EU: Financial Transaction Tax (EUC Report)

Lord Vallance of Tummel Excerpts

Tuesday 17th December 2013 Grand Committee

[Lord Vallance of Tummel (LD)]

My Lords, I simply want to reinforce one specific point that has just been made by the noble Lord, Lord Harrison. Our report raises an important issue concerning the deployment of the enhanced co-operation procedure itself. The FTT case is only the third time the procedure has been used since it came into being in 1999, but it could well become more commonplace in a future where different groups of EU nations wish to take different courses, or proceed more quickly than others.

In the FTT case, the use of the procedure has left a bad taste in the mouth. When it was put to the vote last January, I imagine that, in abstaining, our Government naively assumed that the terms of the tax to be adopted would mirror those the Commission had already put forward and which had failed to find favour with many states, including the UK. But as the noble Lord, Lord Harrison, has said, the proposal the Commission advanced only three weeks later was significantly different, not least in its assertion of the twin principles of “deemed establishment” and “issuance”. That combination of principles could clearly have a major impact on financial institutions in non-participating and third-party countries which could not have been foreseen at the time of the vote.

It seems unlikely that the Commission was entirely unaware of the principles and their potential impact when the vote took place. Was this a matter of oversight or deviousness on the part of the Commission and sponsoring countries? Who knows? However, one can imagine that had the boot been on the other foot and a principal sponsor had been the UK, tales of Albion’s traditional perfidy would have been doing the rounds in the corridors of Brussels. This has not been one of the European Union’s finest hours and I say so sadly, as a strong supporter.

As to the lessons for the future, whatever the outcome of the FTT proposal, the enhanced co-operation procedure needs to be tidied up, made more robust and be seen to be fair. Put simply, all significant cards need to be face-up on the table when a vote is taken to adopt it. Ideally, a fully fledged scheme should be worked up and open to scrutiny before a vote is taken, accompanied by a thorough impact assessment that distinguishes between participating and non-participating countries, and with an analysis of any extra-territorial consequences. Without a reformed approach along these lines, what could be a useful and effective procedure will simply fall into disrepute. That is not in the interests of the European Union or its member states and I hope that, when the dust has settled on the specific FTT issue, the Government will take the initiative in calling for reform of the enhanced co-operation procedure itself.

Sovereign Credit Ratings: EUC Report

Lord Vallance of Tummel Excerpts

Tuesday 15th November 2011 Lords Chamber

[Lord Vallance of Tummel]

My Lords, I first congratulate the noble Lord, Lord Harrison, on his admirable chairmanship of our committee during the production of the report. My first brush with the credit rating agencies was when the Select Committee on Economic Affairs produced its report, Banking Supervision and Regulation, in June 2009. We were highly critical of the part the agencies played in the run-up to the preceding year's financial crisis, of their failure to detect the toxicity of many of the financial instruments they rated, of their potential conflicts of interest and—this was not to be laid at their door—of the systemic risk of hard-wiring ratings into financial regulations and the mandates of institutional investors, which the noble Lord, Lord Myners, referred to. Therefore, it comes as something of a surprise to find myself defending the agencies, at least in part, as they sit in the firing line from the Commissioner for the Internal Market.

It also comes as something of a surprise, although a pleasant one, to agree with almost all of the Government's response to the report on sovereign debt ratings. I will not rehearse again the arguments about the distinction between the rating of corporate and sovereign debt that is set out in our report. Suffice it to say that sovereign debt ratings are almost always unsolicited, so the issues of conflict of interest that surround the issuer-pays model and of ratings shopping simply do not apply.

What matters in the context of sovereign debt boils down to three main things. The first is the oligopolistic nature of the credit rating agency market, which is dominated by the three main players. Such a concentration of power is uncomfortable to say the least. The second is the hard-wiring of credit ratings into the regulatory system and the systemic risk that goes with it. The third is the issue of what regulatory constraints are warranted in respect of the methodology, content and timing of credit ratings. This will inevitably include a degree of political judgment overlaying the economic analysis.

As to the nature of the market, I think it is something of a natural oligopoly. An open market for credit ratings will lead inevitably to concentration on a small core of players with the skills, experience and global reach to do the job. In this respect, the market is similar to that of financial auditors. This is one area where I question the Government's view that one should be,

“lowering barriers to entry rather than intervening in the market directly”,

to quote their response to our report. Lowering barriers is a necessary but insufficient approach when there is a natural and entrenched monopoly of this kind. So if Commissioner Barnier wants to rotate the use of agencies by limiting the frequency with which an issuer can use the same agency, he is broadly on the right track. The promotion of competition in this market will mean not just removing potential barriers to entry but the direct handicapping of the large incumbents, although the calibration might need some work. Incidentally, rotation would not bear directly upon unsolicited sovereign debt issues, where potential conflicts of interest do not apply.

As to the phasing out of the hard-wiring of credit ratings in regulatory structures or in the mandates of institutional investors, everyone seems agreed on the objective, whether they are regulators or rating agencies. However, it is one of the things that is easier said than done, as there is a real risk of throwing out the baby with the bath-water, or at least of unintended consequences. One thought that occurs to me is to take a leaf out of the book of UK corporate governance here and apply the principle of “comply or explain”. If minimum levels of credit rating were not mandatory requirements but subject to the comply or explain rule, there would be at least some leeway for financial institutions to use their own judgment, subject to their explanations satisfying the relevant regulators. That limited exercise of judgment might just put a brake on the automatic mass selling of a security that can follow a downgrading which breaches a mandatory requirement. It is a passing thought that the Government might like to bear in mind.

Finally, and specifically with regard to sovereign debt, what regulatory constraints are genuinely warranted as to the method, content and timing of credit ratings? The sensitivity in certain parts of the eurozone to a credit rating agency having the temerity to pass judgment not just on the credit-worthiness of a nation's sovereign debt but, by extension, on the competence and effectiveness of those who are trying to prop it up is very clear. But that is no excuse for what one might call retaliatory regulation—and there is a sense of retaliation in some of the possible measures being aired by the Commission and others.

In terms of principle, there is no question that the agencies need to be properly registered and subject to some degree of regulation, and it is clearly appropriate for ESMA to insist on transparency of methodology. However, to my mind the recent suggestions that ESMA should effectively determine in advance which methodologies are, or are not, to be deployed is right over the top and an undue interference in the market.

As to the Commission’s thankfully postponed suggestion that ESMA should have the power to ban or suspend credit rating when a country is in negotiations or is covered by an international solidarity programme with the EU or IMF, as we said in our report, and has been said this evening, that smacks of censorship. Perhaps the Commission would like to suspend the “Lex” column in the Financial Times on the same grounds. It also smacks of naivety; as the noble Baroness, Lady Noakes pointed out, a ban could easily put the financial markets into a spin. Other commentators would inevitably fill the gap, and the whole exercise could end up being self-defeating. No doubt the Government will do their best to keep that one at bay, should the postponement prove only temporary.

Credit ratings of sovereign debt matter—hence all the sensitivity surrounding them. If you will pardon my lapse into Franco-German, some may have experienced a brief “frisson de Schadenfreude” when Standard & Poor's inadvertently downgraded French sovereign debt earlier in the month. But it was really no laughing matter. The credit rating agencies may not have precipitated, or even significantly exacerbated, the eurozone crisis, but the oligopoly’s sins of omission or commission can do real damage. It follows that the power and dominance of the three large agencies need to be addressed, but to my mind that is best done through promoting structural change in the market and not by more regulation of a retaliatory kind.

Private Finance Projects (EAC Report)

Lord Vallance of Tummel Excerpts

Wednesday 3rd November 2010 Lords Chamber

Moved By

[Lord Vallance of Tummel]

To move that this House takes note of the Report of the Economic Affairs Committee on Private Finance Projects and off-balance sheet debt (First Report, Session 2009–10, HL Paper 63).

[Lord Vallance of Tummel]

My Lords, although I am no longer a member of the Economic Affairs Committee, I am pleased to introduce its report, Private Finance Projects and off-balance sheet debt, which was published in March while I was still chairman. Before I do so, I should declare an interest as a member of the supervisory board of Siemens AG, one of whose divisions has been party to a private finance project.

I am grateful to all the witnesses who made the report possible and especially to the National Audit Office for its valuable contribution. I should also like to thank Professor Paul Grout of the University of Bristol whose knowledge and experience were essential to our report. The topic is important and affects all of us, but the terminology is pretty turgid: neither private finance initiative, PFI, nor public private partnership, PPP, exactly fire the imagination. “Private finance projects”, or PFPs—the umbrella term that we adopted in our report—is scarcely more compelling, but it has the virtue of embracing both the PFI concept introduced by a Conservative Government and its PPP rollout, largely under a Labour Government. The term “private finance projects” also says what it means: doing public projects with private finance. I will use “PFPs” as a catch-all term today.

PFPs use private sector capital and skills to provide public infrastructure for a lengthy fixed period. Schools, roads and hospitals are typical examples. The public sector client pays the contractors fixed sums over about 30 years for design, build, maintenance and some services. This whole-life bundling of costs into one package sounds straightforward enough but PFPs are still controversial. Their defenders say that risk-taking private contractors bring to public procurement the rigour, efficiency and skills needed to get the most out of scarce resources and that they mostly deliver to time and to budget. Detractors say that PFPs are expensive, inflexible and do not really transfer risk from the public sector. It is not easy to show where the truth lies, since lack of data on the whole-life costs of traditional procurement hampers objective comparison. This sometimes encourages heated assertion rather than cool analysis. In our report we tried to take a balanced view of PFPs, but it can be only an interim assessment; no final verdict will be possible until the bulk of the PFP deals signed in the last decade or so have run their course. Even then, the success or failure of PFPs is likely to be judged on a case-by-case basis, with type of project and local factors helping determine how each is finally evaluated.

PFPs grew from a combination of circumstances arising in the post-war decades. Broadly, growth in publicly funded services and rising expectations meant that far more public infrastructure was needed, but over time the perception grew that traditional public procurement was inefficient. The public sector specified a project, private contractors built it and the public sector was then left holding the baby. There were delays, cost overruns, contractual disputes and chronic neglect of maintenance. At the same time, Governments trying to find resources to meet ever-rising demand were looking for better value for money. It was clearly in the public interest for them to look for a new and efficient approach to public procurement.

The beginnings of what became PFPs were in the 1980s, when use of private finance in public procurement was still hedged about with restrictions. Those restrictions were largely removed in the early 1990s as the Government set out to attract private capital. Typical PFPs bring together private contractors holding shares in a consortium—a special purpose vehicle, in the jargon—formed to carry out a specific public project. The contract bundles together construction and maintenance over a long period and is financed by the contractors, mainly through debt, in return for fixed payments over the years by the public authority. Although the PFP model emerged under a Conservative Government, its use became widespread under a Labour Government such that by 2009 there were about £64 billion-worth of PFP contracts in force. This rapid growth of private finance projects is striking. It is clear that PFPs have played a significant role in the expansion and renewal of the nation’s infrastructure. Most schools and hospitals are now procured through PFPs. It will be interesting to see whether this pattern of procurement continues under the coalition Government.

It is clear that PFPs have built much in a short time, changed the urban landscape and renewed much public infrastructure. It is also clear that PFPs are best suited to certain types of projects, such as roads, schools and hospitals, since they can be clearly specified and are of a size that the private contractor can readily finance. It was striking that very few of our witnesses wanted to go back to traditional procurement in areas where PFPs had become the norm. The PFP model has also been enthusiastically adopted by other countries. On the other side of the ledger, experience already seems to show that PFPs are not the right approach for very large, complex and uncertain projects, such as the renovation of the London Underground. However, even successful PFPs, built to budget and on time, are still at an early stage in their life cycle. Few have been running as long as a decade, whereas many of the contracts are for 30 years. It will be for our successors in the 2030s to draw up a final balance.

Meanwhile our report drew conclusions and made recommendations on the basis of experience so far. Here are some of them. Public authorities should be free to choose the procurement method that offers the best value for money. There should be no institutional bias for or against traditional or innovative approaches. There should be greater clarity about financial liabilities arising from PFPs, which should be published alongside the national accounts. Data should be collected on whole-life costs of projects procured by traditional methods, including maintenance and services over the years, so that there can be meaningful comparison with the value for money of PFPs. The pros and cons of establishing a national infrastructure bank, as a means of combining financing at government rates of borrowing with the rigor and efficiency of private-sector delivery, should be kept under review. The operation of the secondary market in PFPs—the buying and selling of PFP contracts—should be monitored for any signs of a drop in build quality where contractors are able to sell completed projects that they would otherwise have to maintain. The public sector should enjoy a fair share of the benefits from any refinancing of PFPs. We also recommended that the Government should monitor the risk of jeopardising the delivery of essential services where public authorities’ budgets were constrained and where the obligatory nature of payments under PFP contractual commitments might squeeze out other critical but discretionary expenditure.

I am glad to say that the then Government were commendably swift in producing their response to our report. They were positive about many of our recommendations, including the quantification and publication of the country’s PFP liabilities and the collection of comparable data on the costs of traditionally procured projects. The previous Government also declared their intention to establish a green investment bank, which would operate on a commercial basis and involve both public and private sector capital. However, that Government dismissed our concerns about the potential effect on the ability of public authorities to deliver essential services as inflexible PFP payments took a higher share of reduced budgets. We were told that PFP payments represented very little threat to the flexibility of the Government’s budgets.

There is now a new Government. We note the commitment by the Chancellor of the Exchequer to go ahead with a green investment bank, but we have heard little of the coalition Government’s approach to PFPs. Will they still have an important role in public procurement? How far will new private finance projects be constrained by the spending review? What will be the role of the green investment bank with respect to PFPs? Does the coalition agree that public authorities should be free to adopt whatever procurement method offer best value for money? Will the Government ensure that overall PFP liabilities are clearly quantified alongside national accounts? Do the coalition Government share the view of the previous Government that inflexible financial obligations under PFPs will not constrain the ability of public authorities to deliver essential services, even as the comprehensive spending review bites?

We will perhaps not hear all the answers today. That said, it is already clear that PFPs have been a bold innovation and that their impact will remain with us for many years, although, as I have indicated, it is too early for a definitive assessment. Meanwhile, it will remain important for Governments, including the current one, to keep looking for best value for money in public procurement and to keep trying out new methods. These might include: new combinations of private sector rigour and financial accountability with the public sector's ability to borrow cheaply; the extension of PFPs beyond construction, maintenance and ancillary services to include some of the core functions in health, education or even defence; and embracing a flexible approach that allows the choice of the procurement path best suited to each project. The guiding principle of procurement should always be to get the best value for the taxpayer, especially while money is tight. I beg to move.

--- Later in debate ---

[Lord Vallance of Tummel]

My Lords, PFPs clearly present a complex set of financing and procurement issues, and it is relatively easy for them to become politicised—although not, of course, in your Lordships' House. The very adjectives “public” and “private” can produce knee-jerk reactions—a point to which the noble Lord, Lord Lipsey, alluded. As someone who has spent half of his career in the public sector and half in the private, I know that neither has all the answers. What matters in public procurement is to keep learning the lessons of the past, to keep experimenting with new ideas and, critically, to build up real procurement expertise in the public sector—a point made strongly by the noble Lord, Lord Tunnicliffe, and acknowledged by the Minister.

I am very grateful to the Minister for his thoughtful and positive response to our committee's report, and trust that he will keep it high on his agenda.

Motion agreed.