Financial Services Bill

Viscount Trenchard Excerpts

Committee stage
Monday 8th March 2021 Grand Committee

[Viscount Trenchard (Con) [V]]

My Lords, these amendments, which are technical in nature, require banks that prepare their accounts in accordance with international accounting standards to apply prudential filters discounting capital to the banks’ statutory accounts. Having read the amendment, I am not clear which is the tail and which is the dog. Amendment 74 in the name of the noble Baroness, Lady Bowles of Berkhamsted, requires a bank to align its accounts with its regulatory capital or prudential capital, and at the same time requires the bank to align its regulatory capital with its accounting capital, for three separate purposes.

I agree with my noble friend Lady Noakes’s forensic criticism of the amendment. I am not a chartered accountant, but I have worked in corporate finance and mergers and acquisitions for many years, and I find the amendment confusing. Does

“then the accounting numbers must have an adjustment to the … profit and loss account”

mean that the bank concerned must alter its accounting principles and adjust its accounts to use the prescriptive and conservative accounting principles used by the PRA for the monitoring of banks? If so, would a bank be required to restate past years’ published accounts for consistency’s sake? Proposed new paragraph (a) suggests that the PRA’s measurement of capital must be carried through to the bank’s accounts, but proposed new paragraphs (b) to (d) suggest that the bank’s regulatory accounts should be adjusted to conform with the PRA’s measurements. I am not clear how that can be done and what the PRA would have to say about it.

The amendment refers to international accounting standards, which were standards issued by the International Accounting Standards Board, based in London. EU legislation has continued to use the term “international accounting standards”, but they were replaced in 2001 by international financial reporting standards—IFRS. The noble Baroness confirmed that she meant IFRS rather than IAS in her amendment, but how does she intend that her amendment should affect banks that apply other accounting standards, such as American banks, which still prepare their accounts according to GAAP? Concepts in the amendment such as accounting numbers and regulatory capital need proper definition.

I have rather more sympathy with Amendment 77. The International Accounting Standards Board develops and issues IFRS for use internationally. In the EU, things are then at the discretion of the European Financial Reporting Advisory Group—EFRAG—which advises the European Commission on whether and how the IFRS should be adopted for businesses in the EU. EFRAG will consult the relevant national bodies as part of that process; for example, if a new or revised IFRS is issued by the IASB that impacts the banking industry, EFRAG will consult the European Central Bank on the impact of that standard before making a decision on its adoption.

Now that the UK is able to establish an independent endorsement process, it seems sensible that that process should similarly involve the Bank of England in matters relating to IFRS that may impact the institutions over which the PRA has regulatory authority. I am not sure whether the amendment as drafted is satisfactory, but I would support the introduction here of an endorsement role for the Bank. I look forward to hearing my noble friend the Minister’s views on that.

[Baroness Kramer (LD)]

My Lords, in this area I cannot pretend to have the scope of knowledge or the expertise of my noble friend Lady Bowles or the noble Lord, Lord Sikka, but I have a great deal of sympathy with their amendments which comes from long frustration with trying to deal with banking standards. I probably had some small part to play in the focus that the Parliamentary Commission on Banking Standards applied to looking at IFRS and other banking frameworks. I would defy almost anybody looking at the published accounts of Northern Rock, HBOS or RBS to have identified how fragile those institutions were and how easily they would crack the moment any pressure was applied to the very fragile arrangements they had in place. It is no wonder that it was missed by the regulators if they were looking at the disclosures that came from those institutions. They were not falsified; it is just that working your way through the disclosures very often discloses very little.

I spent a good part of my banking career trying to extract real and consistent information from accounting statements. That was largely in the States, so we were using GAAP, which I think many people will acknowledge tells one a lot more than IRFS ever does, but a bank has the resource to do that kind of deconstruction for a potential or existing credit client. Investment firms have the resources to do that kind of deconstruction, and so do regulators, but for any normal investor, and certainly for any smaller creditor such as a trade creditor, it is impossible to have those resources, as it is for any normal politician, even if in the end we carry the buck, in a sense, for whether or not we have a system that works. Over many years, the only clients who ever handed me a straightforward deconstructed set of accounts were Warren Buffett and Charlie Munger, who headed up the GEICO insurance subsidiary. They did it simply because they felt that bankers should know what was going on. That is a good enough recommendation for any company or regulator.

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As the noble Baroness, Lady Bowles of Berkhamsted, pointed out, under the current rules, short selling is a remarkably transparent activity—rather more transparent than the opposite, in fact. From 1 February this year, the notification threshold for reporting short positions was reduced to 0.1% of the issued share capital of an issuer, down from 0.2%. Under reporting requirements such as these, this can never be a shadowy practice; short figures are made available to all market participants in as close to real time as possible. If the Government are minded to accept these amendments, will they encourage a review of the current short selling rules with a view to making them less onerous, in acknowledgement of short selling’s proven utility?

[Viscount Trenchard (Con) [V]]

My Lords, Amendment 78, in the names of my noble friends Lady McIntosh of Pickering and Lord Holmes of Richmond, seeks to commission a review of legislation relating to short selling. It is a pleasure to follow my noble friends Lady Noakes and Lord Sharpe of Epsom; I must say, I agree with everything they said.

From time to time in the UK and in other countries, financial regulators have sought to restrict short selling, as the British Government did to stabilise the market after the bursting of the South Sea bubble in 1720. While short selling has been blamed for market crashes and is considered unethical by some as it is a bet against positive growth, many economists and financial practitioners now recognise short selling as a key component of a well-functioning and efficient market, providing liquidity to buyers and promoting a greater degree of price discovery.

I note that, under the statutory instrument transposing the European regulation into UK law, the minimum threshold for the notification of short positions has been set permanently at 0.1% of the issued share capital of a listed company, whereas in the EU, the threshold will revert to the less onerous 0.2% of issued share capital on 19 March. I consider both thresholds unnecessarily restrictive and wonder why the Government have adopted a rule that will be even more cumbersome and bureaucratic than the EU’s, when the Prime Minister and the Governor of the Bank of England have said that we will get rid of red tape. The EU will relax its red tape on short selling reporting on 19 March but we will not. That is disappointing, is it not? What does my noble friend the Minister have to say about that?

In any case, the competitiveness of the market would be best served by removing the current restrictions on short selling. However, I do not think it would be helpful to place in the Bill this kind of requirement, which will add to uncertainty over the freedom to sell short in future and send the wrong message about the kind of regulatory framework the Government intend to adopt.

[Baroness Kramer (LD)]

My Lords, once again, I am moving outside of any area where I can claim expertise. Essentially, I have no problem with short selling in the right place and time and under the right regulations, but I am concerned that, in the current environment, any move to look at the regulations again would listen more closely to the noble Lord, Lord Sharpe, the noble Viscount, Lord Trenchard, and the noble Baroness, Lady Noakes—in other words, look for opportunities to reduce the restrictions on short selling.

We have had a number of exchanges on short selling in the Chamber. The noble Lord, Lord Leigh of Hurley, is particularly vocal, and I do not think that I represent him unfairly by saying that he believes that the restrictions on short selling that were set in place in 2012, which severely limited naked short selling on AIM, are too onerous and that relaxation would be a good thing. He would argue for bringing more liquidity into AIM. I remember that campaign, which was strong and led by companies that were either listed on AIM or wished to be so but that were concerned about becoming the target of speculators who were not interested in supporting sustainable growth but were very interested in bubbles. Of course, this is a risk that goes alongside naked short selling in particular.

I suspect that this issue will be reviewed; I am sure my noble friend Lady Bowles is right that it should be done in a much wider context—I think the noble Lord, Lord Holmes, agreed with that. But I would not work on the assumption that this comes from a concern that rules need to be tightened and safeguards increased; this will very quickly become a process of trying to see whether we can return to the old animal spirits and largely casino-like speculation that once fired London so powerfully and which many of us think largely contributed to the financial crash in 2007-8. While I understand the concerns of the City of London that it needs to make itself more of an exception in order to gather increasing amounts of business, I am rather disturbed if that mode of exception is to allow a great deal more risk to be taken in ways that then impact on the real economy.

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[Baroness Neville-Rolfe (Con)]

My Lords, it is always a great pleasure to follow my noble friend Lady McIntosh of Pickering, who is sitting today in front of a superb backdrop of the Houses of Parliament—in my opinion, one of the best views in Europe. I await my noble friend the Deputy Leader’s comments with great interest.

I have great respect for my noble friend Lord Blackwell and for all he has achieved. However, I have some doubts about this proposal, not least the amendment’s apparent focus on bigger operators. For me, the second-class treatment of small operators in the financial services sector as a result of regulation by two regulators is the bigger issue. It is there that the pressure on investment funds and on capital, the prioritisation of IT resources and the lack of management capacity—described so well by my noble friend Lord Blackwell—is at its most apparent. Smaller firms also suffer from the overlap and overload mentioned by my very experienced and expert noble friend Lady Noakes. I should say that I speak as a non-executive director of Secure Trust Bank, which is a smaller bank.

I was pleased to see the Chancellor focus on smaller businesses in last week’s Budget—for the first time, I felt—although I am not sure how much that will help in the financial services context.

In conclusion, is this amendment necessary, or can we tackle the issues rightly raised by my noble friend in another way?

[Viscount Trenchard (Con) [V]]

My Lords, my noble friend Lord Blackwell’s amendment is an interesting idea and deserves serious consideration. It requires the establishment of a new joint co-ordination committee, comprising delegates of both regulators under the chairmanship of the Governor of the Bank of England. As long as we retain a “twin peaks” regulatory structure, it is clearly right that both regulators carry out their duties in a co-ordinated manner, ensuring that their activities are consistent and proportionate in meeting their respective general duties and objectives.

At the time of the introduction of the “twin peaks” system, we were told that it was necessary because there was a conflict between the interests of the consumer and those of the Government in maintaining financial stability. However, the FCA is responsible for both consumer protection and the prudential regulation of all regulated companies except very large ones that are considered systemically important. Might not the best way to be sure that the regulators’ actions are consistent and proportionate be to merge them into a single regulator—the FSA—but leave the Bank responsible for macroprudential regulation?

As I failed to add my name to the speakers’ list for the group of amendments beginning with Amendment 2, debated on 22 February, I was able to speak only briefly after the Minister. My noble friend’s amendment deals with much the same ground, which gives me an opportunity, with the Committee’s leave, to make some of the points that I had wanted to make on the first day.

My noble friend’s amendment seeks to ensure consistent priorities between the two regulators. This is hard to do if the objectives confer conflicting priorities on the two regulators. Indeed, it can be argued that being dual regulated at all is time-consuming, expensive and unattractive. However, I strongly believe that we must move quickly to maximise the attractiveness of London’s markets in order to be assured that the City, including our wider financial services industry, will remain one of the two truly leading global financial centres, with all that that means for our prosperity as a nation.

In 1999, I was privileged to serve on the Joint Committee on Financial Services and Markets under the chairmanship of the noble Lord, Lord Burns, during my first incarnation in your Lordships’ House. At that time, we considered arguments that the FSA should be given a competition objective as a fifth objective. This was supported by the BBA and the ABI, but the Government argued, and the committee ultimately decided, to put competition and competitiveness among the principles rather than the statutory objectives. Two arguments that led us so to decide were that ensuring competition was the primary task of the OFT, not the FSA, and that making competitiveness of UK financial services an objective could damage the FSA’s relations with overseas regulators. Our report at that time noted that some members of the committee would have preferred competition and competitiveness to feature among the FSA’s statutory objectives.

Much water has flowed under the bridge since 1999. Following the financial crisis of 2008, the FSA was split into two regulators, and we adopted the “twin peaks” model that had first been introduced by Australia. On 22 February, my noble friend Lord Howe said that discussions about the balance of the regulator’s objectives

“are not arguments for today. The Government’s future regulatory framework review is considering how the UK’s financial services regulatory framework must adapt to reflect our future outside of the EU. That has to be the right place to consider issues such as the regulators’ objectives”.—[Official Report, 22/2/21; col. GC 142.]

The Minister’s response was disappointing. Does he not agree that our departure from the EU and freedom to adopt an entirely different, principles-based, outcomes-oriented regulatory model suggests that the Government should look seriously at this question as soon as possible?

Some encouraging proposals are included in the phase 2 framework consultation, such as the introduction of “activity-specific regulatory principles”, described in section 2.38. However, it seems that the Government do not plan wholesale changes. They conclude in section 2.46 that these regulatory principles could bring about

“enhanced regulator focus on … competitiveness, without needing to change the regulators’ overarching objectives”.

Such an approach is dangerously complacent. Can the Minister confirm that the Government agree with Andrew Bailey that it would be unrealistic and dangerous to stick to EU banking rules in the future? Surely, in financial services, where we enjoy the advantages of scale and can influence the emergence of global consensus around principles-based regulations that support innovation, we should move quickly to establish the right regulatory framework to do that.

Co-ordination between our two regulators has served us fairly well to date, but it is likely that the regulators will continue to face difficulties inherent in a multi-agency regulatory structure where the performance of one regulator is often dependent on that of the other. There is also a challenge in establishing the borders of financial regulation for allocating functions between the FCA and the PRA. In particular, the increased focus on systemic stability and macroprudential regulations has resulted in overlap between the two regulators. The FCA has responsibility for the prudential regulation of more than 24,000 firms in the UK, whereas the PRA is responsible only for the prudential regulation of some 1,500 systemically important banks and investment firms. Further, the “twin peaks” system is inherently anti-competitive for dual-regulated banks and investment companies, which have to report a large amount of monthly data in two different formats to two different regulators.

The PRA’s secondary competition objective is, by definition, subordinate to its other two objectives. In effect, it is simply a principle to which the PRA should have regard. Many countries have financial regulators that incorporate some kind of competition objective among their statutory objectives, and I do not think that there is any evidence that this has damaged their relationships with either the PRA or the FCA.

Furthermore, in his recent report on competition and markets, John Penrose found that

“our independent competition and consumer regulation regime currently has a good reputation, but not a great one. International rankings put our major competition institutions behind USA, France, Germany, EU and Australia. We have stopped making progress on cutting the costs of red tape and, in recent years, have gone backwards”.

This is largely as a result of a constantly increasing number of sectors, including many in financial services, being caught by the tentacles of the very cumbersome, expensive and complicated system of regulation that has been increasingly pushed by the Commission in the interests of harmonisation.

We have prospered and succeeded as a global financial centre not because of our EU regulatory framework but in spite of it. We may have devised much of the financial regulation ourselves and may even have gold-plated some of it, but we did not choose to work within the codified structures on which European law is based. Besides, our regulators are not that different from anyone else’s: they like to make rules, and gold-plating has been the only way that they could do that in recent years.

As Barnabas Reynolds explains well in his recent paper, published by Politeia and entitled Restoring UK Law: Freeing the UK’s Global Financial Market, common law is

“pivotal to the success of a global financial centre … A key element of London's attractiveness to investors is its legal framework, which underpins a flourishing commercial environment with the rule of law”.

I worry that the Government do not yet recognise that we have to replace the entire directives-based, cumbersome, EU-derived financial services rulebook and go back to something more like how we used to regulate: based on common law principles and outcomes. There is huge resistance to change among trade associations and larger financial services groups because the present system helps the strong incumbent against the innovator and the challenger—and is, in fact, a form of protectionism.

I look forward to hearing what my noble friend the Minister intends to do to move in the direction in which we need to go. I believe that my noble friend’s amendment may provide a first step on that journey.

[Baroness Kramer (LD)]

My Lords, I will respond to the noble Viscount, Lord Trenchard. I for one would be very reluctant to go back to the pre-2008 principles-based approach to regulation that led us into a long, slow crash that, frankly, seriously undermined the financial stability of the UK and caused years of austerity. I do not think that is a good example to hold up of the world that we want to return to.

When the FCA and PRA were created—at that point the latter had a degree of independence from the Bank of England, although I think the Governor was always going to be its chair—one of the reasons that it was important to keep some distinct separation was to prevent the groupthink that had been fundamental to the failures that led to 2007-08. Those were failures to identify systemic risk, to ask questions, to create challenge and to recognise that conduct and prudential regulation are equally important in keeping a system as complex and difficult to regulate as the financial services industry on some kind of transparent and rational platform.

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[Viscount Trenchard (Con) [V]]

My Lords, all three amendments in this group would increase the importance of equivalence determinations, which might ultimately be counterproductive.

Amendment 90 seeks to prevent the Treasury making equivalence decisions for reciprocal reasons alone. I cannot see a shred of evidence that the Treasury might do that. When my right honourable friend the Chief Secretary to the Treasury and Katharine Braddick, director-general for financial services, gave evidence to the EU Services Sub-Committee, they made it very clear that, although they would have preferred a comprehensive set of equivalence determinations, the EU declined to grant any, besides two time-limited determinations for the central counterparties, such as LCH, which clear derivatives transactions. It is good news that the Government decided to make their equivalence determinations unilaterally, based on economics and efficiency of markets, and have no intention of making equivalence determinations for political or reciprocal reasons. I suggest that the noble Baroness’s amendment is unnecessary.

Amendment 100 in the names of the noble Lords, Lord Tunnicliffe and Lord Eatwell, is clearly fighting yesterday’s battle. It presumes that the memorandum of understanding now under negotiation with the EU on future regulatory co-operation is likely to lead to the granting by the EU of a number of positive equivalence determinations. This would indeed provide much-needed clarity in the short term but would also make divergence more difficult. Furthermore, the EU has been unwilling to make equivalence determinations on the basis of equivalence of outcomes. Rather, it has made it clear that it expects the UK to copy its rules exactly, line by line, as the price for equivalence determinations.

The Governor of the Bank of England, Andrew Bailey, has said we will not become a “rule-taker” from the EU. He said that, just as we will not diverge for divergence’s sake, we will not align for alignment’s sake. It is unrealistic to think the EU will grant any significant equivalence assessments to the UK in areas where it thinks we may diverge from its cumbersome and expensive regulations. The majority of the financial services industry, rather than looking for equivalence determinations, which can be withdrawn unilaterally on 30 days’ notice, is now looking to the Government to adopt a new and different pro-innovation, pro-competition, common law-based regulatory regime. That is the way to retain and further enhance the position of our financial services industry and our leadership role in developing proportionate, sound regulation at the global level.

Furthermore, the explanatory notes prepared by the noble Lord are puzzling. The decision of the EU not to grant equivalence determinations to the UK has no effect on UK retail investors, because we have granted equivalence to EU firms in many areas to continue to offer their services and products in the UK. I can see that it may well disadvantage EU retail investors, who will be denied access to products and services produced by UK financial services firms, so I do not think this amendment is helpful under any circumstances.

Amendment 105 in the name of my noble friend Lord Hodgson of Astley Abbotts would require a report on the progress towards agreeing the MoU with the EU on regulatory co-operation. This report will be due within two months of the passage of this Bill. However, the TCA requires this MoU to be entered into by the end of March. It seems unlikely that this Bill will even be enacted by then.

Can the Minister tell the Committee when he expects the MoU to be agreed, when a draft will be available and the Government’s expectations as to its content? I usually find common cause with my noble friend but, in relation to his amendment, I believe the retention of freedom to diverge from EU regulations in order to adopt a better regulatory regime in a particular area, ensuring or enhancing the city’s continuing leading role in that area, is more important than slavish alignment to EU rules to beg or ask for the grant of equivalence determinations which could be unilaterally withdrawn at any time. I therefore doubt whether his amendment is necessary but I am interested to hear what the Minister has to say about it.

[Baroness Noakes (Con)]

My Lords, it is a pleasure to follow my noble friend Lord Trenchard who, as usual, speaks good sense on this matter. While these are clearly probing amendments designed to get the Government to say how they see the future of various aspects of financial services, it seems to me that, as regards equivalence with the EU, they are rooted in the language of the past. It has been clear for a long time that the EU sees equivalence either as a route to dictate how the UK’s financial services sector is regulated or as a weapon to be used against the UK as a competitor. The Governor of the Bank of England has spoken strongly against the EU’s apparent positioning on equivalence. He said that either it was trying to say that our rules should never change, which he described as dangerous, or that our rules should change whenever the EU changed its rules, which was “not acceptable”.

There is no doubt that the EU sees the UK as a threat to its way of doing things. It no longer has a leading financial centre within the EU and will struggle to create one, especially if its only weapon is protectionism. We have long been one of the leading financial markets in the world and I hope that we get our number one slot back now that we are unshackled from the EU. That may well take us into new areas of financial services; it should certainly lead to the dismantling of some elements of the EU’s rules that we never liked. The alternative investment funds directive is one clear example; Solvency II and MiFID are others. They never reflected what we regarded as important, and introduced rules which we regarded as unnecessary and cumbersome.

It would have been very easy for the EU to have granted us equivalence at the end of the transition period; we were completely aligned. However, there is a misguided belief in the EU that they can create a rival to the UK and that the best way of doing that is to make it difficult for UK firms to operate in the EU. My own view is that we should abandon any interest in equivalence. Even if we were to get a favourable decision, the EU has retained the right to remove any such decision at short notice. We know that decisions on granting or removing equivalence will not be made on technical merit. They will be political decisions designed to advance the EU’s financial services industry at the expense of the UK. I do not believe that a UK-based financial services operator could ever build a viable business model on the shifting sands of equivalence as determined by a body—the EU—which does not wish us well.

In addition, I do not think that it matters very much. We may find that some areas of our financial services as currently operated will become less profitable—for example, if the EU cuts off its nose to spite its face and denies Euro-denominated derivatives the advantages of London’s liquidity via UK clearing exchanges. Many UK banks and other financial institutions have already set up EU-based subsidiaries to carry out the business that was previously carried out under passporting. That is now water under the bridge—those subsidiary structures will carry on while the business is profitable and cease if it is not.

For these reasons, I believe that the amendments in this group are looking in the rear-view mirror. Of much greater importance is what plans the Government have to support and promote the future—