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I was asked what the status is of ESO officials and whether they are exempt from UK income tax. That is unlikely to be an issue, given that the ESO’s headquarters will not be in the United Kingdom. However, the order provides for exemptions which presumably apply also to citizens from overseas working in either Chile or Germany. I do not think that we have information on how many personnel there are, but we will seek the most up-to-date information and provide it.

How will the order affect the United Kingdom? It is unlikely to have many implications for the UK because the organisation’s headquarters are in Germany and it operates in the southern hemisphere. However, if the ESO were to hold a meeting in the UK, as it did in 2002, representatives of the states parties and officials of the organisation would enjoy the privileges and immunities entered into in our acceptance of this order.

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I hope that that is sufficient to allow noble Lords to continue their support of this draft order and I will get back with the detailed answers that have been requested.

Motion agreed.

Dunfermline Building Society Compensation Scheme, Resolution Fund and Third Party Compensation Order 2009

Dunfermline Building Society Compensation Scheme, Resolution Fund and Third Party Compensation Order 2009
17th Report - Joint Committee Statutory Instruments

Considered in Grand Committee

4.13 pm

Moved By Lord Davies of Oldham

Lord Davies of Oldham: I shall speak also to the Amendments to Law (Resolution of Dunfermline Building Society) (No. 2) Order 2009. Before discussing the draft compensation order, perhaps I may explain why the Treasury took the decision to withdraw the draft instrument laid before Parliament on 4 June and to re-lay it on 15 June. A very minor error was identified in paragraph 7(5) of Schedule 1 to the original draft order; the reference to “properly or reasonably” should have been to “properly and reasonably”. We did not consider that it was appropriate to correct this error using the correction slip process, so withdrew and replaced that draft order. I apologise to the Committee for that slip.

As noble Lords will be aware, the Dunfermline Building Society was resolved on 30 March by the Bank of England effecting a transfer of part of Dunfermline’s business to Nationwide, and part to a bridge bank. Dunfermline was then placed in special administration following an application to court.

Where the Bank of England exercises its property transfer powers, the Treasury is required under the Banking Act to put in place compensation arrangements. The draft order that we are debating today makes provision: for the compensation scheme, at Part 2, in relation to the transfer of business to Nationwide; for the resolution fund, at Part 4, which makes provision for entitlements to the proceeds of resolution arising from the disposal of the business of the bridge bank; and for the third-party compensation provisions, at Part 5, which provide for the mechanism for assessing any compensation payable to third parties affected by each transfer and establish the scheme for assessing any compensation payable under the “no creditor worse off” safeguard. I will briefly overview these components.

First, the draft order specifies that compensation payable to Dunfermline in respect of the transfer of the business to Nationwide should be nil. As the Committee will be aware, the basic principle under Article 1, Protocol 1, of the European Convention on

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Human Rights is that compensation for expropriations of property must normally bear a reasonable relation to the value of the property expropriated. The auction process conducted by the Bank during the weekend of 28 to 30 March effectively determined that the market value of the business was nil because the winning bidder did not pay any consideration. Therefore, the Treasury does not consider it appropriate to engage a valuer to assess the value of the business, and has exercised its discretion under Section 49(2)(a) of the Banking Act to specify in the order that the compensation payable is to be nil.

Secondly, the draft order makes provision for the arrangements for the resolution fund in relation to the transfer of business to the bridge bank. The fund is intended to act as a signal that the authorities do not intend to profit from the resolution.

Lastly, the third-party compensation scheme makes provision for an independent valuer to determine two things. The first thing to be determined is the amount of any compensation payable to any third party affected by an application of Section 38(6) of the Act—that is, the section that specifies that the property transfer instrument made by the Bank is to be disregarded in determining whether a default event provision applies and has the effect of turning off third parties’ contractual termination rights. The valuer will also assess whether there is a difference between the treatment that pre-transfer creditors of Dunfermline would have received had Dunfermline gone into insolvency immediately before the transfers, and the actual treatment of those creditors arising as a result of the transfers. This is the “no creditor worse off” safeguard, which makes provision for the valuer to assess whether it is necessary for the Treasury to pay any compensation in the event that pre-transfer creditors are left in a worse-off position as a result of the transfers.

I shall touch on the appointment process of the independent valuer. In January this year I made a commitment in Committee on the Banking Bill, which we will all recall vividly, about the extent to which the appointment of the valuer would be independent of Government. I said, as reported in Hansard:

“At every stage, the Government have been at pains to ensure that the Treasury is one stage away from decisions that relate crucially to the appointment, performance and remuneration of the independent valuer”.—[Official Report, 19/1/09; col. 1478.]

The draft order provides for the Treasury to set up an appointment panel to appoint the independent valuer. Unlike the appointment process for the valuers appointed to conduct functions under the Northern Rock and Bradford & Bingley compensation schemes, the panel will appoint the valuer rather than making a recommendation to the Treasury about the candidate to be appointed. We consider that this further enhances the already robust independence of the appointment processes that we have put in place in previous circumstances.

The second order, the Amendments to Law (Resolution of Dunfermline Building Society) (No. 2) Order, has been laid in draft under the powers in Section 75 of the Banking Act 2009, which enable the Treasury to make amendments to law so as to give effect to resolutions of failing banks.

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As all Dunfermline’s member business was to be transferred to Nationwide, the Bank’s property transfer instrument was drafted so as to transfer all Dunfermline’s business to Nationwide with the exception of certain property, rights and liabilities specified in the instrument. In particular, Dunfermline’s £660 million commercial loan book was not to be included in the transfer to Nationwide.

However, due diligence undertaken in the weeks following the transfer demonstrated that the technical definitions adopted in the property transfer instrument led to a significant proportion of the commercial loan book being erroneously transferred to Nationwide, together with a small number of social housing loans. “Commercial loan” was defined in the transfer instrument as a loan to persons who were not eligible claimants under the Financial Services Compensation Scheme, as commercial entities would not normally be liable to compensation under the FSCS. “Commercial mortgage loan” was defined in similar terms. A small number of loans which were considered to form part of the social housing book were also transferred to Nationwide by the transfer instrument.

Further due diligence in the weeks following the transfer has identified, however, that a large number of the borrowers on the commercial loan book were in fact eligible claimants under the FSCS rules. That means that the effect of the instrument was to transfer these loans erroneously to Nationwide.

The order before the House today identifies each of the loans that is, and was always intended, to remain with Dunfermline by an individual identification number, listed in the schedule to the order. The order has retrospective effect to 8 am on Monday 30 March, the time when the transfer of Dunfermline’s assets was made, and essentially corrects the error in the transfer instrument as though it had never been made. The effect in law is as though the loans had never been transferred to Nationwide.

In assessing the options to address the mistake in the transfer instrument, the Bank of England, in consultation with the Treasury, has fully considered all possible commercial and contractual remedies that might have achieved the same effect as the draft order we are considering today. The Treasury is satisfied that use of this order and its retrospective effect is therefore necessary to ensure the completion of the Dunfermline resolution, and desirable so as to limit the call on public funds. Treasury and Bank of England officials have of course discussed the scope and content of the order with Nationwide and the administrators.

I merely add the obvious point that we considered at great length whether anything might prove to be retrospective in the Banking Act—I recall the intensity with which that aspect was scrutinised. Here, an error occurred, which is why we are involved in some retrospective activity. I commend the orders.

Baroness Noakes: Until the Minister stood up, I had not realised that we were debating the two orders together, which is entirely my fault, because I can see that properly stated on the Order Paper, so I will be shuffling my papers between the two. If the Minister

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will permit me, I will start with the second of the orders, where the Minister looked, I think, duly embarrassed about using Section 75—not that the Minister should be embarrassed at what has happened, but I hope that there is a due degree of embarrassment at the Bank of England. When Parliament entrusted the property instrument power to the Bank of England under the Banking Act, that was done under the tacit assumption that the Bank of England would exercise the power competently. Clearly, it has not done so.

The various powers in the 2009 Act were not designed for frequent use—indeed, we hope that they will not be used frequently—but we are entitled to some assurance that lessons have been learnt from this occurrence. Has there been a proper formal post-mortem examination at the Bank of England with a view to identifying what went wrong and why? If this had been in a commercial document, it might not have been as easy to revise it as with the stroke of a pen on a statutory instrument.

The Minister referred to our lengthy discussions at various stages of the Banking Bill, and it is fair to say that he struggled to come up with any plausible way in which the Section 75 power would be used. Since then, we have had the No. 1 Dunfermline order, which made a whole raft of changes to law which some of us think could well have been made in the Bill, and had retrospection of the total amount of one hour and 45 minutes—hardly a substantive use.

This order is a more substantive use of the power, but it is for a rather less substantive reason: that is, it is to correct the shoddy draftsmanship of the Bank of England. I am not going to object to the order today, because it is clearly convenient to have the Section 75 power to use in these sorts of situations. However, if the Minister had stood at the Dispatch Box during the passage of the Banking Bill and said that he needed the Section 75 power to correct drafting errors made by the Bank of England when using its property instrument power, we might have invited him to make a more targeted power in the Bill—for example, to correct property transfer instruments—but it is more likely that we would have fallen about laughing at the Government thinking it necessary to have such a power in the Bill to cope with incompetence. As I say, however, we will not object to the order; we simply hope that the Government are not proud of it.

The more substantive of the two orders which the Minister introduced is the Dunfermline Building Society Compensation Scheme, Resolution Fund and Third Party Compensation Order 2009. It is really four orders in one, because it covers the compensation scheme, the resolution fund and the third-party compensation scheme, as well as the appointment of a valuer to carry out the valuation of the amount of recovery for the purposes of the Dunfermline contribution to costs order, which we debated in May.

In broad terms, the order is not controversial. Indeed, I might even say that it is potentially very interesting for Banking Act anoraks—those of us who survived the Banking Bill process—because it will set up the first of these compensation schemes, resolution funds and third-party compensation orders; so it is the first time that these powers will be road-tested. We will

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look very carefully at the progress of the use of the powers to see whether they stand up in the light of real facts and events.

I have a few questions for the Minister. First, will he update the Committee on what is happening to the Dunfermline Building Society? As I understand it, the social housing assets were initially transferred to a bridge bank, owned of course by the Bank of England, but last week the Nationwide, which of course was involved in the original transaction, also acquired those assets. Will the Minister say what the Nationwide paid for those assets relative to their face value? Does this transaction complete the work of the bridge bank that was set up as part of the Dunfermline rescue? Approximately how much—I do not expect him to have definitive figures—will be paid into the resolution fund? I think that that comes from the bridge bank.

Secondly, Dunfermline has been placed into administration. Does the Minister have any information on the progress of that administration, including the likely deficit to be borne by secured and unsecured creditors, including the pension fund? If he does not have the information, will he say how it can be obtained? I could not get any up-to-date information online, which is of considerable concern.

These questions are tangentially related to the work of the valuer appointed under Article 11 of the order, because the valuer will have to work out the “amount of the recovery” for the purposes of the contribution-to-costs order. I believe that the amount of the recovery is the amount that the valuer believes that the Financial Services Compensation Scheme would have got back from Dunfermline, had the FSCS paid out to depositors in the normal way under its rules and then recovered it. Will the Minister confirm that this will entitle—indeed, require—the valuer to assess the value of the business and assets of Dunfermline that would have been sold if Dunfermline had not been dealt with by the special resolution regime? The valuation is necessary irrespective of the fact that the Treasury has now determined the compensation available to Dunfermline as nil. That does not bind the valuer, who has to reach his own view on value. I ask the Minister to confirm that.

Will the Minister comment on the similarities to, or differences from, the calculations that the valuer will be required to make for the third-party compensation scheme? This concerns the amounts that would have been received by the creditors, but I assume that it involves some of the same underlying issues of how much the business was worth and therefore how much would have been paid out to the creditors had the business been dealt with in accordance with the assumptions that are specified.

In that connection I note that, in respect of the third-party compensation scheme, Part 3 of Schedule 2 has some detailed valuation principles about financial assistance and so on, which we have seen in other orders, and which have to guide the valuation. However, I could see no equivalent principles applying to the Article 11 valuation process—that is, the process that will apply under the contribution-to-costs order. Can the Minister explain this disparity of approaches by the same valuer to two different parts of the task that he will be carrying out, and comment on whether that

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might result in inconsistent valuations coming out of the process? Valuation principles are specified for one, although I do not believe that such principles have been specified for the other for the purposes of Article 11.

I have a couple of other detailed questions for the Minister. The first relates to the account holder for the resolution fund. Who is that likely to be? It is required by paragraph 1(2) of Schedule 1. Why does an independent person have to be appointed to hold the money? Why could the account at the Bank of England not simply be the Dunfermline resolution fund? Why does it have to be held in the name of an individual? What does that add?

My other, more detailed, question relates to paragraph 3 of Schedule 2, which says that third-party compensation is to be paid only if it is required to be paid in order to comply with the European Convention on Human Rights. What is this intended to do? In what circumstances would this proviso prevent compensation from otherwise being paid? Is this intended to restrict the operation of the rights to compensation triggered by Section 38(6) of the Banking Act? If so, why was this provision not included in the Bill? It seems quite a significant point to have been included in the order rather than the Bill. Also, has this point been consulted upon?

Apart from these points, we are content with the order.

Lord Oakeshott of Seagrove Bay: I start with the Amendments to Law (Resolution of Dunfermline Building Society) (No. 2) Order 2009.

Well, this looks like a fair old cock-up, doesn’t it? I heard the Minister’s remarks about technical changes and technical mistakes, but if my advisers in a commercial transaction presented me with this and said I had to go back to whoever was signing it all off, I would be incandescent. What happened? What was going on? Who was acting in the Bank of England? Was it acting for itself? Were lawyers involved? These seem to be very basic things that you check. If there were outside lawyers, what was the firm? What were they paid? I hope that the bill has not been paid. If they were from inside, I hope that a few people have been sacked. These are simple basic things, and for the Minister—although it is obviously not his fault—to have to come here and produce pages and pages of numbers of loans is deeply embarrassing and does not meet the standard of professionalism that we expect from the Bank of England. Can the Minister please answer those questions? Taxpayers are not getting value for money when such obvious mistakes are being made.

I thought that I heard him say something along the lines that it was discovered that borrowers on the commercial loan book were eligible claimants under Financial Services Compensation Scheme rules. That mystified me. Can the Minister explain more? I do not understand how borrowers can make claims. Perhaps I am being stupid.

I turn to the second order. Perhaps I may ask one or two more general questions about what happened here and where we are. It has become clear that there is a poisonous pile of debt resulting from poor-quality loan decisions on commercial property by Dunfermline. It was clearly way out of its depth. There was horrific exposure to very dangerous sorts of property. For

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example, a large site in Bournemouth was not income-producing at all. Frankly, no experienced commercial lender should have been involved to anything like that extent—certainly not amateurs playing in a market that they did not understand, like the people in the Dunfermline Building Society.

What independent property valuations have been done? When were the last valuations of the properties securing these large loans? If there has not been a valuation recently—and we are in a depressed market, so it is easy to get the valuers to do a check valuation at low cost—will the Minister undertake that there will be up-to-date valuations of the properties so that we can see how far under water the loans are?

I have some scepticism about how much time and energy it will be worth investing in the valuation of any compensation payable, given what I believe to be the serious negative equity in which the loans are involved—rather as I felt about Northern Rock. But that is a separate case; I am making a specific request that the Government come clean about the current value of the properties on which these loans are secured.

I am sorry; I should have declared an interest. The Dunfermline Building Society was a tenant of a property I manage on behalf of a pension fund. I am waiting for the application to assign to the Nationwide, but it has not come through yet.

Lord Kirkhill: Deputy Chairman, it might be convenient for the Minister if I very briefly intervened to make a few remarks.

The Deputy Chairman of Committees (Baroness Fookes): Could the noble Lord rise?

Lord Kirkhill: Why? I have a gammy leg at the moment, if you don’t mind.

The Deputy Chairman of Committees: Of course.

Lord Kirkhill: Thank you. It is the arthritis of old age. These are the problems that occur if you live long enough. I declare an interest in that many decades ago I was a Dunfermline Building Society manager. I do not intend to repeat the few remarks which I made in the Chamber pre the surveillance of the Statutory Instruments Committee. What I want to say, which follows on from the noble Baroness’s point, is that it is not very clear up there—I live in Scotland—just where we are going with the housing association loan book, which has apparently gone to the Nationwide. On the surface and in public terms, that is a somewhat grey area. If the Minister could be specific on that issue, it would be helpful not only to me and other Members present but to the wider public in Scotland, because the Scotsman newspaper, at least, has tended to publish detailed information.

Lord Davies of Oldham: I am grateful to all noble Lords. I offer my rather belated congratulations to the noble Baroness on her birthday yesterday. I had hoped she had had such an uproarious evening yesterday that

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she would be somewhat blighted today, but no such luck. She is on her usual form. I am therefore obliged to do my very best to answer the detailed questions that she and other noble Lords have asked. I shall examine the detailed questions in Hansard very carefully and if I have failed to answer them I shall write to the noble Lords concerned with fuller answers.

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