Sir
Peter Viggers: This clause gives the Treasury the power by
regulation to make provision for raising money. Does my hon. Friend
know how much further opportunity for debate there would be in the
House of Commons, if the Treasury decided to take up the right to make
regulations? How would the regulations be debated? Would they have to
come before the House, or could the Treasury make them without further
reference to the
House? 11.30
am
Mr.
Hoban: I understand that, through either the affirmative
or the negative procedure, there will be an opportunity for the
regulations to be debated in the House. Of course, that process
includes a restriction, as the regulations are not amendable. As this
brief debate on clause 151 indicates, there are important issues to be
resolved, and different commentators have different views about the
applicability of the rules and how they would work in practice. We
would be prevented through either the affirmative or the negative
procedure from tabling amendments to flush out the Government’s
thinking, or to amend the regulations. In an area where there is so much
uncertainty and complexity, primary legislation is far better that
secondary
legislation. An
issue I sought to raise with the Exchequer Secretary, and which came
out of the consultation paper, was the cost of the bills to the
taxpayer. With conventional products, if there is a big bill issuance
programme, the liquidity of markets and people’s familiarity
with those products help to reduce their price. However, unless there
is a sufficiently large issuance of sukuk bills, there is unlikely to
be sufficient liquidity in the market, thus the cost will increase.
Government recognise that on page 23 of their response, but they take
the view that the price differential would be short-lived. What
assessment have they made of the scale of issuance required to bring
the price of a sukuk bill in line with that of a conventional one? Will
the Exchequer Secretary elaborate on the Government’s comments
on the impact of a sukuk product on the conventional bill market? The
Government suggest that the cost of that programme would build up to
about £2 billion. Does the Exchequer Secretary think that that
will reduce the attractiveness of the conventional bill issuance
programme, and impair the liquidity of those
markets? I
mentioned earlier, in the context of the asset that would underpin the
sukuk bill, that there would be a special purpose vehicle, which would
issue the bonds and hold the lease to the asset. The consultation paper
rightly highlights the issue of who owns that vehicle. That goes back
to the comment by my hon. Friend the Member for Runnymede and Weybridge
that the shareholder would ordinarily bear the risk. There is a
difficult interaction. Traditionally, shareholders bear the risk in
that situation, but under sharia law, holders of sukuk bonds need to
share that risk if the bond is to comply with sharia law. If the bond
holders bear the risk, they expect a higher return, which would make
the sukuk product more expensive for taxpayers than a conventional
bill. That gives rise to a challenge, because we could find ourselves
meeting the demand for sukuk products from retail and wholesale
markets, ending up with a bill issuance programme that incurs
additional costs for the taxpayer, because the rate of return is higher
to reflect the higher degree of risk faced by the sukuk bond
holder.
Mr.
Hammond: My hon. Friend has studied the
Government’s response carefully. Is it clear that the motive for
the programme is debt management? Is it clear that the Government will
proceed only if they can reduce the overall average cost of debt, or is
there some other motive that suggests that the Government might issue
the bills even if the cost is higher than that of conventional
finance?
Mr.
Hoban: My understanding of the Government’s
response is that it is clearly their intention to ensure that the cost
of the sukuk bills is in line with that of conventional ones. It is
important for the Committee to understand how the Government intend to
get there, given the size of the bill issuance programme that they are
contemplating, and the need to ensure that the bills are compliant with
sharia law, which means that holders must participate in some of the
risk. There is a different level of risk for people who invest in an
asset and those invest in a sovereign issue, so I am keen to hear from
the Minister on that subject. These are important issues.
Another risk
arising from bills issued by the Government, as opposed to those issued
by others, is that, at the moment, a Government-backed bill attracts a
low-risk rating in terms of the capital resources required by a bank. I
expect that the Government intend to ensure that the risk attached to
sukuk bills is sufficiently low that any bank holding them is not
required to hold additional capital. That creates another tension,
because if these are meant to be risk-sharing bills to satisfy sharia
law, they must therefore have a higher risk than sovereign-issued
bills, and carry a greater capital requirement. I hope the Minister
understands that tension and will respond to it in her
remarks. An
earlier clause dealt with the way in which rules governing stamp duty
were being used by companies to avoid paying that duty. As I
understand section K of the consultation document, we are in danger of
imposing a double stamp duty. Stamp duty will be paid on the
acquisition of the asset underlying the lease, and when the lease is
sold back to the Government, there will be a further stamp duty charge.
That, too, will add to the cost of the measure. Will the Minister
clarify the Government’s thinking? Are they content with a
double hit for stamp duty, or are they seeking to create a situation
whereby Government-backed transactions avoid that double charge? If
they can avoid such a charge, does that leave a window open for others
to exploit?
I am
conscious that I have spoken at some length on an enabling clause, but
I think it is an important topic for the Committee to debate. It raises
some challenging issues about the cost to the taxpayer of issuance of
this nature; about how it will be structured to minimise additional
capital requirements placed on banks seeking to hold these issues; and
about how we structure the measures correctly so that the right type of
assets are included in the underlying lease. It is important to raise
these issues now, when the Government are contemplating this as a
matter of principle, rather than simply waiting until the introduction
of secondary legislation, when we will get into the detail and the
mechanics of the
measure.
Mr.
Hands: May I echo many of the concerns raised by my hon.
Friend the Member for Fareham and develop some of his arguments? I
totally agree with his points about the complexity of the issuance, the
potential cost to the taxpayer, and the question of what may, or may
not, happen to the non-sterling proceeds of the issuance. With your
permission, Mr. Cook, I should like to speak at some length,
because I have almost a decade’s experience in Government bond
markets and related activities such as derivatives, structured notes
and so on, both in London and in New York.
I
want to illustrate some of the dangers that the Government may face by
providing some examples from past Government issuances of structured
notes. There are two things at work in the clause. The first is the
Government’s desire to encourage Islamic finance, which is
partly a political issue, but it partly a general and laudable
intention better to align investors and borrowers, which is part of the
well-functioning financial system of a proper financial
market.
Kitty
Ussher: I am sorry to interrupt the hon. Gentleman when he
is just getting into full flow. I look forward to the enlightenment he
will provide the Committee from
his expertise in this area, but I was just wondering why he said that a
desire to promote Islamic finance was a political
desire?
Mr.
Hands: I mean “political” not in a party
political sense, but purely in the sense that, almost by necessity,
what all Governments do is something political; it is an aspect of
public
policy. The
second question—and this should be a separate question—is
whether the Government should propose that they themselves act as an
issuer of a sharia-compliant security, which is effectively a
structured note. Traditionally, the United Kingdom, in common with most
other western G7 countries, has avoided becoming an issuer of this kind
of structured note and finance for reasons which, as I shall explain,
have absolutely nothing to do with sukuk or sharia law. I think we need
to have a genuine debate about that: it is not just about Islamic
finance, but whether the UK Government should become an issuer of
structured notes in general, and of sukuk in particular.
I shall
explain what a structured note issuer is in due course, but that is
what we are proposing in the vaguely worded schedule 46. Although the
Government’s intention is to legislate for sukuk issuance, the
rules as they stand would allow the issuance of almost anything, as
long as it did not have what the bond market calls a coupon, which is
an interest payment. Many dangers arise for the UK, not just
operationally, but for our standing as one of the world’s
best-reputation borrowers in the market.
Sukuk,
however we want to look at it, is a form of structured note issuance.
It might not belong to the structured notes that grew up in the 1980s
and 1990s, when coupons were linked to all kinds of exotic indices and
so on, but it is nevertheless structured in a way that determines that
those issues are highly unlikely to be liquid, or to be transparent in
their pricing. Structured notes are tailor-made bonds or other
securities tailor-made for the requirements of an investor, where the
cash flows are not typically the kind of liability sought by the
issuer. Clearly, Her Majesty’s Government and the Debt
Management Office would not normally like to have such a liability on
their cash flow. I am not an expert in the narrow, specialist field of
Islamic finance, but know rather a lot about structured note issuance.
It seems highly unlikely that the Debt Management Office would want to
keep the sukuk cash flow on the books, as that would lead, almost
inevitably, to a derivative transaction especially, as my hon. Friends
the Members for Fareham and for Runnymede and Weybridge have pointed
out, if the cash flow is denominated in another currency.
I urge the
Minister to provide information and explain whether she expects the
Debt Management Office to swap the proceeds. Typically, that would be
into some kind of sub-LIBOR funding, which would provide cheaper
financing for the Government in theory, but with a number of risks
attached, which I shall discuss. So far, the debate on sukuk has
focused largely on the needs of investors. I want to talk about the
UK’s reputation as a borrower in the market, which is absolutely
vital, especially at a time when our volume of issuance—our
volume of borrowing—is going up all the time. The reputational
risk to the UK could be considerable if we take the route that proposed
in clauses 151 and 152, and in schedule 46. 11.45
am While
the Government have taken on the role of providing sharia-compliant
investments, the UK’s interests as a sovereign borrower have
taken second place in the debate. Sovereign borrowers behave in
particular ways in the market. Generally, they behave in a conservative
manner, and with good reason: they have reputations and triple-A
ratings to preserve. Sometimes in the past they have got things
wrong—not, thankfully, in the United Kingdom, but I shall use as
an example the Kingdom of Belgium Ministry of Finance, which got into
awful trouble about 15 years about by entering into all kinds of
structured finance in which it really should not have become involved.
It bet a huge amount of taxpayers’ money—tax
proceeds—on further exchange rate mechanism convergence, at a
time when Belgium was already dependent on ERM convergence.
Essentially, it bet the bank on that, and the whole thing went
pear-shaped in 1992 and 1993 when the ERM blew apart.
There was an
enormous cost to the Belgian taxpayer—not just the pure cost but
the damage to Belgium’s reputation as a borrower. I am using
Belgium as an illustration, but the position is not exactly the same
for the UK, because it will probably swap the proceeds from the sukuk
issuance back into sub-LIBOR funding. However, a severely negative
impact on one’s reputation as a borrower if one is careless, if
not slightly cavalier, in one’s approach to the capital markets
could be very telling. The people who made all the money out of the
Belgian fiasco were not the Belgian taxpayers who were forced to foot
the bill, nor the Kingdom of Belgium Ministry of Finance, which was the
issuer, but the banks.
At the time,
there were investment bankers in London who, at the end of each year,
would calculate three figures: first, how much the Kingdom of Belgium
Ministry of Finance had lost that year in its structured finance
transactions; secondly—tongue in cheek—the cost that that
caused to the Belgian taxpayer; and thirdly, the likely impact on their
bonus for that year. I cannot remember the exact figures,
Mr. Cook, but they were astronomical. It was the Belgian
taxpayer who ended up footing the bill. The damage to Belgium continued
for some
time.
Mr.
Hammond: I am listening with fascination to the story my
hon. Friend is recounting. This is clearly in large part an issue of
scale. Can he indicate what proportion of the Kingdom of
Belgium’s debt is raised in this structured finance form? Will
he suggest that the Minister might like to tell us whether the
Government have any ideas about the proportion of sharia-compliant debt
that would be safe to have in the overall mix to prevent the problems
he is talking
about?
Mr.
Hands: On the second question, I am unable to provide an
answer. On the first question, it was not the Kingdom of Belgium that
issued structured notes or raised finance in that way. The Kingdom of
Belgium essentially betted the bank on off-balance sheet derivative
transactions that were structured in a not dissimilar way
to how the structured note market works, often with similarities to
sukuk, which I shall come on to later. I was using that as an example
to show how a sovereign borrower, not in this case in an example of
borrowing, could suffer a very negative impact to its reputation and
triple-A credit rating.
Another
example at the time, perhaps even more relevant in the issuance of
structured notes, was that of the US Government agencies. They were all
effectively part of the US Government—Fannie Mae, Freddie Mac,
the federal home loan bank system—which were all triple-A rated
and going directly into the issuance of structured notes. A lot of
these would have extremely exotic structures.
On the face
of it, the investor would get a triple-A rated US Government risk,
denominated in US dollars—all the same things that we are
talking about here today with regard to the sukuk issuance to a UK
domestic issuer. However, the coupon or payout on the bond would be
linked to an exotic index, quite often a currency exchange rate. It
might have been linked, for example, to the deutschmark-peseta exchange
rate. Essentially, the investor would be paid a very high coupon in
return for taking the risk on an exotic index. It might have been an
index of commodity prices, for example. It might have been oil-linked
bonds, which I think are going on today. My point is that structured
notes have been around for a long time. The sukuk, although having a
different motivation and philosophical basis, will have a similar
structure.
What happened
with the federal home loan bank issued bonds? They were all triple-A
rated, issued by a sovereign or quasi-sovereign entity into the
domestic market, denominated in US dollars. One could not imagine a
more perfect and easy investment for a US domestic investor.
Unfortunately, most of the bonds went wrong because the bet that was
inherent in the structuring of the bond ended up being wrong. A large
number of people in the United States in the early to mid-1990s thought
that they had a perfectly safe, triple-A-rated Government investment
that would pay a high coupon, but it ended up paying them almost
nothing. One might even see parallels with CDOs and CMOs in the US. One
could say, “So what? The investors should have been aware of
what they were getting into and instead followed a buyer beware
policy.”
My only point
is that in this case it was not the damage to the reputation of those
selling that kind of instrument—the investment banks—that
was particularly severe, but the damage to the reputation of the issuer
or borrower, which in that case was the federal home loan bank system,
also known as the US Government. That reached a particular height in
1995, when an investor called the US army facilities management fund
had been investing in a huge number of those securities, which were
issued by a separate part of the US Government. The bonds that were
issued ended up paying absolutely no coupon at all. The US army
facilities management fund was at that time a short-term money market
fund driven essentially by post-cold war base closures, and all that
those responsible for it had to do was park the proceeds into the money
markets until the end of the financial year. However, for reasons only
known to them and the investment bank advisers, they decided to bet the
proceeds of that on the market through structured note issuance
generally issued by the federal home loan
bank, which is a different part of the Government. When that reached the
front page of The Wall Street Journal, the real damage was done
not to the US army, but to the federal home loan bank system as an
issuer of those notes, and that greatly concerns
me. Mr.
Mark Todd (South Derbyshire) (Lab): This has been an
interesting discussion of an area of policy with which, I must admit, I
am not familiar, but I have still not found the relevance of the hon.
Gentleman’s points to the issue. Is he suggesting that there is
some risk that the British Government might use tools of this kind as a
means of raising funds? Some of his examples suggest that that is his
concern. Surely that is a matter of public policy, rather than a point
about the precise content of the Bill. Or is he concerned about the
damage to the reputation of the City and the availability of these
products generally? I am not clear what his argument
is.
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