Financial Services Bill

Lord Lucas Excerpts

Wednesday 18th July 2012 Lords Chamber

Moved by

[Lord Lucas]

107A: Clause 5, page 17, line 5, at end insert—
“( ) the way in which a financial product or opportunity is drawn to the attention of or otherwise made available to members of the public;( ) the ways in which the provider of a financial product or service derives revenue therefrom, and the way that this is disclosed to the purchaser;”

[Lord Lucas]

My Lords, both segments of the amendment are in effect questions that ask my noble friend where he envisages that the limits of the FCA’s powers will lie in dealing with what I perceive to be a couple of current problems. The first part of the amendment is aimed at things such as tropical forestry investment. One finds full-page advertisements in supplements, in particular in the Guardian but doubtless in other places. Presumably, advertisers think that Guardian readers are notable suckers for green investment. The advertisements promise rates of return varying from 18% to 22% per annum over a period of 15 years, and are backed up by a remarkable lack of financial information of any kind—just lots of happy pictures of growing trees and talk about the value of the eventual timber and the many uses for it, about the unspecified rise in the market price of timber, and so on. As far as I can make out, they are complete scams. I investigated one of them in as much detail as I could—which turned out not to be very much, because not much was forthcoming.

The schemes escape FSA regulation because they are not considered to be collective investment schemes. Although they involve a collection of people pursuing a single investment objective—which is the way the scheme manager makes money—they are not collective in the sense that at their root is individual ownership of a separate plot of trees, land in the UK, wine or another similar separable asset. Therefore, the FSA currently is unable to regulate them.

Thanks to my noble friend, I had very helpful conversations on this matter with his department, where officials said that the tack that I was originally pursuing might lead to the FCA having all sorts of jurisdiction over arrangements that were essentially private, such as arrangements between consenting adults to do something that might or might not be to their advantage but which the FCA would have no business regulating. Therefore, I attempted to reapply myself to what must be—from the frequency and scale of the advertisements—a large-scale fraud by now, and attach myself to the concept that if something is widely advertised as a consumer investment it is something to which the FCA should be able to pay attention. That is a reasonable way of separating large-scale public frauds from minor arrangements that should be outwith the ambit of the FCA.

The second part of the amendment deals with the fees or benefits that accrue to managers of investments. I will take as a particular example stock lending fees. Over a long period the FSA has been unable to make managers declare their full benefits from managing funds. The level of fees in this country is far too high anyway. Managers take far too large a proportion of the total return. Noble Lords may have heard the Danes on the radio this morning, threatening to bring low-cost investment management to the UK. Good luck to them; I hope that they will be permitted to do so. However, we ought also to pay attention to our own business, and to making sure that, where a firm says that it charges 1.5%, that is what it will charge, and that it will not indulge in something that is essentially a risky practice and take all the benefit from it without telling its clients that that is what it is doing.

There are a number of ways in which the City has derived benefit from the investment management process. One that particularly gets my goat is high-frequency trading, which is robbery by any other name. People get a preferential supply of information about trades and are able to surf the wave of real investors’ trades. Every penny that they make is at the expense of real investors—in other words, our pensions. The only reason we tolerate it is that they are doing this to foreigners as well, so we are making more money out of it than we are losing. That is not a healthy way to go on. We should have an open and transparent arrangement for saying how money is earned in the City, and it should be clear to people who are investing exactly what bite the managers and others in the City are taking out of a scheme, so that they can make a reasonable judgment on whether this is the right place to invest or whether they should take their money off to somewhere where they will be allowed a higher share of the total return. I beg to move.

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

My Lords, I am grateful to my noble friend for bringing up these important matters. As he knows, they are not easily dealt with. I will say a few things about where we are. I will not dwell too much on the specifics of the amendment because, as he said, his intention is to provoke a discussion around some of these topics rather than around the specific drafting.

The difficulty around these unregulated activities and schemes is that a line must be drawn between regulated and unregulated activities. Around the margin, wherever the line is drawn, there will always be incentives for rogues to exploit the boundary. This may well be what people are doing on some of the schemes to which he referred—I do not want to express a view. The first thing that we need to recognise is that a line has to be drawn between regulated and unregulated activities. For example, we would not want to draw the regulatory net so wide that it would capture investments in a family farming business or investments by family and friends in a small start-up business—the sort of activity that as a Government and as a House we very much encourage.

Once one accepts that there will be investment schemes that involve a number of people that we do not want to capture in the regulatory net, there will always be a borderline, and I fear that there will also be people who seek to exploit it. It certainly appears that the schemes that my noble friend referred to were structured specifically to avoid being captured in regulations. That means that the regulator cannot act unless either the schemes fall into the regulatory net, or the promoters of the schemes hold themselves out to be regulated. Some fall into the trap of holding themselves out to be authorised and regulated, and then they can be caught. However, the majority do not. I do not think we can simply or easily change the definition of a collective investment scheme in Section 235 of FiSMA to address the point, because either the boundary will shift somewhere else, or we will capture the sorts of legitimate activity that I have referred to.

What my noble friend Lord Lucas usefully draws attention to is the role of the FSA at present, and that of the FCA in future, which is to think very hard about the preventive consumer education work that is needed to warn the public about the risks of these unauthorised schemes. The fact that my noble friend regularly comes back to them undoubtedly helps to raise that awareness. On the other side, the regulator, whether it is the FSA or the FCA, will also work with the police, trading standards, and the Insolvency Service in this space to do whatever they can. However, I appreciate that unregulated activities will be nigh on impossible to stamp out altogether. I am sorry, but it is no great surprise that I cannot give my noble friend Lord Lucas a complete answer on that.

On fund management fees, the main point is to give my noble friend reassurance that there is a substantial regime in place through the FSA’s rulebook regarding the disclosure of investment management fees. There is a lot of debate and discussion in this area at the moment. The fact that it was discussed on Radio 4 this morning shows that this is becoming an issue which is getting a lot of exposure, which must be a good thing in terms of making investors aware of how much of their capital can disappear through regular compounding of fees. Whether the fee levels in the UK are particularly high or not, compared to other jurisdictions, is clearly not a straightforward matter but is another dimension of this which has been referred to. Ultimately I suggest that these issues are not matters for the Bill beyond the fact that I am sure that the FCA will have all the powers necessary in this area. It is an area in which awareness-raising of the sort which my noble friend is engaged in will focus the regulators to use the powers that they have. I am grateful to him for raising these points, but I ask him to withdraw his amendment.

[Lord Lucas]

My Lords, of course, I am grateful to my noble friend for his reply, although I do not share his optimism as to the number of people listening. As far as advertisements are concerned I can see I have lost that argument, and we will wait until some crisis arises and events force the Government’s hand. There we are. People should have been more careful with their money; they should have known that 20% compound for 15 years was probably not safe.

So far as investment management is concerned, I think we have been doing some useful things in these last few years in paying real attention to fees, to executive remuneration, and to other ways in which the return to capital is being eroded and the way in which that is costing us all in terms of pensions, support for pensioners and the health of the economy. I hope we continue to make progress. I shall certainly take an interest in the way the FCA asks for disclosure in this area. However, for the moment I thank my noble friend and beg leave to withdraw the amendment.

Amendment 107A withdrawn.

--- Later in debate ---

[Lord Flight]

My Lords, I believe that the FSA has been looking in some detail at how to regulate platforms, and has been doing so for quite a while because it is difficult territory. It is either about to or just has come forward with its proposals.

[Lord Lucas]

My Lords, I very much support what the noble Lord, Lord Sharkey, has said in this area. My Amendment 117B in this group picks up a couple of aspects of it. The first aspect is,

“the role of regulation in enabling innovative business models to compete with established businesses”.

By regulating this area so heavily we have created a structure where it can be extremely difficult for people to be innovative. The noble Lord, Lord Sharkey, drew an obvious example of that when he talked about the regulations that independent financial advisers have to work under. If IFAs are allowed to talk about ordinary money products but not allowed to talk about peer-to-peer lending products then, by not regulating them and not bringing them under the umbrella of regulation, we are making it difficult for these new entrants to compete. We are creating a barrier to innovation.

This particular innovation is not just fluff or amusement. It promises, if it gets going in a substantial way, to alleviate some of the pressure on the national financial system: you get away from borrowing short and lending long, and away from the £85,000 guarantee, and you put those risks back on the lender. It is also a structure that may prove to be extremely useful in local lending in areas where the lenders can identify that the borrowers are part, in some way or another, of the same community and can, in that way, develop substitutions for pay-day lending and other more expensive and onerous arrangements. So there are real opportunities here to improve the financial system as a whole. The FCA really ought to have regard to the way in which regulation produces barriers for entry in the way that the noble Lord, Lord Sharkey, has described.

But it is not just without government that these barriers appear; they are also within government. One of the principal barriers to the expansion of peer-to-peer lending is the tax arrangements, that you cannot offset your losses on bad debts against the interest you earn on the good ones. Banks can but peer-to-peer lenders cannot. Among the reasons why the Treasury, which is refusing to regulate, will not extend tax concessions is that these businesses are not regulated. So the Treasury itself is causing the problem that is crippling the development of this business.

It is all very well to run a business which is restricted to borrowers of the highest quality, which is effectively what it is at the moment. All the peer-to-peer lenders that I am aware of have pretty low bad debt ratios. That is because they do not lend to risky borrowers, because there is no offset for the losses. The net return to their investors if they did start making loans with, say, an average default rate of 5% would start to become extremely low because there would be no relief for the 5% of losses and they would be paying full income tax on their 12% of income. It starts to make very little sense, so none of the peer-to-peer lenders have gone into that territory. But lending to areas of the community where there is a risk of default, such as young businesses, is exactly the sort of area where this Government are trying to push the banks with so little success, and where businesses such as the Funding Circle would love to go if the Government would make it possible.

As I say, the reasons for not going there are entirely due to the Treasury, and the reasons why the Treasury cannot grant the concessions are also down to the Treasury. It really should be open to the FCA to try to break that circle and persuade the Treasury to face one direction at a time and to promote something which is in everyone’s interests, particularly the Treasury’s. Nor would I just confine our thinking to peer-to-peer lending, which is what is there at the moment. Other peer-to-peer ideas are around. Peer-to-peer investment in start-ups already qualifies. There is an FSA-registered business called Seedrs, in which I take an interest. There are proposals for peer-to-peer investment management. That goes back to an earlier amendment in terms of trying to reduce the return that stays in the pockets of investment managers by disintermediating that business.

There are certainly proposals for doing this in the field of annuities. The opportunity is obvious: old people want income and young people want capital. If you can produce a mechanism where the two can exchange that, you are looking at something where you can cut out a very large amount of cost in the middle, where you could produce for people who are trying to settle their pension fund annuity at the moment a decent rate on which to do it, and where you could provide for young people who need capital a decent rate at which to have it.

The difficulty with doing that is the forest of regulation we have put in place to tie down the existing old-style businesses in that area. The opportunity for and the benefits of innovation in that area seem obvious. So we must have an FCA which understands not just not-regulating but also how regulating constructively will enable businesses to compete where, if they are left unregulated, they may not even be able to exist.

[Lord McFall of Alcluith]

My Lords, I should like to add my support. My name is not on the amendment. A number of months ago I spoke to Giles Andrew, of Zopa, about peer-to-peer lending, and I was very taken by what he said. I think back to the MPC and the American whose name escapes me but who is just departing from the MPC to take up a post at the Peterson Institute in America and his comments about a spare tyre. We lack a spare tyre in the UK in terms of our banking. Whether it is a Labour Government or this Government, none of us has solved the problem of getting lending out. We have a lot to learn in that area. Our top banks are responsible for 450% to 500% of our GDP. We will not make progress on that. This initiative should be looked at. Nothing fundamental will change tonight but it is good that it is on the agenda and I am delighted to be associated with it.

--- Later in debate ---

[Lord Lucas]

My Lords, is my noble friend agreeing with me that the principal reason why there is no ability to offset tax for peer-to-peer lending activities is that they are not regulated and therefore there is scope for abuse?

[Lord Sassoon]

No, my Lords, I am not saying that. There are plenty of different tax treatments for all sorts of regulated and unregulated activities. I see the issues as separate. However, I have indicated a couple of areas in which changing the tax treatment would be difficult and would run counter to some of the broader accepted principles by which we run the tax system. But I would not link the two things explicitly together.