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Lord Jenkin of Roding: I listened to the noble Lord, Lord Sharman, with much interest. I believe that there should be a much clearer duty placed on the FSA, together with the Governor of the Bank of England, and so on, to have regard to the problem of systemic risk. My interest stems from the fact that at about three o'clock on a Friday afternoon in 1970, not long after my appointment as Financial Secretary to the Treasury, I was beginning to think of travelling to my constituency for my weekly surgery when officials told me that there was a problem. They said that the Mersey Docks and Harbour Board would be unable to pay the wages that weekend. I asked them why the board could not appoint a receiver and they replied that under its Act of Parliament it was a statutory port authority and had no power to do so. From the point of view of Merseyside, in particular a large number of widows and orphans, it was a very serious matter and became something of a cause celebre.
It was perfectly clear to me that in that case the Treasury was unable to give advice. Obviously, the bank was involved. Clearly, we did not intend to bale out the board; we had come into office on the clear understanding that we would not assist companies in that way. We had turned our back on what our
predecessors had done. It was an isolated matter. However, the following week I had lunch in the City as a guest of Samuel Montagu where the reaction of the large number of bankers around the table was one of total horror. How on earth could we have allowed an organisation of that kind to go into liquidation? After some discussion my reaction was to say that what they needed was a spectacular bankruptcy to understand the philosophy of the new government. A few weeks later we were greeted by the problems of Rolls-Royce.The lesson I draw is that there must be a clear responsibility. Obviously, a trust port is nothing like BCCI or the failure of the German bank where there was a risk of a domino effect. However, this is an issue of considerable importance. Although my experience of some 30 years ago may not be entirely relevant, it left the searing memory in my mind that there was nothing we could do except shell out large sums of public money, which was not what we were about.
I support the amendment in this group proposed by my Front Bench. We need to ensure that the Bill is clearer on this issue.
Lord Eatwell: I speak with some trepidation having been generally admonished on the last occasion I spoke. I promise noble Lords that from now on my speeches will contain no colourful language, will be irredeemably dull and will concentrate on technical matters.
I speak to Amendment No. 54, which stands in my name and is grouped with Amendment No. 13 relating to the definition of market confidence and systemic risk. At Second Reading I argued that one of the most important tasks of the FSA is the management of systemic risks; that is, the risks that the actions of individual firms may create for the stability of the financial system as a whole. I argued then that this task is even more important than the protection of the consumer. What is the point of protecting consumers' rights if at the end of the day the consumers' savings are consumed in a general financial crisis?
In managing risk and ensuring stability, the role of the regulator is paramount. In the face of a general collapse, the central bank--in our case the Bank of England--may step in as lender of last resort to prop up the markets. But by the time things have gone that far the financial system will already be in extreme jeopardy. Just as important--in many ways more important--are the day-to-day activities of the regulator which seek to limit the risk to which society is exposed: for example, by requiring firms to maintain prudential capital; promotion of effective risk management practices; ensuring that participants in the market are fit and proper; identifying and enforcing best practice, and so on, through the wide range of regulatory procedures. There can surely be little doubt that a core objective of the FSA is the management of systemic risk; that is, the maintenance of stability and--it is crucial in financial markets--the expectation of future stability.
The Joint Committee, chaired by the noble Lord, Lord Burns, recommended that the Government acknowledge on the face of the Bill that a fundamental
objective of the FSA must be the control of systemic risk. In one of the most puzzling actions of the Government to date, they rejected that recommendation of the Joint Committee. The Government's argument, which was paraphrased by my noble friend Lord McIntosh at Second Reading, was that to define the objective of market confidence--that was the committee's proposal--as,
- "maintaining confidence in the soundness of the financial system",
- "maintaining confidence in the effective prudential supervision of individual institutions".
This is a peculiar argument. In fact it is an argument that, in politest terms, contains very little sense. (Your Lordships will note that I am maintaining polite language.) How could the Government maintain confidence in the soundness of the financial system other than by "effective prudential supervision of individual institutions"? That is how it is done; there is no other way. The first goal must embody the second. I do not believe that my noble friend could give me even one example of effective prudential supervision of an individual institution that does not contribute to the maintenance of confidence in the soundness of the financial system as a whole.
Why is the issue of systemic risk so important? Why am I so concerned about spelling out the management of systemic risk as an objective of the FSA? It is because in doing so we would establish beyond all reasonable doubt the central role of the FSA in this area. That is essential for two reasons. First the tripartite agreement between the FSA, the Bank of England and the Treasury--it has been referred to today--clearly establishes the responsibilities of the three bodies in securing the stability of the financial system, and acknowledges the overall role of the Bank of England. Clearly defining the role of the FSA in maintaining stability would add significantly to the clarity of that document.
Secondly, clarifying the role of the regulator is vital for the FSA's international relationships. In the modern world, many of the threats to this country's financial stability derive from international financial markets. It is, therefore, in the international arena that risks must be managed as a co-operative venture between national regulators. The FSA is our national regulator. It should be crystal clear that the British Government have full confidence in the FSA to do that job. My amendment would make crystal clear the Government's commitment and confidence.
In Committee in another place, my honourable friend Ms Patricia Hewitt acknowledged that the term market confidence did mean the regulation of systemic risk, but also stated that it went wider. I have searched for a definition that would capture what Ms Hewitt said. I think that I have managed to find one; help was at hand. My amendment is taken word for word from the FSA's document, A New Regulator for the New Millennium. In other words, my amendment contains
the words of Mr Howard Davies. On page 5 of that document, the FSA states that the objective of maintaining confidence,
- "involves, in our view, preserving both actual stability in the financial system and the reasonable expectation that it will remain stable. This is achieved through ... preventing material damage to the soundness of the UK financial system"--
- "caused by the conduct of, or collapse of, firms, markets or financial infrastructures".
- "explaining on what basis confidence in the UK financial system is justified; this includes stating explicitly what the regulator can and cannot achieve".
I cannot imagine a better characterisation of that wider approach to the definition of systemic risk that Ms Hewitt sought. That is why I have used the FSA's own words in my amendment. I am sure that my noble friend would not want to repudiate Mr Davies's own document and will accordingly be happy to accept the FSA's definition of market confidence as a welcome clarification to the Bill.
6.15 p.m.
Lord Fraser of Carmyllie: The noble Lord, Lord Eatwell, indicated that he was much chastened by some earlier remarks. I hope that it does not upset him more if I say how much I agree with him on the amendment. I am sure that the noble Lord is right. That is not just because I agreed with him in the Joint Committee; we should have some indication of the importance of dealing with systemic risk on the face of the Bill. I like the wording that he has lifted from the FSA report.
The other publication which seemed to back much of what he said was the Treasury's own paper, the Draft Recognition Requirements for Investment Exchanges and Clearing Houses, published in February of last year. Page 3 explains that the requirements for these bodies are expressed at a fairly high level. It continues:
- "The additional requirements concerning default rules are more detailed in nature. This is because if the high degree of systemic risk that can arise from a default on market contracts".
That series of requests for further information tends to be regarded by practitioners as the most excessive and intrusive. If there is to be greater understanding of the relationship between the FSA and individual practitioners as regards requests for further information, the City should understand that they arise because of concern about the control of systemic risk. In all the circumstances, it seems desirable to expand the definition in the Bill along the lines the
noble Lord indicated. If that were done, I believe that there would be a greater understanding of what the FSA will be required to do.
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