Investment Bank (Amendment of Definition) and Special Administration (Amendment) Regulations 2017

Lord Tunnicliffe Excerpts

Tuesday 28th February 2017 Grand Committee

[The Commercial Secretary to the Treasury (Baroness Neville-Rolfe) (Con)]

My Lords, the regulations we are looking at today help to ensure that we have an effective system in place to handle the failure of investment banks. Our approach simplifies and speeds up the special administration process and reduces the cost of the administration for clients and for creditors.

It is of course worth recalling that the collapse of Lehman Brothers taught us that our insolvency regime was not capable of dealing effectively with a failure of a large and complex investment bank. Against that background, we introduced the investment bank special administration regime in 2011 with the aim of changing the insolvency rules so that they more adequately protected the interests of clients. The legislation, rightly, includes a provision for review. I pay tribute to Mr Peter Bloxham, an insolvency lawyer who was appointed to lead this and whose final report was laid before Parliament in 2014. The purpose of the regulations is to improve the functioning of the regime by implementing the Bloxham review recommendations and learning from investment bank insolvencies in recent years.

The reforms we are making seek to strengthen the administration process in three ways. First, the regulations make it easier for an administrator to transfer client assets to an alternative firm. This will benefit clients in the event a firm fails by ensuring they have continued access to investment services. The regulations provide an administrator with the power to transfer the whole investment firm to another institution in spite of certain restrictions which can delay or disrupt this, such as the need to obtain client consent from all affected clients before the transfer can take place. Importantly, the regulations include key safeguards to protect clients and their interests. Clients will be able to request the return of their assets following the transfer, while client risk-management arrangements that the firm has in place will be protected.

Secondly, the regulations make the administration process simpler and quicker by strengthening and extending the bar date mechanism. This is a procedure that gives the administrator the power to set deadlines for clients to submit claims for the return of their assets. In the past, some administrators have been unable to close the client estate following the bar date procedure, allowing the administration process to drag on. These regulations therefore introduce a “hard” bar date, a power which enables the administrator to return assets more quickly to clients. I am very grateful to the chair of the House of Lords Secondary Legislation Scrutiny Committee, my noble friend Lord Trefgarne, for the time his committee has dedicated to reviewing the regulations. The committee paid special attention to the bar date mechanism and I always welcome its expertise and engagement on these sorts of provisions.

Thirdly, the regulations provide greater legal certainty for clients and creditors. This addresses a key weakness in the existing regime. One key change is clarification of a client’s right to receive interest on their claims during the administration process. We are taking away the perverse incentive to engage in arbitrage between client and creditor estates that occurred in previous administrations. In addition, the regulations clarify when an administrator needs to go to court to seek a direction on certain matters. Taken together, these reforms improve the speed at which assets can be returned to clients and enable the administration process to operate both more efficiently and effectively.

The changes we are making were broadly supported in consultation with the different parts of the market that would be affected by the failure of an investment bank. We also took advice from the Banking Liaison Panel on specific aspects of the regime, particularly the safeguards in place. I regret that we did not publish a consultation response document. However, in the Explanatory Memorandum and impact assessment accompanying the regulations, we presented a summary of the eight responses we received. I also note that we did not carry forward a duty on firms to co-operate with the administrator. Following discussions with the Joint Committee on Statutory Instruments we assessed that existing statutory duties that require firms to provide information and documents to the administrator would be effective. These existing duties will enable clients to access their assets quickly and efficiently without imposing an additional and overlapping duty on firms.

These regulations are an important step forward. They are a reflection of the lessons we have learned from the past failures of investment banks but they are also a reflection of the strong future of our banking and financial system. With the reforms we are proposing today, we will be better able to ensure the financial security of the UK and continue London’s role as a leading financial centre. I beg to move.

[Lord Tunnicliffe (Lab)]

My Lords, I thank the Minister for introducing this order. As she has already outlined, the purpose of this instrument is two-fold: to correct the definition of “investment bank” and to extend elements of the special administration regime, the SAR, which is the administration procedure for insolvent investment banks. These measures are part of an effort to improve the regulations and processes that govern the financial services sector. We oppose none of the measures the Government are proposing to introduce, but I have a number of points that I hope the Minister can clarify.

Part 2 of the instrument alters the definition of “investment bank” to include alternative investment funds and undertakings for collective investments in transferable securities. It was the intention of the original legislation that such firms be included in the SAR. However, they have fallen out of scope as an unintended consequence of the introduction of other legislation. As has been said, this is merely a correction. In practical terms, it increases the number of banks covered by the legislation from 700 to 1,000. May I be assured that this rise has been taken into account when considering the resources needed to communicate changes to the SAR?

I will focus the bulk of my time on Part 3 of the regulations. After much discussion, the Banking Act 2009 did not include any specific reform of investment bank insolvency. However, it provided an enabling power to pass new regulations that had to be reviewed within two years. Accordingly, the special administration regime was introduced in the Investment Bank Special Administration Regulations 2011. Peter Bloxham carried out a review and published recommendations in January 2014. This instrument implements some of those recommendations.

The most substantive change the regulations will introduce is changing the “soft” bar date to a “hard” bar date. Under the current legislation, claimants who fail to claim before the bar date can still receive client assets. The introduction of a “hard” bar date would remove this right. This seem perfectly reasonable. The client asset can be closed more swiftly and at a lower cost. However, the key question I have about this switch is how much longer the process of insolvency will last as a result. If I am not mistaken, the “hard” bar date will not be automatic. The administrator will have to apply to the court. For the court to accept a “hard” bar date, it must be,

“satisfied that the administrator has taken all reasonable measures to identify and contact persons who may be entitled to the return of client assets”.

How long do the Government expect the administrator will need before it can collate all this information?

Furthermore, new Regulation 12D(2)(b) sets out the criteria for when the court can grant an application for a “hard” bar date. The first of these criteria is that there can be,

“no reasonable prospect … that the administrator will receive claims for the return of client assets after that date”.

How can the administrator be sure that there is “no reasonable prospect”? Surely this will require extensive research. Again, will this not result in delay before the administrator is confident it has a strong case for the court? The longer a case of insolvency drags on, the greater the uncertainty, and with uncertainty the prospect of market instability.

The next issue is one my honourable friend in the other place the Member for Stalybridge and Hyde raised, relating to the mechanisms in place before assets are pooled, which could assist in a more efficient and reliable return on client assets. The Economic Secretary to the Treasury in the other place stated in response to my honourable friend’s questions that,

“the FCA has taken a number of steps to improve firms’ record keeping. These reforms have been extensively consulted on with practitioners who have experience in dealing with pooled accounts”.—[Official Report, Commons, Second Delegated Legislation Committee, 7/2/17; col. 8.]

I ask the Minister: what specific steps have been taken by the FCA and has it seen a reduction in the rate of regulatory non-compliance cases it deals with as a result?

I turn to the issues raised by the Secondary Legislation Scrutiny Committee. Why have the Government not published the full consultation response to the Bloxham review? I note the Minister’s apology but I hope she can go into a little more detail. I have read the explanation, as has the committee, and I have to say that neither it nor I are convinced by the answers so far. The Government state that:

“The areas raised in the consultation were largely technical in nature”.


Surely this is exactly the place where such technicalities should be debated and scrutinised. I look forward to hearing a more detailed response from the Minister as to why the Government feel it is appropriate to flout their own consultation principles.

My final query for the Minister relates to the procedures used in the event that the administrator’s conduct is challenged. The new sub-paragraph (e) in paragraph 14 states that the FSCS, the financial services compensation scheme:

“may make an application … on the grounds that the administrator is not performing the duties … as quickly or as efficiently as is reasonably practicable”.

I note that the new Section 10A(b) inserted by the order says the administrator must “keep the FSCS informed”, but what does the Minister anticipate that will mean in practice? Surely in order for the FSCS to be confident that the administrator is not fulfilling his statutory duty, he must have detailed knowledge of the workings of the operation. What criteria will be used to judge whether an administrator has failed, and by whom? If the administrator is found to be inappropriate, whose responsibility is it to complete the insolvency? I look forward to the Minister’s response.

[Lord James of Blackheath (Con)]

My Lords, may I intrude a word into this debate? There is an aspect of 2008 that has never been corrected, and which did a great deal to disguise the extent of the insolvencies existing at that time. It might now perhaps be possible to squeeze a solution into something like this.

There is a practice that was prevalent in cases such as Bradford & Bingley and Northern Rock: if a bank or building society had a house on which it had an outstanding loan of, say, £10,000, and the house was worth £1 million, it entered the whole £1 million as an asset on its balance sheet, although it had no legal access or right to that surplus value. Banks did that solely to emphasise the extent of the solvency that they could demonstrate for their loans, but it made a complete distortion of what the balance sheet really was and misled people into letting them trade on for too long. Nowhere have we ever corrected this in any of the accounting rules. This may be the last chance saloon.