Motion to Approve
My Lords, the second bank recovery and resolution directive updates the EU’s bank resolution regime, which provides financial authorities with the powers to manage the failure of financial institutions in an orderly way. This protects depositors and maintains financial stability while limiting risks to public funds. Under the terms of the withdrawal agreement, the UK has a legal obligation to transpose the directive by 28 December 2020. This instrument fulfils that obligation.
In transposing the directive, the Government have been guided by the commitment to maintain prudential soundness, alongside other important regulatory outcomes such as consumer protection and proportionality, when leaving the EU. We have also considered concerns raised by industry on elements of the directive that could pose risks to financial stability and to consumers, to tailor the approach for the UK market. As a result, we are not transposing the provisions in the directive that do not need to be complied with by firms until after the end of the transition period—in particular, an article that revises the framework for a minimum requirement for own funds and eligible liabilities, referred to hereafter as MREL, across the EU. The UK already has in place an MREL framework in line with international standards.
We are also sunsetting certain provisions so that they cease to have effect in the UK after the end of the transition period, as well as including provisions to ensure that the elements that remain in effect after the end of the transition period continue to operate effectively. The sunsetted provisions will cease to have effect in the UK from 11 pm on 31 December. In doing so, we have taken an approach that meets our legal obligations but also ensures that the UK’s resolution regime remains robust and is in line with international standards. We have engaged with industry and stakeholders to help explain exactly what this means for them.
I turn to the draft Securities Financing Transactions, Securitisation and Miscellaneous Amendments (EU Exit) Regulations 2020. This instrument, along with the approximately 60 other financial services instruments that the Treasury has introduced under the European Union (Withdrawal) Act 2018, is vital in ensuring that the UK has a fully effective legal and regulatory financial services regime at the end of the transition period. It achieves this by amending and revoking aspects of retained EU law and related UK domestic law, making a small number of necessary clarifications and a minor correction to earlier financial services EU exit instruments, and providing sufficient supervisory powers for the financial services regulators to effectively supervise firms during and after the end of the transition period.
I turn to the draft Financial Holding Companies (Approval etc.) and Capital Requirements (Capital Buffers and Macro-prudential Measures) (Amendment) (EU Exit) Regulations 2020. The fifth capital requirements directive, known as CRD5, continues the EU’s implementation of the internationally agreed Basel standards. These standards strengthen and develop international prudential regulation, which helps ensure the safety and soundness of financial institutions. This SI will transpose that directive into UK law, as required under the terms of the withdrawal agreement. It will also ensure that the legislation transposing it continues to operate effectively in the UK after the end of the transition period.
As with previous capital requirements directives, the Government will delegate most of the responsibility for implementation to the independent Prudential Regulation Authority—the PRA—which has the requisite technical knowledge and skills to ensure effective and proportionate implementation. This instrument includes only provisions legislatively necessary to ensure that the PRA can implement CRD5. This instrument is in line with requirements of article 21a of CRD5 for holding companies in scope to apply for supervisory approval. The framework and scope of the approvals regime will be administered by the PRA, and the instrument gives the regulator appropriate tools to ensure compliance with it.
The instrument also makes changes to the macro- prudential toolkit, preserving the current level of macroprudential flexibility. The most important of these is enabling the PRA to apply an other systemically important institutions buffer and a systemic risk buffer to certain institutions to address particular financial stability risks.
Although the capital requirements directives were created with banks in mind, they also apply to investment firms. However, the risks faced by investment firms are different from those faced by banks. Therefore, this instrument excludes non-systemic investment firms from the scope of CRD5. Investment firms will remain subject to the existing prudential framework until the Financial Conduct Authority introduces the prudential regime for investment firms, following Royal Assent of the Financial Services Bill.
Finally, I turn to the Bearer Certificates (Collective Investment Schemes) Regulations 2020. The UK has been at the forefront of international changes that are transforming tax authorities’ ability to work across borders to tackle emergency international tax risks. Bearer shares or certificates are anonymous, infinitely transferable and an easy means of facilitating illicit activity such as tax evasion or money laundering. This is why UK companies have been prohibited from issuing them since 2015. The OECD’s global forum noted in its 2018 peer review report that, although the UK had “mostly addressed” its 2013 recommendations concerning the prohibition of bearer shares,
“a small cohort of entities and arrangements … are still able to issue bearer shares or equivalent instruments.”
The report went on to recommend that the UK abolish bearer shares. This instrument implements that recommendation and prohibits the remaining entities capable of issuing bearer shares or certificates—which include certain types of collective investment schemes—from doing so. It also makes arrangements for the conversion or cancellation of any existing bearer shares. This brings those remaining collective investment schemes, including open-ended investment companies formed before 26 June 2017 and all unit trusts not authorised by the Financial Conduct Authority, in line with companies formed under the Companies Act 2006, which are prohibited from issuing bearer shares by the Small Business, Enterprise and Employment Act 2015. Complying with the global forum’s recommendation will help make sure the UK maintains its position at the forefront of the international community, continuing to set standards that help improve offshore tax compliance and fund our vital public services.
In summary, the Government believe that these instruments are necessary and vital for the UK’s financial services regulatory architecture, and I hope noble Lords will join me in supporting the regulations. I beg to move.
My Lords, I do not think there is any controversy in agreeing with these statutory instruments, but it gives us the opportunity to ask a few questions of the Minister in relation to them. Perhaps I could start by reiterating how I am never surprised, but always rather disappointed, that politicians, including those in this House, like those in the other one, are always keen on anything to do with the physical movement of goods. In discussions on the European Union—on leaving the European Union—everything to do with the physical movement of goods gets a huge and popular airing at all times.
I have never particularly worried about issues relating to the physical movement of goods. There will be winners and losers: the more coherent and the more seamless any transition is, the better, but that is better for short-term stability; it is in the interests of the country, so I have a view in relation to it. But I certainly do not have a strong view on whether it is important that we have, for example, a trade deal with the United States. It seems to be one of the issues that is going to dominate Chambers, including this one, in the foreseeable future; but, frankly, on whether there is a trade deal in physical goods, I say that there will be winners and losers either way, with any deal, by definition. That kind of trade will continue regardless.
Indeed, I am more in favour of doing what the Americans historically did, which is protecting not our old industries but our new ones. I have always thought it was a mistake to be overly protecting dying industries and technologies. In the late 1970s and the early 1980s, the United States put a ring of steel around Silicon Valley to ensure that it would have the ability to grow, whereas we paddled our way in the so-called free-trade world without any such subsidy, we lost our competitive advantage and we paid a very heavy price. It was, in a sense, an invisible price, because we were never able to grow those industries even though, in the early 1980s, we were leading the United States in many of those technologies.
When it comes to invisibles and the financial sector in particular, I actually have far more concerns that we get it right. The potential for major instability in the economy and then in the country from getting wrong any transition from one system to another with financial services is huge. The margins of danger are much smaller and the impact on them far greater. The Minister’s statement in this Chamber should perhaps be put in lights in Piccadilly Circus: that the Government are delegating the powers of implementation to the PRA. Well, hallelujah to that. Far be it from politicians to attempt to micromanage, because one of the great successes that we have seen in the last two years is the way in which the Bank of England and civil servants in the Treasury have handled all the negotiations in relation to exiting the European Union. If it is seamless, we do not know, so seamless is the way in which they have managed to do so, but it is undoubtedly the case that we retain greater expertise than perhaps anywhere else in the world, and certainly in Europe, in relation to the regulation of financial services.
I pay tribute—and this House should pay a huge tribute—to Mark Carney, who has now departed, to Andrew Bailey and to all the other key figures who have done this work and had it in the bag well before the politicians were voting in both Houses on how we did or did not leave the European Union, and in what way. In reality, the accord and understanding on financial services was already in the bag. That demonstrates to me that we are in a very strong position here.
The danger now would be if at any stage politicians suddenly got a wild idea that restructuring in this way or that way could have some ideological advantage. The key one I would highlight is the danger of challenger banks. The concept of challenger banks is one that politicians on all sides have welcomed. I have been more critical than most of the establishment banks, the culture within them, the price that we paid, particularly after 2008 in relation to that culture, and the way in which they treated their own institutions and mismanaged them.
However, challenger banks have a different kind of risk—a risk of the unknown. The beauty of the detail of what we are agreeing today is that it provides a well-constructed safeguard around our financial institutions. It is vital that those who have been doing it in precisely the way that I was delighted to hear the Minister outline are allowed to continue to do so. In layman’s terms, no bank must be too big to be able to fail, which is what we had in 2008, but no financial institution must fail in a way that hits the stability of the whole economy. However good the service you might sell or the product you might make and attempt to sell, if that instability is there, the economy will nosedive.
The key challenge is to maintain our strengths and maintain our stability there. Our biggest challenge is not going to be the European Union; it is going to be the emerging economies, particularly the approach of China and the Central Bank of China, and the growing strength of India in financial services and in terms of how the financial world will be operating. Asia has the risks for us and therefore, looking beyond the specifics of the EU, how we ensure financial stability here is critical to all our futures.
My final question to the Minister—in fact my only question—is about derivatives and whether there is any impact on the derivatives market. All the way through, that has been seen to be perhaps the riskiest element of any change—on both sides, us and the EU. Are there any implications from today in relation to that market?
I thank my noble friend the Minister for her excellent exposition of these important, though very technical, SIs. Clearly, as we leave the EU and leave the transition period, we must have in place our own regulations to ensure the safety and security of our financial institutions and the protection of consumers within our financial system.
I welcome these SIs. I do not think that they are particularly contentious, and I do not believe that any of our scrutiny committees have raised particular concerns. Like the noble Lord, Lord Mann, I would like to raise a few issues and ask my noble friend a number of questions, particularly on the issue of capital buffers. Who is in charge of assessing the buffers? What ongoing analysis is undertaken to ensure that the buffers that have been put in place are of the standard that they were expected to be when they were introduced, and how timely is that analysis? For example, has any new analysis been conducted in light of the Covid situation, and what might we perhaps expect in that regard?
In addition, what scenario analysis is undertaken in light of potential market distortions resulting from the ongoing quantitative easing programme of the Bank of England, and the potential interference in capital market valuations that may result from the extraordinary monetary measures which at the moment are focusing on driving down long-term interest rates and driving up asset prices in order to encourage growth or protect downside risk to growth?
On those measures, I express my significant concern at the rise in the levels of debt across our economy, and the almost exclusive focus on interest rates on debt being a measure of security of assets. In particular, there is the idea that government bonds—sovereign debt—are the lowest-risk asset which underpins all our capital asset pricing models and will drive the assessment of the capital buffers backing our financial institutions, and the question of whether we believe that this is wholly reliable in the current circumstances.
I certainly agree with the noble Lord, Lord Mann, that no bank or financial institution should have been—or should be in the future—too big to fail but, in reality, surprises happen in markets. I wonder whether the new financial services regime that we will have after we leave the EU transition next year will consider potential nationalisation, in circumstances where the Government and taxpayers would otherwise have to bail out shareholders—and indeed bondholders—because of the risk of failure of the assets that they invested in and the potential damage to wider society should that failure actually occur.
What assessment is made of the property markets and other asset markets when assessing capital buffers? In particular, there is a question mark as we pull out of the MREL regime—as my noble friend has described—and focus more on the TLAC US regime, which has a different range of assets as its capital measure. Is that expected to continue to be a trend we will follow?
I welcome the emphasis on gender equality in our new regulatory system, in terms of pay. That is most welcome in the financial services sector, as in all other sectors.
Finally, I ask my noble friend how the Government, the Bank of England and the PRA, and other regulators perhaps, see the position of our major pension funds, which are enormous relative to the size of the economy in some ways. Certainly they are much larger than many financial institutions regulated under these instruments. How are those pension funds seen in terms of security, capital buffers and importance of delivery and security? If she has not got the answers, of course she is welcome to write to me.
My Lords, I recognise that this group of SIs largely deals with transposition, technical and in-flight issues, and therefore we do not intend to oppose them. I have questions, however, particular on the first SI on banking recovery and resolution. I am going to try to avoid the tangle of using the terms MREL—minimum requirement for own funds and eligible liabilities, used in the EU—versus TLAC, which is total loss-absorbing capital, used internationally and essentially US- driven. As the noble Baroness, Lady Altmann, made clear, they are not absolutely identical, but we can all recognise that they are essentially the same thing. My concerns are frankly more fundamental.
In response to the financial crisis of 2008, the Financial Stability Board set up by the G20 is requiring systemically significant banks by 2022 to raise the equivalent of 18% of their risk-weighted assets in loss-absorbing capital. I have no problem with that, but much of this in the UK has been in the form of bail-in bonds. How well is this programme working for the large systemically significant entities? I will come to smaller banks later.
There has been real concern about the capacity of the market to absorb the volume of bonds required, especially as recent revisions have required them to be more deeply subordinated. Covid-19 may have made these bonds temporarily more appealing because there are now so few ways to invest money and get any kind of return, but if this strategy of bail-in bonds is going to have problems because the market is stubbornly small, we need to know it now.
I want to probe the Minister on where we are going with medium and small banks, which are not systemically significant. The UK has gone well beyond the Basel requirements—and those of the 27 EU countries, even when we were a member of the EU—by stipulating that small and medium-sized banks that are not systemic should bear the same loss-absorbing capital burden as big banks. The Bank of England has the power to set this threshold without any scrutiny or approval required. This being the UK, it has decided that small and medium-sized banks—in effect, the challengers—did not deserve a more proportionate regime.
In reality, small and medium-sized banks can tap the bail-in bond market—if at all—only by offering huge coupons. They also lack the size to spread the cost of such high capital requirements over a diverse asset portfolio. I know that a review is going on, but can the Minister commit now to the concept of proportionality? The burden, as currently shaped, is making it near impossible for smaller banks to grow as they should. In turn, that undermines support for the recovery from Covid, never mind adding significant obstacles to the whole levelling-up agenda.
I have one more comment, on the final SI concerning bearer bonds. These unregistered instruments really are the backbone of money laundering. The sooner they are gone, the better.
My Lords, I welcome the noble Baroness, Lady Penn, to this exclusive club that hacks through Treasury statutory instruments. I am sure she has been briefed that this is but a formality—the Labour Party will never support a fatal Motion against an affirmative statutory instrument, and the instruments are not amendable so what we do here has no real impact. To some extent, this influences the quality of some of the material that we work with.
With the complexity of these instruments, there is a requirement, frankly, for the Explanatory Memorandums to be of very high quality. In fact, I do not find them so. I find them difficult to comprehend. It is true that the Liberals have an unfair advantage over us by having people such as the noble Baroness, Lady Kramer, who actually know what they are talking about, but the object of the exercise should be that ordinary politicians should be able to understand what we are looking at. I note that the Economic Secretary to the Treasury signed a statement at the end of the instrument saying that
“this Explanatory Memorandum meets the required standard.”
For me, it does not.
What are the four SIs trying to do? Are they trying to make the minimal necessary changes or do they seek to introduce new policy? The European Union (Withdrawal) Act 2018 was created on the basis that its output would be the minimum necessary to cover the transition out of Europe. The other Act prayed in aid in these SIs is the European Communities Act 1972, which of course had draconian powers, but for a specified reason. I am largely convinced that the objective of these SIs is a new policy objective. I have three points to bring out.
It seems that new policy is being introduced in the first SI, the bank resolution one, by the significant sunsetting of the major points set out in section 7.12 of the Explanatory Memorandum. They relate to the distribution of funds, moratorium powers, insolvency priorities and bail-in. I am not clear under which Act this is done, but I cannot see why it is necessary in this SI. These things have an important impact on the balance between the interests of customers and consumers compared with owners. Surely regulation is all about getting that balance right, and surely something that changes policy should be debated more formally. While the Minister referred to stakeholders in her introduction, in practice the stakeholders were all in either the regulation business or the bank business. At no point, as far as I can see, was there any process by which the consumer was represented in those discussions.
I got lost in section 2.10 of the Explanatory Memorandum to the next SI and would value the Minister helping me through it. There is a concept that, after the transition period ends, we will have some reference to EU law, which may be changed from “time to time”. That does not seem to be in line with the concept of sovereignty, which Brexit is supposed to be all about.
Finally, as far as I can see, the financial holding companies SI does nothing more than the minimum necessary for the transition. In studying it, I came across section 7.15 of the Explanatory Memorandum, which is about the removal of members from management boards. That seems quite draconian to me. It allows the PRA to remove individuals from the managing body of institutions,
“if they are found no longer to be of sufficiently good repute, no longer have the right skills, knowledge, experience, honesty or integrity, or are unable to commit sufficient time for the role.”
I have nothing against powerful rules that control bankers, but so much power over individuals, with no apparent mechanism for how judgments will be brought about and with no apparent appeal, does not meet a sense of natural justice.
Finally, I entirely agree with the sentiments set out in section 2.1 of the Explanatory Memorandum to the bearer certificates SI that bearer certificates are a bad thing. We are at one with the Government in seeking their complete elimination.
My Lords, I thank noble Lords for their thoughtful contributions to this debate, including the words of welcome from the noble Lord, Lord Tunnicliffe, for what may be many debates on such issues. I shall take the points raised in turn.
The noble Lord, Lord Mann, is right about the importance of a smooth transition for our financial services sector. He is also right to pay tribute to the excellent work done by officials and regulators to ensure this. He asked about derivatives. These SIs do not address that issue directly, but I reassure him that the UK has already put measures in place to avoid disruption to cleared derivatives markets. The Chancellor announced yesterday that we will be granting CCP equivalence to the EU and EEA/EFTA states. This, together with our temporary recognition regime, means that UK firms will be able to continue using EEA CCPs after the end of the transition period. The EU has also granted the UK temporary CCP equivalence for a period of 18 months after the end of the transition period and has recognised all three UK CCPs. This allows UK CCPs to continue to provide services into the EU.
My noble friend Lady Altmann asked who is in charge of assessing the buffers and what analysis is undertaken to do so. In the case of the other systemically important institution buffer, the Financial Policy Committee is responsible for setting a framework for the buffer, while the Prudential Regulatory Authority applies that buffer to individual institutions. The FPC is required to review the buffer framework every two years and will benefit from PRA and Bank of England analysis of whether the buffers are still achieving their objectives. The PRA will be responsible for setting the CRDV systemic risk buffer, which again includes a requirement to review any buffer rate set periodically. The Bank of England’s Financial Policy Committee is tasked with considering systemic financial stability risks, including those that might flow from higher levels of debt or changes in capital markets. The latest remit for the Financial Policy Committee asks that the FPC and the Monetary Policy Committee should continue to have regard to each other’s actions to enhance co-ordination between monetary and macroprudential policy. This co-ordination has enhanced the strength and resilience of the UK’s macroeconomic framework.
These buffers are an important means of maintaining financial stability. For instance, the other systemically important institutions buffer will help ensure that ring-fenced banks are resilient against potential risks. This instrument seeks to preserve the current level of macroprudential policy flexibility. The actual setting of buffers is largely left to the independent regulators, subject to certain provisions in the regulation. My noble friend also asked about nationalisation. Temporary public ownership is one of the resolution tools available, but it would be used only as a last resort. Progress on gender equality in the financial services sector is essential, and the Government too welcome the provisions in CRDV, which are in line with existing requirements on gender equality in the UK.
The noble Baroness, Lady Kramer, is right to note that the Bank of England is committed to reviewing its framework on the MREL framework—I am sorry to use the acronym—by the end of 2020, but the outcome of that review cannot be prejudged. The Government take a proportionate approach. Indeed, in not implementing the EU’s new MREL requirements as part of these SIs, one of the considerations was that we think the new requirements could impose a disproportionate impact on some medium-sized building societies. That is a reflection of the fact that the Government wish to take a proportionate approach.
The noble Lord, Lord Tunnicliffe, asked about the power to remove board members. This stems directly from the EU directive. I reassure him that the regulator will exercise a power of removal only where a person is no longer of sufficiently good repute to perform their duties, no longer possesses sufficient knowledge, skills, experience, honesty, integrity or independence of mind to perform their duties, or is no longer able to commit sufficient time to perform their duties. The individual in question will have the right to refer their case to the Upper Tribunal if they are aggrieved with the actions of the regulator in this respect.
I also confirm to the noble Lord that he is absolutely correct that this SI forms part of the programme of statutory instruments made under the EU withdrawal Act 2018. The purpose of most of these SIs, apart from the final one, is to ensure there is a fully functioning financial services, legal and regulatory regime at the end of the transition period. The approach taken in this instrument aligns with the general approach established by the EU withdrawal Act 2018, providing continuity by retaining existing legislation at the end of the transition period but amending, where necessary, to ensure effectiveness in a UK-only context.
The noble Lord asked specifically whether the approach to sunsetting certain provisions within the first SI is consistent with that approach. The UK has considered very carefully which provisions would not be suitable for the UK resolution regime after leaving the EU, while still maintaining prudential soundness and other regulatory outcomes, such as consumer protection and proportionality. He mentioned consultation—we have consulted the UK financial regulators and taken into account concerns raised in consultation responses on the potential risks to financial stability and consumers. It is with those in mind that we have taken the approach that we have on sunsetting.
To give him a couple of examples, one of the provisions we have sunsetted is the introduction of a pre-resolution moratoria power and the extension of a moratoria power to eligible deposits. We were concerned that that could create potential risks to financial stability, as it could both increase the risk of runs on the particular banks affected and further trigger runs on unaffected banks, and therefore we have sunsetted that provision.
Another example is the changes to priority of debts and insolvency. These are sunsetted due to concerns around the potential impact that this could have on investor expectations and the market, including pricing. Given the difficulties in predicting where and to what degree the impacts on firms and investors will be felt, it was thought that it was in the interests of prudential regulation to sunset that provision.
The sunsetting of these provisions does not remove obligations, given that the existing UK resolution regime already provides powers for the resolution authority to exercise moratoria powers as part of the resolution. The Prudential Regulation Authority can also impose restrictions on distributions if firms are in breach of their buffer requirements, and it requires firms to include contractual recognition clauses in contracts governed by third-country law and provides for non-inclusion on the basis of impracticability. In many of the areas where we have sunsetted the provisions, there is already existing regulatory provision to take action where needed.
I also acknowledge the noble Lord’s comments on the Explanatory Memorandum; I too find some of these issues complex to get my head around. They are technical SIs, and every effort is made to ensure that the Explanatory Memorandums are as understandable as possible. We will bear in mind the noble Lord’s points in future.
With that, I hope noble Lords have found the debate informative and will join me in supporting these regulations.