Financial Services and Markets Bill

Lord Eatwell Excerpts

Committee stage
Tuesday 21st March 2023 Grand Committee

[The Archbishop of Canterbury]

Going back to the fiscal event, a lot of the pension funds almost went bust. We learned a lesson from that, quite rightly, and I think it is a lesson that will be kept.

The ring-fence and the SMCR have been important for encouraging—not solving—improved standards and culture in the banking sector and for protecting the public from bearing the brunt of future banking failures. We cannot forget the lessons learned with such pain for so many outside the banking sector, who had no idea what goes on in banking but found that life suddenly just did not work any more.

I hope that the Government take a further look, certainly through the consultation, at the lessons of the last few weeks, and that the ring-fence is strengthened, not weakened, and improved. I agree with the noble Baroness, Lady Noakes, about both the ring-fence and the SMCR. Both are cumbersome and need rethinking, but not abolishing.

When asked why he had changed his mind, John Maynard Keynes—apocryphally, I think—replied:

“When the facts change, I change my mind. What do you do, sir?”


Given that the facts have changed over the last few weeks, the Government need to ask themselves whether they are going to change their minds and think harder about adequate protection for the basic financial structures that protect the weakest in our society.

[Lord Eatwell (Lab)]

My Lords, these three amendments project a peculiar background, which is an issue that this Committee debated in an earlier session—that of accountability. The first amendment of the noble Baroness, Lady Kramer, Amendment 216, is too detailed for primary legislation. On the other hand, I sympathise entirely with the noble Baroness’s goals. In a principles-based system, I would have expected these goals to be expressed in the principles and achieved by the rule-making regulator but, given the lack of accountability with which the Government seem so comfortable—I was impressed by the noble Baroness’s argument on Amendment 216—we cannot be confident that changes will be made at the necessary points. There is no vehicle for Parliament to ensure or inspect the rule-making of the regulators.

I think Amendment 216 is necessary because the Government are so weak on accountability. If we had strong accountability, whereby we could hold the rule-makers to account—both positively, in the sense that you are doing something that you should not be, and negatively, in the sense that you are not doing something that you should be—amendments such as this would not be necessary. Amendment 216 is necessary in the way so carefully described by the noble Baroness, Lady Kramer, simply because of the lack of accountability in the system.

This also applies to the other two amendments in this group. The noble Baroness, Lady Noakes, powerfully pointed out that, because of the peculiar circumstances in which it took place, the resolution of SVB UK required a relaxation of the ring-fence. I am entirely sympathetic with the goals of these amendments, which address the overall structure of the industry and therefore the overall risk appetite of this country for banking and financial services. That is what the ring-fence and the senior managers and certification regime are about.

The “but” is the important case highlighted by the noble Baroness, Lady Noakes, where some modification was necessary. If we had proper accountability, this could come to Parliament, which could then examine this example of relaxation to discuss whether it is appropriate to extend it to other banks, so that there is this mythical level playing field in the competitive relationships between them.

I am enormously sympathetic to the goals of these amendments: to the first because it is a practical issue of excessive risk-taking by insurance companies and, as we have seen, pension funds; and to the other two because they refer to the structure of risk which Parliament has decided is appropriate in this country’s financial services industry. It should not be modified wilfully—I am thinking of the marriage ceremony—and without due consideration of the consequences. Therefore, the Government would once again be well advised to reconsider the issue of accountability, which they have brushed away so casually, because it would provide the flexibility for Parliament to be involved in changing the risk appetite of the country as a whole.

[Viscount Trenchard (Con)]

My Lords, I again declare my interest as a director of two investment companies, as stated in the register. I will speak about all three amendments.

In Amendment 216 the noble Baroness, Lady Kramer, seeks to prevent a matching adjustment being applied to a portfolio of assets with a Standard & Poor’s rating of BBB or less. Does this mean a portfolio of assets comprising at least one holding of BBB paper, or a portfolio consisting exclusively of holdings rated BBB or worse? Either way, I welcome the Government’s proposal to remove the disproportionately severe treatment of assets with a credit rating of BBB or below, which will reduce the incentives for insurers to sell BBB assets in a market downturn. These reforms would encourage insurers to revise their investment strategies and risk appetites for investing in sub-investment grade assets, increasing funds available for investment in beneficial infrastructure projects, for example.

In any case—here I agree with the noble Lord, Lord Eatwell—is this attempt to constrain the powers of the PRA not too specific, and the kind of very precise regulation that we want to get out of primary legislation so that we can give discretion on this kind of thing to the regulators? I therefore cannot support this amendment.

I tremble in my shoes to disagree with the good intentions expressed by the noble Baroness, Lady Kramer, the noble Lord, Lord Tunnicliffe, and the most reverend Primate the Archbishop of Canterbury in seeking, in their Amendments 241C and 241D, to make it very difficult to weaken the ring-fencing provisions or change the senior managers and certification regime. It is clear that she and her co-signatories are among those who believe that the introduction of ring-fencing has reduced the risks to which bank customers’ deposits are exposed and that it is therefore important to make it very difficult to weaken the ring-fencing regulations in any way.

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[The Parliamentary Secretary, HM Treasury (Baroness Penn) (Con)]

My Lords, I will speak first to Amendment 216, which pertains to the Government’s announced reforms to Solvency II, made possible through the Bill’s revocation of retained EU law.

The Government are reforming Solvency II, the rules for prudential regulation of the insurance industry currently set by the EU, to reflect the UK insurance market’s unique features. These reforms will provide incentives for insurers to increase investment in long-term productive assets by more than £100 billion. They will also benefit consumers by increasing insurers’ ability to provide a broader range of more affordable products.

The Government have committed to make changes to the matching adjustment, an accounting mechanism whereby insurers can match their long-term liabilities with long-term assets and hold less money to pay out claims. These reforms will incentivise firms to invest significantly more in long-term productive assets such as infrastructure. This investment will support growth across the UK and the Government’s climate change objectives.

The noble Baroness’s amendment would instead result in a stricter treatment for some assets than under current rules. I reassure noble Lords that the Government’s reforms to Solvency II strike a careful balance between boosting growth across the economy and maintaining high standards of policyholder protection. Insurers will still be required to hold extra capital to safeguard against unexpected shocks, they will still have to adhere to high standards of risk management, and they will still be subject to comprehensive supervision from the PRA, our world-class independent regulator.

The noble Baroness, Lady Kramer, asked whether we would replicate the Canadian Government’s position with regard to pensions and insurance firms in this context. She referred to statements in the Budget about pension funds—although I think they were focused more on defined contribution pension funds than defined benefit pension funds. I do not know the detail of the specific Canadian regime, but the reforms proposed here do not pose risks to financial stability. As I said, each insurer must still hold enough capital to survive a 1-in-200-year shock over one year. Insurers will still have to adhere to the high standards of risk management. The Government and the PRA have announced a series of additional supervisory measures that the PRA will take forward to ensure that policyholders remain protected. For example, the PRA will now require insurers to take part in regular stress-testing exercises.

[Lord Eatwell (Lab)]

May I comment on the issue of stress tests, which the Minister also raised during Questions this afternoon? You can stress test only risks that you know are there. It depends on the underlying model that you create to examine in your stress tests. Thus stress tests did not pick up the LDI problem at all because it was not there in the models that were used. In financial services, risks appear in entirely unexpected places, and relying on stress tests is, and has been demonstrated to be, a very weak answer. She should reconsider her reliance on this argument.

[Baroness Bennett of Manor Castle (GP)]

Since it is related, I also question the readiness for a 1-in-200-year shock. We have seen very similar kinds of mathematical approaches, if you like, taken to issues such as flood risk and other climate risks, and they have been found to be very ineffective in dealing with problems. They only increase the failure to understand risks.

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[Lord Sharkey (LD)]

My Lords, I will speak briefly to the amendments in the names of the noble Lords, Lord Bridges and Lord Forsyth. I agree with the analysis by the noble Lord, Lord Forsyth, of the dangers of having Parliament bypassed in the creation of a CBDC, but I will mention two things to which he may not have given enough weight.

The danger crystallises in the possibility of the disintermediation of the retail banking system, which would have incalculable consequences. Given the difficulties people have in dealing with their own banks at the moment, imagine the difficulty of trying to deal with the Bank of England about your personal account when things go wrong or you do not understand what things are doing. Given banks’ habit nowadays of closing people’s accounts without notice or reason, I wonder whether the Bank of England would take the same view if it had that power.

Like the noble Lord, Lord Forsyth, I would prefer any such creation—although I am not sure that I want one—to be via an Act of Parliament rather than regulation. However, regulation is tempting because I notice that proposed new subsection (3) of the amendment tabled by the noble Lord, Lord Bridges, finds a way of amending secondary legislation. With a bit of luck, we will deal with my amendment tomorrow, which does exactly the same thing in exactly the same kind of words but with broader application.

It is dangerous in the extreme to have Parliament excluded on the central bank digital currency, as the Government clearly intend at the moment. We ought to be very careful about that. When it comes to Report, where we need to think about what amendments we press, I would be very tempted to suggest to the noble Lord, Lord Forsyth, that he presses his amendment.

[Lord Eatwell (Lab)]

My Lords, I will make two general comments about these amendments—first, on Amendment 218 in the name of the noble Lord, Lord Holmes.

When I was chairman of the Jersey Financial Services Commission and therefore the regulator in Jersey, I was continually lobbied about the issue of digital identification simply because of the high cost of repetitive KYC investigations that institutions had to go through. It seems that the possibility of having a system of digital identification which would be generally acceptable and generally accepted within financial services would significantly reduce the costs of KYC and would provide a much sounder foundation for the credibility and respectability of the individuals attempting to transact within financial services. So this is broadly a good idea. It is very complicated, as I discovered when I tried to introduce it in Jersey, and it raises very important privacy issues, but, none the less, this is the way that the world is going and we need to think this through extremely carefully. It could be of great benefit to the whole KYC problem.

With respect to digital currencies, the one comment I will make is to remind the Committee of the debate that we had about the decline in the acceptance of cash and the fact that a significant number of people in our country are being deprived of money, since cash no longer works as money—it is no longer generally acceptable in discharge of a debt, which is the definition of money. Therefore, there will be a responsibility for the state to provide a digital form of money, because digital payment, as the noble Baroness, Lady Noakes, argued strongly at the time, will become the standard form of payment and cash is basically going to disappear —apart, perhaps, from the Tooth Fairy.

The issues of digital currency and digital identification are both hugely important for our future and, as the noble Lord, Lord Forsyth, argued—I agree with him most strongly—they require very careful parliamentary consideration.

[Lord Tunnicliffe (Lab)]

My Lords, on the digital pound, we support the Bank of England’s work exploring the potential benefits of a safe and stable central bank digital currency, but the Government’s overall approach to crypto remains unclear.

With the collapse of FTX, it is clear that crypto can pose a real threat to normal people in the real economy and therefore may pose a systemic risk in future. The approach HMT has taken to the digital pound is a welcome contrast to this Administration’s eagerness to lean into a crypto Wild West in the recent past. We need to get serious about attracting innovative fintech companies to the UK by safely harnessing the potential of new technologies. How will the Government do this?

On the amendments in general, the issue of accountability has come up once again. The concept of using primary legislation to have a check on these ideas is clearly practical and therefore very attractive, but it will have problems. If the Government would only embrace our concerns about accountability and come forward with a proper and comprehensive accountability structure, perhaps we would be able to develop a more sophisticated approach than the rather raw power of primary legislation. However, as a fallback it is very attractive.

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[Lord Holmes of Richmond (Con)]

My Lords, I will speak to Amendment 238 in my name. Does my noble friend the Minister agree that “know your customer” and anti-money laundering—KYC and AML—are not working optimally? There is a plethora of examples that we could look at; I will not do so. The simple truth is that they are not fit for purpose and are not achieving their aims. They are not providing the environment that we would want to conduct our financial services in. Does my noble friend the Minister not agree, therefore, that it is high time we had a thorough review of the regulations to put in place a system that works and is inclusive, efficient and effective?

If we look at some of the practical elements, to put it in terms, is it not time that we stopped messing about with gas bills? That takes us to an amendment in a previous group on digital ID, which would go far in resolving many of the issues around KYC and AML. Does my noble friend the Minister not agree? The difficulties that we have heard about and which many members of the Committee may have experienced in all areas of the financial services landscape could be effectively resolved if we resolved the current situation with KYC and AML. It is resolvable; when she comes to respond, my noble friend the Minister could simply say, “I will resolve it”.

[Lord Eatwell (Lab)]

My Lords, on the point made by the noble Lord, Lord Holmes, surely these regulations are derived from the Financial Action Task Force. We would usurp international agreements if we modified our regulations in a way that was outwith the positions established by the FATF.

[Baroness Noakes (Con)]

I completely accept that we need to comply with the Financial Action Task Force regulations but, as we discovered the other day when we were discussing PEPs, the regulations we have in the UK have in some instances gone beyond what is actually required by the Financial Action Task Force. The issue with the KYC regulations is one of immense bureaucracy and great irritation for people to no particular end. It is worth looking again at whether the way we have drafted our regulations, to the extent they go beyond what we are required to do, has in turn led to more problems for individuals.

I am sure we have all had problems but I will share one with the Committee. My husband had a very small investment—way below the level at which it would have to be declared as one of my interests in your Lordships’ House—and there was periodic updating of the know your client regulations. Because of the way that firm’s forms were comprised, it refused to accept my noble friend Lady Neville-Rolfe’s signature attesting that the document was a fair copy, because she could not tick a particular box on the form. It was completely ludicrous.

That permeates the way many financial service institutions have come to apply these rules in practice. They have become highly bureaucratic, operated by people who probably have no common sense and possibly not even a brain. To go back to the regulations and see what is absolutely required and then follow it on through the FCA seems a really important thing.

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[Lord Eatwell (Lab)]

My Lords, I support the amendment from my noble friend Lord Leong. I was a bit shocked to discover that factoring companies are not regulated through the FCA. My discovery of this through my noble friend’s initiative reinforces my view, which he very clearly expressed, that this is the business equivalent for SMEs of payday loans in the consumer retail sector. Given the importance of small and medium-sized enterprises to the growth of the UK economy, which he quite rightly pointed out, one of the most important elements of public policy is to ensure that they receive the best, most appropriate and well-regulated financial services, which provide them with a firm financial platform on which to grow. I hope that the Minister takes this amendment away and has a serious think about it, because this is a serious gap in the regulatory framework.

[Lord Sharkey (LD)]

I rise briefly to support this amendment. It was with some surprise that we also discovered that this sector is unregulated, but we entirely understand how important it is to the small business community. In that respect, it is hard to see why it is not regulated and why it should not be regulated. It is hard to see how any Government could resist the force of the noble Lord’s amendment—but we may see a demonstration of that in a moment or two.

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[Baroness Bennett of Manor Castle (GP)]

My Lords, I thank the noble Lord, Lord Tunnicliffe, for introducing this amendment. I have chosen to address simply the green infrastructure parts, and at this time of the evening I shall park the high-growth debate in the interests of not sidelining the main issue.

The idea of a review is useful here, because the evidence we have of other measures the Government have tried to take to encourage green investment is perhaps mixed—that is the charitable description. I refer to a survey published this month by Pensions for Purpose, which looked at the first wave of obligatory reporting of the scheme introduced in October 2021 based on the Task Force on Climate-Related Financial Disclosures being done by the larger occupational pension schemes and authorised master trusts. That study found that this introduction by the Government was having very limited effects and that it was, to a large degree, being treated as a tick-box exercise. Where it was having an impact on investments, it was not driving towards green investment but rather to a portfolio decarbonisation—a stepping away from things rather than into the kinds of investments we need. This is something we are also seeing implicitly, in that the pension regulator is about to launch a publicity campaign for pension trustees, stressing the need to look at ESG responsibilities, particularly around climate issues—that has been its responsibility since 2019. It is clearly thought necessary to have a publicity campaign about this.

We really need to see steps forward and to see things joined up here. I am reminded of a debate last week with the same Minister, when we finally finalised the UK Infrastructure Bank Bill, which, of course, is looking at another source of investment going into green. I am very encouraged by the Government’s decision to include nature-based solutions there, which is obviously a cross-reference to our need to see much more private investment in nature-based solutions as well. Dare I say it, it would be nice to see some circular economy as well—if I can just put that in there.

On the idea of a review, we desperately need to see money going into green infrastructure. All the evidence we have says that is simply not happening. I also note that the Government need to create the frameworks in other areas of policy to make this happen. I was sitting here, thinking of when I was in this very same Room a few weeks ago with the Energy Bill. One of the things that could be a very good target for investment would be that if we are to get community energy schemes up and down the land—if we get delivery of the widely-backed Local Electricity Bill, as it is in the other place—that would be a great area to see pension funds investing in and supporting. I was at an event this morning debating social value and the importance of that in procurement.

We need to tie all these things together. All these things are running off at different angles, but we are still not creating an environment where people who are putting money into their pensions, seeking to invest in their own future, will have a liveable future for that pension to pay out in.

[Lord Eatwell (Lab)]

My Lords, it is obvious that the issue of pension funds investing in equities and longer-term growth prospects was highlighted by the LDI crisis in the autumn. I hope that, when the Government come to consider the consequences of that crisis, they will look at the letter that your Lordships’ Industry and Regulators Committee sent to Andrew Griffith MP, the Economic Secretary to the Treasury, setting out the reasons it saw for the peculiar financial structures that led to the LDI crisis and the lack of long-term investment in equities and growth stocks by British pension funds. They traced this to the accounting regulations that are imposed on British pension funds—particularly the way in which liabilities are assessed—and noted that, since those regulations were introduced maybe 15 years ago, there has been a dramatic reduction in the investment by British pension funds in long-term equity assets and a focus mostly on rather low-yielding government securities instead.

The LDI scandal was produced by the development of a peculiar financial device using repos, which were then used to make some investment in equities. There is clearly a fundamental problem in the regulation of British pension funds, which has both reduced the returns on their investment and limited the sort of investments they might be able to make in growth assets to their benefit and that of the economy as a whole. There needs to be a major review on the regulation of pension funds, both to make them more secure—to avoid them resorting to very unstable financial constructions to try to increase their returns—and for the overall benefit of the economy.

[Lord Sharkey (LD)]

My Lords, I agree with everything that the noble Lord, Lord Eatwell, has said. We are happy to support this amendment. I simply have two questions and one observation about it.

The amendment says that we must include “green infrastructure”. Is there a practical, generally agreed working definition of what that actually means? I also notice that, in carrying out the review, the Treasury must consult a list of organisations. The final group of organisations is “relevant financial services stakeholders”. Is the intention also to include professional advisers? They would be a vital addition; perhaps that should be made explicit as we go forward.

My observation is that proposed new subsection (3)(c), which talks about

“establishing frameworks to enable DB pension funds to invest in firms and infrastructure alongside the British Business Bank”,

is an extremely good idea. We should make sure that this happens as soon as we can.