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

Mark Field Excerpts

Tuesday 7th February 2017 General Committees

[Jonathan Reynolds (Stalybridge and Hyde) (Lab/Co-op)]

May I, too, say what a pleasure it is to be here under your chairmanship, Mrs Moon, bright and early after such a late sitting in the House last night?

I thank the Minister for his speech. He and I have now discussed several pieces of legislation to improve the oversight and regulation of the financial system following the financial crisis, and the amendments in the draft regulations are clearly another part of that.

It is well documented that even before Northern Rock crashed many people had expressed concerns that the standard insolvency legal procedures did not work for banks. Providing a regime that is fit for purpose must therefore be a priority, so this is a particularly important and interesting area of legislation and, although we do not oppose the draft regulations, I have a number of questions on which I am seeking clarity.

I have two general questions. First, why did more than two years elapse between the January 2014 publication of the Bloxham review and the March 2016 launch of the consultation? That seems to be an abnormally elongated procedure. Secondly, it would be interesting to know why the measures to require certain third parties to co-operate with the administrator, which were considered in the consultation last year, will not be implemented under the draft regulations. Why did the Government feel it was unnecessary to proceed in that area?

On the specific content of the provisions, I have a number of further questions. I appreciate that this area of law is fairly detailed and not especially accessible, but because of its importance I feel the level of scrutiny in Committee must be fairly thorough. I take advice from a number of sources of expertise in the City when preparing remarks such as these for the simple reason that I would never wish someone to read our exchanges following a subsequent financial crisis and find that we had not dealt with any measures with sufficient rigour. I am happy to receive answers from the Minister either today or in writing later.

Proposed new regulations 10A and 10B, on page three, specify how the client assets that the investment bank is required to hold on trust for its clients—money that does not belong to the bank, but which it holds beneficially for clients—are to be dealt with. Basically, the bank needs to confer with the Financial Services Compensation Scheme about such assets. The client asset regulations, which were overseen by the FCA, have been shown to be defective in a fairly recent Supreme Court case. In Lehman Brothers v. CRC Credit Fund Ltd and others in 2012, it emerged that they failed to specify how the trust arrangement worked. The courts held there must be a trust but that the regulations did make not clear how that trust worked. It was unclear whether the trust failed, in that case, because Lehman Brothers had failed to separate each client’s assets into a separate trust account or whether all assets held for clients should be treated as being held on the terms of one enormous trust. The Supreme Court held by majority that there should be held to be one enormous trust, so that clients could be protected.

That creates a certain degree of confusion. Can the Minister say how conferral with the Financial Services Compensation Scheme will solve the chaos, after a bank goes into insolvency, of identifying which assets are held on trust and are, therefore, ring-fenced from insolvency proceedings and which assets are to be divided up among the unsecured creditors?

Several investment banks have been fined by the old FSA and now the new FCA for failing to organise their clients’ assets into trusts in compliance with those regulations. What do the Government propose to do to ensure that banks operating in the UK do not indulge in what might be a criminal practice of treating assets that should be held on trust for their clients as though they belong beneficially to the bank?

In the Supreme Court, in Lehman Brothers v. CRC, Lord Walker commentated that, as a result of that case, in his view, investment banking can be

“more of a lottery than even its fiercest critics have supposed.”

He had some very strong words about regulatory non-compliance. His particular focus was on the failures of the system for protecting client assets in times of bank insolvency and that litigation is important in relation to the regulations being analysed today. The case shows that senior employees at Lehman Brothers had known the bank was failing to protect its clients’ assets for several years and had knowingly used those assets for its own purposes.

[Mark Field (Cities of London and Westminster) (Con)]

The hon. Gentleman makes a good case, and he will appreciate that this is pretty complex. There is an assumption that there are very easily defined pots of money that can be assigned to a particular client, which clearly is not the case. Does he not recognise that the nub of the problem, and the main issue with Lehman’s, was that it was an issue of liquidity rather than solvency? As it happens, it has been able to give more than 100p in the pound, albeit many years on. Therefore, we have learned quite a few lessons from Lehman. The Bloxham review has made an important contribution in trying to clarify these issues, but we should not think it is going to be entirely simplistic to have a template in place that does not lend itself, in part at least, to some of the commercial realities on the ground in the investment banking world.

[Jonathan Reynolds]

I absolutely recognise that and I certainly agree this is a far from simplistic area to get right. It is our role as a Committee to probe the Government on how the regime would operate in the event of that lack of liquidity that we all seek to avoid in future. What are the Government doing to confront this failure on the part of banks, regulators and the FCA regulation in that eventuality? How do the regulations confront those issues?

How does proposed new regulation 10B(12) confront the issue of knowing which assets are to be held beneficially for the bank and which assets are to be held beneficially for the clients? In the interest of certainty, would it not be preferable to require banks to segregate each client’s assets into a distinct account and stop the practice referred to in that Supreme Court decision of bundling all those assets into one large account, perhaps making it easier to misappropriate them due to the size of the account? Does new regulation 10B perpetuate the confusion identified by Lord Walker in the Supreme Court case?

The second point made by the right hon. Member for Cities of London and Westminster moves me on to new regulation 10D on page five. The regulations appear to bundle together too many things that are not the same. Regulation 10D(2) refers to set-off agreements, netting agreements and title transfer arrangements and seems to be based on the assumption that those agreements are similar. That was not my understanding when the regulations were explained to me. Consequently, would it not be preferable for the regulations to separate more clearly the different types of agreement and arrangement so that no confusion is caused by treating them as though they were functionally identical?

As we all remember from 2007 and 2008, it is fairly chaotic when banks go into insolvency. Any uncertainty about the types or nature of assets that parties have will only add to the confusion. The regulations need to ensure that they deal with the different types of right with sufficient clarity to guide the authorities and the insolvent bank’s administrators through a future crisis.

Thirdly and finally, new regulation 10E refers to the Prudential Regulation Authority, which the Government are changing to the new prudential regulation committee. The reference to “security interests” in the title of the measure is unclear and perpetuates the problems of uncertainty in previous provisions. The term “security interest” does not describe any specific legal position, but tends to be a catch-all term that commercial lawyers use to describe a right that they hope will protect their clients if the counterparties go into insolvency. A security interest could be a trust, mortgage, charge and so on, and it would be preferable if the legislation were clearer about the rights involved. The regulations attempt to bundle the rights together, therefore leaving it to general law to sort out the problems of detail that the rights may create in future. However, that does not seem optimal when as much certainty as possible is required.

In conclusion, to move away from the specifics of the regulations, the Minister knows that many of our fellow citizens feel that despite changes for the better, the UK banking system somehow remains a liability, rather than a strength. That worries me and should worry us all because, as we initiate Brexit, financial services are clearly fundamental to the UK economy, and we have to make sure the public understand that. In responding to those points, I hope that the Minister will provide reassurance that the lessons of the financial crisis are being learned and that steps are being put in place to ensure that our regulatory regime is fit for purpose.