Lord Hodgson of Astley Abbotts
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Financial Services Bill
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Lord Hodgson of Astley Abbotts
My Lords, my Amendment 129ZA in this group follows the line of argument ably put forward by my noble friend Lady Noakes. It is about how we set the regulatory bar at a level that does not discourage and squeeze out innovation if it is too high but not so low that there is a free for all and loss of reputation. As someone who briefed me on this said, “This is the Goldilocks’ porridge issue: not too hot and not too cold”.
As my noble friend said, there is a danger of regulators becoming risk averse and, as she put it, having a low tolerance for failure. Innovation stifled because the bar is too high will not cause problems for the regulator because the innovation will disappear, but the failure of a firm trying innovation obviously does. We have a particular interest in the UK because our financial services industry is vulnerable; it is not backed, as is that of the US, say, by a very large domestic market and therefore we have to be smarter, quicker and more innovative. That is what my amendment intends to facilitate.
To give a real-life example of what I mean, some noble Lords may have seen the briefing from the Equity Release Council, which is the industry body for equity release, which allows individuals aged 55 and over to respot money from the property they live in without having to make any monthly repayments. They have a no-negative-equity insurance policy so that people cannot go overdrawn. This equity release is a thriving, growing industry with 150,000 customers and about 25,000 new customers each year.
We have discussed in this House the problems of funding old age. Of course, equity release enables people to stay in their home, either by withdrawing some equity to pay for care, or to make physical alterations to their home to make it easier for them to stay there, but it is not a concept that has taken root anywhere else in the EU, so if the PRA does not have a competition objective, there will be no formal requirement for the regulator to strive for this effective balance between financial stability and an appropriate level of market competition and growth. This could lead to the PRA taking the default position of, first, increasing capital buffers in response to any market issue; and, secondly, disproportionately gold-plating future EU legislation when transposing it into UK law, which could be to the disadvantage of UK firms.
As I say, this will be a particularly difficult issue where EU regulations are being promoted which effectively do not cover any country but the UK because the practice is not carried out elsewhere in Europe. Other noble Lords will have had other briefings; there was one from the Council of Mortgage Lenders that mentions:
“The uncertainty that the FCA’s product intervention powers can have the potential for stifling innovation within the market. There are few details of how these powers might be used and under what circumstances. It is crucial, therefore, that a clear set of governing principles are developed”.
Therefore the four sub-paragraphs (a), (b), (c) and (d) of my Amendment 129ZA, which inserts a completely separate clause on Page 26, deal with the point made very ably by my noble friend, but do so in a slightly wider way.
Lord Hodgson of Astley Abbotts
I ask my noble friend one practical question. I entirely understand what he says about the competition objective of the FCA on page 17. In his argument, that is a reason why it should not be on the PRA. There is no way that the PRA, without its competition objective, can overrule the FCA: that is, there must always be a competition objective in all cases where the PRA cannot outgun the FCA. If there are any occasions where the PRA can outplay the FCA, then of course the competition objective falls away, if there is not one for the PRA. Reading this, it looks to me as though there is a danger that the PRA will be the established centre—the capital centre and so on—and the FCA will be, in some senses, implementing what has been decided as a strategic framework by the PRA. If I have got that wrong, I am delighted to be put right.
Lord Sassoon
I do not think that my noble friend has got it quite right. However, I cannot hide from him the fact that we believe that, because it is right and goes to the heart of the flaws in the present tripartite arrangements, the PRA should have as its single objective the one that I have described. Therefore, the nub of his concern remains, and I cannot pretend that it is not there. All I can say is that we consciously want to have the architecture as I have described it. However, the mitigation—and I think it is an important one—is that the PRA must consult the FCA before taking any steps that could in any way harm the FCA’s objectives, including, in this case, the competition objective. I think it is a reasonable check on the PRA’s action, given the basic architecture which we think is important.
Lord Flight
My Lords, I address Amendments 130B and 144B. I am not entirely clear why these have been grouped together as they cover very different territories.
Amendment 130B reverts to points which I endeavoured to stress much earlier on in the process of this Bill: at the end of the day it is the consumer who pays the costs of regulation; the new twin-peak arrangements are likely to be inherently more expensive because they double up in certain areas; there is no shared overhead cost and there is not that much in the legislation which is at least there as a discipline to keep costs of compliance to a minimum. Amendment 130B seeks simply to write into the Bill that the PRA and FCA should use their resources efficiently and economically towards minimising the cost and burden of compliance on individuals.
Amendment 144B is in very different territory. The Bill provides for the FCA to have product intervention powers, which in the main I accept is a sensible proposal, because without those intervention powers time drags on before faulty products get addressed. In the mean time, consumers get hurt. However, it seems to me that everyone should be learning from that process. Therefore the amendment provides that the FCA should report annually on the use of these powers and on how it has complied with its statement of policy, including an evaluation of the outcomes of the regulatory actions and whatever intervention powers have been used.
Lord Hodgson of Astley Abbotts
My Lords, I have Amendments 131, 132, 133, 134 and 135 in this group. I certainly support Amendment 130B moved by my noble friend Lord Flight but my amendments go rather further and are rather more prescriptive in their approach. They relate to the attitude, approach and culture of the regulator, which we have been discussing. There has been a lot of hollow laughter about culture in the banking system, which I understand, but the financial services industry covers much more than the banks—it covers the IFA community, the insurance community and Lloyds. I think that in recent years the regulator has moved from a reasonably open, even-handed relationship with its regulated firms to one of much greater risk aversion. Of course, I understand that safeguarding client money and avoiding financial crime are very important indeed, but the regulator seems to have forgotten many chunks of the introduction to FiSMA, which sets out other objectives, requirements and issues that it has to consider in carrying out its regulation. Nowhere has this shift in culture been seen more than in the relationships with the smaller and medium-sized firms. Very often these are firms where innovation and some of the most exciting developments are taking place.
Specifically, I should like to draw to the Minister’s attention three or four things which I hope we can agree are being practised in an undesirable way at present and which are regulatory commercial approaches that henceforward we should try to avoid in the structure.
The first is Section 166 inquiries—the expert person investigations. These were designed to be used rarely but there are now 840 outstanding. A rough estimate of the cost of a Section 166 inquiry in professional fees for the regulated firm is £100,000, although it could be £200,000. Therefore, we are talking of between £84 million and £150 million of costs, and that is without the cost in terms of the management time spent providing the information needed for the professional firm carrying out the inquiry on behalf of the FSA.
This is sub-contracting regulation. There is really no restraint at all on the FSA in undertaking these inquiries. Such an investigation costs it nothing; it simply has to engage a professional firm to carry it out and away it goes. That is without the Section 404 thematic reviews, and without TC4, which are the run-off requirements when a firm is closing down. Of course, closing down a firm requires some very difficult judgments to be made about what you will be able to realise from the assets, the time over which you will be able to realise them and the consequent costs incurred during that period. If you make a series of extremely negative and conservative estimates, then of course you can put a firm in a very difficult position and make it almost impossible for it to carry on.
Last but not least is the position of the SIF—significant influence function—committee. I should like to give a real-life example of this, which I want to use to underpin the detail of my amendments. I have recently resigned as the chairman of a regulated firm. In April 2011 we took on from another regulated firm a new finance director, who came with good references. In July, he was told by the SIF committee that he was not able to take up the role of finance director. I went to the FSA and asked why. It said it could not tell me as there was an investigation and it was confidential. I asked the FSA if it could tell him what he had done. It said it could not do that either as it was confidential. That was June or July 2011. He is still waiting to hear the outcome a year later. He cannot find out what he has been accused of and is in a Kafkaesque situation. This is the sort of culture and risk-averse nature of the situation we now find ourselves in. My amendments are designed to prevent this being carried over into the new structure.
In the regulatory principles to be applied by both regulators in new Section 3B on page 28, I seek to add “operational rules” after “burden or restriction” because it is the unofficial stuff that can be made extremely expensive and difficult. It should cover firms as well as people. In particular, in Amendment 134, after “proportionate” I want to add “reasonable and fair”.
I have just given in some detail—and I apologise for going back to it—the example of the SIF committee. I can see how the regulator could argue that, if you have a person who has been involved in a firm which is under investigation, preventing him operating might be proportionate but to hold him in limbo for 13 months cannot be reasonable or fair. It offends the principles of natural justice.
I hope very much that my noble friend, when he comes to wind up and reply to this important set of amendments, can give me some assurance as to how we are going to make sure that the culture going forward is more even-handed and better than it has been over the past couple of years. It is absolutely vital that the future regulatory architecture enables financial services firms to play an effective role in the economy. To enable this role to be fulfilled, the regulatory regime needs to take an approach that considers whether interventions are proportionate, reasonable or fair.
My set of amendments would address a number of concerns. There would be assessment of business-specific risks—for example, the insurance sector presents very different risks from those of banks and has a very different business model. If the regulators are required to consider whether their approach is reasonable and fair, they should ensure that consideration is given to whether it is appropriate to apply regulations drafted with banks in mind to other industries in the financial services sector, including insurance. Then there is the question of the culture. My noble friend has said many times that the Government wish to avoid the stability of the grave. A requirement to have regard to what is reasonable and fair will help to ensure the regulators take a more measured approach. For example, the PRA has signalled a desire to make greater used of skilled persons and external auditors in its approach to supervision. While you have to recognise that these are important regulatory tools, it is imperative that they are used appropriately and in relation to those firms which represent a significant risk to the PRA’s objectives. This set of amendments is designed to help these considerations.
Baroness Noakes
My Lords, I have Amendments 144A and 147C in this group. They are in the name of the noble Lord, Lord McFall, and myself. I want to start by saying that I support what my noble friends Lord Flight and Lord Hodgson have said in respect of their amendments.
My amendments are much more modest. They just deal with Schedule 3, which sets up new Schedules 1ZA and 1ZB to FiSMA, which deal with the much more routine aspects of the FCA and the PRA. These little amendments simply add one requirement to the list of things that the FCA and the PRA have to include in their annual reports to the Treasury. That requirement is to include an analysis of the costs and benefits arising from regulation for which the bodies are responsible. It is important that this report is then laid before Parliament so the issue is kept visible.
These amendments come from the Treasury Select Committee’s first report of this Session, as do others in my name and that of the noble Lord, Lord McFall. The Treasury Select Committee has received a lot of evidence from the financial services sector about the rising cost of regulation—I have mentioned that once already this afternoon. I know that in particular the non-bank parts of the financial services sector feel that they are paying a price that cannot be justified by reference to the risks related to their own activities, which is why the issue of costs and benefits is particularly important.
Lord Hodgson of Astley Abbotts
I return momentarily to Amendments 131 to 135. I am extremely grateful for the Minister’s comments and the comfort that he gave on operational rules and the exchangability of “person” or “firm” under the Interpretation Act 1978, of which I was not aware. On the point about “reasonable and fair”, I think that he said the firm could always take the regulator to the Upper Tribunal. That is not an answer at all. No firm, particularly not a small one, will want to take the regulator to the Upper Tribunal. That is only in theory an answer. There is no way that any firm will want to go through the risks—in publicity, time and reputational damage—to ensure that the regulator has been reasonable and fair. I am not asking my noble friend to come back on this; I understand his point; but his officials should not think that that is an answer, because it is not a practical answer in the real world.
Lord Sassoon
My Lords, I appreciate that the processes of challenge, whether it is by the Upper Tribunal or under the rules of natural justice, are very much back stops and expensive and difficult for firms. That does not mean that large firms have not challenged the FSA and in some cases been successful over the years. I am not sure that it would be any cheaper and easier if such requirements were written into the Bill.
It just remains for me to ask my noble friend Lord Flight to withdraw his amendment.
“(g) the need to ensure that each regulator employs staff with the necessary knowledge, experience and expertise of the sectors that they regulate, and of policy making at the European level.”
Lord Hodgson of Astley Abbotts
My Lords, Amendment 138C proposes a new paragraph (g) to the regulatory principles referred to in new Section 3B. It would ensure that,
“each regulator employs staff with the necessary knowledge, experience and expertise of the sectors that they regulate, and of policy making at the European level”.
The FSA has had issues in retaining quality staff in recent years, and recruitment will remain one of the biggest challenges facing the new regulatory bodies. A failure to address the issue of experience and expertise will undermine the introduction of the new regulatory framework—in particular, the proposed move towards a more judgment-based supervisory approach. The amendment is intended to probe the Government on how they and the regulators plan to address those staffing challenges.
I argue that there should be a commitment that the regulators will ensure that they recruit and retain staff with the necessary knowledge, experience and expertise to apply the regulatory regime in an appropriate and proportionate manner. It will be particularly important that the staff have a balance of sector expertise reflecting the range of industries that they cover, and that appropriate expertise is present at all levels and in all functions. Without proper staffing the regulators will be unable to make sound judgments about the strategies, plans and actions taken by individual firms. They will also struggle to understand the potential impact that regulations and supervisory actions taken against individual firms might have on the financial system as a whole.
Staff employed by the new regulatory bodies will also need to acquire skills and expertise to aid their interaction with the new European supervisory authorities. The ESAs will drive more of the regulatory agenda in future and it is essential that the new authorities play an increasingly influential role in the early stages of development and throughout the process governing the agreement of new regulation. To succeed in this area staff will need the necessary negotiating and influencing skills and require a high level of awareness of the political processes at a European level. We touched on this point during our debate on Amendment 96A, moved by the noble Baroness, Lady Hayter of Kentish Town, at our meeting on 10 July.
I have already referred in slightly unflattering terms to the significant influence of the function committee that authorises individuals on a case-by-case basis before they can take up their roles. A major part of the interview with the SIF committee is taken up with questions designed to discover if the interviewee has the necessary knowledge, expertise and experience. If this test is to be applied to those who run the financial services industry, it should surely also be applied to those who regulate it. I beg to move.
Lord Tunnicliffe
My Lords, I am somewhat surprised to find myself agreeing with the noble Lord, Lord Hodgson of Astley Abbotts. I have been involved in a lot of reorganisations and all too often people do not think about the human content of the organisation, the size of the jobs that they are creating and the extent to which a reasonable human being can do them—whether even an unreasonable human being can be found to fill those roles.
At first sight it is a matter of motherhood and apple pie. To try to get a feel for this Bill and speaking particularly about the PRA, I searched the internet and came across a splendid document by the Bank of England and the FSA, published in May 2011. It is called The Bank of England, Prudential Regulation Authority: Our Approach to Banking Supervision. It is written as a narrative and really it is a gripping one. All that the Minister says about the PRA is that it is going to be focused. It is going to be much more than focused. It is going to be based on a judgment-based supervision, and I quote from paragraph 15 of this document:
“The PRA’s proposed approach has, at its centre, supervisors making judgements, when needed, about current and future risks to an institution’s safety and soundness and about the action it should take to address these risks. It is recognised that this will mean that, at times, the supervisor’s judgement will be at variance with that of the institution. Furthermore, there will be occasions when events will show that the supervisor’s judgement, in hindsight, was wrong. This is inherent in a forward-looking system”.
This is a very significant intervention. Later the document describes the proactive intervention and at stage 3 points out where,
“significant threats to a firm’s financial safety or soundness may have been identified”.
It continues:
“The PRA may require any of the following actions: a change to management and/or composition of the board; limits on capital distribution; restrictions on existing or planned business activities; a limit on balance sheet growth and/or stricter leverage limits; and setting tighter liquidity guidelines and/or capital requirements”.
I am sorry that the noble Lord, Lord Sassoon, is not with us at the moment, but he said that the PRA will not become a shadow director. It is pretty clear that I do not understand what a shadow director is, but this is a significant level of intervention. Then you look at the role. A lot of the time, the people in this role will be doing base-level supervision. Let us hope that we have some financial tranquillity. We are now looking for people who will be capable of taking that level of intervention at pretty short notice, interfering in major institutions’ affairs, and having effects which, it is admitted, could be wrong decisions. That will have to be done with enormous care by people of very high quality.
I am pleased that the amendment brings Europe into play. In front of us we have a very complex set of organisational changes. It is not clear how it will fit with Europe. There will almost certainly be a number of jarring edges. We need people in this organisation who are capable of overcoming the ambiguities and smoothing the path of the relationship with Europe.
I am sure that the Minister will say that this is not the sort of thing that should be on the face of the Bill. If I were in his place, I know that my brief would say that. Nevertheless, it is for the Minister to assure us that processes will be in place, particularly in the PRA, given the intention to use these powers, which already exist, in such a significant way to meet these very serious challenges.
Lord De Mauley
My Lords, I cannot answer that here and now, but I will write to my noble friend on that point.
Meanwhile, I assure my noble friend Lord Hodgson that while staffing is not a matter for the Bill—as the noble Lord, Lord Tunnicliffe, suggested—we regard it as absolutely key for the regulators themselves to consider. On this understanding, I ask him to withdraw his amendment.
Lord Hodgson of Astley Abbotts
I am grateful to my noble friends Lord De Mauley and Lady Noakes and to the noble Lord, Lord Tunnicliffe, for their support. Inevitably, we get down a bit to motherhood and apple pie on these things. However, I say to my noble friend on the Front Bench that the reputation of the regulators will be made quite early on, because the firms will say, “Are these bodies with whom we can have a sensible, grown-up, informed, well judged set of discussions, or have they sent boys to do men’s jobs?”. If they send boys to do men’s jobs, the relationship will never recover, because the regulated firms will not feel that the regulators have the capacity, ability or knowledge to be able to make the informed judgments that this Bill expects of them. I will withdraw the amendment; however, my noble friend must emphasise to the regulators that this will be a once-in-a-lifetime opportunity. If they get it wrong, their reputation will be damaged from the start.
Lord Flight
My Lords, Amendment 140 and Amendments 140B, 140C and 140D are really about the same territory of the co-operation and collaboration between the PRA and the FCA. Amendment 140 is very concerned to focus on the actual, practical dealing with firms in everyday business; it seeks to avoid the making of,
“duplicate requests and the imposition of inconsistent requirements on such persons”.
Those in the industry will be moving from regulation by one body; virtually everyone regulated by the PRA will be regulated by the FCA as well. There is an inevitable tendency for duplication. As we will come to later on, some of that is not necessary. This amendment calls for an addition to Clause 5, which puts in the Bill the objective of avoiding such duplication.
Amendments 140, 140B, 140C and 140D are essentially about the memorandums of co-operation between the two bodies. With regard to Amendment 140B, there are certain exemptions which could significantly limit the territories in which co-operation is required. The amendment seeks to require that additional guidance be given which makes clear the extent to which these exemptions must be used to disapply the duty to co-operate.
Amendment 140C relates to the MoU, which is required to be reviewed regularly and published. However, there is no requirement in the Bill for the PRA and FCA to consult on the changes from year to year and this amendment provides that such consultation should take place. New Section 3E(8)(b) allows technical or operational issues relating to co-operation between the two authorities to be left out of the MoU, but I cannot see any particularly good reason why this is so. Again, this could have a material impact on firms, where important things end up being omitted. Amendment 140D redrafts new subsections here so that they only cover items where publication would be against the public interest, and removes the references to technical and operational issues as being able to be left out.
Lord Hodgson of Astley Abbotts
I have added my name to Amendment 140, moved by my noble friend Lord Flight. I underline the importance of co-ordination and think some means of measuring the effectiveness of the co-ordination mechanisms and processes between the FCA and the PRA should be established. Some annual review would bring significant benefits, and changes could then be incorporated in the MoU that exists between the two bodies, and would help control costs.
As I am sure other noble Lords have, I have had briefings from London First and the Council of Mortgage Lenders stressing the importance of this co-ordination and the need for these two bodies to work closely together. One swallow does not make a summer, but a very large firm rang me up to say that their chief executive was having to have a get-to-know-you session with the FCA and the PRA, talking about the generality of the firm, but they refused to co-ordinate the meeting. The FCA said, “Come down here and we will see you one time but then come down a second time to see the PRA”. He is going to have to make two visits to these organisations. It is a swallow and a cost, but also denotes an attitude, which is the very attitude that I think has to some extent poisoned the present relationships. In order to work in a cost-effective and business-friendly way, the regulators have got to understand that these firms have to operate and cannot just be at the beck and call of the regulator. They have commercial lives to live and the chief executives of these big companies are busy men. It is not beyond the wit of man, and common politeness, for the regulators to be able to agree a common diary approach for what is a getting-to-know-you arrangement, not an inquiry about something relating to their own particular functions. I very much underline what my noble friend’s amendment says. There is an awful lot of work to do if we are not to set off down the wrong road in this very sensitive and potentially extremely costly area.
Baroness Kramer
My Lords, I will speak to Amendment 140A, which is in this group. It is slightly different but we did not seek to have it regrouped, just in the interest of time. Amendment 140A would establish in the Bill that the PRA and FCA are considered equal in status. We have a letter from the noble Lord, Lord Sassoon, dated 18 June, which indicates that it is the Government’s intention to have parity of status, but I would defy anyone to read the Bill and come away with that particular conclusion. In the Bill, as your Lordships will be aware, the PRA has the right to veto certain of the FCA’s regulatory actions. I have no problem with that—it can be right and proper—but it reads over very quickly into a sense that the PRA is the superior body. The PRA is also part of the Bank of England family, a very powerful family. The FCA stands outside of that, which is right and proper. However, it creates the issue about the balance between those two regulators, particularly since the Governor of the Bank of England chairs the PRA as well as the FPC and the MPC. The FCA therefore stands in a different relationship to the governor and has a very different role. The governor is a very important individual in the international community in terms of public recognition and public standing.
Building a little on the comments just made about culture and behaviour by the noble Lord, Lord Hodgson, we must recognise that within departments there tends to be a sort of default behaviour to live in a silo. It is very difficult to persuade organisations to co-ordinate effectively with each other, and to have the kind of respect that goes with parity. Although there is a memorandum of understanding, a great deal of judgment is involved in that memorandum in terms of deciding when it is appropriate to share information, to consult and to co-ordinate. It depends a great deal upon attitude. I have been in at least two meetings with members who were a fairly broad representation of the financial services sector when it has been evident that the assumption of the sector is that the PRA is the lead institution and the tough guy, and that the FCA plays a somewhat secondary role.
This is of particular concern because of the range of financial services sectors that the FCA will regulate. It comprises 27,000 firms contributing £63 billion in tax revenues, providing over 2 million jobs, two-thirds of which are outside London. We must be very careful that it is not regarded as second class in its role. The London Stock Exchange is particularly concerned about this issue because of the role that the FCA must play in Europe. As your Lordships know, it has the seat of ESMA, which is highly significant. The UK market accounts for between 60% and 80% of EU securities trading but has only 8% of the vote on ESMA. Therefore, the status, standing and significance of the FCA will matter enormously in those European discussions which affect the City, the financial services industry, and the international world of finance more generally.
This amendment seeks to, in a sense, make it clear in the Bill that the FCA does not have second-class status and that it is equal in its standing with the PRA. It seeks to make sure that that then gets embedded into the culture of how these regulators relate to each other and co-ordinate with each other, and that the FCA has standing in international eyes, and is recognised by international regulators as the body they can appropriately talk to, and not as a body that they must go around in order to speak to the genuine powerhouses.