmark-setting process. Where a person simply supplies publicly available factual data, such as the stock market closing price, to the administrator of a specified benchmark, their activities will not constitute submission to a benchmark. Similarly, if the administrator of the benchmark happens to subscribe to a general information service such as a newspaper, the provider of that service will also not be carrying out the activity of submitting to a specified benchmark. The draft order includes provisions to ensure a smooth transition to the new regulated regime for those currently involved in the setting of LIBOR.
Finally, the order makes two consequential changes to the definition of “consumer” for the purposes of the FCA’s objectives. These changes ensure that individuals whose rights, interests or obligations are affected by the benchmark are classed as consumers by the FCA in meeting its objectives.
The second order under discussion today underpins the new criminal offences created by the Financial Services Act, as recommended by the Wheatley review. The Government have been clear throughout the ongoing enforcement actions that any organisation or individual found guilty of this sort of wrongdoing must take full responsibility and should be punished, if appropriate, by the civil and criminal law. The Serious Fraud Office has launched a criminal investigation into allegations of LIBOR manipulation under the Fraud Act. However, the Government believe that the FCA should also have the powers to investigate and prosecute this type of conduct in relation to benchmarks in the future. Although the FCA will have powers to investigate misconduct in relation to LIBOR and other benchmarks, none of the offences currently provided for in FiSMA apply to misconduct in relation to the kinds of benchmarks revealed by the recent investigations.
To close this gap, the Government created a new criminal offence specifically related to benchmark misconduct in the Financial Services Act. The Government also took the opportunity to review and expand the existing offences which relate to misleading statements made with a view to inducing the recipient to engage in market activity. These offences are backed up by strong and dissuasive criminal penalties of imprisonment for up to seven years and an unlimited fine.
The draft order specifies the activities, investments and benchmarks to which these offences relate and carries forward the existing law which is needed to support the new offences. Article 3 of the new order specifies the benchmarks to which the new offence applies—specifically LIBOR. Rogue individuals may still attempt to manipulate the rate but if they do, the FCA will have the appropriate powers to investigate and prosecute them.
The amendments introduced to the Financial Services Act last year give the Government the power to regulate benchmarks beyond LIBOR through appropriate secondary legislation. While we have taken swift action to deal with LIBOR misconduct, this does not mean that other benchmarks should go unregulated. We have given serious consideration to whether we should extend regulation to other benchmarks where we believe there to be a risk of manipulation.
The Government consulted on the matter at the end of last year. In answer to the Government’s consultation, respondents argued that an international consensus and framework should be developed under the auspices of the International Organisation of Securities and Commissions, the Financial Stability Board and the European Commission before the scope of benchmark regulation is extended beyond LIBOR. Progress is being made on these international initiatives. The Government agree with the consultation respondents and have decided, for now, to apply those new provisions only to LIBOR. We continue actively to engage in and drive forward the international work on this issue. However, as we have done in the case of LIBOR, we stand ready to move ahead of international work streams and table further secondary legislation to extend the scope should we deem it necessary. I commend these orders to the House.
This group also includes the Uncertificated Securities (Amendment) Regulations, which amend the Uncertificated Securities Regulations 2001 to transfer responsibility for the approval and regulation of operators of securities settlement systems from the Treasury—which had delegated the responsibility to the Financial Services Authority—to the Bank of England. The regulatory arrangements for securities settlement systems have always been modelled on those for recognised clearing houses and recognised investment exchanges in Part 18 of FiSMA. The new powers and other changes to these regulations essentially follow the changes that the Financial Services Act 2012 makes to Part 18. Specifically, the regulations provide the Bank of England with new powers to require reports to be produced by skilled persons in respect of operators, to appoint investigators for the purpose of making inquiries about operators and to publicly censure operators in appropriate cases. In addition, the regulations replace the existing provision regarding the prevention of restrictive practices with provision for the purpose of preventing operators adopting excessive regulatory provision.
The final order in this group is the consequential amendments order. A number of changes to other pieces of legislation are required as a consequence of the regulatory reforms introduced by the Financial Services Act. The majority of these were included in Schedule 18 to the Act. However, a small number of amendments have required further consideration during the Act’s passage and are therefore being made through this instrument. Primarily, it amends references to the FSA’s rulebook in primary legislation, taking into account that both the PRA and the FCA will make rules in the new regulatory system. It also amends references to provisions of the Financial Services and Markets Act 2000 which have been amended by the Financial Services Act 2012. These orders are all necessary for the effective implementation of the Financial Services Act and, on this basis, I commend them to the Committee.
Lord Eatwell
My Lords, I thank the Minister for introducing these orders. I will take them in reverse order, so to speak, since the major issue of the amendments relating to LIBOR and its subsequent management is the most weighty, and we can take some of the later amendments perhaps more quickly and dispose of them.
First, as the noble Lord says, the consequential amendments refer primarily to the specification of which parts of the FSA rulebook are to be divided between the PRA and the FCA. This seems rather minor but has very significant consequences, because you are taking what was, we hope, an internally consistent document and ripping it apart. The question is therefore whether the consistency that existed in the previous document will be retained in the subsequent two documents. It would be helpful if the noble Lord could elaborate a little on that, particularly in the light of the recent arguments being made by Mr Haldane of the Bank of England, who has argued most strongly that the excessive number of pages of regulation should be significantly reduced in order to reduce complexity. If Mr Haldane’s rule is to be followed, will we end up, when these rulebooks are divided following these measures, with more pages or fewer? A particular element puzzled me in this particular order. In respect of Article 13, which amends the Corporation Tax Act 2009, can the Minister explain how transforming “Insurance Prudential Sourcebook” into “Prudential Sourcebook for Insurers” has any substance whatever?
Uncertificated securities is a very important area and there has been huge growth in electronic exchanges and uncertificated insurances of this type. The order refers at many points to the notion of excessive regulation by the managers or operators of electronic transfer systems. Can the noble Lord elaborate on who is to define “excessive” and, indeed, how it is to be specified? If there is to be some clarity in this law, it would help if the notions of “excessive” and “disproportionate”, which are used at several points throughout the order, were clearly defined. There was one other puzzle, rather like the puzzle I have about the Insurance Prudential Sourcebook, on which the Minister could perhaps help me. In the redefinition of responsibility from the Treasury to the Bank of England, it is clear that “Treasury” is a collective noun while “Bank of England” is singular. Why is that? Is it because the Bank of England is a singular person, namely the governor, whereas the Treasury has responsibility shared out more widely?
I now turn to the meat of the matters before us today, the orders referring to misleading statements and impressions, which essential collect a number of areas which will be responsible if other benchmarks should be developed rather than simply LIBOR, and of course to the major one on regulated activities. First, I was very struck by the list of organisations and responsibilities associated with misleading statements and impressions. In the noble Lord’s description of the creation of those lists, he referred to the possibility of further benchmarks being included within the procedures defined within the Act. He told us that these were now being considered internationally, and that we await international rulings on these matters. It seems that there is a stark contrast between the very prompt action that was taken following the Wheatley report in respect of LIBOR and the effective kicking into touch of all the other areas which are of equivalent importance. Can the Minister assure us that major benchmarks used within the City of London are not today being manipulated? Can he assure us that the delays in international consideration of these matters will not result in some of the same activities as we have seen with respect to LIBOR?
Baroness Kramer
My Lords, I shall try to keep my comments brief and, if I may, to follow the order in which the noble Lord, Lord Eatwell, addressed the orders to make life a little easier for the Minister. On those elements of the order that attempt to make sure that the FCA and PRA rulebooks appropriately intermesh, and on the comments of Andy Haldane on the risks that arise when you manage through rules rather than through structure, can the Minister give us some assurance that, behind the clarification of the rules, is the cultural commitment to act together as a coherent unit? The fear that Mr Haldane and others have expressed is that, once the institutions see rules, their first reaction is to attempt to game them. I suspect that it is not the number of rules that is the general concern but the coherence of the regulators in making sure that gaming is not a practice that they will permit.
The heart of today’s discussion is to do with LIBOR. I have a general question on the participation of banks in the LIBOR-setting process. It was the strong wish of many that more banks should participate in the process. At the moment, many seem in effect to get a free ride by allowing others to be the participants in the rate-setting process. They then use the rate across the many instruments and transactions that they sign up to, but because they did not participate themselves, they were in many ways getting a free ride, not exposing their internal positions to public view in the way that the participants were and making it much more difficult for other banks to compete against them when some were being transparent and others were not. I wonder where that process has got to. I understand that it was to be voluntary, and I do not know whether we have had any change in who is involved in rate-setting at this point or are likely to in the near future.
At the heart of my questions for the Minister are the sanctions of themselves. We all strongly support the new offence of making false or misleading statements and false or misleading impressions in the submission of benchmark information in the setting of a rate such as LIBOR. One of the underlying concerns has been the way in which the regulator approaches such violations, which is to come down increasingly hard on the individuals who have been clearly and directly involved in that false submission but not to look upwards to those who create the culture and environment in which that behaviour takes place. Tracey McDermott has said on several occasions that the appropriate way to enforce is to find the problem and then follow the trail and to stop questioning at the point where the trail goes cold. That obviously creates for senior management an advantage in wilful ignorance and makes it beneficial for them not to know in any detail what is happening in their organisation, certainly for there to be no trail that would be easy for a regulator to follow. Many of us have come to the conclusion that the regulator needs to have a way to look through that to make senior members of a company accountable for behaviour that is happening on their watch and which they do not know about through negligence, in a sense, rather than through deliberate deceit on the part of those carrying out the wrongful behaviour. Can the Minister make any comments about that?
The underlying concern is that the regulator has sanctions that are strong enough. Many of us have noticed the distinction between the kind of sanctions that a US regulator can use versus those available in the UK. I know that that is not a direct discussion within the order, but it is so closely tied to it that I wonder whether the Minister would comment.
Lord Newby
My Lords, I am extremely grateful to noble Lords who have contributed to the debate and will attempt to answer the questions they have raised. The first questions related to the effect of the tearing up, or bifurcation, of the rulebook and how continuity will be retained. I hope that the cultural commitment which the noble Baroness, Lady Kramer, mentioned, pervades those at the head of the new organisations and that it will be carried forward. In formal terms, consistency will be maintained by the operation of the memorandum of understanding between the two bodies, the PRA and the FCA, which we discussed in relation to other orders last week.
This is of course not the first time that there has been an attempt to reduce the number of pages. The FSA at one point consulted on it, but the answer it got back was, “Actually, we do not want the number of pages reduced significantly, because they tell us what to do, and if you reduce the number of pages, that puts more of a requirement on us to exercise our own judgment”. That is the balance that we are grappling with here. On the one hand, everybody wants less regulation, but when the consequence of less prescriptive regulation is that people have to exercise more of their own judgment, sometimes they become less keen.
Lord Eatwell
The noble Lord has put his finger on absolutely the point that Mr Haldane was making, which is that the excessive complexity of regulation these days is actually being trapped in a game between the regulated and the regulators; as the regulated develop yet more complex instruments, the regulator responds with more complex regulation, and then the regulated respond with more complex instruments to evade the regulations that have just been introduced. The whole point of Mr Haldane’s argument was that there should be a much stronger and simpler structure and that chasing complexity was a fundamental mistake. Complexity in regulation just adds complexity in taxation, which is the origin of successful evasion.
Lord Newby
My Lords, I have a lot of sympathy with that view. Of course, one of the reasons why, in a slightly different bit of the forest, we are introducing the general anti-abuse rule is to start moving away from a situation in which the regulator is not only almost institutionally behind the game but responds to problems by having to produce vastly long and complicated legislation, which is why the tax code is as long as it is today.
The noble Lord also asked who defines “excessive”. The use of “excessive” is not new and it follows the existing FiSMA provisions. It means not required by UK or EU law; not justified by reasonable regulatory objectives; or disproportionate to any regulatory objectives. So there is a definition and I am glad that I do not have to administer that.
The noble Lord asked why the Treasury is plural and the Bank of England singular. I am sure he will be interested to know that the Treasury is defined in the Interpretation Act 1978 as,
“the Commissioners of Her Majesty’s Treasury”.
This reflects the fact that, for historical reasons, the Treasury has acted through two or more Lords Commissioners rather than a single Minister. I am extremely pleased to know that there is a rationale for that.
The noble Lord asked, in respect of the misleading statements order and the LIBOR orders more generally, about adding further benchmarks, and whether I can be sure that these are not being manipulated now and that delays will not lead to some of the same activities in respect of the other benchmarks. We do not think they are being manipulated now. By definition with these things, one does not always know until long after the event that people are behaving badly, but there is no indication that by sticking to LIBOR at the moment any illicit activities are taking place. We are putting most of our effort into international discussion on these issues at the moment but the legislation is very clear: we can add additional benchmarks unilaterally by secondary legislation if we feel that we need to do so, but at the moment we do not feel that we are in that position.
The noble Lord asked about interim permission. Interim permission is being given to the person who is administering LIBOR on 1 April and to those banks that are submitting to LIBOR. It is being given so that the new regulatory regime can start without any delay and before the longer-term reorganisation of the LIBOR system is in place.
Lord Eatwell
I see that, but to whom is interim permission being given—by whom and to whom?
Lord Newby
I believe—and I stand ready to be corrected—that it is being given to the existing LIBOR setting structure until the new one is in place. If I am wrong, I am sure that I will be corrected reasonably quickly. Indeed, it is being given to the BBA by the FCA because they are responsible for the administration of the system.
The noble Lord asked about the manipulation of LIBOR. The FSA investigation uncovered activity causing significant concern and that was the impetus for the process that we have set in place. Criminal proceedings are ongoing and we hope they come to a speedy conclusion. It was because of a view that LIBOR may well have been manipulated that changes in the legislation took place. We will get to the bottom of the past activity via the criminal investigation but the great thing about what we are doing now means that if there are any future suggestions of wrongdoing, we shall be able to deal with them very quickly.
There were a number of questions about the Hogg committee, how that is proceeding, the type of firm likely to apply and conflicts of interest. The committee just launched the tender process last week. We hope that it will be concluded by the summer. It will be considering the question of conflicts of interest and, at this stage, we are not in a position to say who is going to apply. A number of firms and organisations have put their heads above the parapet to say they are interested but because we have only just started the tender process, we cannot be sure whether they will actually come forward.
The noble Baroness, Lady Kramer, asked about the free ride and whether, when the new benchmark is up and running, more banks will be encouraged to participate in it. That is something that the new managers of the benchmark will need to consider and no doubt they will be looking at it in consultation with the FCA. The noble Baroness asked whether the new legislation would enable and encourage the regulator to follow the trail, so that it is not just looking at the individual trader who is misbehaving but goes up the supply chain. The key thing is that, for the first time, the regulator will be able to look at this all in a systematic way. It has now got the powers to do so and I think that because everybody accepts that it was very serious that LIBOR was being—as appears likely—manipulated in the past, the new penalties and regulatory framework will give the FCA plenty of opportunity to do that.
In terms of whether the sanctions are strong enough, there is no problem about the regulations because there can be an unlimited fine. If we in the UK levy a lower fine than in the USA, this has nothing to do with the legal position. If there is a difference, it is because there is a difference in the minds of the regulators.
The only other question from the noble Lord, Lord Eatwell, which I have not answered—although I will look at the record afterwards and write to him if I have missed anything else—was why an amendment to the Corporate Tax Act is required. I am told that an amendment is needed to reflect the terminology that will be used by the PRA. With these answers, I commend the orders to the Committee.
Financial Services Act 2012 (Misleading Statements and Impressions) Order 2013
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Lord Newby
That the Grand Committee do report to the House that it has considered the Financial Services Act 2012 (Misleading Statements and Impressions) Order 2013
Relevant documents: 18th Report from the Joint Committee on Statutory Instruments, 27th Report from the Secondary Legislation Scrutiny Committee.
Financial Services Act 2012 (Consequential Amendments) Order 2013
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That the Grand Committee do report to the House that it has considered the Financial Services Act 2012 (Consequential Amendments) Order 2013
Relevant document: 18th Report from the Joint Committee on Statutory Instruments.
Uncertificated Securities (Amendment) Regulations 2013
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That the Grand Committee do report to the House that it has considered the Uncertificated Securities (Amendment) Regulations 2013
Relevant document: 18th Report from the Joint Committee on Statutory Instruments.
Social Security (Contributions) (Re-rating) Order 2013
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That the Grand Committee do report to the House that it has considered the Social Security (Contributions) (Re-rating) Order 2013
Relevant document: 18th Report from the Joint Committee on Statutory Instruments.
Lord Newby
My Lords, I am pleased to introduce the Social Security (Contributions) (Limits and Thresholds) (Amendment) Regulations 2013 and the Social Security (Contributions) (Re-rating) Order 2013 to the Committee. As both the regulations and the order deal with national insurance contributions, I hope the Committee will agree that it is sensible that they be debated together. As a matter of course, I confirm that the provisions in the regulations and the order are compatible with the European Convention on Human Rights.
All the changes covered by these two instruments were announced as part of the Chancellor’s Autumn Statement on 5 December last year. I should confirm from the start that the basis of indexation that has been used to calculate the changes covered by these two instruments is the same as that used for the 2012-13 tax year. In the Budget in March 2011, we announced that, from the 2012-13 tax year, the basis for indexation of most NICs rates limits and thresholds would be the consumer prices index instead of the retail prices index rate of inflation. This is because the Government believe that the CPI is the most appropriate measure of the general level of prices.
I will start with the Social Security (Contributions) (Limits and Thresholds) (Amendment) Regulations. These regulations are necessary in order to set the class 1 national insurance contributions lower earnings limit, the primary and secondary thresholds, and the upper earnings limit for the 2013-14 tax year. The class 1 lower earnings limit will be increased from £107 to £109 per week from 6 April 2013. The lower earnings limit is the level of earnings at which contributory benefit entitlement is secured. However, NICs do not need to be paid by the employee until earnings reach the primary threshold. The class 1 primary threshold will be increased to £149 per week from 6 April 2013. The secondary threshold is the point at which employers start to pay class 1 NICs. In line with the commitment in the Budget in 2011, this is being increased by RPI to £148 per week.
From this April, the personal allowance for people born after 5 April 1948 will be increased above indexation by £1,335, from £8,105 to £9,440—the largest ever cash increase. As part of that increase, the basic rate limit will be reduced by £2,360 to £32,010. This means that the point at which the higher rate tax kicks in will be reduced to £41,450 in 2013-14. As I mentioned, the upper earnings limit is not subject to CPI indexation. In order to maintain the existing alignment of the upper earnings limit with the point at which higher rate tax is paid, the upper earnings limit will be reduced to £797 per week.
The regulations also set the prescribed equivalents of the primary and secondary thresholds for employees paid monthly or annually. There will be no changes to NICs rates in 2013-14. Employees will continue to pay 12% on earnings between the primary threshold and the upper earnings limit, and 2% on earnings above that. Employers will continue to pay contributions at 13.8% on all earnings above the secondary threshold.
The social security regulations set out the NIC rates and thresholds for the self-employed and those paying voluntary contributions. Starting with the self-employed, the order raises the small earnings exemption below which the self-employed may claim exemption from paying class 2 contributions. The exemption will rise in April from £5,595 to £5,725 a year. Many self-employed people choose to pay those contributions to protect their benefit entitlement, even though they may claim exemption from paying class 2 contributions. The rate of voluntary class 3 contributions will also increase, from £13.25 to £13.55 a week.
Today’s measure also sets the profit limits for class 4 contributions. The lower profit limit at which these contributions are due will increase from £7,605 to £7,755 a year, in line with the increase to the class 1 primary threshold. At the other end of the scale, the upper profit limit will be reduced from £42,475 to £41,450 for the 2013-14 tax year. This is to maintain the alignment of the upper profit limit with the upper earnings limit for employees. The changes to the class 4 limits will ensure that the self-employed pay contributions at the main rate of 9% on a similar range of earnings to employees paying class 1 contributions at the main rate of 12%. Profits above the upper limit are subject to the additional rate of 2%, in line with the 2% paid by employees. I commend the order to the Committee.
Lord Eatwell
My Lords, these measures are pretty straightforward and I do not have many comments to make, other than that I noticed that in the noble Lord’s introduction, although he made the traditional argument for CPI over RPI, he mentioned particular rates with respect to RPI. Those are clearly elements which are grandfathered within the social security structure. Are those RPI upratings to be maintained over the medium term, or is this a transitional arrangement? I have lost that in the complexity. That is entirely my failing and I should be grateful if the Minister would help me.
Secondly, and more broadly, can the Minister address the issue of entitlements? Both measures refer to securing entitlements, and that is particularly true with respect to the order on contributions. The whole notion of an entitlement is that one has some predictive expectation of returns, but we know today that there is no such predictive entitlement to returns. Governments—I do not say just this Government—change the pension rules upratings with respect to pensions and the pension age. So the entitlement that individuals are acquiring by making those contributions is simply in the hands of this and any future Administration.
Is that an appropriate way of going about that? The whole notion of national insurance was introduced as insurance—as a relationship, therefore, which would be defined between contribution and entitlement. That relationship has now broken down. Should we be rethinking on what basis the relationship between individual contributions and subsequent returns is calculated?
Lord Newby
My Lords, I thank the noble Lord for his comments. On the first point, perhaps I should have said that the RPI, as opposed to the CPI, is used in respect of the secondary threshold and the upper earnings and upper profit limits. Do the Government intend to maintain that in the medium term or to phase it out? We have said that the RPI increase will be for this Parliament, so we have no immediate intention to phase it out.
On entitlements under national insurance legislation and the fact that the Government change the rules, the problem here, I suspect, is that, as the noble Lord said, the link between paying into national insurance and what one gets by way of benefits from the system is very weak. We have gone a long way from the Lloyd George principle, when it was all very straightforward. Because the situation is much less clear than it was when the system was established, it will be quite difficult for the Government either to link national insurance payments more closely to entitlements or to merge income tax and national insurance into a single payment, which I know that my party and others and the Government have considered. We have ended up with a complicated system which succeeds in generating, broadly speaking, the amount of money required to fund the welfare state. I cannot see in the near future, and certainly not in this Parliament, a fundamental rethink about how we do that.
Social Security (Contributions) (Limits and Thresholds) (Amendment) Regulations 2013
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That the Grand Committee do report to the House that it has considered the Social Security (Contributions) (Limits and Thresholds) (Amendment) Regulations 2013
Relevant document: 18th Report from the Joint Committee on Statutory Instruments.
Public Service Pensions Bill
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Lord Newby
My Lords, this group contains a large number of technical amendments. Amendment 1 reflects the fact that some of the obligations in the Bill are set in the main clauses and not in scheme regulations. This means that the drafting of Clause 3, which allows only for consequential, supplementary, incidental or transitional changes as a result of provisions in scheme regulations, leaves a theoretical gap in powers that we would like to plug. If such changes were required solely as a result of provisions in the Bill rather than in scheme regulations, we might not be able to do so without making new primary legislation. We do not believe that that would be appropriate, so the amendments in this group seek to address the slight gap in the current drafting.
Of course, this extends the powers to cover only consequential, supplementary, incidental or transitional changes that result from clauses that have been debated at length in both Houses. Parliament is already aware of the desired effects of the Bill. These powers ensure that the effects can be realised. As we discussed on Report, any use of these powers to amend primary legislation could only be for consequential purposes and to Acts that have already been passed. I therefore hope that noble Lords can support this small but sensible amendment.
Amendments 4 and 5 are minor technical amendments. They are simply to provide consistency throughout the Bill in the form of cross-references to Schedule 4 to the Pensions Act 1995. They ensure that the same format is used in Clauses 34 and 35 as is used in Clause 10.
Amendments 8 and 9 are again minor amendments intended to clarify the wording, in this case of amendments I brought forward on Report. Noble Lords will recall that those amendments give schemes flexibility to define pensionable earnings for the purpose of the final salary link, and also safeguard the value of members’ final salary benefits. The safeguard is that the amount of earnings in the new scheme that are pensionable earnings for the purpose of the final salary link must not be materially less than the amount that would have applied had the person been in the old scheme until the point they eventually left service. The amendments simply clarify the safeguard. They make it clear that it applies to what would have been the person’s pensionable earnings had that person been in active service in the old scheme or deemed transfer scheme, rather than the new scheme. They would, of course, not have been in actual active service in those schemes after 2015, since they would have been in active service in the new scheme instead. The amendments do not change the substance of the meaning of the previous amendments in any way, but are just clarificatory.
Amendment 10 is concerned with circumstances where a pension that is calculated in accordance with the final salary link has been put into payment and the person subsequently returns to public service employment. It is designed to allow flexibility for schemes to continue their current treatment of a final salary pension in payment in such circumstances. Our intention is for the final salary link to accord with the rules on final salary benefits in each scheme that are currently in force. Some schemes currently allow the final salary benefits to be recalculated after a period of re-employment. The provisions in Schedule 7 allow this approach to continue where there is continuity of service, as provided for in paragraph 3. However, many schemes currently treat final salary benefits that have already been put into payment as fully crystallised, and consequently unaffected by any future period of employment in scheme service. Our amendment would allow for scheme regulations to provide that this continues to be the case too, if desired. Rules of existing schemes can also continue to provide for some limited aggregation of periods of employment, as some do at the moment. This amendment assists schemes in the implementation of the recommendation of the noble Lord, Lord Hutton, to honour the benefits built up under the current final salary schemes.
Amendment 11 consists of a series of minor, consequential amendments to the Pensions (Increase) Act 1971. It clarifies how the uprating provisions of that Act apply to those with service in both an existing scheme and a new one. The 1971 Act provides for the uprating of pension benefits for deferred and pensioner members of the public service schemes. The intention is that while a person is a member of a new scheme after 2015, and they have also old scheme benefits, those old scheme benefits should be treated for uprating purposes as though they remained an active member. This should remain the case until the member takes the old scheme pension or leaves the new scheme. This means that for those persons whose existing scheme is a final salary scheme, their benefits in that scheme will be uprated through the final salary link provisions in Schedule 7 to the Bill. For those persons whose existing scheme is a career average scheme, their benefits should continue to be revalued as if they remained an active member. This amendment clarifies how the provisions in the Pensions (Increase) Act apply in the circumstances I have just described.
Where people continue in service, the old scheme benefits should not be treated as deferred from 2015. To do so would mean that those benefits would be uprated in line with prices from 2015, which would run counter to the treatment of old scheme benefits recommended by the noble Lord, Lord Hutton.
The final amendment in this group relates to an amendment I introduced on Report to paragraph 30 of Schedule 8. This paragraph amends Schedule 4 to the Legal Aid, Sentencing and Punishment of Offenders Act 2012 to enable those active members of the Legal Services Commission pension schemes to transfer into the Civil Service scheme on 1 April 2014 to have full access to the transitional provisions contained in Clause 18. This subsequent amendment is a minor tweak to paragraph 30 to ensure that, in addition to those active members, deferred members of the LSC pension schemes who rejoin within a five-year period will also benefit from the transition provisions. This is entirely consistent with wider government policy on the treatment of deferred members of public service pension schemes. It will ensure that employees of the LSC are not unfairly disadvantaged by the changes to their pension provision. I beg to move.
Lord Eatwell
My Lords, I am grateful to the noble Lord for explaining the content of these essentially technical amendments. I particularly welcome the approach, which is in accord with the recommendation of my noble friend Lord Hutton.
I have but one question of the noble Lord, and that is why his remarks were not prefaced by an apology to the House for having put down these amendments as late as 5 pm yesterday afternoon.
Lord Newby
My Lords, I have my apology prepared and I will now give it. I thought it was the next group of amendments about which the noble Lord was particularly concerned.
I apologise to the House for the late tabling of these amendments. There is nothing sinister about it. As noble Lords will have understood, I hope, from my explanation of them, they were extremely minor technical amendments. The reason for the delay was simply to ensure that all legal issues had been adequately addressed in the final drafting. I had hoped we could have done it sooner, but that was the sole reason for the delay in the amendments being submitted. I repeat, I am sorry that we did not do it earlier.
Lord Newby
(a) the affirmative Commons procedure, if the order specifies a percentage decrease for the purposes of subsection (2), and(b) the negative Commons procedure, in any other case.”
Lord Newby
My Lords, on Report, I asked the noble Lords, Lord Whitty and Lord Eatwell, to withdraw their amendments on the revaluation order because of my intention to return with an amendment of my own. I said that I would consider the parliamentary procedure for the revaluation order where it specifies a negative figure, and the amendments that I have tabled, albeit at the last minute, are in line with that commitment.
As I have made clear on several occasions before, it would be wrong to rule out revaluations that set out negative figures on the very rare occasions where either the CPI or earnings were in negative territory. This would be unfair to the taxpayer and represent an asymmetric sharing of risk, which was specifically referenced by the noble Lord, Lord Hutton, in his report.
The amendments that I have brought forward do not affect the ability to track growth directly. I do not wish to rehearse at length the strong arguments I have deployed in the past. However, these amendments increase the level of parliamentary scrutiny in the highly unlikely event that we see negative growth. Where the Treasury order sets a negative figure, which I remind the House it can determine only on reasonable and justifiable terms by reference to the general level of prices or earnings, the order will be subject to the affirmative procedure. This will ensure that Parliament has an opportunity to debate the measure. Given the uniqueness of a situation in which the revaluation of benefits could lead to a decrease in entitlement, the Government believe that this is an appropriate and sensible additional safeguard of members’ interests.
However, I should point out that the vast majority of the revaluations will involve run of the mill legislation that simply sets out the relevant increases in line with announced government policy. For example, if the new schemes are already in place, the order for this year would simply set out the positive change in prices in line with the CPI and the positive change in earnings in line with the average weekly earnings measure. Both of these have been in the public domain for quite some time.
When we are not experiencing something extraordinarily unusual such as negative growth, it would go too far to provide for the affirmative procedure for every order as provided for in the amendment of the noble Lord, Lord Eatwell. Therefore, I hope that the noble Lord will understand why I am not able to accept his amendment. The Government’s amendments strike the appropriate balance between parliamentary scrutiny and sensible regulation-making. I hope they will provide some comfort and that noble Lords will be able to support them. I beg to move.
The Lord Speaker (Baroness D'Souza)
I should advise your Lordships that if this amendment is agreed to I cannot call Amendment 3 for reason of pre-emption.
Lord Newby
Lord Newby
Lord Newby
Lord Newby
“( ) In this Act, the “affirmative Commons procedure”, in relation to a Treasury order, means that the order may not be made unless a draft of the instrument containing it has been laid before, and approved by resolution of, the House of Commons.”
Lord Newby
Lord Newby
“3A After section 8 of the Pensions (Increase) Act 1971 there is inserted—
“8A Section 8(2): references to “service”
(1) In a case where—
(a) paragraph 1 or 2 of Schedule 7 to the 2013 Act (final salary link for persons who remain in old scheme for past service) applies in relation to a person, and(b) the person’s final salary falls to be determined by reference to that paragraph,references in section 8(2) above to the service in respect of which a pension is payable include the person’s new scheme service (within the meaning of Schedule 7 to the 2013 Act).(2) In a case where—
(a) a person is a member of a relevant old scheme by virtue of pensionable service for that scheme (“the relevant old scheme service”),(b) the person is also a member of a scheme under section 1 of the 2013 Act or a new public body pension scheme (“the new scheme”) by virtue of pensionable service for that scheme (“the new scheme service”),(c) the relevant old scheme service and the new scheme service are continuous, and (d) the person’s employer in relation to the relevant old scheme service is the person’s employer in relation to the new scheme service (or any other employer in relation to the new scheme),references in section 8(2) above to the service in respect of which a pension is payable include the person’s new scheme service.(3) In this section—
(a) “relevant old scheme” means a career average revalued earnings scheme (within the meaning of the 2013 Act) to which section 18(1) or 31(2) of that Act applies (restriction of benefits under existing schemes);(b) “employer”, “new public body pension scheme” and “pensionable service” have the same meanings as in that Act.(4) For the purposes of subsection (2)—
(a) paragraphs 3 and 4 of Schedule 7 to the 2013 Act (continuity of employment etc) apply as they apply for the purposes of paragraphs 1(2) and 2(2) of that Schedule;(b) regulations under section 1 of the 2013 Act (in the case of a new scheme under that section) or rules (in the case of a new public body pension scheme) may provide that where a pension is in payment under a relevant old scheme, references in section 8(2) above to the service in respect of which a pension is payable do not include any subsequent period of pensionable service in relation to a scheme under section 1 of the 2013 Act or a new public body pension scheme.(5) Provision made under subsection (4)(b) may in particular be made by amending the relevant old scheme.
(6) In this section, “the 2013 Act” means the Public Service Pensions Act 2013.””
Bank of England Act 1998 (Macro-prudential Measures) Order 2013
Lord Newby Excerpts(11 years, 2 months ago)
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Lord Newby
That the Grand Committee do report to the House that it has considered the Bank of England Act 1998 (Macro-prudential Measures) Order 2013.
Relevant documents: 18th Report from the Joint Committee on Statutory Instruments, 26th Report from the Secondary Legislation Scrutiny Committee.
Lord Newby
My Lords, the background to these regulations is the failure of the previous system for regulating financial services to provide clear responsibility for financial stability, which was shared in an opaque way between the Treasury, the Bank of England and the FSA. This meant that it has been all too easy for the identification and management of risks to financial stability to fall between the cracks in what those organisations believed were their respective roles in protecting and promoting stability in the financial sector. That confusion was a key contributing factor to the emergence of the financial crisis in 2007. None of those three institutions was effectively horizon-scanning to identify macroprudential risks to stability across the system as a whole.
In the light of those failings, the Financial Services Act gives the Bank of England clear responsibility for financial stability. The Bank will no longer,
“contribute to protecting and enhancing”
financial stability; it will “protect and enhance” it. To support this objective, the Act creates a new committee of the Bank, the Financial Policy Committee, with a role of identifying, monitoring and managing systemic risks to the UK financial system. In order to carry out this role, the FPC will need macroprudential measures to mitigate the risks to stability that it identifies.
The FPC will act through the regulators that work directly with financial institutions. The FPC will do this in two ways: primarily through recommendations, which can be made to the regulators, to industry, to the Treasury, within the Bank and to other persons—and, where appropriate, through directions to the PRA and FCA. The FPC’s direction power will be limited to the measures set out in this order. The regulators must comply with a direction but they will have discretion over the timing and implementation method of the direction.
Before discussing the measures that will be granted to the FPC, it is worth noting that there is international consensus on the need for macroprudential regulation. International regulations such as Basel III and CRD4 go some way towards establishing minimum standards while retaining room for national discretion, although areas such as the leverage ratio remain under discussion. The UK strongly supports the ability of national supervisors to exercise discretion where appropriate.
In February 2011, the Government and the Bank established an interim FPC to undertake, as far as possible, the work of the statutory FPC ahead of the passing of the relevant legislation. One of the tasks set for the interim FPC was to analyse and recommend macroprudential measures for which the statutory FPC should have direction-making powers. Following the interim FPC’s recommendations in March 2012 on the tools that the committee should have, the Government consulted on these tools, seeking comments on our intention to: make the FPC responsible for setting the level of the UK’s countercyclical capital buffer; provide the FPC with a direction-making power to impose sectoral capital requirements; and provide the FPC with a time-varying leverage ratio direction-making tool, but no earlier than 2018 and subject to a review in 2017 to assess progress on international standards.
The statutory instrument relates to the ability to set the sectoral capital requirements, or SCRs. I will deal with this tool first, then briefly cover the others. The interim FPC recommended that the statutory FPC should have a power of direction to vary financial institutions’ capital requirements against exposures to specific sectors over time, arguing that often the overexuberance that precedes crises begins in specific sectors before spreading further. The Government agree that this targeted approach would allow these risks to be managed in a more effective and proportionate manner than raising capital requirements more generally.
There are, of course, risks associated with the use of these tools. Although the majority of respondents to the Government’s consultation supported the introduction of SCRs, some noted that the FPC risked being perceived as applying an industrial policy via the application of sectoral capital requirements. The FPC has stated that it would wish to avoid an “overly activist, fine-tuning approach”, which should limit this risk. However, there may be times when using the tools in a granular way would be necessary. The Government will keep the use of this tool under review to ensure that it is being used in an effective, proportionate way. There is also a risk that imposing sectorally specific requirements would merely displace excessive risk-taking in other sectors. The FPC will need to monitor carefully the impact of any policy interventions using this tool and may need to consider adjusting more general capital requirements if displacement is a significant problem. I should take the opportunity to highlight one change that the Government have made to the order since the version that was published for consultation. The current order excludes investment firms that are not regulated by the PRA from the FPC’s SCR power. This will ensure that systemically important firms are captured, while smaller firms are not subject to additional requirements.
I now move on to discuss briefly the other macroprudential tools that the Government intend to give the FPC: the role of setting the UK’s countercyclical capital buffer—the CCB—and from 2018, the power to intervene to limit leverage ratios. These are not covered by the draft order, but give useful context to the debate. The CCB is part of the Basel III agreement and will be implemented in Europe by the capital requirements directive, known as CRD4. It aims to ensure that banking sector capital requirements take account of the macrofinancial environment in which banks operate. It will be deployed by national jurisdictions when excess aggregate credit growth is judged to be associated with a build up of system-wide risk to ensure that the banking system has a buffer of capital to protect it against future potential losses. Requiring banks, building societies and larger investment firms to build up capital during periods of overexuberance should help to increase the resilience of the financial system and might also dampen the credit cycle. Unwinding these requirements in the downturn once the particular threat has passed might help to mitigate contractions in the supply of lending. It is clear that with its macroprudential focus, the FPC will be the body best placed to determine the level of the CCB. This was supported by the results of the Government’s consultation.
As the CCB is expected to be provided for in the CRD4, the simplest way to incorporate it into UK law is via regulations made under Section 2(2) of the European Communities Act 1972 to transpose into UK law the provisions of the CRD4 which relate to the CCB. It is vital that the FPC’s decisions in relation to the CCB should be subject to comparable procedural and reporting requirements to the FPC’s other tools. Therefore, in addition to the requirements imposed by the EU legislation, the Government intend to ensure that the CCB will be subject to the same transparency requirements as other FPC decisions, with a summary of the FPC’s discussions when taking decisions on the CCB set out in the FPC’s meeting record and the FPC’s use of the CCB covered in the biannual FSR. The Government will make any necessary changes to achieve this in the regulations which incorporate CRD4 into UK law.
Lord Eatwell
My Lords, that was interesting introduction to this order as it spent most of its time discussing measures that are not included. It also began with a preamble that was an extraordinary rewrite of history, referring to a failure to identify macroprudential risks prior to 2008. Will the Minister specify any Government or regulatory document that includes a reference to macroprudential risk before 2008 and before publication of the Turner review? He will be hard put to find it. There are some academic articles on systemic risk but the whole issue of macroprudential risk was simply not on the horizon at that time.
I was also somewhat distressed to find that the Government still believe that following the Basel III approach of using capital related to risk-weighted assets is still at the centre of the approach to the determination of stability, particularly in the banking sector. This is using weapons with which we fought the last war to try to deal with the new war. It is an excessive emphasis on the asset side of the balance sheet to the detriment of the liability side, and indeed has been criticised very strongly recently by the IMF. I hope that the Government will rethink their approach and not continue to rely on this outdated measure.
I want to talk about some of the measures before us rather than some that might appear in the future, although the Minister has tempted me to ask what is happening with the leverage ratio. Leverage collars, which after all apply to the liability side of the balance sheet, have been demonstrated to be far more effective than risk-weighted capital requirements. Do the Government still plan to weaken the Vickers proposal of a leverage ratio of 25:1 and to fix the requirements simply on the Basel minimum of 33:1? When thinking about the leverage ratio, is the FPC planning any distinction between deposits and wholesale funding in the specification of a leverage cap?
In its earlier consideration of these measures, the FPC rejected the adoption of a loan-to-value ratio in mortgage finance, arguing that this was a political decision. In this instrument, though, we find the requirement on financial institutions to maintain additional own funds with respect to exposure to residential property. Will that not have the same effect? Is it not a back-door method of introducing loan-to-value restrictions by the requirement to hold additional capital against residential exposures?
Turning to the sectors specified in this instrument, it is striking that the measures are confined to financial instruments issued by financial sector firms. Why is that? If there were a bubble in the stock market, it could involve predominantly financial instruments issued by non-financial firms. Why is this legislation restricted only to instruments issued by financial institutions?
Another peculiarity of the drafting of this instrument is that it refers only to an increase in requirements of holding of own funds. It refers to “additional funds required” and that the PRA may require additional own funds both by banks and by other financial institutions. How will the PRA reduce the amount of funds required since the instrument only allows it to require additional funds? How will that happen?
I also regret the exclusion of smaller firms, to which the noble Lord referred in his introductory remarks. The Treasury seems to have totally failed to understand that a significant amount of the financial crisis was due to the aggregation of a large number of small firms doing the same thing at the same time, which had the same consequence as a large firm doing the similar thing in terms of the development of systemic risk.
The measures also refer to the requirement to ask or require that banks treat particular exposures as if they give rise to an increased level of risk, which is true not just of banks but also of investment firms. How is this level of risk to be specified by the FPC? Is it as a risk weight or as a modification of the stochastic distribution model used in the calculation of the firm’s value at risk? How is it to be done? If it is with respect to the modelling, does that now mean that the ability of firms to use their own risk models is to be modified and that there is to be a standardisation of risk models used by firms in the calculation of capital requirements?
The noble Lord referred to the use of these measures in what he called a granular way and what in the instrument is referred to as a solo basis. What will the relationship be between the FPC’s requirements of measures and competition policy, in the sense that imposing measures on a single firm would have competition implications? Will the views of the competition authorities be taken into account?
I assume that this is the first of a series of instruments that will implement the various proposals aired in the consultation papers issued by the interim FPC. Perhaps it would be helpful if the Minister gave us some timetable as to when those other instruments will be laid before the House.
Lord Newby
I am grateful to the noble Lord for those extremely thoughtful questions, and I will do my best to answer them. He said that systemic risk was not on the horizon before the crisis. I think that the phrase was first used in academic literature in 1979. Although the phrase was not in common parlance, it was well understood, at least by some people, that a bubble was building up that was capable of creating systemic risk. The first problem was that it took a long time for the authorities and the Government to accept that there was a bubble. The second was that when they realised that there was a problem, and indeed when there was a crisis, it was far too late to forestall it. It was then necessary to deal with a crisis rather than dealing with a problem at an early stage.
The noble Lord said that we rely far too much on Basel III and that it is a weapon of the last war. We are part of an international discussion on Basel III. Although Basel III is part of the armoury that we use, it is only one part. Indeed, the measure that we are looking at today is not a Basel III measure. Even if the noble Lord was correct that Basel III does not deal with every issue that we will be grappling with, it is not the only tool that we are looking at.
The noble Lord asked me about the leverage ratio, and whether we still plan to weaken the Vickers ratio. I do not believe that the Government’s view on this has changed.
Lord Newby
The Government said in response to Vickers that they believed he was going too far, and I do not believe that that view has changed. The noble Lord asked about the loan-to-value ratio and whether that tool would not have the same effect as introducing a loan-to-value ratio. In an aggregate sense, in many ways it does so. However, the advantage of this approach over adopting a loan-to-value limit is that it places an overall requirement on an institution in terms of its lending to the property sector, but still gives that institution the flexibility to provide loans at a high loan-to-value ratio. This might take place, for example, in a minority of cases in which the circumstances of the person to whom the loan is being given makes that loan prudent. In many ways it could have the same overall effect on the sector, but it gives institutions greater flexibility than a prescriptive loan-to-value ratio.
The noble Lord asked why the stock market was not included and why we were not including firms in that sector. The answer is that at this point the FPC believes that the definition of which firms are covered includes those firms that are most likely to cause a problem. The FPC has taken the view that firms in the stock market are not creating an equivalent risk to those elsewhere and those already covered. That is its judgement, which one can take a view on. The noble Lord disagrees, but that is the answer to the question.
The noble Lord asked about the order using the word “increase” and how it is envisaged that any increase might be unwound. When the FPC considers that any increase is no longer required, it will revoke the direction.
Lord Eatwell
Let us suppose that we are in the situation that we are in today, that there is no direction in place and that we wish to reduce the own funds. How do we do that?
Lord Newby
My Lords, I do think that that is an eventuality that the order caters for because, as the noble Lord says, it uses “increase”. If I am wrong on that, I shall let him know but, as he has said, the order is relatively straightforward. It will be for the PRA to decide whether it wants to do that, and it may do so, but obviously I will correct the record if I am wrong. It may require an amendment to the order for it to do that.
The noble Lord asked about the aggregation of a large number of small firms. This issue formed part of the consultation. The strong view came back that the effect that was being sought could be achieved by limiting the order at this point to larger firms. If any evidence built up that a large number of small firms could cause a risk beyond that currently envisaged, it would be for the FPC at that point to make appropriate provision.
The noble Lord asked how the FPC would specify risk. It will be for the PRA to determine capital models allowed by firms within the overall levels set by the FPC.
The noble Lord asked me about the timetable—whether there would be more orders and when they were going to be. There may be more orders, but none is envisaged at the moment. There is not a conveyor belt of other orders that are half-thought of. The view is that these measures are adequate for the time being. It is always open for further orders to be brought forward, but there is no perceived need for any further orders at this point.
There is one issue that I have not dealt with concerning the relationship between the FPC and the competition authorities. I hope that the noble Lord will forgive me if I write to him on that subject.
Lord Eatwell
Before the Minister sits down, perhaps we could go back to how an increased level of risk is to be specified by the FPC. Is that to be specified as a change in risk weights in old-fashioned Basel I structures, or is it to be specified as a modification of the value at risk models used by the financial institutions? If it is the latter, are we moving away from the ability of institutions to use their own value at risk modelling towards a standardised model?
Lord Newby
My Lords, as I said earlier, the PRA will set overall levels; the capital models allowed by firms will, I believe be determined by the PRA.
Lord Eatwell
I am sorry, but the noble Lord contradicts the instrument before us. It states clearly,
“if they gave rise to an increased level of risk specified by the FPC”.
It is not the PRA, it is the FPC that has to specify this increased level of risk.
Lord Newby
My Lords, I am told that the FPC has the discretion to do either or both of those things, but the PRA will scrutinise how the FPC’s levels are implemented by individual firms.
Financial Services and Markets Act 2000 (PRA-regulated Activities) Order 2013
Lord Newby Excerpts(11 years, 2 months ago)
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Lord Newby
That the Grand Committee do report to the House that it has considered the Financial Services and Markets Act 2000 (PRA-regulated Activities) Order 2013.
Relevant documents: 18th Report from the Joint Committee on Statutory Instruments, 26th Report from the Secondary Legislation Scrutiny Committee.
Lord Newby
My Lords, I shall speak also to the other three orders made under the Act. As I said in respect of the previous order, the Financial Services Act establishes a system based on clarity of responsibility and focus for the new regulatory bodies, avoiding the confused and ineffective tripartite system that it replaces.
The new system will make the Bank of England clearly responsible for financial stability and will provide for two focused regulators with clear remits. The Prudential Regulation Authority, or PRA, will be responsible for the prudential regulation of firms that manage complex risks on their balance sheets. The Financial Conduct Authority, or FCA, will be a focused conduct of business regulator. This group of statutory instruments relates to the scope of the responsibilities and powers of the PRA and FCA. The Government’s guiding principle in all these orders is that there should be clarity of responsibility and effective co-ordination mechanisms where necessary.
First, I turn to the draft order made under Section 22A of the 2000 Act, which establishes which activities will be prudentially regulated by the PRA. The draft order provides that deposit-taking, effecting and carrying on contracts of insurance, and certain other activities in relation to the Lloyd’s market will all be PRA-regulated activities. All firms that carry them out will be regulated by the PRA. That reflects the complex nature of the risks borne by firms that engage in such activities and the need for specialist prudential regulation. Additionally, the activities of some investment firms are of such scale and complexity or are interconnected with other firms to such an extent that they may pose risks to the entire financial system or to other PRA-authorised firms. The PRA will be able to designate such investment firms to be prudentially regulated by the PRA.
The draft order sets out the criteria which the PRA will apply when considering whether an investment firm should be designated. First, the firm must hold, or be seeking to hold, permission to deal in investments as principal. In other words, it must be an investment firm or be applying to be an investment firm. Secondly, the firm must be of a type and size that is required to have initial capital of €730,000 under the capital adequacy directive. This means that it must be relatively large and complex. Finally, the PRA must conclude that designation is desirable, having regard to its objectives.
When deciding on the designation, the PRA must also give consideration to certain other factors. It must consider the assets of the firm in question. If the firm is part of a financial group, the PRA must also look at the size and complexity of other investment firms in the group, and at whether the activities of the firm in question could affect their safety and soundness. The draft order was first published more than a year ago and it has the overwhelming support of consultation respondents. I hope that it will be equally acceptable to the Committee.
Next, I turn to the threshold conditions order. The threshold conditions are the minimum requirements that firms need to meet to become authorised. They are a key supervisory tool and provide the basis for triggering certain of the regulators’ powers to intervene. On the recommendation of the Joint Committee on the draft Financial Services Bill, which carried out pre-legislative scrutiny on the Bill, the Government reviewed the threshold conditions to ensure that they support judgment-led and forward-looking regulation.
The revised conditions set out in the draft order will provide clarity about which aspects of a firm’s business are of interest to each regulator. They will also deliver clear, relevant and unambiguous standards which firms are required to meet and which will be used by the PRA and FCA in exercising their judgment. Lastly, they are aligned with the priorities of the FCA and the PRA—for example, including a reference to whether firms are “resolvable”, which will be a key consideration for the PRA in understanding the risks posed by individual firms to the financial system as a whole.
I turn next to the Financial Services Compensation Scheme order. The FSCS plays a crucial role in the financial services sector, supporting consumer protection and confidence in financial services while serving to protect and enhance financial stability. The Government are committed to retaining a single Financial Services Compensation Scheme, so that there is a single point of contact on compensation for consumers. However, given the important role that the FSCS plays in the financial system, both regulators will interact with the FSCS, and the Government have legislated that in the new regulatory system the FCA and PRA will have joint oversight responsibility for the FSCS and split rule-making responsibility.
As the scope of prudential regulation by the PRA is set out in secondary legislation, it is also necessary to specify the claims that each regulator may or may not make compensation rules for by statutory instrument. Broadly reflecting the division in regulatory responsibilities between the PRA and the FCA, the order makes the PRA responsible for making compensation rules in relation to claims for deposits and claims under a contract of insurance.
The order also provides that the PRA may make compensation rules relating to the activities of managing the underwriting capacity of a managing agent at Lloyd’s, or arranging contracts of insurance written at Lloyd’s. The inclusion of these activities in the order reflects the PRA’s regulatory responsibility in these areas but does not mean that the PRA will be expected to make compensation rules for them. To be clear, the FSA does not currently make compensation rules for these activities and it is not expected that the PRA will do so. Conversely, the FCA will be responsible for making rules to deal with claims for all other matters. This will include claims for mis-selling.
Finally, I turn to the mutuals order. The FSA’s most important regulatory functions and powers were established in the Financial Services and Markets Act 2000. However, the FSA also has a range of functions under the legislation that governs the establishment and operation of mutuals. This order does two things. First, it replaces references to the FSA in the various pieces of mutuals legislation with references to the FCA, the PRA or, in some cases, both. Secondly, it inserts mechanisms similar to those in the Financial Services Act requiring the two regulators to consult each other and co-ordinate their actions in certain cases.
The division of the responsibilities under mutuals legislation follows the general division of responsibilities between the PRA and the FCA under FiSMA. The PRA is given all of the FSA’s mutuals functions that are relevant to the safety and soundness of PRA-authorised mutuals. The FCA will take over the other functions of the FSA, including those related to registration, the register and the public file, the enforcement of offences and the majority of the functions related to administering mutuals in general.
I draw to the Committee’s attention that the order applies the PRA’s objectives to its functions under mutuals legislation but not the FCA’s. Applying the PRA’s objectives means that when carrying out a function under mutuals legislation, such as directing the merger of two building societies, the PRA will be held to account for whether its actions promote its objectives. However, the FCA’s tasks under mutuals legislation are mostly administrative in nature. It will have little discretion as to how it goes about them, so it would not really be possible to hold the FCA to account for whether it was approaching its tasks in a way that advanced its objectives. In the legal sense, there is little to which the FCA objectives could apply. The FCA’s objectives of course apply to all its regulatory activity in relation to mutuals that is carried out under FiSMA, such as making rules and imposing requirements.
With that explanation, I commend these orders to the Committee and I beg to move.
Lord Eatwell
My Lords, I am grateful to the noble Lord for introducing these orders. Like him, I will deal with them altogether. Before doing so, I declare an interest as a non-executive director of a financial services firm as set out in the Register of Lords’ Interests. Turning first to the PRA-regulated activities order, I still am somewhat puzzled as regards the whole definition of the large investment firm. Are we simply relying on the CRD definition expressed as €730,000-odd or is there some broader definition of what is meant by a “large investment firm” which the PRA has in mind?
Also with respect to that, under Article 6.5, what is the procedure if the FCA disagrees with the PRA’s decision to withdraw a designation? The consultation process should form a check on the PRA and not just act as a rubber-stamping on behalf of other bodies. There should be some scrutiny of important decisions that the PRA wishes to undertake, although of course without undermining its powers. What will be the dynamic when there is some form of disagreement and how are those disagreements to be mediated?
The threshold conditions are entirely appropriate but I want to focus on Article 2A about suitability. I found the discussion of suitability as a threshold condition—a very important threshold condition in any regulatory system—to be rather more vague than I would have expected. For example, under Article 2E(e) those who manage the affairs in investment firms have to have “adequate skills and experience”. Who defines adequate? What is meant by adequate? Does adequacy refer to a particular examination standard or standards of experience which might be expected?
In addition, the PRA might be expected to act with probity. Do we need a more precise definition of probity or will we simply regard it as having not yet been caught? How will we determine the conditions of suitability? Should they not be more precise, as individuals who wish to work in the financial services industry surely should have precise conditions and not be turned down on the basis of those rather general statements?
I have rather more questions on the Financial Services Compensation Scheme. Again, I will start with the problem of consultation between the PRA and the FCA. It seems to me that the PRA and the FCA are required to develop rules for access to the FSCS. How will they disclose that? What is the rule-making procedure referred to in this instrument? What will the procedure look like? Will they review the FSCS’s current rules? Presumably, they will. When we have had that review, will there be a transparent report to Parliament of the substance of that review?
There is a relationship between the discussion of mutuals and the FSCS. As the noble Lord will be aware, there has been considerable disquiet, to put it mildly, among mutuals with respect to the contributions that they make to the FSCS relative to those made by banks. I may have missed it, and if I have I apologise, but has there been any development on the levies made on mutuals in their contributions to the FSCS?
Turning specifically to the order before us, are there any substantial changes to the functions of the regulator in relation to mutuals contained in this order, or is it purely a transfer activity? Let us take one example which attracted my attention as I read through the order and raised this question. Paragraph 5 of Schedule 1 states that the FCA has an obligation to,
“maintain arrangements … to determine whether persons are complying with requirements”.
That is pretty vague. What sort of arrangements do we mean? Could there be some clarity as to what is to be implemented here?
Given the Government’s determination to make five regulators where there was once just one, what will happen with respect to consultation between the PRA and the FCA when action is required rapidly; for example, in criminal proceedings? How can we ensure that the consultation procedure will be prompt?
Overall, we are broadly content with the orders. We are concerned specifically about a lack of clarity at various points, to which I have referred, and about the introduction of additional complexity because of the requirement for consultation at various stages between the PRA and the FCA. I would like some reassurance on those points.
Lord Newby
My Lords, if there is a leitmotif running through the noble Lord’s questions, it has to be about how the two bodies work together. This theme ran also through previous debates in your Lordships’ House and gets to the core of arguments about whether the Government were right to split the FSA at all. The view that we took is that we needed to give greater focus to the two elements of regulation. It was very important, having done that, we then set in place ways in which the two regulators would work together. As the noble Lord knows, there are a number of points in the Act where the two bodies are required to establish memoranda of understanding explaining exactly how they are going to work together. The success of the new structure will depend to a very large extent on that working. I know that the bodies as they are establishing themselves are absolutely aware of that and are putting co-ordination and consultation procedures in place.
Perhaps I may deal with some of the specific points that the noble Lord raised. He asked whether the designation of a larger firm was simply the €730,000 capital requirement. The order takes a number of criteria into account, not all of them from the CRD. I read some of them out. The PRA, for example, has to conclude that designation is desirable, having regard to its objectives—this is part of the regulator exercising judgment. That is an additional criterion beyond the €730,000; it is not automatic.
The noble Lord asked what would happen if the FCA disagreed with the PRA’s decision to withdraw designation. This is a decision for the PRA. We expect it to give considerable weight to the views of the FCA, but it is ultimately a matter for the PRA.
The noble Lord asked whether the definitions should be more precise, in particular the definition of “probity”. The Government do not consider that the concept of probity is significantly more subjective than other criteria against which the regulator must make regulatory judgments. Recent conduct and mis-selling scandals have shown more than ever how important it is that firms conduct themselves with probity, and it is right that the regulators can make an assessment on whether this is the case and take action where it is needed. A general question for legislation is how far it attempts to define terms which are in common parlance and have a common understanding. Our view is that in this respect the legislation goes as far as it should do.
The noble Lord asked about mutuals and whether there had been a change in class. This has been a long-standing beef of the mutuals; they feel that they have to bear the burden of the incompetence, folly and recklessness of others. That is a question for the authorities to decide, but for the time being they remain in the same levy class that they have already stayed in.
I shall try to deal with one or two other points. The noble Lord asked about the procedure for FSCS rules. The same procedure applies as for other rules; there is a duty to consult but no duty to carry out a cost-benefit analysis. There are no plans to change the rules as part of the transition. Once the transition has taken place, it will obviously be for the new regulators to decide whether they are happy with them, but we are not planning to do that at the same time.
On the question of consultation between the FCA and the PRA on mutuals functions, the order makes express provision for consultation where it is needed. The general provisions relating to the FCA/PRA MoU, which I referred to earlier and which are set out in Section 6 of the Act, will apply in this area as they will in many others.
I hope that I have answered the majority, if not all, of the questions posed by the noble Lord, and I commend the regulations to the Committee.