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General Committee Debates
Delegated Legislation Committee Debates
|©Parliamentary copyright||Prepared 2nd February 2011|
Publications on the internet
General Committee Debates
Delegated Legislation Committee Debates
Draft Investment Bank Special Administration Regulations 2011
The Committee consisted of the following Members:
Mark Etherton, Committee Clerk
† attended the Committee
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
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.
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
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.
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.
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
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.
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.
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.
|©Parliamentary copyright||Prepared 2nd February 2011|