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City of London

Volume 497: debated on Wednesday 14 October 2009

[Christopher Fraser in the Chair]

Mr. Fraser, it is a great pleasure to serve under your chairmanship, although I fear that we are both absentees from the Select Committee on Northern Ireland Affairs this afternoon. I hope that the Chairman will forgive us.

About two years ago, I went on a course entitled “An introduction to the City”, organised by the excellent Industry and Parliament Trust. During week 4, one of our number—there were meant to be 10 of us there—was missing. That person turned out to be my hon. Friend the Member for Burnley (Kitty Ussher). We inquired as to her whereabouts and found that she had been made Minister with responsibility for the City after just three weeks on the course. I did not receive similar preferment; I just got a certificate at the end of the period.

I am glad that my hon. Friend the Member for Portsmouth, North (Sarah McCarthy-Fry)—the successor to my hon. Friend the Member for Burnley as Exchequer Secretary to the Treasury—will be replying to the debate. Her rise has been similarly meteoric. At one stage in the summer, for one week, she was in the Department for Communities and Local Government and, having solved all the problems there, was rightly promoted into the Treasury. I suspect that her meteoric rise will continue. She is a tweeter on Twitter with 400 followers and it would be the height of my political career if today’s debate got a little mention in a tweet later on.

Yesterday, in the Library, an hon. Member asked me, “Why are you interested in the City? What is behind this debate?” I could have mentioned the Industry and Parliament Trust course that I attended, or my economics degree—half an economics degree; I got the other half in history—but I should have said that the City has an impact, for good and bad, on the whole of our economy. That is as true for a northern Member of Parliament as for any other MP in the country. The City has much to take pride in, including its history and the fact that, every day of the working week, 340,000 people pile into the City, which has a resident population of only 8,000. The City should take great pride in underwriting ventures across the world, providing seed corn and capital to entrepreneurs starting up new ventures and businesses in each generation. Equally, the relatively mundane business of making markets, providing liquidity and dealing in foreign exchange all have their value in a market economy. Some of my best friends work in the City.

Another virtue of the City in recent years is social mobility, of a kind. The background of people who work in the City has been transformed in the past 20 or 30 years, since the big bang. I chair the all-party group on Ukraine, which has led me to a new understanding of the internationalism of the City and how people from all round the world work there, contributing to all sorts of firms and often returning to work in their home countries with an understanding of Britain and our economy. All those things are to the good.

I am an avid reader of the Financial Times and have been since my first Labour party meeting at the age of 15. I sat through the meeting and, at the end, one of the older members of the party—there were only about 10 there—who was well into his 70s beckoned me over and asked what paper I read. I told him that I read The Guardian and he asked why. I knew that he did not have much of an education himself, so I thought, wrongly, that perhaps he was saying that I should read The Mirror or something like that. But he said, “The Guardian is biased.” I asked what he meant and he told me that he always read the Financial Times, which was his paper of choice. He said, “It has to tell the truth because the political and economic elite read it, so this is the paper you should read, my boy.” I have to say that although I have stuck to The Guardian—there is something about reinforcing our own prejudices, is there not?—I also read the Financial Times occasionally. Over the summer, it has indeed been the paper for people to read if they have any interest in the City.

Lord Turner of Ecchinswell, chairman of the Financial Services Authority, made a remarkable speech earlier this summer questioning the social usefulness of parts of the City. I realise that I am quoting him selectively, but let me read a couple of lines from his speech. He said:

“Parts of the financial services industries need to reflect deeply on their role in the economy, and to recommit to a focus on their essential social and economic functions, if they are to regain public trust”.

Lord Turner continued:

“there are good reasons for believing that the financial industry, more than any other sector of the economy, has an ability to generate unnecessary demand for its own services—that more trading and more financial innovation can under some circumstances create harmful volatility against which customers have to hedge, creating more demand for trading liquidity and innovative products; that parts of the financial services industry have a unique ability to attract to themselves unnecessarily high returns and create instability which harms the rest of society.”

That remarkable speech was given in the Mansion House. He got to some of his audience, because they started criticising him in The Daily Telegraph in the days following the speech for the way he tied his bow tie. Apparently, he is a clip-on man. I am a clip-on man as well.

Without talking too much about ties, I have to admit that I, too, am a clip-on man.

On social usefulness, surely one of the biggest problems that we face, and one reason for the catastrophe in financial services, is the sub-prime market. From the mid-1990s, in the United States of America, it was those who thought there must be more social usefulness in relation to financial services who tried to persuade a huge group of people who should not have had financial products to go that way. Much as Lord Turner may have concerns about social usefulness, when politicians or those with an interest in politics try to impose social usefulness in this area, it can often go awry.

The hon. Gentleman makes a fair point, but we should not let the City alone be interested in the City. As I will mention in a moment, quite a few of the reports on the City in this generation have been written largely by City practitioners. A wider group of people should be involved in things like the Bischoff report, for example, which was commissioned by the Treasury, because in that way we get a more holistic view of social usefulness.

I am a James Bond man: I actually tie my bow tie.

I am delighted that the hon. Gentleman has said that we should take pride in the City and what it does. The City does an honourable job. Its 340,000 workers come from around this region—some 6,000 of them are my constituents. They do a fantastic job and probably create more for Britain’s economy on the international scene than any other sector. I accept that there are major problems, particularly with bonuses, but only for the very highest-paid in the City.

The hon. Gentleman puts his case in a balanced way. Let us not think that it is only Lord Turner who says such things. Incidentally, Lord Turner was also criticised at one point for being “Red” Adair Turner, and it was said that he was only speaking as he did because of his links with the current Government. However, having read the Sunday papers, I note that he is also held in high esteem by the Opposition Front Bench and is perhaps destined for a role in the Bank of England. His views cannot be dismissed so easily.

Stephen Green, another establishment figure, who is chairman of HSBC and the British Bankers Association, and also an ordained Anglican priest, published a book this year. He said:

“The industry collectively owes the real world an apology for what has happened and it…owes the real world a commitment to learn the lesson,”

Paul Tucker, deputy-governor of the Bank of England, said, under the dome of St. Paul’s cathedral:

“We can’t give meaning to our lives and have a financial system and economy of integrity purely on the basis of self-satisfaction… We need to have a sense that what we’re doing is socially acceptable.”

I have reflected on my reading of the Financial Times over the summer and thought about what value there is in any of those criticisms.

Another report, which I recommend to hon. Members, was produced in the summer by the centre for research on socio-cultural change at Manchester university. Manchester is a traditional centre of all sorts of industries, including manufacturing, and services and perhaps has a slightly different perspective. The report was written by a variety of people, including some academics and some people with experience in venture capital and so on. They came up with a number of reflections and I shall go through a few of them and then make one or two concrete suggestions.

First, the authors of the report reflected on the fact that, in this generation, the reports done on the financial crisis have largely been insider jobs. The Bischoff report was commissioned by the Treasury. Of the eight people who were the secretariat or the sherpas for that report, seven came from the City of London; only one was a civil servant. Looking at some of the previous inquiries on finance, I think that the Wilson committee was active in the 1980s, Macmillan did a report in the ’30s, and the Radcliffe committee worked in the ’50s. A much wider range of people were involved in the reports and in coming to the conclusions that those committees reached. Those reports stood the test of time for a generation—I studied them when I was doing my economics A-level and degree. In this generation, there perhaps has not been an outside look at the City following the financial crisis.

Secondly, the report from the centre for socio-cultural change at Manchester university produced interesting figures on tax and employment. Of course the City of London has been a big generator of tax—£203 billion in a five-year period—but, to put that in perspective, there has obviously been a big financial cost, because the City has operated in a very procyclical way. The International Monetary Fund calculates that the direct up-front financing cost to the UK taxpayer has been £289 billion in the past year, which includes the cost of the bank recapitalisation fund, the special liquidity scheme and nationalising Northern Rock and Bradford & Bingley. The IMF calculates that if all the Treasury loans and guarantees are added to that, the figure could be more than £1,000 billion. There has been an economic cost, which has been felt by ordinary people in my constituency.

It is probably worth observing also that in the City there are a number of very highly paid organisations that specialise in telling other people how to avoid paying tax.

Indeed, that is true. The tax benefit from the City is not all one way; we can summarise the position like that. There is a big employment impact from the City and it is not just in the City of London. The financial services sector is an important employer throughout the United Kingdom, although many of the very high-value wholesale jobs are concentrated in the City of London. I generalise, but there are more retail banking jobs in the rest of the country. Some academics have argued that our economy has become imbalanced: Baumol, for example, argues that there is only a certain number of natural entrepreneurs in an economy, and if the economic rent is greater than the value in a particular sector of the economy, it sucks in so much of the entrepreneurial talent that there are fewer entrepreneurs in other sectors of the economy. That may have happened in the City in recent years.

Finally, the authors of the Manchester report question whether some banking activities are what they characterise as a “great transaction machine”. They do not say that there has been too much lending, but that there has been the wrong sort of lending—not a bubble economy, but certain bubble sectors, with about 40 per cent. of bank lending on property and more than a quarter on financial intermediaries. What they characterise as productive business investment has stayed much the same throughout the period, at about 10 per cent. of GDP. They calculate that the amount of bank lending that goes to productive business investment has declined from 30 to 10 per cent. They would say that the very highly paid employees in many of the integrated banks have had a common interest with some of the shareholders in the banks in having as many transactions, often obscure transactions, in derivatives as possible. The banks have certainly produced a lot of our profits. At one stage, about a third of all profits of the FTSE 100 were produced by banks. Again, however, that has not been stable and there has been a cost for many of my constituents who have faced the downturn.

When in doubt, a politician should produce a 10-point plan, so I shall rattle through 10 suggestions that have been made for reform of the City, concentrating on some more than others. The first, which is very much the Government-sponsored idea, is to increase capital requirements in the banking sector. That is good as far as it goes, but we have to reflect on the fact that, just before many of the banks were brought in to see the Government, they were saying that they were meeting all the capital requirements at the time. As we saw in the various television programmes over the summer, bemused bankers were brought in to meet the Chancellor of the Exchequer, assuring him that they did meet the capital requirements. Of course it is easy to get round capital requirements, as various observers have pointed out. One danger is that banks may take on even more risk to sustain high returns on equity. Another is that banks will find a way round higher capital requirements via off-balance-sheet vehicles and exploitation of derivatives strategies and so on. That is a risk.

Moving on to my second suggestion, a variety of people have commented that banks are now too big to fail. Given that they are essentially backed by a state guarantee and that things such as the Glass-Steagall Act in the United States have long since been abandoned, a number of people have advocated a return to simpler banking—narrow banking, as some academics refer to it. John Kay, a distinguished economist who taught me economics many years ago, is a strong advocate of narrow banking—of separating casino banking, if I can characterise it like that, and utility banking. He says, for example, that we should have a system in which a Lehman Brothers should be allowed to fail. A bank should not be so interconnected with the rest of the banking system and counterparties and so on that the consequences of its failing are so disastrous for the rest of the economy.

Although broadly I very much agree with that point and I think that in time the failure of Lehman Brothers will not be seen as the great mistake that conventional wisdom suggests it is, is not the problem the nature of the guarantee? Whereas all of us would accept, I think, that depositors should have their interests guaranteed—there is now an implicit if not an explicit guarantee that all deposits will be guaranteed by the Government—the difficulty that arose in relation to many of the banks that have had problems in the past 12 months is that bond holders also had that guarantee. The extension of that guarantee is relevant in relation to the idea of institutions being too big to fail. The issue is not simply size, but the nature of the guarantees that any Government give.

I accept that point absolutely. The problem will not go away. I was referring to whether we should divide the banking system so that the public are less at risk from failures in investment banking, essentially, and so that there are fewer links into the retail banking sector. Let us consider, for example, the failure of the big insurance firm AIG in the United States. Basically, most people in that firm were involved in conventional insurance. It was perhaps 100 people in one unit, involved in more speculative activity, who brought down the whole firm and put at risk the world economy.

In fact, I shall give one lesson from God’s own county, if I may—there will be only one mention of Yorkshire in the entire debate, Mr. Fraser. The Yorkshire bank has adopted a simple banking strategy down the years. Rather than a pro-business cycle strategy, it uses a through-the-cycle business model. It says that it has stuck to its knitting in recent years. It never became involved in sub-prime lending and self-certification for 100 per cent. mortgages. Indeed, it was criticised, as many traditional or more conservative banks were, for not being innovative enough. Therefore banking structures such as Yorkshire bank do have a future. The Chairman of the Treasury Committee, my right hon. Friend the Member for West Dunbartonshire (John McFall), has tabled an early-day motion on separating retail and casino banking, and that debate will be part of our economic debate for some years to come.

Some commentators say that things cannot be done in an individual country; they have to be done around the world. I wish that we had made some banking rules like those in Canada or Spain, for example, before the banking crash, because even though the rules were not universal, their banks have benefited from the fact that they had a more conservative approach.

The third point is that there should be consideration by the authorities when making regulations of the impact on smaller banks such as Yorkshire bank. Clearly, if there are flat-rate costs, smaller banks will be affected more than larger ones. We must remember that smaller banks often have to use the clearing systems of larger banks. Although the Government have, naturally, been distracted in recent times by the affairs of bigger banks, they should also be interested in the smaller banks.

I will move on to the mutual sector which, looking back, has been a success. It is interesting that our current biggest building society, the Nationwide, was perhaps the least-favoured building society when it came to demutualisation. It was not seen as the most likely candidate and was not demutualised, but it is now a successful mortgage lender. Our building societies have obviously struggled as a result of the financial turmoil, but in many ways they have weathered the storm better than their banking counterparts. A focus on the protection of their members, and lending that is based strongly on money deposited by their customers, has meant that they have been far less exposed than most of the banks.

Building societies have raised a couple of technical points about the Financial Services Compensation Scheme. That is a vital safety net, but it impacts on building societies in an adverse way compared with banks, and the financial regulators need to consider that. For example, Nationwide was hit with a bill of £241 million at a cost of £17 per member as a result of some of the regulation. There must be a case for returning Northern Rock to the mutual sector when it goes back to the private sector.

The fifth point is a suggestion that has been made by commentators far more eminent than myself. There is nothing wrong with securitisation of loans and so on, but in many ways, the shorter the chain, the better and more transparent it is. Various people, including Dominique Strauss-Khan from the IMF and Lord Turner, have revived the idea of having some sort of tax. The Tobin tax was thought up a generation ago as a tax on foreign exchange. I do not think that that would work in today’s circumstances, but some sort of tax on financial transactions would reduce liquidity but also reduce that chain.

The sixth point is about bonuses, which have already been mentioned.

There are two points. Clearly, we already have a tax of stamp duty on general share transactions. Many of the markets—the eurobond or eurodollar market in this country for example—came about simply because of American taxes. Does the hon. Gentleman not recognise that having a range of taxes, particularly on a regional rather than global basis, might see potentially risky transactions being moved to some of the more wild-west elements of the financial services world? Historically, going down that tax route has not tended to work.

I agree with the hon. Gentleman in so far as I think that such a tax would have to be done internationally. Other measures for banking structures and so on could be done domestically, but all those who advocate such a tax, from the IMF to Lord Turner, recognise that it would have to be done internationally.

Moving on to bonuses and remuneration, I am reminded of the phrase, “We’re all in it together”, which has much to be said for it. We are now at the point where some of the remaining banks, such as the Royal Bank of Scotland, Goldman Sachs and others, have done pretty well in recent times. They have done well for a number of reasons: first, because of the Government guarantees, which mean that they have as much liquidity as they need or want, but also because many of their competitors have been knocked out of the market. In the coming days, they are potentially going to announce quite enormous bonuses for some of their staff. I think that Lord Turner was right to muse in the pages of the Financial Times on whether that is right and whether those bonuses have been earned.

The Manchester study that I referred to earlier stated that a lot of those banks have compensation schemes that cover about 50 per cent. of their total financial turnover. It suggested a tax on such bank profits. The last party to do that was the Conservative party in 1991. Again, the banking sector would be wrong to believe that it should be business as usual, and the Government have made certain proposals regarding bonuses.

I must apologise on three points: for disturbing the hon. Gentleman’s thought patterns in the House of Commons Library last night, and also for working at some point at both Merrill Lynch and Lehman Brothers. I have a certain amount of form on this.

I would like to point out that in the eyes of many, both in this country and abroad, we have a very oligopolistic structure—I am sure that the hon. Gentleman will agree. One of the keys to addressing the points that he raises, such as excessive bonuses, is the lack of competition, or potential competition, in terms of access of new financial institutions. I am sure he will agree that after the various mergers that have come about, either spontaneously or at the behest of the Prime Minister or someone else, it is very difficult in this country to deal with the situation. Will the hon. Gentleman comment on that, because it seems that lack of access is an inhibition to addressing some of the problems that he is talking about?

I agree with the hon. Gentleman entirely. I have always been a great believer in competition. From the left, social democrat or so-called progressive side of British politics, we have been too easy on oligopolies or monopolies across a range of sectors. The energy sector is one and possibly the media sector is another. There is a danger in the finance sector now that these great institutions have been created and merged and some are run directly by the state. What follows on from them when they go back to the private sector? We have to think about competition concerns.

Are not these multi-million pound bonuses and payoffs absolutely scandalous? The five directors of MG Rover paid themselves £40 million as the car plant was going bust. Does my hon. Friend agree that we need a high pay commission, or something like that, to police the City and ensure that excessive bonuses that cannot be justified are not paid?

My hon. Friend reads The Guardian too. I am glad—The Guardian needs all its readers these days. I would not set a maximum pay level or bonus level. I would look at the taxation of bank profits and bonuses and approach it that way. However, I share my hon. Friend’s moral fervour. When people such as the chairman of the British Bankers Association make comments such as those I quoted earlier, it has to mean something. Unless the banks address their bonus culture, there will be a role for Government to do more.

I will move rapidly on. An interesting proposal from the Conservative Front Bench is the idea of having a consumer regulator for the retail banking sector. That almost touches on the point made by the hon. Member for West Suffolk (Mr. Spring) about competition and entry into the market. Retail banking could be much more innovative.

The eighth point is purely to ask whether it is time to look again, like Macmillan and Wilson, at having an inquiry into venture capital for our industry and services, and at whether our market is efficient. One of my regrets is that, as I understand it, the private equity movement originated in providing venture capital for new ventures. It has now largely become a vehicle for the takeover of assets and so on, of which Lord Myners has been critical. He has indicated, as have many economists, that he is not sure that such activity brings much economic value in the end. That matter would be worth looking at.

The ninth point is that when the public sector makes big investment decisions, we must be careful to ensure that we do not look too much at the interests of the City as opposed to those of the rest of the country. After the next election, any Government will have tough investment decisions to make about public expenditure. I would hope, for example, that the high-speed rail link, which is of interest to the whole of the country, might be higher up the agenda than Heathrow expansion or even, dare I say it, Crossrail, which has been heavily lobbied for by the City. If it is a choice between one or the other, as it may be, I hope that high-speed rail will be at the top.

I praise Crossrail to a certain extent, although there are no votes in it for me. Most of my residents, particularly those in Mayfair and the Barbican, are not particularly happy with the idea. The hon. Gentleman will know that the Crossrail Act 2008 is now in force, and that it would be relatively straightforward now that the planning consents and so on are in place. Indeed, more than £1.2 billion has already been spent on compulsory purchase and demolition. Should the hon. Gentleman regularly visit the bookshops at the top of Shaftesbury avenue, towards Tottenham Court Road tube station, he will know that the area is already the site of some Crossrail works.

I hope that it is not necessarily either/or. However, insofar as there are plans to limit the amount of investment in the area, Crossrail is now well ahead of the game, and it will make an enormous difference to the whole of the United Kingdom and not only that part of central London in which it is located.

When I am promoted after the next election, perhaps to the role of Economic Secretary to the Treasury, I shall carefully take account of the points made by the hon. Gentleman. If I was drawing up a list, I would put them in the following order: high-speed rail, Crossrail and Heathrow.

A directive on alternative investment managers is being promulgated in Brussels, about which the Mayor of London is getting agitated. I shall not go into massive detail, but I have read the impact assessment done by the European Commission, and there is a case for regulating more alternative investment managers’ funds, such as hedge funds and private equity. I also believe that there is a case for having a set of rules that apply across the sector, because the financial sector is nothing if not innovative, and if we try to regulate only one part of the sector or define it more precisely, we might find that the rules quickly become redundant.

I believe that organisations such as hedge funds are of sufficient size that they have the potential to pose a systemic risk to the economy; lending by banks and the herd instinct of many funds could be destabilising. With pension funds now investing much more in alternative investment markets, consumer protection is becoming more important. I broadly believe that a strong case can be made for regulation by Brussels.

I would point out to the hon. Gentleman that there is no evidence at all that the financial crisis that so catastrophically affected this country and others was the result of the activities of hedge funds. I simply say, as gently as I can, that although one wants ultimately to protect the financial services industry—in the European Union, London is the jewel in the crown—the huge danger, of which we have already seen some evidence, is that it could create a regulatory structure that persuaded our financial institutions to locate abroad. It is a fine balance, and I am sorry to say that there are indications that what is coming out of Brussels—I think that Lord Myners would agree—is excessive and potentially destructive of the financial service industry in London.

I shall briefly quote Will Hutton. This is from The Guardian rather than the Financial Times—there is another view of the world. He said:

“Hedge funds in particular cannot be allowed to peddle the fiction that they had no role in the financial crisis. For the record, in July 2007 London and New York hedge funds had assets under management of some $2 trillion, of which up to $1.75 trillion (we will never know the exact figures) was financed by borrowing. It was the collapse of two Bear Stearns hedge funds and three BNP Paribas hedge funds in July and August of 2007 that triggered the paralysis of the interbank markets in New York and London.”

There are different views on the matter, but whatever the responsibility the alternative investment market had in the past for causing crises, we also have to look to the future, and future-proof ourselves. Such organisations are now big players and they should be regulated. An awful lot of lobbying money is being used to persuade the European Parliament to throw out the proposals, but I hope that my colleagues there will resist that and that they will consider the regulations carefully and that they will properly regulate hedge funds and private equity. Even today, the Financial Times says that according to an American study one in five hedge fund managers have been found to be misrepresenting facts. For consumer protection, there must be a case for backing those proposals.

Slightly controversially, I shall refer to Mr. Rasmussen, the former Danish Prime Minister, who is the nemesis of those hedge funds and private equity firms that are resisting such regulation. He has campaigned for years for such regulation, and came to the City of London earlier in the summer. He said that, at the moment, hedge fund managers appear to be guaranteed 2 per cent. of their investments in annual fees and 20 per cent. in profits. He asked whether, if they had 0.5 per cent. in fees and perhaps 10 per cent. in profits, they would starve. Such questions are relevant and should not be dismissed. Hedge funds are part of our economy, but they should reflect upon the social usefulness of all their activities.

I end by referring again to my economics teacher, Mr. John Kay, who said this summer that our financial sector should be the servant of our wider economy and not the master.

I congratulate the hon. Member for Selby (Mr. Grogan) on introducing this important debate. I shall focus mostly on hedge funds and alternative investment matters, which was the original title of the debate and a subject on which the hon. Gentleman focused in the latter part of his speech.

The hon. Gentleman gave us a quick tour d’horizon of the history of the City of London, and he was right to say that roughly 350,000 people work there every day. For the first time since censuses began in 1801 and certainly since the arrival of the railways, its residential population is beginning to increase, albeit incrementally. None the less, it is a place not only for work but, to a large extent, for rest and play.

I stress that the present lord mayor has firmly been making the case during his programme of overseas visits that the City is not simply about the banks. The banks may have been particularly hard hit in the past year or so, but other parts of the financial services sector have not suffered to the same extent. When seeking to deal with the banking sector, it is important to avoid having a negative impact on those other parts.

The lord mayor and Stuart Fraser, the leader of the City of London corporation and chairman of policy and resources, have sought to highlight the fact that, as well as the banking industry, insurance, communications, technology, legal, accounting and other related professional and business services industries have an essential role to play in stimulating economic recovery and growth. The hon. Gentleman rightly pointed out, with great fairness, that the whole UK benefits greatly from a thriving financial services business; it may be based in London, but it has great strengths in other centres such as Manchester, Leeds, Edinburgh and Glasgow.

I know that my hon. Friend is aware of the fact, but because of the long-standing nature and history of the City of London, its livery companies and various guilds, as charitable foundations, are hugely focused on the broader community, not only in London but outside. They generously contribute to all parts of the United Kingdom in a most commendable way.

That is an extremely good point. Some of the livery companies have strong connections with other areas; for instance, given the historical and traditional importance of steel, the Cutlers are strong in places such as Sheffield. The fact that a huge number of schools have received large sums from trusts set up, often centuries ago, by the livery companies bears witness to what my hon. Friend says, as does the fact that large tracts in Greater London and outside the square mile—places such as Epping forest, Hampstead heath, West Ham park and Queen’s park—are some of the finest open spaces, which are of great benefit to Londoners and those who live in the home counties.

As the hon. Gentleman said, the financial services global competitiveness group report was published on 7 May. It called for greater co-ordination and strategy in the way in which the UK financial services industry promotes itself. I take on board his concern that too many City folk may have been involved, but it is fair to say, as he did, that although the City was regarded—certainly between 1914 and about 1986—very much as a club, it has become much more open, and there is now more social mobility in some areas than we could have dreamed of only 20 or 30 years ago. City professionals may therefore come from different walks of life than would have been the case a generation or so ago.

Since last year, the City of London corporation has been working to set up a new body with the aim of providing a single focus for promoting the financial services industry to a domestic and international audience. It will work alongside existing bodies in international finance, and Sir Stephen Wright plays an important role in that regard, working with the Mayor of London, who clearly has an interest in the issue. There has been some tremendous co-ordination under the auspices of the City of London corporation, with one eye very much on the future and the importance of our capital, alongside Beijing, which held the Olympics in 2008, and Rio de Janeiro in Brazil, which will be a big global capital in 2016.

As a starting point, a small steering group has been established, and it is anticipated that the new body will be launched and perhaps named later this year. It will be independent, practitioner-led, politically neutral and cross-sectoral. Above all, it will try to represent the financial services industry across the UK, not just in central London. The Government, particularly the Treasury and UK Trade and Investment, have been closely involved in the development of the initiative, which will form one of the most important elements of the City of London’s outlook in the years to come.

I want now to say a few words about hedge funds. In many ways, their rise and power represent one of the biggest changes to the global economy over the past half a century. Largely for that reason, there has been a demand, which predates the banking collapses of the past two years, for an alternative investment directive in Europe.

Hedge funds are predominantly limited liability partnerships, so they are exempted from much of the regulation that applies to investment banks and even mutual funds. As pools of highly mobile capital, they have fast developed a reputation for moving financial market mountains by anticipating future expectations. There is no doubt that they thrive on volatility, and the crux of the controversy that surrounds them is the degree to which they cause or affect fundamental shifts in financial markets.

As the hon. Gentleman said, this relatively unpoliced, unsupervised and, until recent years, fairly low-profile sector of the financial services world is now firmly in the sights of the European Commission, as well as of Mr. Will Hutton of The Work Foundation. However, the Commission’s proposed directive to regulate hedge funds and the private equity sphere betrays, as my hon. Friend said, a lack of understanding about the business’s workings.

Alternative investment funds have already accepted that the new regulatory climate means that they will be required to boost transparency, as well as to accept new controls on disclosure and, most likely, on clearing, settlement and custody. However, the draft directive goes a long way beyond that and may make it quite impractical for funds owned by non-EU entities, which make up a significant proportion of the funds operating in London, to distribute their products in the EU.

The combination of such an approach with other perceived regulatory and fiscal burdens may persuade hedge funds to relocate to other financial centres, such as Switzerland, or to return to the United States, with its much more mature market. Similarly, hedge funds that relocate may provide the critical mass for emerging financial centres such as the Gulf or the far east. Such an outcome would be in the interests of neither the UK and the City of London, nor the EU.

At a supranational level, the directive would diminish competition, and I entirely endorse what the hon. Gentleman said, because competition is key. We will no doubt experience a big hue and cry about huge banking profits in the press in the next week or two, but the point is that competition has simply diminished and died away to a large extent. In fairness, I suspect that most of the huge profits that we will see this year will be an exception, and I hope that there will be new players in the market. We must remember, however, that regulation itself is the biggest barrier to allowing new, innovative companies into any new market. One concern is that a highly regulated market will have a very detrimental effect.

The hon. Gentleman is putting forward the hypothesis that regulation invariably leads to capital flight. In a sense, that is making the case for no regulation whatever. However, there is clearly such a thing as a proper degree of regulation, which attracts capital; regulation is not necessarily negative in its effect on markets.

If things are taken to an absurd level, one would have to agree. Clearly, there needs to be some regulation, not least to protect consumers. To return to the history of the City of London, I was joking with my hon. Friend earlier that we should look at the great scandals that took place in the Victorian era, when mines and railway promoters ripped off consumers. Clearly, that did nothing of value. There is a strong argument for saying that much of what should have given this country’s industry a competitive advantage was undermined because there was no proper regulation or sense of transparency in the City of London in that era, when transparency and regulation were very much in their infancy. It is at least valid to say that. Clearly, having an entirely laissez-faire approach does nobody any favours—indeed, it does not bring in crucial investment.

To return to my earlier point, the directive as currently drafted would, at a supranational level, diminish competition and restrict flows of liquidity into the single market. It would also be seen as protectionist at the very time when barriers need to be brought down, rather than erected. At a domestic level, I fear that it would significantly diminish London’s critical mass as a financial centre and reduce individual and corporate tax revenue. The hon. Member for Selby rightly said that the City of London has been a huge cash cow in the past, and one hopes that it will be one in the future.

The directive could also damage the market for the professional services that assist the hedge fund and private equity industry, such as law, accounting, investment consultancy and specialist IT.

This is an important point. Some of the countries that have perhaps been driving the ambition for further regulation have virtually no hedge fund activity. Does my hon. Friend agree that the success of the City of London and the diversity of financial services—I agree that financial services should be properly regulated, but that has not been the case in the past—are hugely important for the whole EU, which is diminishing in importance as trade flows and economic activity move eastwards? The success of the City is one anchor of our future prosperity, and we risk losing it at our peril.

I entirely agree. That is an important point. Power is shifting eastwards to India and China. They have two and half billion people between them, and they will be the two big economic superpowers of our lifetimes—certainly by the middle of the century. That shift has undoubtedly been accelerated by recent events, and nothing would be more catastrophic for Europe—whether within the confines of the EU or as a time zone—to relinquish what should be and has been one of its traditional advantages. The importance that should be attached to the financial services business as a whole cannot be overstated, given the propensity of the 20 million or 30 million people a year who are added to the Chinese and Indian middle classes to save, which means that there will be a great reliance on what should be a great industry for us.

To the directive’s opponents, the European Commissioners’ attention on these issues seems to have been promoted all too often by an unholy alliance of continental bankers and politicians who are concerned in part to effect something of a power grab. Eighty per cent. of the hedge funds managed in Europe are accounted for by London, while fewer than 20 per cent. originate in Paris.

The plain truth is, as my hon. Friend pointed out in an intervention, that the asset management business has not been directly implicated in the global financial crisis, so one must ask why the EU is suddenly giving such priority to its regulation. Typically, hedge funds are small start-up businesses—a far cry from the large international banking institutions whose antics, in part, jeopardised the entire global financial system last autumn. Their offshore domicility often owes much to the need for simplicity in tax and regulation, as places such as the Cayman Islands are not beset by double taxation treaties and reclaim bureaucracy.

The impetus for a European directive derives from panic in response to the economic crisis, alongside a partisan vision of hedge funds and private equity as a wild west show of amoral speculators and asset-strippers. Even one or two people in the Labour party have been known to espouse such views. However, there has been no crisis of asset management. Unlike banks, hedge funds neither leveraged themselves to the hilt—of course, they lacked the balance sheets to do so even if they had been so inclined—nor ran down from adequate levels of liquidity. Indeed, those that have failed—several have—have not threatened the entire financial system.

In truth, one of the unsung successes of the Financial Services Authority—I hope that I am not too far out of line with my party’s views on this matter—has been its ability to keep the hedge funds sector ticking along relatively nicely in recent years. It cannot make sense for a European directive to insist on onerous hedge fund registration requirements by giving Commission officials the right of veto over their investment strategies. That will simply result in the drying up of investment from outside the EU to hedge funds here, which is, as my hon. Friend the Member for West Suffolk pointed out, against not only UK interests but French and German interests and those of the other 24 nations of the EU.

All that investors in the global market ask is to be given free rein to choose their investment managers. Instead, the proposed brave new world for hedge funds and private equity risks forcing EU-based investors to abide by a system of rules whereby they will have to instruct EU-based managers and place their assets in EU funds. A more sensible approach would be to examine how and why hedge funds became so powerful so rapidly. Perhaps the homogenising of mainstream institutions in the financial sector as a result of interdependencies and the converging effect of regulatory creep gave rise to the demand for a new diversity of off-balance-sheet methods to manage assets and credit. In particular, in the aftermath of the Enron scandal a decade ago, stricter regulations that were introduced to control off-balance-sheet activity simply resulted in an explosion in special purpose vehicles, which were created to bypass a culture where stifling regulation presented a massive competitive advantage to those institutions able to reap the benefits of economies of scale.

I am not here to bury hedge funds, but equally I would not give them untrammelled praise. There is little doubt that the emergence, in reaction to regulatory overkill, of a largely unpoliced, unsupervised hedge fund sector had significant distorting effects on the entire financial system. Additionally the huge, largely unregulated profits derived from the most successful hedge funds had a perverse effect on the strategies employed by investment banks whose profits could never emulate those obtained in the tax-free, “regulation-lite” regimes enjoyed by the funds. As those profit margins became ever more the talk of the City half a decade or so ago, unrealistic expectations of compensation were ratcheted up.

By 2004, senior banking executives watched enviously as hedge funds’ profits soared and the brightest and best of their junior staff were poached to make their fortunes in those funds. In retaliation, many leading investment banks elected to allow the emergence internally of “virtual fund” teams specialising in the riskiest but potentially highest-return sectors. More often than not, such star teams negotiated and were granted special shadow profit-sharing status internally. I must accept that that proved to be the worst of all worlds, giving those teams the green light to indulge in relatively unprecedented risk-taking, all the time underwritten by the banks’ colossal balance sheet. That seemingly safe umbrella encouraged ever greater leverage and the spectacle, even in the good times, of such a small proportion of banks’ profits being retained. Naturally, that strategy was questioned only after the credit crisis exposed the folly of allowing an inherently riskier culture of hedge funds to pollute the banking system.

I am glad that I have had the opportunity to speak at some length, and want to conclude with this thought on hedge funds: it is right for policy-makers to engage intellectually with the proposition that the rewards and super-profits should be justified only in return for exceptional performance, rather than as an arbitrage for tax and regulatory breaks; but that requires a much more systematic analysis than the European Commission has provided of the structure of the financial services sector. Scapegoating hedge funds and the private equity industry cannot be a sensible first step on that path.

I congratulate the hon. Member for Selby (Mr. Grogan) on securing the debate and keeping us on our toes by leaving us marginally uncertain as to its exact title. I thank him, too, for sharing his 10-point plan with us. Why he is not Chancellor of the Exchequer I do not know. I assume it is because he is far too cheerful.

Down this end of the Chamber, we have a caucus of northerners—or we did have when the hon. Member for Pendle (Mr. Prentice) was here—but none the less we have no doubt about the importance of the City and the financial sector to the UK and world economies, the British balance of payments and Government revenues. It is critical. We also have no doubt that that is built around a degree of integrity, probity and good regulation, connectivity with the rest of the world, length of experience and downright financial skill. We can, I suppose, praise that without necessarily overestimating it. I sometimes get very big brochures sent to me by the City of London, telling me how it pretty well accounts for most of the UK economy. I am never quite certain whether the information includes all businesses with a head office in London as belonging in the City, or whether it estimates appropriately the substantial economic contribution made by London outside the City. It is also worth mentioning in passing that certain cities, such as Edinburgh, have proportionately—though not in size—a bigger financial sector even than London’s.

We should not, however, underestimate the importance of the City. Look at what goes wrong when things go wrong there. We suffer in our constituencies and across the land. There has been a long and heated debate in the north and throughout the country about the relationship of the City to the wider economy, and in particular the relationship between manufacturing industry and commerce and the City, manufacturing generally being something rather grim up north and City life being something rather sophisticated down south. A refrain that has gone on for decades—as long as I have been thinking about the economy and politics—is criticism of the City for a degree of short-termism and for being attracted by property rather than production, services rather than sustainability.

This is a slightly artificial debate, and all sorts of qualifications are needed, as well as recognition of the positive role that the City has played in the economy as a whole. However, the picture for most of our lifetimes has been of the growth of the services and financial sector in the economy and the decline of the manufacturing sector, even below EU levels, and even given our acceptance of the fact that we all have a problem resisting the modern challenge of China, India and the like. Coupled with that has been the rise of new financial giants. We have mentioned some of those: hedge funds, private equity and venture capitalists within and without the banking sector. It is easy to see it, sometimes, in terms of a further tilt away from the long-term investment in which the mutuals engaged and long-term investment in general.

I know that there are some pretty solid defences of current City fashion, and the hon. Member for Cities of London and Westminster (Mr. Field) did a good job of presenting such defences. I, too, have read the handouts from private equity houses and organisations that emphasise that they are not a bunch of shameless asset-strippers, as they are sometimes characterised by people who do not qualify their remarks sufficiently, and that in fact they re-engineer companies, reconfigure them and in some cases provide more employment and certainly greater profits. I know too—it is a perfectly valid point that has been made several times in the debate—that they are not responsible for the credit crunch. That was the result of very traditional high street banks, which formerly nobody was agin, behaving rather badly and uncharacteristically, in a way that suggested more than a flirtation with casino-type finance. The hedge funds, on the other hand, have had very limited interest and involvement in the mortgage market. However, it has to be said—it was mentioned, I think, by the hon. Members for Selby and for Cities of London and Westminster—that hedge funds did play a part in accentuating financial panic because they are such big players and deal in bank shares, often at critical moments and often with money borrowed from the banks.

If we want to avoid the evils that have beset us recently—the frauds, the Madoff affair, which was essentially a hedge fund affair, the foolishness that has characterised patterns of investment, and the instability that has been all too prevalent recently—we cannot duck the problem of regulating the new financial giants. We cannot back away from that. We must consider the possibility that something needs to be done if not because those organisations are responsible for the past but because, as the hon. Member for Selby said, there might be problems in the future, particularly given the fact that these giants are moving huge amounts of money around the globe and they are relatively opaque financially. They are big players that add enormously to liquidity, which is often said in praise of them. However, they engage in aggressive market behaviour while, ultimately, bearing few of the social costs.

When we talk about hedge funds, we have to put it on the record that 50 per cent. of them, for whatever reason, are situated offshore in places such as the Cayman Islands. I am not saying that they are in league with the pirates of the Caribbean, but we would prefer them to take their fair share of social responsibility, particularly as they have a powerful social effect. I recognise that many operate onshore in the USA and the UK, but they should be prepared to pay up in tax terms for the advantage of working in a well regulated economy. That said, it also has to be pointed out that last year, according to my figures, hedge funds alone paid £3.2 billion in tax revenue, which the UK can scarcely do without at the moment.

I do not want to be generally damning because if we look into what a hedge fund is supposed to be, we would find that the definition is a little more fluid than one might expect. There are different kinds of beast under the label of hedge funds. The French do not use the words hedge fund; they use the expression “fond spéculatif” because not all such funds hedge. The case for a degree of regulation beyond self-policing is quite strong, but the extent of that regulation is the issue. Fundamentally, we all agree that we want to secure the economic advantages that the funds bring, but we also want to ensure that the social benefits are provided, too. As the hon. Member for West Suffolk (Mr. Spring) said, it is a matter of balance and getting that balance right.

I put it on the record that it is not a straightforward equation—that the more regulation that we have, the more capital flight we will get. Mention was made of the Indian financial market, which is regulated much more restrictively than the British markets at the moment, but is still attracting significant capital and investment. There is a debate to be had and Mr. Rasmussen, if nothing else, has started it. He has the Mayor of London going, and there are all sorts of views about whether or not this is a Euro-plot against the British hedge fund industry, which accounts for 80 per cent. of the European total. Nevertheless, the debate is well worth having and should be conducted in a relatively mature way. The insurance companies are having another sensible debate about solvency. To some extent, there has not been a great deal of discussion about the type or quality of debate. In this place, we have talked more about who is to regulate, and not how people are to regulate.

The bottom line for me as a northern MP, whatever regulation or fiscal policy we have, is that we must move away from short-termism, or make regulation much tougher. Moreover, we must move the economy in the direction of sustainability in financial and economic terms and not encourage an environment of the fast buck.

I shall close with a little story that encapsulates the debate. I hope that the hon. Member for Cities of London and Westminster will sympathise with the plight of the company that I describe. I represent a seaside town which for decades had a profitable sweet factory, making a product called Chewits. I did not eat it much myself, but it sold well at the seaside. I went to see the company when it was in process of retooling; it was profitable and doing rather well. It employed people who had to operate at a relatively skilled level and it provided a good mix of employment. It was then bought by a City company. The machinery was sent to eastern Europe, the skilled work force was sacked, the job mix in the town was worsened, the carbon footprint of production was increased and the land was sold for housing. The UK economy did not benefit, but profit was made in the City. That may be the operation of a free market, but I question, in those circumstances, whether it is wise.

I congratulate the hon. Member for Selby (Mr. Grogan) on securing the debate, even though it had a changing title. As my hon. Friend the Member for Cities of London and Westminster (Mr. Field) and the hon. Member for Southport (Dr. Pugh) said, it was until relatively recently entitled “The Impact of the Hedge Funds on the UK Economy” and we had all geared up for that. None the less, the broadening of the title gives us the opportunity to make some more wide-ranging remarks about the City.

I will, if I may, be critical of the hon. Member for Selby, who used lazy shorthand in the title of the debate. He will have offended people who work in Canary Wharf or in the west end, and people who see themselves as part of the financial services sector but who are not located in the City. He has also forgotten about the people in Whitely, just outside my constituency boundary, who work for Zurich Financial Services, and the 300 people who work in the Lloyds Bank call centre in my constituency. They are all part of the financial services sector, as indeed are the staff of banks and insurance companies and the stockbrokers who are dotted across the whole of the UK.

When we talk about the size of the financial services sector and the contribution it makes to the UK economy, we should remember that it is a sector that is based across the whole country and not just in the Square Mile. We must be careful to remember that because it represents a means by which the financial services sector can start to re-establish trust with people by reminding them that it is an integral part of our lives. The debate about hedge funds and the activities of the people in the City and the insurers remind us that they have an impact on our lives. Today, we have talked about hedge funds in a bit of a bubble, but who are the investors in hedge funds? It is not just high net worth individuals; it is our pension funds. Two thirds of the investment in hedge funds come from pension funds, including that of the Church of England. There is therefore a direct relationship between the returns that they make in those funds and the benefits that we enjoy in our pensions. We cannot view the City in isolation, and nor should the City or the financial services centre think of itself in isolation from the rest of the economy.

The hon. Gentleman had a 10-point plan. I will not go through each of the 10 points, but I want to pick up on a couple. Bonuses, for example, are an important issue for people to understand. Over the course of the past two years, the taxpayer has supported the banking system through the stakes taken in RBS or Lloyds, which we supported, and the indirect guarantees and indemnities that are on offer to the financial services sector. The current stability of the banking system is a consequence of taxpayers’ support, not just here but across the world. That support was given to help its balance sheet and not its bonuses, and banks must remember that as they come into the bonus round over the course of the next few months. The bonuses are a product of taxpayers’ support and they should not lose sight of that.

On the hedge fund directive, which both the hon. Gentleman and my hon. Friend the Member for Cities of London and Westminster discussed, we must remember that it is not just about hedge funds. It is the alternative investment fund management directive and it affects hedge funds, private equity and endowments. The Wellcome Foundation and the endowment of Oxford university are affected by it, as well as the funds in Germany that are used to finance wind farm investment. Most Latvians find the finance for their houses through funds and they will be affected by the measure, too. What is happening across Europe is that people who thought carelessly that the measure was just about those nasty big hedge funds are now realising that it has much greater impact.

Why are hedge funds attractive? It is because people want to invest in them and they want the returns from them. However, I think that some people feel under pressure from hedge funds, whose activist nature creates and promotes change in financial markets and economies. In some economies, people are reluctant to accept that change is a good thing in that way.

Some people think that there is a zero-sum game here for Europe—that by introducing tougher regulation on hedge funds, Europe will see business moving from London to Frankfurt or Paris. However, it will not move to Frankfurt or Paris. That business will move outside the European Union: it will go to Singapore, Geneva or New York. The regulatory drive in Europe risks making Europe uncompetitive and forcing jobs and business not out of London, but out of Europe. That is an argument that we need to make, not just here in Westminster but in Brussels and in other European capitals.

There is another lesson that we should draw from the hedge fund directive. When the directive was being drawn up, the Government failed to recognise the wider impact that it would have. I think that Lord Myners is rectifying that, but it would have been far better if the Government had been engaged much earlier while the directive was being thought about, rather than just waiting until it was published. Can the Minister tell us if the Chancellor of the Exchequer spoke to the Commission the week before the directive was published, because I understand that the Chancellor’s French and German counterparts did? It would be helpful to know if the Chancellor was able to put a word in to stop the directive from being published. It seems that the French and German Finance Ministers were rather more successful in getting their views known.

Just to be absolutely clear, the hon. Gentleman suggested that the Chancellor should have stopped the directive, so is the position of the official Opposition that there should not be a directive at all? What is the position exactly?

There needs to be proportionate regulation of the sector, which recognises the risks and responds to them. My hon. Friend the Member for Cities of London and Westminster talked about the Financial Services Authority. The FSA has been very effective in regulating hedge funds, because the regulation is proportionate to the risk. The directive, as it is currently drafted, is not proportionate to the risk. It is a rather muddled document. Furthermore, because of the lack of due process in putting it together, the costs of the directive could potentially outweigh its benefits. We want proportionate regulation that reflects the risk that these funds pose, not regulation simply for the sake of it.

Let me speak briefly about the wider financial services sector. Clearly, the actions of certain banks and financial institutions created the financial crisis that we see today. There was a failure to recognise the risk that certain financial institutions took on through the way that mortgages were sliced and diced and repackaged into collaterised debt obligations, or CDOs squared, tripled or even cubed. There were complex transactions that meant that there was a loss of understanding between the product that people bought and the underlying mortgage.

There was also a failure to understand the risk attached to these instruments. I do not know what other Members read on their holiday, but “Fool’s Gold” by Gillian Tett is a book on the subject that is well worth reading. She sets out in it how little some banks understood about these instruments when taking them on. Their creators—JP Morgan—actually took on very few of them and came through the financial crisis in good shape.

I have a suggestion; in many ways, it is a “back of the envelope” suggestion. It is that unless the senior directors of a bank can explain, within two sides of A4, a product that they are trying to create, such a product should not be marketed by that bank.

My hon. Friend makes a good suggestion. There was a disconnect between the directors and the boys in the engine room: each seemed to think that the other knew what they were doing. I just wonder if that disconnect was not a cause of the crisis.

There are some regulatory issues that we need to address. Clearly, the capital requirements in place for banks had not been fully thought through. The capital requirements under Basle II encouraged procyclicality in lending and they encouraged banks to lend more in the good times. The Spanish banking system had countercyclical capital and it has come through in a much more robust state than the UK banking system and other banking systems. Obviously, we need to get the capital requirements right.

We also need to ensure that there is a proper matching of capital to risk. Certain banks were able to make some quite risky investments and engage in some quite risky trading activities because they had a strong retail base. We should ensure that capital is much more closely aligned to the level of risk in trading activities and capital should also reflect the riskiness of bonus structures. If remuneration structures lead to a certain type of activity, capital should match those structures too.

The regulatory structure in the UK needs reform. We have argued that there should be a “twin peaks” approach, whereby the Bank of England would act as a prudential supervisor and a new consumer protection agency would act as a consumer champion. It is interesting to note that France—a country with which we do not necessarily see eye to eye on these issues—is looking at moving to a “twin peaks” approach, with the Banque du France, France’s central bank, acting as a prudential supervisor, just as in the Netherlands and Australia there is a separate prudential regulator and a separate conduct of business regulator.

That structure is important as it would reinforce the importance of prudential supervision. Our existing regulatory regime, whereby the FSA acts as the prudential regulator and is also responsible for the conduct of business, rather meant that the prudential aspect got lost in recent years, because the accountability of the regulator drove it towards more conduct of business regulation. Our reforms would tackle that problem by ensuring that the regulatory structure properly addresses both prudential supervision and the conduct of business rules that really regulate the way in which consumers buy products from insurers, banks and others, and receive advice.

There is no magic bullet that will solve the problem, only a series of interventions that we need to make. We need to get the capital provisions right and we need to get the regulatory structure right. However, we also need to ensure that the financial services sector sees itself as an integral part of the UK economy. It is only by getting those structures right and by building up that trust that once again people will be content to see the City continuing to grow. People talk about “the imbalance” and say that the financial services sector is too big. The answer is not to shrink that sector, but to grow other parts of the economy. That is the message that we need to think about when we look at the impact of the sector on the UK as a whole.

First, I want to congratulate my hon. Friend the Member for Selby (Mr. Grogan) on securing this debate. I would also like to thank him for his very kind remarks to me and I am sure that, when we win the next general election and form the next Government, he will be considered for a starring role.

I am afraid that I cannot contribute to the debate on bow ties because I have never worn one, hand-tied or otherwise. However, I can confirm that I am a Guardian reader.

The impact of the City of London on the UK economy is, of course, a highly topical issue and one that deserves a rich and informed debate. I think that we have had a rich and informed debate today, which has gone much wider than the original title of the debate, and I thank my hon. Friend for changing that original title to enable us to look at some of these wider facets.

We have had contributions from several hon. Members. The hon. Member for Cities of London and Westminster (Mr. Field) concentrated on the hedge funds, because that is an area of expertise for him. The hon. Member for Southport (Dr. Pugh) touched on hedge funds, but he also looked at the wider economy and regulation. The hon. Member for Fareham (Mr. Hoban) touched on hedge funds, bonuses and the wider financial services sector.

My hon. Friend presented us with a 10-point plan—double the five-point plan. I hope to cover as many elements of that 10-point plan as I can, but of course time is limited. I will do my best.

The hon. Member for Fareham made an important point when he asked what we are actually talking about when we talk about the City of London. Technically speaking, of course, the square mile and its environs, including the west end and Canary Wharf, form the hub of the major global financial centre, but I think that the term “City of London” is more often used as a metaphor for the wider UK financial services industry. That is what I have taken it to mean in the context of this debate.

As my hon. Friend said, the UK financial services industry plays a vital role in our economy. As I have a bit of time, I will start by laying down some facts and debunking a few myths about the City of London and its position that frequently, and perhaps unhelpfully, circulate.

There is an impression that London is only about financial services. That, in turn, translates into concerns that the UK economy as a whole is unbalanced. It is easy to assume that London’s economic output is completely dominated by finance, but the sector generated 17 per cent. of London’s GDP in 2006, compared with a UK average contribution of 7.5 per cent. to regional GDP. That is interesting to note, particularly when one thinks of the remarks made by the hon. Member for Southport about the northern regions. Even regions better known for their expertise in advanced engineering and low-carbon technology have financial sector output nearing the national average. That includes Yorkshire and Humberside.

Balance is a relative concept. The UK financial services industry as a whole, depending on the extent to which financial intermediation activity is measured, accounts for between 7.5 and just over 10 per cent. of national output. As a further comparison, the manufacturing sector alone accounts for about 14 per cent. of UK output. Of course we stress the financial services sector’s importance to the UK economy, but comments about its dominance need to be considered in context.

Many references were made to the importance of City competitiveness, which assumes that the UK financial services industry is only about London. The hon. Member for Fareham and I, who have neighbouring constituencies, know that there are many financial services sector industries outside the City. The reality is that London is home to just under one third of overall UK financial services employment; individual regions such as the north-west generate almost 10 per cent. Regions differ by sub-sector. London is strong on broking and fund management, the east of England on life insurance and south-western Scotland on life insurance and pensions.

Our long-term objective—anybody’s long-term objective—is fair, efficient, stable financial markets that support economic growth and prosperity. That means that there must be interaction between the financial services industry and the wider economy—another point that has been made—but achieving that optimal interaction is, of course, riddled with tensions and challenges. There is a criticism predating the current crisis about the detachment from the broader economy with which the City—sometimes “the City” is used as a synonym for the higher value-added or exotic elements—is seen to operate. On one level, that has to do with the complexity of the products, but on another, the sense of detachment cuts to the heart of economic morality. I cannot remember who made the point that some see it as encouraging a brain drain from other economically valuable sectors at the expense of local economies.

A second tension is the apparent misalignment between risks borne by taxpayers in allowing the financial sector to grow and the actual benefits gained by those citizens from the sector’s basic role in allocating capital and helping society manage risk. A third is the combined gravity of the Government’s actions to tackle problems in individual financial institutions and restore system-wide stability. Questions have been raised about whether there is an optimum size for the UK financial sector relative to the wider economy. That, in turn, has generated a debate, mentioned by many hon. Members, about whether individual financial institutions have become too big to fail and, if so, what the appropriate regulatory response is.

Having identified what the tensions are, I will try to answer the questions raised about how we propose to address them. The Banking Act 2009, the Turner review and the Treasury’s wide-ranging White Paper “Reforming financial markets” have given us some pointers for where to go: more effective prudential regulation and supervision of firms, greater emphasis on monitoring and managing system-wide risks, greater confidence that the authorities are ready and able to deal with problems involving systemically important institutions and greater protection for the taxpayer when an institution fails.

My hon. Friend mentioned the Glass-Steagall Act. The only point that I would make is that banks of all sizes, not just institutions above a certain size, have encountered difficulties. I am not convinced that a cap on size would necessarily be an effective way of managing risks. I believe that looking at systemically important institutions and managing risks is a better approach.

I absolutely agree with my hon. Friend about mutuals. I would; I am a Labour and Co-operative Member of Parliament. In “Reforming financial markets”, we made the point clearly about the importance of the mutual sector, particularly in creating a diversity of institutions. There has been a tendency to concentrate on one type of institution, and diversity balances risk.

I agree. I hope that Northern Rock goes down the mutual route, and that the mutuality of building societies will come back into vogue. Does the Minister not recognise, however, that ever stronger regulation is an impediment to the diversity to which she refers?

It is about getting the balance right and recognising that just because an organisation is managed mutually, that does not mean that the consumer assumes less risk. If consumers invest in an institution, they are entitled to the protection of regulation, whether the institution is a mutual organisation or a plc. It is about getting the balance right.

We talked a little bit about the international level. The fifth point, I think, was a financial transaction tax, or what in my old Co-op days we called a Tobin tax and debated regularly at the annual party conference. I am sure that my hon. Friend will be aware that it cannot be done on its own but would have to be done globally. The Prime Minister said in a recent speech that it was worth considering, and I know that the French are conducting a feasibility study and a working party on it. We will be watching with interest how it develops. It is certainly not something that the UK could do on its own, and there is an awful lot more work to do on it.

I am conscious of the time, and I want to pick up as many points as possible. I turn to corporate governance, because not all risks can be addressed simply through regulation. Sir David Walker is due to report on the governance landscape in the UK banking sector in November.

A number of people mentioned bonuses. We are approaching tackling bonuses with four basic principles: rewards for failure are not appropriate; bonus payments should be based on long-term, sustainable performance; bonuses should be designed to shape future performance and thus subject to appropriate clawback if performance is not good; the regulator should take bank remuneration into account when supervising a bank.

Moving on to hedge funds in my last two minutes, I think that there is a tendency to cast hedge funds as the villains. We have heard many different aspects of that in this debate. Mention has been made of the total value added by hedge fund managers to the UK economy; a PricewaterhouseCoopers report said that it was £76 billion for 2007. The report further highlighted their value with estimates that hedge funds accounted for 1.3 per cent. of the London work force and 5.9 per cent. of total London earnings.

The UK regulatory regime is among the most rigorous in the world and, in general, has stood up well, but the Government and the Financial Services Authority have identified one aspect that requires strengthening: oversight of the impact that hedge funds’ investment position and strategies have on systemically important market sectors. We are looking to strengthen oversight in that area.

On the EU directive, we support the high-level structure and approach of the directive, which is similar in many ways to the current UK regime. However, there are a number of detailed points at which we think the current draft would impose large costs and constraints on fund managers without a commensurate improvement in regulatory protection. If that improvement is not obtained, there is no point doing it. Lord Myners is leading on the issue and we regularly meet with other EU member states. The Swedish presidency is developing a revised draft that we believe will represent a major improvement on the Commission’s draft, and the European Parliament has just started work on the dossier and appointed a rapporteur.

The question of the impact of the City of London on the UK economy requires us to consider more broadly how the financial services and the economy interact, the tensions in the interaction and how Government, industry and other market participants can work together. The joint effort requires proper regulation.