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Public Bill Committee Debates

Draft Banking Act 2009 (Restriction of Partial Property Transfers) (Amendment) Order 2009

The Committee consisted of the following Members:

Chairman: Mrs. Joan Humble
Binley, Mr. Brian (Northampton, South) (Con)
Breed, Mr. Colin (South-East Cornwall) (LD)
Cable, Dr. Vincent (Twickenham) (LD)
Coffey, Ann (Stockport) (Lab)
Duddridge, James (Rochford and Southend, East) (Con)
Fallon, Mr. Michael (Sevenoaks) (Con)
Fisher, Mark (Stoke-on-Trent, Central) (Lab)
George, Mr. Bruce (Walsall, South) (Lab)
Hoban, Mr. Mark (Fareham) (Con)
Kawczynski, Daniel (Shrewsbury and Atcham) (Con)
McCarthy-Fry, Sarah (Exchequer Secretary to the Treasury)
McGuire, Mrs. Anne (Stirling) (Lab)
Milburn, Mr. Alan (Darlington) (Lab)
Mudie, Mr. George (Leeds, East) (Lab)
Seabeck, Alison (Plymouth, Devonport) (Lab)
Turner, Dr. Desmond (Brighton, Kemptown) (Lab)
Chris Stanton, Committee Clerk
† attended the Committee

Seventh Delegated Legislation Committee

Monday 6 July 2009

[Mrs. Joan Humble in the Chair]

Draft Banking Act 2009 (Restriction of Partial Property Transfers) (Amendment) Order 2009

4.30 pm
The Exchequer Secretary to the Treasury (Sarah McCarthy-Fry): I beg to move,
That the Committee has considered the draft Banking Act 2009 (Restriction of Partial Property Transfers) (Amendment) Order 2009.
It is a delight to serve under your chairmanship once more, Mrs. Humble. It seems but moments ago that we debated the Apprenticeships, Skills, Children and Learning Bill also under your chairmanship.
Partial property transfers are an essential part of the authorities’ toolkit, under the Banking Act 2009, for resolving failing institutions. However, the Government have recognised that unless proper safeguards are in place, partial transfers have the potential to disrupt the contractual interest of counterparties and creditors of UK banks. To this end, when the 2009 Act was passed, in February 2009, the Government set out safeguards in secondary legislation designed to protect contracts relevant for regulatory capital purposes. When the safeguards were put in place, Ministers committed to continue to review the order to establish whether more amendments would be needed to enhance further the legal certainty that they provide.
To that end, the Government have engaged constructively with the banking liaison panel and, in particular, its sub-group on safeguards, and the Government have drawn heavily on the BLP’s advice in drawing up the draft order. The amendments build on the protections already in place and will help to ensure legal certainty for the parties involved in a partial transfer. In its advice to the Treasury, the BLP’s safeguards sub-group made five recommendations, which the Government have studied carefully. On four of them we have been able to respond positively, and the results are reflected in the draft order.
I shall explain why we have not taken on board the fifth recommendation. Hon. Members who took part in the debates on the 2006 Act will recall the set-off and netting safeguard, which is designed to ensure that a bank’s set-off and netting arrangements are protected in the event of a partial transfer. Hon. Members will also recall that deposits covered by the Financial Services Compensation Scheme are exempt from set-off and netting protection. That carve out from the set-off and netting safeguard has a number of benefits. For example, it allows the authorities to transfer the retail deposit book of a failing institution to a solvent new institution in a short time frame. That is important to allow the authorities to provide continuity of service to depositors and to protect public confidence. Small companies are included in the definition of FSCS-protected deposits, and so their set-off and netting arrangements are not protected.
Mr. Mark Hoban (Fareham) (Con): If a small company is part of a larger group, does it fall within the retail category for the FSCS?
Sarah McCarthy-Fry: No, but I shall come on to that. The fifth recommendation by the BLP was to extend set-off and netting protection to smaller companies that are part of larger groups.
Mr. Hoban rose—
Sarah McCarthy-Fry: Did I misunderstand the question?
Mr. Hoban: The Minister did, I am afraid. I asked whether a small company that is part of a larger group is protected under the FSCS as a retail depositor.
Sarah McCarthy-Fry: Yes it is.
The BLP sub-group on safeguards discussed and proposed a particular way in which we could extend the set-off and netting protection to small companies that are part of larger groups. It suggested that protection could be provided where banks had placed an identifier on set-off and netting arrangements with small companies that are part of larger groups. Under its proposal, if such identifiers existed, the authorities would have to protect the arrangements. However, the authorities are not confident that an amendment to the safeguards order along those lines would be workable. Furthermore, market participants themselves were not completely confident that such identifiers could be delivered. The Government propose, therefore, that the BLP should continue to work on the matter over the next year, and the aim will be to establish in the safeguards order a way of dealing with small companies that are part of larger groups. Any proposal must address industry concerns, while ensuring that authorities can resolve a failing bank or building society effectively. The Government will continue to discuss with the panel how we can make progress on that issue.
On the substantive provisions, the original order set out transactions that fall under the protection of the safeguards. The amendments ensure that the order covers the full range of transaction types that can be included in set-off or netting arrangements. That was a matter of concern, following the laying of the safeguards order. The Economic Secretary to the Treasury told the House that the BLP would consider the definition of relevant financial instruments in the order. The amendment is the result of that consultation.
We are all aware that the field of activity in question is complex and evolving, but we are confident that the definition of a relevant financial instrument set out in the amendments is comprehensive, and future-proofed as far as possible. Our feedback from industry is that it is content with the new drafting.
The amendments also clarify the legal intention that the inclusion of any excluded right or liability, under a set-off and netting arrangement, does not exclude the entire arrangement from protection under the safeguards order. That is the so-called bad apple problem, arising from the presence of the word “solely” in the original order. Ministers have given assurances that the words “relates solely to” are intended to prevent market participants from wrapping up service contracts with financial contracts, thereby gaining the protection of the order for their service contracts.
However, there is a difference in legal interpretation about the effect of the drafting. Some industry participants took a quite different view of the effect and felt that the drafting was such that the inclusion of any excluded right or liability under a set-off and netting arrangement would exclude the entire arrangement from the order’s protection. That was never the Government’s policy intention, and in the Government’s view the drafting of the safeguarding order did not have that legal effect. However, as there are differing legal views about it, the Government have responded to the concerns and removed the word “solely”. Our feedback from industry is that it is happy with the result.
There is also an amendment relating to section 34(7) of the 2009 Act which deals with trusts. The section established that, where a property transfer instrument makes provision about property held on trust, it may also make provision about the terms on which the property is to be held. A property transfer order may also make provision about how any powers, provisions or liabilities are to be exercised after the transfer. The purpose of the section is to ensure that a property transfer can provide certainty of outcome, and speed of execution, in relation to property held on trust.
The BLP was concerned that section 34(7) meant that trust arrangements for any bond held by a failing bank or building society could be modified or terminated irrespective of the consequences for the transaction, bondholders or other interested parties. A partial property transfer can indeed remove or alter the terms of a trust, but the amendment makes it clear that it can do so only to the extent necessary or expedient to transfer the trust property to the transferee. That includes the legal or beneficial interest in the trust or any powers, rights or obligations of the banking institution in the trust property. Section 34(7) cannot be used to remove or alter the terms of the trust for any other purpose.
The authorities can, of course, make different provision for different cases and circumstances, and the new drafting does not prevent the authorities from making different provision for different trusts. However, the authorities cannot remove or alter the terms of a trust to cherry-pick parts of the banking institution’s legal or beneficial interests or powers, rights or obligations, and the new drafting does not give rise to doubt about that point.
Finally, the order excludes from set-off and netting protection all publicly tradeable securities that are not referred to or described in a netting or set-off arrangement. At the same time, it retains protection for securities that parties expressly rely on for netting purposes, or that are referred to or described in such an arrangement. The benefit of that is legal certainty for all parties involved in a partial transfer. The authorities will be able to transfer all the securities that parties believe should be transferred, while avoiding the risk of inadvertently breaching the safeguards in doing so.
The amendments meet the vast majority of the market’s concerns, and demonstrate that the Government are committed to working with the industry to ensure that the regime is as effective as possible. The Government want to thank the BLP and in particular its sub-group on safeguards for its hard work and thorough advice.
4.39 pm
Mr. Hoban: It is a pleasure to serve under your chairmanship, Mrs. Humble. I think that only the hon. Member for South-East Cornwall and I are veterans of the Banking Act 2009, the debate that we had during its passage and the numerous statutory instruments that have flown from it over the past few months.
Back in February, we debated the order that we are amending today. It is worth putting on record why this statutory instrument and the one that it amends are so important. When the Banking Bill was first published, a concern arose that it appeared to give the tripartite authority the right to disrupt the traditional arrangements in the market that enable banks and other counterparties to net off their assets and liabilities for transactions with others in the market.
The Minister touched briefly on why the matter is so important: it is about regulatory capital. If transactions between two counterparties can be netted off, the amount of regulatory capital that an institution must hold is significantly less. When I spoke to some financial institutions during the debate on the Banking Bill, they pointed out how important it was that the issue should be properly resolved and the right safeguards put in place, as doubt about whether they had to account for the transactions on a gross basis made London a significantly less attractive place to do business. It is right to have safeguards. It is part of the architecture surrounding the Banking Bill; the right to disrupt those relationships was set out in primary legislation, and the protection comes in the secondary legislation.
I remember debating the word “solely” in the Committee that considered the order that we are amending. The then Minister said, “Well, we don’t think it makes any difference, but okay, we’ll amend it just to keep you happy.” What is demonstrated is the level of interest and concern about getting the arrangements absolutely right and precise, so that there can be no doubt, when looking at such transactions, whether netting off applies.
The banking liaison panel was set up under section 10 of the 2009 Act to give the Government advice on how the measures could work in practice, as well as to reflect the fact that changes in market practice might require the statutory instruments to be updated from time to time. As the Minister said, the statutory instrument before us is a product of the panel’s safeguards sub-committee. Anyone who has taken the trouble to read its advice to the Treasury, published on 17 June 2009, will see that it has done its job, and addressed the issues, thoroughly. The first item that it raised was the small companies carve-out, to which she referred. The panel has clearly put a great deal of thought and effort into the advice. There are four and a half pages of detailed analysis explaining why it feels that the carve-out should not apply to small companies that are part of groups.
It is disappointing that in the explanatory memorandum to the statutory instrument, which I think is the only formal response to the BLP’s work, the Government devote two paragraphs to its very reasoned argument. If committee members are to feel that the Government value their advice, they need a bit better justification as to why their proposed changes should not go ahead than two paragraphs in an explanatory memorandum.
I am not sure that the argument given in paragraph 8.4 of the explanatory memorandum passes the credibility test. It says:
“The primary reason for this is that banking institutions do not generally hold the information necessary to identify a small company that is part of a large group that has a set-off or netting agreement with the banking institution; and given this lack of information, it is not currently possible to identify such a company quickly in the context of a resolution under the SRR”.
I do not believe that to be the case. It says something about the appalling state of bank records. If a bank has entered into a legal agreement with a customer and said, “These are the companies where there is a set-off between the accounts,” one would think that the bank would have a record that would be applied to those accounts. The fact that they have not shows very poor record-keeping, and it is surprising that the Government have accepted that as a reason not to proceed with the BLP’s recommendation.
The Government should have been tougher with the banks and said, “You should apply this identifier to those accounts. You should make sure your records reflect your legal agreement with one of your customers.” I am sure that companies would have a record showing where the right of set off applies in the various companies in their group.
The Minister should push the matter back on the banking sector and say that that is not a good enough explanation. If she was fobbed off with that explanation, she should go back to her civil servants and say that we need a better and more reasoned justification for arguing against the changes that the BLP suggested in its well-argued and well-reasoned report of 17 June.
The reason for the retail carve-out—I raised this in my question to the Minister about the Financial Services Compensation Scheme—is that small companies are covered by the FSCS. I had not appreciated the fact that a small company that was part of a larger group would be compensated, even though it was part of a larger group, and a commercial decision had been taken to create and run that group of companies. That creates an incentive for groups to reduce the size of their companies so that they fall within the FSCS limits. Something is not quite right with that.
I know that the Government are not responsible for the FSCS rules, which are the responsibility of the Financial Services Authority, but there is an issue to consider. In tax, as the Minister and I know from discussing the Finance Bill, and in company law where a small company is part of a larger group, the fact that it is part of a larger group takes precedence over the fact that it is a small company. There seems to be a disconnect in the treatment as set out in the order, which we need to think about very carefully.
The Treasury’s explanation of why it has not adopted the BLP’s view about carve-outs for small companies is simply not sufficiently robust to stand proper scrutiny, and the Government should think again about it. Can they not give a better explanation for rejecting the BLP’s view than simply saying that banks are not up to the job?
4.47 pm
It is absolutely right that we should push back on the banks the need to come up with clear reasons why companies cannot be easily identified. At the very minimum, banks should, if they do not, advise groups that particular small companies are not covered by the provisions. The very fact of having to do that would mean that they had to identify those companies, and if they had to do that, they would have to make clear their rights and responsibilities.
I am happy that the BLP has pushed this issue. It has done some really good work. When we looked at the Finance Bill, we knew that a lot of work would have to be done on the issue, and it has clearly been done. However, we are talking about a relatively small aspect, and the Government’s explanation does not hold water. We need a much clearer understanding of why the banks seem unable to identify the relatively small number of groups that would be affected by the provisions.
4.49 pm
Mr. Michael Fallon (Sevenoaks) (Con): I want to add to the points that have been made. First, I welcome the deletion of the word “solely”. I do not want to criticise the Minister, because she is relatively new to all this, and I admire the way in which she has picked it all up. However, there was an element of bad grace about the explanation, given that the Treasury still thought that its drafting was right, when lots of other people clearly thought that it was wrong. None the less, the word “solely” has gone.
I am also not very impressed with the explanatory memorandum. I assume that the declaration on the European convention on human rights applies to the amendment order as well as to the original order, but that is not clear from paragraph 6.1, which refers only to the original order.
On the big point about small companies, I agree with my hon. Friend the Member for Fareham. The banking liaison panel thought the measure was right and that the arguments were compelling in principle. It is not quite enough for the Minister to fall back on the question of whether it is workable. Could it be workable? Does she accept the principle that small companies should be entitled to some setting-off and netting protection? That is an issue of principle. If she would simply say that she accepts that in principle and that the proposal does not seem to work because of the lack of information, that would be fine. It would be good to have on the record whether she accepts that those companies should be entitled to such protection in principle.
Finally, this is now becoming a process. Perhaps those involved in the 2009 Act as it went through Parliament always knew that this would happen, but I was not clear that one order would be laid four months after another. If that is going to continue—the banking liaison panel has been invited to continue its work with the Treasury—we may need to put the panel on a slightly more formal basis, to ensure, for example, that its minutes and advice are published quarterly, before any amendment order is made, so that we know exactly what advice it has given to the Government. That said, I welcome the amendment order.
4.52 pm
Sarah McCarthy-Fry: I am glad that hon. Members in general welcome the amendment order. I note that partial property transfers are an essential part of the authorities’ toolkit for resolving failing institutions, but we also need legal certainty and market confidence that the safeguards order provides adequate protection.
The explanatory memorandum was a bit short. It was never intended to constitute the Treasury’s full response to the BLP, and we will be engaging in further work with the BLP on the matter, as I made clear.
Mr. Hoban: Is this the only current response to the BLP’s work?
Sarah McCarthy-Fry: It is to my knowledge, but perhaps someone has more information on that. I have not seen any other response, but there may well have been, and I will hopefully be able to respond to the hon. Gentleman before the end of the Committee. If not, I will write to him.
Mr. Hoban: Given the emphasis that has been placed on the statutory panel, it is important that the responses to its reports and advice are more than simply explanatory notes to statutory instruments. It is now 6 July, and we are dealing with an SI relating to advice that was given on 17 June. Doubtless the Treasury has an observer on this, but perhaps a little more time should be spent considering the advice, rather than simply trying to ram a measure through before the summer recess.
Sarah McCarthy-Fry: But it was the panel’s wish that the amendments were made before the summer recess, so that we get the safeguards in place as quickly as possible. Indeed, Ministers committed to getting the measure in place before the summer recess. We know that there is more work to be done on small companies, but it is important that we have the other things on the statute book before that time.
The hon. Members for Fareham and for South-East Cornwall said that they did not see why the banks did not hold such information. They may well hold that information, but our difficulty is whether it is possible to get the information quickly enough in the course of a resolution. The BLP members spoke to the banks about that, and the point will be addressed as part of the ongoing work.
I can see strong advantages in the principle that the hon. Member for Sevenoaks described, and we will work on that with the panel to see whether we can find a practical way forward. In addition, the human rights declaration applies to both the amendment order and the original order, which was my feeling in the first place.
The banking liaison panel meets quarterly. Minutes will be approved at its next meeting and will be published, and we will publish terms of reference with the panel, so obviously the process will be ongoing. This order enhances protection for banks and their counterparties. I hope that we can agree it today. As I have said, we will continue to monitor the market impact of the 2009 Act and its related secondary legislation. Mr. Hoban: Is the Minister saying that the only barrier to implementing the small companies element of the banking liaison panel’s advice is the identifier? If the identifier were in place, would the Government implement that part of its advice?
Sarah McCarthy-Fry: It may be that the identifier is not the best way to proceed; there may be better ways. We have to look at the principle of how we deal with bank resolutions; they often have to be done very quickly—often over a weekend. I want to give the banking liaison panel and the industry time to come forward with the best way for us to do that.
I thank all members of the Committee for their constructive comments on the order. The panel will continue to advise the Government on any possible changes in the future, and I am sure that we will return to the issues.
Question put and agreed to.
4.56 pm
Committee rose.

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