Financial Services (Banking Reform) Bill

Lord Eatwell Excerpts

Tuesday 8th October 2013 Lords Chamber

[The Commercial Secretary to the Treasury (Lord Deighton) (Con)]

My Lords, I will consider both Amendments 1 and 2, and I will talk first about Amendment 1, which has been proposed by my noble friend Lord Blackwell. I have much sympathy with the intention behind this amendment and I hope that I can provide some of the comfort that my noble friend seeks. Independent governance is of course key to the integrity of the ring fence to ensure that ring-fenced banks do not simply operate in the interests of their group’s investment bank, in this example, or indeed other parts of the bank, but it is important that any governance requirements are proportionate to the threat to the ring-fence. Where a ring-fenced bank makes up the great majority of a group’s business and the investment bank is therefore small, so the risk of the ring-fenced bank being dominated by the interests of the investment bank is also small.

The Independent Commission on Banking recommended that where the vast majority of a group’s assets were in the ring-fenced bank, requirements for independent governance should be relaxed. The Government accepted that recommendation, and in our June 2012 White Paper we supported,

“flexibility in governance arrangements where a ring-fenced bank represents the overwhelming majority of a group’s business”.

Under the Bill, the precise details of ring-fenced bank governance arrangements, along with other ring-fencing rules, are for the regulator to determine. The Bill sets the objectives that rules must achieve; the regulator then decides what exact structures or restrictions are needed to achieve those objectives. This is appropriate because of the highly technical nature of the issue, and in order to allow requirements to keep pace with developments in a fast-moving market. Rule-making will, of course, require the regulator to exercise its judgment, and proportionality will be central to how it does so. In particular, the regulator will be obliged to consider the costs and benefits of any rules it proposes to make, including ring-fencing rules.

In the case of ring-fencing and governance rules, the Bill also specifically gives the regulator flexibility to consider the proportionality of different requirements. The Bill requires the regulator to ensure “as far as reasonably practicable” that a ring-fenced bank is able to take decisions independently of the rest of its group.

The formulation “as far as reasonably practicable” specifically anticipates circumstances in which certain governance requirements might be impractical or have costs that are disproportionate to their benefits. The case where a ring-fenced bank constitutes the overwhelming majority of a group’s business may be one such circumstance. I hope the noble Lord can therefore feel reassured that the intention of his amendment is already reflected in the Bill. I therefore call upon the noble Lord to withdraw his amendment.

Government Amendment 2 corrects a minor and technical point in connection with new Section 142H, which imposes an obligation on the appropriate regulator to make certain rules requiring that a ring-fenced bank be independent of other members of its group. The clause as currently drafted defines the appropriate regulator only in relation to ring-fenced bodies. However, as new Section 142H also imposes an obligation on the appropriate regulator to make rules applying to authorised persons who are members of a ring-fenced body’s group, but are not themselves ring-fenced bodies, the appropriate regulator needs to be defined in relation to all authorised persons, not just ring-fenced bodies. This is corrected by this amendment, and I commend it to the House.

[Lord Eatwell (Lab)]

My Lords, I wonder whether, in his assessment of the amendment of the noble Lord, Lord Blackwell, the Minister might take into account the fact that it was exactly this sort of procedure that led to the steady erosion of Glass-Steagall over the years. There was a tendency continuously to say, “Well, if we have a particular subsidiary, then perhaps we don’t need to have the separation in this smaller subsidiary”. These steady erosions built up over the years, until by the early part of this century, before its repeal, the effectiveness of Glass-Steagall had been completely eroded. Perhaps the Government should take that into account. There is also the point that, if the investment banking services required by a ring-fenced bank are relatively small, they could, of course, always be purchased from another provider.

Finally, the Minister mentioned that the precise definition of the rules of extent and so on will be defined by the regulators and in secondary legislation. I wonder whether it would be appropriate at this moment to take into account the latest report of the Delegated Powers and Regulatory Reform Committee, which has expressed considerable concern about the scrutiny of secondary legislation that will follow from new Sections 142A, 142B and so forth as we are discussing in this particular context. Are the Government likely to accept the enhanced scrutiny proposed by that committee with respect to these particular sections?

[Lord Blackwell]

I am grateful for my noble friend’s comments on Amendment 1 and for his explanation that the flexibility allowed for in this Bill will be flexibility that the regulator will be expected to interpret. I note the comments of the noble Lord, Lord Eatwell, but clearly the regulator’s role will be to ensure that creep does not occur on the way and that the protection of the ring-fenced bank is the requirement as set out in this legislation. Therefore, with those assurances from my noble friend, I am pleased to withdraw the amendment.

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Moved by

[Lord Eatwell]

4: Clause 4, line 11, leave out first “4” and insert “2”

[Lord Eatwell (Lab)]

My Lords, I am in total agreement with what the noble Lord, Lord Turnbull, has said about the importance of the reviews of this process. We have to realise that we really are breaking new ground here. In a way, this is a leap in the dark and we have no idea whether it will work. Obviously a lot of effort has gone into trying to ensure that it will work, but it is such a novel innovation that we really cannot be sure whether it will, or indeed whether it will have a whole series of unintended consequences.

Accordingly, I feel that it is very important that the process be kept under virtually continuous review. The amendment in the name of myself and my noble friend Lord Tunnicliffe seeks to ensure that the first review and subsequent reviews take place within relatively short time periods of up to two years. The reason for that is that it is only five years ago, almost to the day, that Lehman Brothers collapsed, and let us think what has happened since then. If we were to retain the four-year limit, that would cover almost that whole period, with all the remarkable devastating changes that have occurred.

I agree with the noble Lord, Lord Turnbull, in his proposed new Section 142JA, that such a virtually standing group should act as an independent arbiter and assessor of these matters. It certainly should not be, as in the Government’s proposal, the PRA inspecting itself. That does not seem to be a very satisfactory structure at all. It is not appropriate in terms of giving confidence in the reviews, and it is not fair to the PRA. The PRA should be able to stand up and do its job, and then accept that it will then be scrutinised by the sort of independent group proposed by the noble Lord, Lord Turnbull. My amendment would simply ensure that that group had a virtually standing role in assessing these major changes to ensure that, once we have taken this leap in the dark, we land on firm ground. On Amendment 5, I shall simply reiterate the arguments that I have just made. I beg to move.

[Lord Blackwell]

My Lords, I must express some reservations about the arguments put forward by the noble Lord, Lord Turnbull. It is not that I do not understand the significance of having continuous and effective review of these ring-fencing procedures, but it seems to me that we have set up, with a lot of time in this House and the other place, a regulator that has learnt in that legislation and its constitution and objectives many of the lessons of the past, and we have entrusted that regulator with maintaining the stability of the financial sector and enforcing this legislation, if the Bill is passed. I think there is a danger in seeking to replace the regulation of an industry by an independent regulator with what might be in danger of turning into regulation by parliamentary committee. Parliamentary committees have many virtues and values, but they cannot engage dispassionately in the same evaluation of detailed analysis and commercial information that a regulator can, and they are more likely to be swayed by current opinions of the day. I pay tribute to the work of the commission on which the noble Lord, Lord Turnbull, and other noble Lords sat, which did an excellent job. I worry about the possibility of moving away from regulation by independent regulators, which are deliberately made independent of the Executive, towards regulation by parliamentary committees.

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[Lord Turnbull]

My Lords, in responding to the points that have been made, I want to make it clear that the commission is not seeking to use this Bill to reopen the position we have reached and try to get us back to a policy of separation. What we have is a policy of ring-fencing plus safeguards plus vigilance. I listed some of those safeguards at the start. If that is the policy we are on, we have to make the safeguards and vigilance work. In response to the Minister, I do not think that a process in which the reviewing is done by one of the key players in it, which is the Prudential Regulation Authority, carries any credibility whatever. Its work is important and it should be a contribution to a wider study, and the wider study should be undertaken by someone who is independent of it.

The other argument used by the Minister was that we do not want a state of permanent vigilance. I do not think that it is possible, in an industry which is highly innovative—reference has been made to the term “half-life”—that you can find one system that will last for ever and therefore you need to be able to keep an eye on what you have created and make sure that you are taking steps to keep to that policy until such time—which may be the point of the amendments we shall come to in another group—that you conclude that it is not working. But the search for something which you can just do and then simply routinely maintain is an illusion. If ring-fencing is to be the policy, it is absolutely essential that it is backed by maximum vigilance and some high-powered mechanisms for review. I really do not think that what the Minister has promised us today meets that requirement.

The Minister pointed out that there are of course two reviews here. The other one is much less important and serves a completely different purpose. It is to safeguard a bank that has been threatened with separation against the arbitrary behaviour of its regulator. You could ask why that is needed because there are other safeguards, but if you do not have it, you come to the question of whether the Regulatory Decisions Committee, which is a step on towards the tribunal, should be beefed up. However, that is a recommendation we will come to, which the Government have not accepted. I do not think that the lesser review, the Amendment 10 review, can be taken off the table. If you do that, you increase the case for Amendment 91, recommending a new RDC. My conclusion is that we have not reached an agreement in this area. The debate is interesting, but what it means is that a lot more work has to be done between the opposition, the commission, other members and the Treasury to get to a point of resolution. However, it is essential that the point we reach has a much more high-powered review mechanism in it than is currently set out in subsection (6). I am content to withdraw the amendment on the basis that further discussions between now and Report will take place and that there will be flexibility on the part of the Government in their consideration.

[Lord Eatwell]

My Lords, as I have tabled an amendment to the amendment moved by the noble Lord, Lord Turnbull, I believe that it is for me to withdraw my amendment first and for him to follow. The noble Lord, Lord Deighton, has two objections to the process of review, both of which have, I think, been demonstrated to be false. He said that the first was to secure consensus. From the discussion today, he should be effectively disabused of the idea that the ICB has secured consensus. People have settled around the ICB as the best that can be obtained under the current circumstances, but there is a considerable degree of uncertainty about whether the ring-fence is actually a good idea.

The noble Lord also said that he wanted certainty, but he absolutely does not get certainty in this way because we are very uncertain as to whether this system will actually work. That is why his second objection—that time should be given for the system to settle down and work—is a very dangerous one. As we go through the process of implementation—if eventually Parliament agrees to these ring-fence proposals and implements them—we will discover by sheer practice where the lacunae may be, where things simply go wrong with unintended consequences, and so on. Unfortunately, we will be conducting an experiment and under those circumstances, it is very important that the sort of expert committee that the noble Lord, Lord Turnbull, has proposed, focusing on the particular question of whether this works, with growing expertise and experience, should be in place to review what is happening as the process unfolds.

That is why in particular I was very nervous about one aspect of the proposals of the noble Lord, Lord Turnbull, with respect to the review not taking place for four years and then taking place at five-year intervals thereafter. Although it is “up to” four years, I would be willing to bet that the “up to” will turn out to be about two. None the less, my amendments were intended to ensure particularly that we have the expert committee proposed by the noble Lord, Lord Turnbull, virtually in place as a standing committee with the expertise to guide us through what is going to be a very difficult and uncertain process.

Given the debate, and the views expressed around the House, this is a matter to which we certainly must return after significant negotiations have occurred between Committee and Report stages to try to achieve something of a consensus—at least on the issue of the nature of review. In the mean time, I beg leave to withdraw Amendment 4.

Amendment 4, as an amendment to Amendment 3, withdrawn.

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[Lord Deighton]

The resolution powers all relate to the Bank of England’s powers essentially to step in in advance of a bank’s insolvency so that it can change, for example, the creditor arrangements.

The PRA and FCA already have powers to require regulated entities to take actions that would facilitate the resolution of a firm in the event of its failure. This may include requiring it to raise additional capital, issue debt to the market or make structural changes to enable the firm to be resolved.

However, banks may be organised in a number of ways. Many have a structure whereby the bank is owned by a financial holding company, which may not be regulated. Banks may also be part of corporate groups which contain non-corporate banking entities. In these cases, the existing powers may be insufficient to deliver some of the changes that the regulator feels are necessary to make a bank resolvable. This is because the regulated entity may not have the level of control required to make the change. This may be the case where, for example, capital and debt are issued out of the parent undertaking before being downstreamed to a bank. It may also be operational in nature; for example, where a service company which is not owned by the bank but sits in another part of the group provides critical services in the bank.

The amendment will address these cases and ensure that the PRA and the FCA have the necessary powers to make banks resolvable for all types of corporate structure. It amends new Section 142J to ensure that any reviews by the PRA of “ring-fencing rules” under that section must also cover rules made under the power given in new Section 192JA in relation to parent undertakings of ring-fenced bodies.

[Lord Eatwell]

My Lords, I have enormous sympathy with the amendments and the struggle that the Treasury is having in having effectively to provide rules for parent undertakings in relation to the maintenance of the ring-fence. In many ways, the amendments go at least some of the way to achieving that. However, I should like to ask a question which I asked at Second Reading and which was not answered then. The Minister referred to capital and debt being raised at the level of the parent company and then downstreamed into the ring-fenced entity. If it can be downstreamed, can it not be upstreamed? If that were so, the ring-fence would not exist.

[Lord Deighton]

It is a valve which goes only one way; it cannot be upstreamed—otherwise the noble Lord is right that the ring-fence would not work.

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[Lord Deighton]

The simple way to look at the amendments is that they are to ensure that both regulators have the flexibility to address every aspect of the group structure to ensure that the ring-fence works. That is why we are trying to give as much flexibility as possible to address even the non-regulated entities within the group.

[Lord Eatwell]

My Lords, the noble Lord, Lord Higgins, has raised a very important matter with respect to authorities outside the UK. The proposals under Glass-Steagall and under Liikanen are different from the ring-fence—the divisions appear in different places. In those circumstances, “similar powers” seems to be a very weak description, because they are similar but not the same. With respect to resolution powers, which are crucial in the relationship between the parent body and the ring-fenced entity, that seems to create a degree of uncertainty. Can the Minister clarify exactly what that applies to? Presumably, it applies to the home-host division in regulatory responsibility and therefore subsidiaries of UK institutions in other jurisdictions will be regulated by the home regulator. If the home regulator has different rules with respect to the divisions, it seems to me that there will be a degree of confusion as to what is actually being enforced.

I am grateful for the Minister’s clear answer about the valve that goes one way on the raising of debt and capital. I return to my previous question. Let us suppose that we have a group in which the liability structure of the ring-fenced entity is essentially provided from the parent through the one-way valve and then the parent simply stops providing. In those circumstances, the security and stability of the ring-fenced institution would surely be threatened. The ring-fence would not be working simply because the steady flow of financial support for the ring-fenced institution had been cut off.

[Lord Higgins]

My Lords, I am a little clearer now than I was a moment or two ago. It would be helpful if my noble friend could say what is the position in each of the countries that I just mentioned. As I understand it, the emerging EU proposals—I am looking at a brief from the Law Society—will,

“require banks to create separate entities (although they will be allowed to stay within the same group) in order to split proprietary trading and market making off from other banking activities”.

On the other hand, the United States scheme will require,

“complete separation of proprietary trading but the bank is allowed to undertake market making”.

Under the amendment, we will apparently have those outside bodies setting the rules for banks in the UK. Consequently, we may find that the ring-fence is being drawn in quite different places—the noble Lord opposite seems to agree—depending on which authority is exercising the powers of resolution.

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[Lord Deighton]

I shall try to go through those points one by one. Just to be clear with respect to the foreign banks, the power we were talking about relates to the Bank of England’s rule-making power over parent companies. It allows the Bank of England to support a resolution being carried out by a foreign regulator where the bank is in a different country. It just allows the support of that resolution going on elsewhere so that we have the kind of international co-operation which is necessary for these resolutions. On the point about Liikanen and the convergence in how we are looking at this around the world, the general view of the officials who are working on the European legislation is that we are sufficiently in tune with where that is heading for these arrangements to work effectively.

I was not sure that I entirely followed the risk that the noble Lord, Lord Eatwell, was pointing out. However, risk-fenced banks can of course have equity provided by their parent and, once it is given, it need not be repaid, so the flow can still keep going into the ring-fenced bank.

[Lord Eatwell]

What if it stops?

[Lord Deighton]

That is part of the resolution process that needs to be sorted out but there is nothing to stop it continuing to go in.

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[Lord Turnbull]

I very much welcome this simplified process. It took two steps for the Government to get there, but the prodigal son is welcome at any time. Let us pocket that. I said we would look again at this special review that the commission suggested inserting into the process. I noticed that the Minister was drifting on to the next group, and I thought I was going to introduce it, but let us come to that at the appropriate time.

[Lord Eatwell]

My Lords, I echo the words of the noble Lord, Lord Turnbull. I think this is a significant improvement on the procedures that were previously outlined. I have a number of exploratory questions about this procedure. First, the regulator essentially seems to be judge and jury in this respect. It was the role of the old Regulatory Decisions Committee and, I believe, the ambition of the commission with respect to its development of the Regulatory Decisions Committee to ensure that there was an independent step in any major regulatory enforcement. The main reason why that was introduced into FiSMA was because it was felt that otherwise it would contravene human rights legislation. Are the Government confident that this procedure does not contravene such legislation?

Secondly, with respect to the publication of notices, in the very thorough and welcome briefing that the Minister’s staff provided on these amendments, the Government argued that they would not accept the commission’s proposal that the existence of a preliminary notice or of various stages be publicised. Instead, it was felt that these matters should be kept “secret” until such time as any impact on Stock Exchange listing rules demanded publication that the group was being subjected to such a procedure. It seems to me that this is a slightly dangerous structure. It is a traditional structure of central banks. It has always been strongly opposed by securities regulators which believe much more in transparency in this respect. This lack of transparency is likely to produce rumour and false information in the marketplace. Consequently, if we are going to have this procedure—which I think is well thought out, apart from the one issue that I raised, on which I would like to have assurances—we should make it a transparent procedure because rumours and false information are really damaging to markets. Transparency is always to be preferred, even if that transparency may be extremely uncomfortable for the firm being subjected to this process.

[Lord Deighton]

On the question of the breach of human rights, we are confident. The RDC still exists, and under this procedure we still have the independent Upper Tribunal. We have looked into that.

On the publication of the initial warning, we are all trying to accomplish the same thing, and it is quite finely balanced as to which way you go. I point out, for the benefit of noble Lords, that of course the regulator has the discretion to publish the initial notice but is not obliged to do so. Therefore, in those circumstances in which it is in the interest of the market to do that, it would do so. One of the principal reasons why we are reluctant to do that is because if you have gone public with the initial warning it may make you reluctant to issue the initial warning and to begin a process because of the consequences of that being out in the public domain. This is a tricky area where the arguments are relatively well balanced. We came out with this option for the regulator to disclose it, which we thought was, on balance, the right thing to do. I beg to move.

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[Lord Blackwell]

My Lords, given some of the recent speeches, I again sound a small note of caution. While I understand the need to electrify the ring-fence, the Government and this House should be cautious about legislating on a presumption that universal banking is the wrong commercial or organisational model. I share many of the concerns that have been expressed about the difficulty of having a common culture in an organisation that embraces too many different activities. However, it seems to me that it is primarily a commercial judgment for the management and shareholders to decide whether or not they can make that range of activities succeed. The primary duty of the Government and the regulator is to ensure that whatever is done is not a threat to the financial stability of the system. As I said in my introduction to the first amendment, I support ring-fencing which seems to me to be targeted at that purpose, which is to define the capital and risk exposure of the ring-fenced bank and ensure that it is regulated in such a way that the other activities of the group do not impinge on the capital and solvency of the ring-fenced activity. So long as the Government and the regulator can do that—I understand that people are raising questions about that—it seems to me that the question of other activities in the group is not something on which the Government should rush to legislate.

There are arguments which have not been put in this House about, for example, the ability to serve customers in a common way across different entities in the group, which would not be prevented by ring-fencing. There are arguments about the use of common resources such as IT resources, infrastructure and a whole range of central resources that can be used in a group structure. There may be good arguments or bad arguments but those are arguments that the management and the shareholders should primarily be in a position to consider. Some will succeed and some will fail but it is not up to this House to decide the commercial logic or otherwise of universal banking. The House should decide primarily whether or not the ring-fencing, the safeguards in the Bill and the electrification that is already built into the government amendments will do the job that is intended.

[Lord Eatwell]

My Lords, what is particularly striking about the commission’s report, especially its final report, is the way in which it presents a coherent package of measures. This amendment fits together with the review amendment that we considered earlier as those two elements reinforce each other. As Amendment 117 makes clear, the review element is the key trigger for Parliament to consider whether this measure of separation should be introduced. There is coherence here. What is distressing about the Government’s rejection of the nature of independent review and hostility towards this amendment is that by removing that internal coherence of argument they significantly weaken the overall approach to financial regulation which we are attempting to achieve.

In anticipating this discussion on separation, the noble Lord, Lord Deighton, asserted that the arguments for separation had not been considered and that if you wanted an amendment of this sort you ought to have another commission to consider the arguments. That is just not so as the arguments were considered extensively, first by the independent commission and then by the parliamentary commission. The main point that came out of those discussions was that there was a strong case for separation. However, the experiment of ring-fencing was felt to be worth while as, if it worked, the trauma of separation would not be required. The idea that this issue has not been considered is not the case as it has been considered very thoroughly. It has not been rejected but is seen as a backstop, if you like, to the ring-fencing proposal.

The most reverend Primate made the terribly important point, in a way which has not been brought out by other speakers, that this measure strengthens the whole structure of the ring-fence and will incentivise the banks to regulate each other. There will be an enormous incentive for all the banks to keep an eye on what everybody else is up to to ensure that they are not drawn into this final total separation. The people on the inside who really know what is going on will have a strong incentive to make the ring-fence work because if it does not work they know that there is a reserve power in the Bill. If you really want the ring-fence to work, you need this clause. It is a contingent clause and a reserve power but if we really want the ring-fence to work, the Government should wholeheartedly embrace the amendment of the noble Lord, Lord Turnbull.

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[Lord Eatwell]

The point that the Minister seems not to have taken on board is that the arguments for review and this power have to be seen as a coherent package. The point is that there would be that review; there would be a continuous independent review providing exactly the information that he says is necessary.

[Lord Deighton]

Yes, there would be a review, but not a proper parliamentary process. The argument I am making is that this is such a switch from ring-fencing to full separation that it should benefit from that full process. While I obviously bow to the experience of my noble friend Lord Lawson, these things, if the circumstances dictate, can be done extremely rapidly, where the circumstances demand that kind of urgent move.

I think it is instructive to compare the process of developing the ring-fencing policy to that of this proposal for full separation. The ICB went through an extensive process of deliberation and analysis, carefully collected data, prepared a full cost and benefit analysis and compared that to full separation. It found that a robust ring-fence will insulate essential retail banking services from shocks originating elsewhere in the financial system. It will enhance the authorities’ ability to manage the failure of a ring-fenced bank, or its wider corporate group, in an orderly way. It will, therefore, deliver the financial stability benefits of separation. Ring-fencing will also preserve some of the benefits of universal banking. I made the argument of diversification and scale, not simply diversity. Customers will be able to access the full range of services from a single group: that is a marketing advantage as well. The frictional costs to the economy of ring-fencing are therefore lower than those of full separation. That is, of course, the reason we did not go for full separation. Further, in the event that the ring-fenced bank runs into trouble while the rest of the group is doing well, other group members can support it. That, of course, would not be possible under complete separation.

On a comparison of the costs and benefits, the ICB chose ring-fencing as the superior policy. The PCBS did not provide any new evidence to contradict this position. In this respect, the noble Lord’s proposal for an independent review of ring-fencing is an admission that the evidence base for full separation does not yet exist. The amendment asks us to put a policy into law and then establishes an independent review process in the hope that it might justify it. For us, this is lawmaking done backwards.

That brings me to the Government’s second and perhaps more powerful reason for rejecting this amendment. Let us imagine that a future Government decided that not ring-fencing, or full separation, but a third policy was appropriate. Imagine, for example, that it decided that a Volcker rule was the right policy, or a shift to full-reserve banking. In either case, a review that was limited to deciding whether to enact a reserve provision for separating ring-fenced banks from their groups would be no use at all, and the power would need to be repealed, along with much of the rest of the Bill. Coming back to Parliament would be the only way to give a future Government wanting to change policy the full range of options.

Therefore, on grounds of both substance and of proper legislative process, the Government continue to oppose a reserve provision for a move to full separation and I therefore urge the noble Lord to withdraw his amendment.