Financial Services and Markets Act 2000 (Regulated Activities) (Amendment) Order 2013

Lord Newby Excerpts

Monday 4th March 2013 Grand Committee

Moved by

[Lord Newby]

That the Grand Committee do report to the House that it has considered the Financial Services and Markets Act 2000 (Regulated Activities) (Amendment) Order 2013

Relevant documents: 19th Report from the Joint Committee on Statutory Instruments, 27th Report from the Secondary Legislation Scrutiny Committee.

[Lord Newby]

My Lords, the Government have been clear that the attempted manipulation of the London interbank offered rate is completely unacceptable and has no place in the UK’s financial services industry. That is why we moved quickly after the initial revelations emerged to ask Martin Wheatley, the chief executive-designate of the new Financial Conduct Authority, to consider what immediate reforms could be made. The Wheatley review, which was published in September, provides a 10-point plan to reform LIBOR, including recommendations to both government and market participants. The Government welcomed and endorsed the Wheatley review’s recommendations, and have asked all institutions to which they are addressed to implement them without delay.

The Government believe that the banks and the British Bankers’ Association have to take responsibility for their failings and act on Mr Wheatley’s recommendations, including the removal and replacement of the BBA as operational LIBOR administrator. HM Treasury and the BBA have been working together and have made significant progress in laying the foundations for this unprecedented process. The noble Baroness, Lady Hogg, is now leading an independent committee that will recommend an appropriate successor. This builds on the legislative changes that we have already made. Following the Wheatley review, we introduced the following amendments to the Financial Services Act, which are relevant to today’s debate, to enable benchmark activities to be brought within the scope of statutory regulation under FiSMA, and to create a new, distinct criminal offence for making false or misleading submissions in connection with the determination of benchmarks.

Following a period of consultation at the end of last year, the two draft orders that underpin these changes, which we are debating today, were laid before Parliament. Last week they were approved by the other place. The Government plan to bring both orders into force at the beginning of April. This will continue the Government’s approach of taking decisive action to reform LIBOR.

The first statutory instrument amends the Financial Services and Markets Act 2000 (Regulated Activities) Order, to denote that submitting to and administering a benchmark are both regulated activities. The draft order specifies LIBOR as the relevant benchmark. The regulation of these activities will enhance and strengthen the FCA’s ability to make rules on benchmark-setting, as well as its ability to supervise directly and take regulatory action against those involved in benchmark-setting processes. It will also implement a key recommendation of the Wheatley review. Under this order, the banks that submit to LIBOR and the successor to the BBA will be regulated by the FCA.

The draft order provides certain exemptions to these activities to cover information that was not created specifically for the benchmark-setting process. Where a person simply supplies publicly available factual data, such as the stock market closing price, to the administrator of a specified benchmark, their activities will not constitute submission to a benchmark. Similarly, if the administrator of the benchmark happens to subscribe to a general information service such as a newspaper, the provider of that service will also not be carrying out the activity of submitting to a specified benchmark. The draft order includes provisions to ensure a smooth transition to the new regulated regime for those currently involved in the setting of LIBOR.

Finally, the order makes two consequential changes to the definition of “consumer” for the purposes of the FCA’s objectives. These changes ensure that individuals whose rights, interests or obligations are affected by the benchmark are classed as consumers by the FCA in meeting its objectives.

The second order under discussion today underpins the new criminal offences created by the Financial Services Act, as recommended by the Wheatley review. The Government have been clear throughout the ongoing enforcement actions that any organisation or individual found guilty of this sort of wrongdoing must take full responsibility and should be punished, if appropriate, by the civil and criminal law. The Serious Fraud Office has launched a criminal investigation into allegations of LIBOR manipulation under the Fraud Act. However, the Government believe that the FCA should also have the powers to investigate and prosecute this type of conduct in relation to benchmarks in the future. Although the FCA will have powers to investigate misconduct in relation to LIBOR and other benchmarks, none of the offences currently provided for in FiSMA apply to misconduct in relation to the kinds of benchmarks revealed by the recent investigations.

To close this gap, the Government created a new criminal offence specifically related to benchmark misconduct in the Financial Services Act. The Government also took the opportunity to review and expand the existing offences which relate to misleading statements made with a view to inducing the recipient to engage in market activity. These offences are backed up by strong and dissuasive criminal penalties of imprisonment for up to seven years and an unlimited fine.

The draft order specifies the activities, investments and benchmarks to which these offences relate and carries forward the existing law which is needed to support the new offences. Article 3 of the new order specifies the benchmarks to which the new offence applies—specifically LIBOR. Rogue individuals may still attempt to manipulate the rate but if they do, the FCA will have the appropriate powers to investigate and prosecute them.

The amendments introduced to the Financial Services Act last year give the Government the power to regulate benchmarks beyond LIBOR through appropriate secondary legislation. While we have taken swift action to deal with LIBOR misconduct, this does not mean that other benchmarks should go unregulated. We have given serious consideration to whether we should extend regulation to other benchmarks where we believe there to be a risk of manipulation.

The Government consulted on the matter at the end of last year. In answer to the Government’s consultation, respondents argued that an international consensus and framework should be developed under the auspices of the International Organisation of Securities and Commissions, the Financial Stability Board and the European Commission before the scope of benchmark regulation is extended beyond LIBOR. Progress is being made on these international initiatives. The Government agree with the consultation respondents and have decided, for now, to apply those new provisions only to LIBOR. We continue actively to engage in and drive forward the international work on this issue. However, as we have done in the case of LIBOR, we stand ready to move ahead of international work streams and table further secondary legislation to extend the scope should we deem it necessary. I commend these orders to the House.

This group also includes the Uncertificated Securities (Amendment) Regulations, which amend the Uncertificated Securities Regulations 2001 to transfer responsibility for the approval and regulation of operators of securities settlement systems from the Treasury—which had delegated the responsibility to the Financial Services Authority—to the Bank of England. The regulatory arrangements for securities settlement systems have always been modelled on those for recognised clearing houses and recognised investment exchanges in Part 18 of FiSMA. The new powers and other changes to these regulations essentially follow the changes that the Financial Services Act 2012 makes to Part 18. Specifically, the regulations provide the Bank of England with new powers to require reports to be produced by skilled persons in respect of operators, to appoint investigators for the purpose of making inquiries about operators and to publicly censure operators in appropriate cases. In addition, the regulations replace the existing provision regarding the prevention of restrictive practices with provision for the purpose of preventing operators adopting excessive regulatory provision.

The final order in this group is the consequential amendments order. A number of changes to other pieces of legislation are required as a consequence of the regulatory reforms introduced by the Financial Services Act. The majority of these were included in Schedule 18 to the Act. However, a small number of amendments have required further consideration during the Act’s passage and are therefore being made through this instrument. Primarily, it amends references to the FSA’s rulebook in primary legislation, taking into account that both the PRA and the FCA will make rules in the new regulatory system. It also amends references to provisions of the Financial Services and Markets Act 2000 which have been amended by the Financial Services Act 2012. These orders are all necessary for the effective implementation of the Financial Services Act and, on this basis, I commend them to the Committee.

[Lord Eatwell]

My Lords, I thank the Minister for introducing these orders. I will take them in reverse order, so to speak, since the major issue of the amendments relating to LIBOR and its subsequent management is the most weighty, and we can take some of the later amendments perhaps more quickly and dispose of them.

First, as the noble Lord says, the consequential amendments refer primarily to the specification of which parts of the FSA rulebook are to be divided between the PRA and the FCA. This seems rather minor but has very significant consequences, because you are taking what was, we hope, an internally consistent document and ripping it apart. The question is therefore whether the consistency that existed in the previous document will be retained in the subsequent two documents. It would be helpful if the noble Lord could elaborate a little on that, particularly in the light of the recent arguments being made by Mr Haldane of the Bank of England, who has argued most strongly that the excessive number of pages of regulation should be significantly reduced in order to reduce complexity. If Mr Haldane’s rule is to be followed, will we end up, when these rulebooks are divided following these measures, with more pages or fewer? A particular element puzzled me in this particular order. In respect of Article 13, which amends the Corporation Tax Act 2009, can the Minister explain how transforming “Insurance Prudential Sourcebook” into “Prudential Sourcebook for Insurers” has any substance whatever?

Uncertificated securities is a very important area and there has been huge growth in electronic exchanges and uncertificated insurances of this type. The order refers at many points to the notion of excessive regulation by the managers or operators of electronic transfer systems. Can the noble Lord elaborate on who is to define “excessive” and, indeed, how it is to be specified? If there is to be some clarity in this law, it would help if the notions of “excessive” and “disproportionate”, which are used at several points throughout the order, were clearly defined. There was one other puzzle, rather like the puzzle I have about the Insurance Prudential Sourcebook, on which the Minister could perhaps help me. In the redefinition of responsibility from the Treasury to the Bank of England, it is clear that “Treasury” is a collective noun while “Bank of England” is singular. Why is that? Is it because the Bank of England is a singular person, namely the governor, whereas the Treasury has responsibility shared out more widely?

I now turn to the meat of the matters before us today, the orders referring to misleading statements and impressions, which essential collect a number of areas which will be responsible if other benchmarks should be developed rather than simply LIBOR, and of course to the major one on regulated activities. First, I was very struck by the list of organisations and responsibilities associated with misleading statements and impressions. In the noble Lord’s description of the creation of those lists, he referred to the possibility of further benchmarks being included within the procedures defined within the Act. He told us that these were now being considered internationally, and that we await international rulings on these matters. It seems that there is a stark contrast between the very prompt action that was taken following the Wheatley report in respect of LIBOR and the effective kicking into touch of all the other areas which are of equivalent importance. Can the Minister assure us that major benchmarks used within the City of London are not today being manipulated? Can he assure us that the delays in international consideration of these matters will not result in some of the same activities as we have seen with respect to LIBOR?

--- Later in debate ---

[Baroness Kramer]

My Lords, I shall try to keep my comments brief and, if I may, to follow the order in which the noble Lord, Lord Eatwell, addressed the orders to make life a little easier for the Minister. On those elements of the order that attempt to make sure that the FCA and PRA rulebooks appropriately intermesh, and on the comments of Andy Haldane on the risks that arise when you manage through rules rather than through structure, can the Minister give us some assurance that, behind the clarification of the rules, is the cultural commitment to act together as a coherent unit? The fear that Mr Haldane and others have expressed is that, once the institutions see rules, their first reaction is to attempt to game them. I suspect that it is not the number of rules that is the general concern but the coherence of the regulators in making sure that gaming is not a practice that they will permit.

The heart of today’s discussion is to do with LIBOR. I have a general question on the participation of banks in the LIBOR-setting process. It was the strong wish of many that more banks should participate in the process. At the moment, many seem in effect to get a free ride by allowing others to be the participants in the rate-setting process. They then use the rate across the many instruments and transactions that they sign up to, but because they did not participate themselves, they were in many ways getting a free ride, not exposing their internal positions to public view in the way that the participants were and making it much more difficult for other banks to compete against them when some were being transparent and others were not. I wonder where that process has got to. I understand that it was to be voluntary, and I do not know whether we have had any change in who is involved in rate-setting at this point or are likely to in the near future.

At the heart of my questions for the Minister are the sanctions of themselves. We all strongly support the new offence of making false or misleading statements and false or misleading impressions in the submission of benchmark information in the setting of a rate such as LIBOR. One of the underlying concerns has been the way in which the regulator approaches such violations, which is to come down increasingly hard on the individuals who have been clearly and directly involved in that false submission but not to look upwards to those who create the culture and environment in which that behaviour takes place. Tracey McDermott has said on several occasions that the appropriate way to enforce is to find the problem and then follow the trail and to stop questioning at the point where the trail goes cold. That obviously creates for senior management an advantage in wilful ignorance and makes it beneficial for them not to know in any detail what is happening in their organisation, certainly for there to be no trail that would be easy for a regulator to follow. Many of us have come to the conclusion that the regulator needs to have a way to look through that to make senior members of a company accountable for behaviour that is happening on their watch and which they do not know about through negligence, in a sense, rather than through deliberate deceit on the part of those carrying out the wrongful behaviour. Can the Minister make any comments about that?

The underlying concern is that the regulator has sanctions that are strong enough. Many of us have noticed the distinction between the kind of sanctions that a US regulator can use versus those available in the UK. I know that that is not a direct discussion within the order, but it is so closely tied to it that I wonder whether the Minister would comment.

[Lord Newby]

My Lords, I am extremely grateful to noble Lords who have contributed to the debate and will attempt to answer the questions they have raised. The first questions related to the effect of the tearing up, or bifurcation, of the rulebook and how continuity will be retained. I hope that the cultural commitment which the noble Baroness, Lady Kramer, mentioned, pervades those at the head of the new organisations and that it will be carried forward. In formal terms, consistency will be maintained by the operation of the memorandum of understanding between the two bodies, the PRA and the FCA, which we discussed in relation to other orders last week.

This is of course not the first time that there has been an attempt to reduce the number of pages. The FSA at one point consulted on it, but the answer it got back was, “Actually, we do not want the number of pages reduced significantly, because they tell us what to do, and if you reduce the number of pages, that puts more of a requirement on us to exercise our own judgment”. That is the balance that we are grappling with here. On the one hand, everybody wants less regulation, but when the consequence of less prescriptive regulation is that people have to exercise more of their own judgment, sometimes they become less keen.

[Lord Eatwell]

The noble Lord has put his finger on absolutely the point that Mr Haldane was making, which is that the excessive complexity of regulation these days is actually being trapped in a game between the regulated and the regulators; as the regulated develop yet more complex instruments, the regulator responds with more complex regulation, and then the regulated respond with more complex instruments to evade the regulations that have just been introduced. The whole point of Mr Haldane’s argument was that there should be a much stronger and simpler structure and that chasing complexity was a fundamental mistake. Complexity in regulation just adds complexity in taxation, which is the origin of successful evasion.

[Lord Newby]

My Lords, I have a lot of sympathy with that view. Of course, one of the reasons why, in a slightly different bit of the forest, we are introducing the general anti-abuse rule is to start moving away from a situation in which the regulator is not only almost institutionally behind the game but responds to problems by having to produce vastly long and complicated legislation, which is why the tax code is as long as it is today.

The noble Lord also asked who defines “excessive”. The use of “excessive” is not new and it follows the existing FiSMA provisions. It means not required by UK or EU law; not justified by reasonable regulatory objectives; or disproportionate to any regulatory objectives. So there is a definition and I am glad that I do not have to administer that.

The noble Lord asked why the Treasury is plural and the Bank of England singular. I am sure he will be interested to know that the Treasury is defined in the Interpretation Act 1978 as,

“the Commissioners of Her Majesty’s Treasury”.

This reflects the fact that, for historical reasons, the Treasury has acted through two or more Lords Commissioners rather than a single Minister. I am extremely pleased to know that there is a rationale for that.

The noble Lord asked, in respect of the misleading statements order and the LIBOR orders more generally, about adding further benchmarks, and whether I can be sure that these are not being manipulated now and that delays will not lead to some of the same activities in respect of the other benchmarks. We do not think they are being manipulated now. By definition with these things, one does not always know until long after the event that people are behaving badly, but there is no indication that by sticking to LIBOR at the moment any illicit activities are taking place. We are putting most of our effort into international discussion on these issues at the moment but the legislation is very clear: we can add additional benchmarks unilaterally by secondary legislation if we feel that we need to do so, but at the moment we do not feel that we are in that position.

The noble Lord asked about interim permission. Interim permission is being given to the person who is administering LIBOR on 1 April and to those banks that are submitting to LIBOR. It is being given so that the new regulatory regime can start without any delay and before the longer-term reorganisation of the LIBOR system is in place.

[Lord Eatwell]

I see that, but to whom is interim permission being given—by whom and to whom?

[Lord Newby]

I believe—and I stand ready to be corrected—that it is being given to the existing LIBOR setting structure until the new one is in place. If I am wrong, I am sure that I will be corrected reasonably quickly. Indeed, it is being given to the BBA by the FCA because they are responsible for the administration of the system.

The noble Lord asked about the manipulation of LIBOR. The FSA investigation uncovered activity causing significant concern and that was the impetus for the process that we have set in place. Criminal proceedings are ongoing and we hope they come to a speedy conclusion. It was because of a view that LIBOR may well have been manipulated that changes in the legislation took place. We will get to the bottom of the past activity via the criminal investigation but the great thing about what we are doing now means that if there are any future suggestions of wrongdoing, we shall be able to deal with them very quickly.

There were a number of questions about the Hogg committee, how that is proceeding, the type of firm likely to apply and conflicts of interest. The committee just launched the tender process last week. We hope that it will be concluded by the summer. It will be considering the question of conflicts of interest and, at this stage, we are not in a position to say who is going to apply. A number of firms and organisations have put their heads above the parapet to say they are interested but because we have only just started the tender process, we cannot be sure whether they will actually come forward.

The noble Baroness, Lady Kramer, asked about the free ride and whether, when the new benchmark is up and running, more banks will be encouraged to participate in it. That is something that the new managers of the benchmark will need to consider and no doubt they will be looking at it in consultation with the FCA. The noble Baroness asked whether the new legislation would enable and encourage the regulator to follow the trail, so that it is not just looking at the individual trader who is misbehaving but goes up the supply chain. The key thing is that, for the first time, the regulator will be able to look at this all in a systematic way. It has now got the powers to do so and I think that because everybody accepts that it was very serious that LIBOR was being—as appears likely—manipulated in the past, the new penalties and regulatory framework will give the FCA plenty of opportunity to do that.

In terms of whether the sanctions are strong enough, there is no problem about the regulations because there can be an unlimited fine. If we in the UK levy a lower fine than in the USA, this has nothing to do with the legal position. If there is a difference, it is because there is a difference in the minds of the regulators.

The only other question from the noble Lord, Lord Eatwell, which I have not answered—although I will look at the record afterwards and write to him if I have missed anything else—was why an amendment to the Corporate Tax Act is required. I am told that an amendment is needed to reflect the terminology that will be used by the PRA. With these answers, I commend the orders to the Committee.

Motion agreed.