Brexit: The Future of Financial Regulation and Supervision (European Union Committee Report)

Baroness Falkner of Margravine Excerpts

Wednesday 6th June 2018 Lords Chamber

Moved by

[Baroness Falkner of Margravine]

That this House takes note of the Report from the European Union Committee Brexit: The Future of Financial Regulation and Supervision (11th Report, HL Paper 66).

[Baroness Falkner of Margravine (LD)]

My Lords, on behalf of the EU Sub-Committee on Financial Affairs, I am delighted to introduce this EU Committee report, Brexit: The Future of Financial Regulation and Supervision. Our inquiry was undertaken between September and December 2017, and subsequently, four members have left the committee. They are the noble Lords, Lord Haskins, Lord Skidelsky, Lord Woolmer and Lord Fraser of Corriegarth. I wish to acknowledge their contribution to this inquiry and to the overall work of the committee.

The already small secretariat of our committee became smaller during the course of the inquiry, but we were served by an outstanding policy analyst, Dr Holly Snaith, who left us for the Bank of England. However, we did a nearly direct swap, as we were joined in turn by Matthew Manning, the current clerk to the committee, who is with us today. We are enormously grateful to them both for their work on this report, particularly in light of the challenging circumstances in which the committee has operated in the last seven or eight months.

As noble Lords will be aware, the financial services sector is a vital and thriving part of the UK economy, and questions about our access to the single market in financial services are a highly contentious component of discussions about the UK’s future relationship with the EU. In undertaking this inquiry, we were conscious of the position of the United Kingdom as the pre-eminent financial services centre and the threat that Brexit poses to this very special ecosystem. Therefore, in assessing the future of financial services in the UK, regulation and supervision seemed to us to be key. Although we recognise that the UK will start its future relationship with full regulatory alignment, the nature and extent of maintaining that alignment and managing divergence to the extent that it might occur are vital to the UK’s interests.

In our inquiry we heard evidence from a range of academic experts, industry practitioners and the UK regulatory authorities. Given the EU’s decision to designate Michel Barnier as the sole negotiator, we were unable to take evidence from EU institutions directly. However, we are particularly grateful to Brussels-based economic and financial think tanks, which recognise, perhaps more perceptively than the Commission, that dialogue will need to be an essential element of future co-operation and which therefore freely offered us their insights into some of these issues and challenges. I particularly want to put on the record our thanks to the Centre for European Policy Studies, whose CEO, Dr Karel Lannoo, travelled to London to give us evidence—but of course we are grateful to all those who contributed to the inquiry.

Almost immediately, the agreement of a transition period emerged as an urgent priority. We considered the matter to be of such importance that we chose to write to the Chancellor part way through the inquiry, in November 2017, to emphasise that any agreed transition period was, in his own words, a “wasting asset”—in other words, a delayed agreement would be scarcely better than no agreement at all. Andrew Bailey, chief executive of the Financial Conduct Authority, put it even more bluntly when he told us that an agreement needed to be reached “PDQ”. I think that that needs no interpretation. Catherine McGuinness of the City of London Corporation told us that financial services firms need three things: certainty, stability and proportionality for business.

During our inquiry and in the period since, we have repeatedly been promised a White Paper on financial services by, not least, the Secretary of State for Exiting the European Union. It is therefore disappointing that this has yet again been postponed. This is surely a first and, frankly, minimal step towards providing the industry with an indication of what the Government will seek in a future relationship.

Returning to the transition period, we are pleased that the Bank of England has had the foresight to allow firms to plan on the assumption that a temporary permissions regime will be put in place in the event of there being no deal. However, without an equivalent assurance from the EU authorities that UK firms passporting into the EU 27 can plan on the assumption of a withdrawal agreement being in place, it appears that firms based in the UK passporting into other member states are indeed having to plan on a no-deal scenario. So transition offers little, if any, comfort at the moment. This puts firms in the unfortunate position of implementing costly plans that may be economically and strategically irreversible at the point at which any agreement is reached, thereby negating much of the value of such an agreement.

Another important consideration emerged during the inquiry—that of contractual continuity. In many cases, firms have written contracts that may entail liabilities extending potentially for decades. This is a special concern for the insurance industry. For that industry, agreeing a transition period merely postpones the problem. If firms cannot maintain or service their contracts because they are legally prevented from carrying out licensed activity in another member state, individuals and businesses both stand to lose.

Mr Sam Woods, deputy governor of the Bank of England, told us that the maximum penalty for UK firms conducting a regulated activity without a licence under the Financial Services and Markets Act 2000 was a two-year prison sentence or an unlimited fine. As he put it,

“boards may have some appetite for legal risk, but I do not think many are going to have that kind of appetite”.

Contractual continuity is not just a problem for large, cross-border conglomerates. Consumers, pensioners, drivers and travellers all face the risk of being effectively uninsured. Moreover, the problem of how to treat existing cross-border business overall cannot truly be resolved except within the context of an agreement on a future relationship. Otherwise, firms will remain exposed to risks on their books that they might not be able to mitigate on a continuing basis. Mr John McFarlane, chairman of Barclays, was clear that,

“transitioning is most valuable if it is to somewhere worthwhile at the end”.

Our witnesses were also clear that the effects of no agreement on mutual market access would be negative for both the UK and the EU. The UK is, after all, the single biggest provider of financial services to EU member states. The market fragmentation that would result from a loss of access would harm EU businesses and consumers as well as those in the UK. Indeed, market fragmentation will likely increase financial instability, reversing the improvements put in place as a result of the post-crisis regulatory developments of the last decade.

One key finding emphasised by many of our witnesses was the inadequacy of the EU’s current equivalence framework—that the process of granting equivalence status is political and capable of being unilaterally withdrawn by the Commission at very short notice. The recent experience of Switzerland is telling in that regard. Switzerland negotiated over a considerable period for an open-ended equivalence ruling from the Commission similar to that given to Australia and the US. At the 11th hour, it was granted a single year until the end of 2018. The UK’s vast financial services industry, with the plethora of services that it offers, cannot depend on such a tenuous, politically driven and insecure form of access. An agreement to base market access on a bespoke and genuinely mutual equivalence agreement is far preferable.

In that regard, we took evidence from the International Regulatory Strategy Group comprising senior financial services leadership in the United Kingdom. It recommended that the most suitable form of relationship between the UK and the EU was mutual regulatory recognition. We understand that this is now the Government’s own position, which is why we would have wished to have seen some detail on how they expect the negotiation to proceed.

Until it is clear what form of access the UK and EU will agree on, it is impossible to say with any certainty what opportunities will arise for regulators and firms. Many witnesses were keen to emphasise the considerable resources that they had devoted to complying with EU requirements, however onerous they might have been, and were therefore not necessarily in favour of making changes to the regulatory regime post Brexit. That was especially the case where regulatory divergences might endanger market access. Nevertheless, we heard from some witnesses about possibilities to tailor and strengthen the UK’s regulatory framework once we had exited the EU. Those possibilities must be explored against the background of international standards developed by organisations such as the Basel Committee on Banking Supervision and the International Organization of Securities Commissions.

Indeed, the EU’s regulations are to a large extent merely the European implementation of these internationally agreed standards, and the UK has played an outsize role in their development. This has depended on a deep pool of exceptional talent within the UK regulators. As Andrew Bailey pointed out,

“the work that has been done by the G20 and the Financial Stability Board which Mark Carney”

the Governor of the Bank of England—

“chairs, has been fundamental in putting stronger global standards in place”.

As the UK leaves the EU, it must continue to play an active role in these organisations. Can the Minister tell us what conversations he is having with UK regulators to ensure that their pre-eminent role is maintained?

Some areas where change might be targeted include those where the EU has gone beyond international standards. We heard evidence from witnesses such as Mr Stephen Barclay, the now former City Minister, that the EU has done so in applying prudential requirements to all firms, not just the large cross-border institutions that Basel has traditionally focused on. We believe that there is scope to apply a more proportionate and risk-based prudential framework to smaller domestically focused firms. Indeed, this may encourage the competitiveness that has always been the UK’s strength. It may need to be accompanied by a reconsideration of the regulator’s mandate, but that will be dependent on future developments.

The primary instrument of the offshoring process, the withdrawal Bill, has now been debated by this House. The complexities of transposing the aspects of the acquis relevant to financial services into UK law were raised by many witnesses but not really addressed in the Bill. The sheer volume of statutory instruments that will need parliamentary scrutiny is enormous and we await the detail of how that work will be done. This only highlights the importance of finalising a transition period as a no-deal scenario would place enormous burdens on Parliament’s ability to pass the necessary legislation.

There are also questions about the Government’s proposed approach, specifically to financial services. Several witnesses highlighted the inappropriateness of transposing level 1 EU legislation into primary and secondary legislation. Some of the rules are technical and should, we thought, be left for regulators to make, because they possess the necessary expertise to ensure that they are fit for purpose. Amending them at the speed necessary to keep the UK’s framework adaptive and responsive to change is incompatible with the timescale of parliamentary processes.

In conclusion, I want to highlight that a productive and fruitful relationship between the UK and the EU based on mutual market access is to the benefit of both sides. Without this, financial instability will increase and we will jeopardise the UK’s economy, financial stability and global leadership. I beg to move.

--- Later in debate ---

[Baroness Falkner of Margravine]

My Lords, I thank all noble Lords who spoke in this debate. Naturally, noble Lords would expect me to be extremely grateful to members of the sub-committee who spoke, but I am also particularly grateful to noble Lords who are no longer members of the sub-committee and to those who have never been members. Their remarks are truly the important ones. I also know that there is another debate and many noble Lords have been sitting here patiently waiting for that to commence, so I will restrict my closing remarks to non-members of the sub-committee —and I will keep them brief.

The noble Lord, Lord Liddle, was extremely critical. I think he is no longer in his place but I will continue.

[Lord Bates]

The noble Lord apologised that unavoidably he had to leave the Chamber.

[Baroness Falkner of Margravine]

For the record, the noble Lord was critical that we took for granted single market withdrawal. All I would say is that he should read our 2016 report, Brexit: Financial Services, chapter 2, where we cover all the alternative arrangements. So in that case he was shooting the messenger unnecessarily.

The noble Lords, Lord Liddle and Lord Davies of Stamford, and my noble friend Lady Kramer did not at all like our identification of mutual recognition as a solution that had been raised by our witnesses, not least by the IRSG and several others. They, too, are shooting the messenger. If they had glanced at paragraphs 60 to 63, they would have seen that we have our own reservations about achieving that. We say, in terms, that we need more detail and decisions from the Government on how they intend to proceed—if in fact that is the Government’s position. With his usual objectivity and fairness, the noble Lord, Lord Davies of Oldham, acknowledged that.

The noble Lord, Lord Davies of Stamford, warned us that he was extremely blunt. He knows me well enough to know that I will reciprocate, although rather more softly. I will pick up two points that he made. He said that we were too kind to our regulators as they were tainted by scandals. In the examples that he gave, he omitted to mention that they took place under mainly the watch of a Government whom I believe he was a part of until 2010. They persistently seemed to believe in light-touch regulation. Our belief is that the old tripartite system that has now been replaced by the twin peaks of dual regulation by the FCA and the PRA is rather more robust and resilient. But that is not to say that I believe that banks will never fail. All I am confident of is that the new system will prevent wholesale contagion and a risk to the UK economy overall in terms of the risk to financial stability. In that respect, we should be much more confident of our new system.

Indeed, I know that Members of this House who served on the Parliamentary Commission on Banking Standards helped to create the new system. I believe that my noble friend Lady Kramer was a member of that. So let us have a little more confidence in the new architecture that we have put in place. It has been going for some years and we took our evidence in light of the current framework, not the framework that existed before 2010.

Both the noble Lord, Lord Davies, and my noble friend Lady Kramer commented on how UK institutions were somehow worse than others in terms of the UK institutions’ lack of probity and prudence. I did a quick Google check and I will not detain the House with my findings—we can have a bilateral meeting outside the Chamber. But I can say to the noble Lord rather confidently that Société Générale and BNP Paribas, to mention just two—I am leaving aside Deutsche and all the others—have had whopping fines imposed on them in the period since. So let us not just call out our own institutions. Let us accept that a financial system under a capitalist model will always carry some risk. Let us try to see where regulation can be improved and where it needs to be more resilient and sustained. That is what we were trying to do in this report, in looking forward to how supervision and regulation will take place after we leave the European Union.

It has been a pleasure to take part in this debate. But, above all, it was an incredibly stimulating experience to have conducted this inquiry as chair of the committee. I would just remind the House of the words of the noble Baroness, Lady Liddell, who said that, in deliberating what we found in this report, we were unanimous as a committee in coming to the conclusions. That is the way it should be. It is a very grown-up committee, where the members recognise that and behave accordingly. It has been my pleasure to chair the committee. I beg to move.

Motion agreed.