Clauses 1 to 3 agreed.
Clause 4: Ring-fencing of certain activities
Moved by Lord Blackwell
1: Clause 4, page 8, line 47, at end insert—
“( ) In determining the “specified extent” in subsection (5)(d), the regulator shall have due regard to proportionality where the ring-fenced activities constitute a large majority of the group’s overall activities.”
My Lords, I would be most grateful if colleagues could leave the Chamber quietly, particularly because my noble friend is taking the proper course of declaring an interest which must be correctly entered in Hansard.
My Lords, before moving on to the amendment, and as I did not speak at Second Reading, I want to make it clear that I strongly support the principles of the Bill, and the principle of ring fencing in particular. My amendment is to deal with some of the practical issues of making that work in the financial institutions. The amendment deals with the situation where a financial services group that is primarily operating ring-fenced activities retains a small set of activities that may fall outside the ring fence.
The consequence of the legislation as it stands is that where a group is primarily operating ring-fenced activities but retains some non-ring-fenced activities which may be excluded activities, it would be required to have a separate board for the ring-fenced subsidiary and a separate set of directors operating in it—that is, separate from the group board.
I can understand why having separate boards for a ring-fenced subsidiary may be seen as desirable where the group contains a large non-ring-fenced activity in investment banking or wholesale market activities in order to police the separation between the ring-fenced and the non-ring-fenced activities. The provisions of ring fencing under the Bill should of course deal with that situation by specifying the amount of capital and requirements for security in the ring-fenced activity and its resolution, preventing the flow of dividends controlling the financing relationships between the ring-fenced activity in the group, but I can also understand that having an independent board for the ring-fenced activity where there are other significant activities in the group provides an added level of security to deal with potential conflicts of interest.
However, where the non-ring-fenced activities are of a very minor nature compared with those within the ring-fenced bank, it could potentially lead to a situation where the group board with responsibility to shareholders and to the public has virtually no control over the activities of the ring-fenced activity, despite the fact that the vast majority of the assets and capital are within the ring-fenced subsidiary. That would be a nonsensical situation. It would be poor governance and it would be difficult to operate such a group board in that situation.
The type of activities that I am talking about are those where the ring-fenced bank may feel that to serve its customers effectively it needs to retain some element of activities outside the ring fence not engaging those as a principal part of its business but as part of achieving a proper level of service to its customers.
The amendment would explore that situation where the non-ring-fenced activities are a fairly minor part of the group. There are two ways in which this could be resolved in a common-sense way. The first way would be for the regulator to exercise discretion under new Section 142D to the FSMA to allow a small volume of otherwise excluded activities to be carried out within the ring fence so long as the regulator is satisfied that including those activities within the ring-fenced subsidiary did not put at risk the solvency or ability to resolve the ring-fenced activities if there were situations that used the capital applied to the non-ring fenced activities. So one solution would be to allow the ring-fenced bank to extend its activities. Of course, the regulator would also need to be assured in that situation that allowing the ring-fenced bank to operate those activities would not distort competition with non-ring-fenced banks operating in those markets without the ability to operate within the ring fence.
The second way of resolving this, if the regulator does not feel that it can include those excluded activities within the ring-fenced subsidiary, would be for the regulator to use its discretion under new Section 142H(5)(d) to waive the requirement for separate board membership of the group and its subsidiary, again where the regulator is convinced that in so doing it does not put at risk the ability to resolve the ring-fenced bank where there was a threat to its solvency.
The amendment is probing in nature. The legislation as I have described it allows the regulator to exercise discretion, but I invite the Minister to provide clarity that where the legislation says that the separation of the boards should be “to a specified extent”, the regulator would have the freedom and indeed the expectation that it should exercise that discretion with due respect for the proportionality of the activities within the ring fence and any activities that there may be within the group outside the ring fence. That seems to me to be a common-sense solution. I beg to move.
My Lords, with the leave of the Committee, I, too, would like to participate in these proceedings although, like my noble friend, I was prevented from participating in the Second Reading debate. I strongly support the amendment put forward by my noble friend for the reasons that he has explained very well. I do not think that I can improve on his excellent explanation, but your Lordships should consider that governance would not be improved if there is a situation where the holding company has a completely different membership from the boards of the ring-fenced subsidiaries, and that applies most strongly in the case where the excluded activities comprise only a small part of the activities of the group as a whole. But even in the case where a relatively greater amount of excluded activities are carried out within the group, if the board of the holding company with responsibility to shareholders is comprised of completely different people from the board of the principal operating subsidiaries, does that provide for effective governance? I therefore would like to hear from the Minister something more about what “to a specified extent” means in new Section 142H(5)(d).
My Lords, I will consider both Amendments 1 and 2, and I will talk first about Amendment 1, which has been proposed by my noble friend Lord
Blackwell. I have much sympathy with the intention behind this amendment and I hope that I can provide some of the comfort that my noble friend seeks. Independent governance is of course key to the integrity of the ring fence to ensure that ring-fenced banks do not simply operate in the interests of their group’s investment bank, in this example, or indeed other parts of the bank, but it is important that any governance requirements are proportionate to the threat to the ring fence. Where a ring-fenced bank makes up the great majority of a group’s business and the investment bank is therefore small, so the risk of the ring-fenced bank being dominated by the interests of the investment bank is also small.
The Independent Commission on Banking recommended that where the vast majority of a group’s assets were in the ring-fenced bank, requirements for independent governance should be relaxed. The Government accepted that recommendation, and in our June 2012 White Paper we supported,
“flexibility in governance arrangements where a ring-fenced bank represents the overwhelming majority of a group’s business”.
Under the Bill, the precise details of ring-fenced bank governance arrangements, along with other ring-fencing rules, are for the regulator to determine. The Bill sets the objectives that rules must achieve; the regulator then decides what exact structures or restrictions are needed to achieve those objectives. This is appropriate because of the highly technical nature of the issue, and in order to allow requirements to keep pace with developments in a fast-moving market. Rule-making will, of course, require the regulator to exercise its judgment, and proportionality will be central to how it does so. In particular, the regulator will be obliged to consider the costs and benefits of any rules it proposes to make, including ring-fencing rules.
In the case of ring-fencing and governance rules, the Bill also specifically gives the regulator flexibility to consider the proportionality of different requirements. The Bill requires the regulator to ensure “as far as reasonably practicable” that a ring-fenced bank is able to take decisions independently of the rest of its group.
The formulation “as far as reasonably practicable” specifically anticipates circumstances in which certain governance requirements might be impractical or have costs that are disproportionate to their benefits. The case where a ring-fenced bank constitutes the overwhelming majority of a group’s business may be one such circumstance. I hope the noble Lord can therefore feel reassured that the intention of his amendment is already reflected in the Bill. I therefore call upon the noble Lord to withdraw his amendment.
Government Amendment 2 corrects a minor and technical point in connection with new Section 142H, which imposes an obligation on the appropriate regulator to make certain rules requiring that a ring-fenced bank be independent of other members of its group. The clause as currently drafted defines the appropriate regulator only in relation to ring-fenced bodies. However, as new Section 142H also imposes an obligation on the appropriate regulator to make rules applying to authorised persons who are members of a ring-fenced body’s group, but are not themselves ring-fenced bodies, the appropriate regulator needs to be defined in relation to all authorised persons, not just ring-fenced bodies. This is corrected by this amendment, and I commend it to the House.
My Lords, I wonder whether, in his assessment of the amendment of the noble Lord, Lord Blackwell, the Minister might take into account the fact that it was exactly this sort of procedure that led to the steady erosion of Glass-Steagall over the years. There was a tendency continuously to say, “Well, if we have a particular subsidiary, then perhaps we don’t need to have the separation in this smaller subsidiary”. These steady erosions built up over the years, until by the early part of this century, before its repeal, the effectiveness of Glass-Steagall had been completely eroded. Perhaps the Government should take that into account. There is also the point that, if the investment banking services required by a ring-fenced bank are relatively small, they could, of course, always be purchased from another provider.
Finally, the Minister mentioned that the precise definition of the rules of extent and so on will be defined by the regulators and in secondary legislation. I wonder whether it would be appropriate at this moment to take into account the latest report of the Delegated Powers and Regulatory Reform Committee, which has expressed considerable concern about the scrutiny of secondary legislation that will follow from new Sections 142A, 142B and so forth as we are discussing in this particular context. Are the Government likely to accept the enhanced scrutiny proposed by that committee with respect to these particular sections?
I am grateful for my noble friend’s comments on Amendment 1 and for his explanation that the flexibility allowed for in this Bill will be flexibility that the regulator will be expected to interpret. I note the comments of the noble Lord, Lord Eatwell, but clearly the regulator’s role will be to ensure that creep does not occur on the way and that the protection of the ring-fenced bank is the requirement as set out in this legislation. Therefore, with those assurances from my noble friend, I am pleased to withdraw the amendment.
With respect to the specific question, we have not had the chance to review the delegated powers yet, but of course we will in formulating where we go from here.
Amendment 1 withdrawn.
Moved by Lord Deighton
2: Clause 4, page 9, leave out lines 7 to 9 and insert—
“(a) in relation to a PRA-authorised person, the PRA,
(b) in relation to any other authorised person, the FCA.”
Amendment 2 agreed.
Moved by Lord Turnbull
3: Clause 4, page 9, leave out lines 26 to 39 and insert—
142J Reviews of ring-fencing
(1) The Treasury must make arrangements for the carrying out of reviews of the effects of the operation of the provision made by or under this Part in relation to ring-fenced bodies, including ring-fencing rules made by the PRA and the FCA and any rules made by the PRA and the FCA under section 192JA (rules applying to parent undertakings of ring-fenced bodies).
(2) The first review must be completed before the end of the period of 4 years beginning with the date on which section 4 of the Financial Services (Banking Reform) Act 2013, so far as it inserts this section, comes into force.
(3) Subsequent reviews must be completed before the end of the period of 5 years beginning with the date on which the previous review was completed.
(4) Not less than 9 months, nor more than 12 months, before the date on which a review is due to be completed, the PRA and the FCA must publish a joint assessment of the impact of the operation of their ring-fencing rules.
(5) For the purposes of this section, a review is completed when the report of it is published.
142JA Persons by whom reviews are to be conducted
(1) The Treasury shall appoint not fewer than 5 persons to conduct a review of whom one is to chair it.
(2) A person may not be appointed to chair a review unless the chairman of the Treasury Committee of the House of Commons has notified the Treasury that, in the chairman’s opinion, the person is likely to act independently of the Treasury, the PRA and the FCA in carrying out the review.
(3) The persons appointed to conduct a review must include at least one person with substantial experience in central banking or financial regulation at a senior level.
(4) The reference in subsection (2) to the Treasury Committee of the House of Commons—
(a) if the name of that Committee is changed, is to be treated as a reference to that Committee by its new name, and
(b) if the functions of that Committee (or substantially corresponding functions) become functions of a different Committee of the House of Commons, is to be treated as a reference to the Committee by which the functions are exercisable; and any question arising under paragraph (a) or (b) is to be and any question arising under paragraph (a) or (b) is to be determined by the Speaker of the House of Commons.
142JB Reports of review
(1) The persons appointed to conduct a review must give the Treasury a report of the review.
(2) The report must include an assessment of the extent to which the provision made by or under this Part in relation to ring-fenced bodies, including ring-fencing rules made by the PRA and by the FCA, are facilitating the advancement by the PRA of the objective in section 2B(3)(c) and by the FCA of the continuity objective.
(3) If the report is made before section 4 of the Financial Services (Banking Reform) Act 2013, so far as it inserts section 142JD, has come into force it must also include a recommendation as to whether or not section 4 of that Act should be brought into force to that extent.
(4) The report must include—
(a) recommendations to the Treasury as to the provision that should be included in orders and regulations under this Part, and
(b) recommendations to the PRA and FCA about the provision that should be included in ring-fencing rules.
(5) The Treasury must lay a copy of the report before Parliament and publish it in such manner as it thinks fit.”
I shall speak also to Amendments 10, 14 and 116 in the group. I also express my regret that I was unable to take part in debate on Second Reading. All these amendments relate to the so-called first reserve power, under which a ring-fenced bank group which fails to respect the principles of ring-fencing can be required to divest itself of the non-ring-fenced assets.
First, I must congratulate the Minister on surviving the reshuffle, despite the fact that his tenure is rapidly approaching the average for a junior Minister in the Treasury. More importantly, I must record my congratulations to the noble Baroness, Lady Kramer, on her promotion to Minister of State. She has been an excellent colleague to all of us on the Parliamentary Commission on Banking Standards; she will be sorely missed in our deliberations.
Let me say a few words of introduction. It was always inherent in the timetable of the parliamentary standards work and the timetable of the Bill that many of the clauses to implement our recommendations would need to be introduced in the Lords after completion of the Commons work, but we have certainly ended up with more than we bargained for, with total amendments running at 116 pages and government amendments accounting for 95 pages of that: more than three times the length of the original Bill. That tells us something about the process of legislation. We are dealing with amendments to amendments to amendments which are in turn amending statutes that have already been amended more than once.
The Government’s response to the parliamentary commission’s report stated:
“We today set out plans to implement the major recommendations of Changing banking for good”.
The reality, however, is somewhat different. There are recommendations that HMG have faithfully embraced and provided proposals to implement them. There are also recommendations where the Government say that they accept them but the provisions in the Bill dilute them to the point where they may be ineffective or where they say that legislation is not required: I am sure that we will hear that plea quite often. There is also a long list of recommendations which the Government have rejected or simply ignored: recommendations on leverage, proprietary trading, special measures, a new regulatory decisions committee for banking, the strategic objective of the FCA, and so on. Of course, in Committee and at Report, I and my colleagues on the parliamentary commission will seek to work constructively with the Government to bring us closer to our recommendations so that we succeed in achieving the purpose of the title of the report, which was Changing Banking for Good.
We are locked into this unsatisfactory legislative process, and we will therefore need a degree of flexibility. In debate on a previous financial services Bill, the noble Lord, Lord Eatwell, sought and secured some relaxation of the constraints on speaking at Report. I would certainly support him if he seeks similar dispensation this time.
I turn specifically to ring-fencing, which is the subject of the amendments in this group and the background to it. There was a vigorous debate within the commission on whether to endorse the ring-fencing plan of the independent commission, the Vickers commission. By the time we started work, the Government had effectively told us that they were minded to accept it. Alternatively, should we continue to press the case for full separation of investment banking activities from commercial and retail banking, in effect adopting a UK version of Glass-Steagall, which the US had operated for many years but which was eroded and finally abandoned? The arguments for this were, first, that investment banking activities are inherently riskier and so imperilled the continuity of regular commercial banking and, secondly, that there was cultural contamination in that there were attitudes to risk and remuneration which were alien to good customer-focused banking.
The arguments put against this were that there was no clear mapping of the banks that failed against the divide proposed. Some universal banks, such as HSBC and JP Morgan, survived the financial crash better than specialist investment banks, such as Lehmans, Bear Stearns and Merrill Lynch, while some of the most dramatic failures in the UK—HBOS and Northern Rock—conducted very little investment banking. Their failure was attributable simply to bad lending, particularly in retail and commercial property. We also saw signs of poor behaviour and culture across the whole banking spectrum and it was argued that rather than being a source of risk, an investment bank could also be a source of reinforcement.
In the end, we largely endorsed the ICB proposal but felt that if we adopted the ring-fencing regime, we needed to protect it. This became known colloquially as electrification and was rooted in a belief that banks are limitlessly ingenious and remorseless lobbyists, so some safeguards should be put in place. We agreed to this subject to five conditions. First, the ring-fenced bank should have a substantial degree of independence from the group, subject to the caveats raised today by the noble Lord, Lord Blackwell. Secondly, the directors of the ring-fenced bank should have an additional duty to observe the principles of ring-fencing and preserve the stability of that bank. Thirdly, we sought to reduce cultural contamination by tightening up on banking remuneration, with more remuneration being deferred and for longer and the possibility that previously paid benefits could be clawed back—and, in the event of failure and state rescue, reclaimed. Fourthly, there should be a power to require an individual bank that was abusing the ring-fence regime to dispose of its non-ring-fenced assets. Finally, after a review the Government could decide to change the scheme and require full separation across the whole sector.
In the proposals before us, I would say that we have secured about two-thirds or 70% of the conditions that the commission was looking for. The Bill provides a first reserve power to deal with individual banks and provides for the desired governance of the ring-fenced bank. The Government accept the principles on remuneration but are still arguing about whether those should have statutory force. After what I would describe as a stumble in the Commons, the Government have also come round to introducing a workable process for dealing with individual banks which are misbehaving. The scheme as originally proposed in the
Commons might be called “Five strikes and you might be out in six years’ time”. That new amendment is Amendment 6, which we naturally welcome, and there is also agreement on the kind of behaviours that should trigger separation under new Section 142K. So where do the issues remain?
It is agreed that there should be a periodic review after four or five years; there is an opposition amendment suggesting a shorter period. This scheme is highly innovative and very important. We are ahead of a similar scheme that gets to the same place in a slightly different way and goes under the name of the Liikanenproposals, so it is absolutely right that provision is made to review it.
In the view of the commission, though, the review should be conducted not by the PRA alone but independently, as in proposed new Section 142JA, and it should be required to report on its recommendations, as in proposed new Section 142JB. We have also suggested that where a bank is issued with a preliminary notice, there should be a further independent review of its relations with the regulator. This is to create a safeguard against the regulator getting into a relationship where it is picking on a particular bank. That is in Amendment 10.
In the scheme proposed by the commission, these sanctions could be enforced only after a general review had taken place, but in the Government’s scheme they could be undertaken at any time. So there is quite a lot at issue to resolve between the Government, the Opposition and the survivors of the commission, but I believe that we can achieve reconciliation before we get to Report. The final question, about the differences on the second reserve powers, will come later in the afternoon as it is further down the Order Paper.
Moved by Lord Eatwell
4: Clause 4, line 11, leave out first “4” and insert “2”
My Lords, I am in total agreement with what the noble Lord, Lord Turnbull, has said about the importance of the reviews of this process. We have to realise that we really are breaking new ground here. In a way, this is a leap in the dark and we have no idea whether it will work. Obviously a lot of effort has gone into trying to ensure that it will work, but it is such a novel innovation that we really cannot be sure whether it will, or indeed whether it will have a whole series of unintended consequences.
Accordingly, I feel that it is very important that the process be kept under virtually continuous review. The amendment in the name of myself and my noble friend Lord Tunnicliffe seeks to ensure that the first review and subsequent reviews take place within relatively short time periods of up to two years. The reason for that is that it is only five years ago, almost to the day, that Lehman Brothers collapsed, and let us think what has happened since then. If we were to retain the four-year limit, that would cover almost that whole period, with all the remarkable devastating changes that have occurred.
I agree with the noble Lord, Lord Turnbull, in his proposed new Section 142JA, that such a virtually standing group should act as an independent arbiter and assessor of these matters. It certainly should not be, as in the Government’s proposal, the PRA inspecting itself. That does not seem to be a very satisfactory structure at all. It is not appropriate in terms of giving confidence in the reviews, and it is not fair to the PRA. The PRA should be able to stand up and do its job, and then accept that it will then be scrutinised by the sort of independent group proposed by the noble Lord, Lord Turnbull. My amendment would simply ensure that that group had a virtually standing role in assessing these major changes to ensure that, once we have taken this leap in the dark, we land on firm ground. On Amendment 5, I shall simply reiterate the arguments that I have just made. I beg to move.
My Lords, I must express some reservations about the arguments put forward by the noble Lord, Lord Turnbull. It is not that I do not understand the significance of having continuous and effective review of these ring-fencing procedures, but it seems to me that we have set up, with a lot of time in this House and the other place, a regulator that has learnt in that legislation and its constitution and objectives many of the lessons of the past, and we have entrusted that regulator with maintaining the stability of the financial sector and enforcing this legislation, if the Bill is passed. I think there is a danger in seeking to replace the regulation of an industry by an independent regulator with what might be in danger of turning into regulation by parliamentary committee. Parliamentary committees have many virtues and values, but they cannot engage dispassionately in the same evaluation of detailed analysis and commercial information that a regulator can, and they are more likely to be swayed by current opinions of the day. I pay tribute to the work of the commission on which the noble Lord, Lord Turnbull, and other noble Lords sat, which did an excellent job. I worry about the possibility of moving away from regulation by independent regulators, which are deliberately made independent of the Executive, towards regulation by parliamentary committees.
The noble Lord, Lord Blackwell, referred to the fact that this might become a parliamentary committee. I think it is very clear that this would not be a parliamentary committee. The person who chairs it should,
It would be much more like the Vickers commission.
I thank the noble Lord for that clarification. I was responding to the fact that the amendment suggests that the chair should be approved by the chairman of the Treasury Select Committee. That would certainly alleviate some of my concerns. Nevertheless, the main point is that if we have an independent regulator, we should trust that regulator to do the job we have asked it to do. That does not prevent Parliament, or any Select Committee of Parliament, conducting its own reviews at any time it wishes, or appointing other reviewers if the circumstances require it.
I must just add that my concerns on that would be even greater if this was required to happen at two-yearly intervals, as suggested by the noble Lord, Lord Eatwell, rather than at five-yearly intervals, because the task of the regulator with a permanent body looking over its shoulder would then become almost untenable.
My Lords, I had the opportunity of speaking at Second Reading, which seems rather unusual. I pointed out then, and I remain of the view, that the way that the Bill is drafted, with so much reference to a previous Act, makes it extremely difficult for the House to work out what is happening from moment to moment on an unbelievably complex matter. Having said that, the briefs that have been provided by the Treasury on individual amendments and so on are extremely helpful and do something to ameliorate the problem that I have just mentioned.
It seems to me that we are going very much into uncharted waters here. There is a lot of doubt about ring-fencing, its effectiveness and whether it is a sensible way of proceeding at all. I continue in the view that total separation is a better way of going with it. Certainly, since ring-fencing may cause problems, the case for having a review of it is overwhelming.
With regard to the specific way in which this amendment is drafted, the noble Lord who moved it pointed out that the suggestion is that the people who are appointed to the reviewing body should require the endorsement, effectively, of the Treasury Committee. I think I served as chairman of the Treasury Committee for longer than anyone else has ever served, and I welcome the fact that it is playing an increasing role in these affairs. It also seems to me that the development that has been adopted lately, of saying that it requires a degree of endorsement by the Treasury Committee, is good.
It certainly would be wrong—I think that my noble friend Lord Blackwell has misunderstood the position—to start saying that the review should be carried out by the Treasury Committee. It has, after all, an awful lot of work on its plate anyway. However, having said that, we certainly ought to have this amendment or some variation on it, simply because of the difficulties that the ring-fence system as now proposed is likely to create, assuming that we go ahead with it.
My Lords, this must be the first time in parliamentary history for the amendments to a Bill to be more than three times the length of the Bill itself. Moreover, as others have said, the complexity of both the Bill and the amendments is quite barbaric. I must admit that when I put all the papers on my dining room table to try to make head or tail of them, they occupied 10 feet of space, including all the so-called explanatory documents. Having said that, I thank my noble friend Lord Deighton, who has at least listened to what was said at Second Reading. He has an open mind, which has undoubtedly led to the introduction of a lot of the measures in the amendments that we are now debating in Committee.
I thoroughly support Amendment 3, largely for the same reasons given by the noble Lord, Lord Higgins. We are groping around in an extraordinarily complex area of life and it is abundantly sensible to have these reviews—not just of ring-fencing but a series of reviews—to see how we are coming along and whether the suppositions we are making in the course of this legislation prove to be correct. I disagree with the noble Lords, Lord Eatwell and Lord Tunnicliffe. We need to give time for these new arrangements to bed down and show their paces. Frankly, in each case, four and five years are likely to be better than two years.
I will make a few quick points on the way in which Amendment 3 is put together. We will have an opportunity at the next stage to make changes to what is currently before us. A review panel formed of five persons is unnecessarily large. You might well get by better with three or even two people, so more thought is needed on that. I also note that there is a requirement that the PRA and the FCA carry out their independent reviews but that they publish a joint outcome. Proposed new Section 142J(4) says that they,
“must publish a joint assessment of the impact of the operation of their ring-fencing rules”.
However, they may not agree. You have at least to allow, in this terminology, that that may be the case. You cannot force consensus upon these two august bodies.
“is likely to act independently of the Treasury, the PRA and the FCA”.
We should provide that the person is likely to act independently, full stop. It is not only required that they are independent of those three bodies; general independence is required, and so I suggest that those words be excluded.
Finally, proposed new Section 142JA(3) states:
“The persons appointed to conduct a review must include at least one person with substantial experience”.
That is one person out of five. If we are to stick with five people—and I suggest fewer, or at least the prospect of fewer—it is not enough to have only one with experience of all this. This is an extremely complex area of life—there is no area more complex—and experience on the part of more than one person on this panel reviewers is essential.
That was not quite my final point; I have another quick comment. Proposed new Section 142JB(4) states:
“The report must include … recommendations to the Treasury as to the provision that should be included in orders and regulations”.
It is not inconceivable that there may be no recommendations. Indeed, it is very conceivable that there may be more than one. Therefore the language of proposed new subsection (4) needs amending. I will leave it at that, but I commend the noble Lords who tabled the amendment in this group.
My Lords, I apologise for not speaking at Second Reading; I was out of the country. I support the amendment tabled by my noble friend Lord Eatwell. As many noble Lords said, ring-fencing will be a new experience. However, given what happened in the banking industry, and the damage it caused, we have to start the process with extreme care and great suspicion. Given time, I know that the banks will innovate ways of avoiding ring-fencing; that is the nature of the market in innovation. Therefore, before anything further happens, we ought to have early scrutiny of ring-fencing arrangements, as proposed by my noble friend. Later, if we wish, we may do the next review after four or five years, but the initial reviews must be done as early as possible and as toughly as possible, because if we are kind to the banking sector and it does the same thing again, the public will never forgive us.
My Lords, there have been a number of comments on the length and complexity of the Bill. I am not here to apologise for the Bill, but I know that my officials in the Treasury have worked extraordinarily hard to try to make sense of it and to deliver comprehensive briefs as quickly as the timetable allowed. Therefore, I hope that noble Lords will bear with us as we work our way through this complex process.
At the heart of this group of amendments is the question of the nature of the review and what it is trying to accomplish. The critical point that I want to clarify is that under the Bill the PRA will review the workings of the ring-fence: how well the rules achieve the ring-fence’s objectives and how far the banks are complying. The PRA is not being asked to judge whether the ring-fence is the right policy.
As the Chancellor emphasised in his evidence to the PCBS, the Government have no objection in principle to independent reviews. Indeed, as the House knows well, the ring-fence has its origins in the recommendations of an independent review: that of the Independent Commission on Banking. As I stated, the Bill provides for regular reviews of the operation of the ring-fence. Clause 6 provides for the PRA’s annual report to Parliament to cover the extent of banks’ compliance with the ring-fence—a provision that Amendment 42 will strengthen, as I will discuss in a moment.
Subsection (3) of new Section 142J requires the PRA to carry out a review of ring-fencing rules every five years to assess how well the rules are framed in order to achieve the objectives set for the PRA in the legislation. Should the PRA identify areas where the rules need to be changed, it will have the power—indeed, the responsibility—to do so. Regular reviews of how the mechanics of the ring-fence are working are legitimate and necessary, so it is right that the Bill already provides for them.
On Amendment 42, in response to arguments made in the Commons, we are strengthening the requirement of the PRA to report each year on banks’ compliance with the ring-fence. Amendment 42 requires the PRA to report annually to Parliament on how ring-fenced bodies have used any exemptions to excluded activities or prohibitions. As noble Lords will know, the Bill allows the Government to create exemptions from the exclusion or prohibition of certain activities, as long as the exemptions are not likely to threaten the continuous provision of core services—that is, retail deposit-taking. These exemptions are necessary to allow ring-fenced banks to enter into derivative contracts to manage their own risks. The Government also intend to use this power to permit ring-fenced banks to sell simple derivatives to their customers, subject to safeguards to ensure that this does not expose ring-fenced banks to excessive risks or undermine their resolvability.
It is right that any such exemptions should be closely monitored. We have therefore agreed with the suggestion from the Opposition, who in the other place advocated that the regulator should report on the sale of simple derivatives by ring-fenced banks. However, our amendment goes further, requiring the PRA to report on ring-fenced banks’ use of all exemptions created now or in the future. These will include exposures of ring-fenced banks to financial institutions incurred for the purposes of risk management, providing payment services or trade finance services, as well as the sale of simple derivatives. This amendment will ensure that Parliament has sufficient information to make an informed judgment about whether the ring-fence fulfils its objectives and the exemptions remain fit for purpose.
On the other amendments, it is far less clear to us that we should legislate for repeated reviews of the whole policy. Amendment 3 would effectively reconvene the ICB in perpetuity to ask afresh every few years whether we should continue with the ring-fence at all. I have two main objections to this. First, one of the original aims of establishing the ICB was to secure consensus and certainty over the future of the banking industry in this country. The Chancellor has memorably described how, before this Government took office, he heard four different proposals from the then Prime Minister, Chancellor, Governor of the Bank of England and chairman of the regulator. The ICB process brought together all these voices and others to produce recommendations, including for ring-fencing, that commanded wide consensus support. That consensus gave the industry certainty over the future regulatory framework, which is so important to enable businesses to plan and invest. Reopening that consensus every five years, or indeed even earlier, would undermine that certainty.
If I have learnt one thing in my relatively short period in the Treasury as Commercial Secretary, it is that the one consistent request I get from businesses in every industry is, “Please provide us with a stable and certain framework so that we can plan and invest so as to sustain this recovery”. As I have implied here, shortening the gap between reviews—as Amendments 4 and 5 would do—would add further to the uncertainty. I also question whether it would even be possible for a review to judge after only two years whether ring-fencing was working. Given the scale of the changes involved, any verdict arrived at before ring-fencing has had more time to bed down would surely be premature.
My second objection is to this amendment’s prescription that the terms of reference for these repeated reviews must include considering the case for full separation. This seems rather like requiring that reviews continue until they come up with the right answer. I do not believe that that is appropriate. Given this, I also see no case for delaying the commencement of the Government’s provisions for a firm-specific power of separation until after a review, as Amendment 116 would require.
I turn now to the proposal in Amendments 10 and 14. So that noble Lords are clear, this is quite a different issue. It is for an external review to form part of the procedure for the firm-specific power to require separation. It is the electrification power. As noble Lords will know, the Government have accepted the case for a firm-specific separation power, and we will shortly debate the government amendments designed to make the separation of power already in the Bill more credible and effective. That is what I promised when we first discussed this Bill. However, the Government do not understand the possible justification for an external review to form part of this power. The PCBS proposed this as a safeguard for banks against arbitrary or unreasonable actions by the regulator, but the right of appeal to the tribunal already protects against this possibility. The tribunal, of course, is independent, so an additional safeguard is unnecessary.
Further, an external review could also serve to undermine the electrification process. The PCBS argued powerfully that regulators should not be subject to self-serving lobbying by banks. An external review could easily become an opportunity for banks to lobby during the electrification process to seek to persuade the reviewer that the regulator was acting unreasonably or treating them unfairly. Any bank required to restructure will have a right of appeal at the end of the process, so why give it another opportunity to challenge the regulator? I am also concerned that, even if the bank’s lobbying efforts did not succeed in blocking a requirement to restructure, they could serve to delay it and slow down the process for the regulator to require separation. This seems contrary to the objective, shared by both the PCBS and the Government, of making the electrification process less lengthy and cumbersome. For these reasons, I cannot agree to these proposals, and I call on the noble Lord to withdraw it.
My Lords, I listened very carefully to what my noble friend the Minister said. I am extremely grateful to him for the extent to which he has accommodated the points made by the Parliamentary Commission on Banking Standards, of which I had the honour to be a member and to which the noble Lord, Lord Turnbull, referred—and I entirely endorse his remarks. However, the remarks that the Minister has just made simply do not stack up. Before going into why that is so, let me put a little perspective on what we are doing today. It sounds very dry, arid, tedious and tiresome in many ways. Indeed, it is not a model of how to construct legislation, as my noble friend Lord Higgins pointed out. Nevertheless, it is testimony to the fact that the Government have listened attentively to what the parliamentary commission had to say, and what was said in the other place in response to it.
My noble friend the Minister has already raised matters wider than the amendment that we are discussing. He started to talk about the industry-wide separation power, which we were concerned about but which was not part of this group of amendments. We will come on to that later. In this country, we are suffering, as part of the wider world’s suffering, the after-effect of a most appalling global recession. There were a number of causes of that problem, but it is generally agreed that right at the heart of it was a banking meltdown.
Nothing is more important, therefore, than to do whatever we can to ensure that a further banking meltdown in future is unlikely to occur and to ensure that, if it does occur, the damage will be much less than that caused in 2008 and thereabouts.
There are few pieces of legislation going through Parliament that are more important than this Bill. I am not saying that you can do everything with legislation—there are a number of wider issues. But you have to do whatever you can. It is a long time since this House has had such an important role in trying to ensure that it is put right. It is clear that the legislation that was introduced in the Commons and went through the other place was wholly inadequate, and as a testimony to that are all the amendments that we are discussing today and all the amendments that the Government have moved. It is up to this House to get the legislation right; that imposes a very great responsibility on us and we should look at the legislation in a non-partisan fashion.
The Minister rested his argument on the fact that the Vickers commission came up with this wheeze of ring-fencing. It was a compromise between full separation of commercial and retail banking and investment banking and just leaving it as universal banking. There are a number of problems with the idea of the ring-fence. As the noble Lord, Lord Eatwell, and others have pointed out, this is new territory and has never been done before. We do not know whether or not it will work. We know that separation can work. There was separation in the United States under the Glass-Steagall legislation from 1933 to 1999 when it was repealed and for most of that time it worked very satisfactorily. It was weakened as time went on as a result of the success of the American banks in lobbying various authorities in the United States to make exceptions here and amendments and changes there. We need to watch out for that. It was also weakened to some extent by the ingenuity of investment bankers in finding ways round it, to which the noble Lord, Lord Turnbull, referred. Nevertheless, separation worked pretty well in the United States and in the United Kingdom.
I speak with some experience. It is now more than half a century since I was the principal writer of the Lex column in the Financial Times and I have been a close observer of the banking scene throughout that period. I recall that for most of that period we had a separation between what were called the joint stock banks, which engaged in retail and commercial banking for small businesses and so on, and the investment banks, which were not called that in those days—they were called merchant banks. They were completely separate and it worked very well, so we know that separation can work, and has worked, in the two major banking centres in the world.
It is true that the continent of Europe has always gone in for universal banking. That is so in Germany in particular but is generally the pattern in continental Europe. However, it is no accident that the two major banking centres of the world, London and New York, had separation. That worked. Whether this halfway house can work or not is very uncertain. Although the remarks of my noble friend Lord Blackwell on this amendment showed that he got completely the wrong end of the stick on it, as the noble Lord, Lord Turnbull, pointed out, he was absolutely right to point to one of the problems, although not the only one, with the governance structure. It is a very curious governance structure in which the two subsidiaries of the holding company are together but separate. They are meant to be completely separate even though they both, as boards of directors, have responsibilities to exactly the same group of shareholders. It is a very odd system and we do not know the workings of it.
I say that my noble friend the Minister is unconvincing because his whole point rested on the fact that Vickers said the ring-fence is the right answer and that because Vickers said that we must stick with it and not change it. What we are saying, which is surely much more reasonable, is that we will, of course, give Vickers a chance. Indeed, we will try to reinforce his proposal by means of the so-called “electrification” procedures. However, if it is seen not to be working, we will have to go to separation. One member of the Vickers commission is already convinced that we should go to separation without any intermediate step but I am quite sure that nobody on the Vickers commission wishes to see a failure. Let us give Vickers a chance and see how it works but if it does not work—it has to be kept under review—we should go to full separation. That must be sensible. The fact that the Vickers commission said what it did is really no argument at all.
I am very glad to see the most reverend Primate the Archbishop of Canterbury in his place. He was a most distinguished member of our Parliamentary Commission on Banking Standards and I hope that he will contribute to our debates. One of the things that he has emphasised strongly—I have tried to explain the importance of this—is the problem around the culture of banking. This was accepted by Parliament when it set up the commission and, indeed, my right honourable friend the Prime Minister explicitly said that it was to deal with the culture.
One of the key problems is that retail and high-street banking—commercial banking—and investment banking are two completely separate cultures. It is very difficult, with the best will in the world. I am not against investment bankers, but I do not think they should be bailed out by the taxpayer. We may, from time to time, need to bail out the commercial banks, with their retail depositors and their responsibility for the payment system. They may need that, even though they have enhanced capital funds, but it is wrong, I think, ever to bail out investment banks; they should be like hedge funds, with a fear of failure restraining what they do. They will be imaginative, they will be adventurous, they will be creative, they will be exciting for those who are excited by this kind of thing, and they will have a totally different culture. To assume that you can get two quite separate cultures in the same entity is stretching it a bit. Therefore, we have to see how this will work. It may not work. If we are going to address this cultural problem we have to make sure we address it effectively.
We shall come on to the other amendments in the name of the noble Lord, Lord Turnbull, to which I have added my name, but on this major issue we have to strengthen the Bill in the way that the noble Lord highlighted, endorsed by the noble Lord, Lord Eatwell, for the Official Opposition. We have certainly not heard any good reason from the Minister why we should not do that.
My Lords, I have enormous sympathy with the noble Lord, Lord Turnbull, who said in his introduction that he has never seen such a shambles presented to any House. As Chief Secretary to the Treasury, I had the misfortune for five years, as the noble Lord will know, to take two Finance Bills a year through, mainly because the first Bill had to be amended because it had not been properly scrutinised; it had been guillotined by all successive Governments. Yet I have never seen anything remotely like this Bill and I am grateful to the noble Lord, Lord Deighton, and his staff, who have done a tremendous job in trying to present to us what exactly is going on here. It is very difficult when one is working without a group of secretaries, let alone one, to understand what the devil is going on.
It seems to me that every speaker we have heard so far, apart from the noble Lord, Lord Lawson, is stumbling towards the only real solution. We will have to debate fairly soon to settle whether the House agrees to separation—call it Glass-Steagall, call it what you like. However, while we are stumbling in this direction—I am not sure from what my noble friend on the Front Bench was saying and whether our Front Bench is stumbling towards it as well—it seems inevitable to me that we have to decide this one, major issue. However many times this is reviewed, ring-fencing can never be the solution to the different cultures that the noble Lord, Lord Lawson, referred to. It is quite impossible.
I do not want to take too much of the Committee’s time on this occasion, but we have to settle, once and for all, whether we agree with this ring-fencing idea. It is so complex that it makes the situation even worse, as we have heard in a number of debates. Until we settle this matter, we will go from amendment to amendment for years on end, and have reviews for years on end, getting nowhere at the end of it. I hope that we can have the major debate as soon as possible so that the House can decide.
My Lords, it was, along with other Members, a privilege to be a member of the Parliamentary Commission on Banking Standards. I want to add a few words to what has been said. As a member of the commission whose view on this matter was for full separation, I signed up to the recommendation in order to have unanimity in the committee and because for the rest of us, with due deference to the most reverend Primate the Archbishop, it was an act of faith. That is what the recommendation from the committee was, because ring-fencing is at the moment theoretical. Without naming the person, I well remember someone on the Vickers commission saying to me, “John, we lost our nerve and advocated ring-fencing”. I do not want us to lose our nerve but I want us to be vigilant on this issue.
I well remember the evidence given to us by Paul Volcker who, noble Lords will remember, said, “I cannot really understand what the situation will be if you are the holding company which has authority over the ring-fence. If it comes to making a decision by that holding company’s executives about the future of the company, then the executives of the holding company will win over the decisions at the ring-fence”. At the end of the day, it is the holding company that matters. There is therefore something uneasy and illogical about this issue.
I also well remember another witness, not at the banking standards commission but elsewhere—Willem Buiter, when he was on the Monetary Policy Committee before he went to Citibank to be its chief economist—saying, “Remember that the half-life in the financial services industry is less than three years”. In other words, people will forget what has happened before. Having spent nine or 10 years as chairman of the Treasury Committee, all that I can say is that the banking industry is ever vigilant. If we sit back here for a four or five-year period and then return to the matter to see what has happened, the landscape will have changed completely. All that I would add to noble Lords’ comments is that if this House does not express that it has to be vigilant at all times, we are going to lose out and it could be to the disbenefit of ourselves as a Parliament and to society.
My Lords, I did not speak at Second Reading because I could not stay for the wind-ups, but listened to most of that debate. I should like to press my noble friend on his logic. He says that we cannot have some body to police or check up on the regulator. I am very surprised that my noble friend Lord Blackwell, with whom I am normally absolutely on the same square on most issues, says that we must trust the regulator. There was a reason we got into this mess and, by the way, we still ought to have a proper inquiry into what the regulator was doing and how the crisis happened in the first place. The very last thing I feel like doing is trusting the regulator.
We have also seen the regulators going off to work for the banks at, no doubt very appropriately, very high salaries to help them with their compliance and operation of regulation. Let us face it, I am not sure where I stand on the notion that we should trust the regulator on this matter. Like the noble Lord, I was prepared to go along with ring-fencing but could not see how it could work. But it certainly is not going to work if you have very clever people in the banks and at the regulator, but no one is actually breathing down the regulator’s neck. That seems to be the lesson that we can learn with absolute clarity from the previous experience.
I have to say that my noble friend’s logic was, “We can’t possibly have the regulator being subject to second-guessing all the time. How are they going to be able to carry out the agreed policy?”. As has repeatedly been said in a number of speeches, this is an experiment because it is part of a compromise to try to get the banks reasonably on board and to proceed on the basis of consensus.
In my seven years—perhaps it was nine years—working in an investment bank, I learnt that investment bankers are extremely adept at getting between the wallpaper and the wall. If they can find a way to get around something, they will. That is their job and how they make money and resources. The notion that if we have ring-fencing there will not be lots of clever people finding very good schemes to get around the intention of it and that the regulator will stand up to them, especially if we are in a period of prosperity, flies in the face of the experience that we have had.
It is essential to have someone independent of the regulator looking at this relationship and seeing if it is working. They should report to Parliament, with Parliament ready to enforce separation if it is required. It is by putting their feet to the fire in this way that we can be sure that they realise that it is in their interests to make this ring-fence procedure work. Without that, it will not work and we will be back to where we were before you can say “renewed prosperity”.
My noble friend uncharacteristically showed a lack of logic in what he was saying. If he wants the House to commit itself to this policy, he needs to address this basic question of who will guard the guardians.
I have a lot of sympathy with what my noble friend has said. However, on my noble friend’s thesis, there is the problem that if you have a regulator of the regulator, you should have a regulator of the regulator of the regulator. At some point you have to put some trust in someone. As he has said, bankers are adept at getting around any set of regulations. Is there not a point at which you have to have trust?
I agree, but all questions can be reduced in that way—reductio ad absurdum. On that basis, we would get rid of Parliament, which ultimately is the regulator of the regulator. The regulator is accountable to Parliament. We are dealing here with day-to-day very complex circumstances. In this great House we have many experienced people. In my view, the banking commission has done a brilliant job, as has the Treasury Select Committee in many respects. I think all of us would agree that that was appropriate and that that job has been done. However, as I understand it, in the particular instance of deciding whether this ring-fencing experiment will work, here we are talking about the need for some kind of process which will scrutinise that and will report on an informed and an in-depth basis. That is why I support the amendment in the name of the noble Lord, Lord Turnbull, which seems a sensible course of action.
In the case of the Bank of England, why did it allow interest rates to remain so low when it could see a housing bubble and an asset bubble being formed? Even the former governor, who is now a Member of this House, has acknowledged that and has said publicly that it is very difficult when everyone is making lots of money and the whole consensus is that we have abolished boom and bust. It is very difficult for a regulator to stand up to that, especially if Ministers are egging them on and in their speeches are saying the same thing.
If the purpose of this exercise is to say, as we always say, “What went wrong? What are lessons that we need to learn?”, this amendment points to one of the clear lessons that we need to learn. I am disappointed that my noble friend does not see that.
My Lords, I rise very much in agreement with the noble Lord, Lord Lawson. The particular point that I should like to make is that if we look at events over the past five years, it was not derivatives or standard investment banking activity which got the banks into trouble but unwise forms of large-scale lending. It was the purchase of blind CDO instruments from the US without knowing what was in them and the banking practices in particular of HBOS. These were the areas in which huge amounts of money were lost and which nearly brought down two of the main banks of this country.
Looking at the ring-fence model, it seems rather strange that all that sort of activity will be in the same box as good old-fashioned high-street banking, as I understand it. I repeat my interest as a director of Metro Bank, which is an old-fashioned high-street bank in essence. But if the high-risk areas of banking generally are going to be in the same box as the lower-risk activities of high-street banking, that does not seem to make much sense. The delineation of what is investment banking and what is commercial, high-street banking is not a particularly good one if your objective is to protect the ordinary citizens’ banking activities.
My Lords, like many in the House I did not manage to speak at Second Reading either, but I have spent a miserable summer concluding that Vickers got it wrong. This is a horrible thing to say to my good friends in the Parliamentary Commission, but they got it wrong too about separation. I come from a long career in merchant banking. I was pulled out of the Civil Service to be a merchant banker and I understand very well how ingenious they are. We had a wonderful concept in my youth called the Chinese wall. All I can say is that ivy grew over that Chinese wall and ear trumpets went through it because we are an ingenious lot.
The very complication of the debate that we are having, the horrible complication of the legislation and the very real difficulty of the amendments all stem from the fact that we are trying to do something impossible. Ring fencing will not work. It does not matter how many people you place in charge of it, you need institutional separation. As my noble friend Lord Barnett says, we are going to have to come up against this one of these days.
I am also fairly horrified to hear Members of this House describing ring fencing as an experiment. What are we doing experimenting with the banking system? We have experimented with it before and we should not. We should be sticking to what we actually know will work.
I am in entire sympathy with the points made by the noble Lord, Lord Forsyth. I think that his diagnosis is absolutely accurate, but I differ on the conclusion.
My Lords, I came in this afternoon hoping for enlightenment. I received much more and varied judgment expressed from all corners of the House. But the one thing that everything leads to is an assumption that the ring-fence will not work and I am afraid to say that I agree. I do not say that with any satisfaction. A lot of time and effort has been put into this by very well-informed people, but it is against the ethos of the institutions and the markets in which they operate.
To say that we are going forward as an experiment is merely an attempt to sum up where we have got to in this afternoon's debate. We cannot just leave it like that. If there is generally—not just in this House but in a more widespread way—fundamental doubt about whether something as important as this will work, we have to assess whether we are bound to follow that structure. All I have heard so far leads me to think that ring fencing is not workable. We ought to accept that situation as soon as possible. I leave it to others to follow more logically what I have rather stumblingly set out.
My Lords, in responding to the points that have been made, I want to make it clear that the commission is not seeking to use this Bill to reopen the position we have reached and try to get us back to a policy of separation. What we have is a policy of ring-fencing plus safeguards plus vigilance. I listed some of those safeguards at the start. If that is the policy we are on, we have to make the safeguards and vigilance work. In response to the Minister, I do not think that a process in which the reviewing is done by one of the key players in it, which is the Prudential Regulation Authority, carries any credibility whatever. Its work is important and it should be a contribution to a wider study, and the wider study should be undertaken by someone who is independent of it.
The other argument used by the Minister was that we do not want a state of permanent vigilance. I do not think that it is possible, in an industry which is highly innovative—reference has been made to the term “half-life”—that you can find one system that will last for ever and therefore you need to be able to keep an eye on what you have created and make sure that you are taking steps to keep to that policy until such time—which may be the point of the amendments we shall come to in another group—that you conclude that it is not working. But the search for something which you can just do and then simply routinely maintain is an illusion. If ring-fencing is to be the policy, it is absolutely essential that it is backed by maximum vigilance and some high-powered mechanisms for review. I really do not think that what the Minister has promised us today meets that requirement.
The Minister pointed out that there are of course two reviews here. The other one is much less important and serves a completely different purpose. It is to safeguard a bank that has been threatened with separation against the arbitrary behaviour of its regulator. You could ask why that is needed because there are other safeguards, but if you do not have it, you come to the question of whether the Regulatory Decisions Committee, which is a step on towards the tribunal, should be beefed up. However, that is a recommendation we will come to, which the Government have not accepted. I do not think that the lesser review, the Amendment 10 review, can be taken off the table. If you do that, you increase the case for Amendment 91, recommending a new RDC. My conclusion is that we have not reached an agreement in this area. The debate is interesting, but what it means is that a lot more work has to be done between the opposition, the commission, other members and the Treasury to get to a point of resolution. However, it is essential that the point we reach has a much more high-powered review mechanism in it than is currently set out in subsection (6). I am content to withdraw the amendment on the basis that further discussions between now and Report will take place and that there will be flexibility on the part of the Government in their consideration.
My Lords, as I have tabled an amendment to the amendment moved by the noble Lord, Lord Turnbull, I believe that it is for me to withdraw my amendment first and for him to follow. The noble Lord, Lord Deighton, has two objections to the process of review, both of which have, I think, been demonstrated to be false. He said that the first was to secure consensus. From the discussion today, he should be effectively disabused of the idea that the ICB has secured consensus. People have settled around the ICB as the best that can be obtained under the current circumstances, but there is a considerable degree of uncertainty about whether the ring-fence is actually a good idea.
The noble Lord also said that he wanted certainty, but he absolutely does not get certainty in this way because we are very uncertain as to whether this system will actually work. That is why his second objection—that time should be given for the system to settle down and work—is a very dangerous one. As we go through the process of implementation—if eventually Parliament agrees to these ring-fence proposals and implements them—we will discover by sheer practice where the lacunae may be, where things simply go wrong with unintended consequences, and so on. Unfortunately, we will be conducting an experiment and under those circumstances, it is very important that the sort of expert committee that the noble Lord, Lord Turnbull, has proposed, focusing on the particular question of whether this works, with growing expertise and experience, should be in place to review what is happening as the process unfolds.
That is why in particular I was very nervous about one aspect of the proposals of the noble Lord, Lord Turnbull, with respect to the review not taking place for four years and then taking place at five-year intervals thereafter. Although it is “up to” four years, I would be willing to bet that the “up to” will turn out to be about two. None the less, my amendments were intended to ensure particularly that we have the expert committee proposed by the noble Lord, Lord Turnbull, virtually in place as a standing committee with the expertise to guide us through what is going to be a very difficult and uncertain process.
Given the debate, and the views expressed around the House, this is a matter to which we certainly must return after significant negotiations have occurred between Committee and Report stages to try to achieve something of a consensus—at least on the issue of the nature of review. In the mean time, I beg leave to withdraw Amendment 4.
Amendment 4, as an amendment to Amendment 3, withdrawn.
Amendment 5, as an amendment to Amendment 3, not moved.
Amendment 3 withdrawn.
Moved by Lord Deighton
6: Clause 4, page 9, line 27, at end insert “and of any rules made by it under section 192JA (rules applying to parent undertakings of ring-fenced bodies)”
My Lords, Amendments 6 and 81 insert two new sections into the Financial Services and Markets Act 2000 and make a consequential amendment to new Section 142J. The first new section, new Section 192JA, gives the PRA a power to make rules over the parent companies of ring-fenced entities. Ring-fencing will require banking groups to make large structural changes to ensure the independence of the ring-fenced bank from other entities in its group. The PRA may need to make rules to ensure that the groups in which ring-fenced banks sit are structured and governed appropriately. Rules over parent companies may be needed to ensure that this is the case.
It is important that the regulator has the ability and flexibility to tackle parent companies. They can influence subsidiaries in a number of important ways—through their attitude to risk management throughout the group, for example. This obviously has implications for the incentives faced by a ring-fenced bank. This amendment, therefore, further enables the regulator to strengthen the ring-fence.
I also expect the PRA to use this power to require groups containing ring-fenced banks to adopt a so-called “sibling structure”. This means that a non-ring-fenced bank cannot own a ring-fenced bank and vice versa. Both the ring-fenced and the non-ring-fenced bank will sit directly underneath the holding company. In this way, the PRA will be able to supervise banking groups more effectively, by having a clear divide between the ring-fenced and non-ring-fenced parts of a group. As development of the ring-fencing policy has progressed, the PRA has identified additional supervision benefits to a “sibling” arrangement such as this. I also understand that the Bank of England is encouraging banking groups to issue loss-absorbing debt from the holding company level, which is likely to lower the marginal cost to banking groups from adopting the sibling structure.
New Section 192JB will give the PRA and the FCA, as appropriate depending on the nature of the firm, the power to impose rules on qualifying parent undertakings to require them to make arrangements which would facilitate the exercise of resolution powers in relation to the parent or any of its subsidiaries.
The resolution powers all relate to the Bank of England’s powers essentially to step in in advance of a bank’s insolvency so that it can change, for example, the creditor arrangements.
The PRA and FCA already have powers to require regulated entities to take actions that would facilitate the resolution of a firm in the event of its failure. This may include requiring it to raise additional capital, issue debt to the market or make structural changes to enable the firm to be resolved.
However, banks may be organised in a number of ways. Many have a structure whereby the bank is owned by a financial holding company, which may not be regulated. Banks may also be part of corporate groups which contain non-corporate banking entities. In these cases, the existing powers may be insufficient to deliver some of the changes that the regulator feels are necessary to make a bank resolvable. This is because the regulated entity may not have the level of control required to make the change. This may be the case where, for example, capital and debt are issued out of the parent undertaking before being downstreamed to a bank. It may also be operational in nature; for example, where a service company which is not owned by the bank but sits in another part of the group provides critical services in the bank.
The amendment will address these cases and ensure that the PRA and the FCA have the necessary powers to make banks resolvable for all types of corporate structure. It amends new Section 142J to ensure that any reviews by the PRA of “ring-fencing rules” under that section must also cover rules made under the power given in new Section 192JA in relation to parent undertakings of ring-fenced bodies.
My Lords, I have enormous sympathy with the amendments and the struggle that the Treasury is having in having effectively to provide rules for parent undertakings in relation to the maintenance of the ring-fence. In many ways, the amendments go at least some of the way to achieving that. However, I should like to ask a question which I asked at Second Reading and which was not answered then. The Minister referred to capital and debt being raised at the level of the parent company and then downstreamed into the ring-fenced entity. If it can be downstreamed, can it not be upstreamed? If that were so, the ring-fence would not exist.
My Lords, the clause as I understand it seems to be absolutely essential if the powers involved are to be able to ensure that there is a separation between one part of the bank and the other, in which case it is rather extraordinary that the amendment has suddenly appeared at this stage.
If I understand the clause correctly, it has both national and international implications. My noble friend, in response to my inquiry, referred to the Bank of England, but the clause also apparently refers to any similar powers exercisable by the authority outside the United Kingdom. That gives me cause for concern. It would be very useful if all the actions taken in this country, in the European Union and in the United States worked on the same basis. However, as I understand it, that will not be so. The line will be drawn in rather different places in the United States compared with the European Union and in the European Union compared with the United States or this country. How precisely are the FCA and the PRA to set about ensuring that they can separate the two parts of the bank effectively? I am not clear from the amendment how they will do that.
The simple way to look at the amendments is that they are to ensure that both regulators have the flexibility to address every aspect of the group structure to ensure that the ring-fence works. That is why we are trying to give as much flexibility as possible to address even the non-regulated entities within the group.
My Lords, the noble Lord, Lord Higgins, has raised a very important matter with respect to authorities outside the UK. The proposals under Glass-Steagall and under Liikanen are different from the ring-fence—the divisions appear in different places. In those circumstances, “similar powers” seems to be a very weak description, because they are similar but not the same. With respect to resolution powers, which are crucial in the relationship between the parent body and the ring-fenced entity, that seems to create a degree of uncertainty. Can the Minister clarify exactly what that applies to? Presumably, it applies to the home-host division in regulatory responsibility and therefore subsidiaries of UK institutions in other jurisdictions will be regulated by the home regulator. If the home regulator has different rules with respect to the divisions, it seems to me that there will be a degree of confusion as to what is actually being enforced.
I am grateful for the Minister’s clear answer about the valve that goes one way on the raising of debt and capital. I return to my previous question. Let us suppose that we have a group in which the liability structure of the ring-fenced entity is essentially provided from the parent through the one-way valve and then the parent simply stops providing. In those circumstances, the security and stability of the ring-fenced institution would surely be threatened. The ring-fence would not be working simply because the steady flow of financial support for the ring-fenced institution had been cut off.
My Lords, I am a little clearer now than I was a moment or two ago. It would be helpful if my noble friend could say what is the position in each of the countries that I just mentioned. As I understand it, the emerging EU proposals—I am looking at a brief from the Law Society—will,
“require banks to create separate entities (although they will be allowed to stay within the same group) in order to split proprietary trading and market making off from other banking activities”.
On the other hand, the United States scheme will require,
“complete separation of proprietary trading but the bank is allowed to undertake market making”.
Under the amendment, we will apparently have those outside bodies setting the rules for banks in the UK. Consequently, we may find that the ring-fence is being drawn in quite different places—the noble Lord opposite seems to agree—depending on which authority is exercising the powers of resolution.
I shall try to go through those points one by one. Just to be clear with respect to the foreign banks, the power we were talking about relates to the Bank of England’s rule-making power over parent companies. It allows the Bank of England to support a resolution being carried out by a foreign regulator where the bank is in a different country. It just allows the support of that resolution going on elsewhere so that we have the kind of international co-operation which is necessary for these resolutions. On the point about Liikanen and the convergence in how we are looking at this around the world, the general view of the officials who are working on the European legislation is that we are sufficiently in tune with where that is heading for these arrangements to work effectively.
I was not sure that I entirely followed the risk that the noble Lord, Lord Eatwell, was pointing out. However, risk-fenced banks can of course have equity provided by their parent and, once it is given, it need not be repaid, so the flow can still keep going into the ring-fenced bank.
That is part of the resolution process that needs to be sorted out but there is nothing to stop it continuing to go in.
Amendment 6 agreed.
Moved by Lord Deighton
7: Clause 4, page 12, line 19, leave out from “a” to end of line 24 and insert “notice (a “preliminary notice”).
(1A) The preliminary notice must—
(a) state that it is a preliminary notice,
(b) state that the regulator proposes to exercise the group restructuring powers,
(c) state the action which the regulator proposes to take in the exercise of those powers,
(d) be in writing, and
(e) give reasons for the proposed action (which must include the regulator’s reasons for being satisfied as to the matters mentioned in section 142K(1))”
My Lords, these amendments streamline the procedure for the group restructuring powers—the so-called electrification powers. In another place, following the recommendations of the PCBS, the Government introduced amendments adding new Sections 142K to 142V. These sections give the regulator the power to require a banking group to restructure if the regulator believes this necessary to ensure the objectives of the ring-fence. As the PCBS recommended, the regulator will have the power to require the group to divest completely either its ring-fenced bank or its non-ring-fenced bank, or transfer specific business units out of the group. These extensive powers may be exercised if the regulator believes that the group’s ring-fenced bank is insufficiently independent or if the group’s conduct is such as to threaten the regulator’s ability to meet its statutory objectives. The amendments made in the Commons thus provide for the power to require the separation of an individual banking group that the PCBS recommended.
However, some concerns were expressed both in the other place and in this House that the procedure for the regulator to exercise its group restructuring powers was too complicated and drawn out. It was argued that the number of steps involved and the length of time required from start to finish created a process that was so cumbersome as to be difficult for the regulator to use in practice, and that this risked undermining the group restructuring powers as a deterrent against attempts by banks to subvert or game the ring-fence.
The Government took these concerns very seriously. As noble Lords will recall, I committed at Second Reading to bringing forward amendments to simplify and streamline the process for exercising the group restructuring powers. These amendments do exactly that. Amendments 7, 9, 11 and 12 replace the requirements for three preliminary notices with just one so that if the regulator is considering exercising its powers it need notify the target group only once, stating its reasons for considering requiring restructuring and the action it is proposing to take.
Amendment 8 removes the requirement for the Treasury to consent to a preliminary notice. Previously, Treasury consent was required for each of the original three preliminary notices. Under this amendment, the regulator need give the Treasury only a copy of a preliminary notice. Treasury consent will be required only later in the process for the issue of a warning notice.
Amendment 15 clarifies that any notice of a decision by the regulator not to exercise its powers must be given in writing. Amendment 16 provides that a copy of such a notice be given to the Treasury.
Amendment 17 shortens the warning notice period from 12 to 18 months to three to six months. This period is intended to give a bank about which the regulator has concerns, and to which it has issued a preliminary notice, an opportunity to address the problems identified by the regulator of its own accord. The Government still believe that it is right to give a bank the chance to tackle any problems, but agree that the period originally provided for was too long.
Amendments 13, 18 to 20 and 38 are consequential on the other amendments being made to these sections. Amendments 21 and 22 remove the requirement that the regulator must allow at least five years for any restructuring or divestment to be completed. Now it will be up to the regulator to set whatever deadline it considers appropriate.
These changes will bring the procedure for using the group restructuring powers into line with that proposed by the PCBS. One point on which we continue to differ from the PCBS is the inclusion in the procedure for requiring the restructuring of an external review, which Amendments 10, 14 and 116 would have inserted, and which we have already debated.
As for the total time involved to require the separation of a group, following the Government’s amendments, the minimum total time will be slightly shorter under the Government’s provisions than under the PCBS’s. Under the Government’s amendments, the minimum time from the regulator’s first notice of its intention to require restructuring to the actual imposition of a requirement to separate will be approximately four months, compared to approximately five months under the PCBS’s amendment. These amendments will therefore make the group restructuring powers—the “electrification” powers—an effective reinforcement to the ring-fence.
Some will argue that the Government should have gone further and should also legislate for the option of full separation across the entire UK banking industry. The Government do not agree with this suggestion. To provide for a targeted deterrent against members of an individual banking group that seeks to game or evade the ring-fence is a sensible reinforcement for the ring-fence. To legislate for industry-wide separation, however, would not be a sanction; it would be to abandon that policy. The logic of requiring all banks to separate would have to be that the ring-fence had failed to achieve its objectives of delivering greater financial stability while preserving the legitimate economic benefits of universal banking. It could in no way be described as a deterrent.
The first point that I would make in response is that it was the position of the ICB, which did an enormous amount of work on this, that the ring-fence was not in any sense a compromise but was in fact superior to full separation because of some of the synergies available in the universal bank. The essence of the argument is that the other parts of the bank that may not get into financial trouble actually provide benefits of diversification and scale that can protect the ring-fenced entity from any of the problems that they may have. It is essentially the diversification and scale advantages that universal banking may bring.
I have some sympathy with my noble friend’s underlying suggestion; in much of the discussion so far we have talked about how ingenious bankers are but, given what they have done to their organisations and the industry over the past five years, you have to question exactly how ingenious they are on a consistent basis.
To come back to the point, others are of course perfectly entitled to the view that the ring-fence will fail—we have heard that point of view from many Members here—and a future Government would be entirely within their rights to propose an alternative policy to ring-fencing. However, the only proper way to legislate would be for the Government to conduct research and analysis to match the calibre of the Vickers commission in support of full separation. I note that the PCBS produced no such evidence. Let it build a consensus around its conclusions, and let it come to Parliament with new legislation to be subjected to the full scrutiny and debate that such a step would require.
I very much welcome this simplified process. It took two steps for the Government to get there, but the prodigal son is welcome at any time. Let us pocket that. I said we would look again at this special review that the commission suggested inserting into the process. I noticed that the Minister was drifting on to the next group, and I thought I was going to introduce it, but let us come to that at the appropriate time.
My Lords, I echo the words of the noble Lord, Lord Turnbull. I think this is a significant improvement on the procedures that were previously outlined. I have a number of exploratory questions about this procedure. First, the regulator essentially seems to be judge and jury in this respect. It was the role of the old Regulatory Decisions Committee and, I believe, the ambition of the commission with respect to its development of the Regulatory Decisions Committee to ensure that there was an independent step in any major regulatory enforcement. The main reason why that was introduced into FiSMA was because it was felt that otherwise it would contravene human rights legislation. Are the Government confident that this procedure does not contravene such legislation?
Secondly, with respect to the publication of notices, in the very thorough and welcome briefing that the Minister’s staff provided on these amendments, the Government argued that they would not accept the commission’s proposal that the existence of a preliminary notice or of various stages be publicised. Instead, it was felt that these matters should be kept “secret” until such time as any impact on Stock Exchange listing rules demanded publication that the group was being subjected to such a procedure. It seems to me that this is a slightly dangerous structure. It is a traditional structure of central banks. It has always been strongly opposed by securities regulators which believe much more in transparency in this respect. This lack of transparency is likely to produce rumour and false information in the marketplace. Consequently, if we are going to have this procedure—which I think is well thought out, apart from the one issue that I raised, on which I would like to have assurances—we should make it a transparent procedure because rumours and false information are really damaging to markets. Transparency is always to be preferred, even if that transparency may be extremely uncomfortable for the firm being subjected to this process.
On the publication of the initial warning, we are all trying to accomplish the same thing, and it is quite finely balanced as to which way you go. I point out, for the benefit of noble Lords, that of course the regulator has the discretion to publish the initial notice but is not obliged to do so. Therefore, in those circumstances in which it is in the interest of the market to do that, it would do so. One of the principal reasons why we are reluctant to do that is because if you have gone public with the initial warning it may make you reluctant to issue the initial warning and to begin a process because of the consequences of that being out in the public domain. This is a tricky area where the arguments are relatively well balanced. We came out with this option for the regulator to disclose it, which we thought was, on balance, the right thing to do. I beg to move.
Amendment 7 agreed.
Amendments 8 and 9
Moved by Lord Deighton
8: Clause 4, page 12, leave out lines 25 to 30 and insert—
“(2) The appropriate regulator must give a copy of the preliminary notice to the Treasury.”
9: Clause 4, page 12, line 31, leave out “first”
Amendments 8 and 9 agreed.
Amendment 10 not moved.
Amendments 11 to 13
Moved by Lord Deighton
11: Clause 4, page 12, line 40, leave out from beginning to end of line 11 on page 13
12: Clause 4, page 13, line 13, leave out “third preliminary notice” and insert “preliminary notice under section 142M”
13: Clause 4, page 13, line 15, after “if” insert “, having considered any representations made by any of the relevant persons,”
Amendments 11 to 13 agreed.
Amendment 14 not moved.
Amendments 15 to 22
Moved by Lord Deighton
15: Clause 4, page 13, line 19, after “a” insert “written”
16: Clause 4, page 13, line 19, at end insert “and give a copy of that notice to the Treasury.”
17: Clause 4, page 13, line 20, leave out from second “period” to end of line 22 and insert—
“(a) beginning 3 months after the end of the period specified under section 142M(3) as that within which any representations must be made, and
(b) ending 6 months after the end of that period.”
18: Clause 4, page 13, line 31, leave out “third”
19: Clause 4, page 13, line 34, leave out “third”
20: Clause 4, page 13, line 38, leave out “third”
21: Clause 4, page 13, line 43, leave out from “must” to end of line 44 and insert “specify the date or dates by which each of the following must be completed—”
22: Clause 4, page 13, line 46, leave out “or”
Amendments 15 to 22 agreed.
Moved by Lord Turnbull
23: Clause 4, page 17, line 17, at end insert—
142VA General requirement of separation
(1) Where the members of any group include one or more ring-fenced bodies and one or more other bodies, the members of the group must, before the end of the period of 5 years beginning with the relevant commencement date, take steps to secure that there are no members of the group that are ring-fenced bodies.
(2) If in the case of any group steps to secure that there are no members of the group that are ring-fenced bodies are not taken within the period specified in subsection (1)—
(a) at the end of that period the Part 4A permission of each member of the group that is a ring-fenced body shall be treated as having been cancelled to the extent that it relates to a core activity, and
(b) after the end of that period the appropriate regulator must refuse to give any member of the group a Part 4A permission to carry on a core activity.
(3) At the end of the period specified in subsection (1)—
(a) in section 142H, subsections (1)(b) and (4) to (7) and, in subsection (8), the definition of “specified”, and
(b) sections 142K to 142V, cease to have effect.
(4) In subsection (1) “the relevant commencement date” means the day appointed for the coming into force of section 4 of the Financial Services (Banking Reform) Act 2013 so far as it inserts this section.”
I referred to the second reserve power, which would allow that where, in the commission’s view, it was felt that not just a single bank but the banking sector as a whole was not respecting the constraints of ring-fencing and the scheme was basically not working, it could move by steps to full separation. Of course, this second reserve power was predicated on the assumption that there will be a fundamental review of the kind that some of us have been arguing for. If all that we have is the PRA-led review of the kind that the Government have been seeking, we would certainly not have a sufficiently strong basis. However, that is based on a view of the world in which, first, there is continuous innovation and, secondly, other jurisdictions are making changes—notably in the EU. At some point that, combined with the behaviour of a banking sector, may lead to the conclusion that there should be a further change. Deciding that this scheme is not working does not necessarily lead you to full separation; it could lead you to something else, such as tightening the regime or some other modification.
We have had this argument about the review. However, then you get to the real crunch, which is that even if there is agreement on the review, and the review says that ring-fencing needs to be changed in some way, this amendment says that the further action that has been identified and recommended by a son of Vickers could be implemented under the powers of this Bill. That is the fundamental disagreement. The Government argue that that means that you are doing something completely different. I argue, first, that getting legislation is not an easy thing to do—you have to compete for time; and, secondly, that not being able to implement the conclusions of such a review reduces the effect of the deterrence and increases the opportunity for a log-roll. In any case, the Government would have the last say in the scheme that we have devised. Therefore, if there was a recommendation from a Vickers mark 2, the Government would not be forced to act on it: they could decide that they did not want to act on it and did not have to accept it. Equally, if they wanted to, they would be able to. The position is asymmetrical. Since the Government have a veto, they cannot be railroaded into a policy that they do not want. However, if it is a policy that they do want, they have the power to accept it and act accordingly. That is the basis of Amendment 23, which refers to this power, and of Amendment 117, which states that you cannot exercise this power until a fundamental review has taken place.
Could the noble Lord explain the drafting of Amendment 23? As I understood his explanation, it was that this would be a contingent power that the regulator could enforce if necessary. The way the amendment is drafted, proposed new Section 142VA gives the impression that it would be a requirement regardless of any other condition. Perhaps the noble Lord will clarify how it will become contingent on the regulator deciding that it is necessary.
Perhaps I may say something about this. As the noble Lord, Lord Turnbull, mentioned, we retrenched on this in discussions on earlier groups. This is something to which I attach great importance. The noble Baroness, Lady Cohen, said that the commission had got it all wrong, that ring-fencing could not possibly work and that there would have to be complete separation. I agree with her—and this is no surprise. I was speaking out for complete separation long before almost anybody else I can think of, certainly in this country. For five years I have been writing and speaking on this: before the parliamentary commission and before the Vickers report. It remains my view that this is most unlikely to work, partly for reasons that the noble Baroness gave and partly for others.
Of course, as the noble Lord, Lord McFall, pointed out, we on the commission decided that it would be sensible to have a unanimous report. There was no majority on the commission—and certainly not unanimity—for complete separation. Therefore, we proposed what we proposed. One thing we proposed, which is what this group of amendments is about, was a route to complete separation. This is what the amendment is about: a process by which, if it is seen, and events prove, that the noble Baroness and I are correct, along with many others who think the same, this procedure, which the Government at the present time refuse to accept—something I regret—is a way in which we might get there.
When I asked the Minister what the great advantages were of universal banking, from which we should in no way depart, his main argument was that diversity was a form of strength. I am old enough to remember when industrial conglomerates were extremely popular. In the late Lord Hanson’s group, and others, there were a whole lot of disparate industries in the same holding company, and the argument was that this diversity was a form of strength. In fact, of course, it was a disaster and nobody argues the case for industrial conglomerates any more.
However, at least with industrial conglomerates there is the discipline of the marketplace and you can allow companies to fail. The problem in banking is that the conglomerates are much more serious. You get the problem of “too big to fail”. Indeed, it is not just too big to fail, but too complex to fail and, as we have seen, too big and too complex to manage. That problem has proved to be right at the heart of this. My noble friend the Minister is saying, “Forget about all that, let us make them even bigger and even more complex”. I am afraid that he has not convinced me. In certain special circumstances there may be some slight advantage in having linkages of this kind, as there were with the conglomerates. However, the balance is overwhelmingly on the other side of the ledger. It is a huge disadvantage and a huge risk for the economy, which we should not entertain.
The Government have also said—I do not know whether the Minister is going to say this now but a government spokesman has said it in the past, and I think that the Treasury said it in its response to our commission’s report—that maybe you are right and we should go this way, although their heart is not in it. It should be new primary legislation and not a power under this Act, which, as the noble Lord, Lord Turnbull said, can be exercised only with the agreement of the Treasury and the Government who are responsible to Parliament. We are not saying that an independent committee can decide any more than the Vickers committee could decide. It had to be accepted by the Government of the day. If you say that this has to be new primary legislation the reality is that it will be too much hassle. There will never be time for the primary legislation and it simply will not happen. It is an integral part of the logic behind this Bill. That is why it should be in this Bill and why the noble Lord, Lord Turnbull, is absolutely right.
There are in a sense two separate issues. There is the issue—which we were all concerned about and to which reference has been made during the debate on earlier groups of amendments—of the intense ingenuity of investment bankers, in particular, who may find ways round it and also the success in lobbying. Maybe we need to introduce something—at a later stage maybe; it is too late to do it today—to implement on the statute book the recommendation of the parliamentary commission about lobbying in paragraph 262 of its summary of conclusions. If you look again at what happened in the United States, intensive lobbying led to a weakening of the Glass-Steagall legislation, and British banks are just as able to do it as American ones.
However, it is not just a question of finding clever ways round or lobbying in this instance by particular banks but also, as has been widely pointed out, that the whole structure may not work. If it does not, we have to go for industry-wide separation and that is what this is about. I am not going to talk now about proprietary trading, because we are going to come to it later, but as the issue has been raised I will just mention it now even though it is not really relevant to this group. Proprietary trading has been separated out in the United States. We made recommendations about that too in an earlier report. The final report was not an attempt to sum up everything: we did it in tranches.
This comes back to the question of culture. Maybe I am old-fashioned but I regard one of the essential elements of banking culture to be service to clients. As the whole essence of proprietary trading is that there is no client, the culture of service to clients cannot possibly exist. It is totally alien and the banks are literally in it for themselves. That is a separate issue. The important thing now is that there should be a route to complete separation if too much ingenuity is shown, if there is too much successful lobbying or if the whole system is shown to be flawed, which I suspect will be the case for a number of reasons which noble Lords have already mentioned. We will abandon this route at our peril. I fear that if we do, we will deeply regret it in the future.
My Lords, I apologise that I, too, was not here for Second Reading as I was at the funeral of a close friend. I speak as a member of the PCBS, having had the privilege of a year of lessons from the other members, especially noble Lords here today, and the great pleasure of being rung up by the noble Lord, Lawson, quite frequently at weekends, to explain how I should think about a particular subject, which he has done with great eloquence as well today.
I agree entirely with the speeches made by the noble Lord, Lord Turnbull, twice, and both speeches by the noble Lord, Lord Lawson, which have put the position very clearly. It must be a very long time—and my experience of this House is very limited—since a solution to a major problem was put forward with such a noticeable lack of enthusiasm. Almost everyone who has spoken about the ring-fence has damned it with faint praise, to put it at its most polite. The noble Baroness, Lady Cohen, simply eliminated it quite quickly and very clearly. We are in danger of getting lost in looking at the regulation and forgetting what the regulation is trying to do. This is about a question of a culture and ethnics, not detailed rules. We all remember Bob Diamond, the chief executive of Barclays, saying that culture is what happens when no one is looking.
We know what happened when no one was looking in the culture of some parts of the banking industry—they fixed LIBOR, overgeared and gamed any system of regulation going. All of that was dealt with under regulatory processes that did not work. They still fixed LIBOR, gamed the system and did all kinds of other things. The force of culture in those institutions made it hard to challenge and it is very noticeable that over 10 years when this was going on at its worst the number of people who blew whistles on this was almost zero. The culture made it very hard to discern that what you were doing was not right.
The noble Lord, Lord Lawson, referred to the dreadful effect of the meltdown we experienced in 2008—as was said earlier, five years almost to the day. The terrible cost of that catastrophe must not happen again. That is what we are trying to do. It has affected the City of London for a while but the far-flung areas of deprivation and poverty in our country suffered grievous blows of further damage from which they are still in the process not even of looking for recovery. The damage when the culture goes wrong is not localised. It is not just about the City; it is about people far away who know very little about what is going on there but find that they cannot raise money, that they cannot do their business and that their banking disappears locally. The vast structures of reform that have been and are being passed through Parliament, including this Bill, and that are passing through the regulators and the industry, show that there is a great failure of trust—and trust will be re-established not by regulation but by culture.
We have already heard the problems expressed very clearly about the ring-fence. The noble Baroness expressed herself very pointedly and precisely. But one thing that we found in discussing this issue in the Parliamentary Commission on Banking Standards is that separation is almost as hard to work out as a ring-fence, because you have to decide which bits get separated into which bits. The next thing that happens is that the brilliant merchant bankers, as it was put a few minutes ago, get between the wall and the wallpaper—that, I think, was the memorable phrase—and start putting other bits into the wrong bit. They game the system just as much with separation as with a ring-fence, so I do not think that that is a simple solution.
We have had the prodigal son and elements of faith from the noble Lord, Lord McFall, but we have the Trappist solution here. You live in the same community, but you do not talk; that is how the ring-fence is meant to work. The amendment—and this is why the element of culture is so important—increases vastly the voltage of the ring-fence. If it has to be used, like much of these forms of regulation, it will have failed to some degree. But it says that, if the industry loses its way in ethics and culture, as it did in the early years of this century, there is catastrophe in regulatory terms. Banks will be split up; people will come in and take them apart. The Government have argued that such a drastic step should require further primary legislation, but that argument seems to carry very little weight. The amendment is merely a rational extension to existing provisions and ensures that the banking industry realises that poor culture leads to fatal shocks, not to a little buzz in the fingers, or to lengthy debates in future on primary legislation. It will concentrate minds.
There is no doubt that we are seeing good things happen in the culture of a number of banking institutions. The new leadership in a number of banks is changing the culture very effectively. A professional standards body is being set up. I believe that this is not merely temporary self-interest but, in many cases, a deep sense that there needs to be a change of culture and values. But that is what is happening in this generation, now; it must be reinforced with firm boundaries to the ring fence, with very serious consequences if you walk into it to see what will happen. The amendment will reinforce that change of culture and act as a permanent reminder to the banking industry of the danger of slipping back into the bad old ways. Not to have that reality signalling the boundaries of acceptable ethics and culture is to encourage behaviour that looks first to what is legal, as has happened for a number of years, and never to ask the question, “What is right?”. To have banks ask what is right rather than what is merely legal would be good not only for the bank but for the whole society that it exists to serve, as the noble Lord, Lord Lawson, said.
My Lords, I entirely agree with what the most reverend Primate has just said. As a lawyer of far more years than I am willing to admit, I wonder whether sometimes the legislation that we pass in this place, with the very best of intentions, has in some strange and horrific way an almost contrary effect, for the reason given by the most reverend Primate—namely, that people look at the law rather than what is behind the law and look at the small print instead of the large issues. In my professional life, I have seen this get worse and worse.
One argument above all others persuades me that this amendment is a good one. By and large, I am persuaded that it will leave us with a simpler, more workable outcome than the ring-fence arrangements, which seem to me, even in my most legalistic frame of mind, to be of barbaric complexity. These will be bad enough, but they are significantly more straightforward, more comprehensible and, in a way, more down to earth than the ring-fencing. So I support the amendment.
My Lords, I know that noble Lords are looking forward to hearing the Statement, but this is an important point. I certainly would not be able to add anything to what the most reverend Primate has said in a very powerful speech. I am glad that he liked my analogy about wallpaper and walls. I have to say to my noble friend the Minister that the writing is on the wall here, and it is absolutely clear that if we do not have in this Bill a clear provision that gives the Government power to deal with the sector as a whole, most banks will decide to go with the culture and try to make it work. But they are in competition with each other; one will come up with a clever scheme and the others will say, “They’re getting away with this—we ought to do the same, or we will do some variation of the same thing”. You need there to be a threat to the whole sector, if some of them fall by the wayside. That is another argument, in addition to the ones made by my noble friend Lord Lawson and by the most reverend Primate.
I hope that my noble friend the Minister will think about this very carefully and see the writing on the wall. He will find it very difficult to get this Bill through this House without a provision of this kind being incorporated in it.
My Lords, I make a simple observation from experience. I have seen this attempt at ring-fencing in the past. When you have ring-fenced or non-ring-fenced entities—it does not matter which—reporting up to a group head, at the end of the day that group head can manipulate things at an investment level or at all sorts of other levels to influence the outcome in a way that is unexpected. It does not work, the moment that you have a group, because that is outside the ring-fence. I could give noble Lords instances, but it might cause problems if you did. I would rather say that I totally support the most reverend Primate and this amendment, which is very sensible.
My Lords, what underlies this whole debate is a feeling that the so-called advantages of the universal bank do not outweigh the dangers and disadvantages. My noble friend referred earlier to preserving the advantages of the universal bank, but there is no doubt that such advantages as there might be, regardless of the risks, are significantly reduced, if we have an effective system of ring-fencing. Many of us here feel that the ring-fencing proposal is wrong and unlikely to be very successful. We came up with the Vickers report and the Government have gone along very largely with the proposal that was made, but the reality is that we are going to have a situation whereby we should really be going in the direction of full separation. This is bound to take time. Therefore, an amendment of the kind that my noble friend has proposed would effectively give us a means to get out of the present impasse to a situation where we move towards full separation.
I return for a moment to a point that I made earlier. Where does all this leave us in relation both to the United States and with regard to the European Union? This is clearly a global industry. It is no good our legislating for the situation with regard to British banks if quite different rules are being applied in Europe, or applied to us from Europe, or the rules are different in the United States. There is a strong case for trying to get an international consensus on this, but the ring-fencing proposal seems significantly different from what I understand is being proposed in Europe and certainly what is being put forward in the United States. Therefore, I hope that my noble friend will respond to two points. First, where do we stand with this proposal in relation to the international situation? Secondly, is there not a case for the amendment which, as my noble friend has said, will enable us to act if what has rightly been called an experiment as regards ring-fencing turns out not to work?
My Lords, given some of the recent speeches, I again sound a small note of caution. While I understand the need to electrify the ring-fence, the Government and this House should be cautious about legislating on a presumption that universal banking is the wrong commercial or organisational model. I share many of the concerns that have been expressed about the difficulty of having a common culture in an organisation that embraces too many different activities. However, it seems to me that it is primarily a commercial judgment for the management and shareholders to decide whether or not they can make that range of activities succeed. The primary duty of the Government and the regulator is to ensure that whatever is done is not a threat to the financial stability of the system. As I said in my introduction to the first amendment, I support ring-fencing which seems to me to be targeted at that purpose, which is to define the capital and risk exposure of the ring-fenced bank and ensure that it is regulated in such a way that the other activities of the group do not impinge on the capital and solvency of the ring-fenced activity. So long as the Government and the regulator can do that—I understand that people are raising questions about that—it seems to me that the question of other activities in the group is not something on which the Government should rush to legislate.
There are arguments which have not been put in this House about, for example, the ability to serve customers in a common way across different entities in the group, which would not be prevented by ring-fencing. There are arguments about the use of common resources such as IT resources, infrastructure and a whole range of central resources that can be used in a group structure. There may be good arguments or bad arguments but those are arguments that the management and the shareholders should primarily be in a position to consider. Some will succeed and some will fail but it is not up to this House to decide the commercial logic or otherwise of universal banking. The House should decide primarily whether or not the ring-fencing, the safeguards in the Bill and the electrification that is already built into the government amendments will do the job that is intended.
My Lords, what is particularly striking about the commission’s report, especially its final report, is the way in which it presents a coherent package of measures. This amendment fits together with the review amendment that we considered earlier as those two elements reinforce each other. As Amendment 117 makes clear, the review element is the key trigger for Parliament to consider whether this measure of separation should be introduced. There is coherence here. What is distressing about the Government’s rejection of the nature of independent review and hostility towards this amendment is that by removing that internal coherence of argument they significantly weaken the overall approach to financial regulation which we are attempting to achieve.
In anticipating this discussion on separation, the noble Lord, Lord Deighton, asserted that the arguments for separation had not been considered and that if you wanted an amendment of this sort you ought to have another commission to consider the arguments. That is just not so as the arguments were considered extensively, first by the independent commission and then by the parliamentary commission. The main point that came out of those discussions was that there was a strong case for separation. However, the experiment of ring-fencing was felt to be worth while as, if it worked, the trauma of separation would not be required. The idea that this issue has not been considered is not the case as it has been considered very thoroughly. It has not been rejected but is seen as a backstop, if you like, to the ring-fencing proposal.
The most reverend Primate made the terribly important point, in a way which has not been brought out by other speakers, that this measure strengthens the whole structure of the ring-fence and will incentivise the banks to regulate each other. There will be an enormous incentive for all the banks to keep an eye on what everybody else is up to to ensure that they are not drawn into this final total separation. The people on the inside who really know what is going on will have a strong incentive to make the ring-fence work because if it does not work they know that there is a reserve power in the Bill. If you really want the ring-fence to work, you need this clause. It is a contingent clause and a reserve power but if we really want the ring-fence to work, the Government should wholeheartedly embrace the amendment of the noble Lord, Lord Turnbull.
My Lords, we have already discussed many of these issues as it has been extremely difficult to avoid talking about full separation when discussing the other amendments. However, I pause to review the most reverend Primate’s reminder that the most important thing in these institutions is culture and that we can make as many rules as we like but if we do not force a cultural change bankers will find their way around the rules. Separating banks is absolutely not a recipe for ensuring a better culture. If you look, for example, at the experience at HBOS, which was a pure retail player, there was clearly a massive cultural problem there. Culture is quite independent of some of the structural issues that we are talking about.
I remind noble Lords that we are talking about whether or not there should be a reserve power for industry-wide separation. Inevitably, the discussion seems to be about ring-fencing versus full separation but that is not the debate we are having. It is difficult to avoid confusion around that issue. The high voltage or the extent of the electrification and the incentive to banks is extremely strong in terms of individual bank separation. I outlined in our amendment how quickly and effectively that can be deployed. A bank needs no further incentive than to know that it will be completely restructured if it seeks to game the system. The notion that banks will watch each other is not how the industry operates.
As regards the point made by my noble friend Lord Higgins, the ring-fence rules are internationally consistent and have been designed to make sure that they are compatible with EU and US law although the way each country deals with the issue structurally is different. I remind noble Lords that we are legislating to ring-fence retail from investment banking. That is what the Independent Commission on Banking recommended. The Government oppose this amendment as a matter of substance and process. The complete separation of retail and investment banking which this amendment would provide is not a sanction or deterrent but a different policy. It would not support or reinforce the ring-fence; it would abandon it in favour of an alternative. We can see this in the terms of the review that the noble Lord proposes which might trigger full separation. That review must decide how far the provisions in the Bill—that is, the ring-fencing regime itself—deliver the policy objective so that even if no bank gamed the ring-fence full separation could be triggered.
Having established this as an alternative policy, let me set out two simple reasons why we do not support the amendment. First, if a future Government did decide to switch to a new policy, it could not be appropriate for that change to be effected simply by commencing a reserve provision. That would entail no more than a single order with a single brief debate in each House of Parliament. There would be no detailed scrutiny, no opportunity to consider amendments and no chance for Parliament to assure itself that the circumstances justified the new policy. There would be no development of an extensive evidence base, no cost-benefit analysis and no opportunity to build an extensive domestic and now European consensus. This proposal may therefore be at odds with the desire expressed in both Houses to enhance the process of scrutiny.
The point that the Minister seems not to have taken on board is that the arguments for review and this power have to be seen as a coherent package. The point is that there would be that review; there would be a continuous independent review providing exactly the information that he says is necessary.
Yes, there would be a review, but not a proper parliamentary process. The argument I am making is that this is such a switch from ring-fencing to full separation that it should benefit from that full process. While I obviously bow to the experience of my noble friend Lord Lawson, these things, if the circumstances dictate, can be done extremely rapidly, where the circumstance demand that kind of urgent move.
I think it is instructive to compare the process of developing the ring-fencing policy to that of this proposal for full separation. The ICB went through an extensive process of deliberation and analysis, carefully collected data, prepared a full cost and benefit analysis and compared that to full separation. It found that a robust ring-fence will insulate essential retail banking services from shocks originating elsewhere in the financial system. It will enhance the authorities’ ability to manage the failure of a ring-fenced bank, or its wider corporate group, in an orderly way. It will, therefore, deliver the financial stability benefits of separation. Ring-fencing will also preserve some of the benefits of universal banking. I made the argument of diversification and scale, not simply diversity. Customers will be able to access the full range of services from a single group: that is a marketing advantage as well. The frictional costs to the economy of ring-fencing are therefore lower than those of full separation. That is, of course, the reason we did not go for full separation. Further, in the event that the ring-fenced bank runs into trouble while the rest of the group is doing well, other group members can support it. That, of course, would not be possible under complete separation.
On a comparison of the costs and benefits, the ICB chose ring-fencing as the superior policy. The PCBS did not provide any new evidence to contradict this position. In this respect, the noble Lord’s proposal for an independent review of ring-fencing is an admission that the evidence base for full separation does not yet exist. The amendment asks us to put a policy into law and then establishes an independent review process in the hope that it might justify it. For us, this is lawmaking done backwards.
That brings me to the Government’s second and perhaps more powerful reason for rejecting this amendment. Let us imagine that a future Government decided that not ring-fencing, or full separation, but a third policy was appropriate. Imagine, for example, that it decided that a Volcker rule was the right policy, or a shift to full-reserve banking. In either case, a review that was limited to deciding whether to enact a reserve provision for separating ring-fenced banks from their groups would be no use at all, and the power would need to be repealed, along with much of the rest of the Bill. Coming back to Parliament would be the only way to give a future Government wanting to change policy the full range of options.
Therefore, on grounds of both substance and of proper legislative process, the Government continue to oppose a reserve provision for a move to full separation and I therefore urge the noble Lord to withdraw his amendment.
I think the Minister has erected a straw man here. The straw man is that there is a quite lightweight review, possibly of the kind that he is recommending, rather than the kind others are recommending, and then there is a day in the Commons and a day in the Lords and, bingo, this huge change takes place. What the commission envisages is a resurrection of the ICB. It is not a coincidence that the number five was chosen, as that was the number that worked on the ICB. The ICB went through all the steps that he claimed, of looking at the options, the cost benefits and so on, and evidence was taken in various Select Committees. Therefore, there would be an enormous amount of public discussion, inside and outside Parliament, before this was enacted. That seems to me to be the process and I cannot see what is wrong with it.
The other point is that the Minister downplays the incentive effect. If you have one bank which has no incentive to test the system and is very happy with its niche in the market and it sees another bank pushing very hard at the limits, what is its incentive? Does it simply turn a blind eye? Under this arrangement it has an incentive to support suggestions that the other bank should be reined in, otherwise it then brings big change on the sector as a whole. So it produces, it seems to me, the right incentive set for all the players in the banking sector.
The Minister has heard a lot of quite strong opinions on this. As I said at the start, the prior condition of all this is a proper review arrangement. If that is in place, this is, in the opinion of many, a sensible power to have. It can be enacted, but if the view is that some alternative to separation is better, there is no problem; the Government can go down a different channel. If they want to extend separation, they have the power to do so. As with the first reserve power, further discussions need to take place. I think the divisions here are more fundamental, but, equally, I think the strength of opinion is also more fundamental. None the less, I beg leave to withdraw the amendment.
Amendment 23 withdrawn.
House resumed. Committee to begin again not before 7.07 pm.