Financial Services (Banking Reform) Bill

Lord Lawson of Blaby Excerpts

Monday 9th December 2013 Lords Chamber

[Lord Eatwell (Lab)]

My Lords, everyone in the House has from time to time expressed the view that this is a great experiment. We are not quite sure how the ring-fence will work and therefore it is appropriate that that it be monitored promptly and on a regular basis. I think this is a very sensible amendment—I would do, since I moved a version of it earlier—and I urge the House to support the Government.

[Lord Lawson of Blaby (Con)]

My Lords, I thank my noble friend Lord Deighton for putting forward this amendment. As he said, it is something which the banking commission, of which I had the honour to be a member, has been calling for. It is extremely welcome and it is very good that he has acceded to it. As the noble Lord, Lord Eatwell, said, the whole idea of ring-fencing is something of an experiment. We do not know whether it is going to work and therefore it is necessary that after an appropriate time it should be thoroughly investigated to see whether it is working satisfactorily and, if it is not, to have a move to full separation.

We know for certain that full separation works; indeed, separation was the norm in this country for most of our lifetimes. It is only during the past 25 years that there has not been separation. In the old days, there were the so-called joint stock banks, which were to do with the commercial banks and did retail lending and lending to small businesses, which are now known as SMEs, and there was a completely different group called the merchant banks, which were different people and institutions. For a long time, most of them were partnerships and had a different set-up altogether. They did what is now known as investment banking and it worked extremely well. We know that separation can work but we do not know whether this idea can work, so it is right that there should be a review.

While commending the Government, and in particular my noble friend, for introducing this, I hope that it will not be necessary. That is not because the ring-fence will, as it were, be found to work. I have grave doubts about that if it persists. However, there must be considerable doubt as to whether it will persist. Some noble Lords may have seen the interesting report in today’s Financial Times that the HSBC is thinking seriously of spinning off its UK retail and commercial banking enterprise as a separate company, with outside shareholders taking up to 30% in it. That is according to the Financial Times; we do not know, but there is a good reason for that. If the requirements of the ring-fence are really to be enforced toughly, they will make it so difficult, complicated, burdensome and onerous that many banks should, if they are rational, ask, “Is it actually worth staying together? Might it not be better for us”—the management—“and for our shareholders to separate and release increased shareholder value for that purpose?”. I hope that the institutional shareholders will also keep the banks up to the mark. That would be the happiest conclusion—that we will not even need the review because separation will happen of its own accord. However, just in case it does not we will need the review and I am grateful to my noble friend.

[Lord Turnbull (CB)]

My Lords, we should welcome this shortening of the period, particularly when one remembers that the clock for the new period does not start ticking until the transition to ring-fencing is complete—and that is a date in 2019. If we are adding four years to that, it will be 2023 before this review takes place; so even bringing it back to 2021 is to be welcomed.

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[Lord Deighton]

My Lords, these amendments require the PRA to review proprietary trading by UK banks and PRA-regulated investment companies and prepare a report to the Treasury. That will be followed by an independent review of the issue. The PRA must consider in its report the extent to which regulated firms engage in proprietary trading. It will then have to assess whether that risks their safety and soundness.

As the Parliamentary Commission on Banking Standards showed, proprietary trading can take many forms. That is why we are requiring the PRA to look into what particular risks different forms of proprietary trading can pose to the safety of the firm.

To help to give a full picture to the Treasury and to Parliament, the PRA must also report on steps it has taken to deal with risks from proprietary trading and whether it encountered any difficulties when it tried to tackle those risks. Building on that, the PRA must then give an assessment of whether it believes the tools it has to tackle proprietary trading are appropriate, given the risks that may exist at that time and in future. It must also consider whether restrictions imposed on proprietary trading in other countries have been effective. The experience of the United States in relation to the Volcker rule, which banned proprietary trading by banks, will be particularly relevant.

That review will take place within a year of the ring-fence coming into force. The Government have committed to ring-fencing being implemented in 2019, so this will take place in 2020. In Committee, there was some discussion about the appropriate timing of the review. The Government returned to the original PCBS recommendation, which said that the review must include,

“an assessment of the impact of the ring-fencing rules on proprietary trading by banks”.

To do that, the ring-fence must be in place for at least some time to consider such issues. While the ring-fence and proprietary trading are in many ways distinct issues, they will of course interact. Therefore we think it is right to allow the PRA to consider the impact of risks from proprietary trading on ring-fenced banks and whether the safeguards in place are sufficient for the particular requirements for the safety of ring-fenced banks. I know that members of the PCBS have been very concerned about that in the past, and I want to make sure that this review looks at this important area.

Following the PRA’s report to the Treasury and to Parliament, the Treasury will set up an independent review panel. The first task for that panel will be to consider the evidence that the PRA gathered and come to a view on its findings. It will then have to make recommendations about whether future measures to deal with risks from proprietary trading are necessary. The independent review will be able to make any recommendations in relation to proprietary trading that it considers appropriate. It will not be constrained, and like the PRA review, will be able to consider the experience other countries have had with restrictions on proprietary trading, such as in the US with the Volcker rule. By the time of the review, I imagine that a wealth of information and views will be available to help the independent panel come to its conclusions. The independent review panel must make its recommendations in a report to the Treasury and to Parliament.

As I have said previously, the PCBS heard in evidence that proprietary trading does not currently pose a large risk for the UK financial system, but it can do little harm to keep this area under review, should risks emerge in the future.

As noble Lords have seen when we debated other parts of the Bill, and, indeed, through this Government’s willingness to set up and listen to the ICB in the first place, we are in favour of independent reviews. Therefore we are persuaded that proprietary trading is an area where an independent review in future can add value. These reports will give a future Parliament all the information it needs to assess whether future safeguards are necessary. I beg to move.

[Lord Lawson of Blaby]

My Lords, once again I would like to thank the Government and, in particular, my noble friend Lord Deighton, for moving this amendment. It is in response to a strong recommendation that was encapsulated in a specific report on this subject among the five reports from the Parliamentary Commission on Banking Standards.

Just as in the previous amendment, which concerned the review of the ring-fence, initially the Government were prepared to look at it only from the point of view of whether an individual banking institution had been gaming the ring-fence. They have now agreed to look at the system as a whole, and I am grateful for that. Again, initially the Government said, “No way should there by a review of proprietary trading”, but they have now come round to saying, “Yes, the parliamentary commission was right and there should be a review”. I am extremely grateful to my noble friend for that. He said that there is no risk at the moment. That is because proprietary trading has, for the time being, stopped to all intents and purposes. Yet at its peak it was for many banks up to 30% of their total business. One must imagine that that is quite likely to occur again in future. I do not know whether it will but it is clearly possible. But if I might say so to my noble friend, it is not simply a question of risk—although risk is obviously an important factor.

There was an important debate on Thursday last week on the five reports of the Parliamentary Commission on Banking Standards. Unfortunately, I was unable to attend but I read the Hansard report. It was introduced by a magisterial speech by the most reverend Primate the Archbishop of Canterbury and there were a number of good speeches—it read very well. In particular, I was impressed by the speech by my noble friend Lord Deighton, in which he gave us a little autobiographical counter. He spoke a little bit about his own experience as a banker. One thing I noted in particular. He said he was always conscious of the importance in banking of, “putting the customer first”. That is a very important aspect of banking culture. Indeed, banking culture was one of the most important things that the parliamentary commission was set up to look into.

However, in proprietary trading there is of course no question of putting the customer first—because there is no customer. It is the bank trading on its own behalf. That involves a totally different culture and mindset. If you want to preserve in banking—as I think we should—the culture that my noble friend believes in, as he said on Thursday, then you should ban proprietary trading by banks altogether. It is fine for hedge funds. It is an excellent activity for them and they can do it very well. I am not suggesting that it should be made an illegal activity, but banks should not do it. Most of us on the commission—though clearly not all—came to that conclusion. We called for a review because we were unsure about the practicalities. There is some difficulty in defining the sort of proprietary trading that should be banned for banks because there is a need for market-making. The line between market-making and proprietary trading is very clear in the minds of those doing it, but whether it is clear in law is another matter. We thought it useful to look at the American experience.

Finally on this, I say to my noble friend that we should look at the American experience but not too much at the American legislation. The complexity and detail of the American legislation was simply appalling. It is a problem across the legislative system that they have in the United States. My noble friend quite rightly referred to the Volcker rule because Paul Volcker insists that there should be a ban—for cultural reasons, above all. He also told us, when he gave evidence to the commission, that the legislation introduced in Congress was certainly not the sort he had in mind.

Having said that, I wish the Government well in this. It will be an important review, for the reasons that I have outlined. I commend the Government for repenting, if slightly belatedly—but as the right reverend Prelates on the Bishops’ Benches will know, better “the sinner that repenteth”, et cetera. Thank you very much.

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[Lord Deighton]

We now turn to the proposal to put in the Bill new requirements on regulators to meet the auditors of banks. This issue has been subject to extensive debate. The Government have been clear throughout that the regulators should carry the full responsibility for managing an effective relationship with the auditors of banks they supervise, and be held to account for how well they deliver it.

The reasons for this are strong. Before the crisis, regulators neglected their engagement with auditors while the auditors themselves signed off on the accounts of banks which we now know were, in some cases, in dire straits. The Government took action. There is now a requirement in the Financial Services and Markets Act for the PRA to lay its code of practice on auditor engagement before Parliament, meaning that the regulators will be held accountable for how well they deliver on the requirement to engage with the auditors of banks.

However, it has become clear how strongly the PCBS valued the opportunity to go further and specify the number of meetings in statute, to ensure auditors’ insights are used. For those reasons the PCBS is clear that, over time, this dialogue between auditors and regulators must not be allowed to lapse. The proposed amendment therefore includes two provisions to ensure that this crucial dialogue is preserved.

First, the regulators must disclose in their annual report the number of meetings they have held with the auditors. This allows Parliament to hold the regulators to account for the frequency of meetings. Secondly, the regulators must meet at least once per year with the auditors of firms that the PRA, the leading prudential regulator, considers to be important to the stability of the United Kingdom economy. This is a minimum requirement. The Government believe that it is right to place the duty on the regulator to determine how many more meetings are required with the auditors of firms of particular types, consistent with its risk-based, judgment-led approach. This allows the regulators to focus their resources where the risks are highest.

Some noble Lords may argue that the minimum requirement should be higher. The Government do not agree. The Government have said that the regulators must meet with any firm that may be important to the financial system at least once per year, but within this group, there will be firms of major and firms of minor significance.

For firms of major significance, once may be too little; for firms of minor significance, once may be sufficient. For example, under the PRA’s current code, for banks that could have the most significant impact on financial stability, the PRA code mandates at least three meetings a year. For other firms whose failure could still materially impact the UK financial system, the PRA code mandates at least one bilateral a year. The FCA meets at least twice per year with the auditors of the most significant banks and at least once per year with those in the next largest category.

The Government believe that it is right that Parliament does not seek to specify this level of detail in legislation. To do so would risk misaligning the PRA’s resources with the risks the financial system faces. The Government therefore believe that this amendment arrives at a suitable compromise between the desire to specify in the Bill a minimum number of meetings, to prevent meetings between auditors and regulators from lapsing entirely, and an approach that requires regulators to take responsibility for pursuing proportionate and high-quality engagement, and enhanced mechanisms for accountability. I commend these amendments to the House.

[Lord Lawson of Blaby]

My Lords, once again, I am extremely grateful to my noble friend Lord Deighton and his colleagues in the Treasury for agreeing to bring forward this amendment. As he pointed out, it is in response to a recommendation of the Parliamentary Commission on Banking Standards. Hitherto the Treasury has been reluctant to accept this, but it has now done so and it is in the Bill. Incidentally, this was also a recommendation of your Lordships’ Economic Affairs Committee, in its report on the auditors a little while back. This provision is needed in the Bill because we have been here before. The Banking Act 1987—I introduced the Bill that led to that—enabled these meetings to take place, and for a number of years they did. However, in the run-up to the great banking crisis and meltdown they had ceased. That is why we on the commission felt that this time it was necessary to have this provision in the Bill, and I am grateful to my noble friend for that.

I know that the hour is getting late but I should mention another matter that relates to a recommendation of the commission. There was lamentable failure of these meetings to take place and the fact that the auditors were in front of the crisis—the dog that never barked—was partly because of the lack of meetings and was largely the fault of the regulators at the time. It was their responsibility above all to seek such meetings. However, there was also the lamentable inadequacy of the accounting system at the time, IFRS. It is probably an inadequate system in general but it is particularly flawed when it comes to the auditing of banks. That is increasingly recognised within the accountancy profession. It is too late for me to go into the details, and I have explained the specific failings in previous debates and I will not go over the ground again.

When the commission addressed this issue it said that since we cannot change IFRS because the “I” represents an international agreement—although it is, in fact, a European agreement because the Americans have made it clear that they do not want to have any part of it—the PRA must require the major systemic banks to produce a second set of accounts that satisfies the needs of prudential regulation and supervision. That involves a small extra cost to achieve a considerable objective.

When this matter was discussed in Committee, my noble friend Lord Deighton said that there was no need to put such a provision in the Bill because the PRA had the power to do so—and I very much hope that it will do so. It is up to the Treasury Committee in another place to keep the PRA up to the mark. I hope that the present chairman of that committee will do that. Andrew Tyrie, the Member of Parliament for Chichester, outstandingly chaired the work of the Parliamentary Commission on Banking Standards and he secured its important and unanimous report. However, I was slightly alarmed in Committee when the Minister said that the regulators already have power,

“to make rules requiring banks to prepare additional accounts, to the extent that this is permissible under EU law”.—[Official Report, 23/10/13; col. 1022.]

While I thank him for the amendment, I must ask him: if the PRA wishes a systemically important bank to present a set of accounts in a way that it feels is necessary for proper prudential supervision, what will it be prevented from doing under EU law? The House needs to know that.

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[Lord Deighton]

With respect to the question asked by my noble friend Lord Lawson about what constraints the EU law would put on the PRA getting the information in the form that it requests, this is merely tying it into what comes out of the capital requirement directive IV, just to make sure that it is consistent. I am not aware of a particular constraint, but I am aware that there will be additional disclosure responsibilities that come along with that. We really just want to integrate it, but I do not believe that it is a constraint; it should actually help with disclosure.

[Lord Lawson of Blaby]

I am most grateful, but will my noble friend agree to look further into this and, if there is a constraint, to write to me?

[Lord Deighton]

Of course, I would happy with that undertaking. I fully accept the observation from the noble Lord, Lord McFall, that an audit needs to have the context of the business model behind it to have a proper understanding of where the business is going. We will certainly encourage the regulator to ensure that the dialogue with the auditor takes into account what is really happening in the business and does not just look at the numbers in isolation.

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[Lord Deighton]

That the Bill do now pass.

[Lord Lawson of Blaby]

My Lords, it is incumbent on us to respond to the very kind words of my noble friend Lord Deighton. As he said, the Bill has been completely transformed. I have been a Member of this House for a very long time now but I cannot recall a Bill—let alone a Bill as important as this one—to have been so totally transformed for the better. It is not only a great deal bigger but also a great deal better as a result of its passage through your Lordships’ House. I am extremely grateful and the nation will be extremely grateful.

There has been a lot of nonsense talked about the excessive size of the banking sector in this country. Some people have been even as foolish as to talk about a monocrop economy. The fact of the matter is that banking accounts for a little over 5% of this country’s GDP; it is nothing like a monocrop economy. However, it is a supremely important sector and one in which we are world class.

There is a size problem—I have not got time to go into it now and it would not be proper to do so—with individual institutions. As the former Governor of the Bank of England said, if an institution is too big to fail, it is too big. The size of the sector is a great strength of this country. As the present governor, Mr Carney, said recently, it is a great strength of the United Kingdom that we are prominent and world class in this growing and supremely important industry. We want it to grow further, which I hope it will. It is our great strength. It is what economists call the law of comparative advantage—you should do what you are best at—and this is a sector in which we are very good. However, if it is going to get bigger and bigger, which I think it will and should, it has to be both clean and robust. The purpose of the Parliamentary Commission on Banking Standards was to try to ensure that it would be both clean and robust. That is what the Bill is about.

I say again how grateful I am to the Government, and particularly to my noble friend Lord Deighton, for having implemented so many of the recommendations of the parliamentary commission to ensure that the Bill leaves this House in an infinitely better state than when it arrived here.

[Lord Eatwell]

My Lords, the noble Lord, Lord Deighton, expressed the view that this was the final piece of the jigsaw in financial regulatory reform. He is going to be disappointed in that respect. What we have achieved is but a step on the road. Many issues have still not been addressed and many parts of the financial services industry have not been incorporated into the overall consideration of what is necessary as we move into the future with a successful and resilient banking system, to which the noble Lord, Lord Lawson, referred. More will need to be done.

I add my thanks to those of the noble Lord, Lord Deighton, to the Parliamentary Commission on Banking Standards, and particularly the Members of this House—the noble Lords, Lord Lawson, Lord Turnbull and Lord McFall, the noble Baroness, Lady Kramer, and the most reverend Primate the Archbishop of Canterbury. They have done a fantastic job, as was discussed in the debate last Thursday, and they deserve the thanks of the whole House.

I also thank those on this side of the House who have contributed so constructively to the discussion of the Bill—my noble friends Lord Watson, Lord Brennan, Lord Mitchell and Lady Hayter. I would particularly like to thank my noble friend Lord Tunnicliffe for keeping me in order, as he has done throughout this entire process. I would also like to thank our researcher, Miss Jessica Levy, who has worked alone, as opposed to having a team of officials. She has done the most remarkable job. She is a very talented person and we would not have been able to achieve what we have achieved and contributed from this side without her help.

The noble Lord, Lord Higgins, who regrettably is not in his place at the moment, referred to the somewhat unfortunate process by which the Bill has got to this stage. The Treasury has made a bit of a shambles of it, really, and we have just been catching up through these various stages. I hope that when we next have a financial services Bill that, instead of having this elaborate and confusing process of continuously amending parts of FSMA, we have a proper coherent rewritten Bill to consider at the very beginning and that it is considered properly by both Houses in its passage.

That critical comment about the Treasury has not diminished at all my pleasure in discussing the Bill with the noble Lord, Lord Deighton. Ageing professors typically take rather excessive proprietorial pride in the achievement of their pupils; all I can say at this stage is that I am delighted that my teaching of the noble Lord does not seem to have done him any permanent harm.