Banking Bill

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Ian Pearson: I fear that I shall have to disappoint the hon. Gentleman. I do not want to get drawn into a detailed discussion of Bradford & Bingley or Kaupthing Singer & Friedlander and Edge as these are obviously very recent events. In response to those circumstances and to the thinking that that has engendered within the authorities, we believe that the flexibilities in the amendments and new clauses could be beneficial in situations that might occur. We believe that the additional flexibility could enable successful resolutions and, as I indicated in my initial remarks, potentially optimise the balance sheet of a bridge bank and make the transfer to a private sector purchaser more likely.
Mr. Gauke: I am not sure that it is entirely appropriate to decline to discuss a matter because it arises from recent events. The Committee is capable of discussing recent events. I stress that twice in three paragraphs the Treasury document makes it clear that amendments were introduced in the light of recent experience. It would be helpful to the Committee to know what that recent experience is.
Mr. Gauke: I am grateful to the Minister. May I put it another way? I take the point that events may inspire deeper thinking, new circumstances may emerge and hypothetical circumstances may be considered, but would he say that the inability to carry out supplemental and reverse transfers in the Bradford & Bingley and Icelandic cases has proven to be disadvantageous to the Government in trying to address those matters?
Ian Pearson: I do not want to get drawn on to that ground. We should bear in mind that we often deal with situations in which action needs to be taken very swiftly indeed, with only limited time for detailed analysis. As I explained earlier, in some cases due diligence will not have been possible. In those circumstances, having the flexibility needed to take rapid action can help to maintain the value of a failing bank. I think the hon. Gentleman broadly accepts what we are trying to do with the powers and he is trying to press us on the detail. I have explained to him why some of that is difficult, but the powers are, in our view, worth while and needed.
Mr. Bone: I quite understand the Minister not wanting to be drawn on the specifics of the Bradford & Bingley situation but, in general terms and without being specific, would the Bradford & Bingley transfers have been easier if these tools had been in place?
Ian Pearson: The actions that the Government have taken with regard to Bradford & Bingley are entirely right, and those who look at these matters from outside welcomed them. It is not helpful to try to retrofit the experience of Bradford & Bingley into the Bill’s deliberations, although I am being invited to do so. The key learning points have been that the speed of events and the uncertainty that often arises require the flexibility to take action and the ability to transfer back, with safeguards in place, so that if a deal is done with a private sector purchaser, we will not go back on it. Being absolutely decisive and certain in that is helpful. The measure is designed to allow successful resolutions in the future, and I hope the amendment is agreed to.
Amendment agreed to.
Question proposed, That the clause, as amended, stand part of the Bill.
Mr. Gauke: I have a brief question about drafting, which applies elsewhere. Subsection (6) states that:
“Before making a supplemental property transfer instrument the Bank of England must consult...the FSA, and...the Treasury.”
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Ian Pearson: We have discussed similar subsections in other parts of the Bill and at all stages I have been at pains to point out that the authorities work extremely closely together in these situations and on the exercise of the special resolution regime. When we are talking about supplemental property transfer instruments, it is important that we continue the dialogue among the Bank of England, the FSA and the Treasury. The word “consult” is right rather than “notify” when we expect discussions to take place. In the normal way in which these events are handled, we would expect a close consultation not just on transfer instruments, but far more broadly.
Question put and agreed to.
Clause 39, as amended, ordered to stand part of the Bill.
Clause 40 ordered to stand part of the Bill.

Clause 41

Temporary Public Ownership: Property Transfer
Amendment made: No. 97, in clause 41, page 19, line 4, leave out subsection (4).—[Ian Pearson.]
Clause 41, as amended, ordered to stand part of the Bill.

Clause 42

Restriction of Partial Transfers
Mr. Gauke: I beg to move amendment No. 144, in clause 42, page 19, line 26, after ‘include’, insert ‘any’.
This is a minor drafting amendment seeking greater clarity. I do not want to stray into the wider issues on clause 42, which are substantial. The amendment speaks for itself but I do not consider it vital. If the Minister has anything exciting to say about it, I am sure the Committee will be pleased to hear it, but I am happy to proceed to the stand part debate.
The Chairman: Do I take it that the amendment is not moved?
Mr. Gauke: Yes.
Question proposed, That the clause stand part of the Bill.
Mr. Gauke: We finally reach clause 42, which is at the heart of many concerns about the Bill. To some extent the clause needs to be looked at together with clause 43. For these purposes, I shall make one or two introductory remarks. We recognise the advantages—
The Chairman: Order. Given that the amendment has been withdrawn and there is no amendment tabled for clause 43, I am content to take stand part debates for both clauses together, if that helps.
Mr. Gauke: I am happy with that.
The Chairman: Minister?
Ian Pearson: So am I.
The Chairman: Fine. Let us do that.
Mr. Gauke: I am grateful. My introductory remarks consequently apply to both clauses. Partial transfers are important to the manner in which the Bill is designed to work. They enable a bank to be split, with some assets and liabilities in one entity and the remainder in another. Essentially, we are left with what could be described as a good bank and a bad bank.
My hon. Friend the Member for Wellingborough eloquently set out his objections to the term “toxic assets” and the Minister tended to agree. None the less, there is one bank that is much more commercially attractive and therefore more likely to be acquired by a private sector purchaser, leaving another entity that will contain assets which, to put it kindly, will carry a degree of uncertainty. At a practical level, we have already seen the use of partial transfers in the case of Bradford & Bingley, Heritable and Kaupthing. We will return to those cases, although I know the Minister is keen not to be drawn too much on the subject.
Although the provisions relating to partial transfers are helpful in trying to address some of the difficulties with a failing bank, they are also the area that has caused most concern. Those of us in the Committee who heard evidence from the British Bankers Association and the London Investment Banking Association at the beginning of the process will be well aware of concerns that without sufficient safeguards, partial transfer provisions may have serious implications for the competitiveness of London banks.
I know that the Government recognise some of those concerns. Indeed, the consultation paper published last week highlighted a number of matters raised by stakeholders, including increased cost of capital for UK banks, higher regulatory capital requirements, potential evasion by counterparties, the likelihood that UK banks will seek to restructure their arrangements to ensure that partial transfers cannot easily be applied to business, and the ultimate possibility that all those factors might have adverse effects on UK financial effectiveness.
Sir Peter Viggers: In supporting the thrust of my hon. Friend’s arguments, I remind him that the BBA said in a statement that its strong preference was for the special resolution regime element of the legislation, or at least the part dealing with partial transfers, to be deferred pending a much more detailed analysis of the cost and risk factors arising. In evidence before the Treasury Committee in July this year, the Governor of the Bank of England emphasised that it was far more important to get the SRR legislation right than to rush it according to a fixed timetable. I support the points that my hon. Friend is making.
Mr. Gauke: I am grateful to my hon. Friend, who anticipates my comments and raises an important point. If there is one part of the Bill and the surrounding legislative framework that we need to get right, it is the safeguards provided here. My argument today will stress that, highlight the concerns and examine how the Government seek to reassure. I do not deny that the Government are aware of the issue and are seeking to address it. The Committee needs to examine in some detail whether they have succeeded.
The question is whether the Committee is in a position to make that assessment, because work is still very much in progress. The various methods by which the Government seek to address the issue—the safeguards in secondary legislation, and the code of practice—are at various stages of development and are not necessarily complete.
Mr. Bone: My hon. Friend is introducing the amendment with his usual clarity, but one thing troubling me about the debate is the fact that in many cases, we are dealing with matters of which we have no knowledge. The situation is uncertain. We are in uncharted waters. However, in respect of partial transfers, we are not, because we have seen the examples of Bradford & Bingley and the Icelandic banks. Does my hon. Friend think that the Government are being fair in not being prepared to discuss those partial transfers in detail so that we have practical evidence of what happened?
Mr. Gauke: My hon. Friend makes a valuable point. We have such experience. The Government have experience of how partial transfer works, and that is clearly guiding them, whether with concrete examples of problems that have arisen in the course of those transactions or through something less direct that has none the less been provoked and inspired by them. It is probably helpful to the Government, in assessing whether they are getting legislation right, to have gone through the experience of Bradford & Bingley, Kaupthing and Heritable, but it would be useful if the Committee could benefit from that experience as well. I encourage the Minister to be as open as possible with the Committee about the issues that have arisen from those cases.
I return to the concerns raised by outside bodies, particularly the BBA and LIBA. Essentially the concern relates to the cherry-picking of assets and liabilities so that the good bank gets what is commercially the best for it, leaving the bad bank with the more difficult assets and liabilities. The creditor is therefore left with a divide between the various assets and liabilities, which makes netting and set-off very difficult. It cannot be sure whether it can net or set off its assets, liabilities and contractual positions, which creates a great deal of uncertainty and increases its credit risk and its insolvency risk for counterparties dealing with British banks.
That will ultimately increase the cost of capital for British banks and reduce liquidity. That could have a long-term impact on the UK banking sector. The Treasury consultation document refers to the fact that the UK has a competitive advantage in this area. English law is attractive to creditors in such circumstances and that competitive advantage could be lost. That is perhaps a relatively cheery way of putting it. The fact is that we could be left with a competitive disadvantage if we get this wrong. The safeguards that we are debating in the context of clauses 42 and 43 are, therefore, very important.
I should like to raise one point about the architecture of these clauses. Clause 43 appears to a large extent to be a subset of clause 42. Both clauses refer to the fact that the Treasury may, by order, restrict the making of partial property transfers. It is clear what the different areas covered are. Clause 43 relates specifically to issues of netting and set-off, security interests, structured finance and so on. This is not a major point, but would it be possible to deal with all this under one clause? What is served by the separation of the clauses?
Clause 42 gives the Government power to make regulations limiting the scope of a partial transfer. Last week when I intervened on the Minister to ask whether the safeguards relating to partial transfer would be retained in the code of practice or the secondary legislation, he said:
“The stakeholders we consulted this year have been very much of the view that they want the safeguards in secondary legislation, rather than in the code. We have taken that to heart, which is why we have produced the consultation document. It is right that those safeguards are enshrined in secondary legislation.”——[Official Report, Banking Public Bill Committee, 6 November 2008; c. 366.]
We will come on to the safeguards relating to netting and set-off, which the Government propose to address in secondary legislation. With regard to partial transfers however, they say in the consultation paper that although they have the power to make regulations limiting their scope, they do not intend to so in secondary legislation. They intend to do so within the code of practice. I should be grateful if the Minister could confirm that that is the case and explain why the Government do not intend to make regulations limiting the scope of partial transfers.
12.45 pm
Within the consultation process three scenarios were set out as the possible scope of a partial transfer. The first was a transfer of the deposit book only, to ensure protection and continuity of service for depositors. The second was a transfer to facilitate a pre-agreed private sector purchaser resolution, and the third was a transfer to sanitise the balance sheet of a failing bank by separating good and bad assets. The Government have said that in the light of recent transfers—we come back to the point about Bradford & Bingley, Heritable and Kaupthing—there needs to be flexibility. They argue that the three scenarios set out a while ago do not provide sufficient flexibility, and highlight how Bradford & Bingley required the transfer of related assets such as branches and systems. I understand that, but it seems that it would be perfectly possible, in the light of the recent experiences, to look again at the issue of scope and to amend definitions, so that when we refer to the deposit book we also include related branches and systems. We can return to the scenarios with a view to redrafting them to incorporate those things, and also perhaps to making them more flexible. Nevertheless, that could be done in secondary legislation. I do not see why the recent cases suggest that that cannot be done, and I would be grateful if the Minister would discuss that.
I now turn to Bradford & Bingley. I know that the Minister is not particularly keen to address this matter, but, having experienced the splitting-up of that bank, what is his assessment of the cost of transferring the deposit book to Abbey Santander? What is his assessment of the value of the residual bank, which is essentially the mortgage book still held by Bradford & Bingley? I and my right hon. Friend the Leader of the Opposition visited the offices of Bradford & Bingley last month, and discussed the events involving the bank with staff and management. I would be grateful if the Minister could say where we are with Bradford & Bingley, and whether the Government have made any assessment—this comes back to a point made by my hon. Friend the Member for Wellingborough a week or so ago—of the value of the residual bank. Although we talk about a good bank and a bad bank, the bad bank tends to have assets that are uncertain. Where does the Minister see the taxpayer with regard to the part of Bradford & Bingley that has been taken into public ownership? It still has a substantial mortgage book; as mortgage holders come off their deals, they may be unable to find an alternative deal in the current circumstances and so go on to a standard variable rate. In those circumstances, Bradford & Bingley may prove profitable. I raise the question because it will give us a better understanding of how splitting good and bad banks may work, as a bad bank can do rather well—a point made by the hon. Member for South Derbyshire.
May I raise a question about subsection (3), which seems strange? I do not know what it is meant to do, and it would help if the Minister were able to provide some guidance. It states:
“Provision under subsection (2)”—
orders that the Treasury may make—
“may, in particular, refer to particular classes of deposit.”
One senses that the draftsman has something in mind, but it is not clear to the Committee what it is. It would be helpful to know.
I have already mentioned netting and set-off. Again, I refer the Committee to the evidence received from BBA and LIBA. In essence, they were concerned about the possibility of partial transfer—that a bank or a counterparty would be unable to get a clean, unqualified legal opinion that it could net-off for proper risk purposes. It would therefore have to account on a gross basis for the capital against credit risk. As I said, the Government recognise that concern, and I have cited paragraph 2.4 of the consultation paper.
Clause 43 provides for orders to be created to provide protection. I understand that the secondary legislation structure has evolved in recent months and days. Originally, there would have been a safeguard to ensure that netting assessments could occur for qualifying financial contracts. That proposal was contained in the special resolution regime consultation, but it did not get a particularly favourable response from the industry.
The next proposal was put to the expert liaison group, which met on 31 October. It was that the safeguards would be based on industry master netting agreements. The difficulty with that, identified by the expert liaison group, was distinguishing between an amended industry standard and a bespoke agreement, as a result of which there would be a degree of uncertainty and a potential for evasion.
As the Government propose again to use secondary legislation, all contracts that contain any kind of netting provision will benefit from protection, subject to specific carve-outs. The carve-outs are crucial. The level of protection will depend upon them. Broadly, they will consist of the following. First, it deals with contracts governed by foreign law. I can tell the Minister that paragraph 2.11 of the consultation paper contains an erroneous “not” in the first line—either that or I misunderstand it. It covers contracts governed by foreign laws, which is why clause 36 is significant. We request clarification on contracts governed by foreign law, and what foreign property means.
The second carve-out is debt securities issued by the failed bank. The third is claims that are crucial to the preservation of banking security. It is clear from the draft order that it would include retail deposits, mortgages and other loans, and liabilities other than financial securities in the ordinary course of business.
The final carve-out deals with liabilities that constitute some or all of the counterparty’s claims against the bank, which seems reasonably uncontentious, given that it would favour the counterparty. However, paragraph 2.15 states:
“The Government will also consider adding other carve-outs that may be necessary to ensure sufficient flexibility, while still delivering sufficient certainty to the market. Consultation responses on this point are being sought.”
Hon. Members have noted that great uncertainty remains about how that will work. The structure for providing protection depends on what the carve-outs are, and if they are too broad, or if we do not know what they will be, it will be very difficult for us to assess whether the level of protection provided is sufficient. That remains a concern.
In paragraph 2.16, the Government state that their
“clear intention is to protect contracts relevant for regulatory capital purposes from the threat of disruption under a partial transfer. Therefore this consideration will outweigh any of the carve-outs listed above.”
Clearly, that is designed to provide some comfort and help to the banking industry, which is to be welcomed, but we have two concerns. First, that wording is not contained in the secondary legislation, as far as I can see. Although it is helpful to see it in the consultation paper, it is not replicated in the draft order. Will the Minister explain why?
Secondly—this point has been raised by the BBA—there is a risk of circularity. Under certain circumstances, it is a precondition for netting arrangements to be recognised in the regulatory capital calculations. That would be legally enforceable. If legal enforceability depends on whether an arrangement is recognised for capital purposes, we find ourselves in a circular position. That is not say that the thinking behind paragraph 2.16 is not welcome, but given the circumstances it might raise, we should not be too complacent in making arguments about the carve-outs and saying, “It doesn’t really matter, because as long as we have paragraph 2.16 it is fine.” There might be an issue of circularity.
To be fair, this point is in the consultation paper, but I would be grateful if the Minister could clarify that it is not the Government’s intention that only contracts for regulatory capital protection purposes will be protected. We should pursue providing protection to all contracts containing netting provisions without a carve-out. That might provide the greatest certainty. That is discussed in paragraph 2.25, which says:
“the Government believes that such an approach...would be too restrictive”,
and essentially would mean that a
“partial transfer could only be executed solely on the basis of transferring property ‘counterparty by counterparty’.”
It would help the Committee if the Minister could explain how the issue of netting and set-offs was addressed with regards to Bradford & Bingley, Kaupthing and Heritable. Was it done on a “counterparty by counterparty” basis? What does the Banking (Special Provisions) Act 2008 allow for?
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