Financial Services and Markets Act 2000 (Contribution to Costs of Special Resolution Regime) Regulations 2010

Lord Davies of Oldham Excerpts

Monday 19th July 2010 Lords Chamber

[The Commercial Secretary to the Treasury (Lord Sassoon)]

My Lords, the Financial Services Compensation Scheme, which I refer to here as the FSCS, was established under the Financial Services and Markets Act 2000 to compensate customers of authorised financial services firms when those firms were in default.

When the financial crisis broke in 2007, paying compensation under the scheme was the only way to protect depositors. The Banking Act 2009 set up new arrangements that allow for the resolution of failing banks and building societies in a number of ways, including the transfer of all or part of the business of the failing institution to another institution or into temporary public ownership. These transfers can include the transfer of the retail deposits; that is, deposits held by persons who are eligible for FSCS compensation. The effect is that those depositors are protected not by the payment of compensation under the FSCS but by having new accounts with a different bank or building society.

Transferring a business can involve a cost. A receiving institution will normally expect to receive payment for taking on liabilities such as deposits in excess of any assets that are transferred. However, if a failing institution’s retail deposits are part of the business transferred to a stronger bank or building society, the FSCS will not need to pay compensation to the depositors concerned.

It is appropriate, therefore, for the FSCS to contribute to the cost of using the special resolution regime to resolve a failing bank or building society. It would have been spared the potentially large cost of compensating depositors. However, there has to be a limit on that contribution, which should obviously be the cost that the FSCS would have incurred in paying compensation to depositors.

The Banking Act 2009 inserted a new section into the Financial Services and Markets Act 2000, usually referred to as FSMA, to give the Treasury the power to require the FSCS to make a contribution capped in the way that I have described. It also gave the Treasury the power to make regulations to deal with the detailed points that would arise. Regulations under this power were made in 2009, shortly after commencement of the Act, to allow the FSCS to contribute to the costs of the resolution of the Dunfermline Building Society.

However, it was quickly realised that these new FSMA powers did not get some of the detail quite right. In particular, it was found that no account could be taken of the time that it would take to complete a bank resolution and, therefore, of the interest costs that would be incurred in financing the initial payments to receiving institutions while waiting for the proceeds of the disposal of other assets of the failed institution. Equally, no allowance could be made for the interest costs that the FSCS would have to pay on the borrowing needed to finance a compensation payout. These matters could not be addressed by making revised regulations under the original power provided in 2009. Amending legislation was therefore included in the Financial Services Act 2010 to correct the FSMA powers in these two respects.

The regulations now before us complete the process by making use of the new powers to put the necessary detailed provisions in place to provide for interest costs to be included in the resolution expenses and to calculate the limit on the FSCS contributions to those expenses. They do this by requiring the Treasury to keep detailed accounts of the resolution costs actually incurred, of the recoveries actually made and of the costs and recoveries that the FSCS would have made in the hypothetical scenario in which the failed institution became insolvent and compensation was paid to depositors. Interest is then added to the outstanding balances of these accounts on a daily basis and any contributions that the FSCS pays are deducted. Finally, closing balances are calculated when the resolution ends and a final contribution to resolution costs is calculated and paid—or, if the FSCS has already paid too great a contribution, a refund will be calculated and paid.

To enable the Treasury to do this, the regulations also provide for the FSCS to estimate the amount and timing of the compensation that it would have paid in the hypothetical scenario. They also provide for an independent valuer to estimate the amount and timing of the recoveries that the FSCS would have made from the winding-up of the failed institution in that scenario. There is also detailed provision on making interim payments, on referring disputes to the Upper Tribunal, on the appointment of independent valuers and on the independent verification of the accounts.

The regulations also include transitional provisions to ensure that action taken under the previous regulations is properly allowed for. The previous regulations are then revoked. The powers inserted by the Financial Services Act 2010 provide that interest can be applied to accounts kept in respect of the Dunfermline Building Society under the new regulations as from 19 November 2009. I beg to move.

[Lord Davies of Oldham]

My Lords, I am grateful to the Minister for his clear exposition of the implications of the regulations and for bringing to our deliberations a new term, FSMA. We struggled in the past with the Financial Services and Markets Act, using the full phraseology until we were breathless and even blue in the face. I am sure that the noble Lord, Lord Newby, who participated in many of those debates will join me in appreciating the fact that we now have a short official term for referring to the Act. At least we will delight in that.

I reassure the Minister that, whereas we might have had a little Sturm und Drang over the previous measure, on this one all is sweetness and light, largely because the Minister is describing the implications of the regime set up under the banking legislation that the previous Administration introduced and the crucial question with regard to the costs of the special resolution regime.

I noted carefully, as I know the Minister and his officials will have done, the returns from the consultation. It must always be manna from heaven for the Minister when the consultation indicates that there is no consensus among those who have been consulted on some important items, because that gives maximum freedom to act. I would only say that, where the Government have acted in those terms, we are content with the position that has been broadly identified.

We appreciate that we live in an age of openness and accountability. We accept the point that is indicated in the Minister’s speech and the Explanatory Notes that the question of audit with regard to the Bank of England and its role is very limited, for all the reasons that we know. However, we appreciate that it is important that all those involved with this situation are satisfied that value for money is achieved. The Government have indicated that that is their objective and the Opposition are scarcely going to deny the validity of that position.

I emphasise the obvious fact that the calculation relating to the costs that would have been involved if there had been a bailout, in the event that the institution had actually folded, is difficult. There will always be more than a little quibbling about that situation but, as the Minister will know, we are fully in approval of the broad principles behind these regulations and I am happy to support the Government.