Financial Services and Markets Act 2000 (Ring-fenced Bodies, Core Activities, Excluded Activities and Prohibitions) (Amendment) Order 2016

Lord Young of Cookham Excerpts

Tuesday 18th October 2016 Grand Committee

Moved by

[Lord Young of Cookham]

That the Grand Committee do consider the Financial Services and Markets Act 2000 (Ring-fenced Bodies, Core Activities, Excluded Activities and Prohibitions) (Amendment) Order 2016

[Lord Young of Cookham (Con)]

My Lords, from 1 January 2019 the ring-fencing regime will require structural separation of core retail banking on the one hand from investment banking on the other for UK banks with retail deposits of more than £25 billion. Ring-fencing was the central recommendation of the Independent Commission on Banking chaired by Sir John Vickers, which the Government accepted and legislated for in the Financial Services (Banking Reform) Act 2013. It will support financial stability by insulating retail ring-fenced banks’ core services whose continuous provision is essential to the economy—that is, retail and small business deposits and payments services—from shocks originating elsewhere in the global financial system. It means that banks which provide those essential services become simpler and more resolvable so that core services can keep running even if a ring-fenced bank or its group fails. In doing so, ring-fencing reduces the perceived subsidy that comes from the presumption that the Government will bail out failing banks. Details of the regime are set out in secondary legislation passed in 2014 and it is some of those details that this order amends.

There are 18 different amendments in the order which achieve three purposes. First, to address issues in the secondary legislation that could inhibit the successful implementation of the regime; secondly, to ensure that ring-fenced banks are able to continue recognisable retail banking activities; and thirdly, to close holes that we have discovered in the ring-fence. Together with the PRA, we will constantly patrol the ring-fence for any flaws in the regime and will step in to close them when they are identified.

To assist the Committee, as I note each of the amendments, I will identify the part of the order where each can be found. Unfortunately, as the order is laid out in line with the elements of the existing secondary legislation it is amending rather than thematic, and as some amendments require changes to more than one part of the legislation, my description may involve some skipping around. I am of course happy to provide a more detailed explanation of any aspect of this order.

The first category of amendments tackles issues in the regulations that could work against the successful implementation of the regime. Article 2 of the order, after necessary changes to some definitions, withdraws the requirement for banks’ larger customers to complete a burdensome qualifying declaration and removes the requirement for banks to issue information to customers who are unaffected by the regime. Article 3(3) on page 4 also falls into this category by allowing in certain circumstances the securitisation of assets acquired in a resolution scenario and providing for the treatment of assets held by the banking group before ring-fencing comes into effect. Sticking with the theme of addressing issues that could threaten implementation, the elements of Article 3(6) found at the top of page 7 make it much easier for the PRA to assess compliance with the rules relating to the selling of simple derivatives, while Article 3(7) ensures consistency with the pensions regulations. Finally in this category, Article 3(10), right at the end of the order, addresses what happens when an organisation unexpectedly becomes a relevant financial institution while a ring-fenced bank is exposed to it.

The second set of amendments addresses issues with the regulations that might prevent ring-fenced banks carrying out activities we would certainly expect a retail bank to conduct. Amendments found in Article 3(4) on page 5 ensure that ring-fenced banks can continue being members of payment systems and central counterparties, and that they can hedge risks within the ring-fence. Articles 3(7) and 3(8) on page 7 ensure that ring-fenced banks can manage their liquidity risk. Similarly, amendments found in Articles 3(9) and 3(10) on page 8 ensure that ring-fenced banks can continue lending working capital to small businesses, acting as trustees, providing consultative services, and providing loans to infrastructure projects. The final set of amendments closes holes we have discovered in the ring-fence. Article 3(2) on page 4 expands the list of globally systemic insurers to which ring-fenced banks may not be exposed. Article 3(6) on page 6 tightens the risk calculation that constrains ring-fenced banks’ issuance of simple derivatives.

There are some things these amendments do not do. They do not alter the location of the ring-fence: core activities must be ring-fenced and investment banking activity must be outside the fence. They do not alter the height of the ring-fence: the same degree of operational and financial independence must be observed between the ring-fenced bank and the rest of its group, and they do not alter the timetable for ring-fencing banks. Banks in scope must be ring-fenced 27 months from now and, together with the PRA and the FCA, we are monitoring their progress closely. I beg to move.

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[Lord Young of Cookham]

My Lords, I have taken many statutory instruments through another place, but this is the first SI that I have taken through your Lordships’ House. I am enormously impressed by the detailed consideration which the noble Lord has given to it; it will certainly put me on my guard for any future SIs that I may take through. I am grateful to him for the Opposition’s support for the order before us. The noble Lord has a background in this subject, having been closely involved with the primary legislation.

Let me try to deal with some of the issues that the noble Lord raised. On consultation, the amendments were the subject of a short, technical review—because they are mainly technical changes—with the affected banking groups and their representative body, the British Bankers’ Association. Such a review was proportionate for the amendments, given their technical nature. They have also been drafted in consultation with the PRA and the Financial Conduct Authority.

The noble Lord asked about the impact of the order on risk. Some amendments ensure that ring-fenced banks are able to deliver economic services, as it was always the intention that they should. Some of the activities help ring-fenced banks manage their risk; for example, ensuring they can hedge risks within the sub-group. Other activities permitted by the amendments and the ring-fencing legislation more broadly carry risk, but with this order we are not shifting the ring-fence to include any new types of business but only ensuring that ring-fenced banks are able to deliver the service that they are meant to.

I take the noble Lord’s point on the Explanatory Memorandum. He wants an Explanatory Memorandum for the Explanatory Memorandum, because he found it difficult to follow. I will take that point on board and see whether in future we can do better and make sure that an Explanatory Memorandum lives up to its name.

On securitisation, the bit of the Explanatory Memorandum that the noble Lord focused on, his understanding is correct. Ring-fenced banks are allowed to securitise the assets that they created—this was a recommendation of the Independent Commission on Banking. Ring-fenced banks normally may not securitise assets originating outside the ring-fence. The order makes two changes: first, to what assets ring-fenced banks may securitise after 2019; secondly, to provide for what happens to assets already on their books before ring-fencing comes into existence.

The first change provides an exception to the prohibition on securitising acquired assets for assets obtained following the resolution of a failed firm. Successful resolution is important to ensure that failing firms do not harm the economy or taxpayers. This amendment maximises the resolution options available to the regulators by increasing the chance of finding a suitable private sector purchaser for the failed bank’s assets.

The second change introduces provisions to deal with banks’ existing assets. The current regulations fail to provide for the treatment of both assets created by the banking group before the ring-fence is established and assets acquired by the banking group in the past. The order makes it clear that when ring-fenced banks are created, they may securitise the assets already held by the banking group and those transferred through the ring-fenced transfer scheme. However, to stop banking groups spending the next two years acquiring assets for the ring-fenced banks to securitise, ring-fenced banks will be able to securitise assets held by the banking group only if they were acquired more than two years before the ring-fenced bank was established; for most banks this means 1 January 2017, which will be shortly after this order comes into force.

On the changes to the qualifying declaration, this should simplify matters for businesses. Completing qualifying declarations is likely to require banks’ customers to devote senior staff time to completing the declaration and may require engagement of legal advice, accountants and auditors to sign off the evidence the business provides. This cost to non-bank businesses will be considerably higher than to banks completing due diligence. With the changes, non-bank businesses will not have to undertake the regime that was set out initially. We believe that around 34,000 medium and large businesses will benefit from this change.

On the impact this will have, these amendments are, as I said, mainly technical changes to the ring-fencing regulation. The amendment with the most significant impact is the one I just referred to: the removal of the qualifying declaration process. This will remove a burden on banks and their medium and large business clients during the transition. The Regulatory Policy Committee rules say that the deregulatory nature of this change means that we do not need to prepare a regulatory impact assessment. But we do need to prepare, on a longer timescale, a “validation” impact assessment so the RPC can confirm the deregulatory effect of removing the qualifying declaration process. We do not normally publish these validation impact assessments but in this case I will be happy to, once it has been validated.

Finally, the noble Lord suggested a process of interaction between Opposition Members or other noble Lords and the Treasury to get a better understanding of the regulations that are brought forward. I will take that helpful suggestion away and see how the Government can best respond to it.

Motion agreed.