Clause 11

Financial Services Bill – in a Public Bill Committee on 12th January 2010.

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Rules made by FSA about remuneration

Photo of Colin Breed Colin Breed Shadow Treasury Minister 10:30 am, 12th January 2010

I beg to move amendment 55, in clause 11, page 8, line 33, at end insert ‘; and

(c) the regulatory objectives of the Authority.’.

I welcome you back to the Chair, Mr. Benton, in what is a slightly warmer room than we are used to.

The amendment is small but important.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

The amendment may be small but important, but is the hon. Gentleman not disappointed, as I am, that it is only because of the presence of him and my hon. Friends that the Committee is quorate this morning?

Photo of Colin Breed Colin Breed Shadow Treasury Minister

I was not going to mention that, but I agree that it is a tad disappointing. No doubt the Minister will rustle up a few more of his colleagues in the next few minutes. Otherwise I might sit down and ask for a vote. That would be a more difficult thing.

This is a probing amendment. I want the Minister to explain why we have omitted a particular aspect in the clause. To subsection (3)—

“The rules must secure that any remuneration policy that an authorised person is required by the rules to have is consistent with”—

I seek to add the words:

“the regulatory objectives of the Authority”.

That is one of the key aspects. If we have learned anything from the recent past about the way in which remuneration or compensation packages have operated, it is that they have in many respects driven business both corporately and individually to extremes, causing some of the problems that we have seen. In its monitoring and supervisory role in the past, the FSA might have had a passing glance at the compensation packages or the recommendations of remuneration committees in the individual institutions that it was looking at. It obviously did not get too involved in them, and yet it was a strong driver for the way in which those institutions operated.

Monitoring the performance of banks and other lending institutions must include the fact that the FSA will need to ensure that the remuneration packages, particularly bonuses and such, align with the model that the bank or the institution is undertaking. That is an important role for the FSA. It should have an impact on compensation packages. It should be able to make regulatory rules in respect of the operation of banks and others, which include remuneration and compensation packages. In many respects, the additional measure ought to be the first one, not the third one. The rules of remuneration committees, the impact of their decisions and the way in which bonus contractual arrangements are made are extremely important. The FSA should not only be able to comment but be able to ensure that such packages are commensurate with the appropriate business model that it is monitoring. That it should have at least a role to play when the remuneration rules are set up is a pretty reasonable addition to the subsection.

As I said to the Minister, it is a probing amendment. I am sure there are other ways to do this, but I want to be certain that the way in which the FSA is involved in how banks and others construct performance-related and profit bonuses is appropriate. We have seen much inappropriate use of the bonus systems. I have just come from the Treasury Committee, which is meeting at this very moment; that is perhaps why slightly fewer hon. Members are in Committee. It has been receiving evidence from Mr. Stephen Hester, and already much of this morning’s discussion has related to bonus payments, the packages that were put together at ABN and the contractual package that was offered to Mr. Hester when he took his current job.

As for the likely bonus pot and the distribution of bonuses this year, it has been demonstrated clearly that they will be significant, particularly in respect of the performance of individual banks during last year’s trading. The addition to the clause would be an important way in which the FSA could not only monitor, but ensure that future compensation packages are allied to a sustainable business model that will not lead us into the problems that we have experienced in the past.

Photo of Ian Pearson Ian Pearson Economic Secretary, HM Treasury

For the record, the Government Benches were reinforced by 10.33 am, after only three minutes of our debate, despite the fact that several colleagues are performing sterling work on the Treasury Committee.

I wish to explain to the Committee why the amendment tabled by the hon. Member for South-East Cornwall is neither necessary nor particularly helpful. As he will be aware, clause 11 places a duty on the Financial Services Authority to make rules setting out the standards to which remuneration policies should adhere, in pursuit of the clear and specific objectives that remuneration policies in banks should not incentivise excessive risk taking, and that regulatory action should be appropriate to ensure that that does not happen. That stems from an established international consensus among the G20 and the Financial Stability Board that remuneration policies in the financial services sector should be subject to control to ensure the avoidance of excessive risk, and we agree strongly with that position.

Clause 11 therefore makes express statutory provision for the implementation of the consensus by placing a duty on the FSA to make the appropriate rules. We  need to be clear that the rules will be focused on the vital objective of ensuring that remuneration does not encourage excessive risk taking by key employees of banks. The amendment proposes something different from that, and would add to subjection (3) of proposed new section 139A the additional requirement that the rules that the FSA makes must ensure that remuneration policies are consistent with all the statutory objectives of the authority.

I must say to the hon. Gentleman that requiring the FSA to insist that authorised persons have remuneration policies consistent with a large number of objectives would be difficult from a practical perspective, both for the firms and for the regulator. The rules would need to be extremely detailed and wide-ranging to achieve that. The amendment is therefore likely to detract from the focus of ensuring that remuneration does not incentivise excessive risk taking. It would certainly have the effect of moving the United Kingdom policy on remuneration in a different direction.

A balance must be struck between regulation by public authorities and self-regulation imposed through the normal operation of market discipline. That is very much a live issue at the moment. To say that remuneration policies must be consistent with all the objectives of the authority, including consumer protection, market confidence, tackling financial crime and so on, is not really necessary. The FSA already pursues those objectives through the full suite of available regulatory and enforcement powers. It is not clear that adding an express duty for it to do so through its regulation of remuneration policies would add anything.

Requiring the FSA to subject a limited category of authorised persons to the FSA’s objectives in a small part of their activities would do little to assist consumers or ensure that the FSA’s other objectives were fulfilled. As I have said, the FSA has a full suite of other powers available to it in other areas, and there is a real risk that, if the amendment were accepted, it would detract from the purpose of the provisions and from what we are proposing, which is deliberately focused on avoiding excessive risk taking. I therefore urge the hon. Gentleman to withdraw his amendment.

Photo of Colin Breed Colin Breed Shadow Treasury Minister

The truth of the matter is that banks and financial institutions are different if they are too important to fail, because taxpayers are standing behind them. We know that failure, or the potential to fail, has perhaps been driven as much by remuneration policies as anything else.

I understand it when the Minister says that the measure would have to be detailed, and in general terms we do not want to interfere in the remuneration policies of private companies or get too fixated by the current situation, when there is large taxpayer ownership of a couple of large institutions. Hopefully, this legislation will endure beyond that situation, so we can talk about a more normal situation. Nevertheless, the FSA requires the explicit authority and power to intervene in a remuneration policy.

Will the clause, as it stands without the amendment, allow the FSA to veto or not authorise an institution’s proposed remuneration package or bonus payment system if it feels that the package is not in the institution’s best interests, or because of the systemic risk that would  arise if the institution failed as a result of that remuneration package? If the Minister is able to satisfy me that that is the case, and that we do not need to concern ourselves with the issue, I am perfectly happy for the clause to remain as it is. As far as I am concerned, the key aspect is that the FSA should have the ability, if required, to say to a large bank, “We do not believe that your bonus payment system should be used, given your performance, the business model and the potential systemic risk that would arise if you entered into a difficulty. We therefore say that you cannot use it.”

Photo of Ian Pearson Ian Pearson Economic Secretary, HM Treasury

I am happy to confirm that the focus in clause 11 on avoiding excessive risk taking does exactly what the hon. Gentleman suggests. The FSA also has other powers in other areas to ensure that its other objectives are fulfilled. That is why we do not believe that the powers should be widened in the way that he suggests.

Photo of Colin Breed Colin Breed Shadow Treasury Minister

I think that the Minister is being entirely frank. Our concern was about whether the FSA has that ability. It has had a number of powers for many years that it has failed to use. Perhaps in this particular case, it will focus clearly on its ability to use the clause to ensure that it acts swiftly in future if it becomes concerned, as a result of its supervisory activities, that a remuneration package or bonus payment system may drive an institution in the wrong direction. On that basis, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

I beg to move amendment 54, in clause 11, page 9, line 11, after ‘void’, insert

‘where that agreement was signed after 19 November 2009.’.

Photo of Joe Benton Joe Benton Labour, Bootle

With this it will be convenient to discuss Government amendment 56.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

Thank you, Mr. Benton. It is a pleasure to serve under your chairmanship this morning. I am pleased to see that although I have blazed a trail with my amendment to proposed new subsection 9, the Minister has ridden in behind and has come up with something else, which may well be the amendment that changes the Bill. I would perhaps take some credit for poking in the right direction, but his amendment gives rise to questions about what it means in practice.

I want to start with some brief remarks on the clause. One of the big debates that has emerged from the financial crisis is about remuneration. There are two strands in that debate. The hon. Member for South-East Cornwall just alluded to one of them, which arose from the questioning of Stephen Hester by the Treasury Committee on quantum and the amount of money involved. It plays into the question of why banks can make such large bonus payments, given that the taxpayer bailed them out. That has rightly triggered fierce debate about that aspect of remuneration.

Also—I shall spend a bit more time discussing this—attention has focused on what the right remuneration structures are for banks. Clause 11 provides the FSA  with a framework for introducing rules to that effect. In his report on the FSA’s role in the financial crisis, Lord Turner said that

“within firms, little attention was paid to the implications of incentive structures for risk taking, as against the implications for firm competitiveness in the labour market and for firm profitability. In retrospect this lack of focus, by both firms and regulators, was a mistake. There is a strong prima facie case that inappropriate incentive structures played a role in encouraging behaviour which contributed to the financial crisis.”

In September, Lord Turner said that

“the honest truth is that bad remuneration policies, though relevant, were far less important in the unravelling of the crisis than hopelessly inadequate capital requirements against risky trading strategies”.

The point is that although there is much debate about bonuses, correlating bonus structures to risk and shareholders’ interests is not sufficient in itself to prevent or mitigate the recurrence of a financial crisis. It is a helpful factor, but it is not the silver bullet that people are looking for.

Clause 11 amends the Financial Services and Markets Act 2000 to create new rules about remuneration policy at any and all FSA-regulated firms, not just banks, although that is clearly the principal focus at the moment. Proposed new section 139A(1) says:

The Authority must exercise its power to make general rules so as to make rules requiring each authorised person (or each authorised person of a specified description) to have, and act in accordance with, a remuneration policy.”

Section 139A(3) goes on to say that

“any remuneration policy that an authorised person is required by the rules to have” must be

“consistent with—

(a) the effective management of risks”, which is not defined, and

“(b) the Implementation Standards.”

The implementation standards are in a paper published by the Financial Stability Board in September 2009 setting out how an earlier policy statement, produced by the Financial Stability Forum in April last year, could be implemented.

Will the Minister clarify one point? The FSA’s code of remuneration policy was published the previous month, in August last year. It is not clear from the Bill whether “general rules” refers to the FSA’s August 2009 statement, which predates the implementation standards, or whether, as I think is the intention, more detailed rules will be produced by the FSA to flesh out what was in the code. It is clear from the FSA code produced in August and the implementation standards that the latter, although relatively permissive, are much more specific—for example, on the proportion of a bonus to be deferred—than the FSA’s code, which is more general. Will he explain the interaction between those two documents?

In looking at the FSB’s work programme, a further report on compensation practices will be published in March 2010. It will look at how the implementation standards were implemented across different jurisdictions. I assume that if the March 2010 document argues for a further tightening of the rules, it can be reflected in the FSA’s policies and rules by virtue of subsection (4) of new section 139A, which says:

“When making rules about remuneration policies, the Authority must have regard to any other international standards about the remuneration of individuals working in the financial sector”.

It is clear that work is ongoing. There is not a final international position on this. Further guidance may be issued on the back of the report planned for March. Although the clause is anchored off the back of the FSB’s September 2009 document, I assume that any later documents will also be covered by this.

The changing picture gives rise to my and the Minister’s amendment to subsection (9), which gives the FSA the power to make rules that may

“prohibit persons...from being remunerated in a specified way”.

It may provide that

“any provision of an agreement that contravenes such a prohibition is void”.

When the Minister and I debated the Banking Act 2009, we spoke briefly about the potential power in that Act to tear up directors’ contracts. The Minister was very clear that the power was not there for that purpose, and directors’ contracts would continue in place. It was not clear from the way in which subsection (9) was drafted whether agreement, which pre-dated the publication of the Bill, could be made void, and what protection there was for pre-existing contracts of employment between financial institutions and their employees. Amendment 54 therefore seeks to clarify any contracts entered into prior to 19 November. Hon. Members might wonder why I chose 19 November. That was the date that the Bill was printed. People will know that if their contracts were entered into prior to 19 November, they would not be capable of being made void. However, if the contracts made after 19 November were in breach of international standards, they could be made void. People were given notice at that point about the principles with which the remuneration policy should comply. That is the purpose of my amendment.

Government amendment 56, which applies when the rules are made, is perhaps more generous than mine. It is not clear to me whether the code that the FSA incorporates as part of its rules in August is the same as the rules for this purpose, or whether there is a further set of detailed rules that people would be expected to comply with. Does the code have the same standing as a later set of rules? I am not clear what rules the Minister refers to. Is it the code that was published in August or will more detailed rules be published at a later date, with which people will be expected to comply? Are the contracts that pre-dated those rules still valid? I would like the Minister to clarify that.

Photo of Ian Pearson Ian Pearson Economic Secretary, HM Treasury 10:45 am, 12th January 2010

First, in response to the more general points made by the hon. Member for Fareham about the clause, the moving picture of regulation and the further development of international standards, I must say that the current FSA code is a world-leading example of how a supervisor should tackle remuneration that incentivises excessive risk taking. Under the Bill, we are strengthening the FSA’s hands as a regulator to take action against remuneration policies that encourage excessive risk taking and ensuring greater accountability of the FSA to the Government in that area. The hon. Gentleman is right about further international developments. He referred to the work of the Financial Stability Board; it is a matter on which discussions are still taking place. As a result, the FSA will be changing its code to ensure consistency with the G20 agreement. The plan is that it will review its code in 2010 to take account of experience gained in implementing it, and in the light of international developments, which is something that the hon. Gentleman will want to support.

With regard to amendment 54 and Government amendment 56, I recognise that there has been some confusion over the impact and powers given to the FSA under the clause, but I assure the Committee that it was never the Government’s intention that the power should be used by the FSA to invalidate provisions in existing contracts, nor does the clause include a provision giving the FSA retrospective powers. As the Committee is aware, the Joint Committee on Human Rights recently recommended that the lack of retrospective effect should be made clear in the Bill, and the hon. Gentleman has made a noble attempt to do that with the amendment.

However, the specific wording of the hon. Gentleman’s amendment refers to the date on which the Bill was introduced to Parliament and does not fully address the concerns that have been raised. Any rules that the FSA makes and publishes will, of course, be known after that date so amendment 54 would allow some retroactivity by referring to the date when the Bill was introduced into Parliament rather than the date on which the FSA made its rules.

In contrast, Government amendment 56 provides that any rules the FSA makes about remuneration may not render void a provision that was already in an agreement when that rule was made. The hon. Gentleman raised a broader issue and one that we think is appropriate. He asked whether the code was equivalent to rules for the purpose of voiding any contracts. The answer is no. The rules themselves must provide that continuation of a rule will make a clause void. The code does not, and there will be new rules.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

The code is now part of the FSA rulebook, so I am not sure why it is not regarded as rules for the purpose of the clause.

Photo of Ian Pearson Ian Pearson Economic Secretary, HM Treasury

I accept that the hon. Gentleman is right. I am right, too, given my advice, but if I can provide further clarification during this morning’s debate, I shall certainly do so. The key point is that the Government amendment is broader and more appropriate than amendment 54, and I shall clarify the detail with him shortly.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

I am not quite sure what it is we are broader or more conciliatory to the banking sector about, but there is a problem because we need clarity for contractual purposes. There is also tension because the code, which was introduced in August, is less specific than the implementation standards. For example, the standards define some proportions of remuneration that should be deferred, whereas the code is much more permissive. Greater clarity on that matter would be welcome. If the formulation of the Bill is not sufficiently clear, once the Government amendment is made—assuming that the Committee passes it—will the Government return to the matter on Report? That would ensure that what people are meant to be complying with is crystal clear. People are making formal commitments; for example, the banks have signed up to the Pittsburgh declaration. Many commitments have been made, and we must ensure that we respect contractual obligations. Therefore there needs to be some clarity as to what it is that people are meant to be complying with and what the rules are.

Ian Pearsonindicated assent.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

The Minister nods in assent, so I assume that he will look into that matter again and perhaps table amendments on Report. With his reassurances and explanation on why amendment 56 is superior to 54, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Amendment made: 56, in clause 11, page 9, line 17, at end insert—

‘( ) A provision that, at the time the rules are made, is contained in an agreement made before that time may not be rendered void under subsection (9)(b) unless it is subsequently amended so as to contravene a prohibition under subsection (9)(a).’.— (Ian Pearson.)

This amendment makes it clear that the general rules about remuneration may not render void any provision which is already in an agreement when the rules are made (so long as the provision is not subsequently amended in a way that contravenes the rules).

Clause 11, as amended, ordered to stand part of the Bill.