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Ian Pearson: As Members will know, the Government have amended two elements of parts 5 and 6 of the Bill in response to concerns raised in the other place. The first concern was raised in response to comments received by the Payments Council, a key body representing payment system operators, about exemptions from liability for such operators acting under direction from the Bank of England. Its principal concern centred on a scenario in which an operator could be instructed by the Bankunder its power to give directionsto continue to allow a failing bank to participate in a payment system even when that bank no longer met the criteria for participation. The question raised was whether the operator would be given an exemption by the Bank in respect of any liability arising from acting in accordance with the direction.
The power to give directions is intended to provide a tool for the Bank to use in furtherance of the objectives of this part of the Bill: that is, to ensure that recognised inter-bank payment systems are operated in a manner that minimises deficiencies and disruptions that could threaten the stability of, or confidence in, the UK financial system, or have serious consequences for businesses or other interests throughout the UK. We therefore do not envisage circumstances in which the power would be exercised in the manner suggested. Nevertheless, given the concerns raised, the Government considered it appropriate to address them, which is why Lords amendment 72 gives the Treasury power to grant, by order, an operator exemption from liability in damages in respect of acts or omissions carried out in accordance with a direction if that is appropriate in the circumstances.
The amendment provides that the Bank should notify the Treasury before making a direction, so that the Treasury has an opportunity to consider whether it would be appropriate to make an exemption order. As the Bank may need to give a direction urgently in the interests of financial stability, we believe that the order should be subject to the negative procedure. For obvious reasons, it will be important that any exemption is in place at the time the direction is given. Government amendment 96 is consequential, updating the statutory instrument table in part 8.
The second set of amendments concern the penalty clauses of parts 5 and 6. The Delegated Powers and Regulatory Reform Committee was particularly concerned about their application under part 6. Having considered both the Committees report and the concerns voiced in Committee both here and in another place, the Government made amendments to assuage any fears about how the financial penalty power could be exercised.
Amendment 73, which was agreed in the other place, provides that the Bank of England must prepare and publish a statement of the principles it will apply in determining both whether to impose a penalty and the amount of the penalty in respect of a compliance
failure under part 5 of the Bill. It is intended that these principles will preserve the Banks discretion in assessing whether to impose a penalty and the quantum of that penalty, but will also enhance the transparency of the enforcement regime.
These principles will, no doubt, reflect the range of factors that will need to be taken into account in the decision process; for example, the scale of the compliance failure and the seriousness of the consequences arising, the resources of the payment system, and the frequency of the offence. However, in the interests of preserving the Banks discretion in preparing and issuing the statement, the Government do not consider it appropriate to specify in the Bill the factors that the Bank must take into account. The statement of policy must be published on the Banks website and a copy must be sent to the Treasury. We consider this publication requirement to be adequate to ensure the policy is brought to the attention of operators of recognised inter-bank payment systems and the general public. The Bank must review and revise the policy from time to time, as appropriate.
In the interests of fairness, any penalty imposed by the Bank must, of course, be in accordance with the published policy at the time the compliance failure was committed. This offers guidance to operators of recognised inter-bank payment systems, while maintaining the necessary flexibility for the Bank to impose penalties that are appropriate in all the circumstances in each case. I trust that the hon. Members for South-West Hertfordshire (Mr. Gauke), for Dundee, East (Stewart Hosie), for Southport (Dr. Pugh) and for Gosport (Sir Peter Viggers), who spoke to this clause in Committee, will find that this amendment puts beyond doubt the assurances I offered at the time as to the circumstances in which a financial penalty may be imposed and also the scale of that penalty.
Lords amendment 74 provides that the Treasury must specify in the banknote regulations a method for determining the maximum amount of penalty that may be imposed by the Bank for a breach of regulations or rules. This amendment was designed to address concerns that the Bank could conceivably have been enabled to set unlimited penalties under the banknote rules. As I have said, the Delegated Powers and Regulatory Reform Committee of the House of Lords expressed concerns that penalties were a matter left in banknote rules rather than in regulations. Under the amendment, which addresses that concern, it is intended that the banknote regulations will set out a formula for calculating the maximum penalty to be imposed for under-backing and will make provision in relation to a statement of policy on penalties to which the Bank must have regard in determining the level of the penalty imposed. I would like to reassure hon. Members that provision has already been drafted at paragraph 4 to schedule 1 to the indicative draft banknote regulations, providing that the amount of any penalty must be determined in accordance with a published statement of policy.
All of these amendments address concerns expressed during parliamentary scrutiny of the Bill, and serve to set out in the Bill certain reassurances as to the scope of the powers conferred therein. I therefore commend the amendments to the House.
I have a few questions to ask the Minister on this group of Lords amendments. As he has said, Lords amendment 72 provides that the Bank of England
must give notice to the Treasury before making a direction and that the Treasury may confer immunity from liability. I would be grateful if he would elaborate on the relationship between the Bank of England and the Treasury in those circumstances. It would appear that the Bank takes the lead and that this is merely a notification requirement. What would happen if the Treasury objected to a course of action taken by the Bank? What would happen if it objected to a direction that the Bank gave under clause 188?
Treasury may by order confer immunity from liability...in respect of action or inaction in accordance with a direction.
Clearly, a degree of discretion is involved in the use of the word may. During the Bills progress we have had many discussions on using the term may as opposed to shall or will. Could the Minister give an indication as to the factors the Treasury would take into account when deciding whether or not to confer immunity from liability in damages?
Lords amendment 73 relates to the statement of principles to be applied in determining penalties, which, again, is to be sent to the Treasury. Could the Minister elaborate on the relationship between the Treasury and the Bank of England in this context? Will the Treasury have a formal role in giving its views on these principles? Will it be able to recommend or indeed require that the Bank of England changes these principles?
Banknote regulations must establish a method for determining the maximum amount of a penalty.
I merely note that there seem to be two separate regimes in parts 5 and 6. The one in part 5, which deals with the inter-bank payment systems, provides for a statement of principles with regard to penalties to be produced by the Bank of England, whereas the one in part 6 provides for banknote regulations to specify the maximum penalty. Will the Minister explain why it is appropriate to have two separate regimes, given that we are addressing both those issues in the same Bill, at the same time and in the same group of amendments? There may be good reasons for the slightly different approach being taken, but it might be helpful for the House to hear them. These Lords amendments attempt to address some of the concerns that we raised in Committee, and that is welcome. We are grateful to the Government for, again, listening to some of our concerns.
Ian Pearson: I welcome the hon. Gentlemans support for the amendments, which were agreed in the other place. He is right to say that the Government have carefully listened to the concerns that have been raised in a number of places, not least by Members of this House. He asks a number of detailed questions and rather than respond to each of them individually nowI am not sure that I would be able to do soit is probably best if I write to him and place a copy of my reply in the Library of the House.
Ian Pearson: Lords amendments 84 to 88 provide the Treasury with powers to make regulations with regard to investment bank insolvency. They were inserted into the Bill after consideration in the Lords Committee, after I had signalled the Governments intention to do so in this House.
The powers that the Government are taking with regard to investment bank insolvency are of critical importance. They have been brought forward to enable the Government to address the concerns about the recovery of client assets that have followed from the collapse of Lehman Brothers. I shall take this opportunity to explain how we are proceeding because it has not previously been discussed in this House.
Hon. Members will be aware that when Lehman Brothers failed, its UK arm also collapsed. This subsidiary held a very large quantity of client assets. The exact sum is unknown, but is likely to have run to many billions of pounds. Much of this money may have been simply passing through Lehmans broker-dealer business at the point of default.
At present, those clients to whom those assets belonged have no way of recovering them outside of the normal insolvency arrangements. Those procedures could last for a substantial period of time as Lehman Brothers is one of the most complex insolvencies, if not the most, ever to occur. This is no small matter. If clients are unable to access assets that they believe they rightfully own, it of course has implications for market confidence in, and the effectiveness of, the legal arrangementsincluding those relating to insolvencythat support the UK financial system.
Hon. Members will be aware, I am sure, that a major source of the UKs competitive advantage in financial services is the certainty provided by the relevant legal regimes in the UK. If those were seen to be insufficient, there would be implications for the future of the City of London as a financial services centre. Ineffective operation of insolvency arrangements in relation to investment banks and client assets could also have financial stability implications, if it impacted on the ability of clients to meet their own obligations to third parties. That may have particular relevance in the case of rehypothecated assets where recovery may be especially challenging.
The Government therefore clearly need to act, both to ensure that clients have the ability to recover their assets more easily in any future investment bank insolvency, and in order to maintain confidence in the financial systems of the UK. It is unfortunate however that the sheer complexity of the challenges that have emerged since the failure of Lehman Brothers and its UK subsidiary defy simple solutions. The House will understand that the application of insolvency procedures to an investment bank, or any other large, complex financial institution, is complicated and challenging. To consider ways of revising such procedures is equally complex.
For this reason, the Government have sought the advice of an expert panel with regard to the concrete steps that need to be taken in order to address those challenges. This panel, the establishment of which was announced in the pre-Budget report, is to consider how regulations may best be made that enable the unencumbered return of client assets without creating substantial externalities or negative consequences. The review will examine whether the statutory purpose of administration as provided for in the Insolvency Act 1986, presents problems in the case of institutions that hold client assets; the procedures for administration of a complex investment bank; and arrangements for the continuity of brokerage accounts.
The provisions of these new clauses provide the Treasury with the powers necessary to make any changes that may be required as a result of this review. They are necessarily broad, for the simple reason that it is impossible for the Government to prejudge the conclusions of the expert panel, particularly in such a complex case. Let me reassure the House that the powers that these clauses confer would be exercised only if such changes were deemed necessary. The review may, of course, find that no changes are necessary. The powers are therefore precautionary, insofar as they will not be used without a clearly identified need to do so, and they will be closely targeted if deployed.
Let me briefly describe the provisions of each of the clauses that lay out the powers. The new clause inserted by Lords amendment 84 is the first in the group and sets out the scope of the enabling power. The power will permit the Government to make regulations to change the insolvency regime for investment banks. Investment banks are defined as institutions, incorporated or formed under UK law, that have permissions under part IV of the Financial Services and Markets Act 2000 to carry on the regulated activities of safeguarding and administering investments, dealing in investments as principal or dealing in investments as agent. The clause also defines client assets as they are to be considered within the meaning of those powers and provides the Treasury with an order-making power to alter those scope definitions as necessary and appropriate.
The next new clause provides that the Government may lay regulations to modify existing insolvency law in its application to investment banks or to establish a new procedure for insolvent investment banks. In line with existing insolvency law, the new regime would apply when an investment bank was either unable or likely to be unable to pay its debts or when its winding up would be fair.
The following new clause provides the detail of what the regulations may provide for and how they would work. It includes provision for the regulations to set out those persons who can initiate the special procedure or who can make an application to a court for the procedure to be initiated by court order.
The new clause inserted by Lords amendment 87 sets out the detail by which any regulations may be made. The clause will provide that the regulations should be made by statutory instrument and should be subject to the affirmative procedure. The Treasury must consult before making any such regulations.
Finally, the new clause introduced by Lords amendment 88 provides for a review of insolvency regulations. As a consequence of the clause, the Government must establish an independent review of any regulations that have been made within two years of their coming into force. That review will be independent, expert, and impartial. It will consider whether the regulations have been effective in identifying, protecting and facilitating the return of client assets. It will consider whether, in drafting the regulations, the Treasury has paid due attention to protecting creditors rights and ensuring legal certainty for all relevant stakeholderscreditors, clients, administrators and the investment banks. That is critical and will ensure that the impacts on those firms and persons who may be affected by the regulations are subject to full consideration.
As I have said, the Government believe that the proposals are essential for supporting continuing market confidence in the UK as a major financial services centre. They were debated at great length in the other place, and rightly so. I believe that the provisions are necessary.
Mr. Hoban: I am grateful to the Minister for the time that he has taken to set out the amendments in this group. He was right to highlight their importance and the way in which they have emerged. One point that was raised in Committee was the narrow focus of clause 2, which defined a bank as a deposit taker for the purposes of the Bill. That meant that it covered banks such as Barclays and RBS but not Lehman Brothers, which did not take deposits. That exchange in Committee took place just before information emerged from the administration of Lehman Brothers International (Europe) in the UK. That was a complex matter which gave rise to a number of practical and legal issues around areas such as netting off transactions and expenses and separating transactions to Lehmans accounts and those of its clients.
It is worth quoting briefly an article that appeared last November about the perception of one group of Lehmans clients of the problems that they encountered with its insolvency. It appeared in the Evening Standard and was based on a letter that the Investment Management Association wrote to the Financial Services Authority. It included comments such as:
The core problem was that when Lehman folded, institutions that had placed buy and sell orders for cash equities through the firm had no idea where they stoodwhether the trades had gone through or not. Institutions needed to know because if they had been trying to buy and the deal had not been completed they would want to put that trade with another broker. Likewise, if they had been trying to sell. But what happened was that all the institutions Lehman-related equity transaction held within at the Euroclear Crest settlement system were frozen. The system was locked up. They did not know where they were, whether they were in or out of the marketand this at a time of huge volatility. And it went on for nine weeks.
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