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Clause 5

Banking Bill – in a Public Bill Committee at 5:15 pm on 4th November 2008.

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Code of practice

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury) 5:30 pm, 4th November 2008

I beg to move amendment No. 81, in clause 5, page 3, line 35, at end insert—

‘(ca) how to determine whether the threshold conditions under section 41(1) of the Financial Services and Markets Act 2000 will be breached,’.

Photo of Roger Gale Roger Gale Conservative, North Thanet

With this it will be convenient to discuss the following: Government amendment No. 89.

Amendment No. 80, in clause 5, page 4, line 3, leave out ‘have regard to the code’ and insert

‘comply with the code or publish an explanation of why they were unable to comply with the code in good time after their actions,’.

Clause 5 stand part.

Amendment No. 82, in clause 6, page 4, line 11, leave out ‘and’.

Amendment No. 83, in clause 6, page 4, line 14, at end insert ‘, and

(d) those persons whom it considers to have relevant knowledge of those matters.’.

Amendment No. 85, in clause 6, page 4, line 17, at end insert

‘only after complying with the requirements set out in subsection (1).’.

Amendment No. 84, in clause 6, page 4, line 18, at end add—

‘(5) The code shall not come into force unless it has been approved by a resolution of each House of Parliament.’.

Clause 6 stand part.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

The code of practice in clause 5, which we have already referred to quite a bit today, is seen by third parties as an important part of the legislation, because it is one of the tools that would give the market comfort regarding how the powers in parts 1, 2 and 3 will be exercised. It is therefore important that the code gets it right and that there is sufficient guidance in it to enable people to predict reasonably well when and how the powers will be used. Subsection (2) of clause 5 sets out some of the guidance that will be included in the code. I will start by talking about my amendments, and then speak more generally about clauses 5 and 6 stand part.

My amendments aim to highlight some of the potential deficiencies in the code as currently drafted. Amendment No. 81 inserts some additional guidance on the context. It reads,

“how to determine whether the threshold conditions under section 41(1) of the Financial Services and Markets Act 2000 will be breached”.

The code, to be fair, refers to that. Paragraph 28 states:

“The FSA’s Handbook contains rules and guidance relevant to an authorised firm. In particular, within the FSA Handbook, the ‘COND’ Threshold Conditions contains rules and guidance on the threshold conditions. There are a range of conditions, including: legal status and location of offices; the adequacy of the firm’s resources (financial and non financial) in relation to the regulated activities which the firm carries on; and suitability issues (e.g. competent and prudent management, conducting business with integrity and in compliance with proper standards). These are set out in more detail in the FSA Handbook.”

I am not sure whether the code really provides the guidance that people need to determine whether the threshold conditions will be breached, or which threshold conditions in particular the Government are interested in. For example, one of the threshold conditions not referred to in paragraph 28 is the appointment of a claims representative. I do not know whether the breach of the appointment of a claims representative will trigger the special resolution regime. I hope it does not, but part of the problem is that we are left none the wiser in the code as to whether that is the case.

On the matter of the location of offices, I printed off the relevant section of the conditions handbook to see whether it might provide me with some more detail. It states that

“if the person concerned is a body corporate constituted under the law of any part of the United Kingdom...its head office, and...if it has a registered office, that office, must be in the United Kingdom.”

Would the fact that a FSA-regulated firm decides to change its head office and move out of the UK be sufficient to trigger the special resolution regime? It may be sufficient to remove its authorisation, but do we really want to go down the route of triggering the special resolution regime if a firm happens to change its head office?

The explanatory notes to condition 2.2 talk about how a firm’s head office might be defined. It is not defined in the Act apparently, nor in the post-BCCI directive, nor in the insurance mediation directive. The FSA handbook states:

“This is not necessarily the firm’s place of incorporation or the place where its business is wholly or mainly carried on. Although the FSA will judge each application on a case-by-case basis, the key issue in identifying the head office of a firm is the location of its central management and control, that is, the location of: the  directors and other senior management, who make decisions relating to the firm’s central direction, and the material management decisions of the firm on a day-to-day basis”.

I am not clear whether a breach of that threshold condition is sufficiently important for the stabilisation powers to be used. If it is important we need some guidance in the code to say why. Where the Government are coming from in the threshold conditions is not really about the location of the head office or the appointment of a claims representative—it is about the adequacy of resources. That, to my mind, is the sense of where the Government got to on Kaupthing and Heritable, but all that we know in the context of those two institutions is that the FSA judged that the threshold conditions had not been met. I do not know why the FSA made that judgment and the reason was not apparent from the Treasury’s press release on the topic.

If we are talking about adequate resources we should say so in the Bill and the code. We should give people some guidance in the code as to what it means if adequate resources rules have not been met because I think they are subjective terms. I shall give an example from the FSA’s online handbook:

“FSA will interpret the term adequate as meaning sufficient in terms of quantity, quality and availability, and resources as including all financial resources, non-financial resources and means of managing its resources; for example, capital, provisions against liabilities, holdings of or access to cash and other liquid assets, human resources and effective means by which to manage risks.”

That is a very subjective definition of the meaning of adequate resources. We do not necessarily want the FSA to be tied to a quantitative definition but we require some guidance in the code as to what the FSA would deem inadequate resources, to give a flavour of the sort of areas we are looking at. The code is currently deficient in not providing that detailed guidance, which is why I propose amendment No. 81.

On amendment No. 80, the current situation under subsection (4) is that the authorities must have regard to the code. I think the term “have regard to” is too weak. The authorities might read it, not be very interested, throw it away and not be bound by it, but it is a key part of the structure of this series of reforms and the code is seen by the outside world as an integral part of the package. Simply to “have regard to” the code is not strong enough to give the right degree of emphasis when bearing in mind the powers set out in part 1. That is why I have suggested in my amendment that the requirement should be on the tripartite authorities to comply with the code or publish an explanation of why they were unable to do so,

“in good time after their actions”.

Comply or explain is a term that is used quite often by businesses in their accounts. If something does not comply with the code, they explain why. I am suggesting that the same principle should be used in the provisions.

Some other omissions might be dealt with on a stand part basis. Paragraphs 2 to 13 of the code, which set out how the objectives in clause 4 are to be defined, do not go far enough in detail, although we have dealt with that point in the previous debate. Paragraph 29, on page 7 of the code, uses curious language that leads me to think—although I do not think this is the right  interpretation—that the default tool for the Bank to exercise is the bank insolvency procedure. Paragraph 29 says:

“Under section 8 of the Act, the Bank may only exercise a resolution tool other than the bank insolvency procedure if satisfied that the exercise of the power is necessary”.

It is almost as if the Bank of England will start on the basis that it will exercise the bank insolvency procedure unless it thinks the powers in paragraph 8 that enable it to have a private sector purchaser or bridge bank are better. I assume that the default is private sector purchase, that the bridge bank is the second preferred option, and that temporary public ownership or the bank insolvency procedure rank further down the list of priorities.

Photo of Mark Todd Mark Todd Labour, South Derbyshire

The hon. Gentleman highlights a concern that I share. The code is silent on whether the institutions involved should just stand aside and let the bank collapse, on the basis that its collapse poses no systemic risk to financial stability in the UK. That implication is not set out in the code; in fact, the default position is that the authorities will take some action, almost no matter which financial institution is involved, on whatever scale and however isolated the impact might be. I would welcome the greater clarity in the simple position: “This is a matter for the market to resolve. We shouldn’t be involved at all.”

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

I think I understand where the hon. Gentleman is coming from—it relates to the clarity of the code and what the code says the default options should be. As I understand his view, it is that the instinctive reaction is that action should be taken, rather than that the market should run its course and the bank should end up in administration or insolvency. The drafting of paragraph 29 certainly suggests that the expectation is that default will end up in administration or insolvency, rather than that all the stabilisation powers should be used first. Perhaps the language needs to be clarified further to get it right so that we can understand the sequencing or the priorities.

Photo of Mark Todd Mark Todd Labour, South Derbyshire

Will the Committee permit me to clarify a little further? It is important to emphasise the moral hazard position, which is that the public sector should not be expected to step in whenever an institution appears to be threatened. The last few months have almost given the impression that whatever institution is threatened and whichever group of savers might find their savings in jeopardy, the public purse will step in to resolve the matter. The code is an opportunity to make it absolutely clear that that is not the case. There are circumstances in which an institution may be permitted to collapse because it does not pose a systemic risk to the financial stability of the UK, but the last few months have allowed us to drift away from that debate.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

The hon. Gentleman makes an important point. I am not entirely clear in my mind whether that issue has been properly addressed throughout the crisis. The hon. Gentleman makes the point that before the crisis started, the assumption would be that the market would work its way through some of these issues, that the deposit protection scheme and the Financial Services Compensation Scheme were there to protect consumers and that if a bank collapsed, that would be the route.  That goes back to the moral hazard point of view—the warning to investors, creditors and depositors: “Don’t expect to be bailed out. You need to think about your own position.”

During this crisis, we have moved to a situation where it is expected that our Government and Government generally—the crisis affects countries outside the UK as well—will leap to the rescue; and to use the Minister’s phrase from the evidence session, that we will do whatever it takes to solve the problem. One of the Treasury’s challenges in writing the code is to write it in a way that covers both our present situation and what happens when financial stability returns. That goes back to the comment made during the last debate about the context in which such decisions are made. In a time of financial instability, a different set of decisions might be made from those that would be made in a period of financial stability, when moral hazard may well come back to the fore. However, it is important for the code to distinguish clearly between the two situations, and what the impact will be. It is difficult to draft the bit about what the impact would be, because that itself could lead to a degree of uncertainty, but it would be helpful to be able to tease apart the two different contexts.

Photo of Colin Breed Colin Breed Shadow Minister, Treasury 5:45 pm, 4th November 2008

I entirely agree with the hon. Member for South Derbyshire. We have, to an extent, drifted away from what was the norm only a few months ago. Of course, there is no obligation on the Government to use the powers; they may not consider the time appropriate to use them. The powers are very clearly designed to protect depositors—there is no qualification to that. They may be depositors of very significant funds—well in excess of the compensation scheme limits—and if there was a qualification, standing back and letting the bank go might be perfectly acceptable. Some of the objectives have made that position more difficult, which is a slippery slope that I suspect may make Governments wish to return to something more akin to the norm with moral hazard; otherwise, they will be inveigled into trying to come in under special resolutions to protect almost any situation, because of the extent of the deposits.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

This is a difficult area to get right and I am pleased that I am in the position of having to criticise the code rather than having to draft it. It is a much easier position to be in. The interchange of thoughts about what sort of messages the code sends out is important, because when drafting the code one needs to be very careful about the impression that is created in the minds of depositors, as I alluded to earlier in response to the hon. Member for South Derbyshire before I took the intervention from the hon. Member for South-East Cornwall. For example, if there is a very clear restatement in the code that the limit for deposit protection is £50,000 and that will apply in the future, we may see the shuffling of money around banks, post offices and so on, which may trigger a fresh wave of uncertainty.

We need to get the balance right. It is important, in general, that we try where possible to give as much detail about the context as we can, and to give a degree of predictability even though it may cause some people concern. The more predictability there is in the code,  the greater the market’s confidence that the code is right and the greater the likelihood that it will know how the powers will be used. That is what the code is about—how the powers will be used and how market participants can be confident that the powers will not be used will-nilly, at the drop of a hat. We are talking about the controls and the checks on the exercise of the powers, which is why the code needs to be detailed at the front end to give people a greater sense of how the powers will be put into practice.

I am not a great believer in long documents and I always think that it is better to have a shorter ones, but when I opened the file containing the code of practice, I was surprised at how short it was given the complexity of the issues. While this is an early draft, and I suspect that later drafts may elaborate on some of these issues, this area needs elaboration. How should people expect the powers to work in—to use a different analogy—wartime and peacetime?

I have some more specific comments. Paragraphs 32 and 33 of the code deal with clause 8 of the Bill:

“The test of ‘necessity’ is a high one. In determining whether the exercise of the power is necessary, the Bank must have regard to whether other approaches would resolve the situation.”

Again, I am not sure whether there is enough information in the code to determine when the bank will find it necessary to exercise such powers. The code is a bit light on timings of when things may happen, so we need a bit more specificity in that regard. I draw the Committee’s attention to paragraph 20, which says that there will be a

“revised Memorandum of Understanding between the Authorities” which

“will set out how the Authorities will communicate with each other before and during the resolution of an institution”.

It is not clear when that memorandum will be produced, and it would be helpful to know. When the Treasury Committee debated the matter, it was suggested that we would see the MOU long after the passing of the Bill. To help us understand how the authorities will interact with one another in the context of the Bill, it would be helpful to have sight of that element of the revised MOU before the Bill completes its passage through both Houses.

In paragraph 33, there is a trade-off. It says:

“The assessment must balance the short- and long-term effects on financial stability, public confidence and depositor protection of different resolution options.”

That is absolutely right; I could not disagree with that statement, but what does it really mean? What are the short and long-term effects? The paragraph refers to the need “to protect depositors” but it does not expand to cover the short and long-term effects on financial stability or public confidence.

Paragraph 36 of the code refers to

“the operational risks of managing a bridge bank and the amount of public funding that may be required to keep it operational.”

There is no sense of where the economic decision comes into play. We talked about the protection of taxpayer interests in the previous clause. The code says that

“the Bank will need to take into account in determining the feasibility of different tools” factors such as the operational risks of managing a bridge bank and the amount of public funding that may  be required to keep it operational. I do not get a sense of where the balance of judgment is between this and temporary public ownership.

Paragraph 40 of the code does not say much apart from paraphrasing conditions A and B. I think that more work needs to be done on that area if we are to understand how the Bank, or the tripartite authorities, will act in the public interest and how they will apply the conditions. I would have expected more clarity in that area.

Paragraphs 44, 45 and 46 are important and relate to the announcement of the tools and to accountability. I referred to that matter earlier today in the context of amendment No. 80, in which I call on the relevant authorities to comply or explain. Paragraph 46 relates to something that I mentioned in a previous debate. The Minister responded by saying how transparent the Treasury would be over the exercise of such powers. I asked him whether the announcement made by the Treasury in respect of Kaupthing and Heritable was a model or a template for what we would see under paragraphs 44, 45 and 46 or whether we would see a fuller explanation. The Minister did not come back to me on that point, and I was too slow to pick him up on it, but I will give him a second chance in this debate to explain—if he has not thrown away the notes that his officials prepared. That is important, because it helps to build up an understanding of how the Government will react in the minds of participants. When people are assessing how the powers will be used, they will look not only at the code, but at how the measures are applied subsequently, to see where the gap is between the application and the code. Therefore, we need to ensure that a decent level of information is available to help participants to understand the range of powers. Also, of course, that is an important part of holding the tripartite authorities to account on how the powers will be used.

I am not a member of the Treasury Committee and I was not able to listen to yesterday’s sitting because I was engaged on the Report stage of the Dormant Bank and Building Society Accounts Bill, but I suspect that the Committee would like to debate again Icelandic banks, for example, in the event of the exercise of the stabilisation powers. The more transparency about how the powers will be used and the more announcements that are made about them, the easier it will be for Parliament to hold the authorities to account, which is particularly important when taxpayers’ money is involved.

Paragraph 52 begins with the words: “In exceptional circumstances”. What are exceptional circumstances? Are they so exceptional that the Government do not expect the measure to be used? It is important to clarify the definition of exceptional circumstances.

To go back to time periods, paragraph 60 of the draft code states:

“However, in situations where there is expected to be a lengthy period of time prior to a sale, the Bank shall put in place an appropriate governance structure”.

How long is “lengthy”, and when does one decide when something has gone from being short to “lengthy”? If the powers had been available and the Bank had owned the shares in Northern Rock, it might have thought that it could flog it within a couple of months. However, I suspect that the gap between the Northern Rock rescue  in September and its nationalisation in February would be deemed “a lengthy period” if the powers had been available at the time, and it may have been necessary to put in place appropriate governance arrangements. What is “lengthy”? How long is a reasonable period before steps to put in an “appropriate governance structure” need to be taken?

In his remarks on a previous clause, the Minister referred to the safeguarding in the code of practice of operating strategies. Paragraph 68 states that that

“is likely to involve the bridge bank operating on a conservative basis, to protect the franchise value of the business”.

I am not sure what “conservative” means. Does it mean prudence in the management of liabilities or when dealing with repossessions? Is it “conservative” in that the bridge bank does not take any risks and operates at the less competitive edge of the threshold? Doing so could impede the achievement of its objectives. Knowing the meaning of “conservative” in this context would be helpful to the banking system.

I appreciate that no one expects a bridge bank to exist for too long a period—that is not necessarily its purpose—because there could be other ways in such a period to resolve the situation. Paragraph 72, on the bridge bank report, states:

“The Bank must report to the Chancellor about the activities of a bridge bank if a bridge bank exists for a year. The first report must be made as soon as is reasonably practicable after the end of one year beginning with the date of the first transfer to the bridge bank. A similar report must also be made as soon as is reasonably practicable after the end of each subsequent year”.

My understanding is that Northern Rock reports quarterly to the Treasury, and I am not sure why the reporting requirements for the bridge bank are less onerous. I thought that they would be broadly comparable.

Paragraph 80, which is on disposal and onward transfer, states:

“Following this process, the Bank shall complete the transaction. This may be achieved through a standard commercial agreement...or by exercising the onward transfer powers provided in the Banking Bill.”

I do not know whether there is a practical difference between the two options. Will they be used in different circumstances, or are they interchangeable? It is not clear why that might be the case.

Paragraph 93, on page 16, is also ambiguous as to time:

“If a bank is likely to remain in public ownership for longer than a short period”.

It is sometimes difficult to determine what a short period is. There is no guidance, and the context is the objectives that the Treasury will set for the board of directors. In the case of Northern Rock, even though we are in a period of temporary public ownership, that period has been deemed sufficiently long for the Government to set objectives. The Government could have argued in February that they expected to make a quick sale and therefore would not set objectives. That is a purely hypothetical argument rather than a realistic one, but the presumption should be that objectives will be set for a bank in temporary public ownership.

Having read through the code, I have just picked out some areas where further work needs to be done. I make those points not to sound pedantic or picky but to say that we need to be much clearer about how the code will  operate in practice if it is to be the reassurance that the financial services sector is looking for as to how the powers will be exercised.

To touch on amendments Nos. 82 to 85 to clause 6, which I tabled, I wanted to focus on the consultation process surrounding the code. Since I tabled the amendments, the Minister has tabled a new clause that addresses amendment No. 83, which would insert after subsection (1)(c) a new line (d):

“‘those persons whom it considers to have relevant knowledge of those matters.’.”

The new clause, which is not scheduled for debate today, deals with amendment No. 83, because it sets out clearly who should be consulted. In terms of the broader consultation on revisions to the code, the Government might wish to go wider than that. I have also proposed that the code should undergo some form of scrutiny. I would not normally advocate parliamentary scrutiny of a code, but given the importance invested in this one, Parliament should have the opportunity to consider it. It forms an important part of the framework of the Bill.

In conclusion, the code as we saw it on Thursday, which is largely as it will be when it is made available for public consultation later this week, requires a lot more work. One or two people to whom I have spoken who have seen the code share my view that there should be much more detail about how it will work in practice, and others do not yet see it as the safeguard that they anticipated. I hope that the Minister will see my comments as constructive rather than critical for the sake of being critical. We want to be constructive about how we engage on the code, but there is a lot more work to be done.

Photo of Colin Breed Colin Breed Shadow Minister, Treasury 6:00 pm, 4th November 2008

The proposal relates to an amendment that we tabled to clause 7. Under clause 5(2)(d) the code will provide guidance on

“how to determine whether Condition 2 in section 7 is met”.

While I recognise that we are talking about a draft code of practice, what we have so far does not really explain precisely how it will be determined that condition 2 in section 7 is met. It merely repeats some of the wording from the Bill itself.

A fundamental aspect of both the amendments to clause 4 and what is happening in clauses 5, 6 and 7 is how the external investors may view bank shares or banks in the future. Their investment, which can be considerable, may be far less certain than they had originally expected. The determination of whether condition 2 in section 7 is met is fundamental. We need a clear indication of that in the code because that sort of clarity, along with the other aspects of amendments that are yet to come, and one that has already been withdrawn, is fundamental to the way in which the SRR will work.

Timing is obviously of the essence. I accept that and it is recognised in the guidance. But we need to be much more precise about how that condition is exercised. Upon that will depend so much of the perception of whether a bank can raise more capital, whether it has enough investors to begin with and even future capital-raising exercises if necessary. Unless investors are confident that the plug will not be pulled from a bank in which they are going to invest and that the conditions will be  clearly met and will not be very subjective in their interpretation, they will be reluctant to invest in such businesses.

Photo of Peter Bone Peter Bone Conservative, Wellingborough

I am trying to follow the hon. Gentleman’s argument. Is he making the case that where a bank is in some sort of trouble, but has not reached this stage, investors who might invest in order to save it will stand back if they do not know the precise terms of when the special regime will come in?

Photo of Colin Breed Colin Breed Shadow Minister, Treasury

That is exactly right. As the Minister said, the objective is to try to maintain these entities as going concerns. In general terms that will probably require some sort of recapitalisation and additional investment. The conditions under which an entity may ultimately come under some sort of regime may determine whether that capital-raising exercise is successful. We have to make it much clearer that it is not too subjective and that clear conditions have to be met, so that people understand what will happen. As I said, I can see in the drafts no clear explanation of how it will be determined whether condition 2 in section 7 is met.

Photo of Mark Todd Mark Todd Labour, South Derbyshire

I want to amplify briefly the point that I made in my intervention on the hon. Member for Fareham. We are contributing to the process of producing in the code not a specific disaster plan, but a document that is effectively enshrined in law. As it is referred to in the Bill, it will be a permanent feature of the regulation of banking in this country, and will be used as a reference document of some considerable substance.

I felt when I read the code that it was written, perfectly understandably, in the crisis-room mentality of dealing with the circumstances that we face and how we are using powers now—the hon. Member for Fareham, very fairly, said that it is easier to criticise and a lot harder to write. It was not written in normal circumstances, in which we could perhaps respond with a wider range of policy options than we have been using until now. That is my first, guiding principle.

Additionally, to use a sort of Rumsfeld term, this is an opportunity for us to express certainty about uncertainty, particularly about risk and the principles of risk. One of my anxieties about the way in which the code is written and, of course, to some extent about the necessary actions that we have taken recently, is that they entrench in our citizens, and to some extent our institutions, an assumption that the state will intervene and provide, almost regardless of what circumstances we face. That is, baldly, an unhealthy position.

The document is an opportunity—I should say straight away that this needs to be carefully expressed—to restate some principles of moral hazard that the state’s action should in normal circumstances reinforce, although I recognise that these are not normal circumstances. Those principles, broadly, are that if a person runs or invests in a business, they must expect to take risks and, in some circumstances, may find failure and, in ultimate circumstances, utter failure and complete loss of their investment and employment. That is a part of a mixed economy. We should not try to suggest that if a person is in a deposit-taking institution, for example, such failure might not happen because the state can always intervene and resolve some of their problems. That is  the first moral message that needs to be reinforced. There are circumstances in which a business might collapse. One can imagine circumstances in which that might be allowed to happen, for example, in the case of a small business or one that operates in such a niche function within the marketplace that its departure might not necessarily cause either a loss of confidence or an impact on financial stability. I think that we have recognised that the US, in the Lehman Brothers example, probably made the wrong judgment about when to reinforce moral hazard and that the consequent effect on confidence and stability was so profound that it should have accepted a greater responsibility to intervene.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

That is a very good example of when predictability in the market would help. Actually, the expectation of investors, based on actions that the Federal Reserve took on Bear Stearns, was that it would bail out Lehman Brothers. The fact that it did not, and allowed moral hazard to take its course, became an even greater shock, and triggered a further wave of problems.

Photo of Mark Todd Mark Todd Labour, South Derbyshire

That indicates some of the risks in an inconsistency of approach. The world is inconsistent, but the difficulty is that the jeopardy in that case was rather profound. It was probably the wrong decision. I can see why it was made, but I think it was an error. None the less, there might well be circumstances in which some other institution, not quite like Lehman Brothers, could be allowed to fail; and we should allow it to happen.

Photo of Peter Bone Peter Bone Conservative, Wellingborough 6:15 pm, 4th November 2008

I entirely agree with the case that the hon. Gentleman is making, but I have not been able in my own mind to come up with a situation in which any Government, whatever their political colour, would allow a financial institution to go under. Does the hon. Gentleman believe, in reality, that that would happen?

Photo of Mark Todd Mark Todd Labour, South Derbyshire

In reality, the answer is yes. It could happen, and we should reinforce the message that in some circumstances it would. If we do not give that impression in a document of this kind, we risk giving the impression that, in some way, it is a charmed circle activity in which there is some form of intervention—but not, of course, one that necessarily protects shareholders’ rights; that jeopardy is pretty explicit in the choice of objectives that have been set. However, some other stakeholders certainly have protections in place that provide for the state to be the fall-back position.

The second moral hazard is that depositors should take some responsibility for their decisions when choosing where their deposits should be placed. For perfectly understandable reasons—I do not criticise the Government; I can see where they are and how they got there—we have given the broad impression that whatever has been done by UK licensed deposit-taking bodies, people will be okay to whatever investment limit they have chosen. The difficulty is that if one allows that message to be given out repeatedly, people will chase the best rates without any thought. That, of course, will incentivise market behaviour, which chases exactly those depositors.

It is important, in a document of this kind, to reinforce those principles. It does not need to be done at length, but I would prefer a firm emphasis on ensuring that when the state acts it should, in normal circumstances, seek to reinforce those moral goods in the market place rather than protecting the participants to the point where they lose the inclination for any kind of risk awareness. As the Sage of Twickenham remarked in a debate in which I was able to participate, if we protect everyone from foolish behaviour, we will have a nation of fools. That is a pretty sensible picture of the ultimate outcome of ignoring the moral hazard argument.

I encourage the Government to think further on the approach that they are taking in the code. Much work remains to be done. It has one rather embarrassing typo, which I am sure will be picked up, but there is more work of substance to be done on the document, and I am sure that we can all participate in it.

Photo of Peter Viggers Peter Viggers Conservative, Gosport

The hon. Member for South Derbyshire made a thoughtful, well-informed and well-judged speech. The lesson of politics is that the battle is not so important; it is the war that matters. I do not necessarily expect the Minister to say that he accepts everything said by the hon. Gentleman and that he will order an immediate redraft, but the points that he made may at some point be taken into account. I completely share his view.

I want to address my remarks to clause 5(2)(d), which is on the crucial issue of the trigger for a special regime. We have to go back to 1997 and the creation of the tripartite arrangements between the Treasury, the Financial Services Authority and the Bank of England. The Bank, to great acclaim, was given the responsibility for setting interest rates, and to effect that the Monetary Policy Committee was created. Rather less noticed was the taking away from the Bank of its responsibility for banking supervision. The FSA was given the duty to control and monitor individual banks, while the Bank of England was given a more general power to control financial stability. The FSA fulfilled its duty, but there is little point in glossing over the facts: there were failures, and they happened on the watch of the FSA, which failed to perceive the systemic risks within some banks. We must learn from our lessons. There is no point in being too polite; we must say that there was a failure there.

The Government propose laying further specific duties on the FSA. Paragraph 26 of the draft code of conduct of the special resolution regime clearly states:

“The decision whether the bank or building society fails or is likely to fail to meet the threshold conditions is a regulatory matter for the FSA.”

That concerns me, because I have felt for some time that there should be a division of responsibility in the future, based on our learning from our mistakes in the past. The FSA should be given what I regard as the box-ticking, the responsibility for regulation, for ensuring that individual institutions meet certain criteria. The Bank of England, however, should be given responsibility for what I call banking supervision.

I distinguish between banking regulation and banking supervision. It should be possible for not only the FSA but the Bank of England to pull the trigger, because since the FSA is responsible for the routine financial regulation of banks it will naturally be reluctant to  come forward and say that normal regulation has failed. It will instinctively—naturally—not wish to say that the regulation for which it is responsible has not been successful. There should therefore be a separate mechanism giving the Bank of England the power to supervise, and that power of supervision must provide it with enough personnel and abilities for it to be close enough to the management of banks to know when special action is required. Clause 8(1) states:

“The Bank of England may exercise a stabilisation power in respect of a bank in accordance with section 10(2) or 11(2) only if satisfied that Condition A is met.”

Clause 8(2) then states:

“Condition A is that the exercise of the power is necessary, having regard to the public interest in—

(a) the stability of the financial systems of the United Kingdom,

(b) the maintenance of public confidence in the stability of the banking systems of the United Kingdom, or

(c) the protection of depositors.”

In other words, the Government have put in the Bill the same kind of responsibilities for the Bank as it already has under current legislation. The responsibility for individual bank supervision is to remain with the FSA, whereas the general responsibility for financial stability, under clause 8, will be that of the Bank. That is not good enough.

The draft code of practice envisages, in paragraph 31, that the

“three public interest conditions may overlap (to a greater or lesser degree) depending upon the particular circumstances of the bank or building society and the wider circumstances of the financial system as a whole.”

So the legislation and the draft regulations envisage that there could be some overlap in the responsibilities and powers of the Treasury, the FSA and the Bank. Good, roll it on. Some level of duplication is necessary. It is not good enough to restrict the regulation and the power to pull the trigger to the FSA; the power to pull the trigger must also be available to the Bank of England, because only the Bank of England has long-term experience of bank control, the levers to affect financial stability and the traditions and ability to discern systemic risk, which the FSA, based on its record, has failed significantly to do.

As happens in the United States, I would give slightly different responsibilities to the FSA and the Bank of England, but I think that it is important that the Bank of England should not be restricted to the exercise of general powers and the stabilisation power referred to in clause 8. It should also have the ability to pull the trigger and implement the provisions to introduce the special regimes.

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

As is evident, clause 5 provides for the Treasury to make a code of practice on the use of the stabilisation powers, the bank insolvency procedure and the bank administration procedure. The authorities—that is, the FSA, the Bank of England and the Treasury—must have regard to the code. The clause also provides a non-exhaustive list of the areas on which the code may provide guidance. As hon. Members are aware, a copy of the code was circulated to the Committee last Thursday and, as I said earlier, a consultation document on safeguards, including the code, will be issued on Thursday.

At present, the code covers further explanation of the SRR objectives, how they should be balanced, what regard the authorities should have to the code, further explanation of the roles of the authorities in the SRR, further explanation of how the authorities will judge that the general and specific conditions are met, factors to be considered when choosing the SRR tools, procedure for the announcement of the SRR tools and the Government’s arrangements for bridge banks and banks in temporary public ownership. That is not a comprehensive list, and it will undoubtedly be expanded and clarified as a result of the consultation exercise.

We have already had significant debate about the further explanation of the SRR objectives and how they should be balanced, but the hon. Member for Fareham, in a sort of online stream of consciousness, went through the code in fine detail. I will respond to some of his questions. He asked again whether the Kaupthing Edge announcement was a template. Not necessarily; we will consider such matters on a case-by-case basis.

A related question was how long to wait for a statement. We wish to make a statement as soon as is reasonably practicable, but as the hon. Gentleman said, the type of information given may depend, rightly, on the circumstances. For instance, if there is still a risk of loss of confidence in the banking system, that might affect the timing of an announcement as well as what can be disclosed in it. There are tensions between full and immediate disclosure and effective action. I think that he understands that. It explains why, although we want to publish information as quickly as is reasonably practicable, other considerations must be borne in mind.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

I am grateful to the Minister for that explanation—he picked up that I understand the subtleties—but the announcement about Kaupthing erred on the scanty side in terms of information. For example, it did not say what trigger conditions Kaupthing had breached to lead to the FSA’s withdrawal of permission. That is the level of detail that we want. We do not need to know down to the nearest 5p why there was an issue, but there was nothing to indicate why it had lost that permission. It was missing information that could have been given in any context. Maybe they had lost their claims representative. I do not know.

Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary, Department for Business, Enterprise & Regulatory Reform, Economic Secretary, HM Treasury 6:30 pm, 4th November 2008

I note the hon. Gentleman’s comments and will take them into account as part of our consultation on the code. Regarding the point he makes about the claims inspector, the FSA handbook does refer to all the threshold conditions. The FSA will update its handbook in the light of the Bill and will address such points. On the specific example of the appointment of a claims representative, I can confirm that this condition applies only to regulated activity when it comes to carrying out insurance business.

The hon. Gentleman also referred to paragraph 29 of the code and implied that the bank insolvency procedure is the default option. That is not the intention of this part of the code. This paragraph highlights the need that a strong public interest test, as outlined in clause 8, be met before the Bank of England exercises stabilisation  powers which, as hon. Members have noted, are invasive. That is why we always need to think carefully before exercising these powers.

I want to respond directly to comments raised by my hon. Friend the Member for South Derbyshire. I can confirm that it is the Government’s intention not to create a zero-failure regime. Indeed, the bank insolvency procedure has been created expressly so that there is a credible failure option. It is possible that the authorities could decide in the event of a bank or building society failure that there is not a systemic risk, that the requirement for action under the special resolution regime is not necessary. I would, however, point out that if a significant number of retail depositors were affected we might still want to use the bank insolvency procedure to ensure effective, fast payout under objective 3, or because perhaps public funds had already been committed previously to the institution which relates to objective 4.

I also want to respond to the point my hon. Friend made that the code was written in times of crisis and that it should it reflect the actions in periods of financial stability as well as instability. The point I made that there is a credible failure option in terms of the bank insolvency procedure is an important one. I would want to reflect on my hon. Friend’s point while at the same time wanting to be clear that the code is specifically about the actions within the special resolution regime, that is actions that are being taken not under normal conditions but when a bank is failing. Even then, other tests have to be satisfied. In terms of when the code is written, I think it right that we should respond to circumstances as we see them at the moment, but the Bill allows us to revise the code so it can be updated in calmer times as well as in times of financial instability.

Photo of Mark Todd Mark Todd Labour, South Derbyshire

My hon. Friend will be aware that revising a code to transfer risk back to the public and to commercial organisations will be a lot harder than setting out some of those risks at the start of the process, albeit shrouded carefully in this document.

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

I certainly take the points made by my hon. Friend and, as I have said, we will want to reflect on them. I did want to put back to him the point that the code is deliberately designed to refer to times that are not normal because it relates to the operation of the special resolution regime.

Photo of Peter Bone Peter Bone Conservative, Wellingborough

What happens if the independent Bank of England and the FSA think that the failure of an organisation is a one-off—not systematic—but the Treasury and the Government take a wholly different view?

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

I do not think that it is particularly useful to engage in speculation, but, from my experience and from hearing about recent discussions, there are extensive talks between the three organisations that make up the tripartite authorities in which different options and courses of action are debated. It is not possible to set out general principles in this area. We have to look at how things operate on a case-by-case basis.

The hon. Member for Fareham also asked why a bridge bank should report every year when Northern Rock reports quarterly. He may be misunderstanding what we are trying to achieve through paragraph 72 of the code, which is intended to refer to a report on why the bridge bank exists for more then a year, rather than financial reporting arrangements. We would certainly expect the Bank of England to put in place appropriate arrangements for a bridge bank’s management to report to the Bank in its role as a shareholder.

The hon. Gentleman also asked what “conservative management” is, and I am very tempted to tell him. We are trying to get the point across that we want to take action that will preserve the franchise value of the banking business transferred to the bridge bank, but we do not anticipate the bridge bank competing aggressively for new business, which was one of the concerns that he tabled an amendment on. The code will be subject to public consultation, and I think that all the points raised by Committee members will be taken into account as part of that process.

Amendment No. 81 is designed to ensure that the code includes provisions on determining whether the threshold conditions, set out in the Financial Services and Markets Act 2000, are met. I do not agree with the intention behind the amendment. The threshold conditions are regulatory conditions under the 2000 Act, and therefore provisions about determining whether they are met are included in the FSA handbook, so it is unnecessary to include in the code any provision on that determination. However, as hon. Members will see, the draft code that has been circulated refers to the FSA handbook, so stakeholders can easily find this detail should they wish. The people involved in these areas are well aware of the situation. I therefore believe that amendment No. 81 is unnecessary.

Amendment No. 80 comments on the manner in which the authorities should treat the code of practice. Clause 5(4) requires the authorities to have regard to the code. The hon. Member for Fareham’s amendment however, seeks to require authorities to comply or to explain publicly why they did not comply with the code as soon as possible after any action. I shall set out why I do not agree with that approach.

The provisions of the code are intended to provide guidance. For example, the code may set out provisions that should be taken into account or may provide for the approach that the authorities should normally seek to adopt. The expectation is that the authorities should follow the code, and that if they do not, a public explanation would normally be needed. However, a hard-edged statutory requirement to comply with the code would be inappropriate to its function and would unduly restrict the flexibility of the authorities. There may be a number of reasons why a public explanation is not appropriate; for example, if explaining an action that did not comply exactly with the code meant divulging information that itself would put at risk the SRR objectives of confidence in the banking system or financial stability. I consider that to be the appropriate status for the code, in that it will provide a significant amount of detail about how the authorities will implement the SRR and it can be updated to reflect experience gained from operating the SRR without imposing hard-edged duties  or requirements on the authorities. I therefore invite hon. Members not to support the amendment if it is pressed.

Before turning to the next set of amendments, which refer to clause 6 rather than clause 5, I shall speak briefly to Government amendment No. 89, whose purpose is to remove duplication under the Bill, by removing subsection (2)(f). Clause 11(3)(c) already requires the information provided for in that subsection to be included in the code of practice, so it is superfluous to make reference to it. The amendment is simply a technical correction and I commend it to the Committee.

The next set of amendments refers to clause 6, which sets out the procedure for developing and updating the code of practice. It requires the Treasury to consult the FSA, the Bank of England and the FSCS before issuing the code. Further, it requires the Treasury to lay a copy of the code before Parliament as soon as is reasonably practicable after issuing the code. As the code is required to be a flexible document that can respond to the authorities’ experience in operating the SRR and general market conditions, the Treasury can revise and reissue the code.

Amendments Nos. 82 to 85 would introduce extra procedural requirements before the Treasury could agree and issue the code. First, amendments Nos. 82, 83, and 85 would require the Treasury, in addition to consulting the Bank, the FSA and the FSCS, to consult other interested stakeholders. Secondly, amendment No. 84 would require that the code be approved through a resolution by both Houses of Parliament before coming into force. I do not believe that those additions to the procedure are necessary, and I shall explain why.

A number of parts of the Bill, including the powers and areas that affect stakeholders the most, have been and will be subject to full consultation—indeed, that is something that stakeholders have welcomed—yet none of that is set out in the Bill and nor should it be, as it is already covered by the relevant Cabinet Office and better regulation guidelines on the development of secondary legislation. I recognise that there is, of course, substantial interest in the code. That is why, as I explained earlier, I sent a draft to the new banking expert liaison group last week for discussion at its meeting on Friday, as well as providing a draft to the Committee. As I said, the code will be extensively consulted on when the consultation document is issued on Thursday. Throughout the process of producing the Bill and its supporting  documents, we have had full engagement with stakeholders, and we fully intend to continue to follow Cabinet Office guidelines in producing, and consulting on, new secondary legislation and other documentation supporting the SRR. That, I can assure the Committee, will also be the case with the code of practice. The amendments are therefore unnecessary.

Amendment No. 84 would ensure that Parliament formally approves the code of practice by resolution. Again, I do not believe that such an amendment is necessary. Under the Bill, the Treasury has a duty to lay the code before Parliament and of course Parliament is at liberty to ask questions or call for debate on the content of the code. However, the code, just like the FSA handbook, is not a statutory instrument, so I see no reason to require it to be formally approved by Parliament, just as the FSA handbook is not formally approved by Parliament. Again, I hope that our actions in producing a draft code of practice for the Committee to consider as part of the debate shows our willingness to involve Parliament and stakeholders in the creation of the document. I hope that the amendment will be withdrawn.

I conclude on the general issue of the accountability of the authorities to Parliament. The Committee will be aware that the Treasury Committee—some of whose distinguished members serve on this Committee—has been active and scrupulous in holding the authorities to account in their exercise of powers under the Banking (Special Provisions) Act 2008, and also their actions to deal with the wider financial crisis. That is exactly how it should be. The Government expect the Select Committee and Parliament to continue exercising that important responsibility.

I believe that our approach, with full consultation on the secondary legislation and the code, and with the secondary legislation coming to Parliament in the normal way, provides sufficient safeguards. I am sure that the Treasury Committee will continue to hold all the authorities to account.

If hon. Members wish to press the amendments to a vote, I suggest that, with the exception of Government amendment No. 89, they should be opposed.

Debate adjourned.—[Mr. Blizzard.]

Adjourned accordingly at fourteen minutes to Seven o’clock till Thursday 6 November at Nine o’clock.