Bank of England and Financial Services Bill [HL]

Baroness Kramer Excerpts

Monday 9th November 2015 Lords Chamber

[Baroness Kramer (LD)]

My Lords, I completely support my noble friend Lord Sharkey in this. Although I greatly respect the noble Lord, Lord Flight, I hope that the House will resist his blandishments. I think non-executive directors of banks finding themselves on the Court of the Bank of England would be constantly facing conflicts of interest, and the public perception would be appalling—that the Bank had become the captive of the industry that it is there to regulate. That does not seem to be a sensible principle.

With the changes that are now proposed—for there to be five inside members, if you like, of the court and seven outside—the inside members would need to persuade only one outside member to join them to achieve stalemate. That is an unacceptable balance in any institution which is so important to the economic life of this country. If the argument cannot persuade more than one non-executive director, it cannot have the standing that would allow it to prevail.

Like my noble friend Lord Sharkey, I am still struggling to understand why this change is being made. The only reason that has been presented to me is the issue of transition. If there are only seven members of the board, for a period of time there could be an incoming and an outgoing member on the board at the same time. Perhaps that is a good practice; it sounds reasonably attractive. But for that to be the reason that the board should be reduced on a normalised basis to seven seems extraordinary. I also suggest that an outgoing member might be very hesitant to exercise their rights, knowing that they were about to depart the board. Transitional arrangements could be put into the Bill, and we would be quite supportive of the idea that there might be a period when an outgoing member of the court could remain on the board in certain roles, or perhaps even in a full role, for a brief transitional period to achieve the goals that the Minister is attempting to achieve.

I hope very much that we can resist this set of issues. The Bank of England is sufficiently important and outsiders are absolutely necessary. This House has made sure over the past several years that that is central to legislation and I think we will continue to hold to that importance.

[Baroness Noakes (Con)]

My Lords, I agree with the noble Baroness, Lady Kramer, that the Bank of England is an important institution but I am not sure that that importance needs to translate itself into how the court is constituted. The important activities of the Bank are carried out in what will be the three major committees: monetary policy, financial stability and prudential regulation. The activities carried out by the court are relatively few in number. The question then is: what size of court is going to be efficient for carrying out the functions it is there for?

The model that well serves both the plc community in this country and much of the public sector that is modelled on corporate lines is to have a majority of non-executives. That is being kept in here. I have never heard it suggested that the number of non-executives is somehow important to the quality of governance in plcs. Many have more than a bare majority of non-executive directors but a lot operate strictly within the rules to have just a bare majority. I have not seen any studies anywhere that the ratios have any correlation with the quality of governance that is capable of being exercised.

The noble Lord, Lord Davies, referred to the academic evidence that smaller boards are effective boards—that is one of the things that came out of Sir David Walker’s review into the governance of banks—and that committees should be 4:5 and boards 8:10 or something like that. That is because in a smaller organisation, all members can have a proper voice and there can be a proper discussion, whereas in large boards often it is relatively simple for an inner group to dominate the larger group. That is what the behavioural studies have shown.

[Baroness Kramer]

I respect the views of the noble Baroness, Lady Noakes, very much but is she saying that the current Court of the Bank of England is ineffective because it is too large, and that the effect has been that many of the non-executive directors are not having their voice heard? That is a very serious comment to lay on the table. If that is the case, we really need that evidence because we will want to effect a cure, if this is an answer to a board that the Government have essentially decided is ineffective.

[Baroness Noakes]

My Lords, I have absolutely no knowledge of how the Court of the Bank of England works and have not had that knowledge since 2000, when my tenure on the court ceased. At that time I think that we were a court of 16, of whom 13 were non-executives. I will not claim that we were a very effective board at that. All I am trying to say is that what the Government are proposing is perfectly sensible and in line with general corporate practices. It seems to be entirely defensible.

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[Lord Ashton of Hyde (Con)]

My Lords, I thank noble Lords who have participated in this short debate. The general theme has been that the Government have not put forward a sufficient case for reducing the number of non-executives. I hope that by the end of the debate, we will have been able to elaborate on that. The noble Lord, Lord Eatwell, said that there seemed to be a pervasive feeling through the Bill that non-execs are a nuisance. That could not be further from the truth—good ones are essential, but too many non-execs are not effective. It is crucial to have very high-quality non-execs. I will come on to that as far as the court is concerned.

I agree with the noble Lord, Lord Sharkey, that we have got the figures right in terms of what we have at the moment and what we are going to have, but I come to completely the opposite conclusions as a result of that. I will try my best to outline the Government’s feeling and will also refer, to a certain extent, to some of the points my noble friend made about the academic evidence and the experience of commercial firms, which show that sometimes reduced numbers are more effective.

As noble Lords are aware, the Bank of England Act 1998 states that the court can contain,

“not more than 9 non-executive directors”.

This Bill does not make any alteration to this provision. Before I dive into the detail, it may be helpful to remind the Committee what we are seeking to achieve: a court that is effective in scrutinising the actions of the Bank, holding executives to account, challenging their thinking and exercising its statutory functions. A number of noble Lords have cast this debate in terms of avoiding groupthink, which I agree is very important.

Given that, there are two important factors to bear in mind about the issue we are discussing here, both of which mitigate the risk of groupthink. The first is the number of non-executive directors on the court, which the noble Lord’s amendment focuses on. The second, but no less important, factor is the quality of non-execs on the court. Let me first address the issue of numbers. Within the terms of the current legislation as written, the Government plan to reduce the number of non-execs to two. This will not weaken the court; instead, it will strengthen it.

[Baroness Kramer]

By two.

[Lord Ashton of Hyde]

Yes—by two, to seven. We think that will strengthen it, because the governance of the Bank will be enhanced by enabling the court to become a smaller, more focused unitary board, as several noble Lords have mentioned.

A smaller court is something the Treasury Select Committee advocated in its 2011 report, Accountability of the Bank of England. It recommended that the court’s membership be reduced to eight, emphasising that a smaller court would allow a diversity of views and expertise while still being an efficient decision-making body.

Our proposals exceed the size of court recommended by the Treasury Select Committee, but a court of 12 is significantly smaller than both the court’s original size of 24 and its size more recently, during the financial crisis, of 19.

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[Lord Ashton of Hyde]

I fear I cannot. Can the noble Lord help us? The answer is, no, I cannot tell noble Lords that.

[Baroness Kramer]

Perhaps I could be helpful on that point. As the noble Lord will remember, this legislation is adding one more insider, so the balance with eight would have been five insiders versus three outsiders.

[Lord Ashton of Hyde]

The balance would change if we do what the Chancellor has decided to do—to reduce it to seven—but, as I will come on to, the flexibility is maintained to have nine. The legislation says “up to nine”, and nothing in the Bill changes that. We are still operating on the original number of “up to nine”. The amendment would make it exactly nine and reduce any flexibility.

My original point was that our suggestion is smaller than the Treasury Select Committee’s original number of 12, the court’s original size of 24 and its size during the crisis of 19. The size of the court was identified as a barrier to its effective functioning during the financial crisis. We think that a smaller board will better scrutinise the executive. With fewer non-executive directors, each member has greater opportunity to pose questions to executive members and to debate with them. A larger court can encourage a round table of individual speeches, rather than enabling back and forth discussions and challenge to the executive.

As Professor Capie, former official historian of the Bank of England, noted in his evidence to the Treasury Select Committee, historically, larger boards have often consisted of “simply observers or rubber-stampers”. This was supported by independent evidence from the Walker report, which suggested that the ideal size for a board tends towards 10 to 12 people. Our proposal for five executive and seven non-executive members sits within this range. The Walker report notes that boards larger than 12 people become less manageable and less effective.

The Bank itself has highlighted the benefits of reducing the size of the court. In its 2014 report, it said that,

“consistent with best practice in the private sector, the Bank sees the value of continuing to evolve towards a slightly smaller body, with a non-executive chair and majority”.

Undoubtedly, board sizes in the private sector are on average relatively small. For example, according to the Spencer Stuart board index, the average sizes of boards in 2014 in the US and UK were 10.8 and 10.5 respectively.

Our proposals therefore align the court with current best practice for a unitary board. However, I accept that best practice can, and often does, evolve over time. Therefore, as I said, the current wording provides flexibility, but no compulsion, to increase the number of non-executives up to nine if future evidence suggests that this would be beneficial. Similarly, and importantly, this flexibility will ensure continuity and transfer of knowledge during periods of flux between departing and joining non-executive directors, as the noble Baroness, Lady Kramer, mentioned. But that is not the only reason for the change. We will retain the flexibility, but the normal number will be seven. Specifying that the court must contain an exact number of non-executives, as the amendment does, would lose those benefits.

Let me now turn to the quality of non-execs on the court, which is critical and was mentioned by several noble Lords, including my noble friend Lord Flight. The court has been transformed over the last three years. The Chancellor sought to appoint the highest quality team with significant experience of running large organisations and expertise in matters relevant to the Bank. All non-execs are appointed by the Queen on the recommendation of the Prime Minister and the Chancellor of the Exchequer. The appointment process is run by the Treasury and regulated by the Office of the Commissioner of Public Appointments. It is in line with best practice, with open competitions held for all positions. The Government look far and wide for the best candidates, with roles advertised in the international press. The result is a board of the highest quality non-execs chaired by Anthony Habgood, one of the most experienced and respected company chairmen in the country.

I was asked by the noble Lord, Lord Davies, what consultation took place on reducing the number of non-executive directors. In its December 2014 publication, Transparency and Accountability at the Bank of the England, the Bank made the case for reducing the size of the court. The Government included the proposal to reduce the size of the court to seven in the July consultation paper, with the consultation closing in September. No respondents opposed the proposed reduction in the size of the court.

[Baroness Kramer]

Would the Minister remind us how many responses there were to that consultation?

[Lord Ashton of Hyde]

There were not that many, but I cannot tell the noble Baroness the exact number.

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[Baroness Kramer]

I think the number was 14. Most people did not know it was there.

[Lord Ashton of Hyde]

So clearly it was not a burning issue. As my noble friend Lord Flight said, no member of the court is from a regulated firm—that is absolutely true—which ensures no conflicts of interest. We think that that is the correct way forward. Of course, they bring a wide amount of experience and there are many members of the court whose description is a “former” director of relevant parties, including banks.

Finally, who made the decision to reduce the number from nine to seven? That was made by the Chancellor, on the advice of the non-executive chairman of the Bank. The proposed composition of the court, as recommended by the Treasury Select Committee, was a total of eight: the governor, two deputy governors, an external chair and four other external members.

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[Lord Eatwell]

My Lords, I find this a somewhat naive and shocking part of this small Bill, in the sense that the clause under debate has two objectives. The first is to reduce the powers of the NEDs and the second is to reduce the powers of Parliament. Both of those goals I regard as reprehensible. As the noble Lord, Lord Tunnicliffe, set out, these issues were debated extensively in this Chamber with respect to the Financial Services Act 2012. We went through them in great detail and, in particular, we followed the advice of the Treasury Select Committee of another place.

It is obvious that this measure is designed to reduce the powers of the non-executives, but perhaps I may comment on the second point that I made about the powers of Parliament. That derives from the statement by the Treasury Select Committee of another place, which at that time was referring to a new supervisory board. That, in debate, was transformed into the oversight committee. The Select Committee said:

“Our recommendation that the new Supervisory Board have the authority to conduct retrospective reviews of the macro-prudential performance of the Bank should, if operating successfully, provide”,

Parliament,

“with the tools for proper scrutiny”.

Those “tools for proper scrutiny” are being removed in this clause. I think that Mr Carney’s explanation of the role of the Independent Evaluation Office, which can be summoned into action only by the oversight committee, is particularly revealing.

It has also been argued that, in some sense, the Bank now has two boards—the court and the oversight committee—and that this is causing confusion and reducing the effectiveness of the Bank. That is a very foolish argument. The notion that there should be an independent non-executive committee reviewing the activities of a main board is commonplace, particularly given that the reviews are specifically defined by legislation to be retrospective and not to question the contemporary acts of the court. That process is one that the best unitary boards have embodied in their codes of practice. I am amazed and, as I say, shocked that the Government are attempting to reduce the powers of non-executive directors in this way and, in particular, to reduce the powers of Parliament.

[Baroness Kramer]

My Lords, I will make just a few comments, if I may. I join my noble friend Lord Sharkey, and the noble Lords, Lord Tunnicliffe and Lord Eatwell, in their concern about the changes being proposed and the implications that would follow from them.

Will the Government confirm that, under the arrangements to reduce the number of non-executive directors to seven and increase the number of officials on the board to five, it would take co-operation from only one non-executive director with those officials to effectively prevent any investigation into any area of Bank activity? That is, I feel, a completely unacceptable balance that is being proposed today. The Government will have to come up with a very great justification for why the hurdle must be so low—four current officials—to prevent investigation of historical activity.

Clause 4 effectively falls if Clause 3 falls. Clause 4 makes the situation yet worse, because it contemplates not that the whole court will act as an oversight committee but that a sub-committee can be created in order to carry out that work, comprised of as few as two non-executive directors. For two non-executive directors to be considered sufficient for the important work of investigation, review and oversight of the Bank of England strikes me as completely extraordinary. It is also noticeable that the number two applies to the sub-committee responsible for the remuneration of officials at the Bank.

We are moving into a “two best friends” provision here, and I find it exceedingly disturbing. The Government will have to come up with some justification for why a sub-committee of two NEDs is sufficient to carry out a crucially important task that was absent during the many years in which the Bank of England essentially failed to meet the necessary standards to prevent a systemic crisis in finance in this country. I would like to hear their justification for the number two.

[Lord Bridges of Headley]

My Lords, I thank all the noble Lords who have made very powerful contributions and thoughtful points.

I will not detain your Lordships with lots of history; you know it much better than I do. However, to remind the Committee how this came about, I will repeat something that has already been said. The Financial Services Act 2012 gave rise to the Oversight Committee, largely in response to recommendations made in the report Accountability and the Bank of England from the Treasury Select Committee in the other place. That report recommended that the court should be reformed into a board, with powers to conduct ex-post reviews of the performance of the Bank; that board members should be authorised to see all the papers submitted to the MPC and FPC; and that the board should be responsible for reviewing the processes of the Bank’s policy committees.

The Treasury Select Committee argued that the new board should be called the Supervisory Board of the Bank of England but, despite this name, the structure that was proposed was in fact a unitary board. As has been said, the Financial Services Act 2012 took steps to implement these recommendations, by creating a set of statutory oversight functions. However, instead of conferring powers on the court itself, the powers were conferred upon a new statutory Oversight Committee, made up exclusively of the non-executive directors.

[Lord Bridges of Headley]

That is my understanding. If I am wrong, I will correct myself.

The noble Lord, Lord Sharkey, made his points very forcefully and I fear we may still have to have further discussions—if he can bear it—but let me restate the Government’s position. The problem now faced by the Oversight Committee is simple. As the noble Lord said, for the non-executives to hold the executive to account effectively, they need to meet together, not separately. There needs to be full and frank discussion between the governors and the non-executives on how best to exercise the court’s oversight functions. I am sure the noble Lord would agree that the challenge and recommendations of the non-executives need to be informed by in-depth knowledge of the Bank’s operations. Effective oversight needs to be carried out by the executive and non-executives in partnership, not in silos.

It bears repeating that the key powers of oversight, which are necessary and working, are not lost as a result of their transfer to the whole court. The court will continue to be able to commission reviews as it sees fit. Moreover, the non-executives will continue to be a majority on the court and will also continue to meet together as a group after each meeting of court, in line with best practice. As was discussed earlier today, court contains a high quality non-executive majority and is therefore well placed to oversee the work of the Bank.

It is entirely appropriate that court, as the governing body of the Bank, should be responsible for exercising these oversight functions.

[Baroness Kramer]

I hate to stop the noble Lord, Lord Bridges, in his flow, but could he confirm that, under the proposed structure, if the officials of the Bank collectively believe that an area is not appropriate for investigation, they need the support of only one non-executive director?

[Lord Bridges of Headley]

As the noble Baroness points out, that would obviously be the maths. We will probably have to have further discussion on this, but I would like to come back to the powers.

It is entirely appropriate that court, as the governing body of the Bank, should be responsible for exercising these oversight functions. The Bill is putting in place a model which is widely regarded as best practice in the United Kingdom. It also completes the model that the Treasury Select Committee recommended in 2011, and was subsequently endorsed by the PCBS in 2012. That model is a streamlined unitary board, with express powers to commission performance reviews. Parliament would still see copies of the reports of any performance review published by the court, just as would be the case for reports published by the Oversight Committee. Parliament’s powers are not being reduced and the Treasury Select Committee can summon any non-executive director to give evidence.

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[Lord Bridges of Headley]

My Lords, it is clear that I still have some persuading to do. I would argue that those powers have not changed in the sense that they have been transferred from the committee to the court.

[Baroness Kramer]

The Minister said that the powers have not changed, but would he agree that who exercises the powers has changed significantly? Officials had no opportunity to exercise those powers; they were the powers only of non-executive directors. Now they can be easily exercised by the officials plus one NED.

[Lord Bridges of Headley]

As the noble Baroness rightly points out, obviously her maths is correct and there would be robust discussion. This comes back again to the quality of those who are on the court and their ability to persuade people that such a review is necessary.

That is all I wish to say on this matter.