EU: Financial Regulation (EUC Report)

Earl of Caithness Excerpts

Tuesday 7th July 2015 Lords Chamber

[The Earl of Caithness (Con)]

My Lords, the noble Lord, Lord Harrison, paid a fitting tribute to the staff of the committee, to the participants and to the quality of our witnesses, and I can do no more than say amen to what he said. I pay particular tribute to the noble Lord himself. He chaired the committee wonderfully well for the two years that I have so far sat on it. It is a very diverse committee—on the one hand there were some very strong Europhiles while on the other there were people who wanted to get out of the EU, and still do—yet, thanks to his guidance, we always managed to produce a unanimous report. That is a tribute to his skill. We will miss him but are also delighted that the noble Baroness, Lady Falkner, has taken on a pretty warm seat.

The EU has done a formidable amount of work since the crisis of 2008, with a large number of directives and regulations in a short time. It is probably unique in the EU’s history. Our report poses the question: do the pieces fit? Yes, they fit pretty roughly, but you would expect that from western European countries and the Commission. A more pertinent question is: do they solve the problem? That is more difficult to answer, because obviously a lot of stuff is yet to be implemented and the jury is still out. Still, I shall offer my initial opinions, which I have to tell your Lordships have hardened quite considerably since we produced the report.

Sovereign debt is not mentioned in our report but the European Systemic Risk Board has just reported after three years’ work on the question of sovereign debt. It has said that the favourable regulatory treatment of institutions that buy the debt leads to a continued high-risk strategy. Its recommendation is to do nothing.

The worldwide banking system remains flawed. Unlike companies, banks rely almost entirely on borrowed funds, including money from depositors. That allows them to take bigger risks, and they will crash the economy again—it is only a question of when. It is a greater risk for us in Europe because of the euro, which has a systemic hole in the middle of its heart: member states do not control the currency in which they issue debt.

On banking union, as we mention in paragraph 22 of our report, it was a big mistake that the third leg of the stool, the deposit guarantee mechanism, was dropped. That three-legged stool, which had a bit of strength and balance, is now a wobbly two-legged stool.

It is also interesting to note that some of the Governments that helped solve the 2008 crisis are now in deep trouble themselves and need helping out of the mess that they have got into. Looking back, like many people I was rightly angry at the way that some of the bankers had behaved—but they were a small minority. They took us right to the brink, and caused and are still causing a huge amount of pain. Undoubtedly, however, there has been more regulation than was necessary in those areas that needed attention. The solution to the crisis, which rightly started out at an international level, was expanded considerably at the EU level. Some politicians fed the flames of the anger I have described. Doubtless we all recall the words of President Sarkozy of France at Davos in 2011, and what he said pleased the press and the anti-bank movement a lot.

Bankers were blamed for everything, and when the witch-hunt has started, it is very dangerous to behave or even look like a witch. The result was that the repercussions went way beyond the banks, and most financial service industry and even non-financial firms were caught up in the “Barnier Bible”, Commissioner Barnier’s 41 pieces of legislation. As the noble Lord, Lord Harrison, said, some of the resulting legislation was ill-conceived and due to political pressure; we mention that in paragraph 5 of our summary.

Once the ball was rolling, there was no stopping it. However, I find some comfort in noticing the difference between Commissioner Barnier’s approach and that of the Commissioner my noble friend Lord Hill, whose stated objective is to have the minimum amount of regulation. Let us remind ourselves that 400 of Commissioner Barnier’s regulations have yet to pass into law. Let us also not forget that prior to the financial crisis and the introduction of all these heavy regulations, the City of London was a big contributor to the tax receipts of HM Treasury and the Government. The new rules have substantially reduced the profit of the financial institutions and hence their ability to pay tax.

In the committee we discussed an ongoing concern: namely, what is the UK’s input into all of this? It is hard to judge, but we are reassured by the Government that HMT was fully involved. My experience is that it tends to be more involved than it is given credit for, but I remain sceptical. Even this morning, evidence was taken from the Financial Secretary, David Gauke. It was on a different subject, but he said that there is no Government involvement at all—and that is with the own resources of the European budget. That is a serious concern, and it shocked all of us in the committee that he was so blunt about it.

However, if the UK had serious input into regulations and directives such as MiFID and AIFMD, why are they so burdensome on the industry with no good effect? In our recommendation in paragraph 164 we deal with proportionality for smaller firms, some financial service providers and non-financial firms. While it is perfectly true that having one regulator for the whole of European business is of huge benefit for our global investment firms, the smaller national firms are being severely compromised by the increase in regulation and the cost involved.

I gave an example of a firm in the debate on the Queen’s Speech when I spoke on 4 June in col. 612. I now add that that firm has had a fourfold increase in compliance administration personnel in the last four years and that its annual spend on insurance and regulation this year is up 40% on 2013. With all the extra regulations to come, there is a continued state of change, challenge and fear for small companies.

Were the Government aware of the consequences of these regulations? Does my noble friend Lord Ashton agree that that business could not set up today because of the costs and extra regulatory burden, and that we are already witnessing an amalgamation of firms into even larger companies in order to stay in business? The consequent lack of choice and diversity is bad for the market and for Europe in general. The implications are more severe for the UK than for other member states—as the noble Lord, Lord Harrison, rightly reminded us, we are the financial centre of Europe, and if we suffer, so does the rest of Europe. What discussions have Her Majesty’s Government had with the Commission to correct these excessive burdens?

I, too, must touch on chapter 3 of our report, which deals with the European supervisory authorities. In response to our report, the Government stated that the ESAs will need to continue to ensure that their rules are proportionate and do not overburden industry and regulators with unnecessary guidelines and standards. Who is doing that? Who is keeping a check on the regulators at European level? There is also concern at national level that our regulators are vying with each other to show their virility. Issuing the biggest ever fine is undoubtedly good news for their reputation and pleases those who are against the financial services industry. We need to keep a very careful eye on this. How is my noble friend controlling our national regulators?

Misconduct can be handled in a number of ways, and we have seen some horrific displays of misconduct in financial services. My noble friend will be aware that the Fair and Effective Markets Review, launched by my right honourable friend the Chancellor of the Exchequer and the Governor of the Bank of England in June 2014, has just reported. This is an important area. An effective market and an effective form of behaviour can reduce the amount of regulation. What are the Government doing to encourage the Bank of England and the FCA to promote their report globally, so that there is an international agreement? When are the report’s recommendations for the UK going to be implemented?

I was very fortunate to serve on the committee at a time of such an interesting revolution in the way the financial services industry in both Europe and the world has changed. As I said at the beginning of my speech, my thoughts have hardened: too much has happened in too big an area, and although the consequent fallout has yet to be fully felt, when it is, we will be all the poorer for it.