Bank Resolution (Recapitalisation) Bill [HL]

Debate between Lord Vaux of Harrowden and Lord Livermore

Committee stage
Tuesday 10th September 2024 Grand Committee

[Lord Livermore (Lab)]

My Lords, I am about to write to the noble Lord, Lord Vaux, on the matter that he raises in his Amendment 17, following a commitment that I gave on the first day in Committee. I will also happily reflect any points raised in this debate in that letter, if helpful. In the meantime, I will set out some of the content of that letter, while providing some additional clarity on the points he raises. Again, I hear the request for worked examples that we discussed on day one.

The Bill extends the role of the Financial Services Compensation Scheme to include providing funds at the Bank of England’s request, which the Bank of England could then use to recapitalise the firm in question. As I have set out previously, the intention would be to achieve that recapitalisation by injecting equity into the failed firm, helping to restore it to viability. In the event that the Bank of England places the failed firm into a bridge bank, the Bank of England would become the sole shareholder for that bridge bank.

It is therefore possible that the Bank of England would receive recoveries in a subsequent winding-up of the bridge bank if all other claims were met, reflecting its position in the creditor hierarchy as a shareholder. The Bill provides for any such recoveries to be returned to the Financial Services Compensation Scheme. The Government consider this to be an appropriate method for dealing with funds used in a resolution and in keeping with the existing principles of the creditor hierarchy. I note four further important points.

First, by ensuring an injection of equity, it achieves the core purpose of the new mechanism, which is to restore the firm to solvency. By contrast, if such a payment were classified as debt—even if that had a more favourable ranking in the creditor hierarchy— there is a risk that it would not restore the firm to the necessary level of balance-sheet health.

Secondly, I note that the primary intention in deploying resolution tools using the new mechanism would be to sell the firm. It is therefore the Government’s expectation that a sale should be the outcome in the majority of cases, rather than placing the firm into insolvency and winding it up from a bridge bank.

Thirdly, I point out that, if the firm entered insolvency from a bridge bank and there were still eligible depositors, the Financial Services Compensation Scheme would pay compensation to those depositors and take on their position in the creditor hierarchy, as it usually does. That of course is the right approach, ensuring depositors maintain their super-preferred status in an insolvency. It is important to note that changes to the creditor hierarchy must be considered carefully to ensure there is clarity for investors and market participants as to how they would be treated in a failure scenario. Treating the funds provided by the Financial Services Compensation Scheme as a debt only at the point of winding up the firm, and not prior to that, might create uncertainty as to its interaction with insolvency law more broadly.

Finally, I note that the super-preferred status in the creditor hierarchy that the Financial Services Compensation Scheme currently enjoys in insolvency reflects a different set of objectives. In those circumstances, the Financial Services Compensation Scheme is standing in the shoes of depositors and that preferred status is seeking to protect depositors’ interests. That is different to the intent of the mechanism delivered by the Bill, which is to provide a source of resolution funding to recapitalise a failing firm.

I appreciate the Committee’s interest in what is a technical but important matter. I hope that I have been able to clarify the intent of the Bill and that the noble Lord is able to withdraw his amendment as a result.

[Lord Vaux of Harrowden (CB)]

I understand what the Minister says about the equity of the original shareholders being effectively written down to zero, but what happens with, for example, lenders who are transferred into the bridge bank? It cannot be right that they probably lose everything in the event of an insolvency situation, but if the FSCS, via the Bank of England, has injected a load of money into the failing bank and it then goes into insolvency, there is more money there and therefore those lenders will receive a share of their cash, if there is enough, which they would have lost in an insolvency situation. However, the FSCS gets nothing back because there is nothing to recoup as it has gone to the lenders. In effect, in certain circumstances the lenders to the failing bank may be bailed out by the FSCS through the Bank of England. That does not seem right to me. Those lenders took a risk in the first instance that was not predicated on being bailed out. I think there is something here that needs to be followed up. Have I got that right?

[Lord Livermore (Lab)]

In the letter I will write, we will set out exactly what would happen in the example that the noble Lord gives.

[Lord Vaux of Harrowden (CB)]

I thank the Minister for that explanation and look forward to receiving the letter with the details and, I hope, a detailed worked example. However, an issue remains. The principle must be that a recapitalisation of the bank by the FSCS will not, in effect, bail out the existing shareholders—which it seems it does not do—or existing creditors, with the exception of the depositors, who are protected separately. There is something that needs looking at quite carefully here. I think we will come back to this on Report, but for the moment I beg leave to withdraw the amendment.

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[Lord Vaux of Harrowden (CB)]

The noble Lord has just confirmed the point that we talked about in Amendment 17, that there are situations where the use of the recapitalisation payment can, in effect, bail out some types of creditors. Indeed, he referred to unprotected deposits as being one area that might make sense. This is quite complex and I suspect that when we have seen the worked examples and so on, there is going to be more to discuss. Would he be prepared to meet with officials and Members of the Committee to go through these things prior to Report, so that we can make sure that we all really understand in what circumstances that that could happen and in what circumstances it cannot?

[Lord Livermore (Lab)]

Yes, absolutely; I will very happily meet. I will write a letter setting this out in greater detail, provide the worked examples, and then perhaps we can meet on that basis.

Bank Resolution (Recapitalisation) Bill [HL]

Debate between Lord Vaux of Harrowden and Lord Livermore

Committee stage
Thursday 5th September 2024 Grand Committee

[Lord Vaux of Harrowden (CB)]

Just to clarify, is there anything in the Bill that changes the effect on shareholders and creditors compared with if it had been done by just the bail-in approach?

[Lord Livermore (Lab)]

I am told that the answer to that is no.

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[Lord Livermore (Lab)]

My Lords, I note that this amendment from the noble Baroness, Lady Noakes, is one of several concerning whether Treasury consent is needed when the Bank of England is exercising its powers—in this case, when the mechanism is used more than once for a particular institution.

Addressing the specific case of the amendment, although I think we can agree that it would usually be desirable to have to use the mechanism only once in respect of a particular institution, this may not always be the case. As an example, if a failed bank is transferred to a bridge bank, there is a risk of further deterioration in its balance sheet over time. It is foreseeable that, if that were the case, the Bank of England may need to use the mechanism again in order to recapitalise the institution; this would allow the Bank of England to maintain confidence in the firm, promoting financial stability.

The Government believe that it is important for the Bank of England to have reasonable flexibility to do so, reflecting that the full implications of a bank failure are hard to anticipate in advance. In addition, if further approvals are required, this may undermine market confidence in the original resolution action given that such approvals cannot be presumed in advance.

However, I note a few important pieces of context to this broader position. First, as required by statute, the Treasury is always consulted as part of the Bank of England’s formal assessment of the resolution conditions assessment. In practice, there is also frequent and ongoing dialogue between the authorities. Therefore, the Government are confident that there are proper and robust channels by which it could raise concerns if it had any.

Secondly, given that the new mechanism is ultimately funded by industry, we would expect the Bank of England to consult the Prudential Regulation Authority on any additional request to use the new mechanism. This is important as the Prudential Regulation Authority determines what is considered affordable to be levied on the sector in any given year.

Finally, if additional use of the mechanism had implications for public funds, such as requiring use of the National Loans Fund, provision of this additional funding would be subject to Treasury consent. Overall, the Government believe that this strikes the right balance in preserving the Bank of England’s freedom of action while ensuring the appropriate level of Treasury input into decision-making.

I hope that this provides some comfort to the noble Baroness and respectfully ask that she withdraw her amendment.

[Lord Vaux of Harrowden (CB)]

The one thing the Minister did not cover there was the question of whether, on a second or subsequent recapitalisation payment, the Bank would have to look again at whether the insolvency route is the one it should go down, rather than a secondary payment.

[Lord Livermore (Lab)]

It would always look at the situation at the time and make each individual decision on that basis.

[Lord Vaux of Harrowden (CB)]

It would always do so or it would always have to do so?

[Lord Livermore (Lab)]

It would always have to do so.

[Lord Vaux of Harrowden (CB)]

Okay.

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[Lord Livermore (Lab)]

My Lords, I turn first to the amendment tabled by the noble Lord, Lord Sikka, which seeks to ensure consideration is given to a clawback of executive pay and bonuses from a failed firm before using the new mechanism. I note that while the bank resolution regime does not set out powers allowing the Bank of England to claw back money from shareholders or management, it does provide an extensive and proportionate set of powers to the Bank of England to impose consequences on the shareholders and management of a failed firm in resolution.

First, on placing a firm in resolution, we expect that any existing shareholder equity would be cancelled or transferred. This is an important principle that ensures the firm’s owners must bear losses in the case of failure. In many circumstances, this will affect directors and management who hold shares or other instruments of the failed firm.

In addition, the Bank of England has the power to remove or vary the contract of service of its directors or senior managers. The Bank of England exercises its discretion in deciding whether to use this power. However, as set out in the Government’s code of practice, the Bank of England generally expects to remove senior management considered responsible for the failure of the firm and to appoint new senior management as necessary.

Finally, as reflected in the code of practice, it is a key principle of the resolution regime that natural and legal persons should be made liable under the civil or criminal law in the UK for their responsibility for the failure of the institution. This is delivered by Section 36 of the Financial Services (Banking Reform) Act 2013, which provides for a criminal offence where a senior manager of a bank has taken a decision which caused the failure of a financial institution, if the conduct of the senior manager

“falls far below what could reasonably be expected of”

someone in their position. Overall, this ensures that, as appropriate in the circumstances, there are material consequences for shareholders and senior management when a firm goes into resolution.

More broadly, I can further reassure the noble Lord that the Government recognise the importance of high standards in financial services regulation. The senior managers and certification regime supports high standards by ensuring individual accountability for senior individuals within firms, and by promoting high standards of conduct and governance. The Prudential Regulation Authority sets rules on remuneration and applies these to medium-sized and large banks, ensuring they are proportionate, and there are clear requirements in the PRA’s rules for firms to ensure they have policies on malus and clawback in place to align management incentives with that of the bank.

I should also note the intention of the amendment of the noble Lord, Lord Vaux, to ascertain under what circumstances the Bank of England may be able to recover all or part of remuneration to management and shareholders, or require a shareholder to cover all or part of the recapitalisation costs. If recoveries were made from management or shareholders of the failed firm, the amendment would make it clear that these types of remuneration could count towards these recoveries.

I hope I have addressed the broader point about the treatment of shareholders and former management in my earlier remarks. As a point of detail, I would add that the Government expect any recoveries not otherwise specified in the clause to be covered already by the catch-all phrase “or otherwise” at the end of proposed new subsection (2)(a). I hope that addresses the points raised and I respectfully ask the noble Lord to withdraw his amendment.

[Lord Vaux of Harrowden (CB)]

I think the Minister has answered the point about management, and I recognise that the words “or otherwise” are at the end of the new subsection. Where I am not sure that he has answered the point is on the inappropriate dividends paid to shareholders beforehand—the Thames Water situation, and how that would be dealt with. Just saying that the equity would be written down makes no difference; in this situation, the equity is already worthless. We are talking about recouping the costs of the recapitalisation rather than the fact that the worthless company is worthless.

[Lord Livermore (Lab)]

I have managed to get through several groups without promising to write, but on this occasion I will write to the noble Lord.

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[Lord Livermore (Lab)]

My Lords, I fully understand the substantial focus on the reporting requirements that will apply when the new mechanism is used. I shall start by addressing Amendment 12 on this point, tabled by the noble Lord, Lord Vaux.

The Government agree that, should the new mechanism be used, it is right for there to be a reporting mechanism to hold the Bank of England to account for its decisions, and that this should encompass estimates of the costs of different options. However, the Government intend to achieve the principles of scrutiny and transparency in a different way; namely, through the existing requirements placed on the Bank of England under the Banking Act 2009. As set out in their response to the consultation, it is the Government’s intention to use these existing reporting mechanisms to ensure that the Bank of England is subject to appropriate scrutiny when using the mechanism. The Government have committed to updating their code of practice to provide further details on how these reporting requirements will apply when the mechanism is used; I can re-confirm that the Government intend to include in the code confirmation that, after the new mechanism has been used, the Bank of England will be required to disclose the estimated costs that were considered as part of these reports.

The Government consider that using the code of practice is an appropriate approach to hold the Bank of England to account for its actions, rather than putting these requirements in the Bill. The Bank of England is legally required to have regard to the code and the Government are required to consult the Banking Liaison Panel, made up of regulatory and industry stakeholders, when updating it. Using the code will therefore ensure that a full and thorough consultation is taken on the approach. Given the complex and potentially fast-moving nature of bank failures, this is important to ensure that any approach is sufficiently nuanced to account for the range of possible outcomes under insolvency or through the use of other resolution tools. The Government believe that amendments to the code of practice are more likely to be successful in achieving this outcome. As I committed at Second Reading, the Government will share drafts of these updates to the code of practice as soon as is practicable and will provide sufficient opportunity for industry stakeholders to be consulted on them.

I acknowledge the further amendment from the noble Lord, Lord Vaux—Amendment 24—which would make such reports available to Parliament when the new mechanism was used to facilitate a transfer to another buyer. It is the Government’s clear intention that any such reports required under the Banking Act, following the use of the mechanism, will be made public and laid before Parliament. The Government would not make reports public only if there were clear public interest grounds not to do so, such as commercial confidentiality reasons. This may particularly be the case when exercising the power to sell a failing bank to a commercial buyer. While such cases would hopefully be limited, it is important that they are allowed for.

I appreciate the intent of Amendment 14 in the name of the noble Baroness, Lady Noakes, which would require the Bank of England to report to the Treasury more swiftly than under the current requirements. The use of resolution powers is complex; in some cases, the Bank of England may be executing a resolution over a long period, particularly when placing a firm into a bridge bank. It is therefore sensible for the Bank of England to report a reasonable period of time after exercising its powers, ensuring that its report provides a full and meaningful assessment. On reporting more broadly, I repeat the points made in response to the amendment tabled by the noble Lord, Lord Vaux.

Finally, Amendment 25 in the name of the noble Baroness, Lady Bowles, would require the Chancellor to assess in the light of the Bill the appropriateness of the thresholds used by the Bank of England to determine which firms are required to hold additional loss-absorbing resources, known as MREL. As before, I should start by noting that the Government recognise the important role played by smaller and specialist banks in supporting the UK economy. I appreciate the concerns raised by the noble Baroness at Second Reading.

The Government have carefully considered the perspective of such banks in developing the mechanism in the Bill, which is intended to be a proportionate solution. On MREL, the Bank of England is responsible for determining MREL requirements for individual firms within a framework set out in legislation; that is an important principle, as the resolution authority, the Bank of England, is ultimately best placed to judge what resources banks should hold so that they can fail safely. I point out to the noble Baroness that, as set out in the Government’s consultation response, the Bank of England has committed to consider the potential case for changes to its indicative thresholds. Specifically, it has noted that it will consider whether any changes are appropriate in light of this Bill and other wider developments.

I hope that these points provide reassurance to noble Lords. On that basis, I respectfully ask the noble Lord to withdraw his amendment.

[Lord Vaux of Harrowden (CB)]

I will ask the Minister for one point of clarification. He referred to the reports under the Banking Act that will be provided as covering the costs and expenses. I do not think that he talked about the comparison with the counterfactual of the costs of insolvency, which is a critical aspect of this. Would those reports cover that?

[Lord Livermore (Lab)]

If the noble Lord does not mind, I shall add that to the letter to him.

[Lord Vaux of Harrowden (CB)]

My Lords, I thank all noble Lords who have spoken in this short debate and apologise to the noble Baroness, Lady Vere, for failing to thank her beforehand for signing her name to my amendment.

A number of points were raised. The noble Baroness was right when she discussed the timings. They were put in as a starting point; I would be very happy to look at what is appropriate. I still think that we need to beef up the reporting clauses in the Bill. I am encouraged by what the Minister said about the reports that exist being laid before Parliament, but, as the noble Baroness, Lady Noakes, referred to, there is more to do on the timings.

There is some merit in trying to put in the Bill at least some minimum requirements on what those reports should include. That will be important because, although I acknowledge what the Minister said about the code, we will not see it before Report. If we were able to see the proposed changes to the code before Report we might be able to take a different view. It happens quite regularly that we are told that something will be in a code of conduct, a future statutory instrument or whatever else, but we do not see it before we have to make the decisions on the amendments themselves. In the absence of that, I feel that we will probably want to come back to this on Report. In the meantime, I beg leave to withdraw my amendment.