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It is a pleasure to serve under your chairmanship for this part of the Bill, Mr. Hood. Clause 167 provides an overview of part 5, which enables the Bank of England to oversee certain systems for payments between financial institutions. It might be convenient for the Committee if I outlined what the clause does.
Payment systems are networks for the electronic transfer of money or credit between participating members, linking key financial firms to each other. A typical payment system comprises a scheme company or an incorporated association, members that are mainly, but not exclusively, financial institutions, rules established by the scheme operator covering such matters as settling claimspayment instructions, for examplebetween members, a system in which members input instructions to transfer payments and, in some cases, a separate, related or unrelated, company providing infrastructure, such as supporting IT systems.
The vast majority of economic transactions involve some form of electronic payment; for example, payment systems include those for the payment of financial contracts, such as derivatives; automated payments, such as direct debits; the system for clearing cheques; and systems used by the Government for benefit payments. In some cases, payment systems are embedded in clearing and settlement systems for transferring securities and other financial products. Payment systems are, therefore, vital to the functioning of financial services, markets and the wider economy.
The interlinkages between payment systems, banks and other financial intermediaries mean that any problems with payment systems have the potential to spread quickly through the financial system, ultimately affecting business and consumers. For example, problems in large wholesale systems have the potential to lead to liquidity difficulties for banks and to contagion in the markets. Problems in retail systems may result in much inconvenience and hardship for considerable numbers of peoplefor example, if benefit or salary payments cannot be credited to peoples accounts. As such, robust and effective systems for payments are essential to the proper functioning of the financial markets and the economy.
Currently, the Bank of England undertakes oversight of payment systems on a non-statutory basis, focusing on promoting the robustness and resilience of key UK payment systems. The Financial Services Authority has a statutory responsibility under the Financial Services and Markets Act 2000 for the regulation of recognised clearing houses that contain embedded payment systems. The Bank of Englands responsibilities and its operational role as a central bank naturally mean that it is involved in the design, management and operation of high-value inter-bank payment systems, which helps to ensure that those systems are operated in a prudent and effective manner. However, the lack of formal powers, including mechanisms for enforcement, limits the Bank of Englands ability to ensure that payment systems are robust and resilient. For example, the Bank of Englands ability to regulate the operation of systems is largely dependent on what can be achieved through dialogue with the management of payment systems and its assessment of systems compliance with international standards, published in the Bank of Englands annual payment systems oversight report.
The Government are therefore legislating to formalise the Bank of Englands role in the oversight of payment systems, to ensure that the Bank has the tools necessary to ensure that payment systems are operated in a manner that minimises risks to financial stability and disruptions to business and consumer interests. The provisions will provide, in addition to an important tool for the maintenance of financial stability, an important new statutory lever for the Bank of England to use in fulfilling its new statutory objective for financial stability, as provided for in part 7 of the Bill.
We consulted on whether there should be a statutory power for the Bank of England in those areas. The overall response from the consultation exercise was that it was a good idea, which is why we are proceeding with it in the Bill.
The clauses we are to debate follow a logical structure. I hope that hon. Members appreciate the recognition systems and the principles of regulation, and how they will be enforced, if necessary. Clause 167 provides an overview of what we are trying to achieve with bank payment systems by giving the Bank of England a statutory role. I commend the clause to the Committee.
It is a great pleasure to serve under your chairmanship, Mr. Hood. As this is my first contribution in the main part of the Committee stage, I declare an interest as a non-executive director of a deposit-taking institutionalthough for claritys sake I point out that it is not a payment system or a member of a payment system.
I am grateful to the Minister for setting out a brief introductory overview of the part of the Bill relating to inter-bank payment systems. He is right to highlight their importance. Figures produced by the Bank of England for 2003there may be more up-to-date figuresstate that the value passing through UK payment systems that year was £130 trillion, which is about 20 times the UK annual gross domestic product. That is the equivalent of almost 50 per cent. of GDP flowing through UK payment systems every business day. It is clearly an important system, consisting of high-value transfers between financial institutions but also more numerous, smaller transfers between individuals and/or companies. The Minister set out some of the circumstances, such as the payment and receipt of wages and salaries, Government benefits, direct debits and cheques and debit and credit card payments.
We recognise the potential for systemic risk. The Bank of England and the Government, too, have long recognised the potential for systemic risk from failure within the payment systems. If there is a problem with one there is likely to be a direct and rapid effect on other members. Even if there is no systemic risk, a failure in a payment system may cause considerable disruption to individuals. No politician would want to be responsible for the failure to pay wages and salaries on time.
We are broadly supportive of the provisions but it might be helpful for the Committee if I outlined some of the themes that we want to address during this part of the Bill. As the Minister says, the Bill is presented clearly and logically, which will be helpful to the Committee. We will raise specific questions as we go through each clause, but at this stage it might be helpful to highlight some of the key issues.
The first issue touches on the intervention made by my hon. Friend the Member for Wellingborough. What assessment have the Government made of the existing arrangements? As the Minister explained, the Bank of England has performed an oversight role on a non-statutory basis for some time. As the helpful Library note made clear:
It should be stressed that, to date, there has been no evidence that existing systems have failed or are threats to future stability.
Of course, that is not to say that we should not look to make improvements. I note the points about enforcement and so on. This may be one of those cases where the roof is being fixed while the sun is shining, to coin a phrase.
Well, the sun is shining over this particular roof, even if not over most of the roofs nearby.
It would be helpful if we had a sense of how effective non-statutory regulation has beenfor example, in the dialogue between some payment systems and the Bank of England. The Bank has given examples of situations in which, through dialogue, it persuaded some payment systems to make particular changes. The settlement finality regulations are part of the existing regulatory regime, even though it is on a non-statutory basis, and we will discuss them with regard to our proposed amendments to clause 171. The regulations provide payment systems with some protection from insolvency law, which could disrupt them, but we will discuss those issues later this morning.
The second broad theme is the objective of the oversight. The Bank of Englands payment systems oversight report for 2004 states:
The main objective of the Banks payment systems oversight is to assess and, if necessary, seek to ensure mitigation of risks to the wider economysystemic risk.
I suspect that the Minister will say that one difference is that the Bank states that it will seek to ensure mitigationalthough of course it could take a stronger line as a consequence of the provisions. However, is the focus on addressing systemic risk? What is the purpose of the regulations?
The Bank of Englands 2004 report further states that
efficiency considerations also need to be weighed, which leads me to a further themethere can be conflict between safety and efficiency. The Bank put it very well:
The Bank also recognises that designing and operating a payment system to minimise systemic risk would be counterproductive if the system thereby became so expensive or impractical to use that payment traffic migrated to less safe alternatives.
The Minister will be aware of that danger. We will be seeking reassurance in the debate that the operation of the measures will not result in a less safe system because banks go elsewhere.
It is notable that the Bank of England has previously expressed, perhaps rather modestly, the limits of its oversight, noting that
the Bank as overseer, cannot guarantee that there will never be operational failures of payment systems.
Does the Minister accept that the point applies equally to the new arrangementsit is not about a guarantee, but about doing everything that we can to eliminate riskor would he go further and say that payment systems will now be 100 per cent. safe?
On the balance between safety and efficiency, concerns have been raised that some of the enforcement provisions, which we will come to later this morning, may be so draconian as to dissuade businesses or individuals from being involved in payment systems. Are the costs for payment systems likely to increase substantially? I want to stress that by raising these questions we are not arguing against the provisions, but we think that these are legitimate questions to put to the Government.
The next theme is the scope of the recognition regime. It focuses on payment systems, but I hope that this morning it will become clearer whether the clause will apply to all payment systems or only to the largest. Will there be a differential application of the principles and codes of practice, depending on the nature of the system? Until now the Bank of England has adopted different approaches depending on the type, number and value of payments made, the design of the system, and the potential substitute means of making payments. It is notable that it has particularly focused on CHAPS and CREST, then at the next level BACS, CLS and LCH.Clearnet Ltd, followed by the Cheque and Credit Clearing Company and LINK and finally debit and credit card systems. Will there still be that differential approach and that flexibility? We will probably debate those matters when we look at the principles and code of practice.
What the provision does not do is focus on payment system members, so it is worth highlighting the role played by some major banks, which settle payments for a large number of other banks. Not all banks are members of payment systems and relatively few of them are settlement banks. As the Bank of England has said, in some respects the largest of the settlement member banks have the characteristics of payment systems.
In some other jurisdictions there is close supervision of payment members; for example, system participants are obliged to provide information to central banks. In the UK, the payment system is required to do that, but in jurisdictions such as the US, Australia, Austria, Hong Kong and Singapore the obligation to provide information applies to participants. Central banks can also set membership conditions in Australia, France, Hong Kong, Norway and Singapore. Will the Minister say a little about that?
Another area of potential risk relates to the infrastructure providers. It is interesting that the Bank of England has highlighted the dependence of all the network participants on a single supplier as the second potential source of riskthe first being the systemic risk of a problem in one payment system migrating to another. In particular, SWIFT, which provides messaging services in support of CHAPS, is used heavily in those circumstances. How will the provisions help us to address that potential risk? I think the Minister will be able to answer that question.
The next themefamiliar to our debates on the Billis how the tripartite arrangements will work in this area. Banks, principally regulated by the FSA, are payment system members and play an important role in those systems. The likes of CREST and LCH.Clearnetrecognised clearing houses and investment exchangesare principally regulated by the FSA rather than the Bank of England. How will the Bank work and co-operate with the FSA? The Treasury will make the recognition orderswe will come to that issuebut how will the relationship between those three entities work? The question that we keep coming back to is, Who is in charge? The greater the clarity about that, the better.
The next related theme is the general role of the Bank of England. The Bank has a role as an operator of real-time gross settlement systemsat the heart of the CHAPS systemyet it is also the regulatory body that will presumably supervise CHAPS. How do we avoid a conflict of interest? We support the Bank of Englands performing that role. There are good historical reasons why it should, and the role is central to financial stability. Perhaps in dealing with those points, the Minister will explain why the Government continued to allow the Bank of England to play such a major role in the oversight of payment systems, at a time when, generally, everything was handed over to the FSA.
The final theme touches on the international perspective. It is all very well looking at payments within the UK, but we all know that there will be a huge number of cross-border payments. In those circumstances, how would the provisions that we are debating this morning play a role, and how are the Government working with other central banks and financial institutions to ensure that there is no systemic risk from a breakdown in cross-border payment systems? We must not forget that aspect.
I hope I have been helpful to the Committee in outlining some broad concerns before we turn to each of the provisions in detail. I do not necessarily expect the Minister to respond to each and every one of those concerns now, but I hope they provide a useful summary of some of the points that we hope to raise over the course of the morning. I reiterate that we are supportive of the provisions but, as always, it is appropriate that they have proper scrutiny, and that those who are studying the debate have a better understanding of the intention and practicality of some of the measures that we are debating.
Like my hon. Friend the Member for South-West Hertfordshire, I shall put down a few markers on some issues that have come to lightnot simply from listening to the Minister, but from reading the explanatory notes and listening to my hon. Friend.
Clause 167 imposes a statutory regime on inter-bank bank systems when currently the Bank of England, as I understand it, oversees payment systems on a non-statutory basis. The Governments position seems to be formalising the Bank of Englands role in creating stability, which has to be a good thing. We have seen the huge systemic risk out there, following the current crisis. The build-up we have before us addresses many of the issues which have been raised, and highlighted, by the current crisis, but it has also sought to address issues that have been raised over a long time. It is therefore a good thing, as is the ability of the Bank of England and the Government to make a quick response to problems in the banking systems.
The Bill will enable the Bank of England to retain power of informal oversight when it considers it appropriate. It is that sort of language that I am trying better to understand: what is informal oversight and what does appropriate mean? I appreciate that is not the language used in the explanatory notes or the Bill, but it is the language I have heard people use when addressing the clause.
Our partys position is clearly that formal regulation is a positive thing, particularly when payment systems have a systemic risk. Recent years have seen an explosion in the values and volume passing through them, particularly in derivatives, which many people do not understand. I draw the attention of Members to my register of interest; I have had 20 years significant experience in the banking system. One of the problems is lack of understanding, particularly of derivatives, which have caused some of the major problems relating to systemic risk and, as we have seen, the fall-out from that.
The Minister made a couple of points, using the words robust and resilience, about the system that we are creating. Has he thought about how to stress-test the system to see how robust and resilient it is? He referred to oversight and tools, but I am curious to know which tools he is talking about and what he meant by that term. How will the tools cause minimum disruptionsanother phrase he used? Which groups did the Minister consult when coming up with the proposal and what feedback did he receive? It is important that we understand which issues were raised and how the clause will deal with them.
My hon. Friend the Member for South-West Hertfordshire talked about the tripartite relationship between the FSA, the Treasury and the Bank of England. That tripartite system broke down over Northern Rock. It seemed as though everyone was pointing the finger at everyone else, with no one taking responsibility. How will the provision fix that situation?
Finally, my hon. Friend referred to the important issue of cross-border relationships. Given that the financial system is global, how do we hope to enforce our legislation on foreign entities over which we do not have as much control as we would like? We can try to fix things in the UK, but how will that deal with systemic breakdowns in other countries?
It is a pleasure to serve under your chairmanship, Mr. Hood.
I want to pick up on the relationship with the tripartite system to which the hon. Member for South-West Hertfordshire referred. The clause describes how part 5 of the Bill enables the Bank of England to oversee certain systems. Later clauses cover interpretation and regulation, but I shall touch on them now because it is important to understand where confusion might arise.
Clause 170 allows the Treasury to impose recognition orders. Clause 172 requires it to consult the Bank of England and the FSA and the orders can, of course, be revoked. Clause 174 covers the regulation principles. The Bank of England publishes them, but it is required to consult the Treasury. Clause 175 allows the Bank of England to deal with the code of practice, which many people might consider more important than the principles because it is the mechanics of the processthe nuts and boltsbut nothing in the Bill says that the Bank needs to consult the Treasury at that point. Under clause 176, the Bank of Englandnot the Treasurymay require an operator to establish rules and, under clause 177, the Bank of England can give direction. Clause 178 says that the Bank of England must have regard to the action taken by the FSA.
The interpretation and the regulations of the Bill set out a mix or a balance between the action that the Treasury takes and that taken by the Bank of England, sometimes in consultation with the Treasury and/or the FSA, and sometimes not. I am trying to get to the bottom of the Governments thinking behind why various bits of responsibility have been allocated to the Treasury or the Bank and why consultation is required on certain elements, but not others. I accept that those points touch on subsequent clauses, but I should be grateful if the Minister would explain why the breakdown in responsibility and the particular roles have been allocated in such a way.
I am unhappy to see regulations brought in, unless it can be proved that they should be brought in. The Government probably take the other view: regulations should be brought in, unless there is an overwhelming case that they should not be introduced. That is a difference between us from the start. I refer to Yes Minister, because it is the best example of how the Government work. If there was a failing in the banking system, the Governor of the Bank of England would ask his chairman and chief executive out to lunch and the problem would be sorted out. From the Ministers introduction to the clause, it seems that the system has been working rather well and that there has never been any sign of a problem in the oversight of the payment system. It worries me that we may be regulating because of the present circumstancesbecause we think that we should be doing somethingbut actually it will make no difference whatever to the process or the security of the system. I hope that the Government will persuade me otherwise as we go through the clauses in detail, but that is my concern in principle.
My concern has some backing to it. Her Majestys Treasury produced a helpful impact assessment in October 2008, which states:
The Authorities do not envisage that this provision will amount to a substantial change in practice.
If there is no change in practice, why are we bothering to introduce regulations to make something happen? If it is already happening, there seems little point in bringing it in. It concerns me that the regulations do not have effect across the board, but are restricted to systematic or system-wide consequences. How is it determined in advance whether a bank or clearing house falls within those concerns? At this stage, I am not sure that I am totally in favour of the clause.
I hope that I can persuade hon. Gentlemen of the importance of the clause. The debate has usefully set out the general principles that will be discussed under later clauses.
I will explain the background to this proposal. Since early last year, the authorities have been developing a clearer and more robust framework for the oversight of payment systems. That was part of the Governments wider work to strengthen the framework for financial stability. I emphasise that these measures are not the result of problems in the payment system. However, we must take it into account that the characteristics and importance of payment systems could change, or that wholly new payment systems could develop and take on systemic importance. Given the importance of payment systems to the financial system, and therefore to wider financial stability and consumer protection, it is sensible to pass these measures as part of a package of proposals in the Bill.
I welcome the hon. Member for South-West Hertfordshire to his debut in the Committee. He asked about the scope of the measure and which systems would be covered. The consultation document identified CHAPS, Europea, LCH.Clearnet, BACS, Cheque and Credit Clearing, the faster payments service and the LINK scheme as areas that would be regarded as key wholesale inter-bank systems under the authoritys preliminary assessment. It is important to recognise that such systems process about £1.5 billion daily. That emphasises their systemic importance to our financial system and the UK economy.
I will make a few points on the remarks of the hon. Member for Dundee, East and others who talked about the architecture of the system. He was not making a debating point, but was genuinely interested in knowing how the architecture fits together. I will explain the general principles and we will cover the detail when discussing subsequent clauses, as the hon. Member for South-West Hertfordshire said.
The general principle is that in the first instance it is the responsibility of the Treasury, following consultation with the Bank of England and the FSA, to designate a payment system and make a recognition order under clause 170. It is the responsibility of the Bank of England to exercise oversight of the payment systems. That is clear in the Bill. As I explained earlier, that will put the Bank of Englands current responsibilities on a statutory footing, which we believe is the right and prudent thing to do. We want the Bank of England to consult as appropriate with the FSA, particularly where payment systems are embedded in recognised clearing houses or investment exchanges, which are also subjected to the FSAs regulatory regime. That is why there will be a memorandum of understanding between the Bank and the FSA to ensure that there is no duplication and there is efficient regulation.
It is also important to stress that in all these instances the tripartite authorities will work closely together. There are clearly distinct roles for the Treasury, the Bank and the FSA in this, but we would expect close co-operation on a regular basis between the three organisations that make up the tripartite system.
Before I give way to the hon. Member for Wellingborough I should tell him that the days are gone when the Bank of England gets a bank in and has a cosy chat. It is important that the tripartite authorities work closely together and have good relationships with the banks. There is a wider recognition that putting these arrangements on a statutory basis is the right way forward.
That is most helpful. We used the example of people getting around a lunch table and discussing matters. We are now trying to formalise this in some sort of memorandum of who does what and when. Is this Committee likely to be able to see a draft of that memorandum?
The Committee can see what is in the Bill. It sets out clear and distinct roles. The issue of a memorandum where the FSA regulates and the Bank of England regulates at the moment is pretty much a technical issue, which we would not expect to see in the Bill. I give way to the hon. Member for Fareham, who obviously cannot stay away from the Committee.
I am drawn to it by the magnetism of the subject we have been discussing. The Minister talked about arrangements for the FSA to look at regulated investment exchanges and clearing houses, but a volume of transactions does not go through them, such as derivatives that are not traded through exchanges. How will he ensure that the payment systems that relate to them are covered by the Bill because they are an important volume of transactions in the wholesale market which, if we are looking at maintaining financial stability, ought to be covered in some way by these rules?
There are powers in the Bill that allow the Treasury, in consultation and having received advice from the Bank of England and the FSA, to recognise key wholesale inter-bank payment systems. I have given an indication of which payment systems of preliminary assessment would suggest that we would want them to be recognised. But we need to ensure that we have adequate coverage so that the Bank can discharge its responsibilities for financial stability appropriately.
I presume that the Minister is talking about clause 170 where the Treasury makes the recognition order. I thank him for his previous explanation: the Treasury makes the recognition of the systems and the Bank then does the other bits. That is perfectly reasonable. The question posed by the hon. Member for Fareham is very important, given that London is one of the three key wholesale financial markets in the world. The Minister has just said that there is provision for the Treasury, through regulation or by order, to specify other systems that might come into this. Will he provide a little more detail? Does he have anything in mind? How would he go about putting a recognition order in place for one of those large wholesale systems that is not at the moment an official, recognised inter-bank system? How would that happen and what criteria would be used to do that?
We are talking about the general principles in this clause. We shall get on to those questions when we debate the relevant clauses. The hon. Gentleman also asked about who was consulted and what issues were raised. Consultees included the Bank of England, payment system operators, users of payment systems and the payments council, which is the representative body for payment systems. Everybody wanted to see clarity and responsibility in the system and we believe that the Bill achieves that. Overall, there was widespread support for the legislative proposals and we can proceed with confidence. The financial community broadly welcomes the thrust of what we are trying to do in part 5 of the Bill. No doubt, we will want to tease out some of the detail during this and other sittings.