Considered in Grand Committee
My Lords, among other things, these regulations support the implementation of the Basel III standards in the UK. I will begin by reminding the Committee of the background to this issue.
I am sure that noble Lords agree that strong prudential regulation is vital if we are to ensure that firms have enough capital and liquidity to operate effectively through periods of economic stress. However, the 2008 financial crisis highlighted major deficiencies in international financial regulation. Following the crisis, the international community came together to remedy this situation by developing updated standards known as the Basel III accords.
The UK, as a member of the G20, is committed to the implementation of the Basel III standards, given their positive benefits to financial stability. Now that the UK has left the EU, we must implement many of these standards domestically for the first time. This includes rules on subjects equivalent to those contained in the EU’s second capital requirements regulation, known as CRR2. Many of these rules do not yet apply in the UK due to the EU’s implementation date falling after the end of the transition period.
The Financial Services Act 2021 enables the Prudential Regulation Authority to make rules updating the existing provision in the UK’s capital requirements regulation for Basel III standards—the CRR—where the Treasury has or will revoke the relevant provision of the CRR. The devolution of responsibility to the PRA for updating these rules reflects its expertise in prudential matters. This is combined with a more flexible and tailored approach that comes with having these regimes set out in regulator rules rather than in statute.
On some of the detail of the instrument, to enable the PRA to update the prudential regime to account for these new Basel III standards, this instrument exercises the powers contained in Section 3 of the Financial Services Act to revoke elements of the CRR and make consequential amendments. These revocations must be within the limits imposed by Section 3(2), which limits the provision to only revoking those parts of the CRR which need to be updated to reflect the new Basel standards, and anything that is connected to, or consequential to, those standards.
When it makes CRR rules, the PRA is subject to an accountability framework, under which it must consider the impact of its rules on a number of areas; the relative standing of the UK compared to other jurisdictions; lending to the real economy; and the Basel standards themselves. For rules made after 1 January 2022, the PRA will also need to have regard to the net-zero carbon target. Additionally, the PRA must consult the Treasury on the potential impacts of any rule changes on equivalence.
This instrument contains additional EU exit-related amendments to the CRR. These are required to ensure that the prudential regime continues to function as intended now that the UK has left the EU. This instrument makes an amendment to Article 497 of the CRR. This allows for the Treasury to extend a transitional provision for certain foreign central counterparties to retain temporary qualifying status. Qualifying status allows UK firms to use these CCPs without being subject to higher capital requirements. Were these CCPs to lose this status, they would become substantially more expensive, thereby reducing the likelihood of their use by banks. This amendment will allow for the transitional period to be extended by regulation one year at a time.
These extensions are required as there may be non-UK CCPs that are unable to receive qualifying status through recognition for a prolonged period. However, the Treasury still considers it beneficial that they retain qualifying status. This allows the Treasury to maintain the status quo and avoid disruption were any UK firms to have exposures to those CCPs. It will keep these arrangements under review to ensure that they are fit for purpose; however, we do not expect this transitional regime to be used on a permanent basis.
Under Article 391 of the CRR, the Treasury may determine that an overseas jurisdiction applies prudential requirements to same standard as those applied in the UK and grant it equivalence. Smaller UK banks, in particular, benefit from this article as it allows them to lend more as a single loan to overseas firms. At present, more than 50 banks take advantage of this.
However, the UK’s only equivalence decision in this area is for EEA member states. This is because the EU, and therefore the UK, had not, at the end of the transition period, awarded Article 391 equivalence to any other jurisdiction. To get around this, the European Banking Authority issued guidance allowing EU, including UK, firms to use equivalence decisions under a different article, Article 107, as a proxy for Article 391 equivalence. However, this is in effect regulatory guidance overruling primary legislation. The Government and the UK’s regulators consider this guidance inappropriate and therefore do not intend to replicate it in the UK. It is also impractical to undertake the equivalence assessments in such short timescales.
Through this SI, therefore, the Treasury is using Section 8 powers under the European Union (Withdrawal) Act to put in place transitional arrangements. These will maintain the positive effects of Article 391 equivalence for UK firms. In parallel, the Treasury will seek a legislative opportunity to streamline the system by linking the equivalence regime in Article 391 to that in Article 107, such that a 107 decision will also result in these firms being able to lend more as a single loan to entities in that jurisdiction.
The Treasury has worked closely with the PRA in drafting this instrument. We have engaged with industry throughout the process, including in a public consultation. The responses received from this largely agreed with the Government’s proposed approach, but requested that the equivalence provision be removed for equity investments in overseas funds. The Government agree that this is a disproportionate method for addressing the prudential risks arising from UK banks’ investments in overseas funds, which the PRA could address.
The consultation responses requested that some reporting requirements for market risk—risk arising from movements in market prices—that the EU had introduced ahead of the capital requirements themselves should be delayed until those requirements are introduced. The Government have updated our approach in line with these points, recognising the costs outweighed the benefits of adopting the reporting requirements.
I hope I have given Members a comprehensive overview of this measure. I urge noble Lords to join me in supporting these regulations. In short, this measure enables the implementation of Basel III regulation that is key to the UK’s international standing. In addition, it irons out some of the wrinkles of existing EU regulation. Together, these measures will give UK firms certainty and therefore help them to flourish. I beg to move.
My Lords, as ever, I am grateful to the Minister for introducing this statutory instrument. Unlike the last item of business, which was largely a formality, these regulations represent a significant shift in how the Government and bodies such as the Prudential Regulation Authority ensure that domestic financial regulation is fit for purpose.
During the passage of the Financial Services Act 2021, we spent many hours debating the proposed shift away from the capital requirements regulations to the contents of regulatory rules made by one or more of the Treasury, the PRA and the Financial Conduct Authority. We were told that this was the most efficient way for the UK to implement the new Basel standards, given that the EU no longer does most of the work on our behalf.
Many colleagues were nervous about the new process. This is not because it was an inherently bad idea to set rules domestically, rather than to rely on and continue to amend bits of retained EU law; nor was our concern around giving the PRA and FCA further powers, even if that warranted a higher degree of parliamentary oversight. Rather, there was a legitimate concern about the potential for unintended consequences when large parts of the existing capital requirements framework are revoked at the stroke of a ministerial pen. Indeed, some parts of retained EU law are being swept away entirely, with no requirements for certain revoked provisions to be replaced.
I got to that point in my thinking and was seized by the fact that these are incredibly important regulations. In a sense, the presence in the Room is completely disproportionate to the importance of these regulations. As far as I understand it—I am not an expert in this issue—they are the regulations that secure the safety and stability of the financial systems. Therefore, I thought I had better give it a little more thought. I turned to a letter from John Glen. It was not sent to me; in simple terms, it was sent to my colleague in the Commons, Pat McFadden MP, but it includes me at the end. He sent me a copy of this letter, and therefore I take account of it. I quote the opening paragraph: “I am writing regarding the Capital Requirements Regulation (Amendment) Regulations 2021, which were laid on 12 July. This statutory instrument revokes elements of the UK’s capital requirement regulations to allow the Prudential Regulation Authority to make rules implementing the outstanding Basel standards.” That sentence seems to go to the essence not only of the SI but of the Financial Services Act we laboured over some months ago.
I read on. His next paragraph is all about taking away the rules relating to this area that were in statute, which is what we did with the Financial Services Act, and introducing the rules made by the PRA. It says: “The PRA near-final rules, which fill the space, have been published and you will be able to find them here.” The word “here” is a little blue thing with a line under it. By now I should have learnt that you do not press those, but I did, and I got to a six-page document, which had two parts. One was from 9 July, PS17/21, Implementation of Basel Standards. The other was from 12 February, CP5/21, Implementation of Basel Standards. As I understand it, the first is the current PRA policy and the other document was the invitation to consultation. Tantalisingly, having been introduced to this idea of near-complete rules, I found that the first appendix was:
“Near-final CRR RULES INSTRUMENT 2021”.
Once again I was daft enough to press this. While I had been shocked before, this really took my breath away, because the first page—I had the wit to print only one page at a time—said, in very light grey at the bottom, “Page 1 of 307”. I lost the will to live at that point. I thought: how do you scrutinise 307 pages?
I returned for inspiration to John Glen’s letter, in which he said: “I would encourage parliamentarians”—he is very optimistic using the “s”, I think, but still—“to consider these rules as part of scrutinising this SI. As we discussed during the passage of the Financial Services Act 2021, the PRA ran a consultation on its draft CRR rules from 15 February 2021 to 3 May 2021, which was open to all—businesses, public and parliamentarians—to respond.”
Those two paragraphs seemed to invite us to condition our approval of this instrument on the basis of what was to replace it. Once again, I felt that burden to see whether I could get any way to understand this document better. I am not sure how I got there, but I found a Prudential Regulation Authority document, policy statement PS17/21, Implementation of Basel Standards from July 2021. I thought: let us try that. I turned over the next page, and it has 84 pages. That has to be progress.
At this point, I ran out of time and energy. I thought, “We’re not going to turn this down. Four times since the Second World War, I think, has the House of Lords turned down a statutory instrument. What’s the point?” I thought, “A good compromise is just to read the overview.
I do not know how well the Minister copes with this stuff, but you have only to read the overview to realise that you need a degree in this language to understand it. I did flog through it and, in my ignorance, virtually everything I came across seemed reasonable until I came to paragraph 124. This disturbed me, because this SI is very important—the Minister may say that I have misunderstood its importance, but I think it is important. That paragraph refers to climate change. The world feels a bit rough at the moment—in everything from Afghanistan to the pandemic, it is not in a good place—but the problems we have now pale into absolute insignificance compared with what happens if we do not get climate change right. The odds are stacked against us, let us be realistic. In the UK, we are trying hard, but to get the big powers involved and get them to agree? It is pretty worrying.
I was greeted in paragraph 124 with the words:
“The PRA must also have regard to the target in section 1 of the Climate Change Act 2008 (carbon target for 2050) for rules made after Saturday 1 January 2022. As these rules will be final before that date, they are out of the scope of that requirement. In addition, during the consultation period for CP5/21, the Prudential Regulation Committee’s … remit letter was revised to recommend that the PRC should, where relevant and practical, have regard to the Government’s commitment to achieve a net-zero economy by 2050. As consultation was underway at the point the PRC’s remit letter was revised, the PRA could not consider this new have regard for these particular rules, as to do so would have caused an impractical delay to their implementation.”
That struck me as a real Sir Humphrey kick into the long grass. I was very worried that about the only paragraph I felt I could understand did not have the right feel about it. What is more, I was confused because at this point, for reasons I do not quite understand, I was inspired to read the de minimis instrument which is called for to prove that it is under £5 million per year. All it took account of was the time people took to read the document. It did not take into account the fact that if you get these things wrong, the impact on the financial system can be profound.
That document seemed to say that the requirement to have regard to the target was relevant to this SI, so I was left very uncomfortable with the way this extraordinarily important issue was handled. I would like to know from the Minister when and how the net-zero commitment will be considered in the PRA rules. Is there some future iteration? I know there is this grid or something that says, “we are going to do this, that and the other”, but is that going to be considered at some point?
I then went on to worry, as we did at length when the Act was going through the House, about how we scrutinise PRA rules. In many ways, John Glen’s letter illustrated that if it became an affirmative resolution or something like that, it would be too difficult. But one has to remember that when we were in the EU—I am not talking now about whether Brexit was a good or bad idea—these equivalent rules were considered by the EU Parliament. It took them very seriously indeed and would flog through these rules so that when they came to the member nations they had been examined by a democratic process.
In a sense, all we get here is an invitation to consultation which sits entirely within the PRA and which Parliament can have a hand or an involvement in only if it takes the consultation. It seems to me that you have a situation which all too frequently develops in large organisations and their regulators. When I ran a large organisation, I tried to do the same thing: you try to get your regulator to go native so that you can do things your way. The consultation, as far as I can tell, was among the suppliers of services. There was no way in which the needs of society or customers could be considered.
I recognise that this is a very big question and the Minister might want to write me an essay and not answer today, but is this situation, in which future rules will have no formal parliamentary scrutiny, satisfactory? Should parliamentarians not be more involved in an issue of this importance? If they should have more involvement, how?
My Lords, I thank the noble Lord again for his very thorough analysis of an immensely complicated subject. I will try to address his two substantive questions. The first was on the scrutiny of PRA rules and regulations by Parliament. I assure the noble Lord that Parliament ultimately sets the regulators’ objectives, and it is right that Parliament has the appropriate opportunity to scrutinise the work of the regulators and their effectiveness in delivering the objectives that Parliament has set them. The letter the noble Lord referred to was clear that we set out a reasonably long consultation period earlier this year and had substantive responses from the key players in the sector, and we have responded to those.
The regulator committed to sending these consultations and draft rules to Parliament during the passage of the Financial Services Act earlier this year. Consultation began in February so there has been a decent period to review and report on them. The PRA published its final rules in July—again, well in advance of this SI. The FSMA requires regulators to undertake these consultations and to consider and to respond to representations from Parliament as well as other stakeholders. Mechanisms for accountability, scrutiny and engagement are considered further through the further regulatory framework review. We should not rush to prejudge the outcome of the FRF review. The Government will bring forward proposals through a second consultation later this year.
On the noble Lord’s question about climate change, the Financial Services Act 2021 was amended to include a “have regard to” the net zero carbon target but its application was delayed until 1 January 2022. This means that the PRA does not need to have regard to climate change considerations in making the rules as a consequence of this specific SI. This delay will ensure that there is no unnecessary and impractical delay in implementing the Basel 3 reforms for 1 January next year, otherwise we would be in the unfortunate position where the regulators would have to reopen or restart their consultations which were first published, as I said, in February this year.
I assure the Committee that the PRA will still need to make rules to implement substantive reforms contained in Basel 3.1. I expect the regulators to use the powers again in future to update their rules: for example, to take account of new international standards or developments in the market. The PRA will need to have regard to the net carbon target in setting those rules.
I hope noble Lords will agree that these amendments strike the right balance between taking action on climate change quickly and taking swift action to reform our prudential regimes that aims to prevent a future crisis. I suggest that we write to the noble Lord to update him on the timetable for his specific concern on the net-zero targets.
Before the noble Lord sits down, I recognise that what I have said is perhaps complex so I would be grateful if he would also write to me on whether he has any further reflections on how Parliament might be involved. The formal position, as I understand it, is that the PRA can now make regulations without seeking any formal authority from Parliament; indeed, that is almost the essence of it. I sense some degree of sympathy that somehow Parliament ought to be involved, so if he and the Treasury have further thoughts on that, it would be valuable if they could share them with me.
Of course we will write to the noble Lord to provide a bit more clarity on that. Again, it is that difficult balancing act with incredibly complex regulations—as the noble Lord has so ably demonstrated as he has fought his way through layers of hyperlinks—and I recognise that.
The Prudential Regulation Authority has consulted on these rules. As I mentioned, in July it published the near-final version of the proposed rules, along with an accompanying policy statement. This set out how the regulator has taken into account the public policy factors in the Financial Services Act.
I hope that the noble Lord has found today’s debate informative. I will write to him on the specific items we have discussed. I hope he will join me in supporting this instrument and I beg to move.
Committee adjourned at 6.39 pm.