Capital Requirements (Amendment) (EU Exit) Regulations 2019

Lord Tunnicliffe Excerpts

Monday 7th October 2019 Lords Chamber

[Lord Bethell (Con)]

I beg to move that the House considers the Capital Requirements (Amendment) (EU Exit) Regulations 2019 and the Risk Transformation and Solvency 2 (Amendment) (EU Exit) Regulations 2019.

[Lord Tunnicliffe (Lab)]

Perhaps I may help the Minister. I think he wants to move that they be approved. His speech has been prepared for a different venue.

[Lord Bethell]

I beg to move that they be approved.

As the House will be aware, the Government had previously made all the necessary legislation to ensure that in the event of a no-deal exit on 29 March 2019, there was a functioning legal and regulatory regime for financial services from exit day. Following the extension to the Article 50 process, new EU legislation has come into force and, under the European Union (Withdrawal) Act, it will form part of UK law at exit. Further deficiency fixes are therefore necessary to ensure that the UK’s regulatory regime remains prepared for exit. The two instruments being considered today deal with two new pieces of EU legislation that have recently come into force.

The first instrument resolves deficiencies in the EU’s prudential regime for credit institutions and investment firms to take account of revisions the EU has recently made to the capital requirements regulation. This regime sets out how much capital institutions, such as banks and investment firms, need to hold. The CRR is a directly applicable EU regulation that has applied since 2013. An exit instrument correcting the deficiencies in retained law was laid and approved by Parliament in 2018. Earlier this year, the EU finalised a revised banking package, which included amendments to the CRR made by an amending instrument known as CRR2. This gives effect to some of the internationally agreed Basel reforms, which are the centrepiece of the post-crisis reforms aimed at making banking safer. Similar changes are expected in all G20 countries that follow the Basel guidelines.

Through the UK’s membership of the G20 and its Financial Stability Board, we have committed to the full, timely and consistent implementation of the Basel 3 reforms. Our deficiency fixes for CRR therefore need to be updated to take account of CRR2. There are three main areas where fixes are required: third country treatment, transfer of functions and updates to definitions.

Consistent with the approach taken in the 2018 exit instrument to amend the CRR, the regulations remove the preferential capital treatment given to the largest banks and investment firms in the EU 27 to reflect the fact that the EU and UK will treat each other as third countries in a no-deal scenario. In line with the approach that the Government are taking to all onshored financial services legislation, the instrument transfers a number of functions currently within the remit of EU authorities to the appropriate UK bodies. Functions such as the development of detailed technical rules on certain provisions of CRR will now be carried out by the Financial Conduct Authority, the Prudential Regulation Authority or the Bank of England. Where CRR2 confers a delegated legislation-making power on the Commission, these powers are converted into regulation-making powers conferred on the Treasury. Use of those powers by the Treasury will need the approval of Parliament. Finally, CRR2 amended some definitions used in CRR. The instrument corrects those updated definitions so that they can operate in a UK-only context.

The Treasury, financial regulators and industry agree that it is critical to have deficiency fixes in place by exit day for these new CRR provisions. Without them, there will be considerable legal uncertainty around the capital requirements that apply to banks and investment firms, particularly those that apply to global, systemically important banks. The powers of our regulators to supervise and enforce capital requirements would also be in doubt, increasing the risk of financial instability.

I now turn to the second financial services instrument we are considering today. In January this year, the Solvency 2 and Insurance (Amendment, etc) (EU Exit) Regulations were approved by Parliament. Those regulations addressed deficiencies in Solvency II as it will form part of UK law at exit. Since then, revisions by the EU to the Solvency II delegated regulation have updated aspects of the approach to setting insolvency requirements for insurance funds, including the simplification of capital calculations and greater alignment of capital requirements across insurance and banking legislation. These revisions took effect on 8 July 2019 and will form part of UK law after exit. The substance of the revisions will not result in deficiencies after exit, and the updated provisions will continue to operate in the UK as they do now.

--- Later in debate ---

To pick up my noble friend’s points, small companies will find their flexibility in meeting higher capital requirements constrained because of the complexity of dealing with organisations whose subsidiaries are groups that have grown up across borders. They will therefore incur greater cost, which they will have to pass on to their customer base. Bigger companies will have a lower burden, having much greater flexibility because the rules are different for them and because they can manage themselves in a more complex way. Are we almost deliberately disadvantaging the financial services facing towards corporations and others across the European continent through the changes that we are making? Are we effectively putting in place a disadvantage for a small organisation compared to a large one?

[Lord Tunnicliffe]

My Lords, I agree with the noble Baroness, Lady Bowles of Berkhamsted, that we debate the whole issue of resolution too infrequently. The tone of much of the paperwork here is concern about whether we are putting burdens on the industry that put it at a disadvantage, but one must remember that the whole issue of resolution is about catastrophe. We have had a serious resolution issue only in the 2008-09 crisis, and that was a frightful example of the taxpayer taking the losses in an area where the banks had previously taken the profits. Therefore, resolution is a very important issue, which we should perhaps bring to more democratic discussion more often. I say that with some trepidation because I am at some disadvantage compared with my Liberal Democrat colleagues, since they are professionals and tend to know what they are talking about in this area.

I have to glean the essence of the debate from the Explanatory Memorandum, which I therefore look to a more robust test of the quality of. The problem with British legislation is that so much of it is a statutory instrument that modifies another that amends another that amends a previous Act of Parliament which is by now a decade or so old. It is almost impossible to understand the meaning of this particular statutory instrument from looking to the instrument itself; one is entirely dependent on the Explanatory Memorandum to bring out the essence.

On Saturday—a lovely day to be in, reading an Explanatory Memorandum—I therefore set out and got about as far as paragraph 2.2:

“The EU’s prudential policy regime for banks, building societies and investment firms consists of the CRR”—


the capital requirements regulation—

“and the Capital Requirements Directive IV … together with a range of Binding Technical Standards (BTS). CRR is directly applicable while CRDIV was implemented in UK legislation, predominantly through the Capital Requirements (Country-by-Country Reporting) Regulations 2013 … the Capital Requirements (Capital Buffers and Macroprudential Measures) Regulations 2014”,

at which point I went to the guidance for Explanatory Memoranda. The best bit of guidance comes from the Secondary Legislation Scrutiny Committee in May 2015:

“The purpose of the EM is to provide members of Parliament and the public with a plain English, free-standing, explanation of the effect of the instrument and why it is necessary. It is not meant for lawyers, but to help people who may know nothing about the subject”—


that is me—

“quickly to gain an understanding of the SI’s intent and purpose”.

I have said things like this before: at its best, the Treasury produces some excellent documentation, but the real burden of these SIs is getting some feel for what they mean.

As has already been mentioned, we will not object to or vote against the statutory instrument. That would produce a constitutional crisis, and we have got enough people creating those at the moment without the Labour Front Bench in the Lords doing it. Accordingly, the Minister may have no fear of a Division. I am therefore going to do no more than pick out one or two issues that concern me.

The first is about the commencement. Regulation 1 states:

“(1) These Regulations may be cited as the Capital Requirements (Amendment) (EU Exit) Regulations 2019.


(2) Parts 1 and 2 come into force on the day after the day on which these Regulations are made.


(3) Part 3 comes into force on exit day”.


I have a real problem with that. My understanding is that this is a no-deal-only SI for. I do not understand what happens if we exit the European Union—as is the declared intention of the Prime Minister and many others on the Government Front Bench—with an agreement. Perhaps the Treasury has decided that it is an unreal possibility. If we leave with an agreement, we surely go into a transition period during which this SI would not apply. Can the Minister explain what happens on 31 October if we in fact leave with a deal?

I plodded on through the document and more or less understood what it was about until I got to paragraph 2.16:

“A resolution-specific example of the removal of preferential treatment for the EU27 relates to provisions introduced by CRRII regarding MREL. CRRII imposes additional internal MREL requirements for non-EU G-SIIs”—


which I understand to be global systemically important institutions.

“This has the effect of increasing the amount of MREL that material subsidiaries of non-EU G-SIIs should maintain from a range of 75%-90%, to 90% of the full amount of external MREL that the entity would be required to maintain if it were a resolution entity”.


Since it is in the EM, I assume that that is important. However, I do not have the faintest idea what it means. I would be grateful if the Minister could explain. Lest Members feel that I am being unfair to the Minister, I did alert him to this point this morning.

Later in paragraph 2.16, I found it slightly worryingly that it says:

“The Bank of England, supported by HM Treasury, has proposed to apply its transitional powers to delay the impact of this change until 31 December 2020, giving affected firms in the UK time to adjust to changes to meet their obligations”.


That seems to say in plain language that the MREL reserves will be less than is required in the long term under these regulations, during a period when the world is likely to be particularly turbulent. This seems somewhat unwise. Granted, it has the effect of reducing the burden on the appropriate firms, but I would like to have seen in the document some examination as to what inquiry the Government have made to assure themselves that the increases in risk due to the reduced reserves have been thought through and are deemed to be satisfactory. While I can see that the Treasury has moved with respect to the burden on the industry, it does not seem to have considered the possible increase in risk.

At paragraph 3.1, we are told that this is an “urgent ‘made-affirmative’ procedure”. It is obviously urgent now, but it seems to me that it did not need to become so; it was possible to see somewhat earlier that this statutory instrument was needed. Why were these problems not anticipated? Why could this instrument not come to us under the normal procedure?

I turn to the second statutory instrument. Paragraph 2.1 in the Explanatory Memorandum says:

“This instrument also addresses deficiencies in the UK’s Risk Transformation Regulations 2017 (‘the RTR’) and related legislation. The RTR implements a competitive UK regime for Insurance Linked Securities … business”.


That sounds to me as though it is introducing policy, although it is too complicated for me to be sure. One of the almost sacred tenets of the withdrawal Act was that it would not introduce policy; it would essentially only use the appropriate powers where necessary. That assurance is repeated in paragraph 7.2, which says:

“The financial services onshoring SIs are not intended to make policy changes, other than to reflect the UK’s new position outside of the EU, and to smooth the transition to this position”.


What I found even more confusing was that I could not find where this promise in paragraph 2.1 was. I wondered—as they are in quite separate places—whether it was anything to do with the various references to “special purpose vehicles”. I know that the financial services industry is comfortable with special purpose vehicles—more than at the receiving end in industry—but, having come across them, I slightly shudder. I hope there is no material change to the use of special purpose vehicles brought about by this instrument.