That the Grand Committee do report to the House that it has considered the Dunfermline Building Society Compensation Scheme, Resolution Fund and Third Party Compensation Order 2009.

Relevant Document: 17th Report from the Joint Committee on Statutory Instruments.

I shall speak also to the Amendments to Law (Resolution of Dunfermline Building Society) (No. 2) Order 2009. Before discussing the draft compensation order, perhaps I may explain why the Treasury took the decision to withdraw the draft instrument laid before Parliament on 4 June and to re-lay it on 15 June. A very minor error was identified in paragraph 7(5) of Schedule 1 to the original draft order; the reference to “properly or reasonably” should have been to “properly and reasonably”. We did not consider that it was appropriate to correct this error using the correction slip process, so withdrew and replaced that draft order. I apologise to the Committee for that slip.

As noble Lords will be aware, the Dunfermline Building Society was resolved on 30 March by the Bank of England effecting a transfer of part of Dunfermline’s business to Nationwide, and part to a bridge bank. Dunfermline was then placed in special administration following an application to court.

Where the Bank of England exercises its property transfer powers, the Treasury is required under the Banking Act to put in place compensation arrangements. The draft order that we are debating today makes provision: for the compensation scheme, at Part 2, in relation to the transfer of business to Nationwide; for the resolution fund, at Part 4, which makes provision for entitlements to the proceeds of resolution arising from the disposal of the business of the bridge bank; and for the third-party compensation provisions, at Part 5, which provide for the mechanism for assessing any compensation payable to third parties affected by each transfer and establish the scheme for assessing any compensation payable under the “no creditor worse off” safeguard. I will briefly overview these components.

First, the draft order specifies that compensation payable to Dunfermline in respect of the transfer of the business to Nationwide should be nil. As the Committee will be aware, the basic principle under Article 1, Protocol 1, of the European Convention on Human Rights is that compensation for expropriations of property must normally bear a reasonable relation to the value of the property expropriated. The auction process conducted by the Bank during the weekend of 28 to 30 March effectively determined that the market value of the business was nil because the winning bidder did not pay any consideration. Therefore, the Treasury does not consider it appropriate to engage a valuer to assess the value of the business, and has exercised its discretion under Section 49(2)(a) of the Banking Act to specify in the order that the compensation payable is to be nil.

Secondly, the draft order makes provision for the arrangements for the resolution fund in relation to the transfer of business to the bridge bank. The fund is intended to act as a signal that the authorities do not intend to profit from the resolution.

Lastly, the third-party compensation scheme makes provision for an independent valuer to determine two things. The first thing to be determined is the amount of any compensation payable to any third party affected by an application of Section 38(6) of the Act—that is, the section that specifies that the property transfer instrument made by the Bank is to be disregarded in determining whether a default event provision applies and has the effect of turning off third parties’ contractual termination rights. The valuer will also assess whether there is a difference between the treatment that pre-transfer creditors of Dunfermline would have received had Dunfermline gone into insolvency immediately before the transfers, and the actual treatment of those creditors arising as a result of the transfers. This is the “no creditor worse off” safeguard, which makes provision for the valuer to assess whether it is necessary for the Treasury to pay any compensation in the event that pre-transfer creditors are left in a worse-off position as a result of the transfers.

I shall touch on the appointment process of the independent valuer. In January this year I made a commitment in Committee on the Banking Bill, which we will all recall vividly, about the extent to which the appointment of the valuer would be independent of Government. I said, as reported in Hansard:

“At every stage, the Government have been at pains to ensure that the Treasury is one stage away from decisions that relate crucially to the appointment, performance and remuneration of the independent valuer”.—[Official Report, 19/1/09; col. 1478.]

The draft order provides for the Treasury to set up an appointment panel to appoint the independent valuer. Unlike the appointment process for the valuers appointed to conduct functions under the Northern Rock and Bradford & Bingley compensation schemes, the panel will appoint the valuer rather than making a recommendation to the Treasury about the candidate to be appointed. We consider that this further enhances the already robust independence of the appointment processes that we have put in place in previous circumstances.

The second order, the Amendments to Law (Resolution of Dunfermline Building Society) (No. 2) Order, has been laid in draft under the powers in Section 75 of the Banking Act 2009, which enable the Treasury to make amendments to law so as to give effect to resolutions of failing banks.

As all Dunfermline’s member business was to be transferred to Nationwide, the Bank’s property transfer instrument was drafted so as to transfer all Dunfermline’s business to Nationwide with the exception of certain property, rights and liabilities specified in the instrument. In particular, Dunfermline’s £660 million commercial loan book was not to be included in the transfer to Nationwide.

However, due diligence undertaken in the weeks following the transfer demonstrated that the technical definitions adopted in the property transfer instrument led to a significant proportion of the commercial loan book being erroneously transferred to Nationwide, together with a small number of social housing loans. “Commercial loan” was defined in the transfer instrument as a loan to persons who were not eligible claimants under the Financial Services Compensation Scheme, as commercial entities would not normally be liable to compensation under the FSCS. “Commercial mortgage loan” was defined in similar terms. A small number of loans which were considered to form part of the social housing book were also transferred to Nationwide by the transfer instrument.

Further due diligence in the weeks following the transfer has identified, however, that a large number of the borrowers on the commercial loan book were in fact eligible claimants under the FSCS rules. That means that the effect of the instrument was to transfer these loans erroneously to Nationwide.

The order before the House today identifies each of the loans that is, and was always intended, to remain with Dunfermline by an individual identification number, listed in the schedule to the order. The order has retrospective effect to 8 am on Monday 30 March, the time when the transfer of Dunfermline’s assets was made, and essentially corrects the error in the transfer instrument as though it had never been made. The effect in law is as though the loans had never been transferred to Nationwide.

In assessing the options to address the mistake in the transfer instrument, the Bank of England, in consultation with the Treasury, has fully considered all possible commercial and contractual remedies that might have achieved the same effect as the draft order we are considering today. The Treasury is satisfied that use of this order and its retrospective effect is therefore necessary to ensure the completion of the Dunfermline resolution, and desirable so as to limit the call on public funds. Treasury and Bank of England officials have of course discussed the scope and content of the order with Nationwide and the administrators.

I merely add the obvious point that we considered at great length whether anything might prove to be retrospective in the Banking Act—I recall the intensity with which that aspect was scrutinised. Here, an error occurred, which is why we are involved in some retrospective activity. I commend the orders.

Until the Minister stood up, I had not realised that we were debating the two orders together, which is entirely my fault, because I can see that properly stated on the Order Paper, so I will be shuffling my papers between the two. If the Minister will permit me, I will start with the second of the orders, where the Minister looked, I think, duly embarrassed about using Section 75—not that the Minister should be embarrassed at what has happened, but I hope that there is a due degree of embarrassment at the Bank of England. When Parliament entrusted the property instrument power to the Bank of England under the Banking Act, that was done under the tacit assumption that the Bank of England would exercise the power competently. Clearly, it has not done so.

The various powers in the 2009 Act were not designed for frequent use—indeed, we hope that they will not be used frequently—but we are entitled to some assurance that lessons have been learnt from this occurrence. Has there been a proper formal post-mortem examination at the Bank of England with a view to identifying what went wrong and why? If this had been in a commercial document, it might not have been as easy to revise it as with the stroke of a pen on a statutory instrument.

The Minister referred to our lengthy discussions at various stages of the Banking Bill, and it is fair to say that he struggled to come up with any plausible way in which the Section 75 power would be used. Since then, we have had the No. 1 Dunfermline order, which made a whole raft of changes to law which some of us think could well have been made in the Bill, and had retrospection of the total amount of one hour and 45 minutes—hardly a substantive use.

This order is a more substantive use of the power, but it is for a rather less substantive reason: that is, it is to correct the shoddy draftsmanship of the Bank of England. I am not going to object to the order today, because it is clearly convenient to have the Section 75 power to use in these sorts of situations. However, if the Minister had stood at the Dispatch Box during the passage of the Banking Bill and said that he needed the Section 75 power to correct drafting errors made by the Bank of England when using its property instrument power, we might have invited him to make a more targeted power in the Bill—for example, to correct property transfer instruments—but it is more likely that we would have fallen about laughing at the Government thinking it necessary to have such a power in the Bill to cope with incompetence. As I say, however, we will not object to the order; we simply hope that the Government are not proud of it.

The more substantive of the two orders which the Minister introduced is the Dunfermline Building Society Compensation Scheme, Resolution Fund and Third Party Compensation Order 2009. It is really four orders in one, because it covers the compensation scheme, the resolution fund and the third-party compensation scheme, as well as the appointment of a valuer to carry out the valuation of the amount of recovery for the purposes of the Dunfermline contribution to costs order, which we debated in May.

In broad terms, the order is not controversial. Indeed, I might even say that it is potentially very interesting for Banking Act anoraks—those of us who survived the Banking Bill process—because it will set up the first of these compensation schemes, resolution funds and third-party compensation orders; so it is the first time that these powers will be road-tested. We will look very carefully at the progress of the use of the powers to see whether they stand up in the light of real facts and events.

I have a few questions for the Minister. First, will he update the Committee on what is happening to the Dunfermline Building Society? As I understand it, the social housing assets were initially transferred to a bridge bank, owned of course by the Bank of England, but last week the Nationwide, which of course was involved in the original transaction, also acquired those assets. Will the Minister say what the Nationwide paid for those assets relative to their face value? Does this transaction complete the work of the bridge bank that was set up as part of the Dunfermline rescue? Approximately how much—I do not expect him to have definitive figures—will be paid into the resolution fund? I think that that comes from the bridge bank.

Secondly, Dunfermline has been placed into administration. Does the Minister have any information on the progress of that administration, including the likely deficit to be borne by secured and unsecured creditors, including the pension fund? If he does not have the information, will he say how it can be obtained? I could not get any up-to-date information online, which is of considerable concern.

These questions are tangentially related to the work of the valuer appointed under Article 11 of the order, because the valuer will have to work out the “amount of the recovery” for the purposes of the contribution-to-costs order. I believe that the amount of the recovery is the amount that the valuer believes that the Financial Services Compensation Scheme would have got back from Dunfermline, had the FSCS paid out to depositors in the normal way under its rules and then recovered it. Will the Minister confirm that this will entitle—indeed, require—the valuer to assess the value of the business and assets of Dunfermline that would have been sold if Dunfermline had not been dealt with by the special resolution regime? The valuation is necessary irrespective of the fact that the Treasury has now determined the compensation available to Dunfermline as nil. That does not bind the valuer, who has to reach his own view on value. I ask the Minister to confirm that.

Will the Minister comment on the similarities to, or differences from, the calculations that the valuer will be required to make for the third-party compensation scheme? This concerns the amounts that would have been received by the creditors, but I assume that it involves some of the same underlying issues of how much the business was worth and therefore how much would have been paid out to the creditors had the business been dealt with in accordance with the assumptions that are specified.

In that connection I note that, in respect of the third-party compensation scheme, Part 3 of Schedule 2 has some detailed valuation principles about financial assistance and so on, which we have seen in other orders, and which have to guide the valuation. However, I could see no equivalent principles applying to the Article 11 valuation process—that is, the process that will apply under the contribution-to-costs order. Can the Minister explain this disparity of approaches by the same valuer to two different parts of the task that he will be carrying out, and comment on whether that might result in inconsistent valuations coming out of the process? Valuation principles are specified for one, although I do not believe that such principles have been specified for the other for the purposes of Article 11.

I have a couple of other detailed questions for the Minister. The first relates to the account holder for the resolution fund. Who is that likely to be? It is required by paragraph 1(2) of Schedule 1. Why does an independent person have to be appointed to hold the money? Why could the account at the Bank of England not simply be the Dunfermline resolution fund? Why does it have to be held in the name of an individual? What does that add?

My other, more detailed, question relates to paragraph 3 of Schedule 2, which says that third-party compensation is to be paid only if it is required to be paid in order to comply with the European Convention on Human Rights. What is this intended to do? In what circumstances would this proviso prevent compensation from otherwise being paid? Is this intended to restrict the operation of the rights to compensation triggered by Section 38(6) of the Banking Act? If so, why was this provision not included in the Bill? It seems quite a significant point to have been included in the order rather than the Bill. Also, has this point been consulted upon?

Apart from these points, we are content with the order.

I start with the Amendments to Law (Resolution of Dunfermline Building Society) (No. 2) Order 2009.

Well, this looks like a fair old cock-up, doesn’t it? I heard the Minister’s remarks about technical changes and technical mistakes, but if my advisers in a commercial transaction presented me with this and said I had to go back to whoever was signing it all off, I would be incandescent. What happened? What was going on? Who was acting in the Bank of England? Was it acting for itself? Were lawyers involved? These seem to be very basic things that you check. If there were outside lawyers, what was the firm? What were they paid? I hope that the bill has not been paid. If they were from inside, I hope that a few people have been sacked. These are simple basic things, and for the Minister—although it is obviously not his fault—to have to come here and produce pages and pages of numbers of loans is deeply embarrassing and does not meet the standard of professionalism that we expect from the Bank of England. Can the Minister please answer those questions? Taxpayers are not getting value for money when such obvious mistakes are being made.

I thought that I heard him say something along the lines that it was discovered that borrowers on the commercial loan book were eligible claimants under Financial Services Compensation Scheme rules. That mystified me. Can the Minister explain more? I do not understand how borrowers can make claims. Perhaps I am being stupid.

I turn to the second order. Perhaps I may ask one or two more general questions about what happened here and where we are. It has become clear that there is a poisonous pile of debt resulting from poor-quality loan decisions on commercial property by Dunfermline. It was clearly way out of its depth. There was horrific exposure to very dangerous sorts of property. For example, a large site in Bournemouth was not income-producing at all. Frankly, no experienced commercial lender should have been involved to anything like that extent—certainly not amateurs playing in a market that they did not understand, like the people in the Dunfermline Building Society.

What independent property valuations have been done? When were the last valuations of the properties securing these large loans? If there has not been a valuation recently—and we are in a depressed market, so it is easy to get the valuers to do a check valuation at low cost—will the Minister undertake that there will be up-to-date valuations of the properties so that we can see how far under water the loans are?

I have some scepticism about how much time and energy it will be worth investing in the valuation of any compensation payable, given what I believe to be the serious negative equity in which the loans are involved—rather as I felt about Northern Rock. But that is a separate case; I am making a specific request that the Government come clean about the current value of the properties on which these loans are secured.

I am sorry; I should have declared an interest. The Dunfermline Building Society was a tenant of a property I manage on behalf of a pension fund. I am waiting for the application to assign to the Nationwide, but it has not come through yet.

Deputy Chairman, it might be convenient for the Minister if I very briefly intervened to make a few remarks.

Could the noble Lord rise?

Why? I have a gammy leg at the moment, if you don’t mind.

Of course.

Thank you. It is the arthritis of old age. These are the problems that occur if you live long enough. I declare an interest in that many decades ago I was a Dunfermline Building Society manager. I do not intend to repeat the few remarks which I made in the Chamber pre the surveillance of the Statutory Instruments Committee. What I want to say, which follows on from the noble Baroness’s point, is that it is not very clear up there—I live in Scotland—just where we are going with the housing association loan book, which has apparently gone to the Nationwide. On the surface and in public terms, that is a somewhat grey area. If the Minister could be specific on that issue, it would be helpful not only to me and other Members present but to the wider public in Scotland, because the Scotsman newspaper, at least, has tended to publish detailed information.

I am grateful to all noble Lords. I offer my rather belated congratulations to the noble Baroness on her birthday yesterday. I had hoped she had had such an uproarious evening yesterday that she would be somewhat blighted today, but no such luck. She is on her usual form. I am therefore obliged to do my very best to answer the detailed questions that she and other noble Lords have asked. I shall examine the detailed questions in Hansard very carefully and if I have failed to answer them I shall write to the noble Lords concerned with fuller answers.

The noble Baroness asked significant questions and made the obvious comment that the fact that we are in this position indicates that a mistake has been made. That is certainly the case, but I recall some scepticism on the part of the opposition about the necessity of making provision in the Banking Bill, as it then was, to deal with the possibility of errors occurring. After all, we are all aware of the fact that this work is done in—

Will the Minister point me to the Hansard reference where he ever said that Section 75 was going to be used to rectify errors of this nature?

Section 75 was a very important provision in the Act. I hope that the noble Baroness will rightly identify that a mistake has been made, which we clearly need to take lessons from—I emphasise that point—and recognise the wisdom of the Act being presented in such a way that we are able to make up for weaknesses, particularly against a background where we all recognise that work is done under considerable pressure. We all know that things have to be done with such dramatic suddenness, given their impact on creditors and depositors of banks and building societies: hence the necessity for prompt action. I accept what the noble Baroness has indicated, which was reinforced by the noble Lord, Lord Oakeshott, that this error should not happen at all, and certainly not often. I reassure them that the Bank and the Treasury fully discussed the causes of the error before agreeing to lay this Section 75 order. As I indicated in my opening speech, other possible commercial solutions were canvassed but were decided against.

In any future resolutions the tripartite authorities will continue to work together to ensure that all possible risks to the progress of these transactions are managed as effectively as possible. However, none of us should underestimate the challenge this work presents when one is operating under such time constraints. Of course, I accept, and recognised in my opening comments, that there is justifiable criticism when things go wrong. However, we made provision for that in Section 75. I even said at the time that parties might all have intended to achieve a particular effect, and proceeded on the basis of that intention, but an examination of the instrument may reveal that the text itself was ambiguous or even wrong. In such cases it may be entirely appropriate to correct the drafting with retrospective effect to ensure that the parties who signed up to the resolution are indeed in the position—we all recognise that this is the important point—they intended to be in when they gave their agreement. We were wise enough to appreciate that when people are working under pressure, problems—it might even be a minute technical problem—may arise, and that therefore it was necessary to have a fallback position as far as the Act was concerned.

The noble Baroness is right that no Minister wants to be in this position so soon after the passing of the Act. It is important that the authorities can give assurances that lessons have been learnt, and I convey those assurances today.

I will come on to the points made by my noble friend Lord Kirkhill in a moment. I am all too well aware of the significance of the Dunfermline Building Society to Scotland, but I hope it will be accepted, in the terms that I have outlined, that it was necessary to take this action which was available under the Act. We hope that that action will not need to be repeated, but we are relieved that we have a framework and that the Act is constructed in such a way that we can address ourselves to problems that we become aware of subsequently.

The noble Baroness asked me a number of questions about the independence of the account. It needs to be held in the name of an independent person because both the Treasury and the Bank of England have some interest in the money, in so far as they are entitled to deduct costs. They are therefore a party to the position, so it is proper that it should be handled by an independent valuer rather than in the organisation.

The noble Baroness asked me about the proceeds from the sale of the social housing book. Consideration is to be paid by Nationwide on completion of the transaction, so it is, I am afraid, subject to commercial confidentiality at this stage. I do not ordinarily shy away from trying to answer her questions to me, but in this particular area I think she will accept my answer.

How is the sale of the bridge bank progressing? The Bank of England announced that it has selected the Nationwide Building Society as the third bidder for the social housing loans and related deposits from housing associations that are held by the bridge bank. This followed a competitive process that was conducted by the Bank of England in accordance with the code of practice issued by Her Majesty’s Treasury under the Banking Act 2009. That is the progress that is being made.

The noble Baroness asked me about valuation principles under Article 11. These are difficult areas for me to respond to immediately at this point. If she will forgive me, I will write to her on this point, not least because the degree of complexity that appears to have been identified in the notes passed to me are such that I do not trust myself to deliver them with the clarity and accuracy that she deserves.

What is happening to the Dunfermline Building Society? As my noble friend Lord Kirkhill indicated, he has a close interest in Scotland—

The Minister is moving on, but I am afraid that I did not hear him answer my questions, which were pretty simple, I thought. Was this matter handled entirely in-house? I am particularly interested in the legal advice and the legal process followed by the Bank of England legal team. If it was not, were outside lawyers involved? If so, who were they, and what fee did they get? We have had the horrific revelation today that the Treasury managed to pay £22 million to Slaughter and May last year for financial advice. Was it Slaughter and May? If it was, how much did it receive? If the Minister does not have those facts to hand, will he undertake to write to me urgently, please?

I do not have those facts to hand; part of the answer to that is that that is the responsibility of the Bank of England, but I will take steps to translate the noble Lord’s questions to the appropriate authority and seek to get an answer for him.

On Dunfermline, I have said that the Bank of England selected Nationwide building society as a preferred bidder for the social house loan. We cannot comment on the outcome of the sales process at this stage, as the commercial transaction is not complete as yet. The Bank of England will provide an update in due course: it is under an obligation to do so and will do so. The proceeds of the sale will of course be paid into the resolution fund by the Bank of England. It will be known as the Dunfermline resolution account. Any consideration received from the sale of the shares in the bridge bank, or any distributions made by the bridge bank, for example, following the sale of the business of the bridge bank or by a liquidator appointed to wind up the bridge bank, will be there. The ultimate beneficiary of the account is Dunfermline.

The Bank of England and the Treasury are entitled to be reimbursed—a point I made to the noble Baroness about their direct interest in the issue. The Treasury will need to decide whether any of those costs should in fact be recovered from the monies in the accounts. Before any costs may be recovered from the account, the cost will have to be certified by the independent valuer appointed by the Treasury to have been reasonably and properly incurred. That is the next stage.

On the question of the valuation of the commercial loan book, that will be a matter for the administrator who will be in receipt of the property should the order be passed here and in the other place. I will relay those questions to the administrator; it will be his task to respond to them. Following our exchanges, I will ensure that in due course he is made aware of them.

I was asked by the noble Baroness whether third-party compensation will be worked out on the “no creditor worse off” arrangements, how that will work and how the valuer will treat the business of Dunfermline. The valuer is required to apply the valuation principle in accordance with the Banking Act. Dunfermline entered into the insolvency procedure immediately before the time that the transfer instrument was made. This is a mandatory valuation principle that must be included in a third-party compensation order in accordance with the regulations.

The Government believe that that is the correct position as, in order to enter the special resolution regime, Dunfermline had to be failing to meet its threshold conditions. As such, a bank entering into the special resolution regime will have failed to be a going concern. As it would no longer be able to perform its regulated activities, the threshold conditions are no longer met. In this case, we have decided that it is appropriate that the independent valuer should determine which insolvency procedure Dunfermline would enter into, rather than specify the procedure in the order. The valuer will be able to assess for himself the treatment of any property of Dunfermline.

All in all, we believe that the “no creditor worse off” arrangements provide an entirely effective safeguard of creditor interests where the partial property transfer powers have been effected, as in this case. We believe that the provisions set out in Schedule 2 to the order will provide comfort—I know that my noble friend will appreciate this—to the creditors of Dunfermline and, more broadly, will provide an example of how the Government have met our promises about protecting the interests of creditors where the stabilisation tools are exercised. Accordingly, we reassure creditors, banks and building societies.

I cannot emphasise that point strongly enough; we discussed it at considerable length when we considered the Banking Act. We all know that the special resolution procedures and stabilisation tools exercised are difficult, are operated under intense pressure and are of the greatest importance in terms of fairness to creditors while, at the same time, preserving as far as possible the positions of the assets concerned.

I hope that the noble Baroness will feel that we have responded to that position effectively in the context of the legislation. I apologise if it looks a little as if I have gone over some old ground today, but the perspicacity of the noble Baroness and the noble Lord leading for the opposition parties during the Banking Bill meant that we looked at some of these issues with great intensity at that time, and although I thought there was a possibility of the special resolution procedures being applied, I did not for one moment imagine that we would be in this situation quite so soon.

I hope that the noble Baroness will accept that with regard to both the position that the Government adopted on to the passage of the legislation and the way that we have taken these decisions subsequently, allowing for our obvious embarrassment about the drafting mistake in one of the instruments, most of her anxieties have been allayed.

Before the Minister sits down, he made a handsome offer at the outset that Hansard would be carefully scrutinised and that those questions that were not answered would be answered separately in writing—copied, I hope, to the noble Lord, Lord Oakeshott. I think he will find that he did not answer a number of questions fully, but there is one that he did not answer at all: why there is a limitation that third-party compensation is paid only if it would have been paid under the European Convention on Human Rights. I did not hear him attempt to respond to that. Because I am being kind today, though, I am happy to have all other questions dealt with in correspondence.

As I am also being kind today, I remind the Minister that I said I was mystified by the business about borrowers on the commercial loan book being eligible claimants under FSCS rules. I invite him to write to me without my having to chase him on that point.

In the light of these questions, I shall learn to sit down more quickly. On the latter point, I will have to write to the noble Lord. On the initial point, though, the provision in paragraph 3 of Schedule 2 of the compensation order is intended to limit any compensation to be paid in respect of the turning off of termination rights, and it was included in both Northern Rock and Bradford & Bingley compensation scheme orders. We have therefore already addressed ourselves to these issues in previous orders, and I have nothing to add to that with regard to this one.