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10 Nov 2009 : Column 6WH—continued
That said, although irresponsible banking should and must be curbed, populist and rushed measures designed to rein in City excess should be avoided. After all, the Sarbanes-Oxley Act, introduced in the United States after the Enron and WorldCom scandals, taught us that additional regulation to protect consumers, as it was perceived in that country, may do little to stave off
a crisis and that in a global economy, business will have no hesitation in relocating if regulation becomes too cumbersome.
Having learned from that, we must give the public greater credit and take them with us by explaining clearly how the taxpayer stands to gain or suffer from the regulatory choices that we make. One such way is to defend the UK's position as a global leader robustly against EU attempts to curb the hedge fund industry via the draft alternative investment fund managers directive. I spoke about that problem in this Chamber recently, and the Minister was also there, so I shall not go over the ground again other than to summarise the issue briefly.
Most hedge funds are exempt from much of the regulation applying to investment banks and mutual funds. As pools of highly mobile capital, they have fast developed the reputation of being able to move mountains in the financial market by anticipating future expectations. Hedge funds, which are largely limited liability companies, thrive on volatility, so the crux of the controversy surrounding them is the degree to which they either cause or affect fundamental shifts in financial markets.
Alternative investment funds have accepted that in the new regulatory climate, they will be required to boost transparency and accept new curbs on disclosure and, most likely, on clearing, settlement and custody as well. The draft directive, however, goes a long way beyond that and may make it absolutely impracticable for funds owned by non-EU entities, which comprise a significant proportion of those operating in London, to distribute their products within the European Union.
That, combined with other regulatory and fiscal burdens here, may persuade hedge funds to relocate to other financial centres such as Switzerland, or indeed to return to the United States or emerging centres in the Gulf or the far east. As my right hon. Friend pointed out, such an outcome would be in the interests neither of the UK economy, which fundamentally concerns us, nor of the EU. Such protectionism in a global market would be fatal. At a supranational level, it would diminish competition, restrict flows of liquidity into the single market and be seen as protectionist at a time when barriers need to be brought down rather than erected. At a domestic level, it would also significantly diminish London's critical mass as a financial centre and reduce individual and corporate tax revenue. At its most detrimental, it risks undermining London's competitive advantage in the market for the professional services to which I referred.
The impetus for a European directive derives from panic in response to the economic crisis alongside a somewhat partisan vision of hedge funds and private equity as a wild west show of amoral speculators and asset strippers. However, I reiterate that there has been no crisis of asset management. Unlike the big banks that have been so troubled over the past two years, hedge funds did not leverage themselves to the hilt, having lacked the balance-sheet clout to do so even if they had wanted to. Whatever regulation exists should focus on the issue of leverage. Only in so far as it does so can it be justified.
Nor did hedge funds run down adequate levels of liquidity. Indeed, those that have failed-as of course some have done in the past two years-have not threatened
the entire financial system in their failure. The public must be made aware of that or it will be harder to resist what may seem superficially to be reasonable attempts by the EU to curb reckless risk-taking, but are in reality dangerous moves that will undermine London's competitiveness.
Thankfully, since I last spoke on this issue in Parliament the Swedish presidency has drafted a compromise text on some elements of the draft directive to reconcile British concerns. The important issues are scope, delegation, valuation, leverage, capital requirements and transparency. The compromise proposal is an encouraging step forward. I give credit to some Conservative voices in the European Parliament for that, as well as to the Government, who are belatedly making progress. I hope that we will make significant progress in the coming months. The directive might be revised further because several member states, notably France, are said to be unhappy with the compromise.
I support the broad objectives set out by the European Commission in other regulatory areas, such as a more efficient framework for financial supervision, enhanced financial stability and greater safeguards of the interests of consumers and investors. As my right hon. Friend said, the crux of the matter is an increased competitiveness of EU financial markets and more integration within those markets. We must make it clear to the public and the EU that British policy makers and financial experts are not against efforts to regulate, but equally will not give all regulation the green light simply because public sentiment dictates it. In creating new regulatory structures, it is essential that policy makers across Europe remain focused on the outcomes and keep on track with the key objectives of open markets, increased competition and consistent arrangements globally, regionally and locally.
The City of London believes that there is a clear and compelling case for the creation of a European systemic risk board to ensure that dangers to the stability of the financial system are caught early. The present crisis has demonstrated that monitoring risks at EU level is not enough. That should not deter us from closer co-operation and interaction with global organisations, such as the new systemic risk body in the United States. To have any credibility, such a risk board's membership and voting structures should reflect the financial industry. There is concern that the banking sector will be over-represented on the board and other sectors under-represented. Given that the current crisis originated in the banking sector, the next is likely to start elsewhere. It is therefore imperative that national supervisors from all financial sectors, from securities to insurance, participate in the meetings and in setting up the framework.
On the chairmanship of the board, I support the European Council conclusions that require the post to be elected by the general council of the European Central Bank to ensure that it is viewed, and acts, as an independent body. Furthermore, the board should be able to raise concerns about financial stability stemming from across the EU financial system, including monetary policy, while respecting the independence of the central banks and the supervisors involved.
I support the principle of promoting convergence to ensure a consistency of rules. However, the European system of financial supervisors should not overrule supervisory decisions made by national regulators. The demarcation of powers between national and EU
authorities must be clearly defined and any binding powers should be exercised only as a last resort. There is concern over the timetable envisaged for the development of all of the proposals, but the City recognises the pressure to deliver a workable solution for the future of the EU financial markets.
To return to British shores, in the aftermath of the banking bail-out I was deeply disturbed by the creation of financial institutions that became too big to fail. That relates to the issue of moral hazard that my right hon. Friend raised. In forming such institutions, we recognised implicitly-and explicitly in various Government statements of autumn 2008-that they were too big to regulate and beyond the scope of prudential sanction. That in-built lack of competition will continue to result in a remuneration regime that means high rewards for investment banking employees. Nobody objects to people earning a lot of money when there is genuine flair and innovation, but it cannot be right to reward quasi-monopolistic practices brought about by Government policy and organisations working in cahoots with one another or as a cartel.
I am not naive about these issues. Unravelling the recapitalisation arrangements of the past year will not be a short-term affair. We should not rush to a solution because we should strive to gain the maximum value from what is put in place. I am concerned about the idea of stakes being sold off. That might be politically expedient in the run-up to a general election and would bring funds into the Exchequer, but we must ensure that assets on the Government balance sheet are sold at a time that maximises their value for the taxpayer. I suspect that it will take many years-possibly as long as a decade-to unravel the recapitalisation arrangements. The deal was done without full political scrutiny and perhaps elements of it had to be done in that way. However, it is dawning on the public that there has been, and continues to be, a more extensive nationalisation of banking assets than was envisaged.
With the UK taxpayer propping up banks that are politically too big to fail and providing cover for many commercial enterprises that are part-owned by part-nationalised banks, our economy has a worrying dearth of competition. Given that the Serious Fraud Office has neither commercial nor industry respect, we lack a serious, tough and effective body to deter companies from engaging in fraudulent or market-distorting activity. It is critical that we put the restoration and promotion of competition and market fairness at the heart of future economic policy. Under any plan for sound banking, the SFO requires teeth alongside an all-powerful Bank of England, merged with the FSA.
The public will loudly demand more rigorous enforcement of regulation across business, particularly in financial services. Politicians need to demonstrate a seriousness of intent by outlining robust plans for a tough, not-to-be-messed-with agency that values strong competition and clean business dealings as essential parts of an effective financial system. Such an agency should be linked to or merged with the Office of Fair Trading. Its work should be a top priority for the Department for Business, Innovation and Skills, rather than a minor one in a Treasury that has its hands and its ministerial inboxes full. The United States provides a blueprint for the new SFO regime with its whistleblowing culture, the ability for deals to be cut if businesses show
the willingness to change and a tough prosecutorial threat. The deterrents provided by healthy competition and stiff punishment must form the backbone of the brave new world of banking and business that lies ahead. Nothing less will restore the confidence of market professionals and the trust of the public.
We must accept that the spirit of the age favours greater, more stifling regulations. Unless those come about on a global basis, London and Europe risk being the losers. The public and political instinct today-and for some years to come-is to punish the banks. Everybody in the financial services industry risks being caught in the crossfire. Fund managers, insurers and other advisers risk losing out as Governments exert new control over the sector. It falls to those of us who recall London's historical role as a global trading city, including my right hon. Friend who was a distinguished Minister in the last Conservative Administration, to make the case for extending the reach and influence of measures in this sector to markets beyond Europe's shores.
10.9 am
Mr. Colin Breed (South-East Cornwall) (LD): I congratulate the right hon. Member for Wells (Mr. Heathcoat-Amory) on securing this important and timely debate. It is rather disappointing that so few hon. Members are here. Perhaps the matter should be discussed on the Floor of the House at some stage because, as the right hon. Gentleman pointed out, the ramifications of what is being proposed will probably affect every man, woman and child in this country, not just for a few years, but for a few decades. What might be done in our name in literally a few weeks' time will have enormous consequences for the future of us all, whether we are retiring or just going out to work.
During our debates and discussions over the past year or so since the commencement of what we now know as the global financial crisis, regulation has been the backdrop to much of the legislation that has been passed-indeed, it has also been mentioned in relation to what different regulatory bodies have been discussing between themselves. The Treasury Committee, of course, has been engaged in some of that and I hope that its report on European regulation will be published in the near future.
We have sometimes failed properly to identify what we want regulation to do. Some people want regulation to curb the size of financial institutions; some want it to curb the size of bonuses; some want it to turn the whole financial sector upside down; and some want it to split large international financial organisations into bodies that are smaller, more manageable and potentially more regulated. Those different opinions all have a part to play, but we have become more aware that, although the intentions behind regulation are often very laudable, the unintended consequences of the imposition of regulation are given less attention.
Attempts to boil down what we want from regulation, to address the current situation and provide some sort of sustainable framework for the future, are causing a great deal of consideration, debate, discussion and argument. I agree entirely with the right hon. Gentleman: saying that everything involved can be put together in a few weeks and brought out in some sort of code that will be the panacea for all our past ills is to go down the
well worn route of the Dangerous Dogs Act 1991. The unintended consequences of ill thought out regulation would probably have more impact than the problems that we are supposedly trying to regulate in the first place.
I agree that we need regulation, that it should be tuned to the current circumstances and that supervision needs to be changed and improved, but what do we really want regulation to do for us in this country? At the end of the day, the need for regulation really seems to stem from the problems surrounding debt, which is a fundamental aspect of all the problems that we are dealing with. The amount of debt that has been allowed to build up within the banks, within Government and within personal borrowing-in fact, the whole weight of debt generally-needs to be addressed.
We are only too familiar with the problem of banks being unable to lend to individuals and businesses to get the economy going; in other words, they are unable to support and allow funds to flow into what we know as the real economy. We have allowed the real economy to be forgotten and the financial sector has been the beneficiary. Long-term financial reform and regulation should be about directing lending away from expanding the ever-enormous financial sector towards funding the real economy, rather than loading it down with debt.
Over the past 10 or 12 years, the era of cheap credit and regulation has encouraged all the banks to move away from the real economy, where they thought there was less profitability, towards lending against rising assets. That has created bubbles and false markets in property and derivatives-a situation that continually feeds on itself. If we look at the banks' balance sheets and profit and loss accounts, we see that they apparently benefit enormously from their clever investments. We know that the banks might have looked as if they were just lending to the real economy, but the macro-economic consequences of their actions are very different, and we are suffering as a result.
The credit flowing into those asset markets and the creation of debt overheads has meant that the real economy's capacity to pay that debt has declined. At the end of the day, it is the real economy that will service that debt, and we are beginning to see that already. Unless we generate real profitability within the economy, the assets themselves will not repay those involved because those assets have reduced in value. The idea of backing into assets is that they can be sold at a profit and that someone can repay themselves, but we have seen that the assets have declined. Derivative and property values have all declined and therefore the debt will have to be paid by the real economy. Sadly, that matter has been ignored.
We need a regulatory and policy climate that discourages the pursuit of money only in respect of capital gains and encourages growth in what we know as the real economy. Some of us think that that is what it used to be like. When I was in banking many years ago, banks were there to fund businesses, individuals, entrepreneurs and others to generate the additional profit that not only repaid the bank, but created employment and everything else and increased the value of the country's gross domestic product. Pushing all that money into the
area of cheap credit and deregulation and creating asset bubbles and false property markets is not the way in which we should encourage regulation to go.
There is obviously a need for change in the areas of domestic regulation and the supervision of the domestic banking and financial sectors. There are a great many ideas about how that might be done-for example, whether it should be through the Financial Services Authority or the return of some supervisory powers and regulation to the Bank of England. However it was done, I suspect that the same people would simply transfer from one building to another. It is the culture of regulation, rather than the fact of regulation itself, that we need to address.
On big banks being too big to fail, we have talked endlessly about whether we should split the banks up or whether we should create more solid Chinese walls, perhaps with differential licences for different activities or with different capital ratios and requirements in respect of the regulation of different activities. We have swiftly introduced protection for depositors to try to protect the taxpayer from having to provide guarantees for them, but that has not done very much. We may well have protected the depositor, but the taxpayer is still paying out, even though we have passed legislation this year to try to head that off.
Can we ever get back to the idea of having basic old-style banks and perhaps even going back to re-mutualisation? Somehow, I do not think it possible to rein back and return to the position that we were in, recreating what we knew as the old basic banking system or reintroducing some mutualisation. However desirable doing so might appear, I wonder whether it is actually possible.
When we talk about bonuses and regulation, we must realise that over the past 10 years-or perhaps a bit longer than that, because our regulations were probably set up a couple of decades ago-globalisation, in all its fullness, has, to a certain extent, rendered the existing system inadequate and out of date. The whole area of what might be called bonus and regulatory arbitrage now demands a more robust system of regulation and supervision. Gone are the days when individual nations and countries could regulate everything that happened within their borders in respect of their financial sector operations. We have an international banking financial sector with a huge scope, and where it decides to locate itself creates great benefits and great dangers for that location, as we have seen.
Perhaps a co-ordinated approach and co-operation in regulation and supervision are the obvious way forward, but international regulation and co-operation, although vital, are not easy to obtain. All this is unlikely to happen on a particular day, but it is likely to evolve. In the evolution of that regulation and supervision, there will be difficulties and arbitrage, which we will have to accept.
As the right hon. Member for Wells has said, the European Commission published details of its legislative proposals only a month or two ago. They were based on agreements that were reached by ECOFIN and the European Council. Given the scope, range, complexity and difficulty that they are trying to encompass, it seems almost incredible that anything could possibly begin to be considered within a few months, but that is what is being suggested. Perhaps the establishment of a
European systemic risk board and European supervisory authorities is the way forward. I am sure that there is huge merit in the idea, and people with great expertise have come up with this particular framework, but the regulation that we are trying to create needs to look at both sides of the coin. Regulation must be adequate, but it must also be proportionate. That is not about being popular; it is about being appropriate. The regulations should seek not to stifle competition, but to promote it between financial organisations and financial sector companies, and also between markets. If we regulate out the competition completely, the consequences will be even more dire. Our approach needs to be sustainable and long-term, not short-sighted and subject to continual short-term amendment.
If we rush into the proposals without giving them the considered thought that is needed, which might take some months, we will have all the disbenefits of such a regulatory regime. We will have a short-term, continual need, and there will be disruption in the market. The system will stifle competition between businesses and different markets, it will be totally disproportionate and we will have to battle significant unintended consequences because we will have failed to recognise and address them at an earlier stage.
To echo the right hon. Gentleman, I should say that I have several concerns about the European proposals. We probably have shared intentions regarding the proposals, and the intentions behind them should be welcomed and accepted, but there is great unease and concern about the potential unintended consequences, especially in respect of the speed with which ECOFIN wants to adopt the proposals-in a few weeks' time. That is far too fast, and does not give time properly to consider the relevant issues.
For proper consideration to be given, time is needed for debate and for the intellectual effort that is needed from a great number of people and some bodies that have been mentioned. They seem to be being almost ignored in all this, but they are going to have to grapple with the system and make it work for both their benefit and the country's.
There is no doubt that the measures are controversial, but rushing them through and trying to limit debate because they are controversial does not mean that we will do them justice. How will the measures relate to the global initiatives for regulatory reform? It is great for us to consider them on a European basis-that is right-but how will they fit into what will be happening in the other international markets that are going to be so important if we are to avoid regulatory arbitrage?
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