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Session 2007 - 08
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Financial Services

The Committee consisted of the following Members:

Chairman: John Bercow
Breed, Mr. Colin (South-East Cornwall) (LD)
Cable, Dr. Vincent (Twickenham) (LD)
Cousins, Jim (Newcastle upon Tyne, Central) (Lab)
Dean, Mrs. Janet (Burton) (Lab)
Dobbin, Jim (Heywood and Middleton) (Lab/Co-op)
Fallon, Mr. Michael (Sevenoaks) (Con)
Gauke, Mr. David (South-West Hertfordshire) (Con)
Goodman, Helen (Bishop Auckland) (Lab)
Newmark, Mr. Brooks (Braintree) (Con)
Pound, Stephen (Ealing, North) (Lab)
Steen, Mr. Anthony (Totnes) (Con)
Timms, Mr. Stephen (Financial Secretary to the Treasury)
Tipping, Paddy (Sherwood) (Lab)
Celia Blacklock, Committee Clerk
† attended the Committee
The following also attended, pursuant to Standing Order No. 119(5):
Hopkins, Kelvin (Luton, North) (Lab)

European Committee B

Tuesday 25 November 2008

[John Bercow in the Chair]

Financial Services

4.30 pm
The Chairman: Does a member of the European Scrutiny Committee wish to make a brief explanatory statement about the decision to refer the relevant documents to the Committee?
Jim Dobbin (Heywood and Middleton) (Lab/Co-op): It is a great pleasure to make this statement in your esteemed presence, Mr. Bercow.
It might be helpful to the Committee if I explain briefly the background to the documents and the reason that the European Scrutiny Committee recommended them for debate. To facilitate the single market for financial services, there is Community regulatory legislation. That includes the amended 1985 directive on prudential supervision of undertakings for collective investment in transferable securities, commonly referred to as the UCITS directive. It also includes directives 2006/48/EC and 2006/49/EC, collectively known as the capital requirements directive, which relate to the capital held by banks and other financial services firms in the Community. Finally, directive 94/19/EC relates to deposit guarantee schemes.
The three draft directives that we are debating will amend various aspects of those three areas of regulation. In the past month, the European Scrutiny Committee has considered the first two draft directives on assets and capital requirements twice and that on deposit guarantee schemes once. Although we have satisfied ourselves on some of the issues, we would have preferred more time to consider the documents. The ECOFIN Council will probably feel it necessary to come to conclusions on the proposals on 2 December. We thought that this Committee should be given the opportunity before that to explore with the Minister the purposes and general content of the three draft directives and some particular points.
The Committee may wish to explore the UCITS proposal, the question of a management company passport and consumer views of the proposal. It may also wish to discuss the capital requirements proposal, the compromise text on the large exposures regime, the Government’s key objective of ensuring a proportionate regime for the UK’s smallest banks and building societies, the Government’s wish for modifications for mutuals in the texts on hybrid capital and the Government’s hopes about narrowing the scope of the quantitative retention requirement. In relation to deposit guarantee schemes, it may wish to discuss the practical points in the draft to which the Government want answers, and the Government’s view of the Lamfalussy aspects of the proposal. I hope that I have made that clear.
The Chairman: I call the Minister to make an opening statement.
4.33 pm
The Financial Secretary to the Treasury (Mr. Stephen Timms): I, too, am delighted to speak under your chairmanship, Mr. Bercow. This is the first opportunity I have had to move proposals in such a Committee. I am grateful to my hon. Friend for his explanation, which gave some background. I welcome the opportunity to debate these matters.
The three financial services dossiers under consideration are part of a wider reform agenda under way in the European Union. We are witnessing unprecedented turmoil in global financial markets with a financial crisis that is affecting every country. The Bank of England’s financial stability report suggested that the global banking system has undergone arguably its biggest episode of instability since the start of world war one. That is the scale of the challenge we are addressing. We have already seen the results of that spreading across the developed world and it is threatening to affect emerging markets in eastern Europe and beyond.
The priority is financial stability and the Government will do whatever is necessary to ensure that stability is maintained for the benefit of the wider economy. The turbulence in international financial markets has the potential to affect every country in the world. A co-ordinated international response is therefore required.
4.34 pm
Sitting suspended for a Division in the House.
4.49 pm
On resuming—
Mr. Timms: National action is certainly necessary but will not solve the problems on its own. National systems of supervision are simply not in an adequate position to respond to today’s huge cross-continental flows of capital. The first step has been to take action to stabilise market conditions.
The Government, as part of a co-ordinated international effort, have taken rapid, well-targeted action: we have injected almost £50 billion as capital into our banks; the Bank of England has pledged to double the amount of liquidity it provides to the banks; and we have guaranteed new lending between the banks so that we get them lending to one another again. That has strengthened confidence in the banking system, put financial institutions on a firmer footing and provided support for the real economy. That approach has been widely applauded in other countries, and many others, including major European partners, have followed our lead and taken similar action.
After that first step of stabilising the market, the next step is to work toward the global financial system that we want in place for the future. The financial crisis has revealed problems at the heart of the international financial and regulatory system. We now need to give people confidence that those failings have been dealt with and that those problems will not resurface. That means addressing reforms not only to supervision and regulation of financial markets, but to global governance. The Prime Minister has argued that the reforms should be guided by five principles—transparency, integrity, responsibility, sound banking practice and global governance with co-ordination across borders.
Stronger supervision and regulation of the banking sector is essential. Steps have been—and are being—taken to ensure that, building on the recommendations of the Financial Stability Forum and in line with the road map agreed with our EU partners. As a key global market, the EU has an important role in shaping the international response. ECOFIN, recognising the need for reform to meet future challenges to financial markets, endorsed a programme of work in autumn 2007 on the issues raised by the market disruption, and that work continues this year. On 7 October, the Chancellor and others at ECOFIN agreed to a set of common EU principles, to guide public interventions at national level to ensure swift, appropriate and co-ordinated action with minimal disruption to the EU Common Market.
Within that broader stream of work, there are significant overhauls of two of the directives before the Committee—the capital requirements directive and the deposit guarantee schemes directive. The former is in part the culmination of a longer-term review, and in part a response to the financial disruption. Urgent changes are needed to the latter directive, which has proved to be inadequate in the current crisis. To further the aim of a more efficient single market in retail financial services, we have proposals for reform of the UCITS directive on retail fund management—the third of the three directives in front of us—which have been developed over the past three years.
I shall say something about each directive, beginning with the deposit guarantee schemes directive. The failures of banks such as Northern Rock and Bradford & Bingley in the UK, Fortis in the low countries and HRE in Germany, and the collapse of much of the Icelandic banking system, have exposed weaknesses in the arrangements for depositor protection. Against that backdrop, the European Finance Ministers decided in October to bring forward urgent proposals to update the deposit guarantees directive. The new rules are designed to improve protection for depositors and maintain their confidence in the financial safety net. The changes will, first, increase the minimum level of cover to €50,000 by June next year and €100,000 by December 2011. Those amounts will be adjusted for inflation. It is proposed that that should become a maximum as well as a minimum limit by 2011, subject to the findings of an impact assessment to be carried out by the Commission by the end of 2009. Secondly, the deadline for paying compensation will be cut from three months to 20 working days, with an additional 10 working days in exceptional circumstances. Thirdly, the level of the guarantee will be raised from 90 per cent. to 100 per cent. of eligible deposits.
I am pleased that the opportunity has been taken to update not only the level of compensation and the payout time, but how directive and guarantee schemes operate. In particular, it is proposed that guarantee schemes must be stress-tested regularly and, at a time when cross-border depositors are uncertain about the protection afforded them by schemes in other member states, those schemes will be required to co-operate with one another.
Due to the rapid nature of the agreement on the directive, it was only possible to make the most urgent changes. Commitments to additional work and impact assessment have been proposed in a number of areas. The Commission will be asked to report by December 2009 on the effectiveness of payout procedures and of funding and co-operation arrangements. I hope that that means we can make further improvements and that depositor protection can be put on a sound basis that will maintain confidence for the long term.
Secondly, I shall discuss the capital requirements directive. One purpose of registering capital requirements is to protect depositors or clients against risks taken by the firm, which could result in financial losses. The Basel II capital accord, agreed in 2004 by the G10 central banks, aimed to update and modernise.
4.56 pm
Sitting suspended for a Division in the House.
5.11 pm
On resuming—
Mr. Timms: I was speaking about the changes to the capital requirements directive. The Basel II capital accord agreed in 2004 by the G10 central banks aimed to update and modernise the previous Basel rules, taking into account new developments in risk management. It aimed to significantly improve incentives for better risk management, increased risk sensitivity and reduced opportunities for regulatory arbitrage.
The capital requirements directive, which implements the Basel II accord in EU legislation, came into force on 1 January 2008. As soon as it was agreed in 2006, further improvement work was carried out, focusing in particular on the functioning of the large exposures regime, which acts to limit any bank exposing a significant proportion of its capital base to any other single counterparty. That had not been updated for 15 years. In addition, improvements were made to the limits on some types of capital counting towards regulatory requirements, which had been implemented differently across different member states.
Partly in response to the financial market disruption, the opportunity has been taken to strengthen supervisory co-ordination through the establishment of supervisory colleges in the European Union. Like other colleges being developed at international level, that improves the information flow between supervisors, and requires them to co-ordinate more closely on issues that are relevant to the supervision of a particular cross-border group.
The proposal introduces sound principles for liquidity management—which were recently developed in Basel—and new requirements for securitised products. Those requirements build on the industry-led work to ensure that originators of securitisations are transparent about the products that they sell, and that investors in securitisations understand the risks that they take. A new requirement for both originator and investor to monitor the underlying assets will ensure that risks are kept under review.
The changes to the directive are a mix of enhancements flowing from the review process and new measures designed more specifically with the recent problems in mind, and they represent a valid and valuable contribution to regulation. In particular, they will reduce the systemic risks from large connected banks and ensure that appropriate due diligence, transparency and monitoring is in place in the market for securitised assets. They will improve supervisory co-ordination and implement a first step in improving liquidity standards.
The measures do not go as far as we would like in reforming the capital supervision of European banks over the longer term, and they do not deal with issues identified in more recent months, such as the role of the credit rating agencies, or the potential for pro-cyclicality within the regulatory and accounting frameworks. Those issues must be addressed in due course.
The third directive is the UCITS directive, and the priority must be to ensure that Europe gets the regulatory response to recent market events right. However, we also need to maintain progress towards a more efficient single market in financial services, so that investors in the EU have a well regulated, cost-effective way into investing in stocks and shares once confidence starts to return. The Government therefore welcome the proposed amendments to the UCITS directive, which set common rules for retail investment funds in the EU.
The amendments, which are due to be considered by ECOFIN in December, would make five key improvements to the directive. First, they would streamline the process whereby UCITS managers notify supervisors in host member states of their intention to start marketing their funds locally, reducing the time to market, increasing choice for investors and competition in local markets, and reducing the administrative costs associated with the current system, which investors must bear.
Secondly, the amendments would introduce a management company passport, which would allow UCITS management companies to offer their services in a cross-border fashion to funds in other member states. That would increase efficiency by permitting economies of scale, with one central management company rather than several local ones for firms with international fund ranges. It would also increase investor protection by allowing risk management to be carried out in one centre of excellence as opposed to the current situation, in which there is a split in responsibility between a local management company, often with relatively small resources, and a central hub.
We welcome the report of the Committee of European Securities Regulators and its confirmation that the high level of supervisory co-operation needed to maintain investor protection if the management company and UCITS fund are in different countries can be achieved practically. That is an important reassurance.
Thirdly, the changes would improve disclosure to potential investors by replacing the current “simplified prospectus” with “key investor information”. The simplified prospectus is not properly fulfilling its role as a clear, concise and informative document on which investors can base a decision on whether to buy into a fund. By contrast, the proposals on key investor information should deliver a substantial improvement in that area. The Government particularly welcome the Commission’s commitment to full consumer testing of the detailed implementing measures to ensure that the specified format does the job effectively.
The fourth change would be to introduce a common regime for cross-border mergers of UCITS funds, allowing the consolidation that is necessary if the EU market is to match the concentration and associated economies of scale and low costs seen in the US market, while ensuring that investors are protected when mergers take place.
The fifth change would be to introduce the possibility of master/feeder fund structures whereby one or more feeder funds invest their assets into a master, allowing the feeders to benefit from the investment management expertise of the master’s manager without incurring the full costs of setting up a sophisticated management company.
The Government are confident that the proposals have the potential to deliver a significant step forward for the single market in retail investment funds, providing greater choice and lower costs for UK investors as well as new business opportunities for UK fund managers. We are also confident that the changes would maintain and improve investor protection, particularly through the proposals for better supervisory co-operation, which would run throughout the revised directive.
With regard to the longer-term work, of which the three directives are part, work is under way to deliver a co-ordinated international approach to strengthening the stability and resilience of global financial markets for the future. At the recent G20 summit in Washington, following the G20 Finance Ministers meeting in Sao Paulo, which I attended, the Government pushed for action in three areas: first, to encourage world leaders to take concerted action to address the causes of macro-economic and financial instability; secondly, to establish standards of financial regulation and supervision, as well as improved co-operation between regulators, to address cross-border issues; and thirdly, to reform the global financial and economic architecture to ensure that all countries are better prepared to deal with global economic problems.
Leaders and Finance Ministers of G20 countries agreed that urgent action was needed in a number of areas to tackle the financial and economic crisis. Of course, the UK assumes the chair of the G20 on 1 January 2009 and so will be driving the G20’s work forward.
In conclusion, I hope that I have clarified how these three directives are all important parts of the major forward work programme in national, European and international forums to reform our financial systems. As my hon. Friend the Member for Heywood and Middleton mentioned earlier, Finance Ministers will be asked to vote on all three directives at the meeting of ECOFIN that I will attend next week. The Government believe that it is vital that we play our full part in ensuring that agreement to these three important directives marks the best possible result for UK and European consumers and businesses.
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Prepared 26 November 2008