Financial Services Bill

Baroness Drake Excerpts

Monday 11th June 2012 Lords Chamber

[Baroness Drake]

My Lords, the Bill replaces the tripartite system with a twin-peak model, but the witnesses to the Joint Committee of which I was a member were overwhelmingly of the view that the structure of financial regulation was not the determining factor in how successful a country was in handling a crisis. The chairman of the European Banking Authority said that,

“during the crisis there were different types of construction that equally succeeded or failed in the face of the crisis”.

In many other countries the philosophy was a presumption that markets act rationally. The IMF Global Financial Stability Report stated in April 2006 that,

“the dispersion of credit risk by banks to a broader and more diverse group of investors, rather than warehousing such risk on their balance sheets, has helped make the banking system and overall financial system more resilient”.

To repeat Her Majesty the Queen’s question: why did no one see it coming? Clearly in 2006 the IMF did not appreciate the underlying fragility and interdependence of the financial system.

As other noble Lords said, successful regulation depends less on the structural route taken and more on the regulatory culture, focus and philosophy. Controlling inflation and excesses in the financial system will require informed decisions that from time to time will be unpopular. That is a powerful argument for granting greater independence to the regulator to make informed rational decisions. Under the Bill, the Bank and the governor will acquire unprecedented new power. The granting of independence must be proportionate to the democratic authority vested in both the Government and Parliament. As Sir Mervyn King conceded in his 2012 “Today” programme lecture, when referring to the new powers:

“Independence is … not the discretion to do as you wish, but the exercise of specific powers delegated to us by Parliament to meet a remit set by Parliament”.

With independence come the responsibilities of transparency and accountability. My concern is that the Bill does not yet sufficiently address those responsibilities. For example, it provides for the Bank to notify the Chancellor when there is a material risk to public funds, and for the Chancellor to be responsible for decisions in a crisis involving such funds. It is important that the Bill gives a high level of confidence that this requirement for the Bank to notify the Treasury is set at a sufficiently low level that there should be no surprises, and there must be no ambiguity as to how and when authority transfers from the governor to the Chancellor.

The memorandum of understanding between the Treasury and the Bank details the process by which the judgment of materiality will be made, not the definition. The Government argue that giving a strict definition of material risk runs counter to the emphasis on judgment. While this argument has some merit, memorandums of understanding are easy to change and lack authority. Similarly, this House should satisfy itself that there is a high level of confidence which will not be thwarted by disputes between the Treasury and the Bank and that the Chancellor has sufficient powers to direct the Bank in a crisis—for there will certainly be future crises—but we know that the chair of the Treasury Select Committee has expressed his concern that the Bill currently grants powers to the Chancellor that are too circumscribed.

To fulfil its responsibilities, the Financial Policy Committee will have an armoury of powerful macroprudential tools, which Parliament should scrutinise through an enhanced affirmative procedure, to allow for consideration by Select Committees and for the Treasury to consider their recommendations. The Financial Secretary resisted such an enhanced procedure on the ground that,

“one must ensure that the degree of scrutiny is proportionate to the powers that are being engaged in”.

Macroprudential policy enters uncharted waters and gives the FPC significant powers. I struggle to understand how the enhanced procedure is disproportionate in those circumstances.

The draft Bill enshrined the principle of consumer responsibility but did not place an equivalent responsibility on firms. The Joint Committee 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 subsequently inserted a new principle, to which the FCA must have regard, that,

“those providing regulated financial services should be expected to provide consumers with a level of care that is appropriate”.

However, that does not provide a sufficient level of protection for consumers. It leaves too open the key question of what is an appropriate level of care.

The case for complementing the principle of caveat emptor with a duty on firms is compelling. We currently have systemic inequalities of knowledge and understanding and misaligned interests between consumer and provider, with the consumer consistently the loser. Confidence in financial products has been worn down by mistrust. Professor Kay recently observed that better performing companies are ultimately the only thing that generates long-term value for savers. However, this alignment is getting lost in an ocean of intermediation, where conflicts of interest and complex and high charges exist. The chain of intermediaries in the savings and investment market is increasing.

While there are new features in the Bill to be welcomed, the current framework still limits the ability to address such problems. Perhaps I may illustrate by reference to pensions. The asymmetries of information are well understood, as are the reasons to believe that financial education, however worth while, will never get us to a position where most consumers are capable of making rational decisions about long-term savings. Indeed, auto-enrolment, which will put millions of ordinary people saving in capital markets, is based precisely on that behavioural insight: it takes key decisions out of the hands of the saver altogether. Employers, as now, will make the big decision about which provider to choose. Consumers will save not because they have carefully weighed the costs and benefits, but out of simple inertia. A model of the consumer making active choices is inappropriate.

The obvious next question is: does it matter in practice? I have only limited time in which to answer that question, but research by Fair Pensions suggests that it does. For example, in its survey of the top 10 commercial pension providers, oversight of external managers’ investment governance appeared to be virtually non-existent. The new philosophy of judgment-led supervision includes being forward-looking in anticipating the risks that threaten market integrity. The solution to the governance gaps among those with the discretion to manage other people’s money does not lie in prescribing even more boxes to tick. The Bill should create a framework in which consumers can have trust. The basic principle is simple. If you are looking after someone else’s money, whether as an asset manager, an insurance company, a trustee, a consultant or any other licensed agent, the starting point should be that you must act in that person’s best interests. It is changed behaviour that we need, not simply compliance.

Finally, this Bill is not an easy read because it contains many amendments to the Financial Services and Markets Act 2000, although not to Section 348, which restricts the publication of confidential information by regulators. Consumer groups are concerned about this section. The Joint Committee shared this concern. It recommended that:

“Neither Regulator should be unnecessarily restricted from disclosing information. Section 348 should be amended to make it as unrestrictive as is possible within the confines of EU law”.

The Treasury review commissioned by the Financial Secretary found that even with Section 348 in place, the regulator could be far more open, and as a result the FSA has committed to a fundamental review of transparency. A letter from the Financial Secretary to the right honourable Peter Lilley on 21 May 2012 states that,

“the Government and FSA senior management are absolutely committed to embedding transparency and disclosure as a regulatory tool”.

I ask the Minister to confirm that the Government will amend legislation accordingly should the FSA conclude that that is required to achieve the commitment that the Government have made.