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Committee (5th Day)
3.20 pm
Clause 167: Contingency funding
159: Clause 167, page 88, line 32, at end insert—
“(da) arrangements for institutions that have permission under Part 4 of the Financial Services and Markets Act 2000 to carry out the regulated activity of accepting deposits (within the meaning of section 22 of that Act, taken with Schedule 2 and by order under section 22) but are not incorporated in, or formed under the law of, any part of the United Kingdom;”
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Baroness Noakes: Amendment 159 seeks to extend the contingency funding arrangements to foreign branch banks. We discussed the position of branches of foreign banks in earlier amendments and I now come to their impact on the Financial Services Compensation Scheme.
My amendment adds a paragraph to the list of matters which contingency funding regulations may cover, so that arrangements can be made for branches of foreign banks which are allowed to accept deposits in the UK to contribute. It is clear from the Icesave example that the Financial Services Compensation Scheme had an important role to play in making sure that UK depositors received a return of their funds, both in respect of the amounts which should have been paid by Icelandic authorities and the extra amounts that were paid.
In another place the Minister was fond of defending various aspects of the Bill on the grounds of future-proofing it against problems that might arise. My amendments are not even future-proofing; they are simply dealing with situations that have already arisen and carrying those into the possible new contingency funding arrangements. If contingency funding is introduced—and we will debate that shortly—foreign banks which take deposits in the UK should be included within its scope. I beg to move.
Lord Davies of Oldham: Clause 167 provides for the creation of contingency funds for the Financial Services Compensation Scheme, and this amendment appears to be intended to ensure that contingency funds could be used to meet the expenses arising from the failure of deposit-taking firms which are incorporated outside the UK but have Part 4 permissions like UK banks. The amendment, however, would only cover banks incorporated outside the European economic area which establish branches in the UK. These banks need a Part 4 permission to open a branch here. EEA banks can establish branches here using a passport issued by the home state authorities under the relevant EC directive. They are still authorised persons but qualify for authorisation under Schedule 3 rather than by having a Part 4 permission.
I assume, therefore, that the amendment is a desire to make clear that, if pre-funding were restricted to banks and building societies, as the noble Baroness has proposed, this would not mean just UK banks and building societies. The objective is helpful but the amendment is unnecessary.
Foreign banks which have branches in the UK are authorised persons. Non-EEA banks must join the FSCS and contribute to its levies. European economic area banks which join the FSCS to top up the coverage for their depositors also have to make an appropriate contribution to any FSCS levies. Pre-funding, if it were introduced, would not change that, so the proposed addition to Clause 167 would be redundant. I therefore hope that the noble Baroness, moving what I hope is a probing amendment, will think that this is a satisfactory explanation and be prepared to withdraw it.
Baroness Noakes: I want to clarify a small point. The Minister said that pre-funding would not change “that”, being that foreign banks had to pay an appropriate
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Lord Davies of Oldham: The noble Baroness is asking me to stray down paths on the pre-funding position as a whole that I am not currently prepared to follow. I think, however, that I can reassure her on that point.
Baroness Noakes: I am mystified by the Minister’s reply, but will not prolong this. I might take it up outside the Committee.
Baroness Noakes: I also speak to the related Amendment 159B, and have grouped a question on whether Clause 169 should stand part of the Bill with these amendments, for the convenience of the Committee. These are probing amendments about the investment of funds within the Financial Services Compensation Scheme. As I understand it, if contingency funding were introduced, the aim would be to amass between 1 and 2 per cent of deposits. In today’s money that would amount to around £15 billion, which is a not inconsiderable sum.
My Amendments 159A and 159B amend subsection (2)(f) of proposed new Section 214A of the Financial Services and Markets Act 2000, to be inserted by Clause 167. New paragraph (f) allows regulations to deal with how funds held in the compensation scheme are to be invested, and my amendments say that any such investment must not distort existing markets; that is, the Financial Services Compensation Scheme must not use its financial muscle to become dominant in any investment market. There are many investment markets in which even this sum of money would not be noticed, but that would not necessarily be the case for all potential investment homes for the money.
I have linked these amendments to new Clause 169 because that clause allows contingency fund money to be invested in the National Loans Fund, as specifically referred to in new paragraph (f). In another place, the Minister said that this would in fact be the default option for contingency fund money. Will the Minister confirm whether that is the position? It seems to have both advantages and disadvantages. On the one hand, it is clearly inefficient for the FSCS to set up an investment management arm to manage contingency funds. If it did so, it may well run into the dangers posed by my Amendments 159A and 159B. On the other hand, however, the investment returns earned in the compensation scheme ought to be at least as good as the banks themselves would have got, otherwise that will in due course penalise the banks as they would have lost the opportunity to make their returns and they may have to put even more money into the compensation scheme at a later date.
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Will the Minister explain on what terms the Financial Services Compensation Scheme would expect to lend its money to the National Loans Fund? Subsection (2) of new Section 223A of the Financial Services and Markets Act 2000, inserted by Clause 169, allows the Treasury to set terms. What sorts of terms would be set? Would they be market returns? If they are lower than market returns, how can the Government justify setting up pre-funding, taking the money and sticking it in the NLF to the disadvantage of the banks?
3.30 pm
Lord Davies of Oldham: I appreciate the concerns expressed by the noble Baroness but hope I am able to persuade her that Amendment 159A and Amendment 159B would be unnecessary. As I hope I made clear in my last response, we have no intention of introducing pre-funding. It is not the time for doing that. However, if pre-funding were introduced our intention is that the contingency funds would be invested in the National Loans Fund, as is provided for in this clause—in other words lent to the Government as if invested in gilt-edged securities.
If pre-funding were introduced, the funds built up would obviously have to be invested somewhere until they were needed. Equally clearly, the funds would have to be invested in low-risk investments which could be turned into cash quickly and in all market conditions. The Government are the best source of such investments in sterling. The Financial Services Compensation Scheme could just buy gilt-edged securities but direct investment in the National Loans Fund is more efficient and removes the need for the FSCS to have to employ advisers and administrators to manage its investments—a point the noble Baroness acknowledged in her opening remarks.
As the funds invested in the National Loans Fund will have been lent to the Government, they will replace Government borrowing from other sources. At the end of each day, the Exchequer must borrow from the money market or place funds on deposit with the money market, depending on the net position reached after balancing outflows to finance expenditure again. Any funds from the FSCS will represent an inflow. Arrangements will be put in place to minimise the impact of these flows and ensure there will be no distortion of money markets—the burden of one of the noble Baroness’s anxieties.
The purpose of new Section 214A(2)(f) is to enable the regulations to specify some of the detailed requirements for the investment with the National Loans Fund from the investor’s point of view. New Section 223A(2) in Clause 169 allows the Treasury to agree terms and conditions with the FSCS from the borrower’s point of view. The FSCS is an independent body so will have to contract with the Treasury like any other lender to the Government. We will need to be able to regulate both sides of the transaction but equally to keep both sides separate in our minds.
There is no intention that new Section 214A(2)(f) would be used to require the FSCS to take a different approach from that I have just set out for the investment of contingency funds. If some new approach were proposed in future, parliamentary approval would certainly
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Lord Higgins: Will these payments to the National Loans Fund be identifiable publicly? Will they receive rates of interest? In principle, at what rate of interest will they be paid?
Lord Davies of Oldham: They will be part of the government funds, which will attract a rate of interest. The noble Lord will recognise that we are concerned about the urgency with which these funds might be required. They could be needed at such short notice that there are difficulties about the nature of the investment. The intention is that the Treasury would borrow at the same rate as the markets—the gilts rate. The whole point of this investment is that is has to be risk-free and pretty short term or almost immediate in realisation. The noble Lord will recognise there are constraints about the nature of the funds concerned.
Lord Higgins: Is it possible for the public to identify that such a transaction has taken place and, again, is the rate of interest to be the overnight rate or the three-month rate?
Lord Davies of Oldham: As I indicated, because of the nature of the funds, they will be on a short-term rate. However, whether they can be identified is a difficult question to address. I am not sure that I have the answer to that and so shall have to write to noble Lords taking part in the Committee. Nevertheless, the noble Lord, Lord Higgins, will recognise the nature of these funds and the use to which they are meant to be put.
Lord Higgins: I may understand their nature but if one organisation makes a deposit with the other organisation, I am not clear whether there will be any public accountability to indicate that such a transaction has taken place. If the funds do attract interest, will that interest then be credited back to the organisation making the deposit?
Lord Davies of Oldham: On the second point, I can certainly reassure the noble Lord that that is the case. I merely sought to defend the fact that they would be secure short-term loans because of the nature of the funds and their potential use. On the question of whether they are identifiable, I am sorry that I cannot be more explicit but I just do not have the answer. I do not know what the nature of the accountability would be, given that these transactions can occur with some frequency, and therefore I shall need to write to the noble Lord with that detail.
Baroness Noakes: The Minister has, with the help of my noble friend Lord Higgins, clarified what we are talking about in terms of deposits in the NLF attracting a short-term rate or even an overnight rate. However,
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Amendment 159C had been withdrawn from the Marshalled List.
160: Clause 167, page 89, line 3, at end insert—
“214AA Contingency funding: power to make regulations
The Treasury may make regulations under section 214A only after it has laid before Parliament a report on the impact of a pre-funded scheme on the classes of person from whom contributions can be levied and whether contingency funding is the best way to achieve the special resolution regime objectives set out in section 4 of the Banking Act 2008.””
Baroness Noakes: I shall speak also to the Question whether Clause 167 shall stand part of the Bill, and I shall start with the clause itself. I hope that noble Lords will not have mistaken my earlier amendments, which were designed to improve Clause 167, as approval of the clause. We on these Benches have grave misgivings about pre-funding the Financial Services Compensation Scheme. We agree with the British Bankers’ Association that the case has not been made for pre-funding. In the US, the Federal Deposit Insurance Corporation operates in a very different banking market, with many small regional banks for which failure is not an uncommon occurrence. Banking in the UK is very much more concentrated.
The size of UK banks has an implication for the size of the contingency fund. If it were funded at around £15 billion, as I suggested in my earlier amendment and as I understand has been suggested by those who have been proposing contingency funding, that would not come anywhere near the amounts that would have been required, for example, to pay out Northern Rock’s depositors, had that been necessary. A Barclays or an HSBC does not even bear thinking about in relation to contingency funding. If the contingency funding is perceived to be puny against the large banks, that will
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The regulatory impact assessment calculated the cost to the banks of between £100 million and £200 million, but the banks believe this to be a gross understatement. The amount is considerably below the real opportunity cost to them of retaining the funds within their businesses until they are needed. I do not believe that it is the right time to introduce legislation for pre-funding, and I do not believe that even the Government would claim that the issues have been fully thought through yet. I know that the Minister will say that it is only a power and that there will be consultation followed by an opportunity for Parliament to approve the detailed regulations, but he knows full well that the affirmative procedure falls far short of the scrutiny that a Bill receives. As an order is unamendable, Parliament has only the nuclear option of refusing to pass it.
There cannot be a timing argument. It could never be the case that contingency funding was urgently required. If and when a case was properly made, the Government could take primary legislation in the ordinary way and argue their case to Parliament at that time.
We have tabled Amendment 160 as an alternative to deleting Clause 167; it requires the Government to table a report before Parliament before any regulations under proposed new Section 214A of the Financial Services and Markets Act 2000 are laid. The report should deal with the impact on the persons who will be required to contribute and whether the contingency funding is the best way to achieve the special resolution regime objectives. That will allow Parliament to initiate a debate on the issues and not simply be presented with a government fait accompli in the form of a statutory instrument.
For the reasons I have given, I believe that it is premature to take a power to set up contingency funding. I shall listen carefully to the Minster’s arguments, but even if he convinces me that it is right for the Bill to contain the power, I am sure that it would be equally right for the Bill to contain the additional safeguards in terms of parliamentary scrutiny that I have set out in Amendment 160. I beg to move.
Viscount Eccles: My noble friend’s argument again raises a familiar point, which is that given current circumstances and the way in which the Bill was originally envisaged, there must be a danger that many parts of it will not be brought into action under secondary legislation for a long time to come, if ever, because current circumstances simply would not allow the actions envisaged in the Bill to be taken. The Government should give careful thought to this between now and Report because it cannot be a good thing to enact a Bill in circumstances where large parts of it are impractical.
Lord Stewartby: Briefly, I support what my noble friends Lady Noakes and Lord Eccles have said. This is one of those places in the Bill when it would be sensible for the Government to take our arguments on board. I hope that that will be the outcome.
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The Financial Services Secretary to the Treasury (Lord Myners): The noble Baroness, Lady Noakes, has previously shared with the Committee her interest in the turf. I was minded to think, listening to her contribution, that perhaps she should have her money this afternoon on the 4.10 at Wolverhampton on a horse called Cash in the Attic in terms of whether that would be the right place to have a contingency fund. However, it is a seller and an outsider so it is probably not very charitable of me to recommend that. Instead, in the mood of the Committee, I would suggest Good Spirit in the 4 o’clock at Ludlow.
3.45 pm
Clause 167 provides for the possible future introduction of contingency funds, a method of financing for the Financial Services Compensation Scheme often called “pre-funding”. I have already described how, if a very large firm such as a high street bank or building society went into default, the Financial Services Compensation Scheme would need far more money in a short time than it could realistically raise in levies from the industry or borrow in the ordinary way from commercial sources. I have also explained that the two solutions to this issue are pre-funding or access to borrowing from Government. The latter solution is already possible, and the Bill makes provision to make government lending to the Financial Services Compensation Scheme as efficient as possible.
The clause we are debating provides for pre-funding, and I have already described the detail of how it would be implemented. My colleagues in the Government and I have repeatedly said, as unequivocally as possible: first, that we will not introduce pre-funding now, when the financial sector is already under strain and, secondly, that it would not be appropriate to speculate on when we would introduce it. Given that, I believe that we should also be able to agree that now is not really the time to debate the merits of pre-funding or of a particular proposal to put it in place. That time will be when the Government come forward with a specific proposal to introduce pre-funding to the Financial Services Compensation Scheme.
There are, of course, cogent arguments for pre-funding, and they may help to address the noble Baroness’s perplexity about why we would step down this path. Pre-funding could allow the costs of bank failure to be spread over a longer period of time, before as well as after any failure, and reduce the pro-cyclicality of levy payments; that is, the collection of large levies during a financial crisis. Pre-funding could therefore reduce the risk of contagion and ensure that a failed bank had contributed to the cost of its failure. That is important. The banks would be contributing ahead of any claim on the scheme, and consequently the failed bank would have made contributions towards at least some of the consequences of its failure.
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