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Session 2009 - 10
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Delegated Legislation Committee Debates



The Committee consisted of the following Members:

Chairman: Jim Sheridan
Ainger, Nick (Carmarthen, West and South Pembrokeshire) (Lab)
Ancram, Mr. Michael (Devizes) (Con)
Bailey, Mr. Adrian (West Bromwich, West) (Lab/Co-op)
Breed, Mr. Colin (South-East Cornwall) (LD)
Cable, Dr. Vincent (Twickenham) (LD)
Clarke, Mr. Charles (Norwich, South) (Lab)
Duddridge, James (Rochford and Southend, East) (Con)
Field, Mr. Mark (Cities of London and Westminster) (Con)
Hoban, Mr. Mark (Fareham) (Con)
Hoyle, Mr. Lindsay (Chorley) (Lab)
McCarthy-Fry, Sarah (Exchequer Secretary to the Treasury)
Mitchell, Mr. Austin (Great Grimsby) (Lab)
Mudie, Mr. George (Leeds, East) (Lab)
Smith, Geraldine (Morecambe and Lunesdale) (Lab)
Timpson, Mr. Edward (Crewe and Nantwich) (Con)
Williams, Mrs. Betty (Conwy) (Lab)
Eliot Barrass, Committee Clerk
† attended the Committee

Fifth Delegated Legislation Committee

Tuesday 9 February 2010

[Jim Sheridan in the Chair]

Financial Services and Markets Act 2000 (Regulated Activities) (Amendment) Order 2010
4.30 pm
The Exchequer Secretary to the Treasury (Sarah McCarthy-Fry): I beg to move,
That the Committee has considered the Financial Services and Markets Act 2000 (Regulated Activities) (Amendment) Order 2010 (S.I., 2010, No.86).
I welcome you to the Chair, Mr. Sheridan. This is the first time that I have served under your chairmanship, and I am sure that it will be the first of many.
The order was laid on 19 January 2010 with the intention, subject to parliamentary approval, of its coming into force on 24 February 2010. It seeks to change the definitions regime for regulated activities, as laid out in the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001. The order before us seeks to exempt alternative finance investment bonds from the current collective investment scheme regulations, and create a new specified investment under the 2001 order. The order further seeks to introduce a unique regulatory definition of alternative finance investment bonds for this purpose.
The change will benefit institutions looking to issue corporate sukuk by creating regulatory clarity and reducing potential legal and compliance costs. Under the Finance Act 2009, we introduced relief from stamp duty land tax and tax on capital gains for any transactions undertaken as part of the issue of alternative finance investment bonds. The purpose of the legislation is to remove further obstacles to the issuance of corporate sukuk in the UK.
The FSA has estimated that the regulatory change would reduce the overall costs of corporate sukuk issuance by around £35,000 for a sukuk of the duration of five years.
Mr. Mark Hoban (Fareham) (Con): The Minister described the regulatory category as unique. However, my understanding of the Government’s philosophy, which we share, is that there should be equal treatment for comparable sukuk and conventional products. From looking at the Treasury’s consultation, essentially, corporate sukuk are treated on the same basis as conventional debt instruments. Is that the correct basis? Is she not going slightly wider than the point by suggesting that it is unique?
Sarah McCarthy-Fry: This is a unique regulatory definition of an alternative finance investment bond, not unique to sukuk. That is probably the differentiation that the hon. Gentleman was seeking.
Mr. Hoban: I am sorry. The principle that I am trying to ensure that the Government stick to is ensuring that there is comparable treatment. The Government’s consultation was the basis of putting financial investment bonds on a level playing field with conventional debt instruments. Will the Minister confirm that that is what the Government are doing?
Sarah McCarthy-Fry: I thought I had. That is exactly what we are trying to do. Where alternative investment bonds display characteristics similar to ordinary investment bonds, the legislation puts them on the same footing. I am merely explaining the definition. We hope that some of the problems that people have had with corporate sukuk will be addressed by the order, but that is not the only reason why it is on the statute book—it covers the whole gamut of alternative investments, provided that they are within the regulatory framework. It is not specific to sukuk.
Alternative finance investment bonds refer to a type of financial instruments commonly known as sukuk, or Islamic bonds, but can also refer to any financial instrument with similar characteristics which replicate the economic effects of conventional bonds. Sukuk aim to do that in way that conforms to the principles of sharia, but sharia compliance is not a requirement for the instrument to be treated as an alternative finance investment bond under the order. The sharia-compliant features of sukuk, which include the principle of mutual co-operation and risk and profit sharing arrangements would mean that in some cases, they would fall between the broad regulatory definitions of a collective investment scheme under section 235 of the Financial Services and Markets Act 2000. That arguably puts alternative finance investment bond issuers at a disadvantage to issuers of conventional debt securities, as authorisation of a collective investment scheme involves application fees, ongoing supervisory fees and, more importantly, internal and third-party costs associated with compliance procedures.
Although the structure of sukuk might be such that it does not fall within the collective investment scheme regulations, its uncertainty was cited by the Islamic finance industry as a barrier to the issuance of corporate sukuk. In December 2008, HM Treasury and the Financial Services Authority launched a joint consultation on the regulatory treatment of alternative finance investment bonds. We had four policy options, the first of which would introduce legislative amendments to exempt explicitly such instruments from collective investment scheme regulations and create a new specified investment under the regulated activities order, and introduce a unique regulatory definition of alternative finance investment bonds for that purpose.
Option 2 was the same as option 1, but alternative finance investment bonds would be defined by the existing tax definition. Option 3 was the same as option 1, but would include alternative finance investment bonds under the existing specified investment of creating or acknowledging indebtedness, and option 4 was to do nothing. HM Treasury proposed the first option, which would introduce legislative amendments to exempt explicitly the instruments from collective investment scheme regulations and create a new specified investment under the regulated activities order, and introduce a unique regulatory definition of alternative investment bonds for that purpose to be taken forward. The 20 responses to the consultation paper showed broad industry support for that course of action.
The views of the industry were summarised and the authority’s feedback given in the second document published in October 2009. We receive three responses to that during the second consultation phase and took those views into account in our further refinement of the statutory instrument. We intend the legislation to come into force on 21 February so that the legislative changes and the changes to the FSA’s handbook can take effect at the same time. The effect of the order will be to make alternative finance investment bonds a specified investment for the purposes of the Financial Services and Markets Act 2000, and afford them equivalent treatment to conventional bonds. I hope that it will command the support of both sides of the Committee.
4.37 pm
Mr. Hoban: It is a pleasure to serve under your chairmanship for the first time, Mr. Sheridan. I share the Minister’s optimism in hoping that it is the first of many such occasions.
The principle that both the Government and the Opposition subscribe to in the treatment of sharia-compliant financial products is to ensure a level playing field in both the tax and regulatory arenas. We recognise some differences between the structure of the two groups of products, but we also know that it is important to ensure a level playing field. Its creation has meant that London is becoming a global centre for Islamic finance. It is certainly one of the two leading centres outside the middle east. There has been a range of measures, of which the order is the latest, to ensure that the level playing field is in place.
I want to test the Minister on a couple of matters. A conventional debt product does not require to be listed on a market to get the appropriate regulatory or tax treatment, whereas the alternative finance investment bonds are required to be listed in, I suppose, the context of the statutory instrument as well as section 48A of the Finance Act 2005, which gives a tax definition of alternative finance investment bonds. Several respondents to the Government’s consultation process suggested that it was discriminatory for there to be a requirement for the bonds to be listed. Given that principle of equality of treatment, will the hon. Lady explain why there is discrimination in the statutory instrument? There is a requirement in article 77A(f)(i) and (ii) for a security such as that to be admitted, so I should be interested to know why the Government are diverging from the principle of common treatment.
My second point is linked to the first that I raised. The definition used by the Government in the statutory instrument almost mirrors that of section 48A, which defines an alternative finance investment bond. There are differences between the two, which could lead to confusion. For example, under section 48A(d)(i), there is a requirement for the bond issuer to dispose at the end of the bond term of any bond assets that are still in the bond issuer’s possession. In the comparable provision in article 77A(2)(d), there is no such requirement. That potentially creates confusion because someone could comply with the regulatory definition in the statutory instrument but still fall foul of section 48A. Will the Minister explain why the Government have chosen to almost mirror the provisions in section 48A? Is there not a risk of confusion between issuers, the regulator and the tax authorities where a bond might satisfy one set of criteria but may not satisfy another set? To make a slightly broader point, why have the Government not sought to mirror precisely the terms in the Finance Act 2005 in defining what an alternative finance investment bond should be?
Can the Minister clarify the meaning in article 77A(2)(e) of the requirement for the bond to make a “reasonable commercial return” on the loan? In the consultation, a number of people suggested that it was not necessarily the case that a conventional product would provide what would seem to be a reasonable commercial return, and it would be helpful if she could clarify that discrepancy.
The other point that I want to raise is—I think the Government are trying to correct this, but I am not clear that they have achieved their goal—the issue raised in the consultation that the alternative finance investment bond would have a fixed life, whereas the reality is that corporate sukuk, along with other debt instruments, may have an open-ended life. The Government chose not to change definition 77A(2)(c), but then introduced in a new subsection (3):
“The reference to a period in paragraph (2)(c) includes any period specified to end upon the redemption of the bond by the bond-issuer.”
Can the Minister confirm that that means that an alternative finance investment bond can be issued with an unspecified end date, so that it could be perpetual or it could be redeemed at the discretion of the bond issuer?
The statutory instrument is relatively straightforward. I have no further points to raise.
4.43 pm
Mr. Colin Breed (South-East Cornwall) (LD): The measures are uncontroversial and we welcome the intention of getting clarity and creating a level playing field. My only thoughts are that this is a difficult area on which to get completely level playing fields, because they are different systems of finance. The overall objective to try to broaden the opportunity for Islamic financial products and to make the UK at least a bit of a leader in this—at least in the West, anyway—is a good objective, which we support. Overall, the objectives set out by choosing option 1 appear to be the easiest way forward. I suspect that, as we develop more products along those lines, we will bump up against some existing regulatory aspects of FSMA and such. We are happy to support these relatively uncontroversial measures and hope that they will produce an opportunity for a wider market and a greater availability of products under Islamic finance.
4.44 pm
Sarah McCarthy-Fry: I thank both hon. Members for their contributions to the debate. As I said at the start, we believe that alternative finance investment bonds should be afforded as far as possible a level playing field with their conventional equivalents. There has been discussion about the aim of the order, which is to create clarity in the regulatory treatment of corporate sukuk and reduce potential legal and compliance costs, which have so far been a barrier to issuance. The hon. Member for Fareham and I recently attended an Islamic finance conference in the City, and the matter was raised by several people.
A question was asked about the difference between the definitions of alternative finance bonds used for tax and regulatory purposes. There are different requirements for tax and regulatory authorities and the distinction will ensure that the regulatory regime is not unintentionally affected by changes to or interpretations of tax legislation. The term “alternative finance investment bond” will be used for both for the sake of consistency, even though the definitions differ.
I know there were some objections to the mandatory listing provision. We believe that it is necessary in order to limit the risk of regulatory arbitrage. The risk may be low, but we do not think that consumers should be exposed to inappropriate and avoidable risks. However, that position will be reviewed in two years as we see how it is used in practice.
The purpose of the regulations is to remove uncertainty over the regulatory treatment of alternative finance investment bonds, which includes some types of sukuk. The legislation is predicted to reduce the overall cost of issuing sukuk and, as I said, we are committed to reviewing the regime after a period of two years to ensure the rules are functioning as intended. With that, I hope we can approve the order.
Question put and agreed to.
4.47 pm
Committee rose.
 
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