Clause 12

Financial Services Bill – in a Public Bill Committee at 10:45 am on 12 January 2010.

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Rules made by FSA about recovery and resolution plans

Photo of Rob Marris Rob Marris Labour, Wolverhampton South West 11:00, 12 January 2010

I beg to move amendment 57, in clause 12, page 11, line 5, at end insert

‘or requiring the authorised person to be broken up into several persons by a date specified by the Authority.’.

It is a pleasure to appear before you again, Mr. Benton. Part of the Bill addresses the world recession and its effects in the UK, and the regulatory regime in the UK faced with a world crisis. My starting point in tabling the amendment is that there will be another crisis in world banking, which will be reflected in the UK. I am not foolish enough to predict when that crisis will be, but as someone whose partial background is as a historian, it is clear from looking at the past and the nature of capitalism, driven by greed and innovation, and its cyclical nature, whether one takes Kondratiev long waves or shorter ones, the high likelihood is that at some point in western capitalism within the next 30 years there will be some kind of banking crisis.

The Bill goes some way towards addressing such issues for the future, including the recovery and resolution plans in clause 12, and the amendment relates to resolution plans. Paragraph 106 of the explanatory notes, states:

“A recovery plan aims to reduce the likelihood of failure of a firm by setting out what the authorised person would do in, or prior to it becoming subject to, stressed circumstances”.

It continues:

“Action described in the plan may include the restructuring, scaling back or sale of certain business lines or assets of the authorised person in question”.

A resolution plan, in contradistinction to a recovery plan, is to do with failure. Paragraph 111 of the explanatory notes, states that it is

“action to be taken in the event of failure of all or any part of the business occurring, and action to be taken by a firm where failure is likely.”

Paragraph 110 also states that resolution plans allow for

“gradual implementation, focusing on the largest, most complex and systemically significant firms in the first instance.”

Proposed new subsection 139C(8), which my amendment would change, states:

“The steps that the Authority may take include requiring the resolution plan to be revised.”

My amendment would add after “to be revised”:

“or requiring the authorised person to be broken up into several persons by a date specified by the Authority.”

It is about the break-up of big banks. As drafted, the Bill says that if the authority does not like a resolution plan—a plan that is to do with failure or its likelihood—it can ask for it to be revised. Well, whoopee-doo. We could have a big bank failing and the FSA saying, “You had better revise your failure plan,” or the “resolution plan”, as it is called in the Bill. That is not adequate. The size of our financial institutions in the United Kingdom is the elephant in the room—to use a hackneyed phrase—in the Bill. They are too big. They need to be broken up. To use the description of the Governor of the Bank of England when he spoke in the Lords in December, banks and financial institutions are “too important to fail”.

I have a lot of time for the Governor of the Bank of England because he is, as my hon. Friend the Minister will know, a fellow Wulfrunian—a Wolverhampton native. For some strange reason, he does not support Wolverhampton Wanderers football club; he supports Aston Villa. Apart from that, Mervyn King is not a bad Wulfrunian—not a bad bloke. He raised the issue of financial institutions in our country that are too important to fail.

My amendment is permissive. It would say:

“The steps that the Authority may take include...requiring the authorised person to be broken up”—

“the authority may take” is permissive. The amendment does not seek to break up big financial institutions in the United Kingdom—at the moment. If a Government had such a power—let alone used it—there is a risk that certain financial institutions would decide to leave the United Kingdom, because of such draconian powers. That is a concern. There is also the issue of breaking up large financial institutions—banks—into retail and investment, or, as the Americans call them, utility and casino banks. That has been canvassed by the hon. Member for Twickenham, who is a member of the Committee but has not yet joined us. Breaking up banks in such a way is simplistic. Hon. members will know my concerns about UK banking in contradistinction to Canadian banks, which are the most stable in the world. They were voted the most stable by the World Economic Forum. They are some of the biggest banks in the world and they do retail and investment, so that is not necessarily the way to break up big financial institutions. Although it would be worth looking at, that alone will not solve it.

Photo of Andrew Love Andrew Love Labour, Edmonton

I am following my hon. Friend’s argument closely. A concern raised by his amendment is that it places the breaking up of organisations in the Bill. Yet, as I understand it, the stated intent of the Bill is to set a framework and leave it to the living wills to decide policy. What arguments does he deploy to support putting it in the Bill, when the suggestion is that it be left to the discussions between the FSA and the financial organisation itself?

Photo of Rob Marris Rob Marris Labour, Wolverhampton South West

My amendment is permissive. It does not say that big financial institutions should or must be broken up. It says that the Financial Services Authority may, if there is not an adequate resolution plan, order that a financial institution be broken up. It is merely permissive in that sense. If it were to lead to an exodus of financial institutions from the United Kingdom, I am not sure that would be a bad thing. It would be a bad thing for people who work for them, of course. However, we are faced with the fact that, in our country at the moment, we have spent a huge amount of taxpayers’ money—some of which we might get back, some of which we might not—bailing out failed large financial institutions. We cannot afford to keep doing that. This year, the Government’s borrowing is about £175 billion; it will be of a similar order next year. That is the result of two things: one is the bailing out of financial institutions and the second is that the world recession and the recession in our economy, the effects of which the Government have done very well to lessen, have been hugely costly. The antics of morally corrupt people such as Sir Fred Goodwin or Adam Applegarth of Northern Rock have destabilised our whole system here and similarly across the Atlantic in the United States of America, and the cupboard is bare.

If a big financial institution in the United Kingdom were to go bust in the relatively near future, the taxpayer could not afford to bail it out. To me, it is not a choice between, “Ah well, do we take on a bit more debt in the future to bail out a big financial institution if it goes bust?” or “Do we break it up in the future?”, but a matter of, “We can’t afford to bail out big time somebody in the future, so let’s take some preventive steps now, at least by giving the FSA the power to do it.” I am not saying that it must do so, but just that we should take some preventive steps now to consider breaking up the large financial institutions, as the amendment suggests, because we cannot afford the alternative.

As politicians who are considering the Financial Services Bill and members of society, we need to debate whether the size of the financial institutions relative to the size of our economy is, in fact, too big. I am sure that some hon. Members will agree that at some time in the unspecified future we will again have a financial crisis in the United Kingdom. That is what happens with big financial institutions because capitalism driven by greed and innovation can produce negative as well as beneficial results. If we are to have such a crisis in the future, let us take preventive measures now. Let us talk about it now.

For example, as many of my colleagues on the Government Benches will know, for trade union activists the time to discuss a redundancy policy of the company for which they are working is not when the company is proposing to take redundancies, but when it is not proposing to take redundancies, because that is when a calm debate can take place. At the moment, the signs are that the Government’s heroic actions have stabilised the financial system both in the United Kingdom and more broadly throughout the world, and that things are starting to calm down. So now is the time when we should debate the size of financial institutions in our country and whether there should be a cap on their size, such as on their capitalisation as a percentage of gross domestic product or some such formula. I am not fixed about what. The issue is one on which economists are  fairly evenly divided, but there is a big school of thought in the western world among economists that the “too important to fail” issue is being ignored by politicians.

[Mr. Roger Gale in the Chair]

I certainly pick up in the United Kingdom that, as politicians, we are failing in the debate. We are not having it. It takes a Back-Bench amendment to enable such a debate, and I should be interested to hear what my hon. Friend the Minister—also from the west midlands—says about whether the FSA should have permissive powers. Do the Government propose to have a public or political debate about whether the size of financial institutions in the United Kingdom needs to be cut and, if not, why do they not consider that we should have that debate? If the Minister—as I anticipate he might—says that the amendment is not right, does he think that a different change to the Bill would be appropriate to implement such a power so that its use can be discussed now while matters are calming down? We cannot avoid such a debate; we either have it now or whoever of us is left standing, as it were, when the next crisis hits and we cannot afford to bail out big institutions, will have to discuss the matter then. I would rather have the debate now.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury) 11:15, 12 January 2010

I welcome you to the chairmanship of the Committee, Mr. Gale.

The hon. Member for Wolverhampton, South-West raised some interesting points in his amendment. I was going to touch on something similar in the stand part debate, and if I may, I would like to make some broader comments about clause 12.

The debate is an important one to have. The hon. Gentleman has done us a service by raising the issues, including the one about banks that are too big to fail, and whether there should be a division between different elements of banking activity—the shorthand is: do we need a British Glass-Steagall? In our white paper on reforming financial regulation we said that there was a strong case for dividing up those activities for a range of reasons. However, we feel that the best way to do so is not by unilateral action, but by international consensus.

Meanwhile, there are measures that we can take to improve regulation to try to tackle some of the issues that have emerged from the size and complexity of such institutions. There are ways in which we are able to impose a higher capital requirement for larger banks, which provides a bigger buffer if they suffer losses and changes the economics of a large bank. If we ensure that there is a closer correlation between the capital requirements and the level of risk that people undertake, we may see a separation of utility-type functions from higher-risk activity.

Technically, I think the hon. Gentleman’s amendment may be deficient, which is a rare statement for me to make—that is a phrase that the hon. Gentleman uses quite often to talk about me. I am not sure that his amendment delivers what he seeks, as the case may be that a group can have a number of authorised persons, and he would not deliver his outcome of a break-up of banks—they would just have more authorised persons within a group. However, I do not wish to be pedantic.

The hon. Gentleman’s amendment illustrates one of the challenges that we saw with Lehman Brothers, which is that a single institution can be very complex, and very difficult to wind up. One will then force a position either to rescue that institution or let it fail. We saw the consequences of allowing Lehman to fail. It triggered a fresh wave of uncertainty in the market and led to a further set of actions to stabilise the banking system. Also, the administration of Lehman Brothers’ operation in the UK will, I suspect, be one of the most expensive administration processes, because of the complexity of the records, the fact that trading on Lehman’s own account was on the same ledger as Lehman’s trading for its clients, and because there were no rules or plan in place to wind up the business in an orderly fashion. I know that the Financial Services Secretary has announced some progress on that.

There are complex issues that we need to think about; we are talking about complicated operations. The hon. Gentleman suggests that we might break up “authorised person” into several persons. There are many different ways in which banks can structure their operations. Some could be heavily subsidiarised, with different activities in different subsidiaries. Others could have all their operations within one subsidiary. What would happen if there was proprietary trading, commercial lending and retail deposits in one institution? There are arrangements in place to protect retail deposits, but it may be difficult to segregate those activities and save them separately from the rest of the banking activity. That is why it is important that we look at the plans set out in clause 12.

The Governor of the Bank of England said in October that

“both the structure and regulation of banking in the UK need reform. Banks increased both the size and leverage of their balance sheets to levels that threatened stability of the system as a whole. They remain extraordinarily dependent on the public sector for support. That was necessary in the immediate crisis, but is not sustainable” in the long term. There are many different regulatory responses that we can take, and one of them is to have living wills—the resolution and recovery plans that clause 12 allows.

Andrew Bailey, the chief cashier at the Bank of England, talked about the range of responses that there could be to complex institutions, and he identified three elements: regulation, structure and resolution. The recovery and resolution plans fall within the resolution strand of his thought. There is widespread international agreement. We talked about living wills and the need for them in our white paper in July 2009. There is work going on internationally on how they might work in practice. The FSA has summarised some of the issues in an appendix to its discussion paper on the Turner review.

Let me give some detail on what the plans could entail. The recovery plan should include: detailed plans of the businesses and subsidiaries that could be sold to third parties in any contingencies; the extent to which the business could be de-risked in a relatively short space of time; and the ability to withstand the failure of the largest counterparties. How do they safeguard themselves against contagion? One of the untold stories about Lehman Brothers is that its collapse did not lead to the widespread contagion and the lock-down in markets that people might have expected. Recovery is about a business sorting itself out and moving to a more stable position.

The resolution plans tie into the special resolution regime set up at the time of the Banking Act 2009, and they mesh into the responsibilities that the Bank of England and others have as a consequence of that regime. That relates to issues such as liquidation, transferring deposits, introducing a bridge bank, placing banks into temporary public ownership and deposit protection. However, the plans are at an early stage, and there are issues that I want to raise with the Minister.

The discussion paper published last year refers to a pilot project that began at the end of 2009, in which a small number of banks will produce draft resolution plans. Can the Minister confirm that the pilot is under way? Can he tell the Committee which banks are taking part? Pilots are important because they determine the type of information that we need in the plans. We do not know what sort of information will be required. The Bill is drafted broadly to ensure that the FSA has the power to collect the sort of information required. Until we know the outcome of the pilot, it is difficult to know precisely what will be required, what the cost of the plans will be and how much information will be needed. Also, what will the institutions have to do as a consequence of the plans?

That goes back to a slightly different approach to that taken in the amendment tabled by the hon. Member for Wolverhampton, South-West. Some institutions have raised the question of whether the plans will force them to subsidiarise if they are operating as a single entity. Although the hon. Gentleman’s permissive amendment would make that option specific, there are questions. An institution might ask, “Will one of the outcomes of my discussion with the FSA about my plan be a requirement for me to separate out the activities of different subsidiaries and to undo some of the group structures that are in place?” That is a valid question.

One issue that flows from the pilot—this is not addressed in the impact assessment, because we are at an early stage—is the cost of the plans. How voluminous will they be? What will be the level of detail? How expensive will it be not only to draw them up initially but to keep them up to date? There is a potentially significant cost that we need to bear in mind. That affects the competitiveness of banks based in the UK, compared to others in the global market. That is why it is important to think about the international context.

Work is being done internationally to develop the plans, but will the UK lead the way in their implementation? Have we specifically thought through the costs and benefits of that? It is worth pointing out that principle 8 in the Financial Stability Forum’s work on cross-border co-operation and crisis management says:

“authorities will strongly encourage firms to maintain contingency plans and procedures for use in a wind down situation...and regularly review them to ensure that they remain accurate and adequate”.

The first words in that quotation are “authorities will strongly encourage”, but the UK is mandating the preparation of such plans through the clause. There is concern that the UK is moving faster than other jurisdictions and about whether that is appropriate. The British Bankers Association has said:

“It is a matter for concern that the FSA is being placed under a statutory duty to make rules for the production of recovery and resolution plans without there first being agreement on the  fundamental objectives behind the initiative. These statutory provisions would front run international agreement on the need for, and contents of, RRPs.”

In its response to the Committee’s debate, the CBI, which supports living wills in principle, has said:

“this clause must be consistent with any international agreement otherwise this clause should be removed from the face of the Bill before it receives Royal Assent. Additionally the CBI does not believe that legislation is required for the FSA to implement these new requirements at the appropriate time.”

Can the Minister give some assurances about the pace of development of such things internationally and about how we are ensuring that the FSA remains in step with international agreements?

We have talked about the coverage of the plans in the context of banks, and the hon. Member for Wolverhampton, South-West, spoke about them in the context of bank break-ups. However, clause 12 is not limited to banks, or even deposit takers. The clause gives the FSA the

“power to make general rules so as to make rules requiring each authorised person (or each authorised person of a specified description) to prepare, and keep up-to-date, a recovery plan.”

Although we have been talking about plans in the context of banks, the provisions could apply to insurers, asset managers, hedge funds, independent financial advisers and the insurance brokers on the high streets in our constituencies. Everyone could be required to have a recovery and resolution plan; there is no barrier in the Bill restricting them purely to banks. I am sure that that is a conscious decision, but we need to understand whether this is the first stage in a process that will require all institutions to have recovery and resolution plans, or whether the intention is simply to restrict them to banks and licensed deposit takers. Clearly, institutions other than banks, such as building societies and credit unions, hold customers’ money, and the special resolution regime also applies to them. It would be helpful to have some clarity on that.

The key issues are uncertainty about what the plans will include, the fact that the FSA appears to be in the lead—that is not necessarily a bad thing, but we need to understand the balance of the risks—and what sectors will need to have resolution and recovery plans.

Photo of Roger Gale Roger Gale Conservative, North Thanet 11:30, 12 January 2010

Order. Before we proceed, it will not have escaped the notice of the Committee that we have just embarked on a clause stand part debate. The rule is that we can have only one, so we are now entertaining the amendment that has been moved and a clause stand part debate. There will be no separate clause stand part debate on the clause.

There is another point that I would like to make. Before I came to Committee from an Adjournment debate in which I had participated, I received a call from the office of the Chairman of Ways and Means, indicating that there has been a request for a meeting of the Programming Sub-Committee to be held at 1.30 pm. I have agreed to chair it, if it is held. I say to the Committee—and the usual channels, who are present—that if we are going to hold that meeting, it might make sense to do so at 1 o’clock, immediately after this sitting, rather than at 1.30 pm, but I will endeavour to assist, whichever is more convenient to those involved.

Photo of Colin Breed Colin Breed Shadow Treasury Minister

I will include my remarks on clause stand part in the discussion of the amendment. I understand the reasons why it has been tabled. It has helped us to raise the issue, which has to be tackled at some time or another, as the hon. Member for Wolverhampton, South-West said. However, I do not think that that should be done, for a variety of reasons, either in this Committee or in the timing, because international co-operation is vital. Nevertheless, it is quite right that the big question is whether we can afford to have very large banks attached to medium-sized countries, with all the associated risks—of course, we know what has happened in Iceland and elsewhere—and the issue needs to be tackled. I do not think that the difficulties will come down the line to us as quickly as the hon. Gentleman suggested. Nevertheless, that big issue has to be tackled.

I have been rather lukewarm to recovery and resolution plans in clause 12. I am not certain how they will operate, what their effect will be on competition, what the overall costs will be and what value they will have. Often, unexpected and unforeseen—almost impossible to anticipate—events can cause a catastrophe.

All the pre-planning in the world and all the recovery and resolution plans that may be put in place may simply not be able to anticipate exactly what will befall this sector or, indeed, any other sector. We all know that risk plans are almost part of the daily life of practically everything now—in education, science and the police force, for example, we have to make risk assessments, but too often, the assessment as perceived does not cover the precise problem that sometimes arises.

I think that the whole object is the same. We are going to look through general rules at some stage, and that is the interesting part. I look at this in terms of macro and micro. In a macro sense, when we talk about Glass-Steagall, splitting up investment banks and narrowing banking, such macro-type decisions must, by necessity, include a considerable amount of international co- operation. Questions such as how to split up large groups and how to compartmentalise parts of international businesses in those large groups are difficult to answer. Indeed, they will be subject to different regimes, different legal systems and interpretations and different capital requirements. That will be a difficult aspect.

The simplicity that has been referred to and sometimes accepted by my hon. Friend the Member for Twickenham does not take into account the fact that, when Glass-Steagall was set up, the banking system was wholly different from what it is today. The sheer complexities, internationalisation, interconnectivity and scale are of a significantly different proportion. Therefore, some sort of beefed-up Glass-Steagall is not appropriate—we have to look at it completely differently. However, I understand the context of trying to reduce businesses to a size where they can be properly regulated and where they would not cause a systemic risk, which is likely if they are too important to fail.

There is also is the micro part, on which we should concentrate more when talking about recovery and resolution plans. Even in the domestic sense, if we ignore the international parts of large banking groups, there is a major complexity in the interconnectivity of subsidiaries and subsidiaries of subsidiaries. We know that from our evidence session in the Treasury Committee not that long ago, when we invited the chief auditor of a large firm of accountants to explain the domestic arrangements of the various companies within the HSBC  group. He was completely unable to do so. That a chief auditor cannot explain the interconnectivity, where the notes to accounts now occupy some 60 pages, as opposed to the accounts themselves occupying about six pages, demonstrates that the real complexity is such that perhaps that in itself needs to be tackled to reduce the whole subsidiary complexity.

Such a system is often used to minimise tax, not to avoid or evade it, and to create a suite of companies capable of assisting the banks and their clients to implement ever-increasingly complex transactions between a variety of the subsidiaries. That ultimately means a significant reduction to the taxman.

Identifying such structures and creating simpler ones could be part of the resolution and recovery plans, so that even understanding the way in which the huge groups have been put together would be more helpful in identifying early the problems that will arise. Such action might even help to refuse certain acquisitions or mergers in the terms in which they are envisaged. Companies are sometimes brought into a group in ways that do not assist the understanding of the relationship between each part of the group. In the micro sense—the domestic sense—some work can be done, which will be helpful, but in the macro sense, it is a more difficult area.

The other aspect that I am worried about is keeping things up to date. We know that keeping things up to date is a constant problem. Yesterday, I was part of the tax law rewrite Bill, a 10-year project to rewrite something that made very little difference to the amount of revenue that we received. Goodness knows how much 10 years of rewriting and updating things costs, but let us imagine the costs of rewriting and updating resolution and recovery plans to respond to the Finance Bill each year and the way in which the legal framework of other countries had undertaken mergers, acquisitions or even sales of businesses. That could be a never-ending process, like the tax law rewrite Bill and become an extraordinary cost to individuals. I just wonder whether we will receive value for the money that will be expended.

In respect of competition and innovation, we do not want to create a homogeneous system, whereby we just have shades of a certain business in different financial groups and there is little to choose between products and how they operate. They are so constricted in the way in which they have to respond to recovery and resolution plans that it does not give them the element of innovation or competition that we want. I have some general concerns such as that, but the clause is right overall. The rules that will result after discussions with the Treasury and the Bank of England will be a key part, and perhaps at that stage and when the international scene is a little clearer, the more macro aspects of the matter could be considered. However, although I cannot support the amendment, it has enabled a valuable contribution to be made to the debate.

Photo of John Howell John Howell Conservative, Henley

I, too, thank the hon. Member for Wolverhampton, South-West for tabling the amendment, which exposes one of the great weaknesses of the clause and, indeed, the Bill. The Minister has said on a number of occasions that the Bill will set up various frameworks, but the difficulty is that those frameworks must be so wide because all the retrofitting, whether against international agreements or against the detailed regulations about how the living wills will work, must be done later.

The problem with such frameworks is that anything can be put into them, and there is no clarity about what is going into them at the moment. I understand fully why the hon. Gentleman wishes to bring more clarity to the Bill. In that general aim, he has a large amount of support. However, some practical issues relating to the break-up of corporate structures have been mentioned. Clearly, that was in the Minister’s mind during the evidence session.

The Minister said that the living wills would be a last resort, but he went on to describe them, colourfully, as a manual for surgery. Surgery involves cutting bits out, rather than patching things up. Medicine is patching things up and making the patient better; surgery is the fun bit, involving taking things out and throwing them away. Unfortunately, he did not speculate how the living wills might be used. That is a great shame. Although we do not need speculation, we need more substantial detail of how they might be used, what they might look like and how they will be judged.

The question of how they will be judged touches on the amendment as well. Subsection (5) of proposed new section 139B says that the plans must be “satisfactory”, but we never understand what “satisfactory” is or how it will be judged. We know whose opinion will be taken into account in judging whether a plan is satisfactory, but there are no rules or benchmarks. There is nothing that one would expect of a corporate entity in terms of measuring what is done.

Despite everything that has happened, it is slightly naive to believe that companies do not undertake their own risk modelling. Indeed, the FSA already requires some contingency planning. We need to understand the difference between what companies already do and the FSA already requires and what the Bill will deliver. To use another phrase that has come out throughout debates on the Bill, I am trying to tease out what additionality the Bill will bring. In relation to the break-up of banks and other financial institutions, that may well be the best solution, but emphasising that with an amendment to the Bill skews it the wrong way.

We also need to recognise that corporate structures are not static. Companies are always evolving their structures for different commercial reasons. A lot of emphasis has been put on the structure of that, for a number of reasons. I saw one thing mentioned once in a fleeting reference that was never picked up again but is incredibly important. In any corporate structuring or restructuring in the financial services sector, reputational risk is an overriding consideration. We talk openly about financial risk, but nobody has mentioned reputational risk and the idea of protecting it.

Any suggestion of insider trading is an easy way to trash one’s reputation. In the recent case of the Australian Securities and Investments Commission v. Citigroup, we saw how the idea of insider trading is being taken to an extreme. Citigroup acted for one company in a takeover battle for another company. There were Chinese walls between the two teams on the takeover and the proprietary trading team at Citigroup, which wanted to trade in the shares of the company being acquired. The issue that raged at that time was whether a general aside between two members of the same firm was sufficient to indicate that the bank’s subsequent sale of the shares on its own behalf was evidence of insider trading.

I do not want to blow the issue out of proportion, but it is important; it is one of the issues that is taken into account in putting together or changing a corporate structure and one of the complex issues mentioned by my hon. Friend the Member for Fareham that need to be taken into account.

The logistics need to be explored in further detail. The Institute of Chartered Accountants has made much of the logistical problem of gathering information and undertaking analysis and of whether the plans will be updated periodically or whether they will be rolling plans, which is what I suspect many of them will turn out to be, because situations change frequently in the light of new acquisitions and the addition of new businesses.

The hon. Member for South-East Cornwall, who speaks for the Liberal Democrats, said that we must ensure that we do not reduce the financial services sector to the lowest common denominator. We do not want uniform business models, which increase risk because there is only one model operating in the market. That forces out innovation, and that is not in the interests of the consumer, the taxpayer or the economy as a whole.

Through living wills, we are trying to model stressed situations. I put that in the plural because people will need to model not just a single stressed situation, but a variety of stressed situations. Those situations may have very different outcomes; some may require the break-up of the bank or parts of it, while others may not. We need to be careful about how we approach the issue so that we achieve proportionality and identity problems and what we are doing to solve them. That would be made clearer if there was far more in the clause about what we are trying to achieve and how we will go about it.

The cost of the proposals is relevant and has been mentioned several times. There is no costing in the impact assessment and, therefore, no comparison of the cost here and in other countries. I am quite surprised by that because banks are already required to provide contingency plans and they already do a lot of their own modelling. It would not have been beyond the wit of the Treasury to have come up with a range of costs, because it loves ranges. The impact assessment for the next clause, on short selling, includes a range of benefits that starts at £106 million and goes up to £1,066 million. The Treasury loves ranges, so it could surely have come up with a range to give some indication of the costs in this case. That is yet another example of how providing only a framework, and a loose framework at that, leads to people asking more questions, rather than moving us towards a regime that leads to a resolution.

The hon. Member for Wolverhampton, South-West is right that the future will hold more banking crises. I cannot remember the exact figure, but the International Monetary Fund produced an assessment early in the last decade pointing out that there were well over 50 banking crises—I think that the figure was nearer 70—in the last 30 years of the last century. Those crises all followed a similar pattern to the recent crisis, and we need to ask more generally—not just in this Committee—why that was not spotted and why the lessons were not learned from previous crises. If living wills help in the future that will be great, but there is such imprecision in the clause that I am not sure that it adds much to our understanding of how they will work in practice.

Photo of Ian Pearson Ian Pearson Economic Secretary, HM Treasury 11:45, 12 January 2010

Before I reply to the debate on clause 12 and the amendment tabled by my hon. Friend the Member for Wolverhampton, South-West, I would like to expand briefly on my earlier comments about the difference between the FSA’s current code and the general rules that the Bill requires it to make in respect of remuneration. As I said to the hon. Member for Fareham, the current FSA code is part of the FSA rulebook. However, it is not the case that any breach of an FSA rule on remuneration will automatically make a contract void. Breach of a rule will have that effect only if the rule itself provides for that. The present code does not do that, and will need to be supplemented by new rules to be made by the FSA under the authority provided in the Bill, setting out specific prohibitions and expressly stating that contravention of the provisions will make a contract void. I hope that that clarifies any confusion that might have arisen.

At the outset of his contribution, my hon. Friend the Member for Wolverhampton, South-West said that the “too big to fail” issue was being ignored by politicians. I do not believe that to be true as there has been substantial discussion in the UK and internationally. However, there could perhaps be more debate, and my hon. Friend has certainly provided us with the opportunity to do that this morning.

I shall make a few broader comments on clause 12, before responding specifically to the amendment. I shall also pick up on some of the comments made by the hon. Member for South-East Cornwall. I agree that Glass-Steagall-type provisions that date back to the 1930s are not likely to be relevant, even if they are beefed up, as he suggested, for today’s circumstances. There is no easy or simple distinction between what is sometimes called utility banking and investment banking, and sometimes pejoratively referred to as casino banking. Experience of the past two or more years has shown that firms that stay close to their knitting would not be regarded as performing a utility function, and could get into trouble just as investment banks got into trouble. It is well known that the Government do not believe that the case has been made for a Glass-Steagall split between retail and investment banking activities.

Photo of Colin Breed Colin Breed Shadow Treasury Minister

I entirely agree with the Minister. With separation, we need to understand that the banks that were not in the casino sometimes had access to it. Northern Rock was clearly a mortgage bank, but it funded itself by having access to the casino-type aspects, which was the real problem. It is not only large banks that clearly do both—the funding of banking generally has fundamentally changed and includes this aspect of funding, which is difficult to reverse.

Photo of Ian Pearson Ian Pearson Economic Secretary, HM Treasury

The hon. Gentleman makes a valid point. The issue of being “too big to fail” is of central importance, and I argue strongly that one of the ways in which the Government are responding is through clause 12 and the proposals on recovery and resolution plans, which are sometimes referred to as living wills.

The clause sets out the consultation arrangements between the UK authorities in relation to recovery and resolution plans, provides the FSA with additional enforcement powers relating to the collection of information and requires the FSA to have regard to international developments in making rules for recovery and resolution plans. The point about having regard to international  developments explicitly recognises some of the concerns raised by the CBI and others. I will say more about that in a moment.

We made it clear in our White Paper, “Reforming Financial Markets”, that our strategy for dealing with the systemic risk posed by the potential failure of individual financial firms includes a number of strands such as improved market discipline, enhanced prudential regulation and supervision and strengthened market infrastructure. Another key element, which is relevant, is the focus on stronger recovery and resolution arrangements to reduce the likelihood and impact of banks’ failure. Of course, the Banking Act 2009 has already extended significantly the resolution tools available to the authorities, principally in relation to banks and building societies, and firms’ preparation and maintenance of RRPs is intended to build on that more generally.

We see recovery and resolution plans as a key tool for institutions and authorities to mitigate the systemic risk posed by firms and promote long-term financial stability. As a key new part of the supervisory toolkit, RRPs will create regulatory incentives for firms to avoid being systemically risky, because the quality of a firm’s recovery and resolution plan should have a direct bearing on supervisors’ overall assessment of the prudential risk posed by the firm. In short, if a firm’s recovery plan or resolution plan is not good enough, there will be regulatory consequences. The Government and the FSA are clear that recovery and resolution plans and tougher prudential requirements are key elements of a comprehensive policy to deal with the risk to financial stability posed by firms.

Perhaps even more fundamentally, we see RRPs as an important means of reducing the moral hazard arising where firms are perceived as too big to fail and benefit from an implied safety net of public support. We want firms, no matter how big or complex they are, to face up to the potential reality of their failure. Recovery plans will require them to have realistic plans in place for coping with stressed circumstances, and resolution plans will enable the authorities to prepare for the use of their resolution toolkit if recovery is not possible.

Of course, the FSA already has discretion to make general rules on such matters, which will be further underpinned by its new financial stability objective in clause 5. However, clause 12 places an express duty on the FSA to make rules relating to recovery and resolution plans, exemplifying our strong commitment to taking forward the measures.

By setting out in legislation that such rules must cover the firms subject to part 1 of the Banking Act 2009—banks and building societies—we are prioritising the types of firm that have needed most taxpayer support in the past and whose failure has impacted on depositors and on financial stability most severely. The fact that the duty covers all banks and building societies recognises, as demonstrated by events here in the UK during the crisis, that smaller firms can also have a significant impact on national financial stability and that their resolution can present its own difficulties.

Photo of John Howell John Howell Conservative, Henley

The Minister will be aware of the Building Societies Association’s argument that many building societies are small. The BSA questions the proportionality of the measure for such firms. Does he agree that it would be much better to discuss the matter with a cost-benefit analysis covering them?

Photo of Ian Pearson Ian Pearson Economic Secretary, HM Treasury

I will say something about that in a moment, but I wanted to address the wider issue of scope.

We anticipate that the scope of recovery and resolution plans will be expanded to other types of firm. The Government intend to make an order setting out the timetable after consulting with the Financial Services Authority. By taking that approach, we are enabling the FSA to comply with the duty to make rules in a risk-based and proportionate manner. I will say something more on that in a moment.

The Bill’s provisions do not prescribe the content of recovery and resolution plans. That will be set out in rules, which the FSA will draft based on the evidence gathered from its ongoing pilot project and taking into account the ongoing international work. In response to the point raised by the hon. Member for Fareham, I do not think that it would be appropriate to disclose who is taking part in the pilot project. However, I can say to him that there is a sample of banks, and we expect the outcomes of the pilot work to be known by the third quarter of 2010.

The pilot will contribute to addressing some of the wider policy considerations on the cost of recovery and resolution plans—that point was raised by the hon. Member for Henley—and their potential impact on firms’ business models and profitability, and deal with questions on restructuring. Before making the rules, the FSA will be obliged to consult and publish a full cost-benefit analysis in the normal way. I hope that that reassures the hon. Gentleman.

In this context, I stress that while we are clear that there will be some cost to firms from the preparation and maintenance of such plans, there can be no doubt that, following the events of the last 18 months, firms, particularly those that are systemically significant, must bear a fair share of the cost of increased financial stability, which will include the cost of preparing recovery and resolution plans.

I also want to say a little more about the international dimension. We all understand that our financial services industry operates in a global and inter-connected environment. That is why the Bill explicitly states that in making its rules on recovery and resolution plans the FSA must have regard to international developments in that area. There is a growing international consensus that such plans—be they called recovery and resolution plans, living wills, wind-down plans or even funeral plans, as I have heard in some cases—are a vital tool in dealing with the systemic risk posed by firms, not least large, complex, cross-border firms. The G20’s communiquĂ(c) on 7 November explicitly called for

“the rapid development of internationally consistent, firm-specific recovery and resolution plans and tools by end-2010”.

The work that we are doing in the UK, through the legislation that we are discussing today, needs to be seen in that context.

Through the pilot programme and our close work in international forums such as the Financial Stability Board, we are taking a leading international role. We want to ensure that the financial services sector in the UK is stable and can fulfil its role of supporting the real economy, which is why we have been leading that ambitious pilot programme that will support and inform our own  domestic legislation and European and international work streams in that area. I take the point that has been made by the CBI and others that it needs to be seen in an international context. I believe that the Bill makes explicit reference to allow that to happen, and it is certainly our policy intention that that should be the case.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury) 12:00, 12 January 2010

If by the time we get to the end of 2010 there is no international consensus about living wills and detailed guidance drawn up at a global level, does the Minister believe that the benefits of living wills are such—in terms of the stability that it brings to the UK—that it would be worth proceeding with a variant of those in the absence of an international consensus?

Photo of Ian Pearson Ian Pearson Economic Secretary, HM Treasury

I do not believe that there will be an absence of an international consensus. Indeed, at a higher level, agreement has already been reached on the usefulness of such tools. What needs to go on now are more detailed discussions about the content of recovery and resolution plans. That is the task for the next few months. Our pilot work is really feeding into the international discussions that will take place on the matter. As was said in the communiquĂ(c), we need some internationally consistent approaches to the implementation of the plans in the future, but I do not anticipate problems in getting a significant level of international agreement that such things are necessary for financial stability and should be introduced.

With regard to the amendment tabled by my hon. Friend the Member for Wolverhampton, South-West, I certainly understand his intention behind it. I do not support the idea of breaking up by a certain deadline. The amendment is not necessary and I shall set out briefly the reasons why. We are not legislating for additional powers for the FSA to force firms to restructure their operations as a result of their recovery and resolution plans. My hon. Friend will be aware that the FSA already has plans, as part of its toolkit of disciplinary measures, to require firm restructuring. The Bill obliges the FSA to take appropriate action if it considers that a recovery or resolution plan fails to make satisfactory provision. The FSA can apply the whole range of its current set of tools, including disciplinary measures, when it considers that a recovery or a resolution plan is inadequate. It can use those tools to achieve significant changes in an authorised firm, which could include structural changes.

The tools at the FSA’s disposal include offsetting measures, such as discretionary capital add-ons or so-called own initiative variation of permission powers, which ultimately can include the withdrawal of part IV permissions. The FSA therefore already has powers that may achieve structural changes. My hon. Friend will also be aware of the international debate on whether additional new powers would be necessary and desirable, and what would be the appropriate body to exercise them. Its pilot work will again be helpful in that regard, as will the progress that is taking place on the international template that has been developed by the Financial Stability Board. We should not be proceeding ahead of clear evidence and international agreement with regard to additional new powers, which could have significant implications for the competitiveness of the UK. It is important that we continue to lead and participate in  the international debate about what additional powers might be required for the future. The amendment is not necessary or desirable at this stage, and I hope that I have convinced my hon. Friend of that.

Photo of Rob Marris Rob Marris Labour, Wolverhampton South West

This has been an interesting debate. We have heard some thoughtful speeches and the discussion has been of a higher level than took place earlier on some of the minutiae. Two main themes have come through, one of which was the international dimension of the size of major banks and so on. The other was the complexity of the structures of many such institutions, with different models not a shared model. Indeed, as the hon. Member for South-East Cornwall said, most people cannot understand the structure of some banks.

I certainly agree that there is a strong international dimension. I take my hat off to the Government for making, through clause 12, the resolution and recovery plans part of the armoury of defence for us in the United Kingdom, and for introducing and discussing them at an international level. I am glad that more international debate is going on than I had realised and, from what my hon. Friend the Minister said, more domestic debate. If banks go down again, they could bring us all down with them because we cannot afford to bail them out, and the evidence is that what I regard as a pretty important issue is not getting through a whole lot to the average politician.

On the recovery and resolution plan, the Minister says that in a sense we do not want to get ahead of ourselves on international discussions. I say to my hon. Friend the Minister, “What if those international discussions lead to a position where internationally they are saying that there should be such powers to break up very large financial institutions?” I suspect that the United States might come to that conclusion. They have already started to do that in some ways in terms of breakdown. My amendment is only permissive.

I get a sense from some of this debate that the recovery and resolution plans in clause 12, which I seek to amend, have an echo of sitting on the Titanic debating how many lifeboats we have, whether the staff are trained in putting people into lifeboats and how good the lookouts are, rather than the fact that the Titanic is a bit too big and should not be putting to sea at all. Despite the assurances about the level of domestic and international debates, I am concerned that we could get into a situation, which has happened before, and it happens to people in their personal lives and in the body politic, that when the pain goes away we do not go to the doctor—particularly true of men, of course—and when things calm down, we collectively take our eye off the ball, both domestically and internationally. I therefore I urge the Treasury to keep its eye on the ball, even with things quietening down.

I am heartened by the fact that the Minister intimated that the FSA’s existing powers could lead to a requirement by the FSA for a financial institution to undertake structural changes, and I take such changes to include in certain extreme circumstances the breaking up of that institution. On that basis, and with that reassurance from the Minister, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Clause 12 ordered to stand part of the Bill.