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?
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 Governments
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 peoples 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 Governments 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 Governments 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 Governments 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 Governments 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 decades 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 Governments 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
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 questionand this should be a separate questionis 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 Governments 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 worlds 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 Majestys 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 UKs reputation as a borrower in the market, which is absolutely vital, especially at a time when our volume of issuanceour volume of borrowingis going up all the time. The reputational
While the Government have taken on the role of providing sharia-compliant investments, the UKs 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 wrongnot, 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 moneytax proceedson 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 taxpayernot just the pure cost but the damage to Belgiums 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 ones reputation as a borrower if one is careless, if not slightly cavalier, in ones 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; secondlytongue in cheekthe 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 Belgiums 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
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 GovernmentFannie Mae, Freddie Mac, the federal home loan bank systemwhich 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 dollarsall 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 instrumentthe investment banksthat 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
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. Gentlemans 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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