Queen’s Speech

Baroness Drake Excerpts

Wednesday 16th May 2012 Lords Chamber

[Baroness Drake]

My Lords, the focus in the Government’s programme on fair markets and the regulation of the financial services sector is to be welcomed. With auto-enrolment into pensions, millions more people will save through capital markets. Confidence in those markets has been worn down by mistrust, scandals, charges, complexities and conflicts of interest. Fiduciary duties exist to ensure that intermediaries—those who exercise discretion over other people’s money—act in the best interests of those whose money they look after. However, interpretations of this vital legal principle are dysfunctional, which undermines outcomes for savers, holds back effective shareholder oversight and allows conflicts of interest to prevail.

Those saving in trust-based occupational pensions should be protected by trustees who are legally obliged to act in their best interests. Those saving with an insurance company are subject to the consumer responsibility principle. As FairPensions points out, most savers are unaware of this legal divide. With auto-enrolment, the employer chooses the pension provider and the power of inertia increases saving. The inadequacy of the caveat emptor principle in that situation is evident. However, depending on the type of scheme their employer chooses, savers will find themselves subject to one of two opposing principles: fiduciary duty or caveat emptor. The law should be clarified to overcome the misperception that investors’ duties begin and end with maximising quarterly returns. The Government must provide better understanding and enforcement of investors’ true fiduciary duties.

The Work and Pensions Select Committee concluded in its recent report on auto-enrolment that,

“the Financial Services Bill … offers the opportunity for the Financial Conduct Authority … to look at approaches such as that of introducing something akin to a fiduciary duty for those running contract-based schemes”.

The Joint Committee on the draft Bill recommended that the Bill,

“place a clear responsibility on firms to act honestly, fairly and professionally in the best interests of their customers”.

The Government have responded with a new principle that firms must,

“provide consumers with a level of care that is appropriate”.

I fear that that will prove inadequate.

The issue of rewards for failure is the litmus test of how well fiduciary investors are protecting these savers’ interest in well governed companies delivering sustainable returns. As Professor Kay observed in the interim report of his review of UK equity markets, the purpose of equity markets is to improve the performance of companies that are ultimately the only thing that generates value for savers. They drive growth and create jobs. There is a fundamental alignment between the success of companies and the returns to savers. Equity markets exist to serve companies and savers, not to enrich intermediaries.

By this standard, the pensions industry is weak. From 2000-07, real returns to savers averaged just 1.1% per year, and pension fund payments to intermediaries rose by an estimated 50%. Fiduciary standards of care are an essential part of building a financial system that serves savers and the economy. I agree that it was surprising that the Queen’s Speech made no direct mention of executive pay and shareholder rights. Mean FTSE 100 executive pay rose by 49% from 2010-11. Austerity has clearly passed them by.

The shareholders’ spring has seen the flexing of voting power on remuneration reports, but this will not be sustained without addressing the conflicts of interest and behaviours of institutional investors responsible for casting votes on behalf of funds, many holding the savings of millions of people. Take, for example, regulation of the 25 million with-profits policies worth £330 billion. There is no explicit fiduciary duty to protect the best interest of policyholders. Consumer groups such as Which? have criticised the regulatory framework for with-profits policies and failure to control conflicts of interest. The Prudential Regulation Authority will assume responsibility for systemically important insurance companies, but it will not have the remit to protect proactively consumers who hold with-profits policies.

The Bill must provide for the PRA to consult the FCA and consumer groups on the consumer interest. The Government want transparent regulators, but consumer groups and the Joint Committee on the Bill expressed concerns that Section 348 of the Financial Services and Markets Act gold-plates single market directive limitations on the use of confidential information and will prevent the FCA from using the new powers that the Bill gives to it. The Financial Secretary to the Treasury, Mark Hoban, has confirmed that the Treasury will undertake a review of Section 348 with its recommendations made available through the passage of the Bill. I dearly hope that those recommendations will support disclosure.

Finally, figures from the Community Development Foundation show that about 4% of lending to SMEs goes into businesses in the most deprived communities. I recently read an article about the payday loans company Wonga.com launching a service for small firms. Its founder, Mr Damelin, is quoted as saying:

“All our research … tells us that small-business lending is broken and we intend to use our platform to offer a real alternative”.

Banks are failing to extend credit to small companies, but this reveals a worrying development in the credit market that exposes small firms, particularly small firms in deprived areas, to exponentially high rates.

The culture of the financial services industry must change and it must behave, in the words of the business Secretary, Vince Cable, as the servant of the economy, not its master.