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[Mr. Bill Olner in the Chair] — Financial Services Regulation

– in Westminster Hall at 12:00 am on 10th November 2009.

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Motion made, and Question proposed, That the sitting be now adjourned.-(Sarah McCarthy-Fry.)

Photo of David Heathcoat-Amory David Heathcoat-Amory Conservative, Wells 9:30 am, 10th November 2009

It is a pleasure to see you in the Chair, Mr. Olner. The financial services sector, which is the subject of my debate, is extremely important to the British economy and is about to experience big regulatory changes that have not been adequately debated so far. We can all agree, I think, that the recent history of financial services regulation is not a happy one. When the Government took office in 1997, they gave interest rate decisions to the Bank of England but removed from it banking supervision, which then fell into a black hole between the Bank, the Treasury and what became the Financial Services Authority.

When some of us raised the problem during the passage of the Bank of England Act 1998, we were told not to worry because there was a memorandum of understanding between the authorities. That was fine when everything was going well, but the test of a system is in a crisis, and when the credit crunch hit, there was a great deal of confusion about exactly who was responsible, where accountability lay, who made the decisions and who enforced them. We will make the same mistake again if we sign up uncritically to a system of European financial supervision with exactly the same ambiguities about accountability and control. The Government do not like the impending European system of supervision, but they seem unable to block it and have been retreating from a number of earlier positions on it.

I want to make it clear that I am not defending the status quo as regards regulation. The background is of much-needed regulatory change. I have no sympathy with the big banks that failed during the credit crunch. Many of them behaved like bandits, and some are still behaving badly, lending at extortionate rates to small businesses and others to pay for their casino-lending practices of the past, all of which are underwritten by the taxpayer. Mervyn King, the Governor of the Bank of England, is absolutely right to raise the question of moral hazard whereby if banks and others take risks and are justified, they receive riches and honours, but if the risks go against them they are left with the taxpayer. We must tackle that. Again, the Governor is right to advocate breaking up big institutions to generate real competition and to sort out those that are too big to fail-they will be supported by the taxpayer in extremis-from those that can be regulated in a different way. If institutions are too big to fail, they must be tightly regulated, but a different regime is appropriate for others.

I must declare an interest. I am a director of a not-for-profit health insurer in the south-west, which is extremely prudently run. If it failed, which is incredibly unlikely, it would of course be a disaster for the staff and the policyholders, and the directors would have to resign, but it would pose no threat to the wider economy; there is no systemic risk. That firm and many others like it are nevertheless on the receiving end of a huge and growing volume of regulatory requirements from the FSA. The cost is enormous, and all of it must ultimately be borne by, in our case, policyholders, but in other sectors by borrowers or customers-in other words, the public. So, we are building up an enormous national overhead here in a competitive global market. We must earn our way out of this recession; we cannot spend our way out. The question of international competitiveness is very important. If we turn the country into a nation of regulators, we will remain a low-growth, high-unemployment part of the world economy.

Let me ask the Minister about the alternative investment fund managers' directive-another catchy title. The directive is aimed at the hedge fund and private equity market, which is not responsible for the credit crunch. The EU directive is only in draft, but we know from the present text that its terms are onerous, broad-brush and do not take account of the variety and diversity in the sector. It threatens to be disproportionate to the actual risk because, again, this sector does not pose a systemic risk to the British economy. It is also protectionist because in effect, it will keep out non-EU financial agents, which will raise costs and reduce competition.

Photo of Mark Field Mark Field Conservative, Cities of London and Westminster

I entirely agree with my right hon. Friend's comments on the directive. Will he confirm in front of the Minister that the financial crisis of the last two years has never been a crisis of asset management, which is what is being proposed here? Furthermore, on international competition and protectionism, the biggest worry is that some of the brightest and best in Europe will go elsewhere, rather than staying, thus allowing Europe to take a larger slice of this increasingly fluid global market.

Photo of David Heathcoat-Amory David Heathcoat-Amory Conservative, Wells

I agree with my hon. Friend. The EU has a habit of being obsessed with internal harmonisation. The real question, however, is whether Europe is competitive in the wider world. If such a directive has the effect of driving assets and firms overseas to non-EU jurisdictions, it will be very damaging. That is a particular concern to Europe. I am informed that about 80 per cent. of hedge funds are based in London, and 60 per cent. of European venture capital and private equity managers are based in the United Kingdom. So, the directive is aimed at this country. Will the Minister comment on that and tell us what she is doing to protect our interests? I have given her office the general lines of my debate so that she can prepare some answers.

I am not calling for isolation here. We cannot regulate simply on a national basis. We are global and must, of course, talk to regulators in the United States, Europe, and the far east to try to align the rules, but supervision must remain national. Supervision is the application and enforcement of the rules, and that cannot be given to an international jurisdiction. I understand that that is the Government's position, but it seems to be under attack. Into this debate about how we improve our regulation and stop regulatory failures, there now intrudes the EU's ambition not only to regulate-to make the rules-but to supervise and enforce the regulations.

There is a proposal for three new European supervisory authorities, or ESAs: one for banking, one for insurance and pensions, and one for securities. They would go very much further than the existing regulatory committees that have been meeting in the EU for some years. They would have wholly new powers and authority. They would be rule-making, they would have enforcement powers, they would have emergency powers over firms and national supervisors, and they would have the power to mediate and to impose solutions.

Unless the ESAs are stopped, they will go way beyond what the Government have said is acceptable. Lord Myners, the Treasury Minister responsible for this sector, gave evidence to the European Union Committee of the House of Lords, in which he could not have been clearer. He said:

"The Government support regulatory and not supervisory powers at EU level."

He also said:

"The Government do not see how we could have EU bodies overruling national authorities where national taxpayers can be asked to fund firms that have failed."

He was also sceptical about what he called

"binding mediation given the importance of aligning supervision and crisis management".

He said very much the same thing to me and others when he gave evidence to the European Scrutiny Committee:

"supervision must lie in the hands of national authorities."

So that is the Government's position, and I hope the Minister can confirm that it remains an unaltered requirement of theirs, because the very name given to these authorities indicates the opposite. They are to be "supervisory" authorities and if they are called that they will probably do that, which contradicts the assurances that Ministers have given to both Houses of Parliament.

There are other questions to be asked about ESAs. How will decisions be made in these new authorities? The answer is, by majority voting. However, as we have already heard, the United Kingdom is by far the largest EU financial market. By some reckoning, including the Mayor of London's, the UK is now the biggest financial market in the world, so we must protect this market from unnecessary and burdensome regulation. The EU has a regulatory itch; it lives by expanding its jurisdiction, legal authority and regulations.

Photo of David Taylor David Taylor Labour, North West Leicestershire

A week ago, in Treasury questions, I raised with the Minister's colleague, the Financial Secretary to the Treasury, my right hon. Friend Mr. Timms, the fact that the Tax Justice Network had created a financial secrecy index, which found that the City of London was one of the most secretive, opaque and impenetrable financial regimes in the world. Although it is important that we do not have burdensome and unnecessary regulation, surely there is still more to be done to provide the clarity, transparency and openness that markets often say they have but manifestly fail to deliver.

Photo of David Heathcoat-Amory David Heathcoat-Amory Conservative, Wells

I agree with the hon. Gentleman; openness helps a well-ordered and properly regulated market. Of course, one must ensure that market-sensitive information does not fall into the wrong hands, and there is a question mark about what will happen to the information that is given to these new European regulatory authorities. We need certain assurances about that, but I agree with the general thrust of his question. Nevertheless, my point is that, because of majority voting, we do not want other countries' policy preferences imposed on what is by far the largest financial market in Europe.

There is a rather doleful precedent in the artists' resale right directive, which the Government fought against and voted against. It imposed a levy on the resale of art, supposedly for the benefit of artists and their descendents. However, because it does not apply in the rest of the world, it is having the unfortunate effect of undermining the attractiveness of London, which is the biggest art market, compared with New York, Zurich and other non-EU art centres. It was eventually imposed on us because of majority voting and the European Commission's determination to harmonise within Europe and to pay much less attention to Europe's competitiveness in the wider world-a point made earlier by my hon. Friend Mr. Field.

We also need to know who will sit on these ESAs and who will appoint them. Lord Myners was asked when giving evidence about the question of appointment, and he said:

"I think that that is still open for debate and discussion."

We now need to know who will appoint the members of the ESAs. Also, who will the ESAs report to? Who are they accountable to? Are they accountable to EU Ministers, the European Commission, the European Parliament, or all three? There is the danger of creating exactly the same confusion I referred to earlier, whereby regulation fell between the Bank of England, the Treasury and the FSA-except that the same confusion would now occur at a higher level in Europe.

Furthermore, there are doubts about whether the entire package of proposals is legal and whether the EU can establish these freestanding authorities. The European Commission is using articles under single market powers to establish the ESAs, but these authorities' primary purpose is not to create a single market; surely, it is to stabilise and protect the financial system. Therefore, the Commission should not be using single market articles to establish the ESAs, but it is doing so because that brings in majority voting. Again, I would appreciate the Minister's commenting on that issue.

There is perhaps an even more important problem, which is that it is an established principle that the EU cannot delegate or confer powers that it does not itself possess. In this instance, however, the EU is conferring powers on three supervisory authorities and giving them broad discretionary powers without clear or defined limits. That is an apparent abuse by the EU and it should be challenged legally. Again, I would like to hear the Minister's view on that.

This matter is urgent because there is now a headlong rush to establish these ESAs. The European Council, which met very recently, has urged the Council of Ministers

"to reach agreement by December 2009 on a complete package setting up a new supervisory structure in the EU."

These conclusions were agreed by unanimity, so the Prime Minister believes that, within a month, all this structure can be agreed.

There is a great deal of concern about this. To take just one example among many, the Association of British Insurers says it is concerned about

"handing broad areas of decision-making to supervisory bodies acting collectively, without adequate provision for consultation or democratic oversight."

It also says:

"Multiple sources of regulatory authority will add unnecessarily to the complexity of regulation."

There are many other examples I could give.

It is baffling that the Treasury has allowed itself to be bounced in this way, which breaks all the Government's own rules about the quality of regulation. The Government's own guidelines on better regulation say that it is much better to carry out regulation properly than to carry it out quickly. Also, regulation must respect subsidiarity and proportionality, and there must be a careful assessment of the costs involved. Where is that cost assessment in this case? Where is the impact assessment for the ESA proposals?

What we need in financial regulation is clarity, firmness, accountability and economy. So far, there is very little evidence of any of those qualities in the proposals.

Photo of Bill Olner Bill Olner Labour, Nuneaton

I call David-[Interruption.] I am sorry; Mr. Mark Field.

Photo of Mark Field Mark Field Conservative, Cities of London and Westminster 9:49 am, 10th November 2009

Thank you, Mr. Olner. I am always aware that I am barely a household name in my own home, let alone anywhere else. It is a great pleasure to follow my right hon. Friend Mr. Heathcoat-Amory, who made a sensible contribution to the debate. As he rightly said, the issue of financial services regulation is of great importance.

One concern in the midst of many people's continued lack of trust and confidence in our financial services world-a situation that I fear will continue for some years to come-is that we look on regulation as we do some sort of religion that holds sway, without thinking through all its implications. To be fair, that applies not only to the world of financial services but to much of the public sector. That is not to say that there is no place for regulation. Regulation is necessary, particularly in respect of financial products, in order to maintain confidence.

To go back two decades and more, I think we are all concerned that respect for the pensions industry and other categories of financial services products is so low in the public at large that all too often people do not save for their long-term future. People of my generation, in their 40s, have tended to put too much money into immediately stoking up the housing market, which obviously has negative effects. It is not just that the market might not be sustainable; we need to try to inculcate into the public mind the idea that people, for their own good, should invest for the longer term in a range of savings products, as well as the confidence that they can save in equities and other savings products. It is not an option, therefore, to suggest that there should be no regulation. Many of us have always promoted the idea of light-touch regulation, but I do not think the zeitgeist will favour that in the foreseeable future.

As my right hon. Friend said, these are troubling times for the City of London and our hitherto booming financial services sector. The second enormous cash injection into the Royal Bank of Scotland last week, along with incendiary tales of the return of big banking bonuses, is making the general public question whether anything has changed apart from the size of the ballooning public deficit.

Whether we like it or not, bank lending is unlikely to return to anything approximating normality until probably the second half of 2011. A huge number of toxic assets remain on all banks' balance sheets and have yet to be identified, and they will need to be removed. The times will be troubled, and I think there will be a lot of concern for a considerable time to come among the public as well as in this place about the state of our banking industry.

My constituency houses the City of London and has hedge funds and alternative assets in Mayfair and St. James's. As my right hon. Friend pointed out, the crisis has focused largely on the big banks, but it should not be forgotten that other elements of financial services and their products have remained relatively unscathed. Asset management-hedge funds and private equity-is one such industry, so it is perverse, to put it mildly, that we are going headlong towards signing up to the directive through the European Council.

I praise the relevant Minister, Lord Myners, who has put in a sterling effort in recent months, along with Conservative MEPs, to make the case for ensuring that the damaging aspects of such directives are kept to a minimum. It is clear that there are two distinct schools of thought on the matter, even within the European Council. However, it is very much a work in progress. My constituency also contains a residential population of fairly wealthy global business folk and a service and entertainment sector in the west end that has blossomed from the disposable incomes of a busy London work force that has, to a large extent, received the benefits of the financial services boom, as has been particularly evident in the past two decades.

The financial services industry also helps sustain a huge range of support industries, such as law, accountancy and consulting. It should also be said that the great global success of the City of London includes elements such as the insurance industry, many of whose difficulties arose through the near-collapse of Lloyd's two decades ago. There are some important templates in that for learning how a service industry that looks as though it is on its knees can recover its global pre-eminence.

As London is the engine of the national economy, getting financial services regulation right is vital not just for my constituents but for the nation as a whole. We must accept that a crucial ingredient in regulation of the industry is a public perception of fairness, as my right hon. Friend made clear in his comments. Without that sense of fairness, there is little doubt that we risk allowing the current crisis to discredit capitalism and herald a new era of corporatism and ever more restrictive regulation in the long term.

That said, although irresponsible banking should and must be curbed, populist and rushed measures designed to rein in City excess should be avoided. After all, the Sarbanes-Oxley Act, introduced in the United States after the Enron and WorldCom scandals, taught us that additional regulation to protect consumers, as it was perceived in that country, may do little to stave off a crisis and that in a global economy, business will have no hesitation in relocating if regulation becomes too cumbersome.

Having learned from that, we must give the public greater credit and take them with us by explaining clearly how the taxpayer stands to gain or suffer from the regulatory choices that we make. One such way is to defend the UK's position as a global leader robustly against EU attempts to curb the hedge fund industry via the draft alternative investment fund managers directive. I spoke about that problem in this Chamber recently, and the Minister was also there, so I shall not go over the ground again other than to summarise the issue briefly.

Most hedge funds are exempt from much of the regulation applying to investment banks and mutual funds. As pools of highly mobile capital, they have fast developed the reputation of being able to move mountains in the financial market by anticipating future expectations. Hedge funds, which are largely limited liability companies, thrive on volatility, so the crux of the controversy surrounding them is the degree to which they either cause or affect fundamental shifts in financial markets.

Alternative investment funds have accepted that in the new regulatory climate, they will be required to boost transparency and accept new curbs on disclosure and, most likely, on clearing, settlement and custody as well. The draft directive, however, goes a long way beyond that and may make it absolutely impracticable for funds owned by non-EU entities, which comprise a significant proportion of those operating in London, to distribute their products within the European Union.

That, combined with other regulatory and fiscal burdens here, may persuade hedge funds to relocate to other financial centres such as Switzerland, or indeed to return to the United States or emerging centres in the Gulf or the far east. As my right hon. Friend pointed out, such an outcome would be in the interests neither of the UK economy, which fundamentally concerns us, nor of the EU. Such protectionism in a global market would be fatal. At a supranational level, it would diminish competition, restrict flows of liquidity into the single market and be seen as protectionist at a time when barriers need to be brought down rather than erected. At a domestic level, it would also significantly diminish London's critical mass as a financial centre and reduce individual and corporate tax revenue. At its most detrimental, it risks undermining London's competitive advantage in the market for the professional services to which I referred.

The impetus for a European directive derives from panic in response to the economic crisis alongside a somewhat partisan vision of hedge funds and private equity as a wild west show of amoral speculators and asset strippers. However, I reiterate that there has been no crisis of asset management. Unlike the big banks that have been so troubled over the past two years, hedge funds did not leverage themselves to the hilt, having lacked the balance-sheet clout to do so even if they had wanted to. Whatever regulation exists should focus on the issue of leverage. Only in so far as it does so can it be justified.

Nor did hedge funds run down adequate levels of liquidity. Indeed, those that have failed-as of course some have done in the past two years-have not threatened the entire financial system in their failure. The public must be made aware of that or it will be harder to resist what may seem superficially to be reasonable attempts by the EU to curb reckless risk-taking, but are in reality dangerous moves that will undermine London's competitiveness.

Thankfully, since I last spoke on this issue in Parliament the Swedish presidency has drafted a compromise text on some elements of the draft directive to reconcile British concerns. The important issues are scope, delegation, valuation, leverage, capital requirements and transparency. The compromise proposal is an encouraging step forward. I give credit to some Conservative voices in the European Parliament for that, as well as to the Government, who are belatedly making progress. I hope that we will make significant progress in the coming months. The directive might be revised further because several member states, notably France, are said to be unhappy with the compromise.

I support the broad objectives set out by the European Commission in other regulatory areas, such as a more efficient framework for financial supervision, enhanced financial stability and greater safeguards of the interests of consumers and investors. As my right hon. Friend said, the crux of the matter is an increased competitiveness of EU financial markets and more integration within those markets. We must make it clear to the public and the EU that British policy makers and financial experts are not against efforts to regulate, but equally will not give all regulation the green light simply because public sentiment dictates it. In creating new regulatory structures, it is essential that policy makers across Europe remain focused on the outcomes and keep on track with the key objectives of open markets, increased competition and consistent arrangements globally, regionally and locally.

The City of London believes that there is a clear and compelling case for the creation of a European systemic risk board to ensure that dangers to the stability of the financial system are caught early. The present crisis has demonstrated that monitoring risks at EU level is not enough. That should not deter us from closer co-operation and interaction with global organisations, such as the new systemic risk body in the United States. To have any credibility, such a risk board's membership and voting structures should reflect the financial industry. There is concern that the banking sector will be over-represented on the board and other sectors under-represented. Given that the current crisis originated in the banking sector, the next is likely to start elsewhere. It is therefore imperative that national supervisors from all financial sectors, from securities to insurance, participate in the meetings and in setting up the framework.

On the chairmanship of the board, I support the European Council conclusions that require the post to be elected by the general council of the European Central Bank to ensure that it is viewed, and acts, as an independent body. Furthermore, the board should be able to raise concerns about financial stability stemming from across the EU financial system, including monetary policy, while respecting the independence of the central banks and the supervisors involved.

I support the principle of promoting convergence to ensure a consistency of rules. However, the European system of financial supervisors should not overrule supervisory decisions made by national regulators. The demarcation of powers between national and EU authorities must be clearly defined and any binding powers should be exercised only as a last resort. There is concern over the timetable envisaged for the development of all of the proposals, but the City recognises the pressure to deliver a workable solution for the future of the EU financial markets.

To return to British shores, in the aftermath of the banking bail-out I was deeply disturbed by the creation of financial institutions that became too big to fail. That relates to the issue of moral hazard that my right hon. Friend raised. In forming such institutions, we recognised implicitly-and explicitly in various Government statements of autumn 2008-that they were too big to regulate and beyond the scope of prudential sanction. That in-built lack of competition will continue to result in a remuneration regime that means high rewards for investment banking employees. Nobody objects to people earning a lot of money when there is genuine flair and innovation, but it cannot be right to reward quasi-monopolistic practices brought about by Government policy and organisations working in cahoots with one another or as a cartel.

I am not naive about these issues. Unravelling the recapitalisation arrangements of the past year will not be a short-term affair. We should not rush to a solution because we should strive to gain the maximum value from what is put in place. I am concerned about the idea of stakes being sold off. That might be politically expedient in the run-up to a general election and would bring funds into the Exchequer, but we must ensure that assets on the Government balance sheet are sold at a time that maximises their value for the taxpayer. I suspect that it will take many years-possibly as long as a decade-to unravel the recapitalisation arrangements. The deal was done without full political scrutiny and perhaps elements of it had to be done in that way. However, it is dawning on the public that there has been, and continues to be, a more extensive nationalisation of banking assets than was envisaged.

With the UK taxpayer propping up banks that are politically too big to fail and providing cover for many commercial enterprises that are part-owned by part-nationalised banks, our economy has a worrying dearth of competition. Given that the Serious Fraud Office has neither commercial nor industry respect, we lack a serious, tough and effective body to deter companies from engaging in fraudulent or market-distorting activity. It is critical that we put the restoration and promotion of competition and market fairness at the heart of future economic policy. Under any plan for sound banking, the SFO requires teeth alongside an all-powerful Bank of England, merged with the FSA.

The public will loudly demand more rigorous enforcement of regulation across business, particularly in financial services. Politicians need to demonstrate a seriousness of intent by outlining robust plans for a tough, not-to-be-messed-with agency that values strong competition and clean business dealings as essential parts of an effective financial system. Such an agency should be linked to or merged with the Office of Fair Trading. Its work should be a top priority for the Department for Business, Innovation and Skills, rather than a minor one in a Treasury that has its hands and its ministerial inboxes full. The United States provides a blueprint for the new SFO regime with its whistleblowing culture, the ability for deals to be cut if businesses show the willingness to change and a tough prosecutorial threat. The deterrents provided by healthy competition and stiff punishment must form the backbone of the brave new world of banking and business that lies ahead. Nothing less will restore the confidence of market professionals and the trust of the public.

We must accept that the spirit of the age favours greater, more stifling regulations. Unless those come about on a global basis, London and Europe risk being the losers. The public and political instinct today-and for some years to come-is to punish the banks. Everybody in the financial services industry risks being caught in the crossfire. Fund managers, insurers and other advisers risk losing out as Governments exert new control over the sector. It falls to those of us who recall London's historical role as a global trading city, including my right hon. Friend who was a distinguished Minister in the last Conservative Administration, to make the case for extending the reach and influence of measures in this sector to markets beyond Europe's shores.

Photo of Colin Breed Colin Breed Shadow Treasury Minister 10:09 am, 10th November 2009

I congratulate Mr. Heathcoat-Amory on securing this important and timely debate. It is rather disappointing that so few hon. Members are here. Perhaps the matter should be discussed on the Floor of the House at some stage because, as the right hon. Gentleman pointed out, the ramifications of what is being proposed will probably affect every man, woman and child in this country, not just for a few years, but for a few decades. What might be done in our name in literally a few weeks' time will have enormous consequences for the future of us all, whether we are retiring or just going out to work.

During our debates and discussions over the past year or so since the commencement of what we now know as the global financial crisis, regulation has been the backdrop to much of the legislation that has been passed-indeed, it has also been mentioned in relation to what different regulatory bodies have been discussing between themselves. The Treasury Committee, of course, has been engaged in some of that and I hope that its report on European regulation will be published in the near future.

We have sometimes failed properly to identify what we want regulation to do. Some people want regulation to curb the size of financial institutions; some want it to curb the size of bonuses; some want it to turn the whole financial sector upside down; and some want it to split large international financial organisations into bodies that are smaller, more manageable and potentially more regulated. Those different opinions all have a part to play, but we have become more aware that, although the intentions behind regulation are often very laudable, the unintended consequences of the imposition of regulation are given less attention.

Attempts to boil down what we want from regulation, to address the current situation and provide some sort of sustainable framework for the future, are causing a great deal of consideration, debate, discussion and argument. I agree entirely with the right hon. Gentleman: saying that everything involved can be put together in a few weeks and brought out in some sort of code that will be the panacea for all our past ills is to go down the well worn route of the Dangerous Dogs Act 1991. The unintended consequences of ill thought out regulation would probably have more impact than the problems that we are supposedly trying to regulate in the first place.

I agree that we need regulation, that it should be tuned to the current circumstances and that supervision needs to be changed and improved, but what do we really want regulation to do for us in this country? At the end of the day, the need for regulation really seems to stem from the problems surrounding debt, which is a fundamental aspect of all the problems that we are dealing with. The amount of debt that has been allowed to build up within the banks, within Government and within personal borrowing-in fact, the whole weight of debt generally-needs to be addressed.

We are only too familiar with the problem of banks being unable to lend to individuals and businesses to get the economy going; in other words, they are unable to support and allow funds to flow into what we know as the real economy. We have allowed the real economy to be forgotten and the financial sector has been the beneficiary. Long-term financial reform and regulation should be about directing lending away from expanding the ever-enormous financial sector towards funding the real economy, rather than loading it down with debt.

Over the past 10 or 12 years, the era of cheap credit and regulation has encouraged all the banks to move away from the real economy, where they thought there was less profitability, towards lending against rising assets. That has created bubbles and false markets in property and derivatives-a situation that continually feeds on itself. If we look at the banks' balance sheets and profit and loss accounts, we see that they apparently benefit enormously from their clever investments. We know that the banks might have looked as if they were just lending to the real economy, but the macro-economic consequences of their actions are very different, and we are suffering as a result.

The credit flowing into those asset markets and the creation of debt overheads has meant that the real economy's capacity to pay that debt has declined. At the end of the day, it is the real economy that will service that debt, and we are beginning to see that already. Unless we generate real profitability within the economy, the assets themselves will not repay those involved because those assets have reduced in value. The idea of backing into assets is that they can be sold at a profit and that someone can repay themselves, but we have seen that the assets have declined. Derivative and property values have all declined and therefore the debt will have to be paid by the real economy. Sadly, that matter has been ignored.

We need a regulatory and policy climate that discourages the pursuit of money only in respect of capital gains and encourages growth in what we know as the real economy. Some of us think that that is what it used to be like. When I was in banking many years ago, banks were there to fund businesses, individuals, entrepreneurs and others to generate the additional profit that not only repaid the bank, but created employment and everything else and increased the value of the country's gross domestic product. Pushing all that money into the area of cheap credit and deregulation and creating asset bubbles and false property markets is not the way in which we should encourage regulation to go.

There is obviously a need for change in the areas of domestic regulation and the supervision of the domestic banking and financial sectors. There are a great many ideas about how that might be done-for example, whether it should be through the Financial Services Authority or the return of some supervisory powers and regulation to the Bank of England. However it was done, I suspect that the same people would simply transfer from one building to another. It is the culture of regulation, rather than the fact of regulation itself, that we need to address.

On big banks being too big to fail, we have talked endlessly about whether we should split the banks up or whether we should create more solid Chinese walls, perhaps with differential licences for different activities or with different capital ratios and requirements in respect of the regulation of different activities. We have swiftly introduced protection for depositors to try to protect the taxpayer from having to provide guarantees for them, but that has not done very much. We may well have protected the depositor, but the taxpayer is still paying out, even though we have passed legislation this year to try to head that off.

Can we ever get back to the idea of having basic old-style banks and perhaps even going back to re-mutualisation? Somehow, I do not think it possible to rein back and return to the position that we were in, recreating what we knew as the old basic banking system or reintroducing some mutualisation. However desirable doing so might appear, I wonder whether it is actually possible.

When we talk about bonuses and regulation, we must realise that over the past 10 years-or perhaps a bit longer than that, because our regulations were probably set up a couple of decades ago-globalisation, in all its fullness, has, to a certain extent, rendered the existing system inadequate and out of date. The whole area of what might be called bonus and regulatory arbitrage now demands a more robust system of regulation and supervision. Gone are the days when individual nations and countries could regulate everything that happened within their borders in respect of their financial sector operations. We have an international banking financial sector with a huge scope, and where it decides to locate itself creates great benefits and great dangers for that location, as we have seen.

Perhaps a co-ordinated approach and co-operation in regulation and supervision are the obvious way forward, but international regulation and co-operation, although vital, are not easy to obtain. All this is unlikely to happen on a particular day, but it is likely to evolve. In the evolution of that regulation and supervision, there will be difficulties and arbitrage, which we will have to accept.

As the right hon. Member for Wells has said, the European Commission published details of its legislative proposals only a month or two ago. They were based on agreements that were reached by ECOFIN and the European Council. Given the scope, range, complexity and difficulty that they are trying to encompass, it seems almost incredible that anything could possibly begin to be considered within a few months, but that is what is being suggested. Perhaps the establishment of a European systemic risk board and European supervisory authorities is the way forward. I am sure that there is huge merit in the idea, and people with great expertise have come up with this particular framework, but the regulation that we are trying to create needs to look at both sides of the coin. Regulation must be adequate, but it must also be proportionate. That is not about being popular; it is about being appropriate. The regulations should seek not to stifle competition, but to promote it between financial organisations and financial sector companies, and also between markets. If we regulate out the competition completely, the consequences will be even more dire. Our approach needs to be sustainable and long-term, not short-sighted and subject to continual short-term amendment.

If we rush into the proposals without giving them the considered thought that is needed, which might take some months, we will have all the disbenefits of such a regulatory regime. We will have a short-term, continual need, and there will be disruption in the market. The system will stifle competition between businesses and different markets, it will be totally disproportionate and we will have to battle significant unintended consequences because we will have failed to recognise and address them at an earlier stage.

To echo the right hon. Gentleman, I should say that I have several concerns about the European proposals. We probably have shared intentions regarding the proposals, and the intentions behind them should be welcomed and accepted, but there is great unease and concern about the potential unintended consequences, especially in respect of the speed with which ECOFIN wants to adopt the proposals-in a few weeks' time. That is far too fast, and does not give time properly to consider the relevant issues.

For proper consideration to be given, time is needed for debate and for the intellectual effort that is needed from a great number of people and some bodies that have been mentioned. They seem to be being almost ignored in all this, but they are going to have to grapple with the system and make it work for both their benefit and the country's.

There is no doubt that the measures are controversial, but rushing them through and trying to limit debate because they are controversial does not mean that we will do them justice. How will the measures relate to the global initiatives for regulatory reform? It is great for us to consider them on a European basis-that is right-but how will they fit into what will be happening in the other international markets that are going to be so important if we are to avoid regulatory arbitrage?

What will be the size and composition of the European systemic risk boards and ESAs, and who will appoint them? Their structure might be right, but the detail is absolutely vital. What will happen if we simply sign up to having a series of authorities without really understanding who will be in them? We must bear in mind that, as the right hon. Gentleman said, the UK interest is by far the largest within the European context. If we enter a situation in which we can be significantly outvoted on things that will have a direct effect on our industry and our country, we will need much better safeguards. What discretionary powers will the ESAs have? Will they really have the power to override the decisions of our national regulators? I am certainly not clear about that vital issue, even at this stage. The whole idea of impinging on the responsibility of member states to look after their own sectors is fraught with danger.

Finally, I think that the proposals go far beyond what we understood to be the agreements at ECOFIN. The whole package seems not to be within the basic bounds of those agreements, but to go beyond them. The proposals cannot be hurried through, without proper consideration, on the basis that if we do not do something, another great disaster will happen immediately.

In some ways, we are coping adequately with the current financial crisis. We are trying to ameliorate the situation or to avoid similar circumstances arising in future. Those circumstances would not arise next year or the year after, but would, I hope, be some time away. We have time to deal with this matter, and we need to consider the proposals before we meekly sign up to a whole framework of regulation that could have real unintended ramifications, which we would have to address again in a short while.

In the meantime, markets would be affected because they would be insecure about what the new regulation would be, and people would be only too willing to exploit the weaknesses of the situation, and any unintended aspects of it, for their own benefit. I urge the Government to be very cautious about this matter. If we move too fast, it will be disastrous.

Photo of David Gauke David Gauke Shadow Minister (Treasury) 10:26 am, 10th November 2009

It is a great pleasure to serve under your chairmanship again, Mr. Olner. May I, too, congratulate my right hon. Friend Mr. Heathcoat-Amory on securing the debate and on speaking so eloquently on this subject? The debate is well-timed for two reasons. First, we are clearly still living with the consequences of the turmoil of the past two years within the financial markets and financial services sector. It is easy to underestimate the importance of financial services regulation in this area and how the failure of such regulation has contributed to the problems we have faced. Secondly, the debate is well-timed given the rush to create a new architecture of regulation for financial services at the European level. All those who have spoken have raised concerns about that rush, and I shall make several comments on that. This is a good opportunity to raise this issue, and I am sure the Minister will set out the Government's position on a number of the concerns that have been raised.

Several speakers have made the point that financial services are extremely important to our economy-perhaps too important. None the less, it is vital that we get the regulation of those services right. There has been regulatory failure. The tripartite system that the Prime Minister established in 1997 failed to spot the debt boom and the fragility within our banking system. An age of irresponsibility was allowed to occur in which UK banks became more leveraged than their US competitors, a credit boom built up and the Bank of England-the monetary authority-recognised some of the difficulties but had no powers to address them. Meanwhile, the Financial Services Authority, as the banking regulator, had no remit to monitor the entire picture. In addition, the FSA took a narrow approach to its responsibilities, focusing on conduct of business rules rather than prudential supervision.

The difficulties that we saw in 2007 and 2008 continue to live with us partly because nobody called time on the explosion of debt. When the problems occurred we saw a failure of co-ordination, and the question of who is in charge has never been adequately addressed. It is right that political parties think seriously about how to rectify that, and my party have set out detailed proposals on how to reform our financial services regulatory regime to ensure that there is no repeat of the problems of recent years, and we will do that by giving greater powers to the Bank of England, which must be in charge.

Several Members have referred to banks being too big to fail, and we have an ongoing debate on the divide within banks between utility functions and investment banking functions. The Governor of the Bank of England stated in Edinburgh on 20 October, only a few days ago, that there had been little real reform on that and that the system remains inadequate.

I turn specifically to European regulation, which was the essence of my right hon. Friend's remarks. As we have heard, on 23 September 2009 the European Commission adopted legislative proposals aimed at addressing the regulatory weaknesses at the micro and macro-prudential level through the creation of a European system of financial supervisors and a European systemic risk board. The European system of financial supervisors will comprise a college of national supervisors and three entities collectively referred to as the European supervisory authorities: the European Banking Authority, The European Insurance and Occupational Pensions Authority and the European Securities and Markets Authority.

I debated many of those matters with the Minister in European Committee B on 29 June 2009. At the heart of the Government's approach is an acceptance of a greater European role at a regulatory level, but not a supervisory level, and the Minister rather helpfully set out the distinction between the two:

"Regulation refers to the making of rules. Supervision relates to the processes that implement the rules and how they are applied to individual firms and markets. While it is important that we have a harmonisation of the rules across Europe, we stick to our point that the supervision and application of those rules, and how they apply in different countries, is down to national Governments. That is why we did not support EU supervision...The main thrust of our argument in negotiation was that supervision should be at nation state level."-[Official Report, European Committee B, 29 June 2009; c. 5-8]

I will explore further the distinction between the rule-maker and the supervisor. One concern that has been raised with us relates to the legal powers of the ESAs, a point my right hon. Friend touched on. Having received advice from a leading lawyer in that area, I understand that the ESAs will not have the power to take decisions or make rules because European law requires that those powers are reserved to the Commission, but they can issue guidelines based on their interpretation of the rules. Competent authorities will be obliged to make every effort to comply with those guidelines. The ESAs can also take action against national regulators that do not currently apply relevant EU legislation correctly. I would be grateful for the Minister's view on whether that interpretation of the ESAs' powers is broadly correct.

There is a possible concern about the distinction between regulation and supervision. The ESAs have the power to settle disagreements between national regulators, which leads to a point that is similar to the issue of action being taken against national regulators that do not currently apply relevant EU legislation: whether ESAs will in effect make individual decisions on individual market participants. One can imagine a dispute on a particular matter between two regulators or between an ESA and a national regulator. When decisions are made on an individual market participant, that looks an awful lot like supervision of an individual institution, rather than regulation. The Government's position on that is clear, and ECOFIN agreed that decisions that are specific to individual firms should remain the exclusive preserve of national regulators. There is a degree of uncertainty on the powers the ESAs will have, and uncertainty in that area is a real cause for concern.

Perhaps the most important red line the Government have identified is that the ESAs should not be able to take decisions that impinge upon the fiscal responsibilities of a nation state. The Governor of the Bank of England has said that banks are global when alive but national in death, because it is the national taxpayer who has to step in to bail out those banks. There is a concern that there would be no democratic accountability if an ESA took a decision that effectively required national taxpayers to step in, and the Government have rightly said that that should be resisted.

However, article 10 of the Commission's proposals allows the ESAs to step in in an emergency, and article 11 allows them to step in when there is a dispute between regulators. The measures proposed by an ESA in such circumstances might have a fiscal impact for a nation state. Article 23 sets out an appeal mechanism, although it is not clear how that would work. That might take too much time, and we know from recent history how quickly we must step in when a bank is failing. If we are to step in, we must do so quickly, as we saw during the events of 14 months ago.

Also, the appeal mechanism set out in article 23 does not apply to article 21, which follows up on a recommendation made by the Economic and Social Research Council. The Government have said that it has been accepted all along that the fiscal position will be protected. If so, why has the Commission come up with proposals that seem simply to ignore what the Government claim has already been achieved in negotiation?

Regarding the Commission's ability to declare an emergency, thus giving the ESAs greater powers, on what criteria may an emergency be declared and how would the ESAs use that authority? With financial services we are in a global situation, not just a European situation, so it could be important for the UK supervisors to co-ordinate not only within the EU, but with US regulators such as the Securities and Exchange Commission or the Federal Reserve. Could the emergency powers, if declared, prevent the FSA or the Bank of England from taking immediate steps to co-ordinate with other countries? The restrictions on communications, for example, could be significant. Could it prevent the FSA or the Bank of England from taking immediate steps with regard to a UK entity? Inevitably, European institutions are likely to move more slowly than national institutions, as is the nature of things, so if that happens the Commission's proposals might slow down the ability of UK institutions to react and of UK financial regulators to co-ordinate with other institutions. Mr. Breed spoke about unintended consequences, and there is a concern that an unintended consequence may arise here: in an attempt to strengthen prudential macro and micro-supervision, we may in fact inhibit regulators from taking effective action.

My hon. Friend Mr. Field, as ever, spoke eloquently about the concerns of his constituents and of businesses located in his constituency. I am pleased that he discussed in some detail the alternative investment fund managers directive-again, I debated that point with the Minister in June. The proposals were poorly drafted and protectionist in nature, and they demonstrated a lack of understanding of hedge funds and private equity funds, and their significance. My hon. Friend was absolutely right to state that such funds were not the cause of the difficulties earlier this year. I would be grateful if the Minister discussed what progress has been made in addressing the concerns she outlined to the European Scrutiny Committee in June.

Finally, it is right that we explore the issue of the wider cost to the economy of the banking system's failure in the past few years and its fiscal consequences. At the weekend, the Prime Minister set out four proposals to address that concern, one of which was a transactions tax, or a Tobin tax, about which we have heard nothing in Parliament. Over the years, the Prime Minister himself and the Treasury have been extremely sceptical about such a tax, but the Financial Times reported yesterday that, of the four options that the Prime Minister set out on Saturday,

"UK officials had initially suggested the transactions tax was the prime minister's preferred mechanism out of the four options he had raised".

The proposals were widely condemned by the US, the Canadians and the International Monetary Fund-I believe that all but the French condemned them. Indeed, the Treasury has recently been briefing against the proposal, and the Financial Times reported that, before the end of the weekend, officials had stated:

"We're not that massively wedded to a transactions tax. We're not saying 'it's this or nothing' - we're saying we need a deal".

Never has a Government proposal been withdrawn so quickly. I would be grateful if the Minister took this opportunity to clarify the Government's position. Was the Treasury even aware that the Prime Minister would come up with the proposal? I ask that because the Financial Times stated that the Chancellor was understood to be frustrated by the Prime Minister's promotion of a proposal that he knew the US would have no choice but publicly to oppose.

This is an important area. This is not the place for short-term stunts that will get headlines, as the Prime Minister attempted to do at the weekend, yet further damaging his credibility. It is important that we have a Government who take a long-term view as to what is necessary for the financial services sector. It is also right that they fight our corner and ensure that European Union proposals are right for the UK. I hope the Minister can provide some reassurance that the Government have at least some of those attributes.

Photo of Sarah McCarthy-Fry Sarah McCarthy-Fry Parliamentary Secretary, HM Treasury 10:44 am, 10th November 2009

It is a pleasure to serve under your chairmanship, Mr. Olner. I congratulate Mr. Heathcoat-Amory on securing this debate. There could hardly be a better moment to discuss financial services regulation. I listened with interest to his speech and to those of the other hon. Members who contributed to this short debate: the hon. Members for Cities of London and Westminster (Mr. Field), for South-East Cornwall (Mr. Breed) and for South-West Hertfordshire (Mr. Gauke).

As the hon. Member for South-West Hertfordshire said, this debate follows on from European Committee B on 29 June. The Transport Committee took evidence last week from my noble Friend Lord Myners, and on 10 November there will be a Lords evidence session and debate on the matter. I believe that a debate is timetabled on the Floor of the Commons on the subject, so there will be an opportunity for further scrutiny.

I do not believe that anyone would suggest that more regulation of financial services is not needed. We need action to produce national and global solutions, and most of that will be delivered through the European Union and international forums. We have begun to raise the quality of financial supervision and regulation globally, but we are not there yet. There is more work to do, and a need for more regulation. We support EU regulation in new areas, more harmonised standards and a greater role for EU authorities in enforcing regulation and improving the effectiveness of supervision.

However, the need for more regulation cannot be met by just any regulation-it must be right. If we have regulation for the sake of it, we will suffer twice: from failing to remove systemic risk, and from increasing the costs to those who use the services, from small businesses to pensioners. We have to have high-quality decision making, and it is more important than ever to have an excellent evidence base, meaningful consultation and high-quality assessments of the impact on stakeholders.

The crisis has also taught us that regulatory arbitrage can introduce its own risks, so we must ensure that, wherever possible, there is global convergence of standards. We encourage the EU to play a greater leadership role in setting global standards. Many of the speeches and interventions by hon. Members have been concerned with the search for the right regulation-that is, regulation that is necessary, sufficient and effective. That is why I am glad that we are having this debate. A part of it has focused on EU regulation, so I shall start with that and then move on to national regulation. I shall try to answer as many points as I can in the time available.

The hon. Member for South-West Hertfordshire made a point about transaction taxes. In fact, the Prime Minister had raised the issue earlier, so I beg to differ with the hon. Gentleman. It was not a short-term stunt. The Prime Minister had previously raised an interest in such taxes and said that he was looking with interest at the French working party.

The Treasury's position has always been that imposing such a tax cannot be done by one country alone-we all accept that-and the US has said that it is willing to work with the International Monetary Fund as well. Nobody is saying that there would be an immediate solution, or that we will be able to come up with something straight away, but it is something that is worth looking at. The Treasury's position is that this cannot be done by one country alone. It would have to be global, and that is why a great deal more work must be done on it.

On European supervision, the Government strongly support moves to improve the quality and consistency of supervision, to ensure more effective rule-making and enforcement, and better to identify risks in the financial system. We strongly support proposals to establish the new European supervisory authorities, and to give them a strong rule-making role, a role in enforcing rules, a role in peer review to ensure high standards and an ability to settle disagreements between supervisors. We believe that such moves would improve the quality and consistency of supervision in the EU, and they are supported by the City and, in particular, cross-border institutions operating from London.

However, I am happy to reiterate that day-to-day supervision and crisis management arrangements must remain national, as it is only national Governments who can provide fiscal support to firms. That is why the Heads of Government agreed at the June European Council that the new framework should not impinge on member states' fiscal responsibilities, and that day-to-day supervision should remain national. As a result, it is clear that there can be no direct European powers over firms.

Photo of David Gauke David Gauke Shadow Minister (Treasury)

I am grateful to the Minister for reiterating that point. Can she explain why the Commission came up with proposals in September that do not appear to respect the agreement made by ECOFIN earlier in the year?

Photo of Sarah McCarthy-Fry Sarah McCarthy-Fry Parliamentary Secretary, HM Treasury

I absolutely agree with the hon. Gentleman that in some areas the Commission's proposals do not respect the agreement that was made in June, particularly where they propose European powers over firms, and European crisis management powers. We need to bring the proposals back in line with what was agreed by the European Council in June.

There is interest in the legal issues in these proposals and the Government are well aware of the complex legal matters here. I do not want to go into the detail, but I will be clear: regardless of the technicalities, the Government's overriding objective is that the new framework must be able to withstand legal challenge. We cannot have legal uncertainty and challenges before the courts; that could undermine financial stability. So we are working closely with other member states and the Council legal service to ensure that the bodies are on a sound legal footing. In particular, we are looking at areas where the supervisory authorities can exercise discretion and where the Commission is seemingly playing the role of the courts. Both those areas are problematic, but in both the issues can be resolved.

Photo of David Heathcoat-Amory David Heathcoat-Amory Conservative, Wells

Clarity is essential here. Can the Minister assure us that the new supervisory authorities will not have powers of binding mediation over national authorities and, separate to that, that they will not have powers, even in an emergency, to tell national regulators and authorities what to do?

Photo of Sarah McCarthy-Fry Sarah McCarthy-Fry Parliamentary Secretary, HM Treasury

We do not support direct powers over individual firms. We expect the powers of mediation to be used where there are cross-border situations, but the overriding thing is that there are no powers where there are any fiscal consequences for Governments. That is the overriding principle here.

We know that there are outstanding issues and questions. However, this is a positive agenda for reform. The new framework will better protect consumers, help prevent financial crisis and improve efficiency for firms.

A question was asked about accountability. We believe that the ESAs will be accountable to national Governments through the European Council, but it is likely that they will also be accountable to the European Parliament. The Financial Services Authority will sit on the ESAs, so we will have a powerful UK voice there.

Members spoke about whether the EU response has been too hasty. It is important that we respond swiftly to the crisis, but I agree that such action should not be taken at the expense of high-quality regulation. That is why we are encouraging the Commission to adhere to best practice and conduct consultations and impact assessments on regulatory proposals for regulation of markets and firms. At the June European Council, the EC leaders gave a mandate for the proposals to be adopted swiftly so that the new framework could be fully in place in 2010, which is why the legislative proposals were produced at the end of September. As I have said, we intend that our Parliament should have a full opportunity to debate this matter.

At times the Commission may have been too hasty in issuing a proposal. For example, it was too hasty in respect of the alternative investment fund manager directive, which we debated earlier at the European Scrutiny Committee. We agree that the Commission did not conduct a proper consultation or a robust impact assessment on that directive with stakeholders. We have made it clear that this is not an acceptable approach to drafting legislation, because it has resulted in a poorer-quality proposal that has led to more difficult Council negotiations. The European Parliament has said that it will carry out its own impact assessment on the proposal. I confirm once again that there is nothing to suggest that hedge funds or any other type of fund were a major contributor to recent market events.

Having a high-quality evidence base will also maximise the influence of the EU on the international stage with our international partners and will better enable the EU to attain international regulatory convergence.

Photo of Mark Field Mark Field Conservative, Cities of London and Westminster

I am glad that the Minister has confirmed what I said earlier: hedge funds and alternative assets played no fundamental part in the credit crunch and the financial problems. But the suggestion that the EU will now have much more international influence surely is undermined by what has happened, because it is clear that it was not economic or financial issues at stake, but the raw politics, particularly in respect of one or two of our continental partners who saw this as an opportunity to clip the wings of the City of London, rather than to focus on what would be good for consumers, both in the EU and globally.

Photo of Sarah McCarthy-Fry Sarah McCarthy-Fry Parliamentary Secretary, HM Treasury

Our position is that any regulation, as well as managing systemic risk, has to be good for consumers. There are aspects of the proposal as drafted that could impose large costs and restrictions on fund managers, which is why we are engaging actively with stakeholders in the UK industry, with the Commission and with other member states to develop and make the case for amendments to the directive.

Based on discussions so far in Council, we believe that many member states are keen to make the improvements. My noble Friend Lord Myners has personally committed a substantial part of his time to achieving a good outcome for the UK on the directive. He has had useful discussions with many of the stakeholders, including Members of the European Parliament, the Swedish presidency and his Spanish counterpart. Our overall impression is that most member states are approaching these negotiations with a positive attitude and a desire to avoid unnecessary regulatory burdens. We expect the presidency to aim for a general consensus in Council for a redraft of its directive by the middle of December, so that negotiations with the European Parliament can start.

On the UK and systemically significant firms, in our July 2009 paper, "Reforming financial markets", we set out a number of measures for dealing with systemically significant and often complex financial institutions whose failure could represent a significant threat to financial stability. These measures include strengthened market discipline, better corporate governance, policies on remuneration to ensure that risk is better understood, and enhanced prudential supervision by the FSA. Those measures should go some way towards reducing the probability of firm failure. But we are not proposing to pursue a zero-failure regime, which would be neither realistic nor desirable. It is equally important that, where firms reach the point of failure, the authorities can intervene and, if necessary, resolve the situation with a firm in a way that does not damage the wider financial system and put the public finances at risk.

First, we propose improvements to the overall framework, including enhancements to market infrastructure in key markets to reduce the likelihood of contagion effects. This is crucial where a systemically important firm is allowed to fail. Secondly, we propose stronger resolution arrangements. Improvements have already been made to the regulatory toolkit for winding down failed firms, for example, through the Banking Act 2009. We will legislate, in the forthcoming financial services Bill, to ensure that firms themselves must make recovery and resolution plans to manage their own failure. Those plans will reduce moral hazard. The aim is to reduce the possibility of firm failure, which is the recovery element, and then reduce the impact of firm failure, if it occurs, on the wider financial system, the economy and the public finances, which is the resolution element.

Questions were asked about the proportionality of the FSA's regulation of firms. The FSA supervises firms according to the risks they present to its statutory objectives. As in any risk management, risks are assessed in terms of their impact and their probability. The nature and extent of the FSA's supervisory relationship with a firm depends on how much of a risk it could pose to the FSA's statutory objectives.

The hon. Member for Cities of London and Westminster asked about the regulation of savings and investment products and the worry about over-regulating small firms. The FSA's retail distribution review is addressing structural problems in the distribution of savings and investment products. We have welcomed the FSA's comprehensive review and its positive engagement with stakeholders. The aim of that review is not to over-regulate small firms that do not pose any systemic risk, but rather to address structural problems in the distribution of savings and investment products.

On the suggestions that some have made about a Glass-Steagall-type split between retail banking and investment banking activities, we do not believe that the case has been made for that. First, it is difficult to do. Secondly, if it were feasible it probably would not be enough. Separating investment and commercial banks would not insulate pure deposit-taking institutions from the failure of a large investment bank: Lehman Brothers showed that that was so. Thirdly, it implies that all the risk lies in investment banking. However, we know that it is not just investment banks that involve risk. The recovery and resolution plans or the living wills are key tools with which to mitigate the risk and promote long-term financial stability.

In my introduction I mentioned the importance of getting the balance right. We have already seen the dangers of too little regulation, but in these times there is not enough confidence, and confidence can only build if the regulatory framework is sound. Too much regulation brings its own risks, not just of stifling the recovery, but of penalising some financial services that allow firms to manage their own risk. Only if we get this balance right will we succeed in our goal of making the single market the most competitive, efficient and stable financial market in the world.