Mr. Hands: The hon. Gentleman raises some interesting questions. I think that it is a mixture of all of those. The Financial Secretary told us earlier that those products will be extremely complexI think she described them as uncharted territory. I am suggesting that the UK, as a sovereign issuer of debt, should be extremely careful before getting into that uncharted territory. Secondly, I do not believe that the Islamic or Muslim communities in this country would be the real winners in this or that those lobbying for it have been purely from those communities. Among the biggest lobbyists for such issuance have been the banks, and I believe that that is because the products will be very complex, as the Financial Secretary has already agreed. The big winners from this kind of issuance are likely to be my former colleagues who work in activities related to the Government debt market and in structured derivatives.
Mr. Todd: The issue of the regulation of those products will be pursued separately, because that would be an obligation on the Financial Services Authority. We are debating the mere availability of products of this kind within the UK. I leave it to the Financial Secretary to respond, but I assume that, were they to be available, they would be regulated in the normal way so as to protect against any damage to the reputations of both the investors and the wider financial community. The hon. Gentleman, however, may have other assumptions.
Mr. Hands: The hon. Gentleman makes a very good point, but history shows that it is extremely difficult to regulate structured note markets, partly because they are so lacking in transparency. It is difficult to price that kind of thing. Often a structured note could only be priced by three people in the world: the person at JP Morgan, the person at Morgan Stanley, and the person at the Union Bank of Switzerland. I have not been able to study the precise structure of sharia-compliant instruments, but, in my view, there is an extreme risk, because the banks are likely to be taking a large amount of money out of those products. Let me take you back to the example in the 90s of the federal home loan bank system, Mr. Cook.
Stewart Hosie (Dundee, East) (SNP): Does the hon. Gentleman agree that the vagueness of the regulations and the schedule associated with them allow very few people, and yet almost anybody, to be involved? The
Mr. Hands: Absolutely. The hon. Gentleman makes a powerful point about some of the dangers. As he rightly pointed out, both the clause and the schedule are extremely vague. It sounds like the sort of company that might be set up under the regulations would not be dissimilar to a special-purpose vehicle, the like of which has been in the news a lot in the past year. Such a vehicle could issue things like collateralised debt obligations or collateralised mortgage obligations, a large number of assets are parked into a vehicle and the ensuing cash flow out of the other side is what the investor gets. To my mind, there are a lot of similarities between the two products.
With the federal home loan banks issuance in the 1990s, there would typically be a small issuancewhich I think we are likely to be talking about with these sukuk bondsof, say, $25 million in principal. I clearly recall being on the trading floor when one of those $25 million structured notes was issued. The bank in question, which I worked for, was proud of itself for having taken a million dollars out of the transaction. That was, and still is, a very lucrative part of finance, and the bank did incredibly well.
Finance profits from complexity, especially from instruments of extreme complexity, where the number of people who can price them can be counted on one hand. Who were the losers in that? After the ensuing swap transaction, the federal home loan banks ended up with sub-liable fundingquite nice fundingof probably liable minus 25, which was very attractive compared with the plain vanilla bond that the federal home loan banks could have issued. The real loser was, of course, the investor.
If the investor had been in a position the next day to put a call in and seek evaluation of that bond independentlyregrettably, for the bank concerned, years later that happenedthey would have been surprised to find that the valuation the next day, even before the bond had settled, was only 96 instead of their principal of 100, because the bank had taken 4 per cent. out of the transaction. I think that that is the kind of thing that we have to be extremely careful of with structured notes. We may say buyer bewarewhoever bought that bond should have been awarebut here we are talking about the issuer being the United Kingdom Government, which is where my major concerns come in as a politician rather than as a banker.
We face a reputational risk if we are the issuer of this kind of financial instrument. Sukuk bonds are fine in principle and we want to encourage Islamic finance. As I mentioned earlier, the Government should have an interest in combining matching investors with issuers. Nevertheless, if it would lead to reputational risk for the United Kingdom Government as the issuer of the securities, we need to debate this more clearly. Bear in mind, sometime afterwards the investment bank, or whatever it is that sold the security in the first place, will have long disappeared, but the name left on the piece of paperthat sukuk bondwill be the United Kingdom Government.
It is worth pointing out that there are not that many triple-A sovereign borrowers left: the United Kingdom, Germany, France and, despite the problems in the 90s that I described, the United States, are all triple-A sovereign borrowers. It is not impossible for a sovereign borrower to be downgraded. Fifteen years ago it would have been inconceivable that Japan could be rated anything lower than triple-A, but it is now a double-A minus rated sovereign issuer.
Mr. Brooks Newmark (Braintree) (Con): I have listened to my hon. Friend and it has been hugely instructive, but his examples were, in many cases, assets that were sub-prime, so the underlying assets were at risk and the Government were effectively layering their triple-A security on top of sub-prime assets. What I am not clear about in what the Government are doing and where their argument is going is in respect of where the risk lies with the underlying assets such as with the Federal Homes AssociationFannie Mae, Freddie Mac and so onand as we have seen recently in the sub-prime market.
Mr. Hands: The answer is twofold. First, at least according to the Bill and the two clauses with the schedule, it is impossible to know. It sounds like property might be implied. It says it includes land, but it is not any clearer than that. It sounds to me as though almost anything could be put into that vehicle. The bigger risk, in my view, is that the investor will end up with a pretty raw deal because the bank is highly likely to take out a large amount of money in the middle and we could end up with investors who are very angry with the UK Government, which is something we ought not enter into lightly.
Traditionally, sovereign issuers such as the UK and the Debt Management Office, have been very conservative borrowers. There is a good reason for that. Reputational risk is extremely important in the markets, especially with an issuer like the UK Government, who are about to start issuing rather a lot more gilts and other instruments than in the past. It is vital that we preserve their reputation. The reputation of the UK Government as an issuer in the sovereign bond market is likely to be at risk if we go down the road of issuing structured notes in general and sukuk bonds in particular. The clauses in the schedule in front of us allow us as a Government not only to issue sukuk, but to issue pretty much anything, so long as it does not pay a coupon and does not pay interest. It may even be collateralised on sub-prime assets, which was another point made. I think we should pause, debate what we are looking at here and be careful that what we are getting into is in the best interests of the United Kingdom.
Kitty Ussher: I found that extremely interesting and I defer to the hon. Gentlemans expertise. I was for some years a country-risk analyst and sovereign-debt analyst for the Economist Intelligence Unit, so I am very aware of mistakes that Governments can make across the world and I can assure him that it is not our intention to do anything remotely similar to the examples he gave. We have not decided whether to issue a sovereign sukuk, we will only do so if we think it is in the overall interests of the UK, including value for money for the UK
Mr. Jeremy Browne (Taunton) (LD): During the speech by the hon. Member for Hammersmith and Fulham, the Minister intervened to ask what he meant by the Government having a political motivation, which he then clarified. Is there a political motivation in what the Government are seeking to do in this field? Do they see potential diplomatic or cultural benefits from going down this path?
Kitty Ussher: No, not necessarily, and that is not the reason we are doing it. I was going to come on to our motivation, because it is important. There are two motivations, one more important than the other. The first and most important is that entering these uncharted waters, as I happily said previously, will enshrine the City of London as an international centre of expertise in issuing sukuk, both sovereign and corporate.
Mr. Hands: Does the hon. Lady at least concede that the question of whether the City of London takes a lead on Islamic finance is a different question from that of the UK Government as an issuer of sukuk bonds?
Kitty Ussher: Of course, and it is because the City of London already has a comparative advantage in this area and because deals originating from all over the world are being done through London in this area in the entirely private sector that we wish to give a fillip to that, to the greatest extent that we can, by making the very clear PR and economic point that this is something that the UK Government recognise as important. We want to send out a marker that we wish it to continue.
There is also an extremely important point here about the learning curve that we are rightly being forced to climb to see whether this is in the national interest. We are uncovering little issues here and there around the tax and regulation system that affect not only a potential UK sovereign issuance, but also the corporate issuances that routinely take place. We feel that by working with the industry to address each of these issues as they arise, we will create a more conducive atmosphere for entirely private sector activity that leads to more jobs and greater prosperity in the City of London.
Mr. Hands: The Minister mentioned that she was an analyst of sovereign risk, so perhaps she might think back to the origins of most of the important markets in London at the moment, such as the euro bond market. All those are now centred in London and do extremely well. In none of those cases was the UK Government the very first issuer of a new product. Surely, she must see that we can easily separate the future of the City of London from the role of HMG as a borrower.
Kitty Ussher: Of course, an enormous number of things happen in the City of London that have not been done by Government, and we welcome that. But there are other examples of innovative practices that have started off in the public sector, such as methods of trading, for example, IT systems. The point I would
Mr. Hands: I thank the Minister again for giving way. She is being generous. Surely she must see that it will not enhance the Citys reputation at all if the bond issuance goes wrong and investors end up out of pocket because the banks have taken too much out of it. If investors have instruments priced at 98 or 99p in the pound the next day, that is likely to do great damage to the reputation of the City of London and that of the Government.
Kitty Ussher: By definition, if a policy goes wrong, it is not a good thing for the Government who have proposed that policy. That is why we have not made a final decision. We will only do this if it is in the broad interests of the British economy and the taxpayer and demonstrates sufficient value for money. If we feel that, once launched, a sovereign sukuk would not be able to attract a return that was in our interest, we would not proceed. We have not got to that point yet, and we need to get as far as we can before making that final judgment. I have an enormous number of points to deal with, and would like to make progress.
I said that there were two main motivations for proceeding in this way, and that the first and main motivation was the boost we felt it would give to jobs and prosperity in the City of London. The secondary motivation is that we feel it may indirectly help the development of Islamic retail productsfor example, sharia-compliant high street savings accountsif the outlet on the high street were able easily to invest in sharia-compliant Treasury bills, therefore ensuring that the entire investment chain is sharia compliant.
That would be an indirect effect, based only on anecdotal evidence, but it fits with our broader policy objective of ensuring that nobody in this country should be denied access to conventional financial productssavings, insurance and so onsimply because of their faith. It is about having a level playing field for the relatively small number of people who currently feel excluded because of their faith, which is by no means all Muslims, it is important to say. I hope that that answers the hon. Member for Tauntons question. It is not our intention to attract a different class of investor, oralthough there may be spin-off effectsto curry favour with a certain sector of society or certain countries around the world. We have two aims and the first and most important is economic, for the City of London.
On the time scale, as the hon. Member for Fareham made clear, we published on 2 June the response to a consultation which did not include a final decision on whether to proceed. There are a number of issues that have not yet been resolved and some of the questions raised today involve issues that have not yet been resolved,
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