Relevant document: 11th and 12th Reports from the Delegated Powers Committee
Moved by Lord Sharkey
19: After Clause 11, insert the following new Clause—
“Composition of the Board of the PRA
In Schedule 1ZB to the Financial Services and Markets Act 2000, after paragraph 9(b), insert “, and
(c) the chief executive of the FCA.””
My Lords, the amendment does for the PRA what Amendment 7 did for the FPC. I can be very brief—perhaps even audible. The amendment relates to the PRA in its current form, which we will try to maintain by opposing Clause 12. The Treasury briefing note sets out the current composition of the PRA as the governor, the CEO of the PRA, the deputy governor for financial stability and appointments by the court with the agreement of the Treasury, so as to ensure a majority on the board of external members. The Bank website says that five members of the board are Bank officials; that the board has a majority of independent external members, including the CEO of the FCA and five others.
The requirement that the PRA board has a majority of external members is an important provision. Its purpose is clear: it is to protect against and counter overwhelming influence by the Bank. Unfortunately, whether there is really a majority of independent board members is open to significant doubt. It depends on whether or not, as the Bank asserts, the CEO of the FCA can properly be described as either external or independent. As I said on Monday when discussing the status of her membership of the FPC, the CEO of the FCA has, at best, a qualified independence, not to be compared with the true independence of the truly external members. She depends for her job on the confidence of the Chancellor and of the governor. Her organisation is, in many respects, controlled—or can be controlled—or constrained by the Bank or its organs. The summary sacking of her predecessor, Martin Wheatley, by the Chancellor, with, no doubt, at least the agreement of the governor, is a clear and dramatic illustration of just how much independence the CEO of the FCA has when it comes down to it.
When I raised the same point in the context of the FPC, the Minister disagreed. He asserted simply that the FCA was a completely independent body. The evidence for this is pretty thin, as others have noticed. As recently as August, the Adviser Lounge ran an article headlined:
“Financial advice review shows FCA is not independent”.
It concluded that the regulator can be pushed, both formally and informally, into enacting the Minister’s will. It quoted an historical example. It noted that the former Housing Minister, Grant Shapps, intervened directly in the FCA’s mortgage market review consultation in December 2010—and Grant Shapps was not even a Treasury Minister.
We need to make absolutely certain that the PRA as currently constructed has a majority of truly external members. These members are the equivalent to non-executive directors; their externality is equivalent to independence. The CEO of the FCA, on the contrary, is not by any reasonable test entirely independent of the Bank. The amendment does not remove her from the board of the PRA but simply defines her as external. This means that, in order to ensure the board has a majority of external members, one more genuinely external member will have to be appointed. This is a perfectly simple, reasonable and precautionary measure. I beg to move.
My Lords, I thank the noble Lord, Lord Sharkey, for filling my morning because it took me a little time to work out what this amendment meant. It brought home once again the value of professionals in producing the consolidated version of the various Acts. Unfortunately, they did not produce a consolidated version of FSMA 2000, as amended, and it took me some time to find it on the website. It is worth doing because although this Bill intends to delete the appropriate provisions in favour of the Prudential Regulation Committee, what it does is bring out the essence of the point being made by the noble Lord, Lord Sharkey. Reference is made to paragraph 9(b), but first you have to read paragraph 8 of Schedule 1ZB, which states:
I stress that, because when one turns to the proposed replacement for this schedule to FSMA 2000, which is now Part 3A of what will be the Act as amended by this Bill, no equivalent reference is made to paragraph 8 about there being a majority of non-executive members. As the noble Lord, Lord Sharkey, alluded, it goes on to state:
“For the purposes of paragraph 8 and for the purposes of”, the principles to which Section 3C requires the PRA to have, none of the following can be non-executive members:
“(a) the members referred to in paragraph 3(a), (b) and c), and
(b) a member who is an employee of the PRA or of the Bank”, to which the noble Lord proposes to add proposed new sub-paragraph (c),
“the chief executive of the FCA”.
I want to bring out two points. First, I agree entirely that in no way can the chief executive of the FCA be seen as a fully independent non-executive. The Minister was at a very fine point the other day when he said that Martin Wheatley was not sacked. My understanding is that his term was to run until March 2016 but I believe that he departed in September, presumably on gardening leave. He did not exactly leave quietly. When addressing a meeting at the Queen Elizabeth II conference centre in London, he said:
“I am disappointed to be moving on”, and that he was doing so,
“with a sense of unfinished business”.
He later listed the ongoing work as being to clean up markets through the Fair and Effective Markets review and the implementation of the Senior Managers Regime, which is intended to hold top bosses to account when things go wrong. The article reporting his speech added that the clean-up was prompted by the LIBOR rigging scandal.
Martin Wheatley had many critics and I am sure that he is not a card-carrying member of the Labour Party; I doubt whether he has ever voted Labour, but he was to many citizens who took an interest a man of the people. He took the banks on in a pretty robust way, and I think that an awful lot of people in society felt that the banks needed to be taken on in a robust way. I am sure that he was first leaned on and then eventually fired. It is interesting to note that if you look up the CV of his successor, she is listed as only an “acting” chief executive. In no way can this person be considered to be independent. I assume that when the noble Lord accepts the amendment, he will tidy it up and make a reference to the Prudential Regulation Committee which is to take over the responsibilities presently listed in FSMA 2000. That would introduce a new subsection to what is presently Section 30A of FSMA, which requires there to be a sufficient number of non-executives to outnumber the executives of the Bank plus the chief executive of the Financial Conduct Authority. I think that that is the intent of the amendment even if it is not what it actually says, and I support that.
The whole of the debate on this Bill has been about influence and independence. We will be moving on to the Prudential Regulation Authority or the Prudential Regulation Committee in the clause stand part debate, but I think that not making it clear that there should be a majority of NEDs on the committee is a retrograde step. It almost implies, through the wording of this subsection, that the chief executive of the Financial Conduct Authority is independent.
I have had the privilege of working for Her Majesty’s Government, not as a civil servant but in the public sector. I know about being leaned on and I have to recognise that it is very effective. The one thing you cannot say at the end of the exercise is that you are independent.
My Lords, I thank the noble Lord, Lord Sharkey, for provoking this debate. Unlike the noble Lord, Lord Tunnicliffe, I have not had the enjoyment of spending my morning looking at FSMA consolidated Acts, but I have been looking into this matter. I do not want to go on at length and repeat ad nauseam what I was saying on Monday. As the noble Lord, Lord Tunnicliffe, said, this comes down to a matter of independence. He is absolutely right to pinpoint that. Despite hearing the cases that he and the noble Lord, Lord Sharkey, mentioned, I remain in no doubt that the FCA CEO should be counted as an external member. She is not an executive of the Bank and the FCA is an independent body entirely separate from the Bank.
Noble Lords should also be aware that the legislation further reinforces external representation on the new Prudential Regulation Committee, as compared with the PRA. The majority of external members, as has been said, is increased compared with the PRA board with at least seven external members, at least six appointed by the Chancellor in addition to the FCA CEO, compared with only five internal members: four officers of the Bank and one appointed by the governor. So, for the PRC, external members will be in the majority by at least two. This compares with a requirement for a majority of one on the PRA board.
It could be argued that if you use the power to add an extra deputy governor to the PRC, that majority of externals is lost. I would argue that the power to add an extra deputy governor to court and to the committee requires secondary legislation, so Parliament will have its say. Furthermore, Clause 1 provides that if secondary legislation is used to add a deputy governor to the PRC, it may also provide for an equal increase in the minimum number of members appointed by the Chancellor of the Exchequer to ensure a continued balance of internal and external members.
I shall leave it at that. I hope that the explanation I have provided satisfies the noble Lord and that he will withdraw his amendment.
I start by thanking the noble Lord, Lord Tunnicliffe, for his support, and for reminding us that if the Government get their way in Clause 12, we will need to revisit the provisions governing the number and the definition of external directors of the new arrangements. I remain unconvinced that the CEO of the FCA can in any reasonable way be described as independent. The Government seem to be relying on the force of simple assertion rather than evidence, but I am sure we will come back to this on Report. In the mean time I beg leave to withdraw the amendment.
Amendment 19 withdrawn.
Clause 12: Bank to act as Prudential Regulation Authority
Debate on whether Clause 12 should stand part of the Bill.
My Lords, Clause 12 abolishes the existing PRA. It defines the Bank as the new PRA, exercising its function through the PRC. The key questions here are why, and what is the benefit? I asked these questions at Second Reading. The Minister, in his letter to me, received last Thursday, answered by saying:
“Bringing micro-prudential regulation more fully into the Bank will support the Bank’s aim of installing a unified culture and flexible and co-ordinated working across its twin aims, aims of monetary and financial stability”.
That is very nearly weapons-grade corporate speak.
I invited the Minister at Second Reading to say what that means in plain English and to give concrete examples of how it would operate. I again invite him to do exactly that. I also invite him, having explained what it means, to say why it is better than what we now have. Andrew Tyrie asked the governor a similar question on
Clause 12 brings about a significant change. It brings the PRA directly into the close embrace of the Bank. Despite unevidenced assertions to the contrary, it must reduce the practical and cultural independence of the PRA, and this is absolutely not desirable. Doing all this without a convincing or even intelligible reason is surely the wrong thing to do.
The Treasury briefing paper for the Bill hints at another reason for absorbing the PRA into the Bank—that is, to conform with the governor’s “One Bank” strategy aimed at breaking down barriers within the Bank,
“that could stand in the way of a unified culture and impede flexible and coordinated working across the Bank”.
There are two worrying things about that statement. The first is the “One Bank” strategy itself. As my noble friend Lady Kramer said at Second Reading, the Parliamentary Commission on Banking Standards had many conversations about the importance of ensuring that,
“the Bank was not one single monolith and that there should be an opportunity for real challenge rather than groupthink”.—[ Official Report , 26/10/15; col. 1073.]
The “One Bank” strategy appears to be in danger of doing exactly that—moving the Bank back to monolith status, suppressing opportunities for real challenge and recreating the conditions for groupthink.
The second worrying thing about the Treasury briefing note statement is the reference to breaking down,
“barriers that could stand in the way of a unified culture and impede flexible and coordinated working across the Bank”.
Leaving aside the question of whether a unified culture is always desirable, one has to ask, “What are these barriers?”. What barriers have been identified in the workings of the Bank with the PRA?
The position on Clause 12 is that the Government have simply not put forward any compelling reasons for the changes that it produces. We have seen no strong, or even fairly strong, or evidenced argument that either the current situation is unsatisfactory or that the proposed changes would be better. Absorbing the PRA into the Bank is an important and radical step. It should not be taken without strongly evidenced arguments. In the absence of such arguments, we are left with only weakening of the independence of a vital organisation, with no assurance of any real benefit. Like my noble friend Lady Kramer and my former noble friend Lord Flight, I would prefer to see the PRA more independent rather than less. However, if we cannot have a more independent prudential regulator, we can at least try to stop it becoming a less independent prudential regulator.
My Lords, I refer noble Lords to my interests as declared in the register of interests. It seems to me that these clauses come to the nub of bank regulation in the Bill. The real question that we are looking at is whether it is better to have a stand-alone regulator or one which is integrated into the Bank of England, albeit with Chinese walls, a separate committee structure, independent directors and so on. To answer that question we have to consider why the FSA failed. The FSA was set up very much as a stand-alone organisation with its own rulebook, structures and independence from both the Treasury and the Bank of England, yet it completely failed to identify the problems that were building up in the banking system prior to 2008 and was unable to take action if it did identify those problems. However, there is increasing evidence that it was not even aware that problems were being created.
The noble Lord, Lord Sharkey, suggested that there are no problems with the PRA. That may well be true. Certainly, the PRA has operated well since it was created. I have had personal experience of dealing with people of excellent quality in the PRA and, indeed, of better quality than people in the equivalent posts in the FSA. However, I warn that the PRA has not been tested in the way that the FSA was. There has not been a major financial crisis since 2008. The PRA has not had to face the same problems. Frankly, we do not know whether the PRA would be able to cope with a crisis of the magnitude of 2008 or whether indeed it would suffer from the same problems that the FSA suffered from.
Answering the question of why the FSA failed, my answer would be, as I suggested at Second Reading—at greater length than I am proposing to this morning—that the FSA failed because it had a lack of market intelligence, not because it did not know what was happening in the Bank’s structures or in terms of individual regulated people inside banks. What it did not know was what the banks were actually doing or, more importantly, planning to do. It did not know this in London or the UK’s financial services, but it certainly did not know it globally. The problems in 2008 were very largely created by global problems, not UK problems.
Integrating the PRA into the Bank of England will enable—I hope—the market intelligence to be passed informally to the PRA so that it will be able to react to market conditions and the ideas that are being generated in financial services, and to understand what is coming down the pipeline. I believe that that will enable the PRA or the PRC to be much more effective in anticipating future problems.
I have one question for my noble friend the Minister. It is unclear in all the briefing documents whether the Bank of England—indeed, it ought to be the Treasury as well—will operate with this informal connection of the sharing of intelligence and the sharing of understanding of what is going on in the domestic and global financial markets, in order to enable the new PRC to be able to operate in a way which anticipates the future and does not just react to the past.
My Lords, in response to the noble Lord, Lord Carrington, of course the FSA failed in its task as the problem developed over the several years leading up to the financial crisis of 2007-08. But I think it is very wrong to claim that the Bank of England did not also fail during this period, despite its access, as he reasonably said, to very extensive market intelligence. One of the frustrations of this House was that although the FSA recognised its failure, I am not sure that even up to this day the Bank of England has ever accepted that it played its role in an inadequate way during that period. Indeed, that has been part of the problem in putting remedies in place because, as many have said, a change in culture is an essential part of that process.
The noble Baroness is failing to understand that there was a strict separation between the role of the Bank of England and the FSA, and there was no communication between them at the level which ought to have allowed that information to be passed. That was part of the problem. There was a great separation between the two. If the Bank of England understood what was going on, it did not see it as its job. If the FSA knew there was a problem but did not have the information, it could not communicate with the Bank of England. Bringing the two together—bringing the regulator together with the central bank and, I emphasise, with the Treasury as well—will find a solution.
My Lords, I find it extraordinary that there is an argument that the Bank of England knew what was going wrong but sullenly kept its mouth shut because the constraints gave the key responsibilities to the FSA. We have to break away from that sort of cultural notion that one observes only the very narrowest interpretation of responsibility when we are talking about an organisation such as the Bank of England. I agree that that culture tends to continue. That is one of the frustrations and concerns that we have, particularly with the removal of the oversight committee, which is the one challenge to that ongoing attitude. Let us set that aside for the moment, although I find it a constant frustration not to recognise that the Bank of England did not act when it certainly had an opportunity to lay on the table the many problems it now says it saw with such clarity.
I go back to the underlying issue, which is that the PRA has been a success. The PRA has been absolutely key in establishing the kinds of regulations that have made the Bank safer for the future, setting standards for regulatory capital being an important part of that. In addition, in the period before we had the PRA, it was virtually impossible to get a new bank licensed in this country. We have had Metro Bank but essentially no new bank for 150 years. People had to find an existing banking licence, buy it and go for some sort of change of purpose. The PRA was a leader in changing that whole culture and recognising the importance of bringing in challengers and new players. Had it stayed tightly within the existing Bank family, which had resisted that approach over and over again, I very much doubt that we would have seen that kind of change. So the experience we have had since setting up a PRA which has some distance from the Bank—a small distance, I fully acknowledge, but separate responsibilities governed under company law—has been that it has brought forward change in a way that is not part of the history of the Bank. I am very concerned at the potential for losing that.
The noble Lord, Lord Carrington, also suggested that if we changed the existing structure it would not allow a proper flow of information from the Bank of England to the PRA. But look at the membership of the PRA: we have crossovers in deputy governors, and I believe that the Governor of the Bank of England is the formal chair of the PRA. If these individuals are unable to remember the meetings that they were exposed to and the memos that they read when they wore one hat, and bring that information into the meetings they have when they play their role within the PRA, I frankly find that extraordinary. As far as I understand it, there is no problem of information flow—and if there is, we would very much like to hear from the Minister what the instances are, where there has been that kind of breakdown, and why an individual involved in discussions in one particular part of his or her job has been unable to remember those discussions when participating in another part of it. Those are quite serious allegations. I would like to hear from the
Minister where this communication has so badly broken down when it is quite frequently the same individuals who are involved.
My Lords, again, I support the noble Lord, Lord Sharkey, on his general thrust in this debate. I come at it from a slightly different direction, although I think that the fundamental proposition is, “If it’s not broken, why are we trying to fix it?”. In fact, the supporting paperwork says that it is working well. We need to go behind that—back to the 2012 Act, the FiSMA 2000, as amended, and all that sort of stuff—to look at how the Bank is now going to work.
I think the Bank will move its emphasis from the Monetary Policy Committee towards the FPC. Regarding the control of interest rates and the Government’s injections of cash, depending on which textbook you read, it was the actions of banks in creating credit that formed the bubbles that caused the crisis of 2008-09. I believe that is the technical reason and that we are seeing many bubbles emerging again. As to the process of the FPC, by reading through the consolidated Act we see that its many powers—to make recommendations about new tools, for example—and all the things it is able to do to control the creation of credit, among other things, are absolutely fundamental to how efficiently the money system supports the economy, and hence are fundamental to the economy.
Now, what is the thing that keeps this clean? The thing that keeps it clean is the fact that the PRA is a subsidiary—an independent company, as mentioned, governed by company law—and, therefore, there has to be an arm’s-length relationship between it and the FPC. Under the various terms of the Act, the FPC can create various macroeconomic tools, which it then hands down to the PRA. It hands those down not through some side-channels or influence but, because of that independent legal status, in a very formal way to its subsidiary, and I think that is healthy. I do not believe that in effect moving the PRA closer to the Bank—and, by definition, closer to the FPC—is a good thing. The present separation is working, and I think we should continue it.
The reform included in the Bill ends this subsidiary status. The PRA board will be replaced by the Prudential Regulation Committee and, as I said, that must have the right balance. The Government so far, frankly, have not come up with a good reason for this change. The noble Baroness, Lady Kramer, made the point that mechanisms for information transfer are there, and therefore that is not at risk. The whole purpose of being in a subsidiary company—I headed a subsidiary company of a large organisation—is to get focus on its business, so that there are very clear responsibilities. I think that the move in the Bill away from its being a subsidiary is a bad thing, and I hope that the Government will reconsider the inclusion of this clause.
My Lords, once again I thank the noble Lord, Lord Sharkey, for provoking a very interesting debate and for the thoughtful contributions that he, the noble Baroness, Lady Kramer, the noble Lord, Lord Tunnicliffe, and my noble friend Lord Carrington of Fulham have made.
The noble Lords, Lord Tunnicliffe and Lord Sharkey, absolutely got to the nub of the matter here. We are seeking a PRA that is effective and independent, and getting the balance right between those two aims, and making sure that we achieve both, is absolutely crucial. I would argue that the proposed changes will increase the PRA’s effectiveness—making it better still, to address the point made by the noble Lord, Lord Tunnicliffe—but do not undermine its independence.
Let me first address the issue of increasing effectiveness, and I will try here to steer clear of management-speak. The governor has explained the links—I have crossed out the word “interdependencies” that was in my brief—between monetary and financial stability and why, therefore, it is right that both these macroeconomic policy responsibilities should rest with the central bank. The Bank is also committed to implement a set of changes to its internal organisation, aiming to ensure that different parts of the Bank work even better in pursuit of its twin aims of monetary and financial stability. The Bill builds on and reinforces these organisational reforms.
Ending the subsidiary status of the PRA will reinforce the Bank’s efforts to strengthen its capacity to work effectively across its responsibilities. At Second Reading, it was suggested that ending the PRA’s subsidiary status and creating the Prudential Regulation Committee might represent a downgrade of the prudential regulation function—a point that has been alluded to. I entirely disagree with that. I would argue that this change will have the precise opposite effect. Placing the Prudential Regulation Committee on the same footing as the MPC—and, with our changes, the FPC—means elevating the microprudential role to the same level as monetary policy and macroprudential policy.
This is, I would argue, an upgrade that reinforces not just to the Bank staff but to the wider public, to whom the Bank must be transparent and accountable, that the Bank is not simply an organisation dedicated to setting interest rates but one with equally important macro and microprudential responsibilities.
The Bank has told us that closer integration has increased the feeling among PRA staff that they are an integral part of the Bank’s mission and have broader opportunities for progression across the whole Bank. This can only assist recruitment of the best people to the supervisor, which I am sure is something that all your Lordships will support.
A second benefit from ending the PRA’s subsidiary status is enabling the members of the new committee to devote more time to microprudential policy and operations—the noble Lord, Lord Tunnicliffe, spoke about the need for focus.
The governor explained to the Treasury Select Committee that the change will,
“liberate … a portion of the time of the members of the PRA Board that is spent duly exercising their responsibilities as directors of a company”, while noting the important responsibility that PRC members will continue to have for ensuring that the prudential regulation functions are adequately resourced —a point I will come on to shortly. The governor concluded that,
“time is freed up to do their core job—what they are there for—which is to provide guidance on judgment-led supervision”.
For example, the PRC will no longer have to spend so much time discussing IT provision, as this will be a concern for the Bank at large and ultimately its governing body, the court. Equally, whereas the PRA board had to be involved in discussions on staff terms and conditions and recruitment, the new committee will be able to leave these important concerns to the wider organisation and focus on its role in supervision.
A third benefit of the changes is increased clarity of governance. As the Parliamentary Commission on Banking Standards noted in discussing the existing regime:
“The accountability arrangements of the new structures are more complex than those of the previous regulatory regime”.
Ending the subsidiary status of the PRA and establishing the PRC, MPC and FPC on the same basis simplify and clarify Bank governance. We are clear that these benefits must not come at the expense of undermining the PRA’s strong brand or the operational independence of the PRA’s supervisory decisions, and that transparency around the use of the levy that will continue to fund the PRA’s activities must be maintained.
Let me address the second point, on independence. It is worth explaining what “independence of the PRA” actually means. As I am sure your Lordships will know, the Basel core principles on banking supervision suggest that legal safeguards should ensure that a regulator has,
“operational independence, transparent processes, sound governance, budgetary processes that do not undermine autonomy and adequate resources”.
The Bill provides for all these important safeguards. For a start, Clause 12(2) is very important: it provides that the Bank’s PRA functions may be exercised only through the new Prudential Regulation Committee. The Bank may not exercise its prudential regulation role in any other way.
As we discussed in relation to the previous amendment, the committee will have a clear majority of external members, with at least seven externals compared with five internal members. It is important to note that this is an increase in the weight of external members on the existing PRA board, where only a majority of one is required.
Next, the Basel core principles call for transparent processes and sound governance. Schedule 1 to the Bill sets out clear processes for the new committee’s decision-making. The core principles also stress “adequate resources”. Every year, the committee will report directly to the Chancellor on the adequacy of its resources as well as on the independence of its operations.
Next in the list of protections is a requirement for the Bank to ensure separation between resolution and supervisory functions. This makes sure that the UK remains compatible with relevant European Union directives that insist on such a separation.
Finally, the Bill grants a strong statutory role to the PRA’s chief executive. He will be responsible for the day-to-day management of the PRA and implementation of the prudential regulation strategy. This includes responsibility for how resources are allocated among different teams, managing policy development and overseeing supervisory decisions that do not reach the level of the committee.
The current chief executive, Andrew Bailey, gave his view of the protections for the PRA’s continued operational independence at the Treasury Select Committee in the other place on
“I think the Bill has in it sufficient protection of the independence of the PRA. It is very clear in the Bill that the PRA continues to exist as the prudential supervisory authority for banks and insurers … The independence protections are maintained, and that, I can assure you, has been and will continue to be a very strong focus of mine. Desubsidiarisation simplifies the Bank of England’s governance”.
Therefore, the Bill provides important safeguards to protect against the dangers of groupthink. With those reassurances, I commend Clause 12.
Clause 12 agreed.
Clause 13 agreed.
Schedule 1 agreed.
Clauses 14 and 15 agreed.
Moved by Baroness Kramer
20: After Clause 15, insert the following new Clause—
“PRA: Green Investment Bank
(1) The PRA must carry out its functions in a way that it considers will secure the provision of a “Green Investment Bank” service in the United Kingdom.
(2) The PRA shall by rules specify the purposes that it considers should be supported in the United Kingdom by the provision of a “Green Investment Bank” service.
(3) Rules under subsection (2) shall include the following purposes—
(a) the reduction of greenhouse gas emissions;
(b) the advancement of efficiency in the use of natural resources;
(c) the protection or enhancement of the natural environment;
(d) the protection or enhancement of biodiversity; and
(e) the promotion of environmental sustainability.
(4) In subsection (3)(a), “greenhouse gas” has the meaning given by section 92(l) of the Climate Change Act 2008.”
My Lords, I realise that some of your Lordships will be surprised that we have introduced an amendment with a clause referring to the Green Investment Bank into a discussion of a Bank of England Bill. Your Lordships will be aware that the Green Investment Bank has been one of the great successes of the coalition era. It filled a gap left by a market failure which had resulted in any green project requiring long-term, patient investment having great difficulty in accessing that kind of financing. The Government put something in the range of £3 billion into the Green Investment Bank, which has been so successful that it has since leveraged an additional £6 billion from the private sector. It is universally regarded as one of the most successful creations for enhancing our long-term investment in green infrastructure.
This Government have made the decision that they wish to privatise the Green Investment Bank. Discussions around that should and must take place in the context of the Enterprise Bill, but it is clear from the discussion so far that privatisation presents a problem. In order to completely remove the Green Investment Bank from their books, as the Government intend, they cannot continue to exercise any control over the bank after it has been privatised. They cannot require that the mission of the bank continues to be green investment; new owners could convert the bank to any other purpose at will after privatisation. Indeed, the Government cannot even require that the bank continue as a going concern. It would be quite possible for a new owner to absorb the existing assets into other parts of its business and make the decision that, as those assets were paid down, it would invest in a whole variety of other activities; it need not continue to provide a green investment bank at all. The Government, as I understand it, believe that they are helpless to provide for that requirement post privatisation. I do not think that is the wish either of the Government or, frankly, of Parliament.
As I say, this has been a successful bank. There are real concerns that private investors might turn the bank to another purpose—not because it is not successful but because there will be other ways to make money once the assets begin to return cash. Indeed, as I said, the reason why the bank was created in the first place was that the market showed very little interest in providing financing for these kinds of projects. Hopefully, attitudes have changed because the Green Investment Bank has established a very positive track record, but there is absolutely no guarantee. The future of the Green Investment Bank once it is in private hands is in question.
We faced a very similar problem when the system was set up to enable Royal Mail to be privatised. That privatisation is now going ahead. The Royal Mail, as your Lordships will be aware, was and is the vehicle through which a universal postal service is provided, under which every area of the country is covered by a postal service at a single, identical rate, which applies no matter where in the country anyone is. So my question became: if the Government could find a mechanism through which Royal Mail continued to have that set of obligations, could a similar mechanism provide for the Green Investment Bank to continue to have its existing obligations? The mechanism used for Royal Mail was that of the regulator, Ofcom.
I do not pretend that there is any quality in the drafting, but I have pulled together provisions from the Postal Services Act 2011 and the Enterprise and Regulatory Reform Act to try to establish a similar framework for the Green Investment Bank. The regulator in this case would appear to be the PRA, because that is the role it plays in relation to the banking industry.
I understand that the Government are willing to listen if we can find ways to keep the purpose for which the Green Investment Bank was created. I very much hope that moving the new clause creates an opportunity for the Government—for the Treasury—to become engaged. One problem that we often suffer from within government is that actions get siloed to one particular area. Frankly, the Green Investment Bank has ended up getting siloed over to BIS. But it is an issue that could impact equally well on the Treasury, because the Treasury has the relationship with the banking regulator which I propose to use in this case. It is on that basis that I move the amendment, and I hope that the Government will seriously look to see whether this route offers everyone a mechanism to get to the solution that most wish for.
My Lords, the Green Investment Bank has been one of the great successes of the coalition Government. To quote the words— which I fully endorse—of the Conservative manifesto of 2010,
“we will create Britain’s first Green Investment Bank—which will draw together money currently divided across existing government initiatives, leveraging private sector capital to finance new green technology start-ups”.
Absolutely. It was also in the Liberal Democrat manifesto and, I think, the Labour manifesto. After the Wigley commission, set up by the Conservatives, we all felt that this was an excellent way forward and one that would be successful. The management team at the Green Investment Bank has delivered that well over its first three years.
We on these Benches would prefer that privatisation did not take place quite so quickly. We do not feel that the Government will get its full value at the moment, but we accept that that is the Government’s policy. If the bank does not have proper access to additional private funding, in reality, it will be starved of sufficient future investment by the Treasury. Hence, we want to co-operate strongly with the Government to find a way to ensure that we do not just remove the legislative requirements in the Act, but keep those principles of the bank’s operation not just in its constitution but in the way that it can operate.
We are not happy about the fact that the five principles currently in statute will be put into the mem and arts of the company, because clearly those can be changed by a special resolution of 75% of the shareholders. As my noble friend Lady Kramer said so well, we have no guarantee that the bank will not be purchased just to run it down, make the most of its income stream and use it as an investment for future cash flow. That would be a tragedy for everybody. I am sure that that is not the Government’s intent but at the moment we have no guarantee through legislation that it would not be the case.
When my noble friend Lord Stoneham and I brought up this matter in Committee on the Enterprise Bill, we were very pleased by the reaction of the Minister’s colleague, the noble Baroness, Lady Neville-Rolfe. She said:
“The heart of the problem is that if we could keep the legislation without prejudicing the bank’s status we would, but the advice we are working on is that we cannot do that”.
That is because of the European standards of 2010 but those standards are vague. Having gone through them and having spoken to the ONS as much as I could, I suspect the Government are being conservative in terms of their operation. Here, my noble friend
Lady Kramer and I want to find a way around this. As she said so well, there is a precedent in terms of the Royal Mail.
Again, the Minister’s colleague, the noble Baroness, Lady Neville-Rolfe, in answer to a question about keeping the newly privatised bank off the public sector balance sheet, said:
“The simple answer on the Royal Mail is that it is regulated because it is designated as a universal service provided by Ofcom; it is not itself controlled by legislation”.—[Official Report, 4/11/15; cols. GC 329-30.]
In our amendment, we found a way to mirror that exactly to take on the noble Baroness’s challenge and provide the same legislative framework as for Royal Mail to make sure that privatisation can take place, as the Government wish it to, but at the same time to keep the organisation off the public accounts so it can borrow. It can then continue its success in the private sector in future but operating on the same principles as at the moment.
An example I have often thought of here is 3i, which was set up by the Bank of England as the Industrial and Commercial Finance Corporation in, I think, the late 1940s or early 1950s. It involved private money from the clearing banks at the time but was very much under the Board of Trade. Its constraints were got rid of in 1983 and since then 3i, as it became known, has moved away from SME investment almost entirely. It now deals primarily with mid-cap companies. I do not think its investors would get out of bed for anything less than a deal of £50 million or £100 million. Indeed, its major businesses and expansion are overseas rather than in the UK. I do not criticise that in any way but it gives a good illustration of how, once the shackles are removed from organisations like that, they can be very successful but their mission creep through shareholders inevitably moves further and further away from the original objectives with which they were set up by the Government. Of course, in that instance the Government have had to set up all sorts of other schemes to allow private—and some public—investment into SMEs.
This is an excellent method by which the Government’s aims can be achieved and the House and Parliament can be assured that the green objectives of the bank will continue to be fulfilled in the very successful way that the team at the Green Investment Bank has done over the last three years.
My Lords, the Minister is faced with a rather challenging task here. First, he operates against a background where the Government’s record in recent months has caused great anxiety among all those concerned with improving the environment and reducing the threats of climate change. Here he faces a fairly significant issue—the Green Investment Bank. Of course, the additional complexity is that the bank is itself subject to other legislation under consideration. Irrespective of the merits of the amendment, I could understand if the Minister felt that this were really quite a challenging situation. I will try to find a way out for him as well, as the Liberal Democrat noble Lords emphasised their solutions.
We are not averse to privatising the bank but we are not very appreciative of the urgency of doing it at this time. Crucially, the question that emerged during the debates on the Enterprise Bill and have been identified again today is how the Government intend to maintain the bank’s mission. Of course, it is easy to privatise if one disregards the fundamental objectives of the foundation of the bank. We need to know how the Government intend to guarantee that the bank does not morph in private hands into a different sort of institution and bank. What is the Government’s answer to that? They may not be totally enamoured of the Royal Mail example. Of course, that is buttressed by regulatory standards that we have not so far seen adduced as far as the green bank is concerned.
It is obvious that the Minister must make some progress on this, otherwise the proposal the Government are putting forward elsewhere will occasion increased opposition from this side of the House. I am always in favour of helping Ministers, particularly when it involves them rather than the Opposition doing the work. I suggest that the Minister consults his colleagues in the business department concerned with the process on the green bank and, after those consultations, comes back on Report with a much clearer identification of the progress of the Government’s thoughts on the bank. At present, in the debates on either the Enterprise Bill or this one we have certainly not yet heard anything remotely convincing from the Government to give the assurances we need that if this bank, which has proven to be a successful initiative and is respected for its work, goes into the private sector it will not all too readily be led down paths that depart from its much-valued objectives.
As we are in Committee, I will briefly come back to the noble Lord opposite about whether the Bank of England or the PRA is the right organisation for this. The Green Investment Bank is the Green Investment—I emphasise—Bank, so it seems to me appropriate. I want to make clear that we are open to other suggestions to solve this, if the Government and Minister do not believe this is the best way.
For instance, I am involved in an organisation called Regen SW, which used to be a wholly owned subsidiary of the South-West of England Development Agency. It was privatised and is very successful. I am one of three trustees who look after it. If there were a hostile takeover by a non-green organisation, there are three of us who can exert power to make sure that the original aims of Regen SW are maintained. If something creative can be done in that way, I would be absolutely delighted and we would like to hear it.
My Lords, I thank the noble Baroness, Lady Kramer, and the noble Lord, Lord Teverson, for their extremely constructive remarks—and, indeed, the noble Lord, Lord Davies, who on
Monday offered me sympathy for my position and today offered to be very constructive. Where do we go next? It is going to be very interesting.
The noble Lord can come and join us. I fully understand the intentions behind the amendment. Indeed, I have read the debate that took place last week with my noble friend Lady Neville-Rolfe on the Enterprise Bill, in which the noble Lord, Lord Teverson, set out his party’s position eloquently. I believe that all parties are agreed, as the noble Lord, Lord Teverson, and the noble Baroness, Lady Kramer, said, that the Green Investment Bank has been a real success story, and we need to build on that success. That is why the Government want to allow the Green Investment Bank to continue to go from strength to strength by moving it into private ownership. As part of our work to achieve this, it has become apparent that the existing legislation which governs the bank, the Enterprise and Regulatory Reform Act 2013, would very likely constitute government control over the bank and result in its remaining classified to the public sector. That is why, as the noble Lord and the noble Baroness said, the Government intend to repeal that legislation through an amendment to the Enterprise Bill, which will remove control and ensure that a privatised Green Investment Bank will have the freedom to borrow and raise capital without affecting public sector net debt.
I note, as my noble friend Lady Neville-Rolfe noted, the concern that the repeal would remove the Green Investment Bank’s statutory lock over its green mission, and that is where these amendments come in. The noble Baroness, Lady Kramer, eloquently drew a parallel with the privatisation of Royal Mail and its regulation by Ofcom, and whether the Government might replicate that kind of arrangement for the Green Investment Bank. First, there is a difference between regulating a company such as Royal Mail, which provides a public postal service and is a utility, much like energy or water, and the Green Investment Bank. As a country, we regulate mails as an industry, and the regulator for postal services, Ofcom, has designated Royal Mail to provide a universal postal service for the whole of United Kingdom, as set down by Parliament under statutory obligation. That means that, regardless of the nature of its ownership, for as long as Royal Mail holds the role of universal service provider, it must comply with specific regulatory conditions imposed upon its operations for the purpose of providing a universal postal service throughout the United Kingdom, as well as other regulatory conditions which apply to all postal operators in the market. If Royal Mail was not the designated universal service provider, its operations in the postal market would be subject only to those general market regulations that apply to all other postal operators.
The parallel here would be for the PRA to regulate the green investment market, could such a thing be defined. Not only would this amendment increase regulation at a time when the Government are trying to reduce it, but increasing regulatory costs in the sector would be likely to reduce overall green investment. I am sure that is not something that the noble Baroness, Lady Kramer, would wish. I must reiterate that the Government are implementing the repeal of legislation only as a necessary measure in allowing private capital into Green Investment Bank, reflecting advice from the Office for National Statistics. As I have said, to be classified to the private sector, an organisation cannot be subject to significant government control, and that includes control through excessive regulation. The decision on whether an organisation is classified to the public or private sector is made by the ONS on the basis of EU-wide rules. The ONS looks at all factors of control when deciding whether a corporation can be declassified from the public sector. If the Green Investment Bank was not free to change its articles because of public sector control, it would very likely remain classified to the public sector. Similarly, if the bank as a single entity were to be regulated in this way, it would still be likely to be considered as under public sector control, so this would not provide the solution that noble Lords are seeking.
The Government want to work constructively with noble Lords across the House to secure the future of the Green Investment Bank. I totally agree with the noble Baroness, Lady Kramer, that we need to work across government as a whole, and I shall make sure that all parts of the Treasury are aware of her remarks and see the debate. However, I hope that the noble Baroness, Lady Kramer, the noble Lord, Lord Teverson, and, should he so wish, the noble Lord, Lord Davies, will meet my noble friend Lady Neville-Rolfe at BIS to discuss this matter further. I hope that the noble Baroness will agree to withdraw the amendment.
I am that sure my question is as much of a concern to the Minister as it is to me. The purchasers of this bank could just buy it as an asset to wind down—just to buy the cash flow into the future—which none of us would want. But if there was a public sale, it could indeed happen. That is separate from the ongoing green credentials. Do the Government have an approach to how that might be solved or prevented?
The noble Lord makes an extremely good point, and one that the CEO, Shaun Kingsbury, was asked directly. I am not going to prejudice what my noble friend the Minister in BIS is working on, but that is clearly something that we need to look at. I note that Mr Kingsbury himself said that he believed that the purchasers of or investors in the Green Investment Bank would look expressly to ensure that the specialisms that the bank currently has would continue, and we would want to make sure that that specialism and focus are the core of their investment. That said, I heed entirely what the noble Lord says and will draw it to my noble friend’s attention.
My Lords, I was actually quite heartened by the Minister’s reply, although I suspect not in the way that he intended. He suggested that there were very few obstacles to using the PRA as an appropriate regulator in this case—so perhaps there is an avenue there to be explored. Can the Government look seriously at this issue? I know from having been in government very briefly that to direct the lawyers to look at a way to achieve rather than stop something is a very significant challenge. I hope that now the energies of the Treasury will be focused on this, as well as the energies of BIS. Frankly, if we lose the Green Investment Bank in the role that it plays, we will all be losers. It would be very frustrating to think that that was unnecessary and had only required some significant legal effort to avoid it. I beg leave to withdraw the amendment.
Amendment 20 withdrawn.
Clause 16 agreed.
Schedule 2 agreed.
Clause 17 agreed.
Schedule 3 agreed.
Clause 18: Extension of relevant authorised persons regime to all authorised persons
Moved by Lord Sharkey
21: Clause 18, page 15, line 19, at end insert—
“(2) The terms of the extension under subsection (1) shall not apply to those persons who fall within the definition of “relevant authorised person” in section 33 of the Financial Services (Banking Reform) Act 2013.”
My Lords, last night at 6.39 pm, the detailed impact assessment for the senior managers and certification regime that is part of the Bill appeared in my inbox. At 6.41, it was withdrawn and, at 6.42, it or some version of it was sent again. This was all a bit confusing. But the real problem is timing. It is simply not acceptable to send us an important impact assessment the night before we debate the matter. I have not been able to give this impact assessment anything but the briefest of glances. We need more time to review and think about the contents, but we can now do that only on Report. When we agree the SM&CR issue on Report, could the discussion be held under Committee stages rules? Perhaps the Minister could nod agreement or write to me nodding agreement with that proposal.
Part 2 introduces two very significant changes. It scraps the reverse burden of proof regime for relevant authorised persons, which are defined in the Treasury briefing note as banks, building societies, credit unions and PRA-regulated investment firms. The Bill replaces the reverse burden of proof with a test requiring the regulator to prove misconduct, which is the position we were in before, during and for five years after the crash. In this period, and under that test, no senior manager was jailed and financial misconduct did not cease. The Bill extends this new regulatory regime to all sectors of the financial services industry.
The sections of the Bill that deal with these matters are very complex. I am sure the Minister will say that this amendment has technical defects, and I am certain that he would be right about that. However, we are in Committee and this is a probing amendment. I hope that the intention of the amendment is clear. It does not challenge the extension of a new, less onerous SM&C regime to the wider financial services industry. It seeks to preserve the existing SM&C regime for those currently classified as relevant authorised persons. That is, it seeks to preserve the reverse burden of proof regime for banks, building societies and PRA-regulated investment firms. This would create a two-tier regulatory system. It would allow the regulatory regimes to be proportionate to the risks involved. Those institutions that did, and still can, threaten our financial system would be subject to a tougher regime, but those who cannot or are on the balance of probability unlikely to would be subject to the new lighter regime proposed in the Bill.
“all banks, insurers and securities houses are not all equal in the damage they can do; some are much more equal than others. By extension, rules and regulations designed to impose mild restraint on the giants of the industry can amount to damaging overkill when applied to the typical smaller firm. The answer is a two-tier system of prudential regulation whereby those firms with the potential to put the system at risk are subject to much more intrusive supervision … Guy Jubb, global head of Governance and Stewardship at Standard Life Investments, has suggested something similar for his world”.
A two-tier system is what this amendment seeks to create.
There was considerable anxiety at Second Reading about the Bill’s abolition of the reverse burden of proof regime. In his reply and in subsequent correspondence, the Minister set out the reasons for this reversal. The first is that since the Government propose to extend the regime to all financial services, in the interests of fairness and regulatory coherence it would be vital that the regime be rolled out consistently across the industry. He said:
“it would clearly not be proportionate to apply the reverse burden of proof across the financial sector, including to the small organisations that will now make up the majority of firms which will come under the regime, and which pose more limited risks to market integrity and consumer outcomes”.—[ Official Report , 26/10/15; col. 1081.]
The Minister singled out credit unions as an example of the kind of small firm that would suffer disproportionately under the reverse burden of proof regime, which I remind the Committee has not yet come into force. Here, I entirely agree with the Minister. Credit unions should never have been in the category of relevant authorised persons in the first place and should be removed. However, I disagree with all the other aspects of the Minister’s argument. It entirely ignores the different risk potentials of the major institutions and the about-to-be newly regulated firms, except to say that it would not be fair to impose the stricter regime on the whole sector. It would not be fair, but the stricter regime for relevant authorised persons was made law for all the good and necessary reasons advanced by the Parliamentary Commission on Banking
Standards and accepted by Parliament and the Government. These good and necessary reasons, well rehearsed at Second Reading, are still entirely valid. The facts have not changed. The reverse burden of proof is still needed.
In evidence to the Parliamentary Commission on Banking Standards in January 2013, Tracey McDermott, then director of enforcement and financial crime and now acting CEO of the FCA, stated that the inability to impose sanctions on senior executives was first and foremost due to the evidential standard required to prove their liability. She said that,
“the test for taking enforcement action is that we have to be able to establish personal culpability on the part of the individual, which means falling below the standard of reasonableness for someone in their position”.
That regime produced no convictions or charges against senior managers, and that is exactly where we will be again if we scrap the reverse burden of proof for senior managers in banks, building societies and PRA-regulated investment firms. The extension of the regulatory regime to less risky firms requires a lighter touch, but this does not imply that this same lighter touch should apply to much riskier organisations currently subject to the reverse burden of proof regime.
The Minister advanced two other reasons for removing the reverse burden of proof. The first is that, as Andrew Bailey asserted, it is leading to individuals and their advisers spending more time and resources on mitigating the risk of being held personally liable for breaches on their watch than on running their firms in a manner consistent with regulator’s objectives. This does not seem to fit with the details of last night’s impact assessment. It assesses the maximum cost benefit to large firms as 10% of current costs and as more likely to be 5%. This does not sound as though the lighter-touch regime will free much time or resources. In any case, Parliament’s intention was precisely that these people should spend more time and resources ensuring compliance with the rules. We know what happened when they did not do that. Mr Bailey went on to say that he sees the reverse burden of proof giving rise to a box-ticking mentality. Perhaps it may, but required behaviour often precedes and leads to cultural change.
Another point was raised by Mr Bailey. He said there has been noise around the reverse burden of proof that has been distracting future senior managers from complying with the spirit of other important aspects of the regime. He does not say how he knows he is not being gamed on both these points. I assume he would not deny that financial institutions attempt to game regulators and that he has been told of these things by bankers and others subject to the reverse burden of proof regime. How has he tested what he has been told? How does he guard against and discount obvious special pleading? Without this information, his arguments can have little force.
There is one other argument I have heard made, entirely understandably, about the reverse burden of proof: it runs counter to our strong legal tradition of “innocent before proved guilty”. There is ample precedent for this in law. The reverse burden of proof has been used in the Road Traffic Act 1988, the Health and
Safety at Work etc. Act 1974, the Terrorism Act, the Misuse of Drugs Act 1971, the Trade Marks Act 1994, the Criminal Justice Act 1988 and the Official Secrets Act. The House of Lords, sitting as the Law Lords, dealt with the issue in Sheldrake 2004, UKHL43. It made plain that each statutory provision must be considered on a statute-by-statute basis. The decisive factor before the courts is whether the reverse burden is necessary to ensure that the offences remain workable. Without it, these offences were not workable. That is precisely why we need, and is the justification for, the reverse burden of proof. That has been said and is the case here. This argument has not been advanced in our discussions so far, perhaps because the Minister is familiar with the current status in law of other examples of the reverse burden of proof. As noble Lords will know, the
Telegraph reported on August 29 that Sir Eric Pickles is considering using the reverse burden of proof in his unexplained wealth orders, which I assume are a precursor to undeserved wealth orders.
The fact is that none of the Minister’s reasons for abandoning the reverse burden of proof stands up to scrutiny. We need the reverse burden of proof regime for systemically risky organisations for the reasons advanced by the PCBS and others. Life has not got better, financial misconduct has continued and no senior managers have been punished. The regime that makes punishment not happen is the regime, effectively, that the Bill wants to restore to banks, building societies and PRA-regulated investment firms. Our amendment is aimed at preventing that. The amendment does not interfere with the extension of the regulatory regime. It tries to retain the already approved and enacted regime for riskier, systemically dangerous firms and allow the lighter regime for those firms that are less risky and not systemically dangerous.
We need to be able to hold senior managers personally and directly accountable. As Senator Warren said:
“If large financial institutions can break the law and accumulate millions in profits and, if they get caught, settle by paying out of those profits, they do not have much incentive to follow the law”.
I beg to move.
My Lords, I shall speak against Amendment 21. I confess that my expertise does not rival that of the most reverend Primate the Archbishop of Canterbury, who justly won plaudits for the seriousness and skill with which he served on the Parliamentary Commission on Banking Standards. Regrettably, he cannot be in his place today, but I am at one with him in supporting the Government’s intentions on the reverse burden of proof.
One of the important functions of the parliamentary commission was to consider the change of culture of banks and the standards of conduct of those working in them, particularly its senior managers. Anger, disbelief and misery was felt by so many following the crisis that engulfed the British economy in 2007-08, much of it directed at the banking industry. That anger and disbelief were compounded when those best remunerated within the banks seemed to demonstrate little or no accountability for their actions. Rather, the burden was borne by society as a whole and it was the poorest who suffered most and, arguably, continue to do so. The ability of well-funded senior managers in the banking sector to evade responsibility was considerable. My assessment is that the commission saw sufficient evidence that there was a balance to be redressed. Small wonder that the commission sought to protect the public, including the taxpayer, with a robust regulatory regime and suitable civil and criminal penalties. This included several provisions with a reverse burden of proof.
A reverse burden of proof would mean that senior managers would have individual responsibility for proving that they had fulfilled their regulatory obligations, rather than regulators having to prove that they had not. This goes against the ancient common-law principle of “innocent until proven guilty”. The proposed reverse burden of proof seems to require senior managers in the sector to do something required in no other sphere of work, and which, from a philosophical perspective, causes concern. It is absolutely right that the individual is obligated to ensure that they take reasonable steps to prevent regulatory breaches in their financial institution but, as with other parts of society, it is right that the burden of proof should sit with the regulator to prove such breaches beyond reasonable doubt.
Secondly, I want to express my anxiety at the creation of a two-tier system of regulation in which deposit-taking institutions, including credit unions and building societies, are obligated to operate under the reverse burden of proof but other financial institutions are not. The need to ensure financial stability in the sector is vital, particularly among the largest institutions, but there seems to be a certain arbitrariness regarding who would be covered by the reverse burden of proof. I fear that a two-tier system would risk confusion or a loss of focus both within the banks and other financial institutions, and on the part of the regulators.
Well-funded individuals and corporations are capable of all manner of misdemeanours across our society, in all sectors of the economy. To introduce a reverse burden of proof only for senior managers in the financial services sector would set a grave precedent. What of those accused of pollution, negligence or failure to care? Where would it be extended next, further eroding the fundamental rights upon which our society is properly based? For the sake of all, not least those without the backing of considerable funds, we should continue to insist that the burden of proof must fall on regulators, prosecutors and those in authority who affirm that wrong is done. Better, as in the published Bill, to have a provision that contains a presumption to act reasonably and for regulators to prove that an individual has done otherwise. In view of these concerns, I humbly urge your Lordships’ House to reject the amendment.
My Lords, I draw the House’s attention to my declaration of interests. Before coming to the reasons why I believe that the removal of the reverse burden of proof is a wise move in both practical and administrative terms, I want to say that its removal restores the principle of natural fairness—a fundamental principle of British law to which the right reverend Prelate has just referred, and, if I may be so bold, one to which even bankers are entitled. Also, as again the right reverend Prelate has said, the creation of a two-tier system would not be a very helpful situation to move towards.
The importance of the City of London to the British economy will be a given among your Lordships. If that position is to be retained, bearing in mind some of the abuses we have seen in recent years, it needs to be underpinned by a strict and proper regulatory framework. Under these proposals for senior management conduct, which are supported by the PRA, senior managers remain responsible for taking reasonable steps to oversee the areas for which they are responsible.
The revised disciplinary provisions in the Bill provide that regulators will be able to take action against senior managers on three grounds: first, a breach by the senior manager of the conduct rules; secondly, the senior manager being knowingly concerned in a breach by the firm of its regulatory obligations; thirdly, where there is a breach by the firm of its regulatory obligations in relation to the area for which the senior manager is responsible, a failure by that senior manager to take such steps as a person in his or her position could reasonably be expected to take to avoid a breach occurring or continuing.
The first of those two grounds would also be grounds for action against any other employee or director of the firm, while the third ground in effect replaces the reverse burden of proof. In all three cases the burden of proof now rests with the regulators. Importantly, the FCA’s reaction to these changes makes it clear that the regulators,
“remain committed to holding individuals to account where they fail to meet our standards”.
I therefore believe that the Government are right in claiming that senior managers will remain subject to the same tough underlying conditions. The statutory duty, together with the statement of responsibility, means that senior managers will no longer be able to plead ignorance in these matters.
I make one final point, which to many noble Lords may seem a mere footnote to the bigger issues we are discussing. One of the great attractions of London is that it is truly the most international city in the world. Not surprisingly, therefore, many of the most senior positions in the City are held by non-British citizens. If you are running a global business, in many instances you can just as easily manage that with your team from New York or some other financial centre. I am advised that, had the reverse burden of proof remained on the statute book, many senior managers may well have declined to be posted to London, and that some now here would have moved as soon as a suitable opportunity arose. I believe that we have here a rigorous regulatory framework of the type we need, which no longer carries within it what might well have proved to be a strong disincentive to senior non-British bankers to base themselves in London.
My Lords, I support the amendment of the noble Lord, Lord Sharkey. I bring to the attention of the Committee my position as deputy chairman of the Banking Standards Board, but I speak here in a personal capacity.
This measure abandons a key element of the recommendation of the Parliamentary Commission on Banking Standards—a decision that was unanimous among its members, including the most reverend
Primate the Archbishop of Canterbury. We all signed up to the recommendation to hold senior bankers to account. The essence of the recommendation is that, if misconduct or prudential failings take place, in order to avoid sanction senior managers have to demonstrate that they did all they could to prevent them happening.
I remind the Committee why we came to that decision. We sat for two years and asked 10,000 questions. We questioned senior executives of banks, whose response when anything went wrong was, “No see, no tell. Nothing to do with me”. In fact, senior executives were content to come across as incompetent rather than culpable, no doubt advised to do so by their lawyers. We covered examples such as PPI, which went on for 20 years. I questioned the former chief executive of Lloyds. I asked him, “What about PPI? It’s cost you about £12 billion”. He replied, “Oh, we were on the side of the angels as far as PPI was concerned”. This is a group of people divorced from the reality of the situation in society, and that is why the parliamentary commission unanimously made this recommendation.
I shall give your Lordships another example. We had four UBS executives lined up before us. We were told informally that their salary was probably £100 million a year. One of their star traders had lost more than $2 billion in Hong Kong, so naturally we asked, “Did you know?”, to which the answer was “No”. We said, “You didn’t know what your star trader was doing? Fine. So when did you find out?”. The answer was, “Oh, we found out on the Bloomberg wires”. In other words, it took someone outwith the company to tell the most senior managers that one of their star traders had lost $2 billion.
The director of corporate affairs, Tracey McDermott, came before one of the sub-committees in relation to this issue. She is a very competent and professional person. We asked her, “What happened with the UBS situation?”. She said, “We examined it but the trail went cold. In other words, we couldn’t pinpoint anyone in the organisation who was culpable because there wasn’t a sufficient organisational chart”. Her evidence indicated that at that time—this was mentioned by the noble Lord, Lord Sharkey—the FCA was unable to impose sanctions on senior executives, first and foremost due to the evidential standard required to prove their liability. She added:
“The test for taking enforcement action is that we have to be able to establish personal culpability on the part of the individual, which means falling below the standard of reasonableness for someone in their position”.
That entails showing that senior executives failed to reach a reasonable conclusion and, as the Bill stands, that will remain the evidential standard for proving culpability. So we are back to the future here—a future that has failed time and again. That is why the Parliamentary Commission on Banking Standards was very frustrated at the situation and said that something had to be done in civil law. However, the new standard in the Bill will not effect the change that it is supposed to bring about because the evidential standards remains the same and, as a result, we are going back to an old regime.
I remind the Committee of the long list of recent failures, not least IPOs, LIBOR and forex. Those are what are called the three lodestars of the market, and they were all rigged. It was a corrupt market, and the Parliamentary Commission on Banking Standards was very clear, from the evidence it received, that it was a corrupt market. We had evidence from HBOS, UBS and RBS. PPI mis-selling went on for 20 years and cost £40 billion. What does £40 billion mean? It is about 2% of the country’s GDP, so, paradoxically, the PPI fines helped economic growth. I do not want to live in a country with standards like that.
What did we get from the government response? The noble Lord, Lord Sharkey, met the Minister, Harriet Baldwin, who said that reversing the burden of proof would drive talented people here abroad. That is a canard we have heard for 20 years in the financial services industry, and it is a mentality we have to change. It is quite clear that the Government included the burden of proof because of the unanimous recommendation of the Parliamentary Commission on Banking Standards. They have now taken it out of the legislation because of sustained bank lobbying. Purely and simply, that is the reason. If the Government were honest about that, we would know the direction they were following.
There is a societal dimension to this. I have come from a meeting this morning with people in the City, at which we were talking about this issue. The societal dimension is that, first, no one has ever gone to jail; secondly, no one has ever been held personally culpable, except for one person who got a £500,000 fine; thirdly, the mis-selling scandal, costing more than £40 billion in the UK and more than $200 billion globally, is seen by the financial services industry as a way of doing business because the fines levied do not come out of individuals’ pockets. Until the Government try to change that, public opinion will certainly be against them.
The view has been put forward that taking such action would not be legally sound, and the noble Lord, Lord Sharkey, referred to that. I remind noble Lords of the Sale of Goods Act. If a consumer asks for a product to be repaired or replaced within six months of sale, the retailer has to prove that the goods conformed to the contract in disputed cases. Why cannot the same provisions apply to the financial services industry?
My Lords, I do not wish to interrupt the noble Lord in full flight but I should like to put on the record that the most reverend Primate the Archbishop of Canterbury signed up to the reverse burden of proof, having lost the argument in the PCBS that the reverse burden of proof was unjustifiable. I think that slightly puts in context the phraseology he used.
The commission valued enormously the contribution of the most reverend Primate the Archbishop of Canterbury. However, if we feel strongly about something, it can be a matter of record. I take the point about the unanimity of the commission, and will come to an area where I disagreed with it. I did not get my way, but signed up to it. So it is a case of tit for tat and one for one with the most reverend Primate.
This measure sends out the wrong signal—that Parliament is unfairly on the side of the banks rather than on the side of the public. The Parliamentary Commission on Banking Standards was very clear on enforcement action. We described it as being,
“as rare as hens’ teeth”.
The public want effective reforms. They want senior managers to be personally culpable. They want fines on individuals, not companies, because when the fines are on companies it is the shareholders—ordinary members of the public—who pay them. So the public are being denied and punished twice. The public—I include the noble Lord, Lord Sharkey, and others—want a fair market where risk is rewarded, but where failure is punished. That has not happened.
The point was made about the most reverend Primate the Archbishop of Canterbury. I pushed the concept of duty of care in the Parliamentary Commission on Banking Standards. It did not accept it as a recommendation, although it was in the report. If the Government were serious about this, they would adopt a duty of care, which would transform the financial services industry. My good friend John Kay, who has just written a book on that, Other People’s Money, agrees with me on this issue.
In the absence of the Government doing anything, when we come back to this on Report they will really have to think about how they can make senior executives personally responsible. Otherwise, the value of the Bill and the reforms, the expenditure and the time we have spent on the Parliamentary Commission on Banking Standards will count for naught. It is time for a reassessment by the Government between now and Report. I hope the Minister takes that seriously.
My Lords, I oppose this amendment. I have listened to the noble Lord, Lord McFall, and I fully agree—I suspect we all agree—that the examples he has mentioned of culpable things that have gone wrong cannot be acceptable. However, hearing his comments on the demands of public opinion makes me even more certain that we should oppose this amendment, because the rule of law must be upheld and we must allow the innocent to remain innocent until proved guilty.
Regulation is terribly important and we must give appropriate powers to the regulators to enable them to undertake their work effectively, including the ability to search out evidence in order to ascertain what went wrong and who was responsible. They must be able to break down any firewall that the institutions might have erected. Employees in financial institutions must fear the consequences of acting badly and know that if they break the rules the consequences could be very severe, including heavy fines and maybe a prison sentence.
If we have failed to achieve these things, however, the answer is not to shift the burden of proof so that the defendant has to prove his innocence. That would be tantamount to giving up the challenge. Instead, we must tighten up the regulator’s powers and create an appropriate and effective regulatory regime, one that can achieve what all of us want, which is to protect those dealing with the financial institutions and punish those who fail in their duties.
In this Bill, the Government are aiming to do just that, by extending the regulatory regime to all financial services firms and to give power to the regulator to make and enforce rules of conduct. This materially strengthens the regulator’s position. In so doing, it rightly reverses the burden of proof so as no longer to presume guilt, requiring the defendant to prove innocence, and we should not now allow that to continue.
I welcome the Government’s proposals for several reasons. First, I believe it is right to extend the regulatory regime across the whole financial services industry and thereby strengthen regulation. It is also right that we should not change a fundamental tenet of English law, which is that a person is innocent until proved guilty. As I have indicated, to reverse the burden of proof in this way is an excuse for failing to create an effective regulatory regime. Indeed, it is a lazy way of dealing with a problem and should not be countenanced. The provision that it is now proposed should be reversed, frankly, should never have been enacted. I am pleased that the Government have now recognised this.
In proposing this change the Government seek to treat all financial institutions in the same way. Surely that must be right and fair. Why should there be one rule for large institutions and another for smaller ones? If a financial institution or someone working there breaks the rules then there should be a consequence, and everyone should be treated equally. Any suggestion that there should be a two-tier system so that the present law presuming guilt applies only to certain institutions, but the burden of proof shifts for those institutions that now come within this regulatory regime, is unfair. We should not discriminate between institutions. This could lead to unfair competition and could prejudice the very people we wish to protect—the consumers and customers.
The effectiveness of these new rules, once in force, should be carefully monitored and scrutinised. If, despite the extension of the regulatory regime now proposed, more is required, the Government must not shy away from a further extension of regulatory powers. However, in so doing, they should not then restore the short cut of shifting the burden of proof.
My Lords, I cannot in any way better the speeches of my noble friend Lord Sharkey and the noble Lord, Lord McFall, but maybe I could make a few additional comments.
First, there is the argument in favour of a two-tier system. The regulator is already managing the banks and the financial services industry as a two-tier system. There are different rules for systemically important institutions and for the much smaller institutions whose behaviour cannot disturb the financial stability of the country. If the principle is that the banking industry and the financial services industry should be regulated only under a single tier, the Government are, in a sense, demanding that a great deal of regulation be rolled back, which, they are currently arguing, makes us more secure. We have a two-tier system; we are arguing that that two-tier system should encompass this kind of liability.
I want to also talk about the difficulties in pursuing senior managers when their institutions have been involved in outrageous and illegal behaviour. These are not victimless crimes, although they are often treated as though they are. The collapse of the banking system had a huge impact on people up and down the country: people lost their jobs, had to live through a period of suppressed wages and have seen public services cut. The experiences of ordinary people over the last five years have been wretched, and the trigger for that crisis was a financial crisis created by systemic financial institutions—so many people suffered as a consequence of that.
If I look at the misbehaviour inside the banks, I see that those were not victimless crimes. The families that paid for PPI that they did not need and could not use were often families without large resources—the cost mattered. Small businesses were persuaded to enter into interest rate swaps that were completely inappropriate for them, and some went under as a consequence of the problems generated by those swaps. Money laundering, which was on an industrial scale across many of our institutions, supported the drugs trade, prostitution and people trafficking, all of which did extensive damage to our communities. LIBOR mis-selling and mispriced mortgages and loans for individuals over a long period of time came at a significant cost to them, as well as, frankly, bringing the City of London into disrepute and, for a time, putting it at risk as a financial centre. We know that the United States seriously considered whether or not London could continue to be a major player if it could so poorly regulate its financial institutions as to allow manipulation of a core measure such as LIBOR.
There are serious victims of the various behaviours that we have seen in banking institutions. This requires action to ensure that we do not experience it in future. The House might be interested in the reaction of the banking community to the proposal that the reversal of the burden of proof is abandoned. I received a briefing provided by Simon Lewis, OBE, chief executive of the Association for Financial Markets in Europe. He, of course, is in favour of the removal of the reversal of the burden of proof. However, this is the argument he makes:
“The reversal of the burden of proof creates a conflict of interest between the senior manager and the firm of which he/she is a senior manager. Senior managers will be concerned to protect their own positions and less disposed to participate in the collective decisions of their boards and management committees”, and also, he insists, to listen to challenges to independent control functions. He continues:
“Senior managers will be concerned to protect their own position and less disposed to participate in the collective decisions of their boards and management committees”.
Is that not exactly what we want? We want each individual manager to examine their conscience, to look at the issues, to identify risk—and not to set them aside because the group collectively makes a decision to overlook the underlying issue and the violation.
This is exactly why we must try to break that constant groupthink that has infected bank after bank, particularly those led by charismatic and aggressive chief executives who are able to enforce their personalities on their institutions.
The reverse burden of proof forces on chief executives the strategy of bringing on to their boards individuals who will challenge them; of setting up systems that will challenge; of making sure that compliance and other kinds of risk management processes within their organisations are aggressive, report up and expose. We have said that culture matters, and the reverse burden of proof finally puts on chief executives an imperative to behave in such a way that they de-risk the culture of their own institutions and make sure that wrongdoing is brought to attention rapidly and dealt with.
This was not the culture that prevailed within our banking institutions prior to the banking crisis. The Parliamentary Commission on Banking Standards was shocked that the crisis did not change the culture. It was only as we were taking evidence and the LIBOR scandal was exposed, more money laundering was exposed and the interest rate swap scandal was exposed that banks began to respond and finally, because there was so much light and attention, began to rethink how they should manage their own organisations.
I know from sitting on the sub-committee which took evidence from below the board management that there was still a culture of what was identified as collective responsibility. No one took responsibility individually for the behaviour that happened in their institutions; everyone took cover from the collective. That allowed so much of the misbehaviour that took place.
To give the Committee some further understanding of where the thinking of the banks is going, I would like to quote from an article that was forwarded to me today. It is entitled “Culture and culpability, are we finished with banker bashing?” by Ashley Kovas of Regulatory Intelligence. He captures what I recognise as broadly the thinking within the industry. He says that,
“it is by no means clear to what extent people should be punished for actions done in accordance with their prevailing culture”.
That is very much the message we received from banking institutions. As part of their employment role they absorbed and reflected the culture that was established by senior management. For that reason we have no history of whistleblowing in this industry; there is very little evidence that individuals resist and, if they do, that they manage to remain within the organisations of which they are part. The noble Lord, Lord McFall, and I took evidence from a number of people who, within their own companies, identified various issues around risk and compliance and, essentially, lost their opportunities for promotion or were fired and replaced by more amenable individuals. Changing that culture is not easy.
So, as the noble Lord, Lord McFall, said, we turn to the regulator. The noble Lord, Lord Gold, argued that the regulator needs to be rigorous. Our regulators are highly capable individuals and the fact that they could not in any single instance penetrate through not only one institution but every institution that had been involved in misbehaviour makes it clear how impossible it is for the regulator to act. Senior managers within these organisations are well advised and supported by great legal expertise—and that legal expertise makes sure that there are firewalls in every possible place and that information does not flow up.
We heard about the UBS example and it was extraordinary that senior management, who had received huge bonuses as a consequence of the mispricing of LIBOR, then argued that they did not notice what was happening in their institutions and recognised it only when it was brought to their intention by the media. These firewalls are tough and tight. It is sensible that we should recognise in Parliament that institutions with the kinds of resources that banks have are pretty much impossible to ever penetrate. That was the argument that led the commission to the reverse burden of proof. Given the misbehaviour that was evident, for example, on the trading floor or in the retail bank that was selling PPI, if we had thought there was any mechanism—any reasonable way to proceed upwards through the chain—that would enable us to follow up through to the key decision-makers of the institution, we would have opted for that route. However, no one could present to us a way in which a bank could be required to be structured to enable that trail to be followed.
The noble Lord, Lord McFall, and I were at an event at which John Kay made a remark about senior management which I think was right—“You take the bonus, you take the rap”. That is a fundamental principle which cannot be achieved unless we have a tool such as the reverse burden of proof. These institutions have made sure that they are impenetrable and the regulators in the UK have never found a way of penetrating through.
My Lords, I declare my interests as set out in the register but particularly as a practising solicitor for nearly 50 years.
I heard the noble Baroness talk about fundamental principles. For me, no principle is more fundamental than the presumption of innocence, as one sees in the way that that has been set so deeply within justice systems, particularly in this country. In contributing to this debate, I come at it in a different way: I do not like the reverse burden of proof in any event. However, I have to recognise the extent of the problems that people have set out so clearly, so that would accompany my welcome of the Government’s decision to have what in effect will be the same statutory duty of responsibility right across the financial services industry. I hope there will be a clear message to the industry that, although we recognise that regulation has to be proportionate, there is no way that we can allow to continue the lapses in conduct and responsibility that have taken place.
“My firm belief is that if the financial services industry is to restore the trust and confidence of those it is here to serve firms should not just aspire to meet our rules. They should aspire to be better than that”.
I have always strongly believed in self-regulation. As a solicitor, what I call super rule No. 1 guides us so that, all right, the rule of law has to be observed, but our code of ethics and professional standards should govern everything we do. I just hope that the message will go from this House to the financial services industry that it should follow the example of the professions that set the highest possible professional standards.
I welcome the noble Lord’s comments, in particular that senior managers have to perform way beyond the call of duty. Will he therefore support my call for a duty of care on the industry, thereby avoiding the reverse burden of proof?
There is a duty of care. It depends on how much you enact to support the duty of care. As far as I am concerned, the customer, the consumer and the client matter most of all. With that there is an associated duty of care; there has to be.
I hate to quote Socrates to the noble Lord, but I seem to recall that it was he who said that good men do not need laws while bad men will always find a way around them. So the more you set out rules and regulations and duties, the more you enable people to find ways around them. My argument to the noble Lord is this: can we get away from trying to set down in legislation, rules and regulations everything you can do and everything you cannot do? Can we not return to that essence of your own principles, namely your duty of care and responsibility?
I hope that the noble Lord will not mind if I try to avoid following him down that route. I hope that noble Lords will understand that my objection is that I dislike in any event the reverse burden of proof. I welcome the fact that it is to be abolished, but I want to send a message that the financial services industry should be composed of people who put the customer, the consumer and the client first and observe the highest possible principles both professionally and in the standards they seek to maintain.
My Lords, I do not mean to be in any way offensive to the noble Lord, but we cannot afford to be naive. We were naive for decades and in that period significant abuse took place. I am not talking just about a failure to make proper credit decisions. If we look at RBS, we can see that it lost money the old-fashioned way. It made very foolish loans and abandoned appropriate credit standards. You could call that incompetence rather than venality. But what of money laundering, LIBOR mis-selling and PPI mis-selling? These were not failures of competence; they were quite deliberate abuses of the customer on an industrial scale, year after year after year. The assumption that all the people engaged in those activities have either changed who they are or have left the industry is, may I suggest to him, naive?
Part of the underlying problem is that so much money is at stake here. For senior people who turn their eyes away from abuse, there are very substantial financial rewards. As we have seen, even when there are some penalties such as clawback, they are only a small proportion of extraordinary rewards. We are in a situation where the risk is high if abuse continues. I understand the noble Lord’s concerns over the reverse burden of proof, and I do not support it lightly, but as my noble friend Lord Sharkey said, we have on the statute book at least 10 or 11 other Acts, frequently supported by Members of this House, which have decided that the reverse burden of proof is necessary because it is the only way for the law to be effective.
I am not sure that I am supposed to try to answer the noble Baroness. Perhaps I may just say that if she examines her basic beliefs, she will agree with me that the presumption of innocence is a fundamental human right. I suppose we disagree because the noble Baroness would like to see a two-tier system. I find that very difficult to justify.
I revert back to my view that complementary self-regulation is the way forward. If the trust and confidence that the public had in the financial services industry is to be restored, the message has to go out to the industry that, rather than be subjected to even tougher statutory rules and regulations, the time has come for it to take the lead and determine how its businesses are to be run in the interests of the customer. I hope that that will be the message that goes out from this debate.
My Lords, I had not intended to intervene on this amendment, and before I speak, perhaps I had better remind the Committee of my interests as set out in the register. I think that everything has been said about the natural justice and injustice of the reverse burden of proof, particularly on this side by the right reverend Prelate the Bishop of Southwark. I do not want to take that line because the argument is clear; rather, I want to add two practical thoughts. The first is that if there has been wrongdoing in a financial institution, I do not think that anyone in this House would support the guilty parties getting away with it, however senior they are in the organisation. The question is not whether they should get away with it but whether the powers exist to enable the regulators, and then the proper prosecuting authorities, to take appropriate action. I remind the Committee that the PRA has very extensive powers. If the authority considers that there has been malfeasance in a financial institution, it is able to go in and trawl through the records of that institution in great detail, to the extent of looking at email trails.
I believe that the noble Lord, Lord Carrington, is referring to the FCA, but regardless of that, he has mentioned email trails. Is he aware that the absence of email trails was a fundamental part of the regulator’s decision that it was not able to pursue a single case to senior management level? There was an absence not only of email trails but of any other record which would enable pursuit of a trail from the bottom upwards. The evidence for that is very clear in the transcripts of the Parliamentary Commission on Banking Standards.
I am sorry to keep bobbing up and down, but the point that was made was that those in charge are very careful that there is no email trail and no written trail. That is one of the points about the reverse burden of proof: in effect it requires senior managers to allow an email trail to exist, or indeed some sort of audit trail, because they would be in a position where they would be required to demonstrate that they had taken reasonable steps. When the burden shifts back to the regulator, the regulator is completely stymied at the point where all conversations and exchanges take place in an environment where there are no minutes, no emails, no memos and no existing trail.
I will come on to that in a moment; that is the second point I wish to make. The first point is that the power does exist for the PRA—and, indeed, the FCA—to be able to go and investigate what has happened inside a financial institution in very great depth and in very great detail.
The consequence of the reverse burden of proof would be to make the situation to which the noble Baroness referred even worse. An organisation which knows that there is individual liability where they have to prove that they did no wrong will have lawyers crawling all over them to make certain that at every move, nothing is recorded, nothing is said and nothing is minuted which would put them in a position where they could do anything other than deny all culpability. That is what would happen—and to some extent does happen. But I can reassure the House that destroying email trails is extraordinarily difficult. In most institutions, email trails survive through even the greatest attempts to wipe the hard drives clean. I can assure the noble Baroness that if the PRA wishes to find evidence and has the resources, the determination and the suspicion, it will find the evidence to bring the prosecutions it needs.
My Lords, this has been an excellent debate and the Minister has a great deal to which he needs to respond. It is little surprise that we have been exercised with these amendments, because they go to the very heart of people’s trust and confidence in the financial services industry.
I would suggest that perhaps one reason why this change has been effected by the Government is because of the lack of transparency in the government proceedings. That is why the controversy has arisen. None of us has been privy to the process whereby the Government produced this significant change to the senior managers and certification regime. Clearly, decisions have been taken behind the scenes and without consultation. I do not think that there is much of an email trail on either of those factors.
The fact is that the Government did not even consider that this might be much of a problem, and today’s debate identifies just why that is. I hope, therefore, that the Minister will be able to demonstrate the thought processes behind these changes. The age-old argument that it is not working in practice scarcely holds, because the SM&CR never had a chance to work in practice—so the Government will have to come out with a better argument than that. What advice did they get that convinced them that these changes were the best approach? Did an event occasion the change? Are the meetings that the Minister had on such a significant issue as these proposed changes on the public record?
We also need to consider the role of the regulators and how we can ensure that they are bold enough to spot when misconduct takes place. Has their job not been made harder by the fact that there will no longer be a duty on firms if they suspect wrongdoing? Can the Minister please go into some detail about how the Government propose to ensure that the regulators will be able to rule out ineffective management? We have had a refresher course today in just what ineffective management—and, indeed, corrupt management—has done in terms of damage to so many people’s lives. We ought not to forget that.
I hope that the Minister will be able to address these points in some detail. Of course, he has to take into context just what this debate has demonstrated: how difficult the issue is, but how fundamental it is to the welfare of our society. I expect the Minister to give a detailed response.
My Lords, it has been a very good debate and I thank all noble Lords who have spoken eloquently, and powerfully at times.
I start by taking a step back. As was mentioned by the noble Baroness, Lady Kramer, and many others, the financial crisis obviously exposed deep flaws in the functioning of parts of the financial services industry, with enormous consequences, as we all know, for the economy and people’s living standards. Since then we have also seen cases of malpractice and, at times, criminality—for example, attempts to manipulate benchmarks for personal gain. That is why, as the Chancellor said, the Government are entirely committed to ensuring that the UK financial services sector is the best regulated in the world with markets of unquestioned integrity and the highest standards of conduct. To that end the Government have made far-reaching reforms to financial regulation—reforms that form the backcloth of today’s debate and reforms that your Lordships know all too well.
I shall remind your Lordships of just a few. The Government have introduced a criminal offence of misconduct in the management of a bank. This means that senior managers who recklessly cause their institutions to fail may face a seven-year prison sentence. The UK’s regime for regulating the remuneration of senior staff who can pose risks to financial stability is now the toughest of any major financial centre. PRA-approved senior managers in banks will face deferral of a significant proportion of their remuneration for seven years, and possible clawback to their pay for up to 10 years where there is a material failure of risk management in their business.
These measures apply to exactly the individuals targeted by the amendment of the noble Lord, Lord Sharkey, and encourage the responsible management that he and of course we all wish senior staff in banks to display. To be clear, I am in complete sympathy with the outcomes that the amendment seeks to deliver. Before I turn to the senior managers regime in more detail, I make another point, which my noble friend Lord Hunt of Wirral made. To restore trust in financial services, strengthened regulation needs to be supported by industry action. That is why I welcome and wholeheartedly support the efforts by the financial sector to strengthen the culture and ethics of all staff. In particular, the Banking Standards Board, formed of the largest banks and building societies, is doing vital work. The fair and effective markets review established by the Chancellor is also prompting change. The review concluded that,
“markets require stronger collective processes for identifying and agreeing effective standards of good market practice”.
As a result, more than 30 firms from a broad cross-section of financial markets have combined to achieve these aims.
The extension of the senior managers and certification regime across the financial sector will support and reinforce all these initiatives to improve individual accountability and raise standards. As Andrew Bailey said,
“it creates the framework to establish effective responsibility within firms, while maintaining the role of the public authorities, the PRA and FCA, for supervising and enforcing the public interest”.
Under the current approved persons regime, the regulators can take action only against those individuals whom they pre-approve if they breach one of the statements of principle set out by the regulators—enforceable standards of conduct that apply on an individual level—or if they are knowingly concerned in activity that causes the firm to breach regulations. The range of approved persons covers significant influence functions, such as the chief executive and directors, and customer-dealing functions, such as sales staff. The new SM&CR focuses pre-approval activity much more closely on those at the top of the firm with enhanced powers for the regulators to impose conditions and time limits on these approvals. This is supported by an ongoing requirement for the firm to assess senior managers’ fitness and propriety annually. The regime requires these individuals to have statements of responsibilities to give absolute clarity about who is responsible for which parts of the firm. It will not be as impenetrable as the noble Baroness, Lady Kramer, said. Beneath the senior managers layer is the certification regime. This puts a statutory responsibility for ensuring the fitness and propriety of key staff below senior managers clearly on the firm both at the point of hiring and annually thereafter.
The new regime also enables the regulators to apply enforceable rules of conduct to all employees if the regulators judge that this will advance their objectives. For senior managers, this includes a rule on effective and responsible delegation, which addresses the “nothing to do with me” argument that the noble Lord, Lord McFall, eloquently talked about and the noble Lord, Lord Tunnicliffe, mentioned. The rule states:
“You must take reasonable steps to ensure that any delegation of your responsibilities is to an appropriate person and that you oversee the discharge of the delegated responsibility effectively”, as well as requiring them to ensure that the area of the firm for which they are responsible can be controlled effectively.
Overall, this creates an enhanced regime where accountability is stronger and clearer, where firms must take responsibility for ensuring the ongoing fitness and propriety of senior managers and other key staff, and where the regulators are able to hold relevant individuals at all levels to account if they do not uphold proper standards of conduct. Therefore, I reject the allegation that that is going back to an old regime. It is in this context that I ask the House to consider the role of the Government’s proposed duty of responsibility. I have mentioned that currently the regulators can take action against an approved person if they break one of the statements of principle or are knowingly concerned in a breach of regulations. The combination of the statutory duty and the statements of responsibilities I have described adds a significant third limb to the regulators’ existing enforcement powers with regard to senior managers.
Under the duty of responsibility proposed by the Government, senior managers will be required to take reasonable steps to prevent regulatory breaches in their areas of responsibility. This means that the regulators will be able to hold senior managers in any authorised financial services firm to account for failings occurring on their watch. Senior managers will not be able to avoid this either by claiming ignorance of the circumstances leading up to the failings or by denying that they were accountable for the relevant area of the firm’s business in the first place. This is a serious obligation, with serious consequences if it is not met. A senior manager breaching the statutory duty can be subject to an unlimited fine and/or prohibition. Therefore, the extension of the senior managers and certification regime will significantly strengthen individual accountability across the financial services sector.
I turn to the noble Lord’s amendment and the question of reverse burden of proof. The Government are committed to introducing regulation that is robust but it must also be proportionate and, as far as possible, create a level playing field to support competition. These characteristics are vital for putting downwards pressure on costs to consumers and supporting innovation to help maintain a vibrant, creative, globally competitive industry. The extension of the regime changes the parameters of the debate around the appropriateness of the reverse burden of proof. I shall explain why. As we have discussed previously, the reverse burden of proof is causing banking sector firms and their senior managers to focus on ways of limiting their personal liability should things go wrong.
As Andrew Bailey has testified to the Treasury Select Committee, a tick-box form of compliance is emerging which fundamentally undermines the judgment-led, responsible management that the senior managers regime is designed to support. As well as being an undesirable outcome of itself, these efforts could blunt the effectiveness of the reverse burden of proof as an enforcement tool in relation to the largest, best-resourced firms. By contrast, the vast majority of firms that will now fall within the SM&CR will be small ones. These firms are less likely to have legal resources to devote to protecting their senior executives. There is, therefore, a significant risk that smaller firms could struggle to fill their senior management posts—an issue that has been raised by representatives of some of these small firms. For example, Robin Fieth, chief executive of the Building Societies Association, said last December:
“A continued supply of high quality people is what financial services needs, but I can foresee recruitment issues resulting from the Senior Managers and Certification regimes. It’s a real risk that the pool of high quality individuals willing to take on a Senior Management Function role (SMF) in particular will drop. This will be particularly acute for smaller firms where the penalties are the same but the rewards substantially less”.
This could in turn undermine the Government’s aim to deliver a level playing field wherever possible and adversely affect competition in the industry. The ability of small firms to enter the market is key to driving innovation and putting downward pressure on costs.
Some noble Lords, including the right reverend Prelate the Bishop of Southwark, have expressed concerns about the fairness of reversing the principle that a person is innocent until proven guilty. While there are cases, as the assiduous noble Lord, Lord Sharkey, pointed out, it is unusual in English law. However, even setting these arguments to one side, there remain questions of fairness around the effect on small firms. Perversely, individuals in those firms, where regulatory breaches can cause the least damage, could end up being most exposed to personal liability. The noble Lord accepts this and his amendment would not apply the reverse burden of proof beyond the current population of firms covered by the SM&CR, but it would seek to keep it in place for deposit takers and PRA-regulated investment firms. This also raises issues of fairness. The reverse burden of proof the noble Lord wishes to preserve applies to all deposit-taking institutions, including credit unions and small building societies. If it remained in place for small deposit-taking firms, it would be hard to justify applying the reverse burden on these small firms but not on small firms in other sectors.
Furthermore, the arguments put forward by noble Lords who support a two-tier system are focused on financial stability and the risk that deposit takers and the large investment firms pose to it. However, the reverse burden of proof cannot discriminate between regulatory breaches that threaten financial stability and others. Therefore, its application to deposit takers and not to other firms is arbitrary and would pose serious risks to fair competition within the industry. The risks again would fall mainly on small firms. How easy would it be for a small deposit taker to attract high-quality senior staff in competition with a large insurer or FCA-regulated investment firm where, as well as being able to offer a higher salary, the reverse burden of proof would not apply?
The question the noble Lord’s amendment begs is: where should the line be drawn between those firms to which the reverse burden of proof would apply and those to which it would not apply? This is an extremely difficult question to answer in any way that would deliver a consistent and proportionate regime. As the right reverend Prelate said, it may well be arbitrary. Furthermore, how would enforcement action tackle activity that straddled a period when the firm moved above or below the threshold?
The intent behind this amendment is one we all share—to create a financial services sector in which people are held accountable for their actions. Much has already been done to achieve that. This Bill, as it stands, will improve transparency and accountability still further. This amendment, however, would add confusion and bureaucracy for no benefit. I therefore ask the noble Lord to withdraw his amendment.
I thank all noble Lords who have spoken in this debate. It has been a very good one. It is clear that there is a strong division of opinion on both the desirability of a two-tier system and the reverse burden of proof regime. As the Minister said, these issues are both absolutely central to the regulation of our financial services industry.
It still seems to me that Parliament was right the first time. After a thorough and comprehensive investigation, it was right to put the reverse burden of proof regime into law. It was right to conclude that, if we did not do that, we would remain unable to hold senior managers effectively to account.
We have two categories of financial service organisations—those that constitute, or may pose, a threat to our financial stability and those who cannot pose such a threat. I agree with the Minister that we need a proportionate regulation and that what is proportionate for one of these categories is not proportionate for the other. I accept the difficulty in drawing the line. However, I remind the Minister that we have already drawn the line. The previous Act drew a very clear line. I do not think that we have resolved anything today but it was good to have the arguments in play. I look forward to discussing this issue further on Report under, of course, Committee stage rules. I beg leave to withdraw the amendment.
Amendment 21 withdrawn.
Clause 18 agreed.
Schedule 4 agreed.
Clause 19 agreed.
House resumed. Committee to begin again not before 3.10 pm.