The
Committee consisted of the following
Members:
Chair:
†
Mr Peter
Bone
†
Afriyie,
Adam (Windsor) (Con)
†
Birtwistle,
Gordon (Burnley)
(LD)
†
Brown,
Lyn (West Ham) (Lab)
†
Goodwill,
Mr Robert (Scarborough and Whitby)
(Con)
†
Henderson,
Gordon (Sittingbourne and Sheppey)
(Con)
†
Hoban,
Mr Mark (Financial Secretary to the
Treasury)
†
Jamieson,
Cathy (Kilmarnock and Loudoun)
(Lab/Co-op)
†
Kwarteng,
Kwasi (Spelthorne)
(Con)
†
Leslie,
Chris (Nottingham East)
(Lab/Co-op)
†
McCann,
Mr Michael (East Kilbride, Strathaven and Lesmahagow)
(Lab)
†
McGovern,
Jim (Dundee West)
(Lab)
†
O'Donnell,
Fiona (East Lothian)
(Lab)
†
Pearce,
Teresa (Erith and Thamesmead)
(Lab)
†
Percy,
Andrew (Brigg and Goole)
(Con)
†
Redwood,
Mr John (Wokingham)
(Con)
†
Sharma,
Alok (Reading West)
(Con)
Williams,
Stephen (Bristol West)
(LD)
Wilson,
Sammy (East Antrim)
(DUP)
Mark Etherton, Committee
Clerk
† attended the
Committee
Fourth
Delegated Legislation
Committee
Tuesday 1
February
2011
[Mr
Peter Bone
in the
Chair]
Draft
Investment Bank Special Administration Regulations
2011
10.30
am
The
Financial Secretary to the Treasury (Mr Mark Hoban):
I beg
to
move,
That
the Committee has considered the draft Investment Bank Special
Administration Regulations
2011.
The
Chair:
With this it will be convenient to discuss the
draft Investment Bank (Amendment of Definition) Order
2011.
Mr
Hoban:
It is a pleasure to serve under your chairmanship
this morning, Mr Bone.
The chief
lesson from the financial crisis is that the failure of financial
institutions, including investment banks, can cause great instability
to the financial markets and the wider economy. Interventions by
authorities around the world to support firms and the wider financial
system, in order to mitigate this impact, have reinforced perceptions
that some institutions are too big or too important to fail: the
so-called systemically important financial institutions, or SIFIs. We
therefore believe that it is vital for us to ensure that it is possible
to resolve SIFIs without triggering a systemic crisis or providing them
with taxpayer support. By reducing market disruption in the event of
the failure of an investment bank, the special administration regime
being debated today is a step towards achieving that
objective.
However,
the regime by itself is not enough. That is why the Government are
overhauling the failed tripartite regulatory system, supporting the
introduction of tougher capital and liquidity requirements, and
strengthening resolution frameworks. The Government are also working
closely with the Financial Stability Board and the European Commission
to develop a robust, internationally consistent policy framework to
address the risks posed by SIFIs. Finally, the Independent Commission
on Banking is due to make its recommendations in September on how to
address systemic risk in the banking sector. The Government are looking
forward to receiving those
recommendations.
I
will now turn to the focus of today’s discussion. The Insolvency
Act 1986, although perfectly suitable for winding up most firms, does
not take into account the specific difficulties and potential conflicts
that an administrator faces when winding up an investment bank. This
has been demonstrated through the ongoing administration of Lehman
Brothers International Europe in the UK, where the priority was in
accordance with the administrator’s objectives of rescuing the
company or maximising returns to creditors before winding it up. This
potentially places the administrator in a difficult position if
additional resources and focus are required
to return client assets or resolve counterparty positions. However, we
know that returning client assets or resolving those positions would
contribute to confidence in financial markets and facilitate their
smooth functioning. The existing objectives of administrators therefore
give rise to lack of clarity and create uncertainty, which is harmful
to the UK’s reputation as a safe place for investors to entrust
their assets. It is also costly for creditors, as the administrator
needs to seek frequent direction from the courts before taking the
necessary actions.
The new
special administration regime we are debating today will address the
uncertainty by enabling the administrator to have as a specific
objective the return of client assets, thus reducing the length of
administration and minimising the costs for creditors and the wider
economy. We have gone to great lengths to ensure that this is the case.
The proposed regime has been designed with the help of an advisory
panel of more than 30 industry practitioners. The
regulations are the result of a detailed two-year consultation, and the
new regime has the support of the industry. Having a robust insolvency
regime, which can wind up complex institutions such as investment
banks, and which ensures that investors have confidence that their
assets and money will be returned promptly, is a major source of the
UK’s competitive advantage in financial services. We must
maintain this
advantage.
I
shall provide a brief summary of the two statutory instruments that are
under consideration today. The draft Investment Bank Special
Administration Regulations provide an administrator with three
objectives. The first gives the administrator a duty to return client
assets. The administration of Lehman Brothers in the UK has
demonstrated the importance of the market having confidence that client
assets will be returned promptly. This is to prevent clients suffering
from undue delay in recovering assets belonging to them, and it will
ensure that investors have confidence in the UK financial system.
Having the first objective also allows the Financial Services
Authority, if necessary, to direct the administrator to prioritise the
return of client assets above other objectives, a power I will return
to
later.
To
help achieve the first objective, the administrator will be able to set
a bar date—a deadline—for the submission of claims to
client assets. This will significantly improve the speed with which
client assets can be returned. The bar date will have accompanying
safeguards, which will minimise the possibility of any client losing
out from its implementation; for example by failing to submit a claim
before the bar date, or even failing to submit a claim altogether. The
safeguards will be set out in the insolvency rules, which will be laid
separately before Parliament shortly after the regulations come into
force.
The
second objective is to ensure that the administrator shares information
with market infrastructure bodies and the authorities. When an
institution becomes insolvent, it is essential that the administrator
works with the relevant clearing houses, exchanges and authorities to
resolve failed trades and open positions as soon as possible. A failure
to do so would threaten market confidence and the stability of our
financial markets. It is also important that the administrator works
with the FSA and other authorities to facilitate any actions the
authorities might need to take as a result of the investment bank
becoming insolvent.
Lastly,
the third special administration objective follows the existing
objectives for general administration under the Insolvency Act 1986.
That ensures that the administrator continues to work in the best
interests of all
creditors.
In
addition to the new objectives, the new regime will give an additional
power to the FSA. After consultation with the Treasury and the Bank of
England, the FSA will be able to direct the administrator to prioritise
one or more of the special administration objectives over the others.
However, I stress that the regulations make it clear that the power can
be used only if it is in the interest of stability in the financial
markets.
Another
key component of the regime is that suppliers of key services to
investment banks will not be allowed to terminate their service if the
administrator continues to meet their payments. That will ensure that
the administrator can rescue or wind up a company far more effectively.
The proposal will affect suppliers of any equipment used by the
investment bank in connection with the trading of securities or
derivatives, suppliers of financial data and infrastructure that permit
electronic communication services, suppliers of secure data networks
provided by an accredited network provider and suppliers of data
processing
capabilities.
Adam
Afriyie (Windsor) (Con):
This is a veritable tome of
secondary legislation, and we do not have enough time in this short
sitting to consider it in detail. Something alarmed me. The Minister is
suggesting that under the regulations, a supplier to a financial
institution would be unable to withhold services even if they were not
being paid. There could easily be a situation where a supplier in deep
financial difficulty is forced by the regulator to continue to supply
services without money. There seems to be something fundamentally wrong
with that picture. Perhaps my hon. Friend could paint it in slightly
clearer
terms.
Mr
Hoban:
To clarify the point for my hon. Friend, a supplier
can suspend services if they have not been paid for 28 days. The
measure is not an open-ended commitment to continue supply without
payment, but a requirement for the administrator to make those
payments. However, it is worth making the point. It mirrors what is in
the Banking Act 2009. To create financial stability and ensure the safe
return of client assets, it is clear that the services an investment
bank relies on to complete its business should be available to the
administrator. That is why that power is in the statutory instrument.
However, we recognise the importance of safeguarding the interest of
suppliers, which is why the regulations allow suppliers to cease
providing supply if they have not been paid by the administrator for 28
days. I think that provides the right protection for small
suppliers.
The
second statutory instrument under debate today is the draft Investment
Bank (Amendment of Definition) Order 2011. Currently, the Banking Act
stipulates that firms holding client assets are within the scope of the
special administration regime. The order amends the scope of the regime
to ensure that all investment banks holding client assets or client
money are included. The Government and their investment bank liaison
panel believe that it is necessary that the new regime applies to all
investment banks. Without the order, there would be a two-tier
insolvency regime for the return of client property, which would only
serve to further complicate the process.
However,
the Government have excluded institutions that hold client assets only
for the purpose of carrying on an insurance mediation activity. We have
done that for the simple reason that the special administration regime
is not designed for insurance mediation.
To summarise,
the legislation before the Committee will help preserve the UK’s
reputation as a leading destination for investment banking. It is good
for the industry and good for the client, and I commend it to the
Committee.
10.40
am
Chris
Leslie (Nottingham East) (Lab/Co-op):
I thank the Minister
for his summary of this considerable and important piece of secondary
legislation. I understand that it needs to come into force by a
deadline that is rapidly approaching. Although it is several years
since the collapse of Lehman Brothers, and the focus of the national
media on such questions, the secondary legislation relates to the
repair of the safety procedures that are essential to ensure that we do
not find ourselves in a similar position. Obviously, Lehman Brothers
was the principal example of the collapse of an investment bank, and it
led to a volume of political and policy discussions about the size and
activities of investment and commercial banks, with arguments about
whether banks were too big to fail, and particularly about whether the
insolvency regime in the United Kingdom could handle the default of an
investment
bank.
A
number of lessons should be learned from the Lehman Brothers scenario,
the first of which is that financial regulation worldwide was
unharmonised and still, to a large extent, has difficulties in lining
up across different countries. We also have to learn the lesson from
the poor strategic decision making over Lehman Brothers by the
authorities—unlike over Bear Stearns, which JP Morgan was
brought in to purchase—who were scouring the world for anybody
who would buy it. Even pushing Lehman Brothers on Barclays did not
work, and letting that institution go made the credit markets freeze
up. Our economic climate now is partly the result of that
case.
Several
other aspects of that saga need to be properly understood, including
the opacity and complexity of many financial instruments that
investment banks are involved with. Certainly, there is a lesson about
bankruptcy and insolvency systems, which the regulations seek to
address. They do that through the special administration regime, which
is one of the core components that need to be adopted. It was under the
Labour Administration that the thinking behind many of the proposed
arrangements was started, so I am glad that they have at long last been
brought forward. They are based on consultations that have taken place
since December 2009, and I am grateful to institutions that
responded to the
consultation.
I
have some specific questions for the Minister, because of the
technicality and seriousness of some of those matters. One relates to
the point raised by the hon. Member for Windsor, who asked about
continuity of supplies. That stands out for those listening to such
things; if suppliers to an investment bank hear that said of an
investment bank and know that they will be mandated to keep the
investment bank in business, even if it is in administration, they will
want to know what it involves. I am glad that the Minister has set out
the
28-day rule. Will he elaborate on arbitration in a situation where a
supplier stops working? Many suppliers, seeing that a firm is going
under, will just say, “I’m not going to do any more
business with you.” How will the supplier be forced to continue?
Will it be a matter for the courts, with the administrator having to
undertake a judicial process? If necessary, how will the supplier be
forced to continue the supply of goods and services, and what will
happen if they refuse to do so? Will the Minister elaborate on that
particular scenario, which is hypothetical, but still
important?
Will
the Minister comment on the adequacy of record-keeping in investment
banks? Clearly, we need to share data between regulators and
administrators in the company itself swiftly and easily given that so
much complexity is involved in many of the financial instruments. Do
the proposals contain steps to ensure an adequate threshold of
record-keeping that would be easily interpretable by a special
administrator taking over a particular
scenario?
I
want to ask about the external support that might be available to help
a special administrator make accurate valuations of the assets that
might exist in an investment bank. It would need to be undertaken
fairly quickly and on a speedy time line, and the complexity of the
arrangements suggests a need to ensure that facilities exist to help a
special administrator place valuations on the assets. The Minister has
talked about the abolition of the tripartite system, so when the FSA is
abolished, which regulator will be responsible for the prioritisation
exercise? Will it involve the prudential regulation authority? Will it
be wholly within the remit of the Consumer Protection and Markets
Authority, as proposed? I should be grateful if the Minister could give
us a sense of that because obviously, under his proposals, the
FSA’s lifetime—although referenced in the order—is
short.
Can
the Financial Secretary outline the potential requirement of investment
banks to maintain the operational reserve that is mentioned in the
regulations to cover the expense costs arising from the insolvency
process? How will the scale and size of that reserve be determined, and
when will it take effect? Where will the reserve be kept? Will it be
kept as a budget line in the investment banks themselves? Presumably,
following enactment of the regulations, investment banks will have a
requirement to place the reserve somewhere, or given that there is a
public interest in the reserve, will there be public rights over some
of
it?
Adam
Afriyie:
As I said, this is a fairly hefty tome of
secondary legislation. It looks as though it has arisen mainly because
of the financial crisis two or three years ago. It is easy to blame the
investment banks solely for the troubles that hit the country, but many
of the measures under the regulations could have been taken a lot
sooner, rather than being knocked together in the
past two or three years in response to a crisis. Surely, the
previous Government could have worked on them earlier. It is a massive
tome and there must have been some way to examine the regulations way
before the crisis actually
hit.
Chris
Leslie:
Yes, we should collectively have been taking more
action. Certainly the genesis of the regulations was under the previous
Administration, and I am glad
that we started off the process. I understand the Banking Act to mean
that if the regulations do not come into force next week, the legal
cover for their enactment would lapse. It is the case that the Treasury
has been pushing them right to the wire and, given that we have not
been in office since last May, I would have expected them to have come
forward sooner. However, the regulations are complex, and Treasury
officials will have been working hard to ensure that they come into
effect before the deadline. Perhaps the Minister can explain the
particular timing that the Treasury has
chosen.
The
Financial Secretary mentioned that from time to time, investment
banking can be a complicated affair and that is certainly the case if a
universal bank—in other words, an investment banking
operation—is wrapped together with a retail deposit-taking
institution. Presumably, there will be a joint insolvency procedure, so
if the universal bank fails, and given that that is the point at which
most of our constituents would be affected, can the hon. Gentleman give
an assurance that there is a safety net for them as creditors to
receive their money back if their savings are in an institution wrapped
together with investment banking operations. Will the Minister comment
on the Department’s thinking on the separation or firewalling
between investment and retail banking operations? I know that is
something that the Independent Commission on Banking is looking at, but
it is clearly relevant in this
case.
There
are some important lessons to learn from Lehmans, for example, not
least of which are the cross-border, international perspectives of the
various regimes that apply to special administration. Where are we in
terms of worldwide and, in particular, EU alignment of such
administration regimes? Will the Minister update us on that? Which EU
institutions would take a lead on both the policy alignment of the
administration arrangements and the taking of action, if necessary, on
an investment bank that had operations in several jurisdictions? Is it
something that would fall to the new European Banking Authority, which
seems to be one possible
option?
My
final question is about the separation of client money from corporate
accounts. Some Members may be aware that that has been increasingly
under the spotlight. In the last week, the Financial Services Authority
fined Barclays more than £1 million for mingling client moneys
with their corporate accounts. In its defence, Barclays gave the
impression that it was not actually aware that some £750 million
had been treated in such a way, but once it was discovered, the bank
tried to correct it. That gives us a flavour of the amounts of money
that are sloshing around in some large institutions. Do the provisions
contain the correct arrangements for the proper segregation of client
money accounts, so that we can ensure that in an insolvency situation,
clients have their resources speedily returned to
them?
Two
years after the collapse of Lehman Brothers, there is still too much
vagueness about what would happen if a major investment bank failed. Do
we really know where the chains and the ends of some financial
instruments actually sit within such institutions? Do we really have a
sense of the true leveraging of some banks? Have we, sincerely, made
any real progress on the cross-border insolvency and resolution
regimes? Again, are we sufficiently chipping away at the moral hazard
of this too-big-to-fail issue?
Those
are my particular anxieties. Obviously, we are discussing the issues in
a political context, but all parties want to work together to put these
situations right. For our part, we support the regulations, but I
certainly feel that further leadership is urgently required from the
Treasury on the outstanding
questions.
10.53
am
Mr
Hoban:
I am grateful to the hon. Member for Nottingham
East for welcoming the proposals. He made some important points, and I
want to deal with them
seriously.
The
first point goes back to the comments made by my hon. Friend the Member
for Windsor on why it has taken so long for the measures to be put in
place. The reality is that the weakness of the existing administration
and insolvency regimes was laid bare through the financial crisis.
There was no mechanism in place to facilitate, for example, the orderly
wind-down of Northern Rock. It would have been better if those
processes had been in place earlier, but the Banking Act 2009 is a
serious piece of work that tries to address that. It must be said, and
it is credit to the previous Government, that if one looks around the
international community, the UK is still seen as the leader in
resolution regimes. The regulations take that debate a stage further.
Investment banks are complex institutions. There was a great deal of
work done in the run-up to the Banking Act to get the regime right for
deposit takers, and it is right that time was taken to get the regime
right for this set of
rules.
On
the point made by the hon. Member for Nottingham East about Europe,
there is ongoing work at EU and global level through the Financial
Stability Board. The Government support the Commission’s efforts
to introduce measures and ensure that member states have minimum
resolution toolkits to reduce the cost of bank failure. Given the
difference in legal systems between member states, those cannot be
identical, but we need a common toolkit and the Commission is working
on that at the moment. We are considering in detail the
Commission’s proposal for an EU crisis management framework and
we will respond to the consultation on that in due course. We will also
seek to address the Commission’s intention to catch investment
firms within a future European
framework.
The
debate on reform at European and global level goes in parallel with the
work that is taking place here in the UK. The hon. Gentleman referred
to the Independent Commission on Banking, which is chaired by Sir John
Vickers. Indeed, we set up the commission to look at some of the same
issues. It would be wrong for the Government to prejudge the outcome of
Sir John’s work, but clearly this is an area that he
is looking at
carefully.
The
hon. Gentleman rightly raised the point about the adequacy of
record-keeping in investment banks and ensuring that there is proper
identification of client assets, including client money. That is an
area where more work needs to be done. The FSA leads on that work,
which is outside the scope of the instrument before us today, but the
FSA is committed to enhancing the client asset sourcebook to ensure
proper protection for client assets. This is an area where weaknesses
have been uncovered and more work needs to be done to resolve them.
Within the remit of the FSA is the concept of an operational reserve.
The FSA will take that forward, undertake a cost-benefit analysis and
consult on the proposal in due course.
To
return to the issue of suppliers, and to amplify the point I made
earlier, the supplier can terminate a contract if it has not been paid
for 28 days, or if the administrator consents to the termination or the
court directs the administrator to end the contract—for example,
in a case where the supplier could demonstrate hardship if the supply
was not terminated. The administrator is accountable to the court and
it is very much a court
process.
The
hon. Member for Nottingham East asked what would happen if a supplier
chose to terminate the contract earlier. In the worst case scenario,
which one hopes would not happen, the administrator could go to court
to argue a statutory breach of contract and then use a sanction through
the court to require, through a mandatory injunction, the supplier to
provide the specific goods. Again, there is a requirement on the
administrator to ensure that suppliers are paid for the services that
they
provide.
Mr
Michael McCann (East Kilbride, Strathaven and Lesmahagow)
(Lab):
Does that mean that a company can be compelled to
provide a service even if they have not been paid? In those
circumstances, would the company still have to provide the service if
the court ordered it? That seems rather
bizarre.
Mr
Hoban:
The point is that the administrator must pay the
supplier and, if the administrator has not paid the supplier after 28
days, the supplier can terminate the contract. There are safeguards to
ensure that where a supplier is important or vital to the functioning
of a bank, the court can require the contract to be enforced. Let me
give the hon. Gentleman an example. To make a broader point about
banking, if one of the key contracts was to provide the power to
service ATMs—cash machines—and the supplier cancelled the
contract so that ATMs did not actually work, his constituents and mine
would rightly be angry, and it would cause financial instability if
cash machines stopped working. We need provision to be in place to
ensure that services that are key to continuing the function of an
investment bank can be provided, to ensure that assets are returned and
to ensure that we get the best return to creditors, but with requisite
safeguards for suppliers. That is the right
position.
Cathy
Jamieson (Kilmarnock and Loudoun) (Lab/Co-op):
I am trying
to understand this in the context of investment banks. Can the Minister
describe any other circumstances where there are parallel arrangements
for provision of services for other organisations that are in
administration?
Mr
Hoban:
For other types of organisation the administrator
seeks either to sell the business as a going concern or to wind it up.
There may be situations in which the business is a going concern and
that power may be used, so it is not necessarily unique to investment
banks. It is certainly a requirement under the Banking Act. That is why
the proper safeguard is in place.
If the hon.
Lady has a constituent who is a creditor of a business that could be
sold as a going concern to get a better value, she might want such
services provided rather than see that constituent or business getting
a worse return because of businesses being subject to a fire sale. The
measures contain a set of important
balances to maximise the value that creditors get from the sale of a
business, which is why it is important that the proper safeguards are
in place. Provisions under the Insolvency Act, for example, relate to
supplies of water or gas, the telephone, and so on, so the measures are
not new; they are an extension of existing
arrangements.
The
hon. Member for Nottingham East rightly raised a query about the
interaction of provisions under parts 2 and 3 of the Banking
Act, and the arrangements for a universal bank. Where stabilisation
measures or other measures under the Banking Act are used in connection
with a deposit taker that is also an investment bank, the priority is
either to ensure that assets are transferred to a new owner,
or—where the bank is insolvent—to ensure that deposits
are paid out through the Financial Services Compensation Scheme. That
takes priority over the special administration regime. In reality, in a
universal bank where a number of administrators have been appointed,
such debts would move in parallel.
Chris
Leslie:
When the FSA folds, the new regulator will take on
those
responsibilities.
Mr
Hoban:
Indeed. One of the unfortunate drafting problems in
the Banking Act is the reference to investment banks, but the
regulations cover investment firms. An investment bank will be covered
by the Prudential Regulation Authority. Investment firms will also
include, for example, asset managers, who hold client assets and money.
They will be regulated on a prudential basis by the Consumer Protection
and Markets Authority, so there will be a clear division of powers
between the bodies, depending on the nature of the firm that is being
regulated.
In
conclusion, the measures are an important strengthening arrangement
that will ensure that customers of investment banks have their client
assets and money returned as quickly as
possible.
Adam
Afriyie:
On a point of order, Mr Bone. Can you offer some
guidance? This is clearly a weighty tome, which the Minister has
presented very well. If, however, a Member thinks that there are errors
or difficulties in this massive statutory instrument, such as one or
two of those that we have highlighted, what paths are available to
correct or change them?
The
Chair:
I thank the hon. Gentleman for that point of order.
Statutory instruments cannot be changed or amended in a Delegated
Legislation Committee. In the past, comments have been written to the
Minister. I point out to the hon. Gentleman that on Thursday
there is a Westminster Hall debate on parliamentary
procedures.
Mr
Hoban:
Perhaps I can help my hon. Friend the Member for
Windsor, because I am sure he is not as familiar with the Banking Act
as I am, which is probably wise. A review clause is built into section
236 to ensure that two years after the orders come into force they will
be reviewed to ensure that they remain fit for purpose. That will be
the formal point at which matters can be reviewed. If my hon. Friend
has any further insights, I will be happy for him to follow them up
with me.
The
Government—this Government and the previous
Government—have sought to work closely with industry to get the
arrangements right, and there has been widespread consultation over the
past two years to achieve that, which is why it has taken so long to
table these measures. We want to make sure that they work efficiently
and that the right safeguards are in place. It is because the measures
are so important that we have taken time over them.
It is
important that we strengthen arrangements for the administration of
investment banks. That will make an important contribution towards
financial stability. It demonstrates that we have learned some of the
lessons of the financial crisis. Again, it shows the wider world the
active measures that the UK is taking to minimise the disruption caused
by the failure of financial institutions.
Question
put and agreed to.
Resolved,
That
the Committee has considered the draft Investment Bank Special
Administration Regulations
2011.
Draft
Investment Bank (Amendment of Definition) Order
2011.
Resolved,
That the
Committee has considered the draft Investment Bank (Amendment of
Definition) Order 2011.—(Mr
Hoban.)
11.6
am
Committee
rose.