My Lords, we have just started to emerge from a financial crisis that has affected businesses and consumers across the world. This global crisis has led us, in the same way as other countries around the world, to fundamentally review our financial system and its interaction with the broader economy. Last year, with the Banking Act, we ensured that UK authorities have the power to deal with failing banks, while continuing to protect consumers and taxpayers. This year, we have an opportunity to revitalise the financial framework, so that the UK is ready not only to address the effects of the crisis, protecting consumers and businesses, but also to tackle its root causes.
Well managed, well functioning financial institutions are in the national interest. It is clear that our objective should be to help build a financial sector that supports the wider economy, and is not only commercially viable, but also stable. The Government have a duty to ensure that we harness the lessons of the past two years, and make sure that, in future, any crisis will be not only less damaging, but less likely altogether.
To achieve this, we need to tackle shortcomings throughout the system. There is no one silver bullet that can remedy in a single attempt all the global challenges we face, and that is why we need to pursue a comprehensive set of measures. We need to deal with both the way firms are managed, and the quantity and quality of capital they hold; both the way regulators assess and monitor risk, and the way the authorities co-ordinate their activities; and both the way consumers handle their financial affairs, and the way they get redress in cases of detriment.
This Bill seeks to address some of these important issues. I think all sides of the House will agree that tackling these matters is the right thing to do, and I am pleased that both opposition parties made statements in support of this piece of legislation in another place. Indeed, the Conservative spokesperson in another place said in his speech at Third Reading that, when glancing at the content of the Bill, he realised how much of it he supported. This show of support is indicative of the sensible nature of the measures in the Bill, which are designed to achieve objectives on which we can all agree.
First, the Government have a clear strategy to enhance the focus on systemic risk, and provide a clear mechanism for co-operation. Clauses 1 to 4 establish a statutory Council for Financial Stability, made up of the Chancellor, the chairman of the FSA, and the Governor of the Bank of England. The purpose of this council is to ensure that systemic risks to the stability of the UK financial system and the wider economy can be swiftly identified and addressed. It will deal with both immediate and longer-term strategic issues, and will formally consider the Bank’s financial stability report and the FSA’s financial risk outlook in quarterly strategic meetings.
I am aware of the extensive debate on the institutional structure of financial regulation that occurred during the discussion of this legislation in another place, but I am clear that our model, with an independent central bank and a single, independent financial regulator, is the right approach.
The council will strengthen the existing regulatory structure and provide the high-level framework needed to better co-ordinate the authorities’ approach to financial stability. It will deliver important improvements through a more structured, formal, open and accountable approach to co-ordination between the three authorities.
The Bill requires the council: to meet regularly, at least once a quarter; to be much more open, through minuting its quarterly strategic discussions; and to be accountable to Parliament, through a formal annual report on the council and financial stability that will be laid before Parliament. These are all useful, important changes that improve the way tripartite co-ordination works in practice.
As noble Lords are aware, the Government are keen to have these enhanced arrangements in place as soon as possible, and we have set up the council in shadow form on the basis of the model set out in this Bill and the draft terms of reference. The council met first on 14 January, and minutes of that meeting are now available on the Treasury website.
The meeting, which I attended, was very useful, and I am highly optimistic that it will deliver on its objectives. The council is perhaps not a glamorous or radical upheaval of the current system; instead it is a practical attempt to put the framework for co-ordination on a formal, statutory basis, with greater structure, transparency and parliamentary accountability. I am hopeful that noble Lords will view the usefulness of this forum from a pragmatic perspective, rather than insist on institutional chopping and changing in the hope that simply rearranging the deckchairs will somehow be conducive to the improved monitoring of financial stability. Clearly, that would not be the case. In tandem with the council, the FSA, through Clauses 5 and 7, will be given a financial stability objective and related powers to underline the need to consider systemic risk when supervising individual banks.
Clauses 9 to 11 address the issue of remuneration practices that incentivise excessive risk taking. Misplaced incentives for bankers to conduct business in an overly risky or even reckless manner played a significant part in the run-up to the crisis. The Government will not tolerate any further cavalier behaviour where depositors’ and taxpayers’ money is involved, and where failures could significantly affect the rest of the economy. We need to ensure that remuneration and bonus arrangements do not encourage executives to take excessive and unmanaged risks.
The measures in the Bill are twofold, with proposals to enhance control of the system of rewards on the one hand, and transparency and disclosure on the other. First, Clause 11 strengthens the FSA’s hand to take action against remuneration policies that encourage excessive risk taking. The FSA, as regulator, is best placed to ensure that remuneration is consistent with effective risk management, as it is close to the industry, independent and subject to obligations of fairness. The measures that we propose do not simply reaffirm the FSA’s existing powers: they place a duty on the FSA to ensure that remuneration policies are consistent with effective risk management, and are in line with the Financial Stability Board’s recommendations, which take into account the importance of international agreements in this area.
We are also empowering the FSA to make rules that impose specific prohibitions on the way in which individuals can be remunerated, by providing for any element of a remuneration agreement that breaches such a prohibition to be automatically void, and for the recovery of any related payment made. This will ensure that executives are not rewarded for failing to manage risk effectively. I assure the House that these provisions will not be retrospective, and that the Government have amended the Bill in another place to clarify this point.
Secondly, Clauses 9 and 10 provide the Government with the power to make regulations to implement in full Sir David Walker’s recommendations on disclosure and transparency. This will sit alongside and complement the FSA’s greater control over the system of rewards. These measures will enhance shareholders’ ability to exercise effective oversight over the remuneration paid in companies in which they are investors—a critical deficiency in current custom and practice. We will shortly publish draft regulations setting out the detail of how the Government plan to implement Sir David’s recommendations. The regulations will naturally be subject to full consultation and to the affirmative resolution procedure.
Clause 12 relates to recovery and resolution plans, which are sometimes called living wills. These plans will play a key role in reducing the probability and the impact of failure. They aim to make it more credible that firms will be allowed to fail, thereby addressing the moral hazard problem that is particularly associated with systemically significant firms. The recovery and resolution plans are only one element of the Government’s comprehensive policy to deal with systemic risk posed by firms, which also includes tougher prudential requirements on firms that pose the greatest risk.
Clauses 6 and 18 to 27 contain measures designed to support and protect consumers. The FSA will establish a new independent consumer financial education body with a remit to enhance consumers’ understanding of money matters and to improve their ability to manage their financial affairs. With support and education, consumers will be empowered to make the right financial decisions, and will be better able to manage their money today and safeguard their livelihoods for the future.
The new body will co-ordinate the implementation of a national money guidance service beginning this spring, making available for the first time accessible and impartial information and guidance on a range of financial issues online, on the phone and face to face.
As well as improving consumers’ financial skills and awareness, we need to provide consumers with better mechanisms for redress. In recent years there have been several instances in which a large group of consumers has suffered detriment at the hands of firms. We cannot allow this to continue. The Bill introduces two measures to enable a large number of similar claims to be dealt with more effectively. Clause 26 proposes to streamline and expand the FSA’s existing power to make rules requiring firms to set up consumer redress schemes where there is evidence of a widespread failure by firms to comply with legal and regulatory requirements.
In Clauses 18 to 25, we also propose to enable a representative body to bring an action through the courts on behalf of a group of consumers. This may be necessary when regulatory action is not appropriate, for example, when the law is unclear. This is a ground-breaking development for UK law. It is the first example in the UK of a full collective action in the courts for people with similar claims. It will empower consumers to group together to take legal action against firms, and it avoids the situation where a large number of consumers would have to make identical or similar individual claims.
The rule committee of England and Wales and the rule-making bodies in Scotland and Northern Ireland will make generic rules governing court practice and procedure. The Government will then consult further on the supplementary regulations that may be necessary to deal with financial services claims. These may cover, for example, regulatory alternatives and further conditions for authorising collective proceedings, including the approval of the representative. Regulations can also provide for damages to be awarded as a lump sum and ensure that claims do not become time-barred unfairly. Consumers will be able to use collective proceedings to pursue claims relating to financial services once regulations and court rules come into force. We are also proposing to ban unsolicited credit card cheques which tempt those who may already be in financial distress to increase their borrowing, rather than resorting to cheaper and more appropriate forms of credit.
These measures are key to renewing consumer confidence in the financial services industry. I am sure the House will agree that giving consumers the information that they need to make sound decisions and the opportunity collectively to seek redress are both good and imperative.
I hope that I have provided some additional context to the various measures contained in the Bill and what they will achieve. I very much look forward to the speeches this afternoon, and in due course the Committee debates.
My Lords, I start by thanking the Minister for introducing the Bill and apologising for the absence of my noble friend Lord Hunt of Wirral, who had hoped to make this speech. He will be back for the Committee stage, whenever that might be. I note that the Minister referred to a possible date, and perhaps we can explore that later. It would be interesting to know when the Government plan to fit in a Committee stage, as it will certainly take more than one day and probably quite a few days, and there are a number of other bits of legislation that they hope to shoe-horn into the relatively short time between now and when they go to the country. I hope to take part in that Committee. My noble friend will certainly be back for it, as it cannot take place for two weeks following Second Reading.
We understand from the Minister’s introduction that the Bill is designed to remedy the enormous regulatory failure that the financial sector has just experienced. It is a remarkable mishmash of provisions—some new, some cosmetic and some merely placing on a statutory basis powers that are already accepted.
Unfortunately, the very parts of the Bill where radical changes are needed—those relating to the failure of the FSA to foresee and prevent the collapse of financial stability which triggered the recent great recession—are the most timid. I will leave it to my noble friend Lady Noakes to lay out in detail our criticisms of the opening clauses, Clauses 1 to 5. However, we believe that nothing here will address the macro-level failings of the current system of regulation. On these Benches, our policy is to return prudential supervision to the Bank of England, which would ensure that one body—and only one—has the power and the responsibility for controlling risks to the whole financial system. The current regulatory system has been proven to be a failure by recent events; the sticking plaster that these clauses represent will do nothing to address the underlying structural defects.
The other provisions relating to the duties of the FSA, and to preventing the worst sort of imprudent behaviour in future, are more technical. In many cases, as the Minister made clear, we agree with the principle behind them. They bear close scrutiny, and I and my noble friends are certainly looking forward to engaging on that in Committee, but even here many of those clauses add very little. Powers are being taken in areas that certainly need looking at, but the powers we are being asked to grant the Government—or, for that matter, the FSA—are extremely premature. There is nothing wrong with leading the way in establishing best practice in our financial sector, but many of these provisions could be used to send us in a completely different direction from the rest of the world.
It would be both costly and disruptive to the industry to rush ahead in setting up a system that will have to be substantially downscaled in the near future to prevent the United Kingdom becoming uncompetitive. Nowhere is that more true than in the provisions dealing with consumer matters. We welcome the fact that the Government are taking steps to deal with the shockingly low level of public understanding of financial products—I believe that that is in Clause 6—and with the most irresponsible of financial products. I also welcome the Government’s attempts to set up quick, cost-effective and fair systems of redress for consumers. But do these provisions do that?
Once again, the majority of the provisions are nothing but broad brushstrokes, setting out the most general principles of consumer protection. That haziness is not an advantage; leaving so many critical decisions to a later stage has resulted in much uncertainty and concern among stakeholders. Consumer groups are rightly pleased that the Government have accepted that consumer redress proceedings need to be improved, but the provisions do not guarantee that the final schemes will benefit consumers as they should. It is very unwelcome that the Government thought it appropriate to rush through legislation on these matters without the pre-legislative scrutiny that we believe such matters warrant.
Again, we believe that we are in danger of embedding serious inconsistencies, both internationally and within the domestic sector. These provisions take no account of directives going through Europe on collective redress, nor is there any co-ordination with proposals for a new United Kingdom consumer advocate for the non-financial sectors, which are looking likely to involve only opt-in procedures and maintain a public interest test. Consumers will not be well served by multiple, conflicting redress systems across the United Kingdom economy.
Even within the United Kingdom financial sector, there is confusion and duplication. After the Bill has been enacted, there will be three separate avenues for consumers to seek redress. The Bill is silent on the interaction between the existing ombudsman scheme, the right to undertake collective proceedings and the new powers for the FSA to establish a redress scheme. Would it not be sensible to enshrine in these provisions the progression suggested by the Ministry of Justice last year, whereby court proceedings would be a last resort after the administrative routes had been exhausted? I should be very interested to know what the Government think about that.
With so little spelt out in these clauses, it is not surprising that important safeguards are absent. The Bill allows anybody to be identified as a representative, even where they have no interest in the proceedings, and that opens the way for claims farmers to siphon off damages rightly owed to consumers.
The lack of any criteria against which the court will judge whether opt-out proceedings might be considered suitable leads to further questions about how costs are to be apportioned if the case is unsuccessful and how unclaimed damages will be apportioned. The answers to those questions are also to be left to the rules, which we have yet to see.
These sorts of details are not trivial. The Bill does not even contain the criteria that the court will apply when ruling on whether a collective action should be certified. Matters of implementation detail are, in the main, better left to court rules, but these decisions are fundamental to the question of what sort of system we wish to see established. I think that we need to ascertain that while the Bill is proceeding through this House; again, it is another matter that will need to be addressed in Committee.
Unfortunately, the list of uncertainties is added to by Clause 26. The extension of the FSA’s powers and the exclusion of Parliament in the exercise of those powers were rightly highlighted in the fifth report of the Delegated Powers and Regulatory Reform Committee. Again, that is something that the noble Lord will have to address in due course. The existing powers which the FSA has to impose a redress scheme have been completely rewritten by Clause 26, which I think extends over four or five pages. In the process, many of the essential steps that are required under the Financial Services and Markets Act 2000 before the FSA imposes a scheme on the industry have been dropped. Many of us remember the passage of that legislation. I think it was the noble Lord, Lord McIntosh of Haringey—I see him smile—who took it through this House before the noble Lord, Lord Myners, was here. As I said, many of the essential steps required by that Act before the FSA imposes a scheme on the industry have been dropped, and that is very much at odds—again, I see the noble Lord smile—with some of the debates that we enjoyed when dealing with that legislation. The Minister may want to look at his declaration on the front of the Bill that it is compliant with the Human Rights Act, as I have a sneaking suspicion that the appropriate safeguards that would ensure that FSA decisions were human rights-compliant are being dropped. I simply make that comment in passing but I should be very grateful if the noble Lord would look at it.
Clause 26 also appears to give the FSA the responsibility of second-guessing what a court might decide and of assessing liability not only for breaches of its rules but also for breaches of the law. The potential sums that redress schemes might handle run into the hundreds of millions. It is hard to accept that the courts should be excluded because of the burden on their time or the length of court proceedings when such a significant cost could be imposed on firms by what is a wholly administrative system. Judicial review will obviously not allow firms to challenge the substance of the FSA’s decision, only the process by which that decision was made. It is no substitute for the checks and balances that should be in place for such schemes. However, with the number of distinguished legal luminaries who are to speak later, I have no doubt that others may wish to address that point.
The consumer provisions in this Bill should enable the establishment of just and effective systems for consumer redress. The lack of detail in these clauses unfortunately puts consumers at risk of exploitation by organisations more interested in generating revenue and publicity than in seeking fair compensation for damages—something we have seen in the world of personal injury for many years. The lack of safeguards in the clauses leaves the entire financial sector uncertain as to their rights and responsibilities towards their customers, and without recourse to the appropriate judicial protection. What is worse, both schemes—the collective proceedings and the redress scheme—appear to be retrospective. I appreciate that the Minister addressed this point earlier on another matter, but is he happy with establishing systems that will be imposed on actions taken before the Bill comes into effect? Does he not think that that is unfair and completely counter to the principles of natural justice?
As I said at the beginning, I do not know when we will have the opportunity to discuss these matters in greater detail. The sands are fast running out on both this Parliament and this Government. The Government want to squeeze a vast array of legislation into a limited amount of time. However, I can assure the Minister that, when the business managers tell us that it is appropriate to have a Committee stage of this Bill, we will want to give it a full and detailed examination of the sort that this House can give before it continues its progress. I am sure that the noble Lord will be looking forward to that Committee stage.
My Lords, during the Queen’s Speech debate in November 2009, I made a short contribution about customer involvement and engagement with retail banks. I wanted to say something more about that this afternoon and to encourage my noble friend the Minister, for whom I have the greatest respect, to think widely and laterally about how he might do more to engage customers and give them the opportunity to influence events before they happen. Already, only two speakers into this debate, we are concentrating on redress and compensation, which means dealing with customer problems when it is too late. We need to think about ways in which we can engage customers in a meaningful dialogue with their retail banks that is helpful to all parties but avoids the pitfalls of the past.
In my previous contribution I was essentially arguing that a heavy reliance on regulation—the FSA in particular—is a top-down approach. To help customers, we really need to pay closer attention to what can be done from the bottom up. What can be done to give customers more say—even some power, perhaps—in how they regulate their own relationships with the banks? I drew attention to how customer engagement was the hallmark of the mutual sector, where customers or members can attend annual general meetings, debate motions with the board of directors, elect directors to the boards of mutuals and take part in a whole range of activities that engage them with their banks or building societies in a way that does not happen in the private sector.
I recognise that the private sector is different and that customers do not own the banks. I understand that shareholders own them; Governments might own them in the short term but in the long term the banks belong to shareholders. However, I believe that there is a strong case for giving the rest of the bank’s stakeholders—its employees and customers—a much greater say in how the bank is governed and managed.
In my previous contribution, I asked the Government to think about three things. First, would it be possible to have the equivalent of an annual general meeting for the customers of banks? Obviously it would have to be organised in a different way, but there would be an opportunity for a group of members to engage with the chief executive officer and other directors to discuss how the bank is performing and how that performance affects stakeholders—the customers of the bank. Secondly, I asked for an annual customer meeting in those regions where a bank has more than 10 branches. Thirdly, I asked for banks over a certain size, which is to be determined, to have a consumer council or council of members that would meet at least four times a year with—this is crucial—the chief executive officer and the directors to debate the bank’s performance and to get the customer view of that performance.
Following the debate last November, I decided to put these proposals to the chief executive officers of five retail banks that I selected at random. I had substantive and helpful replies from John Varley at Barclays, Eric Daniels at Lloyds and Stephen Hester at RBS, to whom I am grateful for their time and consideration. All made a good case for a traditional, top-down approach to customer relations. HSBC has apparently been unable to find my letter and I have heard nothing from Mr Hoffman at Northern Rock.
With this information as a background, I want briefly to press the case even more firmly for a new, bottom-up customer engagement approach that involves customers and gives them rights about how they should be consulted and engaged with by their banks. I want to see customer engagement that goes beyond what the chief executives outlined in their letters, such as satisfaction surveys, customer panels and focus groups. All those are things that banks do regularly and successfully, but I want them to bring their customers together with the chief executive officer and other directors for a period of half a day or perhaps a day in order to have a meaningful debate on an agenda that can be mutually agreed, but agreed in a major way by the customers themselves. I want to see an end to the customer as the passive recipient and a start of customer power. I want customers, not the banks or politicians, to set the agenda on the issues that they want to talk about. I want the debate to be between the customers and the board and to have directors pay real attention to what customers think about topics that customers decide.
If we can do this—and I believe we can—we can open up the banks to real customer engagement. If we can replace banks’ questions down to customers on things such as, “Do you find our staff friendly?”—a fair and important question—with real questions such as, “Will you tell us and have a real debate about what you think about our remuneration policy?”, we will be moving away from the normal stuff towards hard debate between customers and the people who run their banks. That is the sort of thing that I am looking for. We can change the behaviour of the banks and we can change the paradigm of bank and customer consultation. In doing that, we can change the culture of how this stuff works.
To achieve bottom-up stakeholder and customer engagement, we do not necessarily need legislation; I understand that. The banks could do this, but I do not think that they will. Are the Government, whom I admire and greatly respect despite all their problems, prepared to stand on the side of customers and give them some real power? That can be done either by pressing the banks to do some of the things that I am arguing for or by putting something in the Bill that would help to move in that direction. I do not know what could go in the Bill or even how to do it, but I still feel strongly about what needs to be done and I hope to be able to work with the Government to make something more meaningful happen than what we have at the moment or have had in the past.
My Lords, if the previous speaker will allow me, I will not follow his interesting proposal. I would rather start from what the Minister made clear was the principal object of this Bill, which is to ensure so far as is humanly possible that a banking meltdown such as we recently experienced, at immense and continuing cost to the public finances, the taxpayer and the economy as a whole, does not occur again.
The present Prime Minister cannot escape his substantial share of responsibility for the disaster, not least by his precipitate abolition as Chancellor of the greatly improved system of bank supervision that I introduced in the Banking Act 1987 and its replacement by the fundamentally flawed tripartite system. Indeed, the dysfunctional nature of his regime is all too eloquently exposed by the changes being proposed in the Bill.
Some of my best friends are bankers, although I cannot compete with the Minister in that regard, but the popular view that the root cause of the crisis was the greed and folly of all too many bankers is justified. The success of the market economy derives from the fact that greed and folly are in general kept in check by the disciplines of the marketplace. In banking, the disciplines of the marketplace in the last resort are all too often absent. That is the heart of the problem. It has long been recognised—at least since the 19th century, with Bagehot and all that—that the particularly grave consequences of banking failure mean that the authorities have to stand ready to help failed banks. The quid pro quo is that banks are obliged to submit to a form of regulation that is neither necessary nor desirable in the case of other industries.
What kind of regulatory framework do we now need to put in place? That is really what we are discussing today more than anything else, although I acknowledge that there are some other issues. Clearly, we need to ensure that the banking system is adequately capitalised at all times. But it is neither practicable nor sensible to try to put in place for the banks as they are now a sophisticated regulatory system that is both flexible enough to deal with all the many complex forms of modern banking and robust enough to provide the safeguards that we need. If we try, the system either will be inadequate or will stultify the financial sector with overregulation—probably both. We need a fundamental structural reform of the banking industry—a reform that will maximise the extent to which we can rely on the disciplines of the marketplace and minimise and simplify the burden that regulation has to bear.
A year ago, I wrote an article in the Financial Times advocating a return to something along the lines of the American Glass-Steagall Act 1933. The purpose of that would be to enforce a separation between narrow, commercial, deposit-taking utility banking on the one hand and high-risk investment banking on the other. It is quite simply unacceptable that taxpayer-guaranteed retail deposits should be used to finance high-risk investment banking activities and that the taxpayer should be required to bail out banks whose solvency is threatened when those activities come unstuck.
Any such separation is, needless to say, anathema to those who currently run broad or universal banks. Maybe they have intimidated the Minister. Incidentally, being a free-standing investment bank did not seem to prevent Goldman Sachs, for example, achieving no small success in its field. Be that as it may, the universal bank lobby raises four objections, all of which need to be considered.
The first is that corporate clients require their commercial banks to offer them the full range of financial services and that to restrict their activities in any way would drastically reduce the financing options available to business and industry. This is palpably absurd. While many corporates may well desire and need a wide range of financing options, they have no need to get them all from the same institution; probably many of them would prefer not to have to do so.
The second objection is that the crisis was caused not—it is said—by the banks engaging in high-risk, high-reward proprietary or principal trading but by old-fashioned imprudent lending, largely against house purchase, as with the subprime market in the United States. The truth of the matter is that both activities made major contributions to the meltdown but, whereas the second can be addressed by straightforward capital-adequacy-based regulation and sensible supervision, the first cannot.
The third alleged objection to a new Glass-Steagall is that, even if such a separation were made, the collapse of a “pure” investment bank can still be a systemic threat—look at Lehman, they say. However, the case for compulsory separation is that it very substantially reduces the threat of systemic risk in a way that nothing else can. Moreover, had the core commercial banking system been thoroughly sound, the collapse of Lehman, although a shock, would not have posed any systemic threat. In any event, I am not arguing that investment banking should be completely free of all prudential regulation, although such regulation would need to be light touch, both for practical reasons and to allow the sector’s creativity to flourish adequately—something that is most unlikely to happen in the current climate without a new Glass-Steagall.
Only one serious objection has been raised to the reform that I am suggesting, which is that in the complex modern financial world it is impossible to draw a line between those activities that a narrow bank is permitted to undertake and those that it is not. In particular, it is said that prohibiting narrow banks from engaging in principal trading, or proprietary trading, would be unenforceable because such trading is indistinguishable from a bank’s normal treasury operations, when it is merely acting as an agent, notably in hedging its risks. But however difficult it may be to draw a line, it is perfectly possible. Moreover, it is generally agreed, even by the Government, that a new and improved system of prudential supervision and regulation will in any case need to insist on different capital adequacy and other requirements to reflect the different degrees of risk in different activities, so lines will have to be drawn anyway. That is a practical point of the first importance.
A key question is whether the separation that I am advocating needs to be complete institutional separation or whether it can be achieved by the less brutal means of a ring-fence or a firewall within a single institution, with retail depositors being given absolute priority in the event of a failure. While the latter may appear at first sight a judicious compromise, it is in fact seriously inadequate. There are a number of reasons why that is so. First, the characteristic of such ring-fences is that they are not watertight under extreme pressure. The ring-fence option rests much more weight than is prudent on the assumption of sophisticated and effective supervision and regulation. In practice, it is likely, if not certain, either that the regulators will be outsmarted by the hugely better paid and more motivated practitioners or that they will be excessively heavy-handed to try to prevent this, and maybe both. As the sage Paul Volcker, whom I remember well as the distinguished chairman of the American Federal Reserve during my time as Chancellor, and who is now an adviser to President Obama, recently observed:
“I am not so naïve as to think that, even with the best efforts of boards and management, so-called Chinese walls can remain impermeable against the pressure to seek maximum profit and personal remuneration”.
If the investment banking activities come unstuck, this will inevitably weaken and possibly bankrupt the group as a whole.
Moreover, we have only to look at the United States to see the practical reality. Citibank, for example, has always been a wholly separate, and thus theoretically ring-fenced, corporate entity within Citigroup, but that did not save it. It is of course true that, even with complete separation, narrow commercial banks might still have normal banking exposures to investment banks and other financial companies, although in practice these customarily access the capital markets directly. Normal banking prudence is much more likely to limit the scale and nature of such exposures than is the case with a conflict of interest that arises when the institution and its shareholders have a substantial equity interest in investment banking.
Only a structural reform of the kind that I have been advocating can make financial regulation both effective and realistic, allowing investment banks the freedom to pursue their own often high-risk creativity and innovation without endangering the entire financial system and the economy as a whole. Protection of the economy—and, indeed, of the taxpayer, who has had to bear an unacceptably heavy burden in bailing out the financial sector—could be secured by ensuring, by regulatory requirements and supervision, that the commercial or utility banking sector was always thoroughly healthy. The discipline of the high-risk investment banking sector, which would be forbidden from taking retail deposits, would thus be left largely to market forces, with only relatively light, simple and thus realistic regulation, so avoiding the highly damaging increase in moral hazard that the current “too big to fail” doctrine has brought with it.
The essential point is that broad or universal banking, for a number of reasons, greatly increases systemic vulnerability, so there is a strong public interest in preventing it. This is the conclusion that is now being reached by President Obama in the United States, on the advice of Paul Volcker, whom I quoted a moment ago. Whether the American Congress will allow him to implement it remains to be seen, but it is most encouraging that, in a letter in yesterday’s Wall Street Journal, it has been strongly supported by no fewer than five former US Treasury Secretaries from both parties.
Meanwhile, that is also the conclusion that has been reached by Mervyn King, the Governor of the Bank of England, as his eloquent testimony on a number of occasions, including to both the Economic Affairs Committee of this House and the Treasury Committee in another place, has made clear. Indeed, in his most recent appearance before the latter committee, the Governor went further and addressed the argument that, however desirable a structural separation of the kind that I have been discussing may be, it is not something that the UK could do on its own without grave damage to the competitive position of the City of London.
I know that my honourable friend George Osborne, while largely accepting the case for structural separation, has been concerned about this. With a financial sector that is five times as big in the UK as it is in the United States, relative to the size of the economy as a whole, the Governor pointed out that, in fact, the boot is on the other foot. He told the Treasury Committee:
“The only way we can really sustain a large financial centre in London … is if we can make sure that it doesn’t impose a prospective burden on taxpayers”.
Only in this way can we fully restore global confidence in the British economy, with all that that implies.
The point is this: there are some who argue that having a banking and financial services sector as large as ours, in relation to the economy as a whole, makes us uniquely vulnerable—a sort of Iceland writ large—and that it should be a deliberate object of government policy to reduce it. I reject that. The City of London has historically been a great source of strength to this country and should continue to be so in the highly competitive globalised world of the future. However, it will be source of strength, rather than a source of weakness, only if it is made much more robust by the essential structural change that I have outlined.
I began by remarking that the overriding object of this Bill is to ensure so far as is humanly possible that a banking meltdown such as we have recently experienced does not occur again. The structural reform that I have been advocating is not a sufficient condition for this, but it is, without doubt, a necessary condition. The Government’s failure to recognise this is the greatest single error in the regulatory regime that they are now seeking to put in place.
I am all in favour of sinners who repent, but does the noble Lord recall that in the 1980s the Conservative Government supported the big bang and deregulation almost endlessly, which gave rise in the end to the repudiation of the Glass-Steagall legislation in the United States? If he repents, perhaps that is good. In general, I support his arguments, as I argued against them when he was in the Government.
I thought that that error might be made by someone, which is why I took the precaution of bringing the opening page of chapter 32, “Fraud and the City”, of my memoirs. I will not read the whole thing, but it begins:
“It might seem surprising at first sight that a Government, and a Chancellor, so committed to deregulation, including financial deregulation, should have spent so much time over, and been so concerned with, financial regulation. Indeed, some have seen it as a tacit admission that financial deregulation went too far. But this is to be confused with words”.
Incidentally, this was published in 1992, so we have a lot of benefit of hindsight. It continues:
“Financial deregulation in no way implies the absence of financial regulation for prudential purposes and for the prevention, so far as possible, of fraud. Economic freedom, as much as political freedom, is possible only within the framework of the rule of law”.
I went to considerable lengths to improve in the Banking Act 1987 prudential regulation of the financial sector in this country.
My Lords, I wish this would go on a bit longer as we have a lot to learn. I welcome the Bill. Like the noble Lord, Lord Lawson, I take the view that, no matter what you do, the system will have crises and cycles. All you can do is learn from the previous crisis, do your best repair job and wait for the next one. The most interesting problem that we have seen recently is not that the banks failed—banks have been failing for ages. Indeed, it was the failure of Overend and Gurney which resulted in the Bank of England getting the power to become a lender of last resort and to do much more supervision over banking. At that time, banking was an innovation. Each time there is a wave of financial innovation, the regulators lose control over the system, the system crashes and on we go. That is roughly my view.
We have to examine this legislation in terms of whether it will take care of what we have learnt from previous crises and whether it makes adequate repair or caution for such a crisis recurring. I do not believe that the system in the 1990s was perfect. I came to your Lordships' House in 1991 and I remember Barings Bank and the BCCI going. At that time, the Bank of England also had the problem that, while it had to regulate and supervise, it was also supposed to encourage the City to be a big player on the international field. There was a conflict between welcoming many more banks to work in the City and regulating them, which was a problem.
The latest crisis was not because the banks misbehaved because they were large banks—although that was one element. The much more important element, which we had not experienced for some years in developed economies, was that there had been six or seven years of excessively cheap credit, thanks to the global imbalances. At the same time, the pattern of global trade ensured us a low rate of inflation. Normally, under the monetarist idea, if you have too much credit, inflation happens and the system checks itself. We have learned that; I fought all those battles many years ago. This was the first crisis of the global system and we were not able to take it on board. The Chinese surplus balances were providing cheap credit for us, and the Chinese exports which earned that surplus credit were keeping inflation low. The Chinese were acting almost like a drug dealer by loaning back to the drug addict the money he had just paid to buy the drug.
You have to look at what the banks did in the context of this excessively cheap credit environment, with low inflation and central bankers not able to provide the kind of regulatory warning that they should have. We have it now in the memoirs of Alan Greenspan. We know, basically, that central bank after central bank failed either to tell their Governments to balance their budgets or to provide any kind of regulatory interest rate policy, except when it was too late. The problem was not that we had a crisis—many economists were muttering about one, we just did not know when it would happen—but that it cost us too much to rescue these banks. I agree with the noble Lord that, in a system of free market, the process of greed and so on has to be regulated by the force of the market. However, if you remove the threat of bankruptcy, you remove that regulatory mechanism, and that is where the problem was.
I, being a Hayekian libertarian, among other things, would have preferred the banks to go and for us not to have rescued a single bank. We were told that all sorts of dire things would have happened. I doubt that. The next time around, we ought to do some simulations as to what those dire things would be if it happened. So we rescued the banks despite all the warnings of moral hazard that Mervyn King muttered.
I should like to put one question to my noble friend—I am sorry that I have not given him notice of it. What will be the final cost of the bank rescue? Has he any estimate of what would happen if banks get better and restore profitability and we are able to get rid of all this bank equity that we have bought? What will be the final cost—not the current cost—to banking? It may turn out to be much smaller than what we are currently facing.
I like the Bill because it says what we can do next time around to minimise the cost of rescuing banks which are about to fail. The living will is an early warning system to the banks that they have to look after their own health; it is like a health check for banks. It will provide the Council for Financial Stability with an early warning of the banks that are likely to fail. That is a good thing. So the next time around we might not have to shell out as much money as we did this time.
However, there is a problem which I would urge the Council for Financial Stability to think about. We have found out that when the system fails, it is not only one bank that fails; the failure of one bank affects all other banks. Where we had systems of micro-prudential supervision, we are now talking about macro-prudential supervision— and I can assure your Lordships that most people do not know what macro-prudential supervision means.
Most people do not even know what financial stability means because we have not really worked out those concepts in detail in serious, mathematical computer modelling. These things have been done by physicists but not by economists. One of the tasks of the Council for Financial Stability will be to work out the theoretical part, to conduct research and development as to how it will know when the next financial crisis is likely to occur and not be surprised by it.
I would much rather worry about the interconnections within the banking system which spread the contagion. For example, Lehman Brothers, which, although it was not very large by any definition, still caused a lot of problems because of its interconnections with the rest of the system. Those are the problems which the Council for Financial Stability will have to address. If it can deal with them in terms of research and development, and if the living will can be done robustly, this Financial Services Bill will make a lot of difference.
My Lords, before attempting to contribute to this debate, I must declare a number of interests. I am chair of 3i Group, whose asset management subsidiary is regulated by the FSA. I am also an adviser to the FSA and, perhaps most importantly, in May I shall become chairman of the Financial Reporting Council, a very modest part of the regulatory architecture that we are discussing here. I am also chair of Frontier Economics, which has done a good deal of work in the field of regulation.
I therefore rise not so much to oppose the Bill, which has a number of valuable elements, as many noble Lords have said, as to plead for full consideration of the options for change. This is not a time for half-cooked solutions. The reconstruction of financial regulation was rushed, as the noble Lord, Lord Lawson, said, by the incoming Government in 1997. In giving the Bank of England independence in the operation of monetary policy, the Government won many plaudits, although the real test of this will not come until we have successfully negotiated an exit from our current parlous fiscal position. That will require very close co-ordination between the Bank of England and the Treasury, in which neither can see itself as entirely independent.
Meanwhile, the counterpart to a much applauded enhancement of the Bank’s monetary role was a deliberate demotion of its role in financial supervision. It was thanks only to Lord George fighting a doughty rearguard action that the Bank retained as much capacity in this area as it did. Despite his protests, the Bank’s crucial role as guardian of the financial system, informed by its knowledge of the different elements, was effectively demoted.
With the supervision of financial institutions passing to the FSA, a gap opened up in our arrangements. Responsibility for macro-prudential supervision simply disappeared into that hole—how right the noble Lord, Lord Desai, was to say how difficult a role that is. As a result, it is now widely acknowledged that we have suffered particularly badly from what economists call “the fallacy of composition”, whereby individual institutions were assessed, more or less well, but the aggregate effect of their actions was not.
I appreciate that the Bill is intended to reverse this by bridging the gap with the creation of the Council for Financial Stability. I am sorry to say that I simply do not think that this is enough. A committee that meets quarterly to consider reports prepared by one or other of its constituent members is surely not a full answer to the crises that can erupt 24/7 in markets and that are characterised by rapid contagion. Like the noble Lord, Lord Desai, I think that those interactions are the real challenge for macro-prudential supervision and that we should not be distracted from it by focusing on the scope or breadth of individual institutions. I cannot, with the best will in the world, see what this part of the Bill really adds. I presume that the Treasury, the Bank and the FSA already hold high-level meetings at least quarterly; they do not need an Act of Parliament to do so. I presume that they already discuss reports prepared by one or other of them; they do not need an Act of Parliament to share views. The key point is that the Bill does not resolve the question of where ongoing institutional responsibility for macro-prudential regulation lies. Responsibility for rapid pre-emptive action cannot be blurred and is not resolved by papering over the current arrangements.
Of course, however, there are many other extremely useful elements in the Bill, such as the strengthening of the FSA’s powers and implementation of some of Sir David Walker’s proposals. It is the key issue of responsibility for macro-prudential regulation that I believe deserves further consideration. Such consideration should surely include the proposal by the shadow Chancellor to bring macro-prudential and financial institutional regulation back together, reversing the actions of 1997. This will itself raise a number of inevitably difficult issues, so he is to be commended for saying that he would take time over such restructuring. He would not, in other words, repeat the hasty change of 1997. We cannot simply put the banks back under the Bank without creating a dangerous regulatory gulf between, for example, banks and insurance companies. We have to take care that a recognition of the interdependence of so many elements in our financial markets and the rest of the economy does not lead us to create a regulatory behemoth.
Making a split between macro-prudential and financial regulatory parts of the FSA, on the one hand, and its consumer protection activities, on the other, is, in my view, a good answer, executing it successfully will take great care. As this part of the FSA became more of a microeconomic regulator, the boundary between it and the competition authorities would need to be redrawn if we were to avoid regulatory overload. However, the suggested separation makes sense; it would enable both sets of issues, macro-prudential and microeconomic, to be looked at more clearly. Lessons could be learnt from other regulated industries where similar issues of consumer protection arise and a similar reconciliation of the role of the sector economic regulator and the competition authorities can be achieved.
Over the past decade the FSA has been bedevilled by a tug of war between those who believed it should focus all its attention on the treatment of customers and those who believed it should be focused on the risks to the financial system. While those objectives should be synonymous in the long term, in the short term they are not and may lead a regulator to be looking in the wrong place at the wrong time.
I note that the Bill makes some recognition of the fact that one institution has been asked to do too much by spinning off the FSA’s educational role. I believe that we should give proper consideration to more radical change. This is not just a tidying-up job; it requires detailed consideration to create a regulatory system that is clear, focused and accountable.
Perhaps I may end by noting that at the FRC we are fully cognisant of the responsibility to play our own modest role, with the review of the combined code in tandem with the Walker report; sponsorship of the stewardship code—for which I know the Minister has been such a moving force; and the constant review of the quality of financial reporting, accounting standards and audit quality. The key challenge here has been finding the appropriate dividing line between the FSA’s responsibility for regulating the practices of financial companies and the FRC’s responsibility for codes of corporate governance practice that apply to all companies.
In reviewing the combined code—and here I pay tribute to the magnificent work of its current chairman—the FRC did not want either to create two separate classes of companies or to load non-financial institutions with inappropriate guidelines. It is important that the FSA can play a full part in seeking to get this balance right, not only in the UK but in European councils where so much is now decided with respect to standards affecting UK companies and their accounts, auditors and investors.
A strong financial sector—on this I agree very much with the Minister—continues to be of inestimable value to the UK. Deep and liquid quoted equity markets have enabled many UK companies to survive the economic storms of the past year. Investors have stepped up to the plate with a long list of rights issues. The largest private equity industry outside the US, in proportion to our economy, will be an important source of growth capital during the recovery, the more so given that banks’ continuing need to rebuild capital will continue to constrain lending.
However, we continue to rely on the banks themselves for the essentials of business recovery—trade finance and working capital—as well as for continuing to contribute substantially to GDP and tax revenue. We must beware of creating a regulatory system that inhibits their ability to do so, that is pro-cyclical or enmeshes the banks in so much regulatory interaction that lending continues to shrink. We face plenty of uncertainty about the health of the financial sector and the pace of the recovery, not just for the next few months but for years of economic convalescence. Designing the right regulatory framework for this should surely be undertaken in a new Parliament with full consideration and care.
My Lords, I rise briefly to argue one point. The Bill is the appropriate legislative vehicle to extend the operation of the FSA to credit unions in Northern Ireland. I was greatly encouraged when I listened to the opening speech of the noble Lord, Lord Myners, to hear that one of his concerns was the broad spread throughout the population of financial competence. It is perfectly clear that the credit unions have been agents of good authority in this respect.
Noble Lords may not be aware that credit unions in Great Britain essentially engage only 1 per cent of the population. In Northern Ireland it is very different; they engage 26 per cent of the population. They play a significant role, in part, it might be said, because of the role that the Nobel laureate John Hume played in his youth in promoting credit unions. They operate as agents of stability in a society which, as all noble Lords know, at many points in the past 30 years has not been the most stable part of the United Kingdom. The credit unions of Northern Ireland are worthy of our benign intentions.
As matters stand, the credit unions in Northern Ireland can operate in only three main areas, namely share accounts, loans and life assurance. Credit unions in Great Britain operate in around a dozen areas: current accounts; internet and telephone banking; standing orders for payment of wages; ATMs; home, travel, health and car insurance; mortgages; debit cards; direct debits; bill payments; junior saving accounts; and child trust funds. Credit unions in the Republic of Ireland have a similarly wide—indeed, even wider—range of potential operation. The passport to credit unions in Northern Ireland having this wider range is for them to come under FSA regulation. In other words, I propose that, in the context of the Bill, it should be possible to remove the exemption in the Financial Services and Markets Act 2000, which prevents FSA regulation of Northern Irish credit unions.
When this matter was discussed in another place, the Minister, Mr Ian Pearson, who also had the benefit of having been a Northern Ireland Minister at an earlier stage of his career, expressed sympathy for this broad argument but noted that there were certain technical difficulties. I must concede that there are, not least to do with time. Mr Pearson noted that the Northern Ireland Assembly’s legislative consent would have to be sought. The Bill asks already for the Northern Ireland legislative Assembly’s consent to be sought in three other instances of practice that the Bill intends to institute. However, it does not at this point ask for legislative consent in this area. He also argued that there would be a difficulty in finding time for sufficient statutory public consultation on the credit union issue. It is normal in Northern Ireland to have a period of statutory consultation on an issue of this kind; that is entirely correct.
None the less, in recent weeks in the Grand Committee of this House, there have been several discussions about the operation of the public consultation in Northern Ireland. It has been revealed to be in certain cases remarkably perfunctory. There has been simply a notice on a website and perhaps one or two comments from interested parties. Certainly it would be possible to carry out a public consultation on this issue within a month, and there need be little fear as to what the public’s reaction would be.
All parties in the Northern Ireland Assembly are agreed on the desirability of this change. It is quite unusual to get complete agreement across all parties in the Northern Ireland Assembly. I have to concede that there is usually one occasion when one can obtain such agreement—that is when one is proposing an extraction of cash from the UK Exchequer. Ever since the Financial Relations Committee in the 1890s, there has been a pattern whereby, on such occasions when people in Northern Ireland approach the Treasury, they put aside their differences.
However, in this case, the Treasury, in a paper published last year, also agreed that this plan was a desirable development. We are faced with something unusual—not only is there agreement among all the parties in the Northern Ireland Assembly but also the agreement of the Treasury in London. I should be very grateful if the Minister would consider, as the Minister in the other place said, if the Government receive—as in principle they should receive—encouragement from the Northern Ireland Assembly, asking the Assembly for legislative consent in this matter.
My Lords, I intend to interrupt just for a few moments this enormously important debate on the philosophy of financial regulation and stability to pick up on one part of the Bill which has not attracted a great deal of attention so far, although both opening speakers referred to it—Clauses 18 to 25 on “Collective proceedings”. I do that without apology, not because what has been discussed so far is not hugely important, because it is, but because, as my noble friend the Minister rightly said, these proposed provisions are groundbreaking. It is therefore right to spend a few minutes looking at them.
They are groundbreaking because they would provide for the first time in English law something which is akin to, although in important respects different from, a class action with which we are familiar in US proceedings. For the first time it will be possible in the most radical form of collective proceedings—opt-out proceedings—to have them brought on behalf of people who do not know that they are being represented and to bind them in the result or enable them to benefit from damages from proceedings about which they knew perhaps nothing and certainly took no part. The Bill would make provision to disapply limitation periods and make particular provisions about damages—for example, for the first time, by not requiring a careful assessment of loss before damages are awarded.
The provisions are groundbreaking in that sense and apply in this Bill only to claims in relation to financial services, but it follows a recommendation by the Civil Justice Council in relation to proceedings more generally. As we approach this part of the Bill, we need to recognise that it has an importance in relation to financial services, but it also has an importance as a potential precedent in the future for other civil proceedings.
I wish to make two points in this short intervention. First, I must declare my interest as a practising lawyer. There is another specific interest that I shall declare in a few moments which is relevant to the final point I want to make. The first question is: should we be welcoming this innovation? As a matter of principle, is this form of collective proceedings a good thing? This has been a matter of debate for a number of years—whether we should move more towards a class-action system. For myself, subject to the safeguards to which I want to return, I regard this as a good thing for us to attempt to do. That is because, frankly, it is very difficult for many people who suffer—and the financial services sector is one in which that has happened—effectively to bring proceedings whereby they can vindicate their rights and receive compensation. That is enormously difficult to do and, therefore, something which helps to provide that access to justice is very well worth considering.
On the other hand, we have to recognise that there are excesses and abuses which many would see in the class-action system. I have to be careful about what I say, as I am now partner of a firm which is headquartered in New York and whose heritage is New York and US law. But there remain—and will remain—differences between our system and the US system which are important in protecting against abuse. First, we still, at least for the moment, apply a principle that the loser pays the costs. That means that there is a disincentive to bring bad proceedings. Secondly, we do not have a principle of triple damages, which can often increase enormously the damages which result. We do not in civil cases, with very few exceptions, allow juries to assess damages—that is another cause of high damages awards in United States cases.
However—this leads me to my second point—a lot of the questions about whether the safeguards will be there and abuses prevented depend upon the detail of these proposals. Here there is a difficulty: it is intended, for reasons which I understand and with which I am familiar, that a lot of the detail will be contained either in regulations or rules of court. At least in one case it is not entirely clear whether the same matter could be prescribed in both, because it appears that the identification of cases for collective actions could be both prescribed and the criteria for them set in rules of court. There seems to be an overlap. If my noble friend the Minister will forgive me, I also have some concern that it is intended that the regulations will in due course be made by the Treasury, which, as a former spending Minister, I enormously admire, but it is not the place where the greatest repository of knowledge about legal proceedings lies. I hope therefore that he will say something about how in practice those ministries which have that expertise will be involved in the regulations—for example, the Ministry of Justice.
Many details will need to be prescribed or set out in rules of court. Just what are the criteria for deciding which cases are fit to be collective proceedings? Which are fit to be opt-in and which are fit to be opt-out proceedings? When are limitation periods to be excluded? How are damages to be dealt with? These are important questions to which great attention needs to be paid. Our difficulty in this case is that not only are the criteria not in the Bill, which I entirely understand, but we face the difficulty of an accelerated period in which this legislation has to reach the statute book. I personally hope that this part will reach the statute book. In those circumstances, can the Minister reassure us that a way will be found for some of the important detail of this matter to be debated without the normal process of having to draw it out of him through probing amendments in Committee, so that by the time that the legislation is finished—probably in wash-up—we will have a much better idea of what the draft regulations will be? That is a concern.
I want finally to pick up on an issue referred to in Clause 23(5)(b)—the possibility that in opt-out proceedings there will be a sum of money left which is not, at the end of the day, distributed. The Civil Justice Council recognised that if there are to be proceedings in which people are represented but not actually taking part, you may well end up with a sum of damages awarded for which there is no recipient. The proposal is that provision should be made in regulation as to the purposes for which that money is applied, including “charitable or other purposes”. In his masterful and detailed report on costs, Lord Justice Jackson touched on this point, making what he described as a modest proposal that a potential recipient of this money is the Access to Justice Foundation. Here I make my second declaration; I am the chairman of the board of trustees of that foundation, which was established for the purpose of receiving money, awarded by the court, under Section 194 of the Legal Services Act 2007. The foundation was established by the professions and by the pro bono and legal advice industries. I therefore simply note that declaration of interest, but we as a House, when we are asked for the first time to approve a situation in which a defendant may be ordered to pay money that will not actually go to the people who have suffered the loss, will want to know the intended destination of the surplus money.
My Lords, even as your Lordships debate this Bill, a worrying number of corporations are considering leaving this country and moving their business abroad—half the FTSE top 30 companies, if one is to believe the press. Taxation and the increasing costs of complying with endless streams of regulation are forcing even the most patriotic and loyal of companies to reconsider whether they can afford to stay in this country and remain competitive in today’s world markets. As if there were not enough difficulties already, the Bill in front of us today will create further reasons for financial institutions to take their business elsewhere.
The Bill responds to the financial crisis, but it perpetuates the very tripartite system which so significantly managed to avoid spotting the banking crisis. A fish cannot swim with two heads, let alone three. This system demonstrated that, with responsibility divided, the ability to identify and cope with problems is significantly reduced. At the same time as proposing to continue with a system which has proved its incompetence, the Bill introduces a series of measures which will have the effect of accelerating the rush for the exit from these shores.
There has been much talk of the billions of pounds of taxpayers’ money which has had to be used to bail out the banks, but those billions were required because the parameters within which banks operate, and for which Government are responsible, were inadequate. Bankers go into business to make money. It is up to Government to make sure that, as bankers pursue this goal, the urge is harnessed and kept in sensible bounds so that it can continue to be a creative force within the economy, without becoming a problem. However, the responsibility for monitoring the financial sector was removed from the organisation which had the knowledge and experience to handle the matter: the Bank of England; and given to a novice, the FSA. Sadly, this is not the only example where this Government’s obsession with discarding the collective memory in favour of something shiny and new has ended in tears.
It is worth pausing for a moment to put the billions used to bail out the financial sector into perspective. In the current climate, it is all too easy to forget that the financial sector has itself been a very significant contributor to the economy and to the Exchequer. During the financial year to 31 March 2009, the total tax contribution from the financial sector, as assessed by PricewaterhouseCoopers, was £61.4 billion, or 12.1 per cent of total government tax receipts—not as high as previous years, but still a very meaningful contribution. If one does an extrapolation of the PricewaterhouseCoopers calculations for this and previous years, one comes to a total tax contribution since 1997 of about £700 billion. The numbers are not precise but, although approximate, they are sufficiently accurate to make the point that the financial sector is an immense contributor to the economic prosperity of this country—something to be preserved and looked after.
The other side of the balance sheet is the Government’s total net contribution to the rescue package. This is a complicated calculation which involves many assumptions, but rather than send you to sleep by going through all the figures, I will just say that a perfectly reasonable estimate is that the maximum eventual cost to the taxpayer is unlikely to be more than £10 billion. If this seems low, in view of some of the numbers which have been bandied about, I would point out that the last PBR revised the estimate of losses from financial intervention from between £20 billion and £50 billion to £8 billion.
All in all, the Exchequer is hugely in profit. Any sane person would be grateful, and ask themselves what the fundamental and underlying causes of the banking crisis were. They would also ask how the basic parameters within which financial institutions operate could be changed, if not to totally prevent then at least to significantly reduce the harmful effects of a downswing, while maintaining the benefits of a strong banking sector—in spite of claims to have abolished boom and bust, it is not possible to eliminate cycles.
Instead of examining the basic structure, the Government intend to compound their errors by continuing the failed tripartite system and giving increased power to the FSA. This organisation appears to be wedded to control of the minutiae and the detail, rather than endeavouring to establish the principles required to achieve the type of robust framework within which financial institutions can be left to get on with their business without causing harm to the rest of the economy.
In spite of public comment warning of perils ahead, the FSA ignored all the signs of an impending financial crisis—overgearing, dubious assets, over-complex financial instruments, and so on and so forth. Instead, it built up a massive overhead. With precious little outside discipline and controls over the tax it levies on those it regulates, the FSA continues to increase in size, as if the number of employees was a substitute for joined-up thinking. In its business plan for 2009-10, it anticipates staffing levels of 3,000. To put that in perspective, the Treasury’s latest report projects core Treasury staffing levels in March 2010 of 1,386—less than half the FSA.
What have all these people been doing for the FSA, if not identifying underlying and serious potential problems? They were creating red tape and issuing fines: over £100 million worth, much of which where no harm had been done and the offending organisations themselves had identified the fault. In an earlier debate, I asked whether the £14 million of bonuses paid to FSA employees last year were related to the level of fines. I was assured that that was not so, but it took five months to extract from the FSA how it calculates bonuses. What would have happened to an organisation overseen by the FSA if it had taken so long to respond?
It is now proposed to give the FSA massive new powers, among them the power to control salaries and bonuses. If Her Majesty’s Government are a significant shareholder, depositor or provider of funds in a bank or a business, they have every right—even more, a duty—to consider how much those employed are paid. However, in a free society government should not be interfering with arrangements between private citizens. The red herring is raised about the level of bonuses, and how they take money away from shareholders and prevent the building up of necessary reserves so that the Government are forced to provide assistance, but, with the odd exception, bonuses are paid from profits, generated by the person receiving the bonus. External control over the pay structure will only drive the wealth creators to go elsewhere.
John Varley and Bob Diamond of Barclays Bank have led the way in waiving their bonuses. Others have followed. But for how long will this go on when, by moving to a friendlier location, the individuals would be so much better off? If people are prepared to waive remuneration one year, will they be prepared to do so in successive years? In today's world, there is no compulsion to stay in the City of London: it may be more convenient, but it is no longer essential.
It is all very well for the Minister to complain in the press that while bankers took home billions in bonuses, the owners of bank shares over the past decade have had a return of zero. Compared to the returns under the Labour Government, that is wealth beyond the dreams of avarice. Records show that since the Prime Minister's first proper Budget in 1998, sterling has lost value against almost every major currency; the stock market is down; our budget deficit is worse than that of Greece; we are borrowing nearly £200 billion a year—that is, if we can continue to do so without printing the money—unemployment has increased; provision of pensions has been seriously damaged; and gold has been sold at less than a third of today's price, losing about £6 billion.
The FSA will be given the power to impose unlimited fines. If a final push were needed to make those dithering rush for the exit, that will certainly provide it. Why would one want to do business where an unlimited liability hangs over one's head for what could be an unintended error, and where the track record of the institution with the power to impose a fine shows that when it comes to penalties, it has an extremely itchy trigger finger? The FSA should be abolished rather than being given increased powers. It has a culture incompatible with being a public body. Not only does it consider itself to be better than others; there is a continual stream of statements from senior executives stating how the organisation should be feared and disliked. One cannot expect fair and impartial treatment from an organisation whose chief executive says:
“There is a view that people are not frightened of the FSA. I can assure you that this is a view I am determined to correct. People should be very frightened of the FSA”.
It is shameful that the head of an organisation acting on behalf of Her Majesty's Government as policeman, judge, jury and executioner should make such a remark. It shows the attitude of a bully, and is not worthy of the fine traditions of public service in this country. Financial markets should be governed by establishing clear and easily understood principles, rather than by attempting detailed controls over day-to-day activities that will inevitably fail.
My Lords, the Bill gives great new powers to the FSA and strengthens it considerably. The case has been made today by the noble Lords, Lord Henley and Lord Howard, and very strongly by the noble Lord, Lord Lawson, for abolishing the FSA and transferring the powers to the Bank of England. It is not a party political issue: it is an issue of what is the right thing to do.
I will quote some of the things that have been said elsewhere. Hector Sants, the current chief executive of the FSA, who has an obvious interest, was quoted recently as saying that this would return regulation “to the dark ages”. I hope that the noble Lord, Lord Turner of Ecchinswell, who is not here, will forgive me for quoting him. He was originally an agnostic, but said in an interview with Bloomberg Television in Davos, a very popular place these days, that,
“in the middle of a financial crisis, I wouldn't have done it”.
He said last year that he was agnostic about the Conservative plans to axe the regulator and beef up the powers and responsibilities of the Bank of England; but he is opposed to it now, in current circumstances.
Well, everybody can change their mind and he has changed his. For my part, I could accept the case in principle. After all, the FSA has failed appallingly in the regulation for which it was responsible, so it is not difficult to recommend its abolition. On the other hand, although in principle I would have no objection, in current circumstances—with great respect in particular to the noble Lord, Lord Lawson—the case has not been well made. The fact is—
The noble Lord and I have debated at length on many occasions, in particular in another place, and I do not propose, given the shortage of time, to have a major debate with him now. As I said, in principle I would not object; but all that would happen would be that most of the staff of the FSA would be transferred to the Bank of England. I doubt that anybody has denied that, and I doubt that regulation would necessarily work better in those circumstances than it has done in recent times.
The Bill makes many proposals that could be helpful: I will refer to just a few. First, I turn to the central case for the Bill. My noble friend Lord Myners, referring to the Council for Fiscal Stability, said that it was “not glamorous”. I am sure that he is very fond of glamour, but the main issue facing the council will be getting the balance right between what is described in the Bill as growth in the economy, stability and firm regulation. It will not be easy, and I fear that much of the work of the Council for Fiscal Stability—and here I share the concern of the noble Baroness, Lady Hogg—will be talking about it. I am not sure that much will be done in practice by the council.
More important are the other measures in the Bill. There is concern about whether the council will be able to do what the Bill says it will—namely, to co-ordinate the response to risks. The response to risks, as we have seen in recent times with the problems that we have had with the banking system, is clearly essential to the Bill and to any action that we take to prevent the problems happening again.
En passant, many objectives are set out, but four are set out as the main objectives of the Bill. One is the need to promote awareness and educate the public. A new quango will be set up to do that. I am not sure that a new quango to promote awareness among the general public will do much good. Perhaps a special quango to make MPs and Peers more aware of the problems that we face would be more helpful.
The Bill gives great powers to the FSA, which is fine. Everybody agrees that the powers should be strengthened, wherever the FSA staff are. However, the problem is that they were not short of powers when they made the mistakes that they did, so there is no guarantee that the people who are now in the FSA, wherever they end up, will not fail again. It is not clear what will happen then, other than possibly to sack one or two people who have made the major mistakes of failing to regulate.
Let me refer to just one of the Bill’s new powers—short selling. The case has been made strongly to stop excessive risk-taking. I can understand an individual—possibly an adviser—recommending it in certain circumstances. I make it clear that I have not engaged in short selling, but I understand the case for using it. Now the FSA will have many new powers, including short selling, which is referred to specifically in the Bill. It is fine to prohibit individuals who are working in the industry in that regard, but why are the banks being allowed to do it themselves? Something could be said about other potentially toxic assets used by banks, whether they are split or not.
Martin Wolf, a very good reporter in the FT, referred to Volcker’s rule. We should all have regard for Volcker, as the noble Lord, Lord Lawson, pointed out. He said that banks would no longer be allowed to own, invest or sponsor hedge funds, private equity funds or propriety trading operations for their own profit unrelated to serving their customers. President Obama referred to it when he spoke of the separation of the banks.
The noble Lord, Lord Lawson, referred to the Glass-Steagall case at length. He made the strongest case yet for it, but of course he is never more certain of anything than when he is expressing his views, as he and I know all too well. The Volcker rule, including taking control from the banks of toxic assets generally, seems to me to be sensible. Whether or not we agree with the Governor of the Bank of England, who recently I have not agreed with too often, as my noble friend knows, the case for Volcker’s rule is strong. Even if we do not go along with the main proposals of President Obama, that case has been strongly made, and I hope that my noble friend will give us good reasons if he is going to reject it. He has said before in the House that he supports much of what the Governor of the Bank of England said about President Obama’s proposals, so maybe he agrees with this as well.
I shall now turn briefly to something else that the noble Lord, Lord Turner, said—I am not sure whether this was also in Davos. As I said, a lot of people spent a lot of time there recently. He spoke of valueless carry trade and talked about synthetic CDOs. Most of those who are speaking in this debate know what they are and the various other matters that have been dealt with by banks to our cost recently. Will we see some action on that as well as on short selling? There are calls by the noble Lord, Lord Turner, and others for fresh powers to curb bank lending. Will the new powers allow the control that is required?
The Bill could be very useful if the regulations within it are used properly and are properly controlled. I return to my earlier question: how do the Government propose to check what the FSA is or is not doing with regard to its huge additional powers that we are rightly giving to it in the event that it fails once more?
My Lords, it is a great pleasure to follow the noble Lord, Lord Barnett. I want to go a bit further on the subject of education, and certainly beyond the position of my own Front Bench.
I will confine my contribution to Clause 6, proposed new Clause 6A, which is headed:
“Enhancing public understanding of financial matters etc”,
and to proposed Schedule 1A which selectively spells out the detail of the:
“Further provision about the consumer financial education body”.
These arrangements are to replace the duty placed on the FSA in the 2000 Act to ensure public awareness of financial matters. In its annual reports, the FSA has faithfully listed that as one of its duties. We can speculate on what has persuaded the Government to drop the FSA’s public awareness duty, as in Clause 6(3), and to substitute that at much greater length and expense the arrangements for a new body—the consumer financial education body. It may just be that the Minister considers that awareness is not enough, and instead we need the seriousness of education, which seems unlikely. It may be that the FSA has said that its awareness effort has been small but without more delegated authority, money and staff it can do no more about it, and that if we want education, we should give the FSA the responsibility and resources to deliver it through a body under its control.
The switch from awareness to education needs justification. The banking and credit crisis showed that it was not only the public who lacked awareness, but those in charge in the highest places as well—a point strongly made by the noble Lord, Lord Barnett. It remains true that members of the public are capable of imparting more awareness than was or ever could have been delivered by the FSA. Indeed, who operating from within the financial system was fully aware, or is aware today, dare I say it? What has been illustrated here is the mistake of legislating to give a duty to a public body which it cannot perform, and the reluctance of that body to say so.
We then move to the next fallacy, which is that it was not the policy but the chosen method of implementation that was wrong, and that it was not sufficiently rigorous and the resources put into it were inadequate. This leads to the, “If at first you don’t succeed, try and try again” syndrome. It is a favourite response of this Government to policy failure, disregarding the fact that the premises on which the policy was based were faulty in the first place. How can the Government and their agencies expect to compete in the matter of financial awareness and education with all those whose livelihood depends on that? Surely it would be better to leave these matters alone securely in private hands.
I suppose the Minister will say that it falls to government to fill a gap because of market failure. However, my questions are as follows. How in the first place is this market failure described? Indeed, do we know how to describe it? And is there any credibility in the description of how the FSA and its subordinate body could correct this market failure, considering exactly what the history of failure has been, is and, as the noble Lord, Lord Desai, said, is likely to be?
Whatever history’s full evaluation of our understanding of the financial system turns out to be, we need to be cautious when we claim a high degree of knowledge and certainty about it today. Nevertheless, there is to be this new, expensive and curiously funded body. Given its title, we are left to speculate on the switch from the public as a whole in the 2000 Act to consumers only in this legislation. Is that because the providers are beyond education or is it because there is top-down comfort in a role for the great and good as educators of members of the public in “how to manage their financial affairs”? This mechanistic approach replacing the broadly based “public awareness” is no improvement; it is just another decision to choose process with no measurable outcomes in sight.
What is also surprising is the decision to create yet another body with a chair, a chief executive and a board. There will also be a practitioner panel and a consumer panel. The body is bound to be bureaucratic and therefore expensive. That is the price paid for public accountability. This creation of yet another public body is evidence of the residual fly-wheel effect, whereby this Government cannot resist committing ever more resources to the public sector when we all agree that it is only growth driven by the private sector that can return our finances to long-term health.
The way in which this body is to be funded also looks curious. In paragraph 14 of Schedule 1, the Treasury is given the power to join in the funding by way of grant or loan, met out of money provided by Parliament. Perhaps the Minister will confirm that Treasury intervention should be seen as a reserve power unlikely to be called upon in the near or medium-term future.
However, in paragraph 12 the FSA may make rules determining who should pay the education body’s costs and in what proportion. Now it is true that the FSA has rule-making powers under the 2000 Act but none of these powers has anything to do with payments to the FSA. Giving a public body an unfettered right to demand money cannot be right. Am I correct in thinking that the power in paragraph 12 sets a precedent? In paragraph 13, the OFT has a similar power to impose payments to meet the costs of the education body by general notice to consumer credit licensees. What is the justification for this power?
Both those powers seem to be an attempt to transfer the body’s costs on to the private sector, which is an entirely inappropriate idea. We depend upon growth in the economy to restore our finances over time, and that growth needs to be driven by the private sector. It is, in any event, deeply irresponsible to burden the private sector with additional costs in support of an activity wholly unsuited to the public sector.
It is amazing to think that the Minister could possibly support these arrangements. Perhaps he will think again. Having, with typically bad husbandry, pulled up the bush of public awareness, he may conclude that it is not such a sorry case after all and so rapidly replant it. Even if the “public awareness” duty has not delivered much, at least it is suitably vague and inexpensive. Dropping the education scheme from the Bill would bring the advantage of shortening the volume of legislation by some nine pages. However, the main issue is the avoidance of yet another cost centre within which inputs will always be more beguiling than measurable outputs.
My Lords, before participating in this debate, I should draw attention to my interests as a director of Standard Life and as a board member of the Office of Fair Trading, which is referred to in this legislation.
As other noble Lords have said, financial services are extremely important and, although the sector has had its problems, we should not denigrate the important role that it has played and, one hopes, will play in creating wealth for the UK in international markets. As the noble Lord, Lord Myners, correctly said, the objective of this Bill should be to help financial services to work better. Against that test, I am in the camp that views the Bill as something of a mixed bag: there are certainly some good things but there are many things that require further consideration.
However, before we go further, we should note that the Bill is silent on perhaps the most important issue, which is what role national regulators will be left to play, whether located in the FSA or the Bank of England, under the evolving EU plans for pan-European regulatory supervision. The draft directive on hedge funds is a case in point. As we debate the powers in the Bill, it would be helpful to understand better what powers the Government believe the UK will have in future to set our own policies for the financial services industry or to represent our distinctive UK view in international forums.
To return to the Bill as it stands, I fully support the aim to strengthen what is called “macro-economic prudential regulation” in the UK. Whatever institutional arrangements are put in place, it must be right to ensure that consideration is given to the stability of the financial system as a whole, as well as to the soundness of individual institutions.
It is, with hindsight, an amazing case of myopia that ballooning levels of government and private debt prior to 2008 rang so few alarm bells, and that the multiplier effect of credit expansion outside the conventional banking system, supported on a very small base of capital, was not seen as a dangerous source of instability. It is hoped that this generation has relearnt those lessons, but going forward it is important that some institution is tasked with the responsibility of monitoring these macro-economic developments and that it has the tools to curb credit expansion and reinforce capital levels as required. That institution must be sufficiently independent of the Government of the day and independent of considerations to do with fiscal convenience and electoral cycles.
Alongside that macro-prudential supervision, we then continue to need effective supervision of individual organisations to ensure that the risks they run do not put the wider financial system at risk. I use the word “supervision” rather than “regulation” deliberately because I think that, if the FSA has a fault, it is that historically it has seen its job too much as applying and enforcing regulations in a detailed tick-box approach, instead of applying mature supervision based on understanding and making judgments about the situation of individual firms. That is one thing that was lost in the removal of the old supervisory system.
Having said that, there is one area where I think we need to question whether the Bill currently goes far enough in prescriptive regulation, and that is on the constraints around the activities and balance sheets of deposit-taking retail banks. In this area, I go part of the way with my noble friend Lord Lawson and the noble Lord, Lord Barnett. There is no getting around the fact that retail deposits are special because they form a core part of the nation’s money supply. Because, in the interests of the wider economy, people need to have confidence in money as a form of payment, it is inevitable that Governments stand behind the value of money deposits in regulated retail banks and that they stand behind those banks. We have seen only too recently the level of panic and disruption that can occur if people start to lose confidence that their money on deposit is safe.
However, that government guarantee essentially means that the large retail deposit base of many retail banks is a subsidised, low-cost source of funds for those institutions. If and when those deposits are used to fund high-risk activities or assets, even on the margin, the risk and reward are asymmetric—the bank and its employees get the upsides but the Government, as guarantor, get the downside exposure. This inevitably encourages higher levels of risk-taking than would occur, for example, in a partnership where the principals took all the upside but also all the downside risk. The current regulatory approach seeks to redress this asymmetry by imposing higher capital requirements on riskier activities, effectively raising their cost of funds. To this the current Bill adds the requirements of creating recovery and resolution plans, which aim to set out how an institution facing financial difficulty in one area of activity could limit the damage so as to prevent the whole organisation becoming insolvent.
All these are sensible steps. However, I still believe there is a case for going further and requiring retail banks, where their deposits are guaranteed, to ring-fence those deposits and capital so that they are applied to prescribed assets and activities with appropriate matching risk characteristics. Unless there is that clear segregation —some kind of firewall, as it has been described—I find it difficult to see how one can avoid extreme risk events in the rest of an institution ultimately falling back on the funds and capital represented by guaranteed retail deposits. The fact that that backstop funding is available from the Government is inevitably reflected in the capacity of the institution to take on risks and counterparties that would not be available on equivalent terms without the government guarantee.
As this Bill goes through, the House should look at whether there are practical ways of achieving this ring-fencing of retail deposits and their capital backing. As the noble Lord, Lord Lawson, pointed out, it is this objective which lies behind the recent Volcker proposals in the US and the much earlier Glass-Steagall legislation. Where I differ from my noble friend Lord Lawson is that I do not think it is necessary or desirable to go as far as Glass-Steagall, which prohibited investment banking and retail banking activities being undertaken in the same institution. I am inclined to believe it should be possible to hold both a retail bank and what, for shorthand, I will call an investment bank as separate subsidiaries under the same group holding, enabling the holding company to combine the offerings as they see fit in developing integrated services for major corporate customers if those customers see fit to buy them.
That requires clear regulations that limit the ability to move funds from the retail bank to the investment bank so that recourse to the retail bank’s capital is blocked. This may sound difficult, but it is not dissimilar in principle to the rules around corporate pension funds or to policyholder-owned with-profit funds in life companies where the bankruptcy of the ultimate holding company does not allow shareholders to have access to those protected funds. I am not convinced by the argument that, operated in this way, it would be impossible to draw the dividing lines. Equally I am not sure that the Volcker proposals have got it quite right in focusing on proprietary trading. We should be clear that the risks that retail deposits should be shielded from are not just speculative position-taking, but also—and perhaps more importantly—balance-sheet investments in high-risk securities.
As we now all understand, much of the crisis for many financial institutions was caused not by their own proprietary trading but rather by their willingness to invest in complex secondary and tertiary securities, where the underlying borrower risk had been masked and the risk exacerbated by complex and poorly understood derivative positions. In principle, therefore, the retail bank might be limited to investing its guaranteed deposits in primary loans—by which I mean loans to known customers where the bank had made its own risk assessment—together with government securities and transient exposures held to support customer transactions. All other activities could be funded in a separate legal entity where the suppliers of funds—whether depositors, shareholders or other counterparties—knew the risk that their capital was exposed to and understood that they would not be protected by a bail-out of the retail bank.
I have dwelt on this issue at length because it is complicated and because I would suggest it needs to be a major part of our ongoing consideration of this Bill. It may be that the Government can convince us that the provisions in this Bill are adequate, but if there is a time to get this right, that time is now.
While I am on the subject of omissions, let me briefly flag one other related area which I think is a missed opportunity. Under current accepted accounting conventions, banks are not allowed to make provisions against specific loans when they put them on the books. They can only make provisions when there is a recognised risk of default. It is assumed that all loans will turn out to be good loans, despite the historic evidence of average default rates. As a consequence, the impact of loan losses on bank capital levels serves to exaggerate the economic cycle. Capital is not held when things are going well but capital is rapidly destroyed in a downturn. I have never understood why the same principles that apply to prudent insurance risks—in other words, recognising and providing for expected outturns at the start of a contract—do not apply to lending risks. It may be that the Government feel they are not powerful enough to take on international accounting standards, but I would be interested to know whether the Government have considered this issue or whether it has just been ignored.
There is much else in the Bill I could speak to, but in the interests of time let me quickly pick out a couple of other points. First, there is what I feel is a rather strange set of provisions relating to remuneration reports. I should make clear that I have no problem with the regulator—or supervisor, as I prefer to call them—taking an interest in the structure of remuneration and wanting adequate reporting to ensure that remuneration did not incentivise excessive risk-taking, but I confess I do not understand what is special about financial services that requires additional reporting about the absolute levels of remuneration compared to any other sector. Why is it useful and appropriate to require more information about the levels of non-director remuneration in financial institutions than in other sectors with highly paid talent—for example, broadcasting, sports, advertising agencies, or even lawyers? We may or may not think individuals in any or all of these occupations are overpaid, but we need more justification from the Government before we legislate for this level of intrusion into the activities of private companies as to why they want to single out one sector for special treatment.
The noble and learned Lord, Lord Goldsmith, referred to the groundbreaking clauses around class-action suits. Like him, I have some concerns about the lack of clarity about how they will be applied. Again, I stress that these are personal views. Clearly, there is a difficult balance to be drawn between procedures which help customers get proper redress on the one hand and the risk of creating a costly industry in class-action suits where lawyers are the main beneficiaries on the other. The decision on whether and under what circumstances to allow the opt-out way of proceeding rather than claimants having to opt in is clearly crucial to this balance. While it may be sensible for the courts to have discretion in deciding this, I am not sure that we should legislate to give them a free hand without greater clarity about the criteria and filters which the Rules Committee may subsequently develop. I hope that when we address this part of the Bill the Government can set out on the record what kind of guidance they expect to be applied or, even better—as the noble and learned Lord, Lord Goldsmith, asked for—let us see the draft regulations as they might be developed.
I have not had time to address the many other issues covered by this Bill but these will all no doubt be part of the debate to come. Let me end where I started by welcoming the objectives of this Bill while believing that there is a great deal of work still to do before we can be satisfied that this collection of measures is best fitted to the task.
My Lords, I declare an interest as the chief executive of London First, a not-for-profit business membership organisation whose mission is to make London the best city in the world in which to do business. My perspective today is not that of the financial services sector alone, but that of business in general. This is the third piece of legislation introduced by the Government in response to the credit crunch, but it is right that this ground should be thoroughly tilled.
As other noble Lords have noted, the financial services sector is vital to the UK economy. At around 8 per cent of GDP, according to PricewaterhouseCoopers it contributed over £24 billion in corporation and payroll taxes to the Exchequer in 2008. The sector supports 300,000 jobs in the capital and underpins 700,000 sought-after jobs elsewhere in the UK. The City is the most international of the world’s leading financial centres. Many globally mobile businesses and individuals choose London. Their taxes help to fund our public services. Those businesses do not need to be here but they choose to be, partly because of London’s wider attractions but also because of our historic strengths in the sector.
In his 2009 report for the London mayor, Bob Wigley listed our strengths: a deep talent pool, world-class support services underpinned by a stable legal framework and, at least until recently, a predictable and competitive tax and regulatory regime. To surrender or dilute these strengths would be an act of self-harm that would embolden our rivals and undermine our economic prospects. Therefore, as I see it, the criterion against which this Bill should be judged is whether it will nurture a sustainable financial services community in an increasingly competitive world and, as a prerequisite to that, whether we can rebuild a valued and trusted financial community.
The G20 communiqué last April noted:
“Major failures in the financial sector and in financial regulation and supervision were fundamental causes of the crisis. Confidence will not be restored until we rebuild trust in our financial system”.
Trust is fragile; it is much easier to lose than to acquire. The City’s reputation clearly has suffered both globally within the industry and locally among the British public. There is little that we can do by legislative decree to restore trust. The banks must acknowledge that their public image has been damaged by aspects of the behaviour of some and they must be seen to put their own houses in order. What we can do is address shortcomings in Britain’s regulatory framework so as to underpin both trust and competitiveness.
When reviewing the Bill’s specific provisions, I start with the perhaps counterintuitive thought that tough regulation can be a source of competitive advantage. Rules that are effective and consistently enforced make Britain a safe and attractive destination for global business. I welcome in Clause 1 the creation of the Council for Financial Stability to deal with cracks in the tripartite structure and I can see the arguments for more radical change that noble Lords on the opposition Benches have set out. However, in this debate on the structure of regulation, I would also emphasise the importance of calibre and conduct. As the fallout from the credit crunch made all too clear, we need more experienced and, dare I say, possibly better-paid regulators who have the wisdom and discretion to enforce the legislation that we enact and the codes and rules that flow from it.
I also welcome the duty in Clause 8 for the FSA to promote international regulation and supervision in support of financial stability. It is important that our agencies contribute to the search for international common ground. As a key player, we can provide insight and leadership, but in pursuing more effective regulation we should be like a pacesetter, not a runaway leader. We must not get too far ahead of the pack. We need to find the balance between leadership and imposing too many costs, especially unforeseen costs, on our financial sector versus others.
I understand the Government’s concerns over pay. There has been public outrage at the bonus policy of some banks whose survival has been the result of public support. However, progress has been made. Banks will adhere to the FSA’s code of practice on remuneration and, I understand, have agreed to meet the Pittsburgh principles and to support in principle the Walker review’s recommendations both on corporate governance and on pay disclosure. However, I fear that the proposals in Clause 9 go too far. Giving the FSA powers to override freely negotiated contractual arrangements fundamentally undermines transparency, certainty and predictability, which are the gold standard of good regulation.
Similarly, I understand the ambitions for recovery and resolution plans, the so-called “living wills”, in Clause 12. However, what is appealing theory is often poor practice and I fear that we are moving too far, too fast. There is no international agreement on how these plans should work or any clarity as to what a British model would look like, yet the FSA will be subject to statutory obligations. I ask the Minister whether it would be better if we waited for a workable template that could be promoted by the FSA under Clause 8 before we move forward. Surely we should be wary of saddling ourselves for all time with overengineered solutions to an extraordinary shock, the fallout from which remains unclear. Ten years from now, in a post-credit crunch era, when trust is restored and international conditions more certain, hindsight will probably tell us that we overegged here or inappropriately egged there. Sir Hugh Casson once said:
“The British love permanence more than they love beauty”.
Let us seek the beauty of efficacy rather than the ugliness of permanence. Will the Minister consider adding a sunset clause to those provisions that radically increase the powers of the regulator so that Government and Parliament can actively reconsider their salience in a few years’ time?
Sir Win Bischoff, in his report to the Chancellor last year, argued that for Britain the future is about partnership between the financial services sector and the wider economy, as well as the partnership between the UK and the financial centres of the emerging economies. The other partnership required is between Parliament, Government and the sector. We need to move on from bashing the banks and start focusing on how they can continue to be a strong source of competitive advantage for Britain.
My Lords, towards the end of a debate of this kind, most of the key issues have been identified and discussed by other noble Lords, but over the years I have had the advantage, if advantage it is, of looking at many of these questions from different points of view. In the 1970s, as head of the treasury department of a merchant bank, I used to report to the Bank of England, while in the 1990s I was a member of the board of the Financial Services Authority. Also, for a number of years I was chairman of the audit committee of an international bank. I find myself absolutely astonished, appalled and baffled by what has happened over the past two or three years and I have been trying to get to the bottom of it. I shall pick out just two or three of the key issues that we need to address.
The first is who should take the lead in the critical area of supervision. This is not a matter for dogma or for personalities; it is a matter of practicality. The conclusion that I come to is that the Bank of England seems to be better situated to deal with these things than the FSA. There is a difference of style and culture between the two. The style of the FSA tends towards the legalistic. I am not at all surprised that it is now felt that the FSA in later years paid a disproportionate amount of attention to consumer issues at the expense of the supervisory side. That may have had an impact on its performance. The Bank of England has much greater practical experience of markets. Being close to and understanding the markets lies at the heart of the most difficult aspects of banking supervision.
One can identify practical examples of where the Bank seemed to have got the message rather earlier and more thoroughly than the FSA. I do not want to run down the authority because I respect its chairman, just as I respect the Governor of the Bank of England. However, the FSA was more detached from the market system, which you need to know about if you are going to be an effective supervisor. If the idea is to have one authority embracing these functions, it should probably be the Bank of England and not the FSA. I am encouraged by what has been said by the noble Lord, Lord Turner, about the supervisory enhancement programme—rather a typical title for what is really an executive and administrative exercise—but I very much agree with my noble friend Lord Blackwell that there is confusion in many people’s minds between regulation and supervision.
Regulation is about making rules and setting up a structure in which the regulated bodies have to conduct their business. Supervision is a question of micro-prudential issues, institution by institution. That requires a very different cast of mind. The central problem of the crisis of the past two or three years is that things were being done by a large number of substantial institutions in many countries that, when aggregated, produced a global financial crisis. But nobody seems to have been looking at them closely enough to see the macro side as well as the micro that was in front of them and at which they were meant to be looking.
I constantly scratch my head and try to work out what sort of reaction to these dangerous activities was felt inside the institutions and by their auditors. There were the operatives who implemented the policies of taking on what would become toxic assets and dealing with complicated derivatives. There were the management and board of those institutions. There were the internal audit department, the audit committee, the external auditors and the supervisors. Everybody got it wrong. If I am not out of order to quote Her Majesty, she got it absolutely right with her killer question when she went to the LSE. She asked:
“If these things were so large, how come everyone missed them?”.
It is a question that needs an answer.
I do not know how, on such an enormously wide and varied scale, the principal financial bodies could really have missed everything. Were they not looking or were they looking in the wrong direction? We need to know more in detail how these things came about. If you have a problem, you need to know what has gone wrong in detail and why before you can put it right. I hope that the measures in the Bill will contribute to a much sounder system in future, but that will depend on people asking the right questions and, on past form, one cannot be 100 per cent confident that that will happen.
There has been a tendency to use mathematical models to measure risk. Such models have their use but they are only as good as the assumptions that you feed into them. More and more it seems as though some of those mathematical models were rather off beam. The Governor of the Bank of England, at least two years before the Northern Rock crisis, issued a warning that he felt that the markets were mispricing risk. They were indeed. It took a while for that to become evident, but I do not think that anything happened at the FSA end. I do not think that the FSA asked of every institution that it was supervising, “What does the governor’s remark mean in this case? Have we looked at the areas where things could be mispriced that would cause danger to the institution itself?”. We still have a whole raft of unanswered questions and, at the outset of consideration of a Bill such as this, we have to face the fact that there is still a lot that we do not know that we need to know.
My noble friends Lord Lawson and Lord Blackwell and the noble Lord, Lord Barnett, mentioned the separation of different kinds of banking. I have tried to work out how you would do that in practice and how you could have an effective firewall between the two. My noble friend Lord Blackwell said that you could have two separate incorporated bodies as subsidiaries of the same parent. In theory, that might work, but, in practice, you would have two bodies performing very different types of business but where the capital and implicit guarantee of the funds of the body were separated from an area where business was being done on an entirely different basis. It might work, it might not, but it is an important point and should be looked into further.
Many of the problems of the past few years have come through having monetary policy too loose for a long period. It is not just the property bubble; there were other areas, which I will not say more about now. We should not lose sight of the fact that the tremendous pressure on the acquisition of assets came from surplus funds in the system. That casts doubt on whether the consumer price index can really carry on on its own as the important point of reference.
My Lords, it is now a year and a half since the collapse of Lehman Brothers and since that fateful weekend when the UK banking system teetered on the edge of collapse—a collapse only prevented by the decisive action taken by this Government with a bank rescue plan that was, in due course, copied around the world.
The rescue was, as we now know, a remarkable success. Indeed, it has been almost too successful in that many bankers, with their notoriously short attention span, have already consigned the crisis, and their role in it, to history. Fortunately, the Government and the regulatory authorities have taken a very different view. Every major financial centre has undertaken a wide-ranging review of the structure of the regulatory system. In Britain, the new thinking was launched by the Turner review in March last year, followed later by the Treasury White Paper, in July, and by several valuable Bank of England studies. The de Larosière committee set out proposals for EU reform last February. The US Treasury published its own White Paper nine months ago, and in December the Basel Committee on Banking Supervision published its own comprehensive proposals.
These studies display a remarkable degree of unanimity. All acknowledge serious shortcomings in regulatory analysis prior to the crisis. Those shortcomings derived from the philosophy of banking regulation embodied in Basel II, the conventional wisdom in the decade before 2007. That conventional wisdom decreed that greater transparency, more disclosure and more effective risk management by individual firms would manage risk effectively. The result was a regulatory system that was highly market sensitive and strongly pro-cyclical—in other words a regulatory system that encouraged herding, fed panics and, by ignoring the system-wide costs of risk-taking by individual firms, weakened the defences of the financial system as a whole in the face of extreme events. All in all, the Basel II philosophy resulted in a regulatory infrastructure that made the downturn much worse than it might have been.
To give them credit, the authorities everywhere have rapidly reset their regulatory compasses. They now argue for a new approach that, in professional jargon, is known as macro-prudential regulation, which was referred to earlier in the debate. Broadly, that means that the activities of firms should be regulated according to the impact they have on the stability of the system as a whole—the macroeconomy.
What sorts of measures flow from this approach? They include, first, that regulators should take particular notice of the interconnections in the financial system, tracing as best they can the pathways through which financial contagion can spread. This requires a detailed knowledge of markets that in this country is found only in the FSA, but that detailed knowledge must be projected on to a system-wide template. Secondly, it requires that any institution which poses systemic risks—be it a bank, a prime broker, an insurance company or a hedge fund—should be strictly regulated. Thirdly, systemically relevant institutions should undertake pro-cyclical provisioning. That means accumulating capital in good times to provide a buffer against downturns. Fourthly, “leverage collars” should be enforced, relating the ability of the banks to expand their balance sheets to macroeconomic conditions—note, macroeconomic conditions, not the circumstances of the individual firm. Fifthly, measures must be taken to ensure that firms can fail without endangering the stability of the system. As if this was not enough, all this must be implemented on an international scale because systemic risk is a characteristic of global markets.
This is a truly radical agenda. Let us suppose, for example, that pro-cyclical provisioning became the norm. The economy is booming; tax revenues are rolling in, sustaining a healthy fiscal balance; house prices are rising; borrowing is easy; everyone is happy, and a general election is approaching. Then the regulator sharply slows down the economy by severely restricting bank lending. Just imagine the furore. But that is the sort of approach that macro-prudential regulation will demand.
Lying behind this radical approach is the sort of radical thinking that everyone involved in financial policy should be confronting. As an aside, that is why it is disappointing to encounter yet again the intellectual vacuum that characterises the contributions of the Official Opposition. From the Opposition Front Bench we heard nothing that remotely amounted to a vision of how the content of financial regulation might be reformed. Instead, as nature abhors a vacuum, all that the Opposition propose is a shuffling of institutions that will condemn the FSA and the Bank of England to at least 18 months of bureaucratic restructuring, when they should be getting on with the job of complex regulatory reform. Those of us who were involved with the pre-FSA regulatory system, and who worked on the transition to the FSA, witnessed the degree to which these bureaucratic upheavals paralyse effective regulation for an unexpectedly long time.
How does the Bill measure up to the new approach that all serious students of regulation propose? I must confess that I searched in vain for the new vision. I would be grateful if, when he sums up, my noble friend will indicate where the essence of the new macro-prudential approach is to be found in the Bill. If there is to be pro-cyclical provisioning, which measures in the Bill will help to implement those procedures? How does the Bill face up to the Bank of England's concerns that this provisioning should be based on clear but simple rules rather than discretion? Which authorities are to be accountable for devising and implementing such rules? Does the legal apparatus introduced in the Bill permit the introduction of macroeconomically defined leverage collars? If so, how are such measures to be related to the overall stance of macroeconomic policy?
The essential problem with the Bill is that, in Churchill’s famous phrase, it is a pudding without a theme. However, it contains some very tasty plums. Among the plums are the establishment of the Council for Financial Stability and the addition of the financial stability objective to the list of objectives of the FSA. Having spent a considerable amount of time and effort in the debates on the Banking Bill trying to persuade my noble friend that there should be such a council and that the FSA’s responsibility for stability should be recognised, and having been rebuffed on the former and severely lectured to the effect that the latter was totally unnecessary, I cannot but welcome these measures—
“joy shall be in heaven over one sinner that repenteth”.
Even in the absence of an overall macro-prudential vision, there are a number of other plums that provide useful sustenance. The requirement that the FSA promotes international regulation and supervision is one such welcome measure, though I must confess that I thought it did that already. Will my noble friend explain how in practice its activities will change? What will the FSA do now that it did not do before?
The measures on short selling address an obvious systemic problem and are welcome, but I worry that they deal with the symptom and not the disease. The disease is the general problem of herding, notably the simultaneous deleveraging that the Basel II standardisation of risk modelling so actively encourages. Herding is a product of the homogenisation of the marketplace, a homogenisation greatly enhanced by the liberalisation of financial markets and the conglomeration of financial institutions that has been one of liberalisation's consequences. Without direct measures to address the phenomenon of herding, the temporary suspension of short selling is a sticking plaster on a gaping wound.
The requirement that institutions develop recovery and resolution plans is also a welcome addition to the armoury of measures designed to reduce systemic risk—in this case tackling, at least in part, the problem of “too big to fail”. I have one concern with the provisions as drafted. The recovery and resolution plan drawn up by an individual institution will necessarily be based on the risk parameters as observed by the institution itself. It will not be possible for the institution to take into account the systemic costs of its recovery plan, or indeed of its resolution procedures. The need for the authority to take explicit note of systemic issues when assessing recovery and resolution plans should be in the Bill, and I intend to bring forward amendments to that effect.
I am sure that the provisions with respect to remuneration will be a major focus of public attention. I confess to being agnostic on this matter. Clearly, if remuneration practices actively encourage greed and excessive, even immoral, risk-taking, and hence increase systemic risk, they should be constrained or eliminated. However, given the market and regulatory structures existing in the run-up to the crisis, even if all bankers had been models of moral rectitude, the result would not have been much different.
There is one measure that is not in the Bill that I believe would significantly improve the quality of regulation in the UK. When I joined the board of the old Securities and Futures Authority in 1997—I had the pleasure of serving with the noble Lord, Lord Hodgson—I harboured considerable suspicion about the role of practitioners in self-regulatory organisations. Would they not simply look after their own? During my time at the authority, observing the performance of practitioners at first hand, I changed my mind completely. Far from looking after their own, the practitioners were typically tougher than the staff. Practitioners who were given responsibility for regulatory decisions “went native” as regulators. Their commitment was to “the industry”. They were concerned with the maintenance of integrity and fair market dealing that would be to the ultimate benefit of the financial services industry as a whole.
I was also impressed by the very high level of expertise that the practitioners brought to guiding the work of the staff of the SFA. These were people who worked in the markets on a daily basis and were at the leading edge of their various disciplines. I am very sad to say that the Financial Services and Markets Act was a notably anti-practitioner measure. Practitioners were corralled into advisory bodies, well away from statutory decision-making responsibilities. From my time on the FSA's Regulatory Decisions Committee, I can testify that this was a major error. The quality of enforcement work I saw at the FSA was considerably inferior to that performed at the old SFA. If we are to improve the expertise that is brought to bear on UK financial regulation, we need to find new ways of involving practitioners directly in the regulatory process. I will be considering whether the Bill can be amended to achieve that goal.
One final comment: it is commonly argued that regulatory reform can take place only on an international scale, and that all national measures should be suspended or postponed until full-scale international agreement is reached. This is a wonderful device for kicking reform into the long grass. It is also nonsense. Most of the important regulatory innovations in the past 40 years were launched unilaterally or by one or two countries. The first Basel capital accord was a bilateral deal between the UK and the USA when the noble Lord, Lord Lawson, was Chancellor of the Exchequer. Moreover, the structure and content of the UK regulatory system has never been the same as that in the US, to no obvious detriment. We must push ahead as fast as we can. The multilateral system will fall into place in due course.
Eighteen months or so on from Lehman Brothers, it is disappointing that a comprehensive reform package is not before us. What is in this Bill is worth while, but it is less than a halfway house. There is much more to be done before the regulatory system catches up with the last crisis, let alone prepares for the next one.
My Lords, I am grateful to the Minister for introducing this debate. I must declare an interest, in that I am employed by Mizuho International plc, which is regulated by the FSA, and I am a director of other investment companies.
As this parliamentary Session limps toward its eventual end, the Government are introducing ever more disappointing legislation. This Financial Services Bill, following on from the absurd Fiscal Responsibility Bill, completely fails to inspire or provide any confidence that the Government have finally got to grips with the changes that must be made to regulation in order to minimise the risk of another catastrophic regulatory failure, to nurture our crucial financial services sector back to health and to protect the interests of depositors and borrowers while economic conditions remain fragile.
As many noble Lords have already said, the tripartite arrangements have not worked well. It was always unclear how the Bank of England could properly carry out its objectives to achieve monetary stability and maintain financial stability, without having even the ultimate right to supervise the activities of the principal players in financial markets. With this Bill, the Government have missed the chance to restore the ultimate authority of the Bank of England as macro-prudential regulator. The Minister argues that the Council for Financial Stability will ensure that improved co-ordination between the tripartite authorities will largely eliminate the risk of failure of our regulatory system in future. The Bill does not provide enough comfort that the council will, in reality, be any more effective than the tripartite standing committee which it replaces. It permits delegation of representation by any of its members, so I think it unlikely that the Chancellor of the Exchequer, the Governor of the Bank of England and the Chairman of the FSA would really meet in person as the council, at least once a quarter.
It is clear that the Bank of England is best placed to have the primary responsibility for evaluating systemic threats to financial stability. In order to do that effectively, it needs to have clear, ultimate responsibility for macro-prudential regulation and the right to obtain whatever data it deems necessary in order to discharge its responsibilities effectively. The Government’s proposal to give the FSA an additional objective to maintain financial stability—identical to that of the Bank of England—merely serves to confuse further an ambiguous situation.
However, there is a much more serious ambiguous situation which this Bill does nothing—and, I fear, can do nothing—to address. That is that the Government have signed up to the creation of three new super-regulators at the European level. In this situation, the FSA can no longer make any regulatory policy by itself. Even though its voice and influence will clearly be stronger than those of the financial regulators of very many of the other EU member states, it still will have but one vote out of 27 in deciding matters of regulatory policy, on which we will not always agree with France or Germany. That the Government have allowed this situation to arise is extremely serious, and leaves successor Governments with enormous problems. London is the only significant wholesale financial market in the EU, and is arguably the leading financial market in the world. Our regulator should clearly have the right to sit at the top table of financial regulators, alongside the SEC of the United States, Japan’s FSA and other regulators of major financial markets. But the European Banking Authority, the European Securities and Markets Authority and the European Insurance and Occupational Pensions Authority will claim that they should play this role; and however effective our subordinated authorities—be they the Bank of England or the FSA—may be at protecting London’s interests, the loss of national control of our regulators will make it increasingly difficult for Britain to maintain, and further enhance, its role as the world’s leading centre for international financial services.
The prosperity of London’s key industries will become yet more vulnerable to the whims of legislators and regulators from the EU and other countries. The hedge funds directive, the Alternative Investment Fund Management Directive, is a good example. Even though, belatedly, the Government have tried to obtain improvements to protect the interests of alternative fund managers operating in the UK, the draft directive, which was published five months ago, is still regarded as unworkable as it currently stands by the European Union Committee of your Lordships’ House. The committee has only this month urged that,
“the Government should not agree the Directive unless it is compatible with equivalent legislation with regulatory regimes in third countries and in particular in the United States, in order to avoid a situation in which EU AIFMs lose competitiveness at a global level”.
As the Minister knows, most of the EU’s hedge fund industry is here in London. He has himself expressed concern that the directive could lead to an exodus of hedge funds and private equity funds from London. Does he accept the view of the committee not to agree the directive unless it is substantially improved? Do the Government have the power not to agree the directive, should they wish to withhold their consent?
I do not wish to say that we should set our regulatory policy in isolation, but financial markets are global, not European. It makes no sense to co-ordinate or, worse, subordinate, at the European level without first agreeing broad common standards and principles with the United States, Singapore, Hong Kong, Japan, Dubai and all other international financial centres. That is why I welcome the Government’s intention to give the FSA a duty in Clause 8 to promote international regulation—though I would like to see a reference to the “necessity” rather than just the “desirability” of maintaining the competitive position of UK financial services.
As far as the separation of commercial banking and investment banking is concerned, I agree with my noble friend Lord Blackwell that sufficient protection for retail depositors probably could be obtained through strictly ring-fenced, separately capitalised subsidiaries under a revitalised and renewed supervisory regime. I remember, as a member of the Joint Committee under the noble Lord, Lord Burns, which scrutinised the Financial Services and Markets Bill in 1999, that some members regretted that the maintenance of the competitiveness of the UK’s financial markets was not made one of the FSA’s objectives. The need to have regard to competitiveness is merely one of the principles which should be taken into account in pursuing the objectives. Will the Minister tell the House why the Government have not used this opportunity to protect the competitiveness of the City, given all the other measures they have taken recently which threaten its competitiveness?
In 1999, the Joint Committee also had reservations about giving the FSA an objective of promoting public understanding of the financial system, the “public awareness” objective. This has never sat well with the FSA’s principal activities of prudential regulation and oversight of wholesale and retail businesses. The Government have attempted to rectify this by removing the public awareness objective from the FSA and giving it to a new institution—the rather weakly named consumer financial education body.
The principal voluntary agencies—Citizens Advice, Consumer Focus, Which? and others—whose work is so valuable, especially under the current economic conditions, have all welcomed the improved focus on consumer financial education that this body should create. But, however desirable greater public awareness and better understanding of financial markets may be, have the Government considered other more cost-effective ways of supporting it? I think that the noble Lord, Lord Barnett, said the same thing. My noble friend Lord Eccles also correctly questioned the role of the public sector in this area.
We already have too many expensive quangos with a chairman, chief executive and board of directors, even if, as in this case, they are not to be regarded as exercising functions on behalf of the Crown. Would it not be cheaper and more efficient to expand the remit of Consumer Direct, funded by the Office of Fair Trading? The FSA’s subvention for public awareness and its contribution to the “Money Made Clear” scheme could be passed to Consumer Direct. This might be more effective and a cheaper way of achieving the Government’s purpose, helping to avoid escalation of levies payable by market participants, which also threaten competitiveness and therefore, ultimately, consumer choice.
Consumer Focus also sensibly asks why the Government have not used the opportunity provided by the Bill to strengthen further consumer protection against credit card companies, such as by requiring them to allocate a consumer’s debt payments to their most expensive debt first, as is sensible, rather than last, as they mostly do at present.
Clauses 9 to 11 deal with executive remuneration. I believe that these provisions are far too interventionist, especially the power to override employment contracts. I agree that the harmful incentivisation of traders to produce substantial short-term returns in order to maximise their bonuses should be ended. However, the increased capital backing for these high-risk businesses, which is or will be required, will solve the problem by reducing the margin earned in these businesses to a reasonable level. Basically, remuneration arrangements should surely be no concern of the state, except where the state is also the shareholder, as it is in the cases of Northern Rock, RBS and the Lloyds Banking Group, among others.
Clauses 13 to 17 deal with the FSA’s enforcement and disciplinary powers, which are already arguably too intrusive and dictatorial. For example, the powers to prohibit or restrict short selling are too restrictive. Surely, powers should be directed at particular instruments rather than institutions. The BBA correctly points out that the FSA’s short-selling rules should not be grouped with market abuse rules. Clauses 19 to 25 deal with collective proceedings. I agree with the CBI and the BBA that we should resist the proposal to allow an opt-out approach to collective redress because it would accelerate the undesirable trend towards an increasingly litigious society.
Clause 26, covering consumer redress schemes, attempts to widen the definition of a consumer to include a person who may have contemplated using a service, which, as the BBA has pointed out, is far too broad. The clause also enables the FSA to act as prosecution, judge, jury and executioner in this area, which is unsatisfactory. There must be a system of consumer redress which is subject to independent court approval. I doubt that this Bill will ever reach the statute book, but it has been a privilege to participate in this debate and I look forward to the Minister’s reply.
My Lords, I apologise to my noble friend for missing most of his opening speech, but he will be gratified to know that the two or three minutes that I heard convinced me that I need to support this Bill. I also need to declare an interest as chair of Consumer Focus. I will not have that post for much longer but my speech will unashamedly be on behalf of the consumer. Missing from this debate has been a recognition among my colleagues—with their vast experience of the City, the banking system and regulation—of the utter distrust and dismay that has affected large numbers of our citizens in relation to the banking system and how it has behaved in recent years.
As customers of banks we have seen our once respected high street banks revealed as gamblers with our money. As taxpayers we have seen the Government bail out the whole system with no very obvious return to the consumer, deposit holder and those seeking loans from the banks. We have seen state-owned banks and a change in the structure of the banking system lead to a reduction in the availability of credit, as well as an increase in the price of credit for small businesses, at a time when the official rates of interest are at an all-time low.
Meanwhile, consumer groups such as mine, the competition authorities and others have revealed the misdemeanours of banks in relation to overcharging for overdrafts, bamboozling customers over the real cost of credit cards, requiring non-effective protection insurance of unsuspecting customers and so on. In all those areas, ordinary individual consumers and small businesses are pretty much bereft of any serious means of redress that they can normally afford.
In all that, the regulators have failed. The FSA has failed not only as a macro-prudential regulator, but also as a protector of the consumer interest. Last year, Consumer Focus drew up a report of all economic regulators. The FSA turned out to be one of the least well grounded in terms of consumer experience, one of the least transparent in information to consumers and one of the least demanding of the regulated industries in relation to the provision of meaningful information to consumers.
I know that there is a view in the City and the financial commentariat—a few moments ago, it was expressed in this House by the noble Lord, Lord Stewartby, who is not currently in his place—that one of the reasons for the FSA’s failure was that it has concentrated far too much on consumer protection. That is misguided. I do not exactly argue the opposite, but I believe that the FSA has failed consumers just as much as it has failed the banking system. If we are looking at changing the powers and the role of the FSA, we have to address both parts. Whatever the name on the door of the organisation, our regulatory system has to address both problems.
In broad terms I support the Bill and the provision that it makes for more effective processes and for redress for consumers collectively. I support the changes in the role and enforcement powers of the FSA and the provisions for enhanced consumer education for financial capability. The Bill also deals with abuses, such as the bewildering array of charges for store and credit cards.
I congratulate my noble friend on the bulk of the provisions in this Bill, although I have some misgivings, to which I will turn in a moment. What concerns me about bits of this debate so far—I am aware of the debate outside this Chamber, too, although this view was also expressed by the noble Lord, Lord Henley—is that there is a move, supported by the CBI, to dilute virtually out of existence the provisions in the Bill that provide for collective redress. I will not repeat the arguments made by my noble and learned friend Lord Goldsmith on the need for provision for collective redress and the desirability of having some form of opt-out redress in this system. He also dealt effectively with the argument that this will get us into an American-style class action bandwagon for lawyers.
I have not the same interest to declare as my noble and learned friend Lord Goldsmith in relation to bonanzas for lawyers, but there is no comparison between the situation provided for in this Bill for collective redress and that which prevails in the United States. We operate a different system and there are safeguards in this Bill to ensure that there is not abuse of the system. What is proposed is much needed because, although the sufferers from abuse in the financial sector and many other sectors are often relatively small-scale in the scheme of things, a large number of people are affected. An opt-out system is the only way in which that problem will be seriously addressed. Indeed, in other jurisdictions, such an operation already exists—in the Scandinavian countries, in the Netherlands and in Portugal—and we do not see a large-scale, American-style range of litigation, because the very existence of that provision makes providers behave better in the first place.
On the role of the FSA, I support the creation of the proposed consumer financial education body, but I have some reservations about it. My concern is on two levels. Work has been done in the FSA—the Money Made Clear programme is particularly impressive—but we have to recognise that, despite the poor record of much of the financial sector on consumer service and consumer protection, some areas can be made more effective by a more effective organisation in this area. Also, taking what has perhaps been the most effective part of the FSA’s empire in relation to consumer protection out of the FSA may make the remainder of the FSA concentrate less on consumer protection, consumer enhancement and consumer information than it currently does. That danger is enhanced by the inclusion of Clause 6, which removes the objectives from the FSA for improving financial understanding.
Is it my noble friend’s intention that the FSA will no longer have any responsibility in this field? Surely this needs to run through its regulatory and supervisory interventions in any case, even though there may be a separate body delivering the education programme. It is even more incongruous that that responsibility should be taken away, because the FSA is still responsible, under Schedule 1A, for setting up the new body. In the long run, the new body should probably be entirely separate from the FSA, but that is not what the Bill says. It is also important for more general purposes that the FSA should retain some responsibility in this field.
We know that there are alternative plans around for restructuring the boundaries of regulatory activity in this area and that the Opposition—the noble Baroness, Lady Hogg, mentioned it today—would, if elected, probably abolish the FSA entirely, move micro-prudential regulation to the Bank and have a separate consumer protection agency. I could be persuaded of that, but it would, on the face of it, leave the consumer dimension of this out of the responsibilities of the main regulator, which would, under those circumstances, be the Bank of England.
I want to mention two other aspects. The first is consistency across the consumer field, both within the financial sector and more broadly. There are parts, particularly the credit dimension of financial services, which are non-mainstream—those that affect the poorest elements of our society—and there is a mishmash of regulation in that area at the moment. This applies in part to the relatively benign activities of credit unions, which the noble Lord, Lord Bew, mentioned in a Northern Irish context, but also to the less benign activities on home loans, pay-day credit, pawnbrokers and pre-payment systems, right through to illegal activities by loan sharks. This is a sector on which more and more people are dependent for credit; as credit becomes more difficult to obtain in the mainstream sector, more people are being pushed into this sector. I hope that the Bill’s provisions, including the redress provisions, will extend to them.
I also think that these provisions should extend, or be capable of being extended, more widely. I mentioned in my declaration of interest that I shall soon cease to be chair of Consumer Focus. This is because, in another part of Whitehall, as the noble Lord, Lord Henley, mentioned, the BIS department is creating a consumer advocate, whose job will subsume the job that I currently do as chair of Consumer Focus. I would like to see the consumer advocate have a role in the financial services area, but it is not clear whether that will happen. Moreover, I would like to see the collective redress provisions extendable into areas other than the financial services. I think that, at this stage of the Bill and this stage of the parliamentary process, the only way I could hope to get that would be through a relatively simple clause that would provide for an affirmative resolution to extend the provisions into other areas. I do not expect the Minister to come up with full-scale provisions in this area, but I should like to see what I have suggested reflected in the Government’s intention to enhance consumer powers and the redress that consumers can obtain.
My final points relate to the structure of the banking sector. The Minister may recall that, when we suspended the competition laws in relation to Lloyds-HBOS a few months ago, and when he dealt with the Banking Act in 2009, I made a couple of suggestions. One was that those retail banks with a significant part of the market should reflect the consumer interest within their own structures, much along the lines mentioned by my noble friend Lord Sawyer. My other suggestion was that, at some time, when this crisis at least looks as though it is over, we should have a proper competition inquiry into the structure of banks. We have ended up in this country with an oligopolistic situation in mainstream banking, much of which is partly owned by the Government.
I do not know what the ideal structure of banks would be. I do not know whether the proposition of the noble Lord, Lord Lawson, on Glass-Steagall is operational in these current, modern circumstances. I do not know whether it is right that some banks are too big to fail and too big to be broken up. However, I know that the current situation is probably leading to less choice, less flexibility, more people excluded from access to financial services and the domination of our financial and banking structure by relatively few companies. We need a competition inquiry into that. It is not necessarily the case, of course, that more banks will necessarily mean more choice—we could end up with more banks and fewer branches, fewer products and fewer choices for individuals—but at least we should have a proper, thorough investigation into that. I suggest a Competition Commission inquiry into the whole area.
My final point is on the governance of banks. When I raised this with the Minister previously, he referred me, as he may recall, to the then impending Walker report. While I agree with some of the provisions suggested by the Walker report, I do not think that it goes far enough. The people who govern the banks failed us dramatically. The people whom the shareholders put in there on their behalf failed them and they failed the wider society. The current governance of banks is not sufficiently different. Banks are different from other public companies and we ought to recognise that in the law that covers their governance. Until we do, we run the risk of making the same mistakes again.
My Lords, one of the interesting things about the Bill is the very wide range of submissions that have been received by me and, I am sure, by other noble Lords in advance of this debate. There are, of course, the usual suspects, but a much wider range of people and organisations has got in touch with us than is, I think, normally the case. The more direct among them have described the Bill as “a ragbag”. The smoother have described it as “an eclectic mix”, but whatever the adjective one uses to describe it, there is evidence of the Bill having been put together in quite a hurry and some of the Minister’s opening remarks left me to wonder whether his heart was really in it.
As I came 18th in the debate, a lot of the ground has been extensively ploughed, so I shall confine my remarks to something on the architecture, something on collective claims and something on the consumer financial education council and avoid repeating a lot that has been said before. I have interests to declare as the chairman of three firms involved in private equity, specialist insurance broking and the provision of independent financial advice. They are all in the Register, but they are all firms regulated by the FSA and I am an authorised person of the authority. I was also a founder member of the Security Investments Board and subsequently, as the noble Lord, Lord Eatwell, kindly pointed out, a member of the board of the Securities and Futures Authority, one of the self-regulatory organisations replaced by the FSA under FiSMA.
This is not a cry for the re-establishment of the ancien regime. Self-regulation was tougher in its impact than is popularly supposed, as the noble Lord, Lord Eatwell, pointed out. I am afraid that it could no longer command public confidence; it could too easily be characterised as letting your friends off over lunch. However, it had at least one aspect in its favour which I agree with the noble Lord, Lord Eatwell, is worth preserving in the future: it was very close to the markets that it regulated, because it was made up of practitioners who were earning their daily bread dealing face to face with a range of firms. Therefore, one came to know quite clearly the quality of the processes and the quality of the people in individual firms, which are critical issues in a fast-moving industry. My concern is that, as we create the more elaborate structure envisaged in Clause 1, with more committees, there is a danger that theoretical discussion in the citadels of government will obscure the hard edge of developing market practice.
I hope that the Minister will forgive me. He has been a hard-edged practitioner, I know, but I have noticed that even he is falling under the spell of the theoreticians. We had a very interesting discussion at Question Time the other day in which we explored the possibility of extending ISA eligibility to AIM shares. The Minister said:
“The noble Lord should recognise that AIM is a market for listed companies. At the time of listing, it is not in itself a source of new capital for investment. That takes place before, so buying a share of an existing company does not represent the flow of new funds into a business”.—[Official Report, 27/01/10; col. 1409.]
That is theoretically true, but if the noble Lord takes off his ministerial hat and puts on his investment manager hat, he will recognise that it is practically incorrect. It is incorrect because when as an investment manager you make your investment, you are hoping to sell it; in order to sell it, you need the secondary market. A buoyant secondary market is therefore an important part of the primary market. In addition, when you recycle in the secondary market, you free up funds for reinvestment in the primary market; that is, in new companies. I look forward to discussing with the Minister in Committee how he sees the proposal working in practice, day to day, as opposed to in the laboratory tests that he is running in the Treasury.
That takes me to my second point about architecture. At Second Reading in the other place, a number of exchanges dealt with the speed with which the architecture of the FSA was outlined after the 1997 general election and the lack of consultation that accompanied it. From my worm’s-eye view at the SFA, it seemed that the jelly was set pretty quickly. One has to wonder whether a period of reflection might have led to a better structure. As my noble friend Lady Hogg pointed out, one wonders whether greater consultation on the very far-reaching implications of this Bill and the plenary powers that it grants would both improve the proposals and, equally importantly, improve public buy-in. It is interesting that the British Bankers’ Association says in its briefing:
“A fundamental concern is whether the consequence of some of these proposed actions can fully be assessed in the short time that has been allocated to the Bill for Parliamentary debate, particularly in those instances where the Bill is conferring statutory obligations in respect of requirements that have not yet been defined”.
A further discussion arose in the other place about the attitude of the Bank of England to the dismemberment of its empire. All I recall is the late Eddie George, then Governor and later a distinguished Member of your Lordships' House, turning to his deputy, Howard Davies—now Sir Howard Davies—head of the LSE and then to be the first chair of the FSA, handing him a dollar bill and saying, “This is the buck that stops with you”. Whether that was the action of a happy man or an unhappy man, it is up to noble Lords to judge, but I judge the latter. However, this is the question: where does the buck stop? Where does the new financial stability objective rank alongside the Bank of England’s view of future economic prospects and the Treasury’s politically driven agenda? We need to tease out the relative priorities in Committee.
So much for architecture; I said that I wanted to say a few words about collective proceedings. Here, I follow the points made by the noble and learned Lord, Lord Goldsmith. I have no theoretical objection to the idea of collective proceedings, but I am concerned that we have not got the balance right in the Bill. On the narrow question of “opt out or opt in?”, for me, the default position should be “opt in” if we are to avoid ambulance-chasing on a grand scale. However, the general point is the truism that we live in an increasingly litigious society, reflecting partly changing socio-economic attitudes and partly the changes in methods of legal remuneration. One only has to listen to Classic FM to hear a firm advertising itself as “fast, friendly and free” to know that increased litigation is with us. Further, from time to time, cases may be brought, not to win the case but to ventilate an entirely separate, often political, grievance. When we were taking the Companies Act through this House, we had many discussions in Committee about the issue of derivative claims, which runs parallel to this issue. The noble and learned Lord, Lord Goldsmith, then for the Government, and his colleague, the noble Lord, Lord Sainsbury, understood concerns about managements being distracted by frivolous claims, or claims whose primary objective was outwith a company’s remit. I think that it is fair to say that the Government listened. Various provisions were put into the Bill, particularly at Clause 263, to provide a balance—they were things that a court would have to take into account before allowing a derivative claim to proceed. I hope that the Government will look at those debates and at what was done then and see whether there are not some ways forward here to get the balance right. It is important that companies and managements of banks are not diverted by claims that are not seriously central to their purpose. To do that, we need clear, detailed rules before we leave Committee stage.
I turn finally to the consumer financial education body, which, again, is a good idea which has not yet been properly thought through. I share the concerns of the noble Lord, Lord Barnett, about a quango. I am concerned about the huge and prescriptive nature of Schedule 1, which makes the FSA’s task, especially with its new, added responsibility for financial stability, incredibly difficult; that is, of being responsible for regulation of markets on the one hand and for the protection of customers on the other. However, the Government do not call them “customers”; they call them “consumers”, which gives the whole game away. When the Minister was running his extremely successful unit trust group, he would not have called them “consumers”. They did not consume his unit trusts; they were customers. The whole phraseology around the way in which the body is being set up and the way in which the FSA is approaching it does not hit the central point that we are trying to achieve. I therefore wonder whether the FSA is the right place to be locating the body at this stage. We have a highly prescriptive schedule; we have the absence of any requirement for public interest representatives on the council; and we have a failure in Part 3 of Schedule 1 to require, as opposed to permit, an annual value-for-money audit. Finally, as the Minister said in his opening remarks, the body will establish a new service called money guidance. Offering guidance to millions of our fellow citizens is potentially a huge business. I understand that it is being trialled only in the north-west and the north-east, but it is about to be rolled out. It will require very careful and experienced handling. I am not clear at this stage why the Bill does not talk about the establishment of some form of national money guidance as part of the objectives of the body, and how it will be executed and carried out. That is an issue at which we will need to look very carefully in Committee.
There are other important points in the Bill—for example, the provisions on short selling in Clause 13 —which need close examination, but unless we get the architecture right, so that basic structure is effective, unless we prevent our financial institutions being distracted by frivolous claims and unless we have a proper, effective system for educating our fellow citizens, I doubt that we will have a Bill which is fit for purpose.
My Lords, the Bill is an odd mixture of the grand sweep and the fine detail. It is, as the noble Lord, Lord Eatwell, said, a pudding without a theme, even though many of its ingredients might in themselves be quite palatable. Just to pursue the culinary theme, the noble Lord, Lord Hodgson of Astley Abbotts, described the infrastructure as made of jelly. I am tempted to say that that is why it wobbled so much in the crisis.
I turn to the grand sweep of the Bill—which is where the Bill begins, with macro-prudential regulation. It proposes formalising the tripartite agreement by establishing a Council for Financial Stability and it adds to the FSA a financial stability objective and an objective of promoting international regulation. As a number of noble Lords have pointed out, these provisions largely formalise what already exists. It is very difficult to believe that they represent a major change of substance. I very much agree with the noble Baroness, Lady Hogg, when she says that a new Parliament should be spending its time discussing many of these big issues. It is perhaps unsurprising that much of the debate in your Lordships’ House tonight has concentrated on them.
Although it is commonplace to attack the tripartite system, as we have had it up to now, for its behaviour and performance before the crisis broke, once the crisis did break, it worked pretty well. In the lead-up to the crisis, the problem was not the structure but the fact that there was a bubble mentality that affected all the players, whether it was the Bank, the FSA, the Treasury or the banks themselves. To argue that changes, including the changes proposed in the Bill, would have made much difference to that bubble mentality is largely wishful thinking.
Equally, it is wishful thinking to believe, as the Conservative Opposition do, that changing the name on the door of the FSA will make a fundamental difference in the effectiveness of the regulatory system. The noble Baroness, Lady Hogg, made some very cogent arguments as to why it will be much more difficult to change the system as the Opposition propose to do than they themselves have set out. As she pointed out, they have made it clear that they do not intend to do it in a rush. I will be very interested to see if and when they do indeed get round to it. It seems to me that once you start unpicking the system, the problems that she described will grow in importance.
More than anything else, what will make regulation over the next decade more effective is the fact that the regulators themselves have just had the shock of their lives and they do not want to repeat going through that process. Future generations of regulators need an enforced study of the circumstances that led up to this crisis. That will be much more relevant to their effectiveness than their job titles or the committee structure within which they are expected to operate.
The big issue that was debated this evening, which we will have to come back to, was whether one should be splitting up the banks. Slightly unusually, I agreed with almost everything that the noble Lord, Lord Lawson, said on the issue. It was extremely interesting that he got such heavyweight support from his Conservative colleagues. There were differences of nuance—whether or not a firewall can be effective—but the basic principle was accepted by the Conservative Benches. I shall be very interested to see whether that support for breaking up the banks is reflected in the summing-up of the noble Baroness, Lady Noakes.
I turn to the measures in the Bill with a less grand sweep. We welcome the establishment of the consumer financial education body, because responsibility for consumer education is fragmented. We currently have a patchwork quilt with holes in it, and one hopes that this provision will result in the replacement of that patchwork quilt by a more coherent approach. I share the concerns of the noble Viscount, Lord Eccles, about the costs and bureaucracy that the body could involve. The important thing is to ensure that, having collected the money, the body gets it down to those who can spend it effectively, which will not be the body itself. Organisations such as the CAB are already doing so much good work in this area.
The watchword of the body is obviously “prevention is better than cure”. I generally like the idea which the noble Lord, Lord Sawyer, adumbrated about involving customers in the actions of retail banks. One of the benefits of such an approach would be to improve the education of customers, who would be encouraged to look not just at how the banks work but at how they get involved in the financial system.
We are glad to see legislation on remuneration. We are also pleased to see the likelihood of the imminent implementation of the Walker report. The Bill as it stands is extremely draconian; it means that the Government can do almost whatever they want on remuneration, subject to secondary legislation. As with other aspects of the Bill, it is unsatisfactory that we have not seen draft secondary legislation at this stage.
I do not agree with the noble Lord, Lord Blackwell, when he says that we should not set out non-director remuneration for public view. The levels and forms of remuneration for non-directors played a part, arguably a significant one, in some of the excessive risk-taking by the banks, and therefore in the debacle that followed. In that respect, senior and highly remunerated bank employees are different from Jonathan Ross and Wayne Rooney. Equally, I cannot agree with the noble Viscount, Lord Trenchard, when he says that this should not be a matter for the state. The state is still picking up the bill for the remuneration systems that led to such reckless risk-taking.
Recovery and resolution panels have not been much touched on; it is a very technical issue. They sound quite sensible in principle, but I have considerable doubts about their practical value. I share the concerns raised by the noble Lord, Lord Eatwell, when he talked about the difference between what is good in systemic terms and what is good for an individual institution. One of the common features of these plans is that they will involve banks that are going into administration selling off parts of their business. If you have a systemic problem as we had 18 months ago, all the banks will be faced with the same problem: they are trying to flog off the same kind of assets into a falling market. The Treasury documentation talks about the banks negotiating a deal with potential purchasers in advance of their going into administration. That seems wishful thinking. It seems extremely naïve to think that one bank could go to another which might be a purchaser and say, “If we go bust, how much will you buy this part of the bank for?”.
I also have concerns about the bureaucracy that is implied and planned under this system. I had the benefit on a recent transatlantic flight of reading the Treasury’s document entitled Establishing Resolution Arrangements for Investment Banks. Although this document is an intellectual tour de force and extremely long, the more I flicked through it, the more it made my heart sink. It proposes, for example, establishing a board-level business resolution officer—a BRO—who will spend up to a day a week working on resolution plans. The BRO will produce a BIP—a business information pack—for administrators which is described as a “living document”, continuously updated. It will probably require a client assets trustee, and it will require a client asset agency as part of the FSA. As the noble Baroness, Lady Valentine, pointed out, this really is over-engineering on a pretty grand scale.
Collective proceedings are the most complex and controversial part of the bank, once we have dealt with macro-prudential management. The principle of giving easier redress to classes of people who have suffered loss as a result of the behaviour of financial services firms is one that everyone supports. My principal concern about the Bill’s approach to this is that it puts in place two parallel approaches—one via the FSA and one via the courts. In principle, groups of consumers could pursue the two in parallel, which does not seem sensible. It would be better for the FSA to be the first route for those seeking collective redress. The advantage of going to the FSA first is that the FSA is likely to be able to operate more quickly and cheaply—and to get the redress sorted out—than going through the court route. I agree with the noble Lord, Lord Henley, that the court route should be the last resort, rather than, potentially, the first resort.
Like others, I have several other concerns about the details of the provisions. I agree with the noble and learned Lord, Lord Goldsmith, that there has been inadequate consultation. There has been no consultation of any substance. I am concerned that the provisions apply only to FSA-authorised firms, not to firms holding consumer credit licences. We will table amendments to deal with that.
At the moment, the Bill raises a number of unanswered questions. Who will be able to initiate collective proceedings? How do the provisions of the Bill chime with international discussions and likely developments here? How will costs be apportioned? Will the “loser pays” principle remain? Is it sensible to have both opt-out and opt-in approaches? These are all issues that need to be debated at some length in your Lordships’ House. There is another area where I have some concern. Like a number of other noble Lords, including the noble Lord, Lord Whitty, I fear that—although we will not necessarily get to the US stage of massive class action suits left, right and centre—American law firms are setting up practices in the UK specifically to deal with these issues. Even before we had this provision, in previous mis-selling cases, such as the split capital investment trust case, investors gave law firms significant sums, which they often could not afford, to pursue class actions that were bound to fail. We cannot be at all complacent in this area, but I fear that the consumer bodies have sometimes sounded complacent.
As for the Bill’s consumer redress schemes, although the prohibition of credit card cheques is obviously welcome, we will be looking to add a new provision to ban unsolicited increases to credit and store card limits. This is a major problem for the vulnerable groups who build up debt on credit cards, which they are encouraged to do, without having to express their opinions.
This debate has a slightly surreal air to it. We are discussing an extremely important and complex Bill as though it were business as usual. However, we all know that unless the Government give the Bill total primacy over all other parliamentary business over the next month, the chances of it going through your Lordships’ House in the normal manner are nil. It is set to be a victim of the wash-up. That is a serious concern. As we have debated tonight, many aspects of the Bill are contentious and need detailed debate. To make matters worse, over the next few weeks we face the prospect of concentrating on those parts of the Bill which will be reversed if we have a Conservative Government, because those are the parts that come up first. Many of the consumer provisions are towards the end of the Bill. We are in danger of giving them little or no consideration. This is a most unsatisfactory situation. What plans, if any, do the Government have to ensure that the Bill is properly debated, rather than being either nodded through or eviscerated in the wash-up?
My Lords, this rag bag of a Bill tells us all that we need to know about a Government who have lost their sense of purpose but are struggling on, pretending that they are doing purposeful work. Two weeks ago we debated the vacuous Fiscal Responsibility Bill. That Bill is now an Act but it is no more and no less likely that the Government will be fiscally responsible. This Bill has as its centrepiece the Council for Financial Stability, but if it passes into law, it will be no more and no less likely that financial stability will be preserved. Some parts of the Bill are welcome in principle but are still works in progress and carry the danger of legislating in haste. This House must, in particular, be on guard against good intentions or populism resulting in bad law. We will need to do a lot of work to make what is in the Bill good legislation. There are also great gaps in the Bill where substantive matters should have been addressed. We shall try to fill those gaps. All told, it is not a fine Bill.
My noble friend Lord Henley has already deconstructed the Government’s not even half-baked plans for collective action. The spectre of US-style class actions, referred to by the noble and learned Lord, Lord Goldsmith, has rightly terrified the business community in the UK. It has not been reassured by what the Government have said in another place. My noble friend also exposed the weakness at the heart of the changes to the consumer redress powers in Section 404 of FSMA. They are retrospective and sweep away parliamentary oversight and replace it with only judicial review, which is not a proper remedy. We are clear about our support for effective consumer remedies. We would be completely behind the Government if they had demonstrated a balanced and holistic vision of consumer redress in the financial sector, across all consumer-facing sectors and in the European context. However, after 13 years they have chosen to use their last gasps in power to pursue this imperfect legislation.
The consumer clauses might be flawed but they do at least tackle an issue of real substance. There is far less substance behind the clauses which set up the Council for Financial Stability. No one should be taken in by dressing up the failed tripartite arrangements in new legislative clothes. I am sure that lessons were learnt from the failures in 2007 and the tripartite authorities will not make the same mistakes again. They do not need the Bill for that.
The recent financial crisis exposed the consequence of the Prime Minister’s vandalism when he tore banking supervision out of the Bank of England. He single-handedly destroyed the link between macro-prudential oversight and micro-prudential action. My noble friend Lord Stewartby reminded us that warning signs of overleverage were analysed by the Bank but not translated into practical action. Interdependencies, which were correctly identified by both the noble Lord, Lord Desai, and my noble friend Lady Hogg, were missed. My party’s policy is to reunite macro and micro-prudential supervision in the Bank. There will be no need for a Council for Financial Stability under our policies.
Leaving that to one side, the Bill is just not good enough. It fails to identify who is in charge or where the buck stops, to use the phrase of my noble friend Lord Hodgson. It also fails to identify the tools that are needed to maintain financial stability. It leaves many big issues unresolved. How should banks and other systemically important organisations contribute to the cost of failure? Should the structure of the banking industry be changed to minimise risk? My noble friends Lord Lawson and Lord Blackwell offered slightly differing visions of this but agreed that we must address the issue. My honourable friend George Osborne has never ruled this out, but we have always stressed the importance of concerted action in such areas on a global basis. We shall need to return to many of these issues in Committee.
At first sight, the financial stability objective introduced by Clause 5 is just another government U-turn. The noble Lord, Lord Eatwell, reminded us that last year, during the Committee stage of the Banking Bill, he sought to introduce that to the FSA. The Minister said clearly and emphatically that it was not “appropriate”. Now it appears that it is. The Minister will need to come to Committee with his files full of analysis of why, one year later, Clause 5 is now appropriate.
We are completely behind the desire to improve financial understanding and education. While I share the distaste of my noble friend Lord Eccles for yet another public body with its own bureaucracy, we support the creation of a consumer financial education body. The base lines in this area are shockingly low and the task is therefore huge.
We are not surprised that the new body will be expensive. The impact assessment talks of costs to the industry and government of £1.5 billion. Only a fraction of this could conceivably come from dormant account money. My party’s view is that the financial services industry should pay for this body, but that means that the industry should have a say in what is spent and how it is spent. The Bill does not achieve this.
In the impact assessment, there are some completely wild figures relating to the benefits of the consumer body. We need a much clearer idea about monitoring the achievements of the new body and its value for money. There are also issues about its engagement with consumer groups. Even in this relatively uncontentious part of the Bill, there are major issues for us to explore in Committee.
We should all like to think that the new consumer financial education body will deliver sensible financial planning and increased saving, but the hard truth is that the biggest problems to solve lie at present in excessive personal debt. Education, at least in the short term, will not be enough on that front. That is why we welcome the Bill’s ban on credit card cheques, but we are equally disappointed that the Government have not gone further. My noble friend Lord Marlesford, who was unable to be with us for the whole of today’s debate, intends to table amendments to place greater responsibilities on credit card issuers. I agree with my noble friend Lord Trenchard on the other measures needed on credit cards, and we should deal with the OFT’s powers in relation to bank overdrafts following the Supreme Court’s decision. We also agree with the Financial Services Consumer Panel that consumers should have the added protection of earlier disclosure of warnings issued by the FSA for regulatory breaches. We will bring forward amendments in Committee to deal with all these issues.
We have made it abundantly clear that we strongly disapprove of many of the current bonus arrangements in banks. They have profited from action taken by Governments and monetary authorities around the world to protect the global financial system. We believe that banks should now be rebuilding their balance sheets and supporting British businesses with increased lending, not paying large cash bonuses.
We completely agree that the remuneration practices of banks must reflect risk and that the regulator must be concerned with that. But we must be wary of legislating for a regime which speaks to today’s rather than tomorrow’s issues. Remuneration controls may well be part of a rational framework of prudential supervision, but they must not be drafted with the court of public opinion in mind.
We must also ensure that we keep in step with the rest of the world and get the balance right between protecting financial stability and usurping the role of owners and shareholders. These are not easy issues to deal with in legislation, as we shall doubtless expose when we scrutinise Clauses 9 to 11 in Committee.
The issue of the draft regulations on remuneration disclosures has also been raised. The Minister in another place said in early January that the draft would be released for consultation “as soon as possible”, and the Minister in this House used the word “shortly”. He will know that this phrase and word are two of the most slippery in the ministerial lexicon. Can the Minister assure the House that the draft regulations will be available before our Committee stage?
We have also made plain our support for recovery and resolution plans which are set out in Clause 12, but, as with the remuneration clauses, we must be sure that our legislative response is properly targeted and durable for the long term, rather than a response to short term issues. It must also be aligned with international rules and be proportionate. We are less than clear that that is what the Bill achieves.
There are many issues related to the various additional powers that this Bill seeks to confer on the FSA. Our concerns here tend to be more detailed and technical but, if there is a common theme, it is between the need for the FSA to get the job done, which we recognise, and the FSA being able to steamroller anything or anyone in its path. We will need to explore the balance in Committee.
There is one overall point which we must not lose sight of as we scrutinise this Bill. It concerns the cumulative impact on our financial services sector of post-financial crisis changes, including those in this Bill. The financial services sector is a large and important part of our GDP, as my noble friend Lord Howard reminded us. While we may wish that other parts of our economy were stronger to balance this out, I hope that no one wishes harm to one of our most successful industry sectors. As we go through the remaining stages of this Bill, I hope that noble Lords will bear in mind the warnings of the noble Baroness, Lady Valentine, that punishing the banks for their real or perceived failings may end up harming the UK. Overloading the banks with regulatory responses and other burdens may have the effect of cutting off our nose to spite our face.
Where does that leave us overall? This Bill is not a major contribution to the big issues facing the financial sector. There are some good points, but many parts of the Bill have as much capacity to do harm as good. Our task of course is to eliminate as much of that harm as we can.
Today’s debate has demonstrated that the passage of the Bill will not be straightforward. Your Lordships’ House will need to devote considerable effort if we are to return it to another place in anything like an acceptable form. The Government can do their own sums. There are relatively few days left for scrutiny of legislation. If the Government choose to use those days on this Bill, we will not be found wanting.
My Lords, it is a pleasure to produce the closing speech for the Government on Second Reading. It is the second important and significant piece of legislation on which I have had the pleasure of doing so in recent weeks. The Fiscal Responsibility Bill, which is clearly so welcomed by the opposition Benches, will have profound and long-lasting consequences for the management of the economy, and today we have the Financial Services Bill.
This has been a very stimulating debate and we have been very well informed by the breadth of opinion on Benches on both sides of the House. I am grateful to noble Lords for the astute points they have made. I must be clear at this point that it will not be possible within a reasonable time period to answer all the questions that have been raised because they have been so rich, varied and wide in regard to many issues. We look forward to a very engaging Committee stage, but I apologise now to those noble Lords whose questions I do not give answers to. I will, however, go through Hansard and, where there are specific questions which require a factual or policy answer, I will endeavour to write to the noble Lords concerned and copy my reply to others.
The noble Baroness, Lady Noakes, asked a specific question about when we expect to provide the House with draft copies of our proposed regulations on remuneration. The word “shortly” in my lexicon means quite imminently and I certainly intend to ensure that that is done ahead of the Committee stage so that the House has that information.
I start with some discussion of the institutional framework because this issue was raised by a number of Members of the House. The noble Lords, Lord Lawson, Lord Howard of Rising, Lord Henley, my noble friend Lord Barnett, the noble Viscount, Lord Trenchard, the noble Lord, Lord Newby, and the noble Baroness, Lady Noakes, all focused on the early clauses of the Bill and the institutional framework.
The suggestion from the Opposition that handing the Financial Services Authority’s powers back to the Bank of England would have prevented the financial crisis, or indeed would prevent a future one, is misguided. Many major institutional frameworks exist in different countries across the world, but no model of financial regulation has been successful in fully insulating a country from the crisis. Arguably, the only advanced economy able largely to withstand the banking crisis was Canada, and its regulatory structure is very similar to our own.
The causes of the crisis were numerous and diverse, and the FSA has acknowledged the shortcomings of its past regulatory approach. This is commendable: I am aware of no other financial regulatory body that has been quite as forensic and open in its self-analysis of its shortcomings, and in clearly articulating how it intends to address those issues in future. However, the solution is not to rearrange the responsibilities of those with roles to play in preserving financial stability. It is rather to ensure that all the responsible parties have the right tools at their disposal to maintain financial stability, and that the right framework exists to ensure effective co-ordination of the authority’s activities. What matters is not who does the job, but that the job is done effectively—the noble Lord, Lord Newby, among others, made that point—and that the institutional framework is clear and coherent. The answers are less around architecture and more around behaviour and competence. The noble Lord, Lord Hodgson, also spoke about the need for practical solutions as opposed to vesting this entirely in matters of dogma.
Change to the institutional system by moving specific responsibilities from one body to another will not, by itself, make a difference, other than to cause significant disruption at a time when attention should be focused on practicable and workable improvements to regulatory performance and decision-making. At this critical time, we need the authorities to focus on reducing risk, not on having to deal with disruption and uncertainty caused by unnecessary institutional upheaval. I was somewhat alarmed to hear suggestions from the opposition Benches that, if they were to find themselves in power, the organisational change would not take place immediately. I can tell Members of the House, from my experience through the FSA having a reporting line to me, that the current uncertainty in the FSA has been extraordinarily debilitating to the effectiveness of the day-to-day management of the organisation. Addressing this uncertainty has put an enormous strain on the senior management. The Opposition have to make up their mind on this and be clear about whether or not they intend to do it. We are accustomed to the Opposition changing their mind on almost everything. This is now another area where we hear coded messages to the effect that, “Well, perhaps we will take our time over the faster, further and deeper institutional change that we were going to make and not do it immediately”. That simply is not a tenable solution; we need predictability.
In connection with the council, the noble Lord, Lord Hodgson, among others, raised the question of who is in charge; the Governor of the Bank of England was also asked this by the Treasury Select Committee. The Government’s vision for the council is one of close co-operation, monitoring and co-ordination. It is a model which respects the independence of both the Bank and the FSA. The council’s role is to ensure that the authorities have distinct responsibilities but that they continue to work together effectively and closely. Fundamentally, the council is a forum for the effective co-operation of three authorities, each with clear and distinct roles to play. It is not about a power hierarchy; it is about working together to achieve the right outcomes. Its role is not to take binding decisions; there will not be votes. It is not for the Government to impose their will on an independent Bank of England or an independent financial services regulator. Each authority is accountable for its actions, and the Chancellor is ultimately accountable to Parliament and the taxpayer. The council is about effective co-operation and co-ordination. The package of proposals will ensure this happens in a much more transparent, formal and accountable manner than under the previous tripartite arrangement. I hope that provides a clear and comprehensible answer to the question raised by the noble Lord, Lord Hodgson.
I could go on for a long time about the Glass-Steagall arguments. The contribution of the noble Lord, Lord Lawson of Blaby, was very thoughtful, well-researched and nuanced in its observations. In response to a question, he quoted from chapter 32 of his memoirs, The View from No. 11. In fact, last Friday I put his book to one side in my library with a view to rereading all of its 1,150 pages, I recollect.
We can go over this territory extensively. I am not persuaded that the issue of size was fundamental to failure, nor that the combination of utility, retail, commercial and investment banking activities in one organisation is in itself a cause of weakness. The noble Lord very clearly articulated the arguments which are advanced as to why it is not possible to separate the banks. I recollect his fourth argument in particular—that it was not possible to distinguish between proprietary trading and more conventional activities of a bank—but I simply do not accept that argument because we are having to do that in terms of the appropriate capital requirements. We prefer the combination of much more capital behind the riskier activities, much more stringent liquidity requirements and better governance—and here I look to the noble Baroness, Lady Hogg, and ask her not to perform a modest role at the FRC but an absolutely critical one. We are thrilled that the noble Baroness has been appointed chairman of the FRC. The role the FRC will continue to play in corporate governance and in stewardship—the neglected part of the discussion and debate around governance—is going to be so important to strengthening our banking system. We are then going to back that up with much enhanced regulation and supervision, including recovery and resolution plans, on which many comments have been made today. I am not persuaded by the arguments for separating banks along Glass-Steagall-type ground. However, if I had been persuaded, it would have been by the eloquence of the noble Lord, Lord Lawson, in his presentation.
I have talked also about stewardship, which touches on the issues of reward and remuneration. I make it clear that the Government do not propose to become involved in setting salaries or bonuses. However, I disagree with the noble Lord, Lord Blackwell, with whom I worked 10 years or so ago in a major clearing bank, and for whom I have the deepest respect. I believe that if a bank's remuneration practices give rise to unacceptable risks, it is appropriate for the FSA to make that clear and require either much more capital or a variation in the permissions of that organisation, or ultimately to say that a contract with this type of clause—perhaps a clause that hugely rewards the profits of an activity of an individual or team, with no consequences for the losses made—is not something that we will accept as part of a well managed banking system, with effective systemic risk management.
There is a key argument about disclosure of remuneration. The noble Lord, Lord Blackwell, made reasonable points when he asked why the industry had been picked out. The answer, which came from the noble Lord's own Benches, is very clear and concerns the importance of the systemic risk within banks. The noble Lord, Lord Lawson, also spoke to that, quoting Bagehot among others. We are trying to empower shareholders so that they can take more informed and engaged decisions, thereby protecting us as consumers. The noble Lord, Lord Sawyer, spoke about the importance of empowering the consumer. Consumers, customers and individuals have a very important role through their insurance policies and pension schemes as investors in banks, yet they have completely failed to exercise their responsibilities when it comes to remuneration in banks. They claimed that one reason why they failed is because they did not have the information. I am not persuaded that that is a credible defence: as the owners of the business, they could have insisted on being given the information. However, if it falls to the Government to facilitate them in making better-informed decisions, by making sure that the information is available to them, then we will do so. It is not for the satiation of prurient curiosity or for any other motive, but to encourage more informed and constructive stewardship. It is conceivable that we might find that the information proves useful to institutional investors, in which case they may urge other companies to make similar disclosures. Thus the practice may not always be limited to one sector.
The noble Lords, Lord Henley and Lord Newby, and my noble and learned friend Lord Goldsmith commented on the lack of draft secondary legislation. I understand noble Lords' eagerness to have sight of draft regulations that are being prepared, both on the disclosure requirements around remuneration, about which I have already spoken, and the rules in relation to collective proceedings. I reassure the House that the Government are committed to bringing forward drafts at the earliest opportunity, and that these will be consulted on in the usual manner. With regard to collective proceedings, draft rules have been published and will be available to inform the Committee's discussions of the clauses. The rules will be fully consulted on later this year, once the draft has been finalised. I say to the noble Lord, Lord Newby, that draft regulations on Clauses 9 and 10 will be available before the clauses are debated in your Lordships' Committee.
The noble Viscount, Lord Eccles, and my noble friend Lord Whitty raised questions about the impact of removing the FSA’s public awareness objective. Transferring this in enhanced form to the new consumer financial body will not diminish the regulator's obligations to consumers. The FSA must continue to consider and safeguard consumers' interests through its customer protection objective. Under this objective, the FSA must consider the risks to consumers of different kinds of financial dealing, consumers' differing degrees of experience and expertise in financial matters, and consumers' need for advice and information. Consumers will benefit from these measures. The new body will be focused entirely on supporting them to manage their financial affairs and navigate the financial system. The regulator must continue to consider their needs and to protect their interests.
I will say a few words on the issue of consumer redress, which elicited a number of contributions in our debate. There have been several instances in recent years in which a large number of consumers have suffered detriment at the hands of regulated firms. The proposed provisions give the FSA the power to order firms to carry out investigations, assess their liability and pay out compensation, or to make other redress to consumers in the case of widespread mis-selling or other illegal activity. Consumer bodies have expressed extensive support for this provision, along with provisions for collective proceedings. The use of this power by the FSA would be subject to public consultation and a cost-benefit analysis, and the FSA would need to be satisfied that this was the most appropriate way of meeting its objectives before we went ahead.
The noble Lord, Lord Newby, my noble and learned friend Lord Goldsmith and others touched on issues of US-style class action as a consequence of Clauses 18 to 25. I do not believe that such things will happen. There will be no US-style litigation culture because there are numerous and major differences between the US and UK legal systems. In the UK, the “loser pays” principle applies, as my noble and learned friend reminded the House, which is an effective deterrent to spurious claims. Nor is there any provision for US-style punitive awards or triple damages. There is not the same burden of extensive upfront disclosure and lawyers cannot take a share of the damages. Nor are juries able to make exceptional damage awards. I assure the House that the Government would regard any move away from these principles as extremely serious. The UK has strong case management by the court. The Bill includes powers to ensure that collective proceedings cannot take place until certain matters have been considered and criteria have been met. It therefore contains wide powers to ensure safeguards for defendants both from the start and in the light of experience.
I have every hope that we will and I believe that that is what I have said. However, as I occasionally mis-speak, I will write and correct that if I have misdirected the noble Lord.
I reassure noble Lords and the noble Baroness, Lady Valentine, in particular, that the Government recognise the importance of a competitive world-class City that is profitable, responsible, strong and something of which we can be proud. If other European countries had London and Edinburgh, they would be fighting tooth and nail to protect the competitive and comparative advantage that we have. This Government should do the same. I hope that that might give the noble Viscount, Lord Trenchard, some reassurance on the AIFM directive and other areas of European regulation. We need to be alert and vigilant to the direction of travel in Europe with some of these ESAs and the thinking behind them, which, if we are not vigilant, would encroach on territory that we believe is important should remain as part of our national responsibilities.
The noble Baroness asked why we were putting a financial stability objective into the FSA when her recollection was that I had said last year that it was—
Well, we were of the view at the time that the market confidence clause covered that requirement, but I listen attentively to the noble Baroness and think about what she says over the weekends, on my holidays, when walking with my dog and so on. Her comments are never far from my mind, particularly when they echo the contribution from my noble friend Lord Eatwell. In the circumstances, we believe in acknowledging that internationally regulators are now increasingly focusing on the issues of systemic risk. We will be ensuring that the FSA is positioned alongside many other international regulators in having that responsibility. I have now concluded that it is appropriate, because we are a learning Government.
I shall wrap up very soon but I want to say that I am sympathetic to my noble friend Lord Sawyer, who is not in his place.
Yes he is.
I apologise; there is so much to do here! My noble friend Lord Sawyer made some powerful points about consumers. I am absolutely sympathetic to what he said but I do not think that the Bill is the appropriate vehicle for carrying that in Parliament. However, I understand that Mr Gary Hoffman of Northern Rock has not replied to him, so I shall be ringing Newcastle tomorrow morning to ensure that a reply wings its way.
My noble friend Lord Desai asked whether I would hazard a guess as to how much the support that the Government have provided for the banking system will cost the taxpayer. I am very confident that it will cost the taxpayer nothing. I am very confident that the support that we have provided through shares, the credit guarantee scheme, the special liquidity scheme and the asset protection scheme will produce a net surplus for the taxpayer in due course. Of course, as my noble friend will understand, the real cost is the economic consequence of the fact that the economy has been performing well below capacity; that cost will be with us for ever. Where we talk about billions of pounds, that is the price that we have had to pay for the greed and the mismanagement perpetrated by some people in the banking industry, most of whom are no longer involved in that industry.
I am conscious that I have been speaking for 22 minutes and I think that I have probably exhausted the patience of the House. I am aware that there are other points that I have not addressed and on those, as I said, I shall write to noble Lords.
Bill read a second time and committed to a Committee of the Whole House.