Compensation (London Capital & Finance plc and Fraud Compensation Fund) Bill

Viscount Younger of Leckie Excerpts

2nd reading & Committee negatived & 3rd reading
Tuesday 19th October 2021 Lords Chamber

Moved by

[Viscount Younger of Leckie]

That the Bill be now read a second time.

[Viscount Younger of Leckie (Con)]

My Lords, in the UK there is a wide range of opportunities for people to invest and help make a better future for themselves and their families. The Government’s role is to ensure that the system of regulation is suitably robust, so that individuals are treated fairly and have confidence in the financial system that they entrust with their hard-earned savings. While our regulators are working hard to minimise harm to consumers and pensioners, unfortunately, no system of regulation can completely eradicate the risk that firms fail, or that some bad actors, intent on committing fraud, slip through the net.

This Bill relates to two areas where it is necessary for the Government to step in to ensure a fair outcome for London Capital & Finance investors and victims of pension liberation fraud. This two-measure and two-clause Bill will provide the necessary powers for these two separate groups to receive the compensation they deserve. The first clause relates to a new government scheme to compensate London Capital & Finance bondholders who lost money after the firm entered administration in 2019. The second clause seeks to provide the Secretary of State for Work and Pensions the power to make a loan to the board of the Pension Protection Fund. The purpose of that loan is so the existing fraud compensation fund, which the Pension Protection Fund administers, has the necessary funds to continue to provide compensation to eligible pension schemes.

This Bill, which garnered widespread support in the other place, demonstrates that the Government will take action and step in when necessary. There are some important issues at stake. One, on which I am sure there will be considerable debate this afternoon, is the competence of the regulator. There is also the question of when and how the Government should step in to provide compensation. I would like to touch briefly on each of these issues and to provide some context for each of the measures and how they are intended to operate.

The House will be aware that the Government have committed to establishing a compensation scheme for investors in the failed mini-bond firm, so-called London Capital & Finance, or LCF. LCF was an FCA-authorised firm that sold unregulated non-transferable debt securities, commonly known as mini-bonds, to investors. Some 11,600 bondholders, many of whom had invested a significant portion of their savings, lost around £237 million when LCF went into administration in early 2019.

Following the unprecedented scale of this collapse, the Economic Secretary directed the FCA to launch an independent investigation into the FCA’s regulation and supervision of LCF. Dame Elizabeth Gloster led the investigation, which concluded that the FCA did not effectively supervise and regulate LCF during the relevant period. Dame Elizabeth’s conclusions raise serious questions about the regulator’s approach to supervision and I would like to use my remarks later in this debate to provide some further detail on the plans they have in place to address her recommendations.

LCF’s business model was highly unusual both in its scale and structure. In particular, the firm was authorised by the FCA, despite generating no income from regulated activities. This allowed LCF’s unregulated activity of selling non-transferable debt securities, commonly known as mini-bonds, to benefit from the so-called halo effect of being issued by an authorised firm, helping LCF gain respectability among bondholders, many of whom were elderly.

In response to regulatory failings detailed in Dame Elizabeth’s report, and the range of interconnected factors that led to losses for bondholders, the Government announced that they would establish a compensation scheme. The scheme will be available to all LCF bondholders who have not already received compensation from the Financial Services Compensation Scheme. It will provide 80% of bondholders’ principal investment up to a limit of £68,000, which represents 80% of the compensation they would have received had they been eligible for FSCS protection. Where bondholders have received interest payments from LCF or distributions from the administrators, Smith & Williamson, these will be deducted from the amount of compensation payable.

The Government expect to pay out around £120 million in compensation to around 8,800 bondholders in total, and have committed to ensuring that the scheme has made all payments within six months of the Bill securing Royal Assent. However, it is important to emphasise that the circumstances surrounding LCF are unique and exceptional, and the Government cannot and should not be expected to stand behind every failed investment firm. This would create the wrong incentives for individuals and an unacceptable burden on the taxpayer. Ultimately, investors must choose investments that are suitable for their risk tolerance and invest in high-risk, high-reward schemes only if they are prepared to lose the sum that they invested.

Government stepping in to provide compensation in response to regulatory failure or maladministration is unusual, but not entirely without precedent. Noble Lords will recall that the Government provided compensation to investors in Barlow Clowes, an investment scheme that failed in the 1980s, and in respect of Equitable Life. Like the LCF scheme, compensation was based on a percentage of investors’ losses.

Turning to the specifics of the Bill, the LCF measure is contained in Clause 1 and includes two key elements. First, it provides parliamentary authority for the Treasury to incur expenditure in relation to the scheme. Secondly, it makes a minor technical change which disapplies the FCA’s rule-making processes for the purposes of the LCF compensation scheme. The Treasury intends to use Part 15A of the Financial Services and Markets Act to require the Financial Services Compensation Scheme to administer the scheme on the Treasury’s behalf.

By disapplying FCA rule-making requirements, existing rules pertaining to the FSCS can be applied to the scheme without the need for the FCA to undertake a lengthy public consultation and impact assessment. This reflects the fact that the Government are fully funding the scheme and so there is no need to directly consult with FCA levy payers. It also avoids any unnecessary delays to compensation payments that such consultation would inevitably entail.

As I set out, this is a two-measure Bill, the second clause of which concerns loans to the board of the Pension Protection Fund. Clause 2 will amend the Pensions Act 2004, inserting a new section, which will give the Secretary of State for Work and Pensions the power to lend money to the board of the Pension Protection Fund, which manages the Fraud Compensation Fund. Pension savings are the largest financial asset for many people across the United Kingdom, for which they will save over the course of their working lives to provide for themselves in their retirement. That is why the Fraud Compensation Fund was established: to provide a safety net and pay compensation to occupational pension schemes which have lost out financially due to dishonesty.

When the Pension Protection Fund was set up in 2004, pension liberation fraud did not exist. This fraud involves members being persuaded to transfer their pension savings from legitimate to fraudulent schemes, with promises of high investment returns or access to a lump sum or loan from their pension scheme before the age of 55 without incurring a tax charge. It was not and could not have been envisaged for such schemes to be in scope for the Fraud Compensation Fund when it was established. Therefore, clarity was needed as to whether these schemes were eligible to receive compensation through the fund.

On 6 November 2020, the High Court found these pension liberation schemes to be in scope for compensation through the Fraud Compensation Fund, subject to meeting eligibility criteria. Since then, the Government and the Pension Protection Fund have worked rapidly to ensure that all those who have been victims of pension liberation schemes—an expected 8,806 people—are able to be compensated through the Fraud Compensation Fund.

One victim of this fraud is one victim too many. I reassure your Lordships that the Government are fully committed to working with regulators, the industry and enforcement agencies to protect people from pension scams perpetuated through transfers from one pension scheme to another, and to making it as hard as possible for criminals to carry out their malevolent intentions. It is estimated that the pension liberation fraud claims will exceed £350 million, far greater than the approximately £43 million currently held in the Fraud Compensation Fund. Therefore, there is a need for the Fraud Compensation Fund to have access to additional funding, and this Bill provides exactly that.

This Bill is necessary and important. It will ensure financial protection and fair outcomes for victims of pension liberation fraud. It will also provide some relief and closure for London Capital & Finance bondholders. I commend this Bill to the House and beg to move.

--- Later in debate ---

[Viscount Younger of Leckie (Con)]

My Lords, I thank all those who have contributed to this afternoon’s short but important debate, and I will address as many of the issues raised as possible. A considerable number of questions were put, not least by the noble Lord, Lord Sikka. I doubt that all will be answered, but I promise that I will do my best and will write to him and others who have participated as necessary. I particularly appreciate, however, the depth of his speech.

At the core of this Bill lies the need to ensure adequate protection for ordinary people who are saving and investing for their future: individuals who, in seeking a better return for their nest egg, have suffered a financial loss which in some cases amounts to almost all their savings. As was mentioned earlier, these are not in general wealthy individuals: the average loss, for example, for a London Capital & Finance bondholder is between £15,000 and £20,000. The impacts serve to highlight the need for a regulatory system that includes the proper protections for consumers, as has been made clear in this afternoon’s debate.

I start with the issues about the failures and regulation of the Financial Conduct Authority raised by many noble Lords, including my noble friend Lord Moylan, the noble Lord, Lord Davies, and the noble Baronesses, Lady Bennett and Lady Kramer. Quite understandably there is concern over the egregious failures in relation to LCF that have been identified and described in great detail in Dame Elizabeth Gloster’s comprehensive report. I echo the favourable comments made by the noble Baroness, Lady Kramer, at the beginning of her speech, about the thoroughness of the report—that much, I think, we can agree on. In particular, the FCA failed to properly enforce the financial promotions regime, which seeks to ensure, among other things, that communications with customers are clear, fair and not misleading—a key theme emerging from this debate. The report also raised issues about the FCA’s ability to join the dots between different pieces of supervisory intelligence to build an accurate and comprehensive picture of what was happening at LCF. In what follows I will give what I hope will be some reassurance, particularly to the noble Lord, Lord Sikka.

The FCA has now put in place a comprehensive plan to address all Dame Elizabeth’s recommendations, including through its transformation programme. I will give a bit of detail about this. It includes strengthening the senior leadership team, recruiting more staff, providing better training, and, crucially, introducing new systems to build better intelligence on firms. The FCA’s process for authorising firms has also been strengthened considerably and, following the improvements, the percentage of applications that are withdrawn has doubled. This reflects the FCA’s desire to ensure that firms start with high standards and maintain them, with the aim of reducing the time, cost and burden of dealing with firms that fail to meet its standards.

Furthermore, the FCA has committed to reporting every six months on the progress of its transformation programme. In response to the point raised by the noble Lord, Lord Tunnicliffe, I say that my colleague in the other place the Economic Secretary continues his close dialogue with the chief executive, so that the Government are fully apprised of the progress and can hold the regulator properly to account.

I would like to touch on an interesting debate on competitiveness initiated by the noble Baroness, Lady Bennett, but there is not much time to expand on it. I understand her views but I do not agree with them. There is a balance to be struck between consumer protection and competitiveness. The UK has a world-leading financial services sector, employing more than a million people nationwide. These jobs are spread across all regions of the country, with two-thirds of those working outside London. The sector also supports British businesses to expand, manage cash flow, invest in themselves and ultimately create more jobs. In 2019 alone, the UK exported £60-billion worth of financial and insurance services, with a trade surplus of £41 billion.

There has been a great deal of debate about the need to improve the competitive standing of our financial services sector. However, episodes such as the collapse of LCF serve to illustrate that our world-leading sector can succeed only if it is supported by a regulator that consumers and businesses can trust, underlying the importance of the reforms already under way at the FCA. I hope this provides a more expansive answer to the noble Baroness, Lady Bennett.

My noble friend Lord Moylan also raises some important points about regulation and about incentives in the retail investment market. I am of course happy to meet to discuss these matters further, and I will pass on this request for a meeting to my honourable friend the Economic Secretary. I would like to say a bit more to my noble friend, because more than a decade of rock-bottom interest rates has led some investors to seek alternative investments to generate returns. The high interest rates on offer from LCF should have prompted questions from potential bondholders about the risks. While some may have understood those risks and invested anyway, it appears that LCF’s disclosure materials and marketing strategy—back to communication —led others to believe that they were investing in a product far safer than it was.

In September, the FCA published the latest on its strategy for dealing with the problems and harms in the consumer investments market. The FCA’s goal is to see more people investing in mainstream investment products, and it has committed to explore regulatory changes to enable firms to provide more sales and support services to mass-market consumers investing in straightforward products, such as stocks and shares ISA wrappers.

The FCA has set up a dedicated team to help firms to develop mass-market automated advice models—or so-called robo advice—in its continued efforts to ensure that consumers can access high-quality, affordable and suitable financial advice, as well as free-to-access financial guidance, when they need it. The FCA is also taking action to address issues relating to inappropriate high-risk investments such as those mentioned by my noble friend Lord Moylan. For example, it is using data and technology to spot harms faster, continuing its campaign to help consumers to make better-informed investment decisions, and removing out-of-date permissions to reduce the risk of firms misleading consumers about the level of protection offered or giving credibility to unregulated activities.

We must also ensure that regulation targets the correct activities. On the specific issue of mini-bonds, the FCA introduced a ban on the sale of the most speculative and opaque instruments to retail investors in January 2020. The Treasury is also considering proposals to introduce further regulation of so-called non-transferable debt securities, following a consultation earlier this year. I think the noble Lord, Lord Sikka, asked for an update on the consultation. As he may know, the consultation closed on 21 July. The Treasury is considering responses and should be in a position to decide how to proceed in the autumn—later on in the autumn, it is fair to say.

I turn to the compensation matters for LCF. A number of noble Lords, including the noble Lord, Lord Sikka, and the noble Baronesses, Lady Kramer and Lady Bennett, asked: why LCF and not other firms? LCF is not the only firm to have failed and, within any healthy regulatory environment, it is inevitable that firms fail from time to time. However, this implies no complacency whatever. I have made it clear already, I hope, that we must never drop our guard on regulation but it is an important point of principle that the Government do not step in to pay compensation in respect of failed financial services firms that fall outside the Financial Services Compensation Scheme. As I have explained, this would create a moral hazard for investors and potentially lead to individuals choosing unsuitable investments, believing the Government will step in if things go wrong.

Inevitably, there will be some individuals seeking compensation in relation to other failed companies and investments. But it is important to emphasise that the situation regarding LCF is exceptional. It is the only failed firm issuing this type of opaque instrument that was authorised by the FCA. To answer the points raised, this is why LCF alone is covered by this compensation, and not the other unregulated minibonds. Let me be clear also that the fact that LCF was authorised was central to many of Dame Elizabeth’s findings. In comparison, other minibond firms such as Blackmore Bond and Basset & Gold were not authorised by the FCA. Indeed, the FCA cannot be said to have the same set of responsibilities towards failed minibond issuers that were not authorised, since the issuance of minibonds is not a regulated activity.

I turn further to the London Capital & Finance clause. The first part of the Bill will provide parliamentary authority for the Government to pay compensation to LCF bondholders. I recognise that this has been an exceptionally difficult time for bondholders, and I hope the compensation via the government scheme will offer some relief of the distress and hardship they have suffered and provide some closure on this difficult matter. The noble Baroness, Lady Kramer, asked about consultation. A consultation and impact assessment would slow down this process and create unnecessary delays to compensation payments, hence the reason for bringing into the Bill the matter of not needing that.

The noble Lord, Lord Tunnicliffe, asked about preparations to launch the scheme. The Treasury has been working closely with the Financial Services Compensation Scheme, which will administer the scheme on the Government’s behalf to ensure it can launch and begin making payments swiftly after Royal Assent. This will ensure all payments can be made within six months, and I have confidence that they will succeed in that aim.

I hope this helps with the question raised by the noble Lord, Lord Sikka: the Government expect to pay out around £120 million in compensation to approximately 8,800 bondholders in total. My maths is not too good, but I make that around £12,000 to £13,000 each. As noble Lords are aware, the purpose of the second clause of this Bill is simple: to ensure the Fraud Compensation Fund has the funds necessary to continue to pay compensation to eligible schemes that make a claim.

I turn to future pensions scams and how the Government can be sure that scams of this nature do not happen again. This was a key point raised by the noble Lords, Lord Tunnicliffe and Lord Davies. I would like to give some reassurance to noble Lords about the several measures being taken to look at this. To answer a point raised by the noble Lord, Lord Davies, about how the pensions regulator, TPR, should be strengthened: when scam cases started to emerge over a decade ago, the Pensions Regulator was faced with a very high volume of potential investigations. To target finite resources most effectively, The Pensions Regulator prioritised resources to the highest-risk cases and took steps to liaise with other agencies to disrupt this activity. There were several reasons why the Pensions Regulator may not have taken direct action on a particular case: often, another agency was already acting or best placed to act; or, the scam was no longer actively operating, and the Pensions Regulator had to consider whether the risks to savers would be mitigated by appointing a trustee. That was then; we need to look to now.

Crucially, HMRC has tightened its schemes registration process. It now carries out a detailed risk assessment of a scheme administrator before deciding whether to register the scheme and has power to deregister a scheme where it has reason to believe the pension scheme administrator is not fit and proper. Those who have defrauded through pension liberation fraud have been deregistered and the schemes transferred to independent trustees. Companies and their directors have been referred to the Pensions Regulator for enforcement action. Some cases are also being actively considered by the Pensions Ombudsman through its pensions dishonesty unit. The Pensions Ombudsman currently has 32 pensions dishonesty complaints relating to 19 different schemes. These cases are in varying stages of the pensions dishonesty unit process. The House will know that the Pensions Regulator and the Pensions Ombudsman are independent bodies, and the Government cannot comment otherwise on individual cases.

Furthermore, the Pension Schemes Act 2021 gives the Pensions Regulator stronger powers so that savers can be confident that their pensions are protected, and the regulator can act if pensions are put at risk. DWP is now planning the secondary legislation relating to Section 125 of the Act. These measures make it significantly harder for fraudsters to successfully set up pension liberation schemes with the intention of committing fraud.

We have heard about the loan in contributions today from noble Lords including the noble Lord, Lord Sikka, who raised the point about the expectation of cost recovery. The expectation is that costs will be recovered over a 10 to 15-year period to spread the costs for the schemes through the proposed levy. The reason a loan is required is that the Fraud Compensation Fund is currently funded by a levy on eligible occupational pension schemes which, as I said earlier, will not be sufficient to fund these additional pension liberation claims in the short term. It is a widely accepted principle that the pensions industry should meet the cost of protecting the pensions sector, rather than the taxpayer, which perhaps addresses some points raised by the noble Baroness. However, I understand that the costs must also be tolerable and manageable for the industry. The Government will therefore consult by the end of the autumn about the fraud compensation levy ceiling for all eligible occupational pension schemes.

Focusing on the levy, in particular the flat rate of the compensation levy, which was raised by the noble Lord, Lord Tunnicliffe, it is important to note that it is for the Pension Protection Fund to set the levy within the ceiling set in legislation, not the Government. I am told that for the 2021-22 financial year master trust schemes, to reflect their particular characteristics, are being charged an annual levy rate of 30p per member, with other eligible pension schemes being charged 75p per member.

The noble Lord, Lord Davies, raised some points about the Pension Protection Fund. Briefly, both the PPF and the Fraud Compensation Fund were established by the Pensions Act 2004. Since coming into operation in 2005, the Pension Protection Fund has taken responsibility for more than 1,000 defined benefit pension schemes, comprising more than 260,000 members. It paid out £860 million in benefits in 2019-20, the last year for which statistics are available.

I would also like to address pension freedoms, as raised by a number of noble Lords, including the noble Lords, Lord Davies and Lord Tunnicliffe, and the noble Baroness, Lady Bennett. As the House will know, pension freedoms are different from pension liberation fraud, which involves members being persuaded to transfer their pension savings from legitimate to fraudulent schemes, with promises of high investment returns or access to a loan from the pension scheme before age 55. Pension liberation fraud and pension freedoms are entirely separate issues. Pension freedoms were introduced in 2015, after these pension fraud cases. The purpose of pension freedoms is to give individuals the choice as to how to access their own hard-earned savings, as the Government believe it is right that individuals are trusted to choose how to access their pension income.

In response to the criticisms made of pensions freedoms today, I highlight that Financial Conduct Authority research has found no significant evidence of consumers drawing down their savings too quickly. The extensive retirement outcome review in June 2018 found that those withdrawing defined contribution savings had other forms of retirement income or wealth.

I turn now to points raised about the online safety matters. We heard reference to this from the noble Lords, Lord Tunnicliffe and Lord Davies. I remind noble Lords that this measure is specifically to provide a loan to the Fraud Compensation Fund, to ensure that it can compensate those who have suffered pension fraud. So, online fraud is out of scope, but I understand that the online safety Bill will not tackle fraud facilitated through paid-for advertising—a point raised, I think, by the noble Lord, Lord Davies—such as advertisements on search engines. I am aware that DCMS is considering how online advertising is regulated through its online advertising programme. I have my noble friend Lord Parkinson here, who I am sure will nod his head.

In the brief time available, I will try to answer a few final questions before concluding. One point raised by the noble Lord, Lord Sikka, was on Woodford. There are important differences that distinguish LCF from the Woodford Equity Income Fund, because Woodford operated an authorised fund, which, unlike many bonds, was regulated by the FCA and was within the remit of the Financial Services Compensation Scheme. This means that where individuals have a legitimate claim to compensation—for example, because products have been mis-sold—they are able to make a claim to the FSCS. As the noble Lord will know, the FCA is investigating what went wrong at the Woodford Equity Income Fund and considering what rule changes may be necessary to help prevent such issues arising in the future. It would be improper for me or the Government to intervene or comment before this investigation is complete.

Another point was raised by the noble Lord, Lord Sikka, on the SFO investigation. Very briefly, as he will know, the SFO launched its investigation in March 2019 and he will understand that I am not able to comment on the ongoing investigation, except to say that it is a highly complex case which the SFO is working hard to unravel. I hope that provides some reassurance.

There are some other questions but I want to address the one raised by the noble Baroness, Lady Kramer, on why compensation is set at 80% and the cap at £68,000. I answer that by saying that the government scheme appropriately balances the interests of bondholders and the taxpayer and will ensure that all LCF bondholders receive a fair level of compensation in respect of the financial loss they have suffered. With any investment, there is a risk that sometimes investors will lose money but, to answer the question, to avoid creating any misconception of moral hazard for investors and leading investors down the line that choosing unsuitable investments will lead them to receive compensation in full, a wide range of factors needs to be taken into account. These losses would not ordinarily be compensated for at 100%, and 80% is a level that has been set in terms of the LCF bondholders’ initial investment, taking it up to a maximum of £68,000.

Bearing in mind the time, I will certainly read Hansard and write a letter to answer any questions that I have not managed to address, if I feel that that is the case. I thank all noble Lords who have engaged in this debate and I commend the Bill to the House.

Bill read a second time. Committee negatived. Standing Order 46 having been dispensed with, the Bill was read a third time and passed.