I beg to move, That this House
agrees with Lords amendment 84.
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Lords amendments 84 to 88 provide the Treasury with powers to make regulations with regard to investment bank insolvency. They were inserted into the Bill after consideration in the Lords Committee, after I had signalled the Government's intention to do so in this House.
The powers that the Government are taking with regard to investment bank insolvency are of critical importance. They have been brought forward to enable the Government to address the concerns about the recovery of client assets that have followed from the collapse of Lehman Brothers. I shall take this opportunity to explain how we are proceeding because it has not previously been discussed in this House.
Hon. Members will be aware that when Lehman Brothers failed, its UK arm also collapsed. This subsidiary held a very large quantity of client assets. The exact sum is unknown, but is likely to have run to many billions of pounds. Much of this money may have been simply passing through Lehman's broker-dealer business at the point of default.
At present, those clients to whom those assets belonged have no way of recovering them outside of the normal insolvency arrangements. Those procedures could last for a substantial period of time as Lehman Brothers is one of the most complex insolvencies, if not the most, ever to occur. This is no small matter. If clients are unable to access assets that they believe they rightfully own, it of course has implications for market confidence in, and the effectiveness of, the legal arrangements—including those relating to insolvency—that support the UK financial system.
Hon. Members will be aware, I am sure, that a major source of the UK's competitive advantage in financial services is the certainty provided by the relevant legal regimes in the UK. If those were seen to be insufficient, there would be implications for the future of the City of London as a financial services centre. Ineffective operation of insolvency arrangements in relation to investment banks and client assets could also have financial stability implications, if it impacted on the ability of clients to meet their own obligations to third parties. That may have particular relevance in the case of rehypothecated assets where recovery may be especially challenging.
The Government therefore clearly need to act, both to ensure that clients have the ability to recover their assets more easily in any future investment bank insolvency, and in order to maintain confidence in the financial systems of the UK. It is unfortunate however that the sheer complexity of the challenges that have emerged since the failure of Lehman Brothers and its UK subsidiary defy simple solutions. The House will understand that the application of insolvency procedures to an investment bank, or any other large, complex financial institution, is complicated and challenging. To consider ways of revising such procedures is equally complex.
For this reason, the Government have sought the advice of an expert panel with regard to the concrete steps that need to be taken in order to address those challenges. This panel, the establishment of which was announced in the pre-Budget report, is to consider how regulations may best be made that enable the unencumbered return of client assets without creating substantial externalities or negative consequences. The review will examine whether the statutory purpose of administration as provided for in the Insolvency Act 1986, presents problems in the case of institutions that hold client assets; the procedures for administration of a complex investment bank; and arrangements for the continuity of brokerage accounts.
The provisions of these new clauses provide the Treasury with the powers necessary to make any changes that may be required as a result of this review. They are necessarily broad, for the simple reason that it is impossible for the Government to prejudge the conclusions of the expert panel, particularly in such a complex case. Let me reassure the House that the powers that these clauses confer would be exercised only if such changes were deemed necessary. The review may, of course, find that no changes are necessary. The powers are therefore precautionary, insofar as they will not be used without a clearly identified need to do so, and they will be closely targeted if deployed.
Let me briefly describe the provisions of each of the clauses that lay out the powers. The new clause inserted by Lords amendment 84 is the first in the group and sets out the scope of the enabling power. The power will permit the Government to make regulations to change the insolvency regime for investment banks. Investment banks are defined as institutions, incorporated or formed under UK law, that have permissions under part IV of the Financial Services and Markets Act 2000 to carry on the regulated activities of safeguarding and administering investments, dealing in investments as principal or dealing in investments as agent. The clause also defines client assets as they are to be considered within the meaning of those powers and provides the Treasury with an order-making power to alter those scope definitions as necessary and appropriate.
The next new clause provides that the Government may lay regulations to modify existing insolvency law in its application to investment banks or to establish a new procedure for insolvent investment banks. In line with existing insolvency law, the new regime would apply when an investment bank was either unable or likely to be unable to pay its debts or when its winding up would be fair.
The following new clause provides the detail of what the regulations may provide for and how they would work. It includes provision for the regulations to set out those persons who can initiate the special procedure or who can make an application to a court for the procedure to be initiated by court order.
The new clause inserted by Lords amendment 87 sets out the detail by which any regulations may be made. The clause will provide that the regulations should be made by statutory instrument and should be subject to the affirmative procedure. The Treasury must consult before making any such regulations.
Finally, the new clause introduced by Lords amendment 88 provides for a review of insolvency regulations. As a consequence of the clause, the Government must establish an independent review of any regulations that have been made within two years of their coming into force. That review will be independent, expert, and impartial. It will consider whether the regulations have been effective in identifying, protecting and facilitating the return of client assets. It will consider whether, in drafting the regulations, the Treasury has paid due attention to protecting creditors' rights and ensuring legal certainty for all relevant stakeholders—creditors, clients, administrators and the investment banks. That is critical and will ensure that the impacts on those firms and persons who may be affected by the regulations are subject to full consideration.
As I have said, the Government believe that the proposals are essential for supporting continuing market confidence in the UK as a major financial services centre. They were debated at great length in the other place, and rightly so. I believe that the provisions are necessary.
I am grateful to the Minister for the time that he has taken to set out the amendments in this group. He was right to highlight their importance and the way in which they have emerged. One point that was raised in Committee was the narrow focus of clause 2, which defined a bank as a deposit taker for the purposes of the Bill. That meant that it covered banks such as Barclays and RBS but not Lehman Brothers, which did not take deposits. That exchange in Committee took place just before information emerged from the administration of Lehman Brothers International (Europe) in the UK. That was a complex matter which gave rise to a number of practical and legal issues around areas such as netting off transactions and expenses and separating transactions to Lehman's accounts and those of its clients.
It is worth quoting briefly an article that appeared last November about the perception of one group of Lehman's clients of the problems that they encountered with its insolvency. It appeared in the Evening Standard and was based on a letter that the Investment Management Association wrote to the Financial Services Authority. It included comments such as:
"The core problem was that when Lehman folded, institutions that had placed buy and sell orders for cash equities through the firm had no idea where they stood—whether the trades had gone through or not. Institutions needed to know because if they had been trying to buy and the deal had not been completed they would want to put that trade with another broker. Likewise, if they had been trying to sell. But what happened was that all the institutions' Lehman-related equity transaction held within at the Euroclear Crest settlement system were frozen. The system was locked up. They did not know where they were, whether they were in or out of the market—and this at a time of huge volatility. And it went on for nine weeks."
Interestingly, the letter went on to talk about the lack of a proper contractual framework for some of the transactions, something that was highlighted once the implementation of the markets in financial instruments directive had taken place. Clearly, therefore, various issues emerged from the administration process for Lehman Brothers in the UK with which we need deal. That is why, when the Government announced in the pre-Budget report that the Bill would be amended to introduce new rules to deal with the administration of investment banks, they received support from Conservative Members. However, there was also a recognition that the framing of the rules was not straightforward and, in his remarks, the Minister made very clear the complexity of the issues involved.
I want to touch on two issues. The first has to do with the principles underpinning the regulations, and the second with the parliamentary process. One of the challenges arising out of these matters is definitional, especially as the term "investment banking" is not found in the Financial Services and Markets Act 2000. So Lords amendment 84 lists the sort of activities that such a business might undertake and uses that as the basis of the new clause.
Is the Minister happy that the definition is broad enough as it stands to capture investment banks that are incorporated in the UK? Does he envisage any further changes? The Bill limits the powers to UK-incorporated institutions, and Lehman Brothers International (Europe) was obviously a UK-incorporated business, but there are branches of European economic area banks that operate in the UK and undertake investment banking activity that would fall outside the Bill's terms.
Has the Minister had discussions with his EU counterparts on this matter? If the law in Germany or France on the administration of investment banks was not especially satisfactory or clear, the collapse of a German or French investment bank would have an impact on London's international activities.
Clearly, some learning from the experiences of Lehman's clients has gone on. Subsection (3) of the new clause that is amendment 85 sets out the "have regard to" factors. It is important to set out the framework in which the regulations will be put together, to ensure that they work in the interests of the UK financial services sector, and to make sure that there is certainty for banks, for creditors and clients, and for liquidators and administrators.
The issues that the Government will have to tackle when they draw the regulations together will in a way mirror some of the matters that have been debated in the context of set-off and netting. Those matters have been discussed throughout the Bill's passage, and it is worth reiterating the importance of achieving a proper resolution of the issues to do with set-off and netting.
In my conversations with regulators and practitioners, it has been made clear that getting this wrong would mean that transactions would be accounted for on a gross rather than a net basis. That would flow into capital requirements and make London less attractive for international businesses, but Lords amendment 86 illustrates some of the challenges that the Government will face. It also makes it clear why there needs to be some proper parliamentary scrutiny of the secondary legislation.
For example, subsection (6)(b) of the new clause makes provision for determining which
"assets are to be...treated as client assets".
The use of the phrase "are to be treated" as client assets is key, as that is very different from saying that the assets "are" client assets. The process will be that someone will have to assume that the assets are client assets, but they may belong to somebody else.
A difficult process of identification will be involved.
Subsection (6)(f) of the new clause says that the regulations may provide
"for the creation or enforcement of rights...in respect of client assets".
We are talking about the creation of new rights in respect of those assets, and potentially re-writing contracts, so the provisions in the regulations are significant. It will be difficult to introduce them in secondary legislation.
That brings me on to my second point, which is about how the regulations are made and reviewed. Significant concern was expressed in the other place about the fact that the powers are to be introduced through secondary, rather than primary, legislation. The bank insolvency procedure and bank administration procedure arrangements in parts 2 and 3 of the Bill are being put in place through primary legislation, and the Insolvency Act 1986 was clearly primary legislation, so there was concern about the extent of the regulations that will have to be made through the regulation-making powers in the Bill. Obviously, we welcome the fact that the regulations will be scrutinised under the affirmative procedure, and the fact that there will be statutory consultation before they are laid before Parliament. It is important that the consultation works and is thorough, because as every Member in the House is aware, there is no power to amend individual items in regulations, under either the affirmative or the negative procedure.
The Minister talked about the review that will take place two years after regulations are made. Perhaps my memory is faulty, but I am not sure whether he touched on the sunset clause in subsection (4), which is inserted by Lords amendment 87. The subsection says:
"If the power to make investment bank insolvency regulations has not been exercised" within two years of Royal Assent, the powers lapse. That gives rise to the question: is it the Government's intention to make regulations under those powers? The Minister indicated that work looking into the matter was under way, but is it the Government's intention at the moment to bring forward powers under that process, or can we assume that the powers will lapse after two years?
Furthermore, as the Minister said, a review clause was inserted into Lords amendment 88, which requires a review of the regulations to be completed within two years of the regulations coming into force. There is a double lock there: if the regulation powers are not used, the power to make them lapses, and if the powers are used, there is a review after two years. There was a debate in the other place about whether a sunset clause should apply to the regulations, so that they, too, lapse after two years. There would then be consistency between the two sets of sunset clauses.
I understand that it was argued in the Lords that it would be better for primary legislation to be made, and for the normal processes to be used to replace the secondary legislation. I had some sympathy with the view that there should be proper parliamentary process, particularly given that the powers in the regulations are so extensive and can impact on contractual rights. There is a strong argument for enhanced parliamentary scrutiny, and perhaps for applying a sunset clause to any regulations made, as well as to the power to make them. However, on the other hand, there was a strong argument about the need for certainty. One of the themes that has characterised the Opposition's contributions to the Bill, both here and in the other place, is the idea that there should be certainty for industry.
The London Investment Banking Association has expressed the concern that if a sunset clause applied to the secondary legislation, it would create uncertainty. However, it supports the sunset clause that applies if no powers are made. Clearly, its position is quite subtle and nuanced. The association's concern is that if the regulations were subject to a sunset clause, there would be a perception that our insolvency procedures were in a period of flux. When people pledged or committed assets, they would not know whether there might be a change to the rules the next day if the rules had expired.
I accept the position that we have reached, whereby if the regulation-making powers are not used, they will lapse. If they are used, there will be a review after two years. In reaching that conclusion, I suspect that the Government have erred in favour of certainty rather than parliamentary scrutiny. The test that they will face in introducing secondary legislation is to ensure that there is proper consultation with interested parties. Secondary legislation needs to be robust and command broad support. Inadequate consultation and a failure to listen will lead to poor secondary legislation, which will act as a disincentive to investment banks being based in the UK.
The hon. Gentleman made some typically reasonable points and managed in the end to argue in favour of the Government's position as set out in the amendments, particularly why we resisted a sunset clause of the type that was considered in the other place, and why we reached the decisions that we did.
With the leave of the House, I shall make three brief points in response. First, history will judge very harshly the collapse of Lehman Brothers and the failure of the United States to intervene. It is obviously difficult to consider counterfactual scenarios and what might have happened had Lehman Brothers not been allowed to collapse, but it seems clear that that collapse precipitated a catastrophic crisis in confidence in the banking system and created a huge number of problems that have reverberated around the world and still affect the UK. The Lehman Brothers insolvency in the UK, as the hon. Gentleman rightly pointed out, is extremely complex and will take considerable time to resolve. We all wish that we were not in that position.
My second point is in response to the hon. Gentleman's comments about applying the Bill to non-deposit takers. As he knows, the special resolution regime has been designed for deposit takers. It is an SRR objective to protect depositors and now to ensure the continuity of the banking service. The amendments deal only with clarifying the insolvency procedures for UK investment banks. Branches will be subject to home state insolvency.
The hon. Gentleman asked whether we were discussing that with our European partners. We are in discussion with the European Commission, as is the Financial Services Authority, on issues relating to branches and to their regulation. I believe that the actions that have taken place over recent months have demonstrated that significant improvements are needed to the regime of home state regulation if it is to be effective in the future and if it is to give depositors confidence that a branch operating in the UK and regulated in a home state inside or outside the EU or the EEA can be regulated robustly in the home state.
My third and final point is about subsection (4) of the new clause inserted by Lords amendment 87. The hon. Gentleman is right to say that the Government will make regulations, if necessary, as a result of the expert review that is taking place. The sunset clause exists to provide certainty to the market that the regulation-making power will lapse if not used. The wider proposals for sunset regulations would not work because they would, as has been clearly demonstrated, lead to far greater uncertainty. The proposed review has been welcomed by the markets and those who consider these matters. Again, we think that it strikes the right balance because changes to the insolvency regime are likely to be needed with respect to investment banks. However, we are not yet in a position to be definitive in legislation.
I think that the hon. Gentleman understands that.
I am grateful to the Minister for those remarks. It is important to get the issue right and for there to be the right degree of certainty. One of the comments made by the IMA was about the poor state of the contracts in respect of some of the transactions. Is further work by investment banks and their clients, to improve the clarity of the contractual terms that govern the transactions between them, an alternative to secondary legislation?
Different organisations, including the one to which the hon. Gentleman refers, have made a number of suggestions. We need to proceed carefully on this issue, which is extremely complicated. We have to ensure that we take the views of experts and carefully consider what policy interventions might be necessary. Only if it is explicitly recommended by an impartial group of experts should we proceed. Firms can expect that any changes to be made will be permanent. Again, that is vital for promoting certainty.
We are well aware of the fact that we need to act decisively and without undue delay. I confirm to the House that there will be no vacillation as to the new insolvency procedures and that we will lay regulations, if appropriate, as soon as we have received firm advice from the expert panel. I am sure that what I have said will give the reassurances that the House seeks. I believe strongly that it will give confidence to those watching our proceedings who need to have legal certainty for their transactions.
Lords amendment 84 agreed to , with Commons privilege waived.
Lords amendments 85 to 88 agreed to.