Q Simon, I want to focus on your responsibilities with respect to the Basel rules and the expertise of the regulator. Can you set out the competence that you have within your organisation to do this, and could you comment on the suitability of the UK to implement its own approach to the Basel framework, perhaps with reference to what happens in other jurisdictions to give the Committee a sense of how we fit alongside international comparisons?
It is important to recognise that the Prudential Regulation Authority has been a strong supporter of Basel 3.1. It has been very influential in the way it was finalised, and I think that it is committed to implementing the Basel 3.1 framework in an internationally aligned way. That is important for our members, particularly if they are internationally active, because they want a coherent and harmonised regime across the world. If you are a UK bank operating in the UK, North America, Europe and Asia, you want one version of Basel 3.1 and you want it to be implemented in a coherent way. If not, and if there are different approaches to regulatory reporting, to how credit risk is assessed and to liquidity requirements, you have to implement a number of different versions of Basel 3.1, which will be more difficult.
In terms of UK Finance’s competence in, if you like, holding the PRA to account, we have a wide range of members for whom Basel 3.1 implementation is very important. I am pleased to say that I have good working relationships with Vicky and her colleagues at the PRA.
Q I am conscious of time, so I will allow others to come in, but I wish to ask Daniel about the work that you are doing on LIBOR. This is an incredibly complex area with lots of challenges, and the key issue is around the wind-down of the benchmark and the move to deal with the tough legacy contracts. Could you comment on what the Bill achieves with respect to that, whether there are any alternatives to it, and what the implications would be if we did not do what we are planning to do in the Bill?
Certainly, the issues with the lack of sustainability of the LIBOR benchmark are very well documented, and it is important, as the Financial Stability Board has acknowledged at an international level, that we move away from LIBOR on a smooth and timely basis. It is also very important, certainly from an industry perspective, that as a result of moving away from LIBOR on to more robust reference rates, customers who have contracts referencing LIBOR are not inadvertently affected by that transition.
What this Bill seeks to do—and we are very supportive of its provisions—is to make sure there is a safety net in the form of powers being granted to the FCA, to ensure that those contracts that cannot be migrated on an active basis before LIBOR ceases have a solution so that the customer has a clear outcome for the contracts beyond LIBOR cessation.
These powers are important because before 2017, and the acknowledgement that LIBOR would cease, many contracts did not have clear, robust terminology setting out what would happen if LIBOR ceased. They may include terminology addressing if LIBOR should be unavailable for a day or two, and that might be the reference point those contracts would take. In that instance, without these powers, we may have seen customers falling back on to the last available LIBOR rate to the point of cessation, essentially becoming a fixed-term contract. We may have seen customers falling back on to cost of funds, which would create very diverse and disadvantageous outcomes for them. Equally, we would have seen fairly significant levels of contractual disputes beyond the end of 2021. These powers, in preventing all those negative outcomes for both customers and market integrity, are absolutely critical as part of the transition.
Q Thank you both for coming along this morning, virtually. Could I begin with you, Simon, and ask about onshoring and divergence? The Bill onshores significant bodies of EU legislation and directives. From the point of view of UK Finance, where would you like to see the Government and regulators diverge from that body of EU law in the future?
I am not sure that we would want the UK Government and authorities to diverge significantly, if at all, from other standards. We are not sure yet what Europe will do in respect of Basel 3.1. We do not expect draft legislation from the Commission until around Easter next year. That said, from the way in which the Commission has implemented previous iterations of Basel, I would expect it to stick quite closely to that Basel 3.1 framework, for the same reasons I have mentioned: international coherence and harmonisation, and easing the comparison of different banks and jurisdictions.
Q We have had the Chancellor’s announcement on equivalence from the UK end of the telescope last week. Do you think there is a relationship between the degree of divergence we pursue in the future from the EU rulebook and equivalence decisions from the other end of the telescope, that is, by the EU or EU member states to UK companies selling into their markets?
Yes, I think there is likely to be work to be done there. Of course, one of the accountabilities the Financial Services Bill gives the PRA is to take financial services equivalence and international competitiveness into account, and, importantly, the banks’ ability to continue to provide finance to UK businesses and consumers on a sustainable basis. I think we will all want to understand how different regulators around the world—not just in Europe—look at the PRA’s implementation when it gets down to those technical standards, which is why it is important for both Parliament and UK Finance to make sure there is no inappropriate deviation from international standards. I can assure you that if UK Finance members see that there is, we will speak up about it.
Q May I ask you, Daniel, a question about LIBOR to fill in a small gap in the knowledge of those of us who have not followed every twist and turn of this? The measure became a scandal because it was being manipulated for the benefit of the traders who were submitting information. That information was based sometimes not on actual trades but on their estimates of what trades would cost. What changes have been made to the administration of LIBOR in recent years to stop those things?
It is absolutely right to acknowledge the issues with conduct around LIBOR in the past and the reforms that have taken place to make sure that those things are prevented. That includes the FCA oversight of the LIBOR benchmark, the introduction of the benchmark regulations at a European Union level, and transcribed into UK law, and broader reforms since the financial crisis, including the senior managers regime to ensure that the issues with LIBOR are not repeated. As the Committee will be aware, the fundamental reason why it is important to move away from LIBOR is that the underlying markets on which the rate is based have largely dried up. Therefore it is right to move us on to robust reference rates based on markets that are highly liquid and not reliant on expert judgment.
It is important to remember that individuals in banks who are responsible for benchmark submission and administration are classified as so-called certified persons under the senior manager certification regime and they have to be certified as fit and proper every year by their firm. If they are not certified as fit and proper, they will lose their job and will find it very difficult to find a role in financial services again.
LIBOR as it is formed today includes both elements of actual transactions and expert judgments of firms. These expert judgments, as a result of the issues in the past, are subject to those very high levels of governance control that I have talked about being introduced as a result of the benchmark regulation—absolutely appropriate as a result of the issues with LIBOR in the past. The underlying reason why we need to move away from it is that we want to be internationally on rates that do not require that expert judgment.
Shall I go first and talk about the prudential regulation of banks? The Financial Services Bill achieves what it sets out to do: to implement a coherent version of Basel 3.1 in the UK. It is quite important to our members that we do Basel 3.1 the same in all the major financial centres in which firms operate. If a firm that is regulated by the UK operates in a different host country and the host country says, “That UK firm operating on our patch is supervised by the PRA and the PRA has introduced a watered-down version of Basel 3.1”, then they would add extra supervisory levels to bring it back up to the Basel 3.1 standard. That leads to a bifurcated approach with different regulatory standards in different countries, which makes life very difficult. A coherent approach, which is what the Bill seeks to achieve, is what we and our members want.
Q So when the EU makes its regulations, and it goes ahead with what is in its interests, essentially you would want us to mirror the EU wherever possible?
We would not want to see wholesale deviation from Basel 3.1. Of course, Europe itself may choose to deviate from Basel 3.1, and that is a matter for its legislative process. I would not want to see the UK deviate from the agreed framework for Basel 3.1.
Q Are there any international competitors that you think have struck the correct balance with a regulation that you would want to see us take on here?
I think there is a difference of approach in some G7 countries. Some perhaps apply a graduated or targeted approach to regulation. Canada, Japan and the US apply different iterations of the Basel standards to different sorts of firm. A large, internationally active bank would face the full gamut of Basel 3.1 in all its glorious granularity—in my view, that is right and proper—but a smaller, less systemic bank might face a different approach.
Of course, Basel 3.1 is applied by Europe—and that is what we are bound by at the moment—to all banks, not just those internationally active banks that are the target of Basel 3.1. The EU took the decision back, I think, in 1992—before even I got involved in this space—to apply the Basel III framework to all banks, from the smallest local Sparkasse in Germany to the largest, internationally-active bank.
I feel we must ask ourselves whether that is right; should there not be a risk-adjusted approach to safety and soundness? A sub-regional building society operating in the UK, for instance, has a vanishingly small probability of bringing the whole financial services system crashing down if it fails. Is it right to ask that firm to comply with all aspects of Basel 3.1? Maybe not.
We don’t know yet how Europe will determine equivalence. I hope that our colleagues in the EU will look at our implementation of Basel 3.1, compare it with their own implementation and ask themselves the question, “Does this achieve what Basel 3.1 is seeking to achieve?” If they do, I hope there will be a form of equivalence—however we term it in the future—determination.
As the Committee can imagine, from an industry perspective, we are absolutely focused on ensuring that the transition away from LIBOR—which is the right thing to do—is done in a way that treats customers fairly and consistently.
There is an awful lot of work being done at both an international and domestic level to agree standardised approaches to transition, where possible, but also to ensure that there are clear expectations from our regulators—here in the UK, it is the Financial Conduct Authority—about how that transition should be done.
Lots of work has been done and lots of work remains to be done, and, as you can imagine, we are speaking very frequently to the regulators here in the UK, and also working through the national working group to ensure that customers are transitioned on a fair and transparent basis.
Q Obviously, LIBOR is a benchmark. Any benchmark is a sign of some of the profit that can be made on a transaction. If there are differences of approach or changes, there are areas where customers can be fleeced or left out of pocket without, in some ways, even realising it because of the very technical nature of these kinds of transactions. To what extent do you have a consumer protection voice helping you with these changes? Do you think that the protections for consumers who may be disadvantaged during this transition are strong enough?
We are one voice from the perspective of the banking and finance industries, but it is important also to recognise that, within the overall national working group in the UK, there are voices that, rightly and properly, represent the end users of LIBOR, be they corporates themselves or the representatives of corporates. Although those voices are important in our national transition working group, it is equally important to address the concern that you articulate, which is absolutely right: the guidance that the FCA has provided to all firms that are transitioning their customers that the process should not be used to move customers on to inferior terms or rates that would be expected to be higher than LIBOR would have been. After speaking to our members in the industry, that message from the UK conduct authority has been heard loudly and clearly. All of us who are focused on moving away from LIBOR are acutely aware of the history of the benchmark and committed to ensuring that we move away from it in the right way and in a manner that treats customers fairly.
Q Obviously we will be keeping an eye on that as it happens.
Mr Hills, the industry has been lobbying the Government, Parliament and regulators to design regulations that will make UK firms more internationally competitive. Indeed, all of us in the room would share the aim of protecting our financial services industry. Do you think that the Bill achieves that?
Yes, I think it does. The important thing is that the Bill achieves that by setting expectations of how the Basel 3.1 framework is implemented in an internationally coherent way. The PRA has to think about not only international competitiveness, but financial services equivalence, and the Bill achieves that.
I do not think that it is in the interests of the UK financial services industry and banks to introduce a divergent regime. We are talking about the importance of the City, and we want people to bring their money to the City for the right reasons, not the wrong ones. UK Finance members are certain that it is in no one’s interest to diverge from internationally agreed frameworks because that creates the risk that we bring in the wrong sort of people.