Legislative Scrutiny: Financial Services Bill and the Pre-Budget Report - Human Rights Joint Committee Contents

Bill drawn to the special attention of both Houses: Financial Services Bill

1  Date introduced to first House

2  Date introduced to second House

3  Current Bill Number

4  Previous Reports

5  19 November 2009


7  HC Bill 6

8  None


This is a Government Bill which was introduced in the House of Commons on 19 November 2009. The Chancellor of the Exchequer, the Rt Hon Alistair Darling MP, has made a statement of compatibility under s. 19(1)(a) of the Human Rights Act 1998. The Bill received its Second Reading on 30 November 2009 and began its Committee Stage on 8 December 2009.

Both the Financial Services Bill and the Pre-Budget Report contain measures which are designed to reform remuneration practices in the financial services industry. Because these measures affect individuals' remuneration, they engage the right to peaceful enjoyment of possessions in Article 1 Protocol 1 ECHR and require scrutiny for compatibility with that right.

Powers to control remuneration: the Financial Services Bill

The Financial Services Bill both imposes a new duty on the Financial Services Authority (the FSA), and gives it new powers, in relation to remuneration.[1] The new duty on the FSA requires it to make rules requiring certain persons to have and implement a remuneration policy, and the FSA's rules must require such remuneration policies to be consistent with the effective management of risks and the Financial Stability Board's "Principles for Sound Compensation Practices Implementation Standards". The Bill gives the FSA a broadly worded power to make general rules which may:[2]

  • impose specific prohibitions on the way in which a person is remunerated;
  • provide that any provision of a remuneration contract which contravenes such a prohibition is void (and therefore unenforceable); and
  • make provision for the recovery of any payment which may have been made under such a provision.

In the Lords debate on the Queen's Speech, Lord Woolf raised the following concern about this broad power in the Financial Services Bill:[3]

Finally, I turn to a Bill that at first sight may seem rather inappropriate, considering the title of this debate. I refer to the Financial Services Bill, because in my view its provisions relating to the possibility of forfeiting the salaries of bank employees raise constitutional issues. As the Bill is drafted, the delegated legislation provisions-they appear in a form with which we are unfamiliar-give powers to the Financial Services Authority to take action that could interfere retrospectively with the private contractual rights of employees without providing any backing for that in primary legislation. I submit that this is not an appropriate use of delegated legislation. In my experience the provisions are unprecedented and should surely have been the subject of very careful consideration.

The relationship between an employer and an employee with regard to salary is a matter of great importance to the individual concerned. If interference in that relationship of the sort contained in the Bill is to be undertaken by an authority, it should be done only through very clear and specific provisions contained in primary legislation. We are told that the rules may,

"(a) prohibit persons ... being remunerated in a specified way;

(b) provide that any provision of an agreement that contravenes such a prohibition is void; and

(c) provide for the recovery of any payment made, or other property transferred, in pursuance of a provision that is void".

However, we are not told how and when this is going to be done. The powers will enable the FSA to make rules that authorise it to take action that is clearly penal in nature. As arrangements that lead to the payment of bonuses normally cover a continuing situation, there is clearly a risk that they could be retrospective in effect. I suggest that this aspect of the Bill needs careful examination, particularly in view of the fact that there is no provision in the Bill to enable action taken to be subject to any form of appeal process and that any resort to the courts would have to be through judicial review.

Although Lord Woolf expressed his concerns in terms of the Bill raising "constitutional issues", similar questions arise under Article 1 Protocol 1 ECHR: is the FSA's general power to make rules about remuneration intended to include a power to interfere with existing contractual rights, which amount to "possessions" within the meaning of that Article? If so, the scope of the power to do so must be defined on the face of the Bill with sufficient precision to enable those who might be affected to ascertain when and how they might be affected. In addition, the interference with existing contractual rights must be shown to be proportionate in the sense that they strike a fair balance between the individual and the general interest.

It appears, however, that the wide power given to the FSA in the Bill is not intended by the Government to authorise interference with existing contractual terms. At the conclusion of the Second Reading debate the Minister made clear that it was not the Government's intention to give the FSA the power to interfere with existing contracts:[4]

There is general consensus that remuneration practices in the financial services sector were a contributory factor in the recent financial crisis. That is why we are taking decisive action to tackle remuneration practices that incentivise excessive risk taking. … The shadow Chancellor and others asked about the power that we have proposed in that area and about concerns expressed by Lord Woolf. The power that we are proposing is not a power to interfere with existing contracts-the FSA is not being given retrospective powers. As a public authority, its actions are required to be compatible with the rights in the European convention on human rights, which are protected by the Human Rights Act 1998.

This was confirmed by General Counsel to the FSA, Andrew Whittaker, in Public Bill Committee:[5]

Q 136Mr. Hoban: The other area, which we have managed to avoid commenting on so far today, is remuneration. Will you explain the powers to do with seeking to take over employment contracts?

Andrew Whittaker: Yes. I should start by saying that we are happy with the powers proposed in the legislation. We have an existing code of conduct in relation to remuneration. It focuses on methods of remuneration, to ensure that those that are used are not ones that promote risk. The new legislation would provide an additional backing to that kind of code—specifically, if it were incorporated in the form of rules—that would enable provisions that we had bound by rules then to be ineffective. It would not be a retrospective effect. It would apply after the date on which the rules come in to contracts that are made after that date. We do not see any virtue in retrospection. Indeed, we see a positive virtue in provisions encouraging people to formulate their contracts in a way that complies with the code—that complies with the rules.

Q 137Mr. Hoban: To be clear about it, if someone had an existing employment contract that was in breach of your code, you would not seek powers to tear up that contract, or does it relate only to future contracts?

Andrew Whittaker: Yes. In that situation, it is conceivable that there would be other action that we would want to take. We might, for example, be concerned about the exposures that would result to the firm from that contract of employment. Therefore, we might ask for additional supervision of a trader who was incentivised in a way that we believed was dangerous, but the effect of this clause would not be to make that an unlawful term.

It therefore appears that the generally worded power in the Bill, which on its face appears to give the FSA the power to interfere with existing contractual terms, is not intended to do so. We recommend that the Government make this limitation explicit on the face of the Bill, which should meet the concerns about the provision's compatibility with Article 1 Protocol 1.

The tax on the payment of bonuses: the Pre-Budget Report

In the Pre-Budget Report on 9 December 2009 the Government announced that, in advance of the measures in the Financial Services Bill concerning remuneration taking effect,

where bank (and building society) employees are awarded discretionary bonuses, in whatever form, above £25,000 in the period from the Pre-Budget Report to 5 April 2010, the banks paying these bonuses will pay an additional bank payroll tax of 50 per cent on the excess bonus over £25,000.

In view of the overlap in the subject matter of this part of the Pre-Budget Report and the Financial Services Bill, and the fact that there has been much high profile discussion in the media about whether the tax on bonuses is in breach of the Human Rights Act, we have decided to look at this particular aspect of the Pre-Budget Report in this report.

The Government's justification for the tax on bankers' bonuses is explained in the Pre-Budget Report: it says that it is to encourage banks to take full account of factors such as a prudent approach to risk and the need to ensure a sound capital base when making their decisions about bonuses.

The Government attaches great importance to tackling the remuneration practices that contributed to excessive risk taking by the banking industry. The Government has made clear that the sector needs to develop sustainable long-term remuneration policies that take better account of risk and facilitate the build up of loss-absorbing capital. However, evidence suggests that some may be intending to pay bonuses for the current year that are not consistent with a prudent approach to risk.

… This tax will encourage banks to consider their capital position and to make appropriate risk adjustments when settling the level of bonus payments above the threshold, which is at the level of median earnings in the UK. If banks choose to make awards that are not consistent with a prudent approach to risk, it is only fair that they contribute more to the public finances, in a year when profits have been facilitated by significant taxpayer support for the banking sector as a whole.

It is intended that in the longer term, the remuneration practices will be changed as a result of corporate governance and regulatory reforms … The one-off bank payroll tax will apply until 5 April 2010, but the Government will consider extending the period of the charge so that the tax remains in place until the relevant provisions of the Financial Services Bill come into force.

Tax measures necessarily involve taking property from the citizen (or, in this case, banks) and therefore engage Article 1 Protocol 1. However, the second paragraph of that Article provides:

The preceding provisions shall not, however, in any way impair the right of a state to enforce such laws as it deems necessary … to secure the payment of taxes or other contributions or penalties.

The powers of the state under this provision are recognised by the European Court of Human Rights to be very wide.[6] They are not, however, unlimited. Taxing measures must satisfy the requirements of proportionality, but the threshold of justification to be met by the State is very much lower than in relation to other ECHR rights. The approach to be adopted to determining whether a taxing measure is compatible with Article 1 Protocol 1 is authoritatively set out in the judgment of the High Court in R (on the application of the Federation of Tour Operators) v HM Treasury which concerned an Article 1 Protocol 1 challenge by tour operators to the increase in Air Passenger Duty announced in the 2006 Pre-Budget Report:[7]

[134] The latitude to be accorded by the judicial branch of government to the Executive and Legislative branches varies with the context: see the speech of Lord Nicholls in A v Secretary of State for the Home Dept; X v Secretary of State for the Home Dept [2004] UKHL 56 at [80], [2005] 2 AC 68 at [80]:

"80 … the courts will accord to Parliament and ministers, as the primary decision-makers, an appropriate degree of latitude. The latitude will vary according to the subject matter under consideration, the importance of the human right in question and the extent of the encroachment upon that right."

[135] The right engaged in the present case is less important than Human Rights Convention rights under, for example, arts 2, 3 and 5. In this connection, it is pertinent to recall what the European Court of Human Rights said in James v UK (Application 8793/79) (1986) 8 EHRR 123, para 42 of the judgment:

"42 … the object and purpose of Article 1 (P1-1) … is primarily to guard against the arbitrary confiscation of property."

The encroachment on the claimants' rights under A1P1 in this case does not approach confiscation, and does not demand anxious scrutiny by the court. Far from it, in the present context (see (1986) 8 EHRR 123, para 46):

"46. … The Court, finding it natural that the margin of appreciation available to the legislature in implementing social and economic policies should be a wide one, will respect the legislature's judgment as to what is 'in the public interest' unless that judgment be manifestly without reasonable foundation …"

[136] Thus in the Gasus case [Gasus Dosier-und Fördertechnik GmbH v Netherlands (Application 15375/89) (1995) 20 EHRR 403], referred to above, the European Court of Human Rights held that a measure entitling the Netherlands tax authorities to seize and to realise property in the possession of a defaulting taxpayer that belonged to the applicant, who had sold that property subject to its retention of title, was not disproportionate. It expressed the approach of the Court of Human Rights in such a case as follows (see (1995) 20 EHRR 403, para 60 of the judgment):

"60. As follows from the previous paragraph, the present case concerns the right of States to enact such laws as they deem necessary for the purpose of 'securing the payment of taxes' …

In passing such laws the legislature must be allowed a wide margin of appreciation, especially with regard to the question whether—and if so, to what extent—the tax authorities should be put in a better position to enforce tax debts than ordinary creditors are in to enforce commercial debts. The Court will respect the legislature's assessment in such matters unless it is devoid of reasonable foundation."

[137] In my judgment, there is no difference between the approach of the court to a measure to secure the payment of taxes in the sense of that considered in Gasus and the approach to a substantive tax measure, ie a decision to impose a particular tax or to increase it. In order to challenge successfully such a measure, it must be shown that the legislature's assessment is "devoid of reasonable foundation".

As the Court of Appeal in the same case made clear, an indication of whether a taxing measure is "devoid of reasonable foundation" will be whether it imposes "an individual and excessive burden" on particular people.

Both the High Court and the Court of Appeal in the Air Passenger Duty case concluded that, while the decision to increase that tax was open to criticism, on grounds that the Treasury had overlooked certain matters and it was a tax with retrospective effect, nevertheless it was impossible to conclude that the measure was "devoid of reasonable foundation", nor did it impose an excessive or individual burden on tour operators. The Article 1 Protocol 1 challenge to the taxing measure therefore failed.

It is therefore clear that the hurdle facing anyone challenging a taxing measure under Article 1 Protocol 1 is very high. They must demonstrate that the measure is devoid of reasonable foundation or imposes an excessive and individual burden which is disproportionate to the public good. Even on the basis of the summary justifications provided in the Pre-Budget Report it would appear difficult to conclude that the measure is devoid of reasonable foundation. The measure is likely to raise a not insignificant amount of revenue (estimated to be about £0.55 billion); it is part of a package of measures designed to address excessive risk-taking in the banking industry and to require banks to consider the soundness of their capital base; it is directed at banks rather than individual bankers; and it is intended to be a one-off tax, in place only until the more systemic reforms in the Financial Services Bill come into force. Nor is it likely that those who are most directly affected by the new tax will be able to demonstrate hardship amounting to an excessive individual burden. In our view it is therefore unlikely that the tax is incompatible with Article 1 Protocol 1 ECHR.

1   Clause 11, inserting new s. 139A into the Financial Services and Markets Act 2000. Back

2   New s. 139A(9) Financial Services and Markets Act 2000. Back

3   HL Deb 23 November 2009 col .161. Back

4   HC Deb 30 Nov 2009 cols 935- 936 (Ian Pearson MP). Back

5   PBC 8 Dec 2009 cols 47-48. Back

6   See e.g. Gasus Dosier und-Fordertechnik v The Netherlands (1995) 20 EHRR 403. Back

7   [2007] EWHC 2062 (Admin), [2008] STC 547.Stanley Burnton J.'s reasoning on Article 1 Protocol 1 was unanimously upheld by the Court of Appeal, [2008] EWCA Civ 752, [2008] STC 2524 at para. 21. Back

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