Financial Services (Banking Reform) Bill

Lord Phillips of Sudbury Excerpts

Wednesday 23rd October 2013 Lords Chamber

[Lord Hollick (Lab)]

My Lords, I support the two amendments in this group. They address real flaws in the current arrangements. The comments of the noble Baroness, Lady Noakes, were interesting on whether the flaws are now covered by the codes of practice. The concern in the committee report to which the noble Lord, Lord Lawson, referred—I was part of that committee—was that there was no active and effective dialogue between the auditors and the regulators. Regulation requires as much light as possible to be shone on what is going on in the organisation being regulated. In part, that is to do with the provision of information and data—of which there are tonnes in banks. At another level, it is very important to give a perspective and a judgment. This goes to the heart of some of the problems.

First, and bluntly put, the auditors—as has been pointed out—are appointed, paid and retained because they work with the management of the bank. Their duty is to shareholders, of course. However, the reality is exemplified by Barclays, which had the same auditor for, I think, 240 years. It is very important that we underwrite the independence of the auditor. The statutory requirement to talk to regulators helps auditors have the necessary degree of independence so that they can inform the regulators of what they are concerned about.

The second issue is that of the accounts. As the noble Lord, Lord Flight, made clear, investors have a completely different set of accounts. They put IFRS to one side because it is incomprehensible and meaningless. It is completely pro-cyclical in banking, which is the most dangerous thing to be. The fund managers look at their own accounts, but of course if you sit on the board of a bank—as a number of Members of this House do—you see a different set of accounts as well. You see the management accounts about how the bank is trading. You look at the bankbook and try to assess the risks. Before IFRS came along, when times were good it was a practice for prudent bankers to say that some of the loans might turn bad and that it was necessary to put some provisions to one side. IFRS has stopped that practice, although we were told in our committee that IFRS is reconsidering the rules; its rules committee has recognised the shortcomings of IFRS. A Member of this House has also written a very good report which tries to get accounting back from being totally rules-based to being principles-based and asking: “Is this a going concern? Is it a true and fair view of accounts?”.

The audit firm that signed off Northern Rock to say that it was a going concern—when it was funded entirely by overnight money—made a clear misjudgment, shall we say. The bank’s own management accounts—and indeed the auditor’s own judgment—would have helped the regulator to look at that much more closely. It is therefore important that the Government think again on this. The argument about cost is not a real one; that is a bit of nonsense, to be blunt, because these sorts of accounts are published and provided to board members to review the performance of the organisation.

As for relying on expectation, we owe it to the taxpayers in this country to have rather clearer rules. Expectations and codes of conduct are all very well, and one would wish to have them clearly set out and published. However, in a matter as serious as this, it is very important that there is a legal requirement to do this. The noble Lord, Lord Lawson, wishes that he had put one into the 1987 Act. The Government owe it to the taxpayers to think again on these issues.

[Lord Phillips of Sudbury (LD)]

My Lords, I am going to build on what has been said by the noble Lords, Lord McFall, Lord Barnett and Lord Hollick. Then I will make one suggestion in respect of Amendment 92, which I support. Comment has been made about the fact that the accountancy profession has got too concentrated for public benefit. It is altogether too cosily placed vis-à-vis the very largest banks and companies. The noble Lord, Lord Hollick, referred to Barclays using the same auditors for more than 100 years; it that is not a recipe for slack auditing, I do not know what is.

The noble Lord, Lord McFall, noted that many accountancy firms provide both auditing and consultancy services. Sometimes, the non-auditing services are more valuable than the auditing services, which is a crazy situation. It is a pity that the Bill does not address that because if, as auditor, you ought to be saying some things with “rigour”—the word quoted by the noble Lord, Lord Lawson, from an article by Mr Woolf—how can you avoid a deep conflict of interest? I suggest, and experience bears me out, that you cannot bring to the very difficult task of auditing the rigour that is on occasions necessary to bring a bank or a large company to heel and to ensure, as far as any audit can, that some of the disasters we have seen are thereby avoided.

As I say, I am sorry that we are not addressing that issue in this Bill. Perhaps it is not too late to table such a provision on Report. However, I fear that a great deal is lacking. I think I am right in saying that all the big four accountancy firms have been penalised or fined many millions of pounds in the past few years. I remember that in America, KPMG was fined more than $450 million for running fraudulent tax schemes for years on end. What happens to these firms’ reputation and business? Very little does, as far as I can see. I suggest to my noble friend Lord Lawson and his co-proposers of Amendment 92 that it is not clear beyond peradventure that the bank under consideration should not be present at these statutory meetings. It may seem an obvious common-sense point that you cannot have such a statutory meeting with somebody from the relevant bank being present. However, given the cynicism of our world, we should make that clear. Given that we are at a flexible stage of our consideration of the Bill, if Amendment 92 goes forward, I recommend that that provision be included in it.

[Lord Blackwell (Con)]

My Lords, I do not think anyone can disagree with the arguments put forward by my noble friend Lord Lawson that the regulators should have access to the best available information from the auditors and should be able to request the information relating to the accounts that they want. What I am less clear about from this discussion is whether there is a need for that to be built into this legislation. I should be very grateful to my noble friend the Minister if he would clarify whether there is anything in the current law that prevents regulators doing exactly what these amendments suggest.

Like my noble friend Lady Noakes, I sit on the board of a bank and on its audit committee. Things have moved on considerably since 2008. It is clear to me that as regards the major banks, the PRA has frequent confidential discussions with the auditors; and those are perfectly proper. It is also clear to me that the PRA can, and does, request information from the relevant bank in any form that it feels it needs to have to perform its duties. Therefore, the question is whether there is anything in the current legislation that would allow an auditor to refuse to meet the PRA or to refuse to provide information on the grounds of commercial confidentiality or conflict. Are those powers extant in existing legislation? Is there anything that allows a bank to withhold financial information if it is requested by the PRA? If those powers are already available, I am less clear what these amendments would add.

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[Lord Eatwell]

My Lords, I support the noble Lord, Lord Lawson, in this amendment. It seems a modest amendment, calling for a review in three years’ time when the appropriate information from the United States will be available. It will be valuable to have this clause in the legislation to ensure that that review takes place, because it is so easy—given the exigencies of the moment—for major issues, which were recognised as major in the past, to be neglected because of day-to-day pressures. Therefore, having done all our work on banking in the Bill, if we set this process in motion so that the review happens, we will be performing a valuable service.

[Lord Phillips of Sudbury]

My Lords, I, too, support the amendment. I moved Amendment 91B at the close of our second day in Committee, which overlapped to a considerable extent with this amendment. In my amendment, I also talked about looking at the cultural as well as economic effects of this mass of gambling, as it is, within the financial markets. I hope that the Government will smile upon this; it may be that if it comes back on Report I will try to amalgamate my amendment and this one.

[Lord Higgins (Con)]

My Lords, I also support my noble friend’s amendment, but with some qualifications and a request for some clarification. The amendment simply refers to “proprietary trading by banks”; that does not distinguish between one part of a ring-fenced bank and another. The arguments on this issue are so clear that we should take a perfectly clear view that there ought to be no proprietary trading whatever by any ring-fenced bank.

There is also no real need to wait three years for such an inquiry. My noble friend referred to the Volcker rule in America; not all of us in this Chamber have Paul Volcker as a personal friend, but I have great respect for him. He is absolutely right that this should not be carrying on in the United States. Although it may be that there has been a decrease for the moment, over a period of three years the situation might change somewhat. Therefore, we could take a clearer view on this between now and Report than is set out in the amendment. As my noble friend has pointed out, this is effectively the banks’ carrying out risky trading on their own behalf—in the past, not infrequently, it was risky trading on their own behalf with clients’ money—and this, again, is a crucial point. Perhaps we should clarify that aspect of the matter, but I have not the slightest doubt that this is a move in the right direction and I hope that we can make rapid progress on it.

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[The Lord Bishop of Birmingham]

My Lords, I rise to speak on behalf of the most reverend Primate the Archbishop of Canterbury. He regrets very much that he cannot be in his seat today, but it is seldom that one has the opportunity to offer Christian baptism to a young couple, particularly when their child is a future heir to the throne of this country. None the less, I know that he, like me, would want to echo the support for these amendments, which have been spoken to by the noble Lords, Lord Turnbull and Lord Eatwell. In a sense, I now regret that I am here doing my duty, because I could not have put it better myself.

In the wake of the economic debacles following 2008, one of the greatest areas of concern among the public was the apparent lack of change in the financial fortunes of those whom they viewed as being most responsible for the banking crisis. As we have heard, the salaries of senior bankers seem to remain high and bonus levels have quickly regained their old levels, while for many ordinary people and ordinary businesses across the country, it has been a matter of tightening the belt and looking very seriously at difficult household and commercial budget decisions. The submission of the Church of England’s Mission and Public Affairs Council to the banking commission said of this disparity between what I am going to talk about as two cultures that it,

“has gravely harmed the public perception of banking”.

Recognition of the disjunction between these disconnected groups—the wider public, who need the services of good banks, and those who lead those banks—is, I believe, at the heart of what these amendments seek to achieve. It is about implementing sensible measures, and we have been very sensible this afternoon, one with another, about what needs to be done: striking an appropriate balance between risk and reward; looking to the long-term benefits of decisions made by key figures in the banks; and giving incentives for a trustworthy and productive culture, rather than one that promotes excessive risks, ending in disaster. Deferred remuneration, which we have in this proposal, and clawback provisions —central components of the proposed remuneration code—are technical terms, but at the heart of these principles is a simple question: what sort of culture, as has been mentioned by several noble Lords, do we want to establish in these organisations? As the most reverend Primate the Archbishop of Canterbury has already pointed out to the Committee, one rather well known former banking executive said that there had been a culture in the banks focused on what happened when people were not looking.

There is now an increasing interest, including in your Lordships’ House, in culture, and we heard from the noble Lord, Lord Lawson, about the two principles of prudence and customer-centred or customer-focused culture. I hope that both the Government and the banks will give a high priority to insisting on these profound changes in culture. Indeed, at a regional level—and this may seem a little parochial for the high level of discussion that we are engaged in this afternoon—in Birmingham and the Midlands, well resourced bank employees from well resourced organisations, their banks, are already looking way beyond their computer screens and boardrooms to wider and deeper responsibilities in the community. They are looking at simple things such as finding and supporting young entrepreneurs, and giving basic financial skills to local citizens—I have said before in your Lordships’ House that there are 100,000 citizens in Birmingham who do not have a bank account—and they are even getting involved in making sure that future employees of the bank in our local primary schools have enough food at breakfast so that they can learn the basic skills of their education.

These tentative cross-cultural relationships and initiatives give me hope not only that executives in banks will run sound businesses but that, as they experience and affect for good the lives of ordinary citizens, including those who are much less protected than themselves in ordinary life, the worthy values printed in the foyers of the headquarters of many of our large banks may at last begin to enter not just the policies of the banks and their structures and cultures but the policies, structures and cultures of the leading executives in those banks. I shall mention just one of those banks where these values appear; in fact, I may not mention which bank it is because I think that noble Lords should try to work out which one I am talking about. Those values read: “Serving Customers”; “Working Together”; “Doing the Right Thing”—a new one that has been inserted; and, fourthly, “Thinking Long Term”. It is in the policies, structures and cultures of the leading executives in those banks that I believe culture change will really happen. We have high expectations of that change but, as many noble Lords have said, it needs to be undergirded by legislation. It cannot be left simply to hope or chance or to the individual motivation of altruistic colleagues.

Therefore, I welcome that in both amendments we find provisions to limit sales-based incentives at both the individual and business unit level. In the PPI scandal, we saw what happens when banks come to value the sale of financial products as the objective of the whole exercise, with little or no thought for customers’ needs. Banks are now having to take responsibility for this culture of “selling at any cost” and the new remuneration code before us seeks to make explicit the realisation that an excessively sales-based culture can be very damaging both to the financial well-being of customers and to the reputation of the banks.

I hope that my noble friend the Minister will recognise that this amendment is not seeking to overly restrict remuneration, devalue the work that our senior bankers undertake or unduly affect the competitiveness of our world-beating banking sector. What it does is to set out some of the values and virtues that should underlie the banking system: long-term risk management; a fair balance between risk and rewards; valuing customer needs above the sale; and, above all, valuing collective interest beyond the individual or the unit, or even the bank itself. This will be good for both business and society.

[Lord Phillips of Sudbury]

My Lords, I commend the mover of the amendment, the noble Lord, Lord Turnbull. If, as I assume, this matter is brought back at Report, I should like to raise two questions. The first concerns the fact that the code is to be solely the responsibility of the FCA and the PRA. I wonder whether it should have a broader base than that. The City is a real bubble. The two authorities are part of that bubble, as are most of the people working in them. Everybody—particularly the noble Lord, Lord Turnbull, in moving the amendment—has said that we have to break out of this small enclave to understand the wider national, social and cultural impact of what is going on in the square mile. I just throw that idea out.

My second question concerns proposed new subsection (3)(a) in the amendment, which requires that those subject to the code shall,

“receive a proportion of their remuneration in the form of variable remuneration”,

although it does allow specific exceptions. For the life of me, I do not see why that is being insisted upon. Twenty-five years ago, most of the senior bank executives and those on the boards of banks did not receive a variable element in their remuneration at all. The problem that the amendment seeks to address was not present then, or at least not remotely to the degree that it now is. Therefore, again, if this matter is to be brought back at Report, I should be grateful if more thought could be given to the need for subsection (3)(a).

[Lord McFall of Alcluith]

My Lords, I support the amendment. The most important and admired banker of the 20th century—the late Sir Brian Pitman, the former chairman and CEO of Lloyds—came to the Future of Banking Commission, which I established, and on which David Davis MP, Vince Cable, Roger Bootle and others served. He gave us a lesson that day: he said very clearly that he understood that banks should be run for the long-term benefit of shareholders, and that that was what customers wanted most.

Sir Brian’s synopsis of what mattered to him as a banker was very clear, when he said in evidence to us:

“Nobody is a greater believer in shareholder value than me ... It’s long term shareholder value and everything has to be structured around the long term, particularly the remuneration structure … The minute you move to a huge emphasis on short term big bonuses you're going to change the behaviour. It is perfectly possible, in our case for 17 years when I was there”—

at Lloyds, that is—

“we were doubling the value of the company every three years for 17 years. Nearly everybody had shares in the company; messengers were worth a quarter of a million pounds when I left because we’d been successful as an organisation. But we believed it all had to start with the customer”.

He was very clear that if you had the customer in mind in terms of remuneration, you had to measure it on a 10-year basis. Only that way do you find out about the business cycle, and about whether the money paid in bonuses is money that has really been earned at all. As was said earlier, that money was not really earned in the past, because remuneration was based on expected profits, which did not materialise.

For the senior executives in banks it was upwards all the way: whether the bank went down or up, they had their bonuses. Sir Brian distinguished banks from other organisations as follows: “Banks and insurance companies have the unique ability to engineer increases in profits by pulling a lever that forces their banks to take more risks to lend and invest more relative to their capital resources, unlike other institutions”. That is why, in our report, we wanted a statutory basis, and we wanted the regulator to look at this issue.

When the noble Lord, Lord Lawson, and I were on the Parliamentary Commission on Banking Standards we considered the same issue on our sub-committee. We examined Barclays and its culture, and looked in particular at the structured capital management division —which, incidentally, the noble Lord, Lord Lawson, referred to as tax avoidance on an industrial scale.

We wanted to find out about the business model for that, and we spoke to insiders. When Sir David Walker and Antony Jenkins came to the committee, we had prepared questions, and my question for Sir David was along these lines:

“I would like copies of all management reporting and management performance information provided to Roger Jenkins”—

who established BarCap, along with Bob Diamond—

“and Iain Abrahams to support the bonus pool”—

in other words, to provide the numbers for us. I continued:

“The second one is the information used for the purposes of calculating the bonus pool of the structured capital management division, and the information used for determining the bonuses in particular for”,

three senior executives for the past decade.

The reason why we asked for that information is that the noble Lord, Lord Lawson, said in the evidence session that Roger Jenkins, who established the division, had had more than £40 million in one year. Bob Diamond had £100 million over a 10-year period. We wanted to find out exactly how they had earned that. The insiders told us that in 2008 BarCap was responsible for 110% of the profits of the whole entity. Here we had a tax avoidance unit on a massive scale masquerading as a bank, and responsible for 110% of the profits—and we did not have a clue how they made their money. I said that we wanted the information,

“in sufficient detail in order to identify each of the subcategories of the structured capital management business. In that respect, it will be the year-end management accounts information and quarterly reports information”,

which we received. We went on to ask for more—and we received absolutely zilch information. So, as we take this banking reform Bill through the House, we still do not know exactly what BarCap was up to.

What I—and the noble Lord, Lord Lawson, and others—want to know is that the regulator has the authority, so that it can see exactly how a business is performing and getting its money, and what business model and culture it has, so that the remuneration structure does indeed have a long-term basis and serves the long-term interests of society and of customers. That is not happening to date. That is why the amendment is before the House.