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Session 2008 - 09
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Public Bill Committee Debates

The Committee consisted of the following Members:

Chairman: Mr. Roger Gale
Barlow, Ms Celia (Hove) (Lab)
Cable, Dr. Vincent (Twickenham) (LD)
Campbell, Mr. Ronnie (Blyth Valley) (Lab)
Dorrell, Mr. Stephen (Charnwood) (Con)
Duddridge, James (Rochford and Southend, East) (Con)
Griffiths, Nigel (Edinburgh, South) (Lab)
Hoban, Mr. Mark (Fareham) (Con)
Keeley, Barbara (Worsley) (Lab)
Kilfoyle, Mr. Peter (Liverpool, Walton) (Lab)
Lepper, David (Brighton, Pavilion) (Lab/Co-op)
McCafferty, Chris (Calder Valley) (Lab)
Main, Anne (St. Albans) (Con)
Pearson, Ian (Economic Secretary to the Treasury)
Pugh, Dr. John (Southport) (LD)
Redwood, Mr. John (Wokingham) (Con)
Smith, Mr. Andrew (Oxford, East) (Lab)
Rhiannon Hollis, Emma Berry, Committee Clerks
† attended the Committee

Fifth Delegated Legislation Committee

Tuesday 17 March 2009

[Mr. Roger Gale in the Chair]

Banking Act 2009 (Restriction of Partial Property Transfers) Order 2009
10 am
The Chairman: Before we start, I wish to make it plain that this is not an opportunity to debate the entire banking system, Kaupthing Singer and Friedlander, the Post Office bank or other related issues. We have an order and regulations, and I would be grateful if the Committee confined the debate to those two issues.
The Economic Secretary to the Treasury (Ian Pearson): I beg to move,
That the Committee has considered the Banking Act 2009 (Restriction of Partial Property Transfers) Order 2009 (S.I. 2009, No. 322).
The Chairman: With this it will be convenient to consider the Banking Act 2009 (Third Party Compensation Arrangements for Partial Property Transfers) Regulations 2009 (S.I. 2009, No. 319).
Ian Pearson: It is a pleasure to serve under your chairmanship this morning, Mr. Gale, to discuss the order and regulations. Members of the Committee who followed closely the passage of what is now the Banking Act 2009 will know that partial property transfers may be made under the special resolution regime provided for by the Act. Following close consultation with stakeholders, I believe that the statutory instruments that we are discussing today provide strong legislative safeguards for creditors and counterparties of United Kingdom banks in the event of a partial transfer. They deal with the concerns put to the authorities that partial property transfers could negatively affect creditors and counterparties’ rights and interests.
Mr. Peter Kilfoyle (Liverpool, Walton) (Lab): Will the Minister say who the stakeholders are, with whom he has had consultations? Are they the banks?
Ian Pearson: There is a range of bodies, such as banks, building societies, lawyers, representatives of the British Bankers Association and other key stakeholders in the financial community. I will explain about them later in more detail.
As I have said on many occasions and as stated during the consultation stages for the SRR and the parliamentary stages of the Act, the Treasury’s aim in providing the legislative safeguards has always been to avoid damaging, negative financial market consequences as a result of taking partial property transfer powers. That aim will be delivered by the instruments, which provide legal certainty to the market and an assurance that the Government would have to have regard to leaving creditors no worse off after a partial property transfer.
As well as running a full public consultation process with the publishing of a dedicated consultation document on 6 November 2008, the Treasury has worked extensively with industry stakeholders, particularly with the expert liaison group—which is being replaced by the statutory banking liaison panel—to reach an outcome that is acceptable to both the market and the authorities. As members of the Committee may be aware, during that process the Government listened to the concerns raised by hon. Members and others, and moved their policy significantly towards providing the market with greater legal certainty.
I shall now explain the safeguards order in more detail. It is made under sections 47 and 48 of the Act. In summary, it provides legislative protection against possible disruption under a partial property transfer for important risk management arrangements and other financial arrangements in use in the markets today. Those arrangements include set-off and netting arrangements, financial collateral arrangements and structured finance arrangements. Members of the Committee will be aware that the Government have provided broad protection for set-off and netting. The order provides that property included under a counterparties’ set-off and netting arrangement with a bank may not be split up under a partial transfer. The possibility of damaging cherry-picking of a counterparty’s relationship with a failing bank is therefore avoided, and the ability to obtain clean, legal opinions in relation to the effectiveness of set-off and netting should not be compromised.
However, to allow the authorities the necessary flexibility to carry out partial transfers in the interests of financial stability and depositor protection, the order features a number of carve-outs from the protection provided. The most notable of them is property belonging to the financial services compensation scheme eligible person, which is not covered by the set-off and netting safeguard. That particular carve-out from the set-off and netting safeguard will allow the authorities to transfer, for example, the retail deposit book of a failing institution to a solvent new company in a short time frame, which is important to allow the authorities to provide continuity of service and protect public confidence.
I now turn to an important point on the practical effect of the order. Property that is not covered by the set-off and netting safeguard is referred to as “excluded rights” or “excluded liabilities”. Under the order the authorities may, for example, choose to transfer only the excluded rights and liabilities, and leave the remaining rights and liabilities in place in the original entity, irrespective of any wider set-off and netting arrangement that the authorities would otherwise have needed to keep whole. However, it is not the Government’s policy intention that the presence of excluded rights or liabilities under a wider set-off and netting arrangement should render the entire arrangement unprotected by the order. I want to make it clear that, in the Government’s view, the drafting of the safeguards order does not yield this legal effect.
The Government have always made it clear that the safeguards will be subject to review and, as hon. Members will remember, the Banking Act provides for a banking liaison panel of financial services representatives to keep the ongoing effect of the existence of the special resolution regime under review. As part of the Government’s existing commitment to work in partnership with the industry in this vital area via the panel, I can announce that one of the first orders of business for the panel will be to review the safeguards order. If changes to the order are necessary, and compatible with the authorities’ flexibility, the Government will make such changes before the summer recess. I hope that that will reassure stakeholders on that point.
However, I should make it clear that although an initial review this summer is appropriate, and the panel will advise the Government on possible changes needed in the future, perhaps sparked by market innovation, it is not the Government’s intention continually to change the safeguards order. Any perception that the order is subject to constant change could itself damage the certainty that the order intends to bring to the market. Taking a little more time to review the order should allow a less hurried process for the Government and industry stakeholders to definitively iron out any outstanding concerns in the medium term.
Before I leave the subject of the banking panel, I would like to comment on the transparency of the Government’s consultation process, to pick up on a point made in the other place yesterday. To enable stakeholders who are not members of the banking liaison panel to stay abreast of the issues discussed and the progress made by the panel, the Government will aim to publish a narrative of how the responses to the 6 November consultation document fed into the orders before us today. Furthermore, we will ask the panel if it, as the expert liaison group did, will consent to the publication of its minutes. I should note that any material published will be consistent with the confidentiality that the panel may decide it needs to carry out its role effectively. The Government will, of course, continue to listen carefully to any representations made by stakeholders who are not represented by the panel.
I now turn to the next safeguard featured in the order. This safeguard protects financial collateral and other secured arrangements to which a bank is party. It provides that where either party has a security interest over an asset held by its counterparty, related to a liability owed by that counterparty, the asset must not be “split up” from the liability under a partial transfer. In this way, counterparties can continue to be confident that they will be able to have recourse to security that they have taken.
There is also a safeguard for financial arrangements broadly covered by the term “structured finance”. Those arrangements are referred to in the order as “capital markets arrangements” and refer to, for example, covered bonds and securitisation vehicles. The safeguard provides that partial property transfers may not interfere in the operation of such arrangements to which a bank is party by transferring some, but not all, of the relevant property, rights or liabilities.
Hon. Members may recall that, in the later stages of the debates on the Act, issues related to “events of default” and financial contracts were discussed, especially in the other place. The order provides certainty for counterparties that a partial property transfer will not prevent them from calling events of default in relation to specified financial instruments, or set-off, netting or title transfer financial collateral arrangements. The order also protects the operations of important central market counterparties, such as clearers and settlement houses, from possible disruption under a partial property transfer. For example, clearing house “default rules”, which are given legal force by part 7 of the Companies Act 2006, are given explicit protection.
I now turn to the “no creditor worse off” third party compensation arrangements regulations, which are made under section 60 of the Act. Their purpose is to ensure that, following a partial transfer, no creditor will be worse off than they would have been had the whole bank been put into an insolvency procedure. In summary, the regulations provide that, where certain stabilisation powers have been exercised under part 1 of the Banking Act, the compensation scheme order or resolution fund order must include a third party compensation order.
The compensation order must or may include certain provisions. For example, it must provide for the appointment of an independent valuer, and it must provide for the valuer to assess the treatment that the creditors of the failing bank, which was subject to a partial transfer, would have received had the whole failing bank been put into insolvency. The order must also provide for the valuer to assess the treatment that such creditors have received, are receiving or are likely to receive if no compensation—or further compensation—is paid. If the independent valuer determines that a creditor in such a situation has been made worse off than they would have been had the bank entered insolvency, he must consider the compensation to be paid to that creditor. In assessing the amount of any compensation, the valuer would be obliged to follow the principles specified in the regulations. Those include the principle that no financial assistance would have been provided to the bank by the Bank of England or the Treasury after the relevant time specified in the regulations.
I would like to take the opportunity to remind the Committee of the important protections that the order and regulations provide to the market. The legislation, formed in intensive consultation with the industry, meets the vast majority of the market’s concerns. The Government continue to be committed to working with the industry to ensure that the regime is as effective as possible. Indeed, I would like to thank our various stakeholders for their hard work on the subject up to this point. I commend the secondary legislation to the Committee.
10.12 am
Mr. Mark Hoban (Fareham) (Con): Thank you, Mr. Gale. It is a pleasure to serve again under your chairmanship this morning.
The two statutory instruments are important, as they form part of the architecture of the Banking Act 2009. They particularly focus on the powers that the Act gives the Bank of England and the Government to break up a bank as a means of rescuing it. The comfort that they provide is to send a signal to the financial services sector that the powers will not undermine the traditional rights of creditors, hence the safeguards in the order, S.I. No. 322. The regulations, S.I. No. 319, give the compensation arrangements when there is a partial transfer.
Let me deal with the safeguards order first. One of the fundamental parts of how the financial services sector operates in the UK is the ability for transactions between parties to be netted off against each other. So, rather than settling individual transactions at the end of a period, the net balance on the account is settled. That is obviously a cheaper process for the businesses involved but, because the netting-off process is legally enforceable and part of the standard transaction documentation, it also has an important regulatory consequence—the net rather than the gross position is used to calculate capital requirements. Using the gross position would increase the capital requirements to be held by various financial services businesses.
When the Banking Bill was first published, the Minister and I were quickly aware of the concern in the financial services sector that the partial transfer provisions potentially led to there being no legal certainty about the netting. As a consequence, that would have driven capital requirements to be put on a gross basis, making London a less attractive place to do business. The Minister referred to the consultation responses that he received to the document published in November. There are a couple of comments that I wanted to pick out from that. Citibank expressed a particular concern about this issue:
“A financial institution subject to Basel or Basel-type regulation can only net pre-settlement risk exposure with respect to a single counterparty for close-out purposes if the institution has sufficient certainty of its legal rights to enforce its contracts with the counterparty, even in insolvency.”
The statement is clear on the importance of legal certainty. It went on:
“If the Bill is adopted as proposed, we feel that UK banks seeking funding in the capital markets...would have an obligation to disclose in their offering documents that the government agencies have the statutory ability to transfer parts of the bank at any time that they have concerns about the solvency of the institution. This can be done without any compensation to creditors and introduces significant uncertainly”.
There was widespread concern in the marketplace about the impact of the measures. Indeed, the Government recognised that, and have made significant efforts to counteract that impression in the order—it is part of the safeguards put in place to protect financial institutions from the uncertainty that arises from the power to have partial transfers.
On the same point, there is concern regarding the definitions in article 1 of the order, where the instruments are excluded. It goes back to the issue regarding the use of the word “solely”. It is not often that people get excited about the use of that word, but some have done so regarding its use in the order, on page 2, in the second sub-paragraph (c). The concern is that where a netting-off arrangement includes a financial instrument that is not covered by MiFID, it renders the whole protection on netting off invalid. I understand that the word “solely” was inserted at a late stage in the drafting process, and there is some concern that that negates some protections that the Government are seeking to put in place. I would be grateful to the Minister if he could clarify the use of that word in his summing up: whether it is part of the review regarding how the order is drafted, which he indicated will take place in the summer, and whether there are any more improvements that can be made.
I also understand—it will be helpful if the Minister is able to confirm this—that where a financial instrument is excluded from the definition based on MiFID, and it falls within the context of financial collateral arrangements, those arrangements override the definition. One point that has been expressed is that such arrangements are not straightforward; they are expensive and inefficient, and add to the cost of doing business. If their use is simply to bring a netting arrangement within the scope of the order, then they are a sham, not a genuine transaction, and I think that we are reluctant to see people use sham transactions to come within the remit of the order.
The next issue that I want to raise is the treatment of foreign property. During the consultation process a number of people highlighted the way that the draft statutory instrument tackled the issue of foreign property. In its consultation response, LIBOR stated:
“The consequences of the inclusion of foreign property in nettable relationships still not do appear to have been fully thought through.”
There is a sense that although many of the netting arrangements will predominantly include transactions subject to UK law, there might be foreign property in there. Its concern was as a consequence of the original wording of the draft order, which said in article 2:
“This Order...does not apply to partial property transfer where the only property, rights or liabilities of a banking institution which are not transferred are foreign property”.
That was the phraseology that caused concern among consultees.
Under the revised order, the wording has been changed significantly:
“For the purposes of this Order, a property transfer instrument or order which purports to transfer all of the property, rights and liabilities of a banking institution shall be treated as having done so effectively...notwithstanding the possibility that any of the property, rights or liabilities are foreign property and may not have been effectively transferred by the property transfer instrument”.
A lot more comfort has been provided to market participants as a consequence of that revision of language. However, there remains some residual concern, especially about whether an overseas regulator would accept the ability of the Bank of England to make a transfer of an agreement to a bridge bank. If the overseas regulator accepts that the Bank of England can do that, netting can continue. If it does not, netting will cease, and that will have an impact on the amount of regulatory capital to be held. That will have a knock-on effect on the competitiveness of London. There is clearly uncertainty in the markets about whether the revision of the wording about foreign property has gone far enough to provide certainty.
The next issue is the use of the phrase “retail balances”, which the Minister touched on in his earlier remarks. This is an important carve-out from the legislation that would facilitate a bank rescue where the retail accounts could be moved to another provider. That is effectively what happened in the rescue of Bradford and Bingley.
Although we typically think of the financial services compensation scheme as protecting individual consumers, it also protects some small businesses. The concern was that the carve-out mentioned by the Minister in connection with the FSCS would inadvertently capture small businesses, which could put at risk some of the netting arrangements that take place between small companies and their banks. A concern has been raised that the FSA might look at the inclusion of that carve-out and think that banks should look at their relationship with small business customers on a gross, rather than net, basis. That could potentially lead to an increase in the capital requirements that they have to hold. It would be helpful if the Minister clarified that.
My final point on this statutory instrument is that raised by the Minister about process. As he said, there has been a significant consultation exercise—108 pages of consultation responses raising a significant range of issues have been received by the Treasury. It is clear from reading the draft order that the Government have listened to those responses. However, their thought processes in responding to those comments—those that they decided to take on board and those that they ignored—are not transparent.
The Minister referred to the banking liaison panel that will succeed the expert liaison group established to look at the Bill. I welcome his announcement that there will be increased transparency surrounding the panel’s work, because it is important for people who are not part of the process to see how the Government have responded to the issues raised in the consultation and to understand how the responses have shaped the final legislation. Restricting the debate and that information to a small group would work against the principle of transparency, which we are keen to see and which would give confidence to people about how the Banking Act, the related secondary legislation and the code of practice will work.
The secondary statutory instrument, No. 319—the “no creditor worse off” measure—puts in place an important safeguard for creditors. As the Minister said, at the heart of the statutory instrument is provision for the valuer needing to look at the position of the pre-transfer creditors, comparing their actual treatment with the treatment that they would have received had an insolvency procedure been used. I have a couple of brief comments about that, and would like some clarification from the Minister.
On the insolvency procedure, there are two options, which could lead to very different outcomes for creditors. In administration, there is an orderly wind-down—of a bank or any other organisation—and the potential for a sale. That orderly wind-down could give a very different outcome for creditors in comparison with, say, a fire sale, in which there would be a forced sale of assets and the vendor would accept a lower price simply to close the business down quickly.
As I understand it, the third party compensation order will establish which route is taken. However, what factors will the Treasury bear in mind when deciding which route to use, whether administration or liquidation? Will Ministers opt for a route that maximises the benefit to the creditors or one that minimises the cost to the taxpayer? What safeguards are there to ensure that the route chosen would be a fair one and reflect the likely outcome if the bank had gone into one of the insolvency procedures?
The statutory instrument makes it clear that the independent valuer would be appointed under the order, but who will appoint the valuer? Consultation documents said that, although the Government would pay for the valuer, they would not be directly responsible for appointing someone, so who would choose the valuer? What consultation would there be with major creditors, for example, before a valuer was appointed? Such points are relatively detailed, but it is important to make sure that we get them right, and to give clarity about when third party compensation orders will be used.
In conclusion, I was reassured by the Minister’s earlier remarks about the banking liaison panel looking at the safeguard order as one of its first priorities when it next meets. I also took on board his comment that we do not want to create a sense of uncertainty, with the statutory instrument being changed regularly—the Minister and I spend enough time debating statutory instruments without wanting to add to our load. Equally, there needs to be a clear sense that the statutory instrument and the safeguards in place reflect the reality of how markets in London operate and that they are broad and inclusive, rather than narrowly defined. That broad and inclusive approach would add to the confidence that people feel in how the Banking Act will apply in practice.
10.29 am
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