Clause 22 — Termination rights, &c.

Employment Opportunities – in the House of Commons at 6:45 pm on 10th February 2009.

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Photo of Michael Lord Michael Lord Deputy Speaker (Second Deputy Chairman of Ways and Means)

With this it will be convenient to discuss the following: Lords amendments 8 to 16.

Lords amendments 18 and 19.

Lords amendments 21 to 30.

Lords amendments 32 to 45.

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Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary (Economic and Business), Department for Business, Enterprise & Regulatory Reform, Economic Secretary (Economic and Business), HM Treasury

This group of amendments covers two broad but interrelated issues: default events and partial transfer safeguards. The majority of the amendments made in the other place have been in response to the concerns of stakeholders and reflect the approach that we have adopted—to listen and to try to build consensus.

As hon. Members will know, we have tried throughout this Bill to balance the need for the authorities to have the right powers to effect a successful resolution with the right protections to protect legal certainty and market confidence. The Government have sought to consult stakeholders and provide the protections that precisely target their main concerns. Admittedly, that approach has taken numerous consultations and several amendments to the Bill, but I do not apologise for that. The Bill is certainly much improved as a result. With that approach, which includes the safeguards in secondary legislation, we have got the balance right. I wish to place on record my thanks to stakeholders and members of the Opposition for working with us to achieve that overall result.

I do not propose to cover the detail of the amendments at any great length. As I have said, they are the result of numerous rounds of consultation and co-operation between all concerned. Baroness Noakes provided my noble Friend the Financial Services Secretary and Minister for the City with an opportunity to read into the record, at some length, the technical detail of and effect achieved by each amendment.

I propose instead briefly to summarise the amendments. They achieve two things. First, they amend various technical definitions in the Bill to provide complete certainty on important legal concepts including termination rights, trust interests, and set-off and netting. Secondly, they provide a balance between, on the one hand, the legitimate interests of bank and third-party counterparties in being able to contract with certainty for termination rights where set-off and netting arrangements are involved in financial contracts and, on the other hand, the ability of the authorities to transfer banking business to a new company—either a private sector purchaser or a bridge bank—with certainty over what contracts have been transferred.

The balance is achieved via the mechanism of the conditional transfer provided for in an amendment to clause 34, which will be backed up by the necessary safeguards to be made under clause 47. I can, of course, provide more detail on these matters should any hon. Member wish me to do so. However, as I have said, they have been extensively explored in the other place and put on the record there.

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Photo of John Redwood John Redwood Conservative, Wokingham

I can see that these are important technical matters, and I would appreciate a reassurance on them from the Minister. Rapid resolution of these issues if a company goes under or gets into difficulties is terribly important for lots of better run businesses that are relying on the counterparty arrangements. Have the Government made any progress in ensuring that that resolution can be done quite speedily?

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Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary (Economic and Business), Department for Business, Enterprise & Regulatory Reform, Economic Secretary (Economic and Business), HM Treasury

I certainly agree that speed is important, particularly when it is needed to exercise the special resolution regime and to decide which of the stabilisation options to pursue. People will often be acting in a highly pressurised situation where decisions need to be made quickly. We think that the Bill and its provisions are fit for purpose, and they work as far as stakeholders are concerned. I think that it is fair to say that most discussion has been on partial transfers and safeguards and the impact on counterparties. That is why we have taken a substantial amount of time to try to get this right by working with stakeholders. That is why I expressed my thanks to those who have worked with us. We believe that we have a compromise that has broad support.

As I said, the Government have always acknowledged the invasiveness of the powers to switch off termination rights and make partial transfers. With these amendments, I believe that agreement has been reached that the necessary safeguards have been put in place, imposing suitable restrictions on the powers of the authorities. We have worked closely with stakeholders through the expert liaison group and through scrutiny in this House and the other place. We have also worked with further external stakeholders who have made a number of valuable points during all stages of the Bill. The Bill now provides the right balance between targeted protections for the market and appropriate powers for the authorities to effect successful resolutions of failing banks.

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Photo of David Gauke David Gauke Shadow Minister (Treasury)

First, may I express my agreement with the Minister about the importance and sensitivity of this subject and acknowledge that the Government have sought to consult stakeholders widely? They have certainly involved us in the discussions. I pay tribute in particular to my noble Friend Baroness Noakes, who was heavily involved in discussions with the Treasury, the expert liaison group and various stakeholders. I acknowledge that the Government have granted us and my noble Friend that opportunity. It has been clear throughout that the Minister in this place has been aware of the difficulties with these subjects. He has been keen to listen to representations from outside groups as well as from Members of this place and the other place.

It is perhaps worth reiterating briefly the particular issue that applies with partial property transfers, to which my right hon. Friend Mr. Redwood alluded in some respects. When a bank is in difficulty and finds itself entering the special resolution regime, it might find that some properties and contracts are transferred to a bridge bank, for example, whereas others remain in the residual bank. The counterparty contracting with that bank might face considerable difficulty. Normally, that counterparty would be able to net or set off the various contracts with one party, but it would now find that it was contracting with two parties and that netting and setting off might not be available. That substantially increases the risks involved for that counterparty. In this field, that has considerable consequences on things such as regulatory capital. A regime that does not adequately address the issue will have an impact on the competitiveness of the UK banking sector at a time when that would be most disadvantageous.

It is right that this matter has been closely scrutinised throughout the progress of the Bill. It is right that the other place considered the subject very closely and made a number of amendments, which are before us. Before I raise one or two questions about the amendments, I want to make one point about the scrutiny.

The Government have done their best and have tried to consult widely, but the nature of the legislation and the desire to push forward with the Bill within a restricted time frame could mean that additional issues come up. As it happens, I was contacted yesterday by an expert in private international law who raised concerns about the definition of foreign property in clause 39. It would be inappropriate to raise those points at this stage, but I mention that merely to highlight that there might still be issues that need to be addressed. Of course, a great deal of the legislation is dependent on the secondary legislation, which might in some cases have been published but is yet to receive approval. I hope that the cross-party consensus and co-operation on the primary legislation will continue when we come to the secondary legislation.

Let me turn to the specific issues. Amendments 7 to 10 and 21 to 24 relate to clauses 22 and 38, which are to do with the circumstances in which it might be necessary to disregard either a share transfer or a property transfer as an event of default. We accept that without these provisions it might be impossible for a bank to continue to operate when a counterparty—we are not necessarily talking about financial counterparties and could be talking about service providers, for example—might have the opportunity to walk away from their contract because an event of default would have been triggered by the share transfer or the property transfer.

Yesterday, Lord Myners referred in the other place to "wide counterparty flight", and that is the issue here. The provisions have been expanded to address the question of conditions precedent and the concern about that that has arisen during the Bill's progress through the Parliament. Given that we are dealing with new wording that has not been debated in this House before, will the Minister say something about the thinking behind amendments 10 and 24, in particular? What are the circumstances that he is concerned about, and how was the problem drawn to his attention?

I turn now to amendment 18 to clause 34, which states that a transfer may be conditional on a certain event or situation occurring. Will the Minister give the House a little more information about what sort of events or situations he thinks may trigger a transfer? I can see that the proposal has the advantage of flexibility: the case made for the clause as a whole is that it provides greater certainty to the transferee and protects those who have contracted with the original bank, and those are both worthy objectives.

I also note that Lord Myners also remarked in the other place yesterday:

"The early indication from consultation with stakeholders is that this approach will be supported."—[ Hansard, House of Lords, 9 February 2009; Vol. 707, c. 966.]

I believe that that is right, and my noble Friend Baroness Noakes endorsed the observation, but some people might be a little concerned about the use of the phrase "early indication". How widely have the Government consulted on the approach set out in amendment 18? Are they satisfied that it enjoys widespread support?

Finally, various essentially technical amendments are proposed to clause 48, which provides the power to protect certain interests. That is where the safeguards lie, and where the protections for counterparties exist. At many stages in the Bill's passage through Parliament, we have debated why more safeguards cannot be included on the face of the Bill. Why not go further and exclude financial contracts altogether? My understanding is that the financial collateral directive excludes the majority of financial contracts from this area, but not all of them. I should be grateful if the Minister would update the House about the Government's thinking on this matter, and provide a little more information about the progress that will be made on the relevant statutory instruments.

The real substance of the legislation in this area will be set out in the statutory instruments, and it is not necessary to go once more through the whole debate about the balance between statutory instruments and primary legislation. No doubt the Minister will argue that there is a need for greater flexibility, but it would help the House if we had a little more information about what progress will be made.

These are very technical matters, but they are hugely important. The Minister has acknowledged that throughout, and we welcome the real progress that has been made in the House of Lords. However, I hope that the Government will continue to review this area and communicate with the banking liaison panel even after the secondary legislation has been passed. If any difficulties arise, such as market uncertainty or a loss of confidence, I hope that the Government will be prepared to return to the issue as a matter of urgency.

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Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary (Economic and Business), Department for Business, Enterprise & Regulatory Reform, Economic Secretary (Economic and Business), HM Treasury 7:00 pm, 10th February 2009

As Mr. Gauke rightly notes, these are technical issues, but in many instances they are absolutely crucial for ensuring legal certainty. It is important that the detail is got right, and that is one reason why we have had the extensive consultation that I mentioned earlier. I can certainly assure the hon. Gentleman that the banking liaison panel will monitor the legislation, and we also want to use it in the wider role that I have announced previously. If problems arise, we want to be able to take the widest possible advice about potential solutions.

I shall respond briefly to some of the technical points that the hon. Gentleman raised. I am sure that the banking liaison panel will continue to look at any further technical issues that may arise, but the hon. Gentleman asked about conditions precedent. That provision is already in commercial use and could easily be substituted for a termination right. Since the Bill was introduced, the authorities have been concerned that the definitions used in it did not cover the conditions precedent device with absolute certainty.

For example, a contract may provide for B to perform an obligation in favour of A, but only when one of a number of specified events has or has not occurred. Typically, those events would be similar to events that would entitle a party to terminate a contractual arrangement—such as non-performance by A of his obligations to B, or matters relating to A's creditworthiness. As a result, the Government consider it essential to leave no doubt that devices such as conditions precedent are caught by the Bill, and have introduced amendments to achieve that. Otherwise, counterparties could seek to opt out of the special resolution regime, and private sector purchasers might be reluctant to accept transfers of banking business, for fear that they would be ineffective.

The hon. Gentleman asked how the conditional transfer under amendment 18 would work. Its aim is to prevent counterparties from closing out against the transferee simply as a result of the transfer, while at the same time preserving their termination rights against the residual bank. I emphasise that that does not prevent the counterparty closing out should the transferee breach the obligations that have been assumed.

An unfettered right to close out against the transferee or new company carries potential risks for the resolution. The new company could immediately be required to pay crystallised liabilities, and that could create liquidity stress. Moreover, a counterparty that closed out on such a basis would have acquired a better right than it had in the first place, namely the right to close out not against a failing institution but against the more creditworthy bridge bank or private sector purchaser. That is not the same as the termination right for which the counterparty had contracted, and the Government believe that the amendment to clause 34 offers a way of overcoming that concern.

Government amendments 14, 18 and 28, among others, concern default events. Amendments 14 and 28 respond to concerns raised by interested stakeholders about the drafting of clauses 22 and 38, and I shall give the House an example of how we have worked. My noble Friend the Financial Services Secretary arranged a meeting between Treasury officials, parliamentary counsel, and the City of London Law Society to resolve these problems. The amendments are the result of the concerns that have been addressed.

We have always been clear that the purpose of the clauses is not to prevent termination rights from being exercised when the transferee defaults on the obligations that they assumed. If a party assumes a contract under transfer, and then breaches an obligation under that contract in a way that is unrelated to the transfer, the counterparty should be able to exercise any right to terminate the contract that may arise in consequence. Interested parties thought, for technical reasons, that the drafting did not achieve that outcome, and although we did not agree, we were happy to respond to those concerns by bringing forward amendments that are intended to dispel any doubts that might exist. That is another example of the consensual approach that we have adopted.

Finally, I turn to Lords amendment 18, to which the hon. Gentleman referred. It relates to clause 34. The amendment is part of a Government package to respond to the concern that the powers relating to default events would lead to market uncertainty for financial contracts, particularly those with set-off and netting arrangements. I should make it absolutely clear that under the financial collateral arrangements directive, the Government must allow financial collateral agreements to take effect in accordance with their terms, including by respecting terms that commit the counterparty to closing out. As the hon. Gentleman is aware, we are talking about a minority of financial contracts that are not protected under the directive. I do not have the technical expertise to go into the detail of what those contracts are, but I gather that those who understand these matters know what we are talking about.

The hon. Gentleman asked how widely we had consulted on some of the issues. The best response that I can give is to say that we have consulted influential legal advisers on our approach. The indication is that they will advise clients that clean legal opinions can be provided. We will publish draft orders on Royal Assent, which hopefully will be received this week, and will make the statutory instruments on commencement next week. It is right that we continue to make progress on those issues. A significant number of technical issues have been addressed in the amendments, but we will of course want to continue to keep them under review. The banking liaison panel is a useful forum that will enable us to do that.

Lords amendment 7 agreed to.

Lords amendments 8 to 16 agreed to.

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