Financial Services and Markets Bill – in a Public Bill Committee at 10:15 am on 25th October 2022.
With this it will be convenient to discuss that schedule 2 be the Second schedule to the Bill.
We have already discussed the provisions the Bill delivers to allow us to replace the entirety of financial services retained EU law with domestic legislation that is in line with the established FSMA model. The Government will use the powers in the Bill and work closely with the regulators to give effect to that. However, it is important that we act now, where we can, to tailor our regulations to seize the benefits of EU exit and support our world-leading financial services sector. Clause 2 and schedule 2 do just that, making two sets of important and immediate transitional amendments to retained EU law. These are technical and important changes, so forgive me for taking some time to set them out.
First, schedule 2 makes a series of priority reforms to the UK’s regulatory regime for wholesale capital markets as identified through the Government’s wholesale markets review. The regime is predominantly set out in EU-derived legislation collectively known as the markets in financial instruments directive—MiFID—framework. The resilience, effectiveness and competitiveness of the UK’s capital markets rest on strong and effective regulation.
However, the MiFID framework was designed for the EU and intended to ensure detailed, harmonised rules across 28 jurisdictions. Many of the rules are therefore not calibrated optimally for the UK and, in a number of areas, have not delivered the intended benefits. This has led, for example, to duplication and excessive administrative burdens for firms or has stifled innovation. Such rules clearly do not work for a global financial centre such as the UK.
Parts 1, 2 and 4 of schedule 2 deliver the most urgent reforms identified through that process. The reforms will result in a simpler and less prescriptive regime that meets the needs of UK markets while still maintaining the highest regulatory standards. Part 1 of schedule 2 removes unnecessary restrictions on firms’ ability to execute transactions, deleting the share trading obligation and double volume cap. The EU argued that these restrictions would increase transparency in share trading, but evidence suggests that they have prevented firms from accessing the most liquid markets and therefore achieving the best price for investors.
Separately, the MiFID framework requires trading venues and systematic internalisers to publish details about bids and offers before a trade has been completed, and information about the size and volume of trades once they have been executed. That is known as pre and post-trade transparency. The Government believe that the transparency regime for equities is generally working well but is overly complex. To simplify it, part 1 revokes current requirements about when firms are exempt from pre-trade requirements and gives the FCA new powers to set conditions.
Separately, part 1 amends the definition of a systematic internaliser so that investment firms dealing on their own accounts do not have to undertake complex and costly calculations to determine whether they are a systematic internaliser. It also removes restrictions on midpoint crossing for certain investment firms, ensuring that those firms can trade at the midpoint between the best bid and offer, which will lead to better prices for investors.
Schedule 2 also makes three amendments to the derivatives trading obligation, or the DTO, which requires firms to trade certain derivatives on UK venues or recognised overseas venues that have been recognised as equivalent. The first amendment realigns the counterparties in scope of the derivative trading obligation with the clearing obligation. The second amendment gives the FCA a new rule-making power to exempt post-trade risk reduction services from the DTO, as well as the best execution requirement, to encourage firms to use those services and thereby reduce systematic risk. The Bank of England is given an identical power to exempt it from the clearing obligation. The third amendment gives the FCA a new power to modify or suspend the DTO, subject to Treasury consent, to prevent or mitigate disruption to markets.
Schedule 2 also amends the transparency regime for fixed income and derivatives markets, which is poorly calibrated. It was introduced only in 2018 and was modelled on the transparency regime for equity markets, without ever taking into account the differences in each market. That has resulted in low levels of transparency and has negatively impacted price formation.
The final reform that schedule 2 makes to the MiFID framework is set out in part 4 and relates to the position limits regime, which restricts the maximum size of a net position that a person can hold in a commodity derivative. The Government support the objective of position limits, which is to reduce risk in commodity markets, but believe the scope of the regime is disproportionate and unnecessarily prevents the build-up of liquidity. The Bill therefore revokes the requirement for the FCA to apply position limits in commodity derivatives and allows it to transfer responsibility for setting position limits to trading venues, which are well placed to identify volatility. To ensure that there is appropriate regulatory oversight, the schedule grants the FCA a power to develop an overarching framework and a power to set limits directly if certain conditions are met.
Moving on to the next set of provisions delivered through schedule 2, part 3 amends the UK securitisation regulations to increase choice for UK investors in simple, transparent, and standardised—or STS—securitisations, with all their benefits, by creating a framework to recognise non-UK STS securitisations in the UK. That follows the Government’s review of the securitisation regulations, which was welcomed by industry.
Securitisation is the packaging up of assets or loans and selling them on to investors. This allows lenders such as banks to transfer risks of assets to other banks and investors. Soundly structured securitisation can be a helpful tool to ensure that lenders have enough capital to continue lending to consumers and businesses throughout economic and financial cycles.
The UK supported the international Basel Committee and the International Organisation of Securities Commissions when they developed criteria for simple, transparent and comparable—or STC—securitisations. Those were implemented in the UK as STS securitisations in the Securitisation (Amendment) (EU Exit) Regulations 2019.
The framework for STS securitisations is designed to make it easier for investors to understand and assess the risks of a securitisation investment. Bank and insurance investors in such securitisations can be eligible for lower capital requirements compared with other securitisations.
Other than some exceptions under temporary EU exit transitional arrangements, the UK securitisation regulation allows only for firms established in the UK to designate their securitisations as STS. The schedule creates a framework for the Treasury to designate other countries as equivalent to the UK in relation to STS securitisations. That will allow UK investors to receive better capital treatment, giving them greater choice of sound securitisations and, more widely, supporting the development of STS securitisation markets.
Together, the changes to the MiFID framework and the securitisation regulation are vital reforms to bolster the competitiveness of UK markets. They demonstrate the Government’s commitment to work at pace to reform financial services regulation. I recommend that the clause and schedule 2 stand part of the Bill.
Obviously, this is an extremely complex area of technical regulation. It requires the regulators, alongside the Basel Committee and the international authorities regulating the flow of this kind of stuff, to operate effectively. If securitisation goes wrong or if markets begin to be opaque, with transparency going down, there can serious consequences for the countries in which such firms are based. That might also engage systemic threats to the banking structures of those countries. We have been through that before, and we know what happened when securitisation went wrong in the global financial crisis and what damage that caused to the global infrastructure.
Clearly, those tasked with ensuring that that does not happen again—those in the Bank of England, the prudential regulators and the FCA who have a handle on this, as well as the international regulators trying to set standards—have to be very aware of how such regulation might change and effect firms in the markets. However, there will always be a push in these markets to move the boundaries towards something less opaque and more profitable for those doing business, hoping that the risks can be left somewhere else. When risks crystallise, however, they are left on the balance sheets of nations that have to cope with cleaning up the mess. So, while I approve of modernising such regimes, little alarm bells go off in my mind when I think about attracting more such business. That kind of business is attractive if it is safe; it is not attractive if it is unsafe.
The Minister ploughed through his speech about all the technicalities of the shift away from EU-regulated systems and about how onshoring back to the UK will be done. Given how large our banking, financial services and insurance sector is, we are clearly at systemic risk if we get this wrong. We have to get the balance right between ensuring that any new regimes are transparent and safe enough to be hosted in our country. The Minister took us through some of the technical changes, but will he reassure us about the transparency and safety issues in the new regime that I have hinted at?
If the sun moves much further, I will have to sit on the other side of the room to keep it out of my eyes, so my apologies for having to move seat during the debate, Dame Maria.
I thank the Minister for doing what I hoped he would have done in the debate on the revocations in clause 1: outlining in terms understandable to a lay person why some specific items of EU legislation are no longer appropriate for the United Kingdom—in fact, it is questionable whether they are appropriate elsewhere. I would have wanted to see that before the changes proposed in other parts of the Bill. On the basis of the Minister’s comments, and the fact that none of the regulators we heard from raised concerns, I am willing to accept that the changes suggested in the clause and the details in schedule 2 are appropriate.
I want to draw attention to a comment the Minister made earlier and to give him the chance to correct it. He suggested that this is EU legislation that Parliament never had the chance to scrutinise, but that is not the case. I spent several years, as other hon. Members did, on the European Scrutiny Committee. Every single piece of legislation the European Union intended to implement came before that Committee, which had the authority to call in Ministers and to put a stop on them approving things at EU Council meetings if the Committee was unsatisfied as to the impact. The House of Commons—the whole of Parliament—had the right to take action to prevent any of those directives from coming into force. The fact that Parliament seldom did that is a failing of this and previous Parliaments. The fact that Ministers had so much free rein to do what they liked, and could ignore Parliament if they wanted to, is not the fault of the European Union; it is because of the relationship between Parliament and Government. This Parliament is unfit for purpose, and Ministers from other members of the European Union would not have been allowed to agree to those directives without a vote in their respective Parliaments. I hope the Minister will be willing to correct the record. We can agree or disagree about legislation that the European Union put in place, but to suggest that this Parliament was somehow unable to have any impact on that legislation is simply not accurate.
Has the Minister picked up any feedback from the sector about the Government’s proposed reform to the position limits—a regulation under MiFID II—and the fact that they have not been adequately assessed for commodity market speculation risks? How does he plan to keep that issue under review? If he has heard of concerns, is he planning to address them?
I am happy to stand corrected by the hon. Member for Glenrothes, but I am not happy to relitigate matters that the British people settled, given the chance in a referendum. I hope the hon. Member will reciprocate by looking forwards, not backwards, so that we can go forward with the best financial services regulation for the UK.
The matters raised by the hon. Members for Wallasey and for Hampstead and Kilburn are precisely within the scope of the regulators, and they have been consulted on. The hon. Member for Hampstead and Kilburn raised important points about the commodity market. The regulators are aware of those, and they will remain under constant review. Parliament itself has the ability, as always, to set the perimeter within which the regulators operate. Having addressed those points, I have no further comments.