UK-EU Relationship in Financial Services (European Affairs Committee Report)

Earl of Kinnoull Excerpts

Wednesday 17th May 2023 Grand Committee

Moved by

[The Earl of Kinnoull]

That the Grand Committee takes note of the Report from the European Affairs Committee The UK– EU relationship in financial services (1st Report, HL Paper 21).

[The Earl of Kinnoull (CB)]

My Lords, on 23 June last year the European Affairs Committee published our report, The UK-EU Relationship in Financial Services. The Government responded in August and we are debating this important subject nine months later. I regret this structural time lag for committee reports, but warmly thank the Senior Deputy Speaker and the Chief Whip for their efforts in trying to address this and in getting our debate today.

Before I begin in earnest, I thank our staff Nick Boorer, Dominic Walsh, Tim Mitchell, Kutumya Kibedi, Sid Gurung and Louise Shewey, as well as the committee’s specialist adviser on this report, Professor Sarah Hall. We are lucky in this House with our committee staff in particular and on the EAC especially. I know that the whole committee felt that they were hugely hard-working and skilful in everything they did to help to settle this report and in the evidence process that underpins it.

We took evidence between February and March last year on the state of the UK-EU relationship in financial services, covering four main areas in the sector: first, the impact to date of the UK’s exit from the single market; secondly, the impact of the absence of a framework for UK-EU regulatory co-operation; thirdly, equivalence; and, fourthly, regulatory form and divergence, and agreements with third countries. I am going to focus on a few themes that the committee felt were especially salient, starting with the impact of Brexit on the UK financial services sector, as we then found it.

The sector employs 2.3 million people and makes up 10% of total UK tax receipts. It comprised 19.1% of all UK services exports. The EU is a very significant trading partner in this sector, making up 37% of total UK financial services exports in 2019. I note that, in the latest ONS “Pink Book”, those numbers are broadly similar. We are all reminded that the sector, although it is traditionally associated closely with the City of London, is well established across the UK. In fact, two-thirds of those employed in the sector are outside London. Our witnesses were generally optimistic about the sector’s future, with many fewer job moves to the EU than anticipated—the EY Brexit tracker, which has now ceased, recorded just 7,000—but we warned against complacency, as it is not clear whether the full impact has yet played out.

The Government’s response provided further details on the steps they were taking on the future of financial services, with reference to the Financial Services and Markets Bill and the State of the Sector 2022 report, both of which were published in July last year, a month after our report. The interesting State of the Sector report provided scant detail about how the Government intend to support financial services outside London, however.

In addition, neither the Government’s response nor the inaugural State of the Sector report engaged with the committee’s recommendation that the report include

“for at least the next five years a section dealing expressly with the UK-EU relationship in financial services”.

My first questions are to ask the Minister to provide further details on how the Government intend to support financial services outside London, when this year’s State of the Sector report will be published and whether it will contain the information that we requested, specific to the UK-EU relationship on financial services.

Moving on to regulatory co-operation, our report also examined the fate of the UK-EU memorandum of understanding, or MoU, for regulatory co-operation on financial services. The UK and the EU concluded technical negotiations on that MoU almost two years ago, yet it has still not been signed or entered into force. We noted

“the widespread view that the MoU has become a casualty of”

wider difficulties in the UK-EU relationship and concluded that, although the non-finalisation was not causing major problems, it

“would still have value as a mechanism for strategic dialogue”.

That is, I am afraid, committee code for conferring a mutual benefit on both the UK and the EU. Following the surfacing of the Windsor Framework, a European Commission spokesman indicated that the Commission was ready to start work on the so-called finalisation of the MoU on financial services. Two and a half months on, what discussions have the Government had recently with the EU on that MoU?

I turn to equivalence. As highlighted in our report, the UK

“has issued positive determinations for EU … states in 28 of the 32 areas identified for the equivalence process”,

whereas

“the UK holds just one, time-limited equivalence decision from the EU”,

on central counterparties. This contrasts with the multiple equivalencies that other jurisdictions, including the US and China, enjoy from the EU. Witnesses to our inquiry suggested that the decision by the EU to withhold equivalence from the UK

“is political rather than technical”.

However, although we expressed regret at the state of affairs, we concluded that this a unilateral decision for the EU and that

“it would be misguided to base the UK’s future strategy for the sector on something that is not in the Government’s gift and that currently seems unlikely to be forthcoming”.

We also concluded that

“the low number of equivalence decisions is not seen within the sector as a matter of fundamental concern”.

The Government’s response indicated some agreement with this analysis, although it provided little detail in respect of the committee’s request to

“set out the extent to which it believes there to be a competitive disadvantage as a result of the imbalance in equivalence decisions”

from the EU for the UK compared with other countries. Have there been any further discussions between the Government and the EU on equivalence in the past six months, in particular in the period since 27 February and the surfacing of the Windsor Framework agreement?

I come to regulatory reform and divergence. I noted at the start of my remarks the size and importance of the sector. In essence, during our inquiry, the Government and the Bank of England were finishing a thorough and sensible analysis of the regulatory environments; it was sensible because the UK had moved from a one- size-fits-28 environment to a one-size-fits-one environment. The analysis involved a substantial number of reviews and consultations; its key elements are set out in table 1 on pages 42 and 43 of our report. The analysis was to lead to legislative change. The largest part of that—the Financial Services and Markets Bill—is before us in this House now. The final stage will be the implementation of the whole new environment.

Although the Government’s response provided, as requested, some further details on their plans for regulatory reform, it was clearer on regulatory changes that were already planned or under way—particularly those included in the Financial Services and Markets Bill—than it was on the future direction and regulatory plans for UK financial services. Our report noted that, under the Government’s plans, greater powers will be moved downwards towards the regulators, in particular the Financial Conduct Authority and the Prudential Regulation Authority. Although we are supportive of this, we emphasised absolutely the need to establish “appropriate mechanisms” for parliamentary scrutiny and accountability of regulators and recommended that the Government facilitate this. Their response was non-committal in this regard; indeed, this has been much debated during the passage of the Bill and will, I suspect, be voted on when we come to Report stage.

Another controversial proposal was the new secondary competitiveness objective, which will be included in the financial services regulators’ remit. The Government are now taking this forward; it is another thing that has been much debated during the passage of the Bill and one that the committee was keen should include regulators being “responsive, consistent, and proportionate”. Indeed, this was covered in one of the amendments to the Bill that I put down.

Divergence will also be driven by changes in the EU, as well as in the UK. In the context of possible changes to EU legislation, the committee raised concerns about the Government’s apparent unwillingness, as we saw it, to actively seek to influence the EU in the UK’s interest and request clarification. The Government’s response described a

“proactive strategy of engagement with the EU institutions and Member States”.

Naturally, that will continue to interest the committee.

Can the Minister provide further details on the specific steps that the Government intend to take to support greater parliamentary scrutiny of the regulators, in recognition of their increased powers? Does she feel that regulators should be responsive, consistent and proportionate?

In closing, I come to the opportunities. Our report also examined areas of opportunity for the financial sector, particularly in novel areas where there is little regulation in place, such as fintech and green finance. We welcomed the Government’s approach to regulatory innovation and the Government have since announced that they plan to publish an updated green finance strategy this year. The committee also welcomed the Government’s pursuit of a mutual recognition agreement with Switzerland. Since then, the Swiss Government have said that the two parties expect this to be concluded by the summer of 2023. Finally, the committee welcomed the Government’s general approach of openness to the outside world and non-reciprocity in our financial services sector. Can we expect publication of the UK’s updated green finance strategy shortly and, if so, when? Do the Government still expect the mutual recognition agreement with Switzerland to be concluded by this summer?

I lived with this report for several months and it was an exceptionally interesting time; we met many very able people in our financial services sector. I very much look forward to the debate that we are about to have. I beg to move.

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[The Earl of Kinnoull (CB)]

My Lords, for once I find myself hoping that the noble Lord, Lord Callanan, will be on his feet for a very long time, but I will not. I thank everyone who has taken part in a most thought-provoking debate all round; what a lot of expertise has been shown. I also thank and praise the Minister, who managed to answer all eight of my questions in one way or another, which was a remarkable achievement. I thank her for that.

I welcome the noble Lord, Lord Livermore. I think we will very much enjoy his expertise in this House over the next period. His speech was jolly good. I thank him for his kind words about our report.

I must finally thank my committee, which was really helpful on what was a very difficult report. Many of the committee were not terrifically experienced in financial services but took to it all round. I will privately thank the noble Lord, Lord Liddle, afterwards for his very kind words.

A lot of very good points were made. I will not repeat them all, of course, but I will highlight three things that came out of the debate. The first was the theme of complacency. Although in the period into which the committee was inquiring it found, slightly to its surprise, that only 7,000 jobs had moved—unfortunately, EY has now stopped doing that particular survey, so it is not possible to see with any certainty what has happened—we need to watch very carefully. If things are seen that are wrong, the Government will have to be very nimble to deal with whatever problems come up. I note that that was mentioned by almost everyone: the noble Lords, Lord Liddle, Lord Bilimoria and Lord Desai, the noble Viscount, Lord Trenchard, and the noble Earl, Lord Effingham, were all keen on this topic.

The second thing was a really good point about divergence risk, made by the noble Lord, Lord Liddle. We are engaged in this three-stage process, as I said: analysis, legislation and implementation. We are almost at the end of the legislation bit of that. The divergence risk remains really important to watch, and that balance between a bit of change to help our differently shaped financial services industry and whatever risk that comes with will be very important to watch as well. That was a very sharp point and I associate myself with those words.

I have labelled the final of the three themes I was going to highlight “workforce”, but it includes visas and the regulatory clearance point. I have heard stories similar to the nine-month thing. Everything that can be done to improve access to talent and to get the processes smooth for visas in financial services would be enormously good in assisting our prize industry and would not cost the Government anything. I hope this will be a theme. The noble Lords, Lord Hannan, Lord Bilimoria and Lord Holmes, majored on that. I thank them very much.

I look forward very much to our discussions about the secondary competitiveness objective. We asked almost all our witnesses about that over the three months and a worrying number of different ideas as to what it actually meant came back. I cannot say that I particularly understand it. There have been lots of amendments to try to give it a bit of shape. We will discuss that again. I was very encouraged by the good words that the Minister just said on the scrutiny of the House.

All that said, I beg to move.

Motion agreed.

Financial Services and Markets Bill

Earl of Kinnoull Excerpts

Committee stage
Wednesday 1st February 2023 Grand Committee

Moved by

[The Earl of Kinnoull]

45: Clause 24, page 38, line 19, at end insert—
“(4B) The FCA must monitor and measure to what extent it has advanced the competitiveness and growth objective in various ways, including but not limited to—(a) the PRA’s responsiveness to entities that are regulated or seeking to become so,(b) its consistency of approach to entities that are regulated or seeking to become so, and(c) the proportionality of its approach to the regulation of entities that are regulated or seeking to become so.”Member’s explanatory statement
This amendment seeks to provide some measurable ways in which the competitiveness and growth objective can be monitored and subjected to scrutiny.

[The Earl of Kinnoull (CB)]

My Lords, in moving Amendment 45 in my name, I will speak also to Amendment 63. I apologise for being unable to contribute at Second Reading; the opening speeches were at the same time as a major evidence session for the European Affairs Committee. However, I sat through much of the debate and have my well-thumbed copy of Hansard here. I declare my relevant interests, as set out the register, as a shareholder of Hiscox Ltd and Schroders plc and a director of Alpha Insurance Analysts.

In my commercial career, I was a director, chief executive or chair of regulated financial services businesses in eight different major jurisdictions. I dealt with the regulators in those jurisdictions and regulators in other EU jurisdictions because of the passporting regimes, and with regulators in places where we decided not to set things up.

However, this amendment has nothing to do with that. Its genesis was in the report of the European Affairs Committee from June last year, The UK-EU Relationship in Financial Services. That report was a major piece of work; we took evidence from a galaxy of stars, including two of the four deputy governors of the Bank of England. The report was settled in the usual House of Lords way, on a unanimous basis.

Paragraph 145 of our report begins a section titled “A competitiveness objective”. In considering this, the committee was trying to form a better view on four real issues: first, the wisdom or otherwise of a competitiveness objective; secondly, what it actually meant; thirdly, how a regulator might implement such a thing; fourthly, how Parliament might scrutinise it. We will come to the fourth issue when we discuss later amendments, particularly those to Clause 36.

We put the problem of the competitiveness objective to our galaxy of star witnesses, including both of the deputy governors of the Bank of England. It was quite difficult for us to form a view on the wisdom of it because, throughout our evidence generally, there were considerable differences among all the witnesses as to what a competitiveness objective amounted to. That difference in the set of views, which were honestly held, was quite difficult for us to reconcile. While the committee generally felt that it was a good idea, it was a bit like how I took the mood of the Second Reading debate to be. There was an interesting set of differences in what it meant; if you do not know what it really means, it is jolly difficult to implement it consistently across a regulator. How will you do that not only between regulators but within a regulator when the FCA has several thousand employees? We were a bit dubious about that. In terms of scrutiny, if it is all unclear above you, scrutinising it is jolly difficult.

The committee tried to assist in this. We wrote various descriptive paragraphs; in paragraph 151, the first of our two conclusive paragraphs on this—not on actual scrutiny—we said:

“The Committee notes that, as a result of the Future Regulatory Framework Review, the Government is considering introducing an additional, secondary ‘competitiveness’ objective for the Financial Conduct Authority and the Prudential Regulation Authority. However, it is equally important for the UK’s overall economic competitiveness for the Government and regulators to work together to develop a broader regulatory culture that is responsive, consistent, and proportionate”—


I emphasise those words.

Noble Lords will have noted that the words “responsiveness”, “consistency” and “proportionality” appear in Amendments 45 and 63. These amendments are designed to give effect to what we as a committee wanted to do, which was to give some directional help to regulators as to how they would be able to implement a competitiveness thing and to have measurable things before them. I must say that I have played the refrain of “responsiveness, consistency and proportionality” to various market associations since the report and I have heard nothing but a feeling that that is at least a start in finding a way of being able to help to define this elusive thing of the competitiveness objective.

It is worth quoting our second paragraph of conclusions:

“We ask the Government, in its response to this report, to explain in further detail how a secondary ‘competitiveness’ objective would be applied by the regulators in practice and how success will be measured.”


The Government’s response to our report was, in general, a very good one. I worked out that I have been in receipt —either as a committee chair or member—of well over 50 government responses, and I can promise noble Lords that this one was pretty good. On this particular bit, however, it was very weak. The response on this area had a quite a lot of paragraphs, but most simply repeated the question. The operative sentence is:

“The regulators will be responsible for operationalising their new objectives.”


I must say that my spellcheck is not modern enough for “operationalising”, so I am not quite sure what that means. But I am sure that the Government are washing their hands of that, which I feel is a mistake.

I submit that the European Affairs Committee’s view on this—remembering, of course, that the committee is cross-party and this was, as usual, an entirely unanimous report—is that there are three benefits to having clarity in this area. First, as a client—either an existing client or a prospective new client who wants to come in to be regulated in the United Kingdom—it provides some clarity. It is jolly good, let me say, if you are thinking of moving capital or business to a jurisdiction, to feel that the regulator will be responsive and consistent and will take a proportionate view of things. Those are all things that are directly relevant to any decision to set up in that jurisdiction or to maintain yourself in that jurisdiction.

Secondly, it is good for the regulators, because they will then know what they are meant to be doing. As I said, we asked regulators about that in our evidence sessions and we heard different answers as to what the thing meant. Thirdly, it is good for scrutineers. We, as scrutineers—I have jumped over the fence now; I am a solid scrutineer and do not do any business at all—will be able to ask the right questions and to have metrics given to us to see whether the regulators are doing a good job. That, I would submit, is a win-win-win scenario.

These two amendments build faithfully on the work of a major committee of this House and should, I feel, properly be part of this Bill. I beg to move Amendment 45.

[Lord Naseby (Con)]

My Lords, I will not repeat what the noble Earl has said, but I thank him for the depth of his proposal and the work that he has done in tabling these amendments.

I remind the Committee that I have chaired two quoted companies. I have been chairman of one friendly society and seen through both Houses the Mutuals’ Deferred Shares Act, so I think that I have some heritage, in particular in the mutual movement, which I think is really important to our society and our economy. I take a deep interest in that mutual movement and, indeed, I know that my noble friend on the Front Bench and the Government are particularly concerned about helping the mutual movement move forward. This group of amendments is there to help that.

For me, these two amendments are central to the Bill. I have said this before and will say it again: growth in financial services is dependent on, and an extension of, what is happening in the financial world. There are some really exciting new developments happening, but they need help and occasionally a little persuasion. The FCA has a major challenge on its hands. I welcome that, as I am sure it does, but there is an understandable danger that having an increased spectrum of activities is new to the FCA. It should be reminded to look around the corner, do a little investigation and find out what is happening underneath and therefore what is coming forward. I am sure it will do that, but it needs prompting and these amendments do that.

I say finally to my noble friend on the Front Bench that the mutual movement, both the friendly societies and the credit unions, is looking for new ways to raise capital. That is fundamental to both those mutuals. I therefore hope the Government will look at the noble Earl’s amendment with an open mind and accept it.

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[Baroness Kramer (LD)]

My Lords, I take serious note of the comments of the noble Viscount, Lord Trenchard, because they reflect my fear that the amendments in the names of the noble Earl, Lord Kinnoull, and the noble Baroness, Lady Noakes, and the first amendment in the name of the noble Lord, Lord Holmes, could easily be interpreted as pressure to raise the international competitiveness objective and the growth objective very close, if not equal to the financial stability objective. Frankly, that should be a major concern to us all. I do not want to put the regulators on the back foot when they prioritise financial stability.

In many ways, that is how it was in the 1980s and the 1990s, and we saw how the industry responded to that set of priorities and arrangements. The industry was blithe about risk as long as it generated short-term profit. In discussing the new international competitiveness and economic growth objectives, I have heard from many in the industry that they want them not only to be given greater weight but even to be primary objectives and to stand entirely equal with financial stability. That is such dangerous territory.

At Second Reading, I quoted Paul Tucker, a former deputy governor of the Bank of England, who lived through all that turmoil of 2007-08 and after, who urged Parliament not to give the regulators—particularly the PRA—an international competitiveness objective, praying in aid former governors of the Bank of England, who knew the very soul of the industry and knew that that would be dangerous and unadvisable. Those were not his exact words—his were more excoriating.

Risk in the financial sector is asymmetric, as we saw in 2007. The profits of risky behaviour go to the leading figures in the industry, and they typically keep those proceeds, despite the failure of the sector and the organisation and, in many cases, despite the fact that if you were to go back and unpick it, one could say that such proceeds were based on false profits.

The taxpayer then had to come in and rescue the sector with £137 billion in 2007-09. Much of that has been recouped, but what has not, even to this day—and which we and the country live with—is the damage to the wider economy. We had more than a decade of austerity, and it is a price we are still paying to this day. At our peril do we put ourselves in a position where there is increased likelihood of a repeat of that cycle.

I remember from his memoirs that Alistair Darling was shocked that banking chiefs uniformly showed no gratitude for the massive rescue package that kept their businesses afloat after the 2007-08 crisis. I sat on the Parliamentary Commission on Banking Standards, but have yet to find one to take any significant responsibility, not only for their institution but for the broader sector.

On competitiveness, let me quote from the report of the Parliamentary Commission on Banking Standards, because this was central to its findings of why the industry had become so out of control and behaved as it did:

“There is nothing inherently optimal about an international level playing field in regulation. There may be significant benefits to the UK as a financial centre from demonstrating that it can establish and adhere to standards significantly above the … minimum. A stable legal and regulatory environment, supporting a more secure financial system, is likely to attract new business.”


That was the consequence of nearly two years of taking evidence.

I turn to other amendments. Those in the name of the noble Lord, Lord Tunnicliffe, in this group focus the need for mutual and co-operative financial services. I wholly support that. I very much support the proposals of the noble Lord, Lord Holmes, on the establishment of regional banks. Local services focused on geography or a specific group are often treated as an afterthought or a Cinderella part of the sector today in the UK, but they can be the best way to deliver opportunity to ordinary people, including those presently excluded, and to help small businesses, especially in difficult times. We shall return to some of these issues in later amendments that we will discuss today.

I also support the amendments of the noble Lord, Lord Holmes, which, in essence, are on efficiency. They seem to mesh very well with the amendments of my noble friend Lady Bowles, which are about transparency and mechanisms to evaluate the performance of regulators.

I return to my additional theme: I introduced a discussion on financial stability, almost out of shock that we now have such an intense focus on enhancing international competitiveness and economic growth—as if, somehow, financial stability were not the absolutely fundamental delivery that we expect from our regulators. Without that, frankly, everything else is worth nothing.

[The Earl of Kinnoull (CB)]

Before the noble Baroness sits down, I would just like to ask her a question about her very interesting speech. This also allows me to say that, in Amendment 45, the first “PRA” should read “FCA”—a good spot by the noble Viscount, Lord Trenchard. But I do not quite understand how financial stability is threatened by a regulator being responsive, consistent and proportional. Could the noble Baroness explain that again?

[Baroness Kramer (LD)]

The noble Earl may find that this is already a requirement of the regulator, but this is not about that. If the amendment were taken in the way that I suspect the noble Earl reads it, I might feel reasonably comfortable with it. However, as we listened to the discussion, we saw where this was going. The noble Viscount, Lord Trenchard, captured that: the industry is looking at these kinds of amendments as a mechanism by which it can find leverage to enhance the status of the international competitiveness and economic growth objectives. If we could find a balance, in asking for the kind of language that the noble Earl, Lord Kinnoull, is after, but making sure that that does not become weaponised and potentially raises those objectives to an equal status to financial stability, I would feel much more comforted.

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[Baroness Penn (Con)]

As the noble Lord himself noted, proportionality is already within the regulators’ objectives and operating principles. It is a concept that the Government support in how the regulators undertake their business. I believe that it is provided for within the current framework.

I hope, therefore, that the noble Earl, Lord Kinnoull, will withdraw his amendment and that other noble Lords will not move theirs.

[The Earl of Kinnoull (CB)]

I thank the Minister. It has been a fascinating hour and 20 minutes on reporting requirements. The common themes, I think, have been clarity and independence. I associate myself with the remarks of the noble Lord, Lord Bridges, and his very good way of expressing the problems with the Bill. Coming from the insurance industry, I was of course very worried by what the noble Lord, Lord Ashcombe, had to say about the number of insurers being set up in Bermuda versus the number being set up here. Bermuda overtook the UK in 2004 in size of market; we remain number two but we are going backwards, and this needs to be addressed.

I feel that many of the amendments in this group need to be discussed with the Minister. I hope I will see her nod her head. My amendments derive from a big committee of this House which thought a long time and took a lot of evidence on this. The amendments tabled by the noble Lord, Lord Holmes, have a lot of merit in them as well. When we sit down, we will certainly hear the warnings issued by the noble Baroness, Lady Kramer, in our ears, but I hope that she agrees to discuss those well before Report so that we attain some additional clarity and some independence for the data that comes to whatever it is that will scrutinise all this. In the meantime, I beg leave to withdraw the amendment.

Amendment 45 withdrawn.