Financial Services (Banking Reform) Bill

Lord Newby Excerpts

Wednesday 23rd October 2013 Lords Chamber

[Lord Higgins]

My Lords, we have had a fascinating debate within a debate between the noble Viscount and my noble friend Lord Lawson. I merely make one or two points. It seems to me that there is a case for a remuneration code. In a way we could let the amendment end after subsections (1) and (2) and leave it to the FCA and PRA to take a view. It raises the question of whether, after they have done so, the code they come up with ought then to be considered further in this House. I leave that on one side.

As far as culture is concerned, what my former constituents regard as unfortunate is the whole culture of bonuses. I think that they take very strongly the view that the people concerned should be paid a rate for the job and then get on with it. Rather than specify, as this amendment does, that a proportion must be in the form of remuneration which is variable, I think they would rather the opposite—or at any rate, that the proportion which is variable should be limited.

There are, of course, very real practical problems concerning remuneration in a company which is clearly going on the rocks, when one needs to recruit someone to sort it out. That is a particular case. More generally, we could usefully consider the points made by the noble Lord, Lord Turnbull. The argument for his attitude, if I understand it correctly, on variable remuneration is, “If it is variable, we can claw it back at some later stage”, but that may be a long while after the actual events have taken place. There is also the problem of companies being not just too big to fail but, as has been said on previous occasions, too big to manage. Part of that problem is that we are looking at remuneration for banks which are in that situation. What has become clear in recent events is that people have been paid very large sums when the organisation they are asking to manage is not capable of being managed at the size that it is. Be that as it may, there is a case for a remuneration code, but we should probably leave it to the bodies concerned, which are suggested in this amendment.

[Lord Newby (LD)]

My Lords, we have had an extremely wide-ranging debate on many aspects of bankers’ remuneration. I remind the House of the two specific amendments in front of us. The first imposes a duty on regulators to prepare an additional code on remuneration in relation to senior managers of banks, while the second proposes additional powers for regulators to claw back deferred remuneration of employees of banks that require state aid.

The statutory requirement on regulators to prepare another remuneration code aims to implement a set of remuneration reforms similar to those recommended by the Parliamentary Commission on Banking Standards. I will explain why the existing remuneration code, current rule-making powers and further regulatory action in response to the parliamentary commission provide a clear basis for the implementation of these proposed reforms.

The existing remuneration code addresses the commission’s objectives for regulating remuneration in a way that combines a concrete legal basis with a rigorous system for application. The remuneration code is made under the rule-making powers given to the regulators in the Financial Services and Markets Act 2000, including Section 137H, which extends the provision which may be included in remuneration rules. Any breaches of the regulator’s rules, including breaches of the remuneration code, can be punished with serious sanctions. The code reflects the Financial Stability Board’s principles and standards for sound compensation practices, and European legislation under CRD IV. So this is a code established under statute and therefore might not in any way be thought to be ephemeral.

The content of the existing code already goes a long way to addressing the content proposed in the amendment and, where that is not the case, the regulators have indicated their intention to consult further on any necessary changes. So, for using profits to calculate pay, the existing code states that firms must assess current and future risks, and the need for consistency with the timing and likelihood of the future revenues. This clearly requires firms to calculate profit-based remuneration carefully with regard to risks to the bank. On the balancing of risk and reward, the code makes extensive reference to the close relationship that remuneration and risk considerations must have. Reward calculation based on profit and non-financial metrics must encourage effective risk management and not constitute a risk itself.

On pay deferral, the code specifically requires that at least 60% of variable remuneration above £500,000 or to a director of a significantly-sized firm is deferred over a period of not less than three to five years. On top of the existing requirement, the regulators have said in their response to the PCBS that they will consider adding to their code requirements on deferral. In this area, the existing code is already rigorous and set to become even more so. Regarding the issue of variable pay for non-executive directors, the PRA has stated clearly in its response to the PCBS that there is currently a presumption that this practice should not take place and that this will continue to be the case.

The FCA is conducting a thematic review of sales-related incentives and assessing what action would most effectively prevent those presenting conduct and stability risks. This could include further high-level remuneration principles for staff not subject to the full remuneration code. Additionally, the PRA and FCA have stated that they will update the remuneration code following consultation next year. This review will take into account the PCBS recommendations, including those on a greater use of instruments such as bail-in bonds to tackle the practice of compensating recruits on change of employment and greater and more granular disclosure by remuneration committees in banks’ annual reports.

Therefore, to specify in primary legislation exactly what the code should cover on top of the rigorous current approach seems unnecessarily rigid. The exact content of the code will need to be updated from time to time, including in the light of international best practice. Ensuring that the regulators have the necessary powers and authority to undertake such changes in a timely manner is crucial—and that is already achieved in FiSMA. Overprescribing in primary legislation risks adding an unwieldy layer to what is already an effective process.

I believe we have already given the regulators the necessary powers to apply rules to manage financial stability risk and promote responsible behaviour in banks. The existing code is based on internationally agreed principles and is responsive enough to incorporate new provisions when called for. Indeed, nowhere is this clearer than in how the PRA and FCA revisions of the code, and the FCA thematic review, will take account of the parliamentary commission’s recommendations.

On the subject of the clawback of deferred remuneration at banks in receipt of state aid, I should begin by being clear that the Government perhaps more than that of any other country, recognise the consequences of bailing out financial institutions. We have been clear that individuals must be held accountable for misconduct and that there should be no rewards for failure. The Government agree that there should be specific powers available for the regulator in relation to remuneration at banks where they require state assistance. The ability to reduce or revoke deferred remuneration when a bank requires state aid would further strengthen accountability and complement the extensive reforms which the Government have undertaken to remove the implicit taxpayer guarantee.

However, regulators already have the power to require the cancellation of deferred remuneration and loss of office payments where a bank requires state-aid support under their existing powers. In the PRA code, specific provision is made for the reduction of deferred remuneration where a bank suffers subsequent poor performance. Additionally, the reforms introduced under the EU capital requirements directive IV have reinforced existing rules on pay at banks in receipt of state support so that: bonuses are strictly limited where inconsistent with the maintenance of a sound capital base and timely exit from government support; regulators will be able to require banks to restructure remuneration in a way that is aligned with sound risk management and long-term growth; and directors should not receive a bonus unless justified.

The Government sought to build on these measures to strengthen further the accountability of individuals who are responsible for an institution which requires government intervention by requesting the PRA to consider the PCBS recommendations on this issue. In response, the PRA has stated that following consultations next year revisions to its code will strengthen and broaden the circumstances in which unvested awards can be reduced and vested awards clawed back. The PRA is also considering to whom these rules should apply and whether further powers are desirable in this regard.

However, extending these powers to cover the removal of pension benefits which have not yet become payable, but which the individual concerned has a contractual right to receive, is difficult. That would restrict the rights of the individual concerned under the European Convention on Human Rights to the “peaceful enjoyment” of his or her possessions. The Government do not consider that this would be appropriate. The PRA will consult further on these issues early next year, including on the details of how the powers should be drafted and the population of staff to whom it should apply.

The noble Lord, Lord Turnbull, specifically asked to whom the remuneration code applies. The code currently applies—and will continue to apply—to around 2,700 firms, including all banks, building societies and capital adequacy directive investment firms. That includes broker-dealers and asset managers—such as most hedge fund managers and all USIT investment firms—as well as some firms which engage in corporate finance, venture capital and the provision of financial advice, brokers, multilateral trading facilities and others. In terms of who is covered within those firms, the code defines “Remuneration Code Staff” to include,

“senior management, risk takers, staff engaged in control functions and any employee receiving total remuneration that takes them into the same remuneration bracket as senior management and risk takers, whose professional activities have a material impact on the firm’s risk profile”.

Some of the principles in the code must be applied to the whole firm, including those on guaranteed variable remuneration and the more general principles around risk management et cetera.

The right reverend Prelate talked about the culture in the banking sector and changes that he is seeing in Birmingham, which he hopes are the start of a process. I think we would all agree that that is desirable. In some of the big banks at least, there has undoubtedly been a noticeable change in culture in recent months and years. The right reverend Prelate and a number of other noble Lords talked about the overall level of remuneration. That is a matter for the bank’s shareholders but the Government and my colleague in another place, Vince Cable, have strengthened the powers of shareholders to require boards to explain and get approval for what they plan to do on remuneration. That has considerably increased transparency and, I hope, might have a moderating influence.

The noble Lord, Lord McFall, asked whether the regulator would have access to Barclays management information, to know how it makes its money. I think we talked a bit about this in an earlier debate. The PRA has access under Section 165 of FiSMA to require banks to provide it with all the information or documents that it reasonably requires for its function. That is a very broad power and would cover the information referred to.

The nub of our argument, as the noble Lord, Lord Turnbull, rightly pointed out in his opening speech, is that we have a code. It is operating with increased rigour and will be amended next year to take account in detail of what the parliamentary commission has said. That being the case, we do not need any further provision.

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[Lord Turnbull]

Amendment 97 would create a regime of special measures. In the report of the Parliamentary Commission on Banking Standards, from paragraph 966 onwards, we argued that regulators should have a power to give notice to a bank where they believe that the bank’s systems, professional standards and culture do not provide sufficient safeguards. First, they could require an independent investigation, and then require a remedial programme of corrective action. This would be seen as a precursor to enforcement. It is basically a way of trying to avoid getting into the morass of enforcement. A similar regime is operated in the US by the office of the controller of the currency. It is called the safety and soundness plan.

Although the amendment refers to the PRA or the FCA, I believe that it would work best if the special measures plan was jointly owned. The twin peaks system of regulation has its advantages but there was always a danger that with each regulator focusing on its specific areas of concern, between them they would fail to capture the bigger picture. There could be a more generic problem of standards and culture and this would be an opportunity to work collectively and engage with the bank.

It may well be that yet again the response is that regulators have these powers already. Indeed, if they believe that the way that a bank is being run is a risk factor, they can impose a capital add-on. However, the argument against all these cases where we have these powers already comes back to if that is case, how did we get into this problem in the first place? What we are trying to establish is whether things will be different in the future. It would help us judge that better if the PRA/FCA could produce a working document on how they envisage using powers of this kind—a special measures regime—where they are looking for generalised improvements in the culture and the way that a bank is being managed. I beg to move.

[Lord Newby]

My Lords, we agree with the spirit behind the special measures proposal, as the noble Lord expected, but we do not believe it is necessary to give the regulators new powers in this area. They already have the powers to do everything the PCBS has asked. We have therefore been working with them on how they could respond to the recommendation using their existing powers.

The regulators published their responses earlier this month. These responses explain that both the FCA and PRA can, and in fact do, use the powers that they already have to do many of the things that the PCBS recommended and that are included in the amendment. The regulators have a significant range of powers to identify and tackle serious failings, either to rectify existing problems or prevent further consumer loss or reputational damage to markets. In fact, the regulators are able to replicate all the steps outlined in the amendment using their existing powers.

For example, the regulators already have the ability to give notice to a firm through an appropriate mechanism, be it a letter or an e-mail, as a matter of course if they have any concerns or think there may be a problem. The regulators will look to engage with the firm to address the concerns they raise. Whenever it is appropriate, the regulators may request information from the firm under Section 165 of FiSMA. If, following an investigation, the regulators believe further action is needed, the PRA and FCA can use their powers under Sections 55M and 55L of FiSMA to impose requirements on firms to undertake or cease a particular action. These powers can certainly be used to require a bank to adopt additional safeguards or to strengthen its existing safeguards.

Similarly, the regulators can appoint an independent person to undertake investigations using their power under Section 166 of FiSMA to commission a skilled persons report, or under Section 167 to conduct an investigation into the business of an authorised person. Both the PRA and FCA are committed to doing so in instances that they believe add substantially to their understanding of an issue. However, we do not think it is appropriate that the use of an independent person should be a requirement in all cases. There are some instances where the necessary information will be available from other supervisory sources making any such requirement unnecessarily costly and counterproductive.

Finally, there are already duties in regulations made by the regulators that require firms to deal with their regulator in an open and co-operative way. It may be that the noble Lord has not had a chance to look at the responses from the regulators and that, having done so, he will be satisfied, or, equally, that he would like further clarification. I suggest to him and any other noble Lords who have a particular interest in this matter that, if they have any further concerns having looked at those documents, we would willingly arrange a meeting with the Treasury to discuss any further elaboration that the noble Lord feels would help clarify how the system is going to work. Given that the powers exist, we really believe that the special measures powers envisaged in the amendment are unnecessary, and I therefore ask the noble Lord to withdraw it.