Bank of England and Financial Services Bill [HL]

Baroness Kramer Excerpts

Monday 9th November 2015 Lords Chamber

[Baroness Kramer (LD)]

Although this has been a brief debate, it is an important one. Can the Minister describe why he takes the view that the chief executive of the FCA is not inherently different from a fully outside member of the FPC, particularly when prior legislation would indicate that there is a close family relationship?

[Lord Ashton of Hyde]

I am certainly able to do that; I was just coming to that very point, I assure the noble Baroness.

We think that the balance of membership is appropriate, as the work of the FPC is one of the key elements of the Bank’s strategy to meet the financial stability objective. It is therefore essential that the Bank can be held accountable for its performance against that objective. The effect of the amendment would be to place the committee outside the Bank’s control.

[Baroness Kramer]

I am sorry to interrupt the Minister again, but he said that the effect of this would be to place the committee outside the Bank’s control, so he is describing the chief executive of the FCA as part of the Bank family. That is the logic of that sentence.

[Lord Ashton of Hyde]

I am sorry, but I do not think it is. If we say that the CEO of the FCA is one of the external members, that places it outside. I am coming to the question of whether you can describe the non-executive member as also external; I promise that I will come to that in a minute.

We should also consider the overall size of the committee. The noble Lord’s amendment would bring the number of voting members on the FPC to 13. Setting aside any superstitious concerns, there is a risk that the committee could become unwieldy and cumbersome. This could be particularly problematic for the FPC, as it is required to seek to make decisions via consensus, which of course becomes more difficult as it grows in size. The amendment would make the FPC the largest of the Bank’s policy committees. The MPC has only nine voting members and the PRC is likely to have 12 members. I believe that the additions to the FPC will be a net benefit to the FPC, but further expansion risks tipping the scales toward a detrimental impact on the workings of the committee.

I come to the question of the CEO of the FCA, to which the noble Baroness, Lady Kramer, referred. We are in no doubt that the FCA CEO should be counted as an external member of the FPC. The CEO of the FCA is not an executive of the Bank, and the FCA is entirely separate from the Bank.

There is no doubt that having the FCA CEO on the FPC is of huge value to the committee. It is true that her membership of the FPC brings particular benefits in terms of regulatory co-ordination, but she also has extensive relevant expertise, and, crucially, she brings an independent viewpoint and external challenge from outside Threadneedle Street, because the FCA is a completely independent body with a different set of objectives. It is also worth noting that this reciprocates the arrangement on the FCA board, where the chief executive of the PRA is counted, alongside the Treasury-appointed chair and the other members, as a non-executive. The CEO of the FCA is therefore eminently qualified to operate as an external, non-executive member of the PRA board.

In summary, the Government believe that it is appropriate to have an equal number of internal and external members, as the committee has today. This will ensure sufficient input from the Bank of England as executive and internal Bank of England expertise, while supporting the external, non-executive members’ role of providing a challenge to members’ thinking.

With those explanations in mind, I should be grateful if the noble Lord would withdraw his amendment.

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[Baroness Worthington (Lab)]

My Lords, today we are discussing a Bill that should have the long-term sustainability of the financial system at its heart. To that end, we are discussing provisions that would open up the Bank to further scrutiny, maintain existing scrutiny and guard against the possible repetition of groupthink. Amendment 8 would change the list of risks, as set out in the Bank of England Act 1988, that the Financial Policy Committee must consider in order to include long-term systemic risks to our financial stability.

These risks may arise from fundamental structural changes that have important implications for our financial system and therefore our long-term sustainable economic growth. There are some risks to longer-term financial stability that do not emerge within the typical time horizons of financial markets or the monitoring of the Bank. The time horizon of the Financial Policy Committee’s stability activities is not set in statute but according to the governor; it typically extends a little further than that of the Monetary Policy Committee, which is one to three years, but certainly no further than the outer boundaries of the credit cycle—around five to seven years. The danger is that, by the time fundamental structural changes that have been developing in the background are acknowledged by markets and regulators as an important issue for financial stability, it may be already too late. Unsustainable investments may have become embedded in institutions’ balance sheets, with capital locked into enterprises and business models that may have been rendered uneconomic as a result of long-term changes.

I will touch on three areas where risks are apparent over longer-term time horizons. The rise of new technology, which has already radically and permanently reshaped both the real economy and the financial industry, and future innovations such as machine learning, artificial intelligence and the rise of digital currencies, will have important implications for the wider economy and the robustness of our financial sector. Demographic change around the world is also reshaping economies, and with them their financial services industries. The increasingly ageing populations in developed economies will have implications for the pensions and the insurance industries. An IMF report found that if people live just three years longer than expected, in line with past underestimations, such an increase in longevity would add 9% to pension liabilities for private pension plans in the United States. These demographic changes have important implications and we must not be caught in just short-term thinking.

Lastly, we face the profound challenge of long-term changes in our natural environment, including the overarching risk of global climate change. This challenge has two elements: the implications of physical changes in the environment for the real economy, and the responses to that change from governments and other key actors as impacts become more apparent and policies are introduced. The financial services industry, like every other industry, will have to respond and adapt to climate change. The risk it presents, though relatively long term, should be integrated into prudential regulation now.

In recognition of these risks, Defra invited the Bank of England in 2013 to take part in an adaptation reporting cycle under the Climate Change Act. The Bank took part on a voluntary basis, and that is welcome. However, it was the PRA that undertook to respond to Defra’s request. The Financial Policy Committee’s response to the invitation was recorded in its minutes of the meeting of March this year:

“The committee’s central expectation was that the risks to financial stability were likely to be beyond the FPC’s typical policy horizon”.

That is precisely the problem that governor Mark Carney highlighted when he referred to the “tragedy of the horizon”. It is the problem I wish to raise by moving this amendment.

Of course, it is to be welcomed that the Bank is looking into the implications for the insurance industry, but as I said, this goes far beyond just insurance. Researchers from Oxford and Cambridge universities estimate that between 5% and 20% of the average diversified equity investment portfolio is at risk of re-evaluation as a result of climate change. The UK, although home to only 0.2% of the world’s coal, oil and gas reserves according to Carbon Tracker in 2013, listed in London alone reserves equivalent to 18.7% of the remaining global carbon budget. The over-representation of fossil fuels in our markets is a subject that I hope we can return to on Wednesday, as I have tabled another amendment on this theme.

To sustain economic development regulators must take into account long-term trends and changes that markets may fail to see. That means allowing time horizons to be determined not by the credit cycle, market behaviour or the Bank’s price stability objectives, but by the unknown future risks our financial stability regulators must be equipped to guard against. As global leaders will meet less than a month from now in Paris to discuss the long-term sustainability of the planet and climate change, it is right that, across all areas of policy, we ask what the implications are of this historic meeting. Making our financial sector more attuned to the risks of climate change and other long-term threats is something the UK can and should show global leadership on. Our current governor is already making the case. The Government can and should do more. I look forward to hearing the Minister’s response. I beg to move.

[Baroness Kramer]

My Lords, I added my name to this amendment because this is a crucial discussion and an important opportunity to draw the Government’s attention to these issues. This Government, like many others and almost every speaker on financial issues in this House, have expressed their frustration with the short-termism that dominates the British financial services industry: a search for short-term profits rather than understanding the longer term perspective. Indeed, the Chancellor has often voiced frustration at the fact that UK pension funds are very unlikely to invest in the kind of long-term infrastructure projects he sees as essential for our country. Canadian pension funds will gladly invest, but not UK ones. We suffer from this ongoing blight. Of course, the ultimate frustration is that many of those who put their money into such pension funds would be absolutely delighted to see it invested in infrastructure, renewable energy and sustainable projects, because they are often looking for a 30 to 40-year horizon regarding the return on the money they invest. However, that is not the way the system works.

When the Bank of England was given responsibility for financial stability, there was an assumption that part of the thinking would then extend into that long-term arena, and that the Bank would be freed from the narrow and short-term issues of stability. In fact, I think the Chancellor talked about avoiding the stability of the graveyard and looking at the much longer term horizon. So far, the Bank has not used its wide range of powers or its influence to enter into that territory. Whether it is sustainability as defined by projects such as renewable energy, rail infrastructure or broadband, a wide range of projects need a response from the UK’s financial services. That surely requires the Bank to take some role, and to take cognisance of this issue. I hope that debates such as this will persuade the Treasury and Government to engage much more extensively in those conversations with the Bank in its various and many parts, and to consider whether the relevant committees should at least have regard to those priorities, and potentially see them as obligations and duties, given the important role that long-term investment plays in the future of the UK.

[Baroness Wheatcroft (Con)]

My Lords, listening to the debate this afternoon, it is clear that many have concerns about the power and influence of the Bank of England. However, I cannot help but feel that this amendment takes that concern a step too far. Much as I have great admiration for Mark Carney, I cannot imagine how he is expected to predict the effect of artificial intelligence. The duties we are putting on the Bank are already extremely far-reaching. The responsibilities now placed on the Financial Policy Committee are deep and will have a huge impact, but to ask it to range as far as this amendment is surely to demand something beyond common sense.

The role of ensuring financial stability is crucial. It means keeping our financial institutions on the straight and narrow, and watching out for problems. However, to ask for those decisions to be taken in the light of what may be happening 20 or 25 years from now is surely a step too far. The role of Government in thinking about such issues is clear, but we would be in very dangerous territory if we thought of the FPC as the arm of government to influence such decisions.

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[Lord Young of Cookham (Con)]

My Lords, I will make a brief intervention in this debate as a former Treasury Minister and ex officio member of the PAC. As we have heard, Clause 11 sets up a new interface between two public institutions, both of which are independent: on the one hand the Bank of England, independent since 1997, and on the other the Comptroller and Auditor-General, who has been independent for a lot longer. In establishing this new interface, clearly one has to get the balance right.

From the exchange before the Treasury Select Committee last month, it is quite clear that the original drafting caused difficulties for the Bank of England and was amended. If one looks at Mr Roxburgh’s answer to a question posed by Helen Goodman, it is clear that there was an agreement that there had been a change in the drafting because of the reservations of the Bank of England. However, it is quite clear that the clause as now drafted causes difficulties for the other partner, namely the Comptroller and Auditor-General. The briefing note says that it “greatly limits” the Comptroller and Auditor-General’s freedom of action and that it does not provide him with,

“the independence that is essential to accountability”.

If one looks back at the C&AG, there is no history of him looking at policy issues in his investigations. There is of course concern that if the Bank of England is given an exemption of this nature, other institutions subject to audit by the C&AG might seek a similar exemption—the BBC is a possible example. At Second Reading my noble friend who wound up the debate said that the concerns that were ventilated then were,

“well argued and should be taken very seriously”.—[Official Report, 26/10/15; col. 1082.]

Obviously, it is important to avoid a public spat between two important independent institutions. The sensible way forward is for the Minister to promote bilateral discussions between the NAO and the Bank of England to see if they can come up with a memorandum of understanding, which, if necessary, might then be incorporated into the Bill if an amendment is necessary. However, there should be some discussions before Report so that there can be an agreement on the appropriate terms of trade between these two public bodies.

[Baroness Kramer]

My Lords, I will briefly join in the debate. We have two very highly regarded independent organisations—the Bank of England and the NAO. I say to the Government that it is unfortunate that legislation has come forward without resolving the relationship between the two of them. This House should not be in this position today, and neither should either of those two institutions. I very much hope that the Government will take the advice proffered and bring these various parties together to get a resolution here. Both are key institutions that need to have their independence appropriately protected.

In answer to the question asked by the noble Lord, Lord Higgins, the two lines about which he was concerned a moment ago, which are taken out and replaced by what he read as almost two identical lines, almost get to the crux of this matter. The amendment strengthens that assurance that the NAO and the Comptroller and Auditor-General do not in any way seek to question the merits of policy objectives. It is trying to make that absolutely clear by putting in a stronger statement to that extent. The problem the NAO has, as the noble Lord, Lord McFall, said, is that due to the way in which the language is now drafted, the Bank effectively now has a veto over which studies are undertaken. Frankly, that is, I think, unacceptable to every party.

We in Parliament depend very much on the NAO and the reports it provides to us. It is very important for us to be able to receive that information, knowing that it is impartial and independent, for us to be able to perform the role we play. All the discussions today have talked of the importance of oversight. While we very much respect the Bank of England, we are all incredibly conscious that it has made very serious mistakes in the past which have cost us dear, and that we all need to play a role in interacting and making sure that we understand and are appropriately taking on our responsibilities toward that institution. Frankly, it is very hard to see how we in this House or in the other place can do that without effective reporting from the NAO.

I hope that the Government will take this matter away for reconsideration because these are significant concerns. I take great heart in hearing from the noble Lord, Lord McFall, that the Federal Reserve board in the United States is one of the bodies on this globe that most asserts its independence and integrity. The Federal Reserve accepts a similar kind of oversight from the US Government Accountability Office, and it seems to me that we have a template there. If it works for the Federal Reserve, surely it can work for the Bank of England.

I hope that these amendments will be taken exceedingly seriously. While the noble Lord, Lord Bichard, is not in a position to speak himself, there are many in this House, including the noble Lord, Lord Higgins, and the noble Baroness, Lady Noakes, who will be able to appreciate the importance of the points that he would have made had he had the opportunity.

[Baroness Noakes]

My Lords, I support the amendments. I was deeply shocked to see that the Government proposed to give the Bank of England a veto over whether the Comptroller and Auditor-General could undertake a particular value-for-money study. I have believed for a long time that it has been an anomaly that the Bank of England has not been within the remit of the Comptroller and Auditor-General. I do not believe that any public body, however great and however independent, should be able to stand on that greatness and independence and say, “I do not want the National Audit Office or the Comptroller and Auditor-General to examine what I have been doing”. Public audit can be effective only when it is unfettered, and the concept of fettering the Comptroller and Auditor-General is, frankly, unacceptable.