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Financial Regulation: EUC Report
Copy of the Report Vol I
Copy of the Report Vol II
Motion to Take Note
7.35 pm
Moved By Baroness Cohen of Pimlico
That this House takes note of the Report of the European Union Committee on The future of EU financial regulation and supervision (14th Report, HL Paper 106).
Baroness Cohen of Pimlico: My Lords, in opening this debate, I need to thank several people for their help in a long and difficult inquiry in which we took a huge amount of evidence. My thanks and those of the committee are due to our special adviser, Professor Rosa Lastra, without whom I do not think we would
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In the particular circumstances of this report I also owe a personal debt of gratitude to my friend and colleague, the noble Lord, Lord Woolmer, who had to oversee and supervise the writing of the report while I lay palely in hospital earlier this year. Little did he know when he sought a place on this committee what it might entail, but I and the committee are truly grateful to him.
I have another and sad acknowledgement to make. Lord Steinberg, a valued member of this committee who made a substantial contribution to this report, died suddenly last week, and is much missed by us all. He was a good man and a good colleague.
In discussing or writing about the complex subject of financial regulation, the committee used the following definitions of supervision and regulation. We took regulation to be the actual rules that are written down and supervision as the application of those rules to a particular firm and making sure that it follows those rules. We have stuck to this throughout.
I will begin with regulation. At the time of the publication of the report in June, the European Commission had brought forward four proposals for the reform of the regulatory system. One was on capital requirements, another on deposit guarantee schemes, a third on the regulation of credit rating agencies and a fourth on the regulation of alternative investment fund managers. The first three of these proposals has been firmed up into European Union law. As Sub-Committee A is in the middle of a detailed inquiry on the fourth, alternative investment, I will not comment on that matter today.
The proposal on deposit guarantee schemes-which, as I am sure all will remember, guarantee bank deposits of up to €50,000, which rises to €100,000 by December 2011-was greeted with general acclaim. The amendments to the capital requirements directive were generally well received by our witnesses, but the directive on credit rating agencies was less so. In general, we identified a need for the Commission to abide by better regulation principles when drafting legislation. Thorough consultation of affected parties must be conducted on all the proposals and rapid action in response to the crisis must not come at the expense of poorly drafted regulation. We urge the Commission, where necessary, to conduct reviews of emergency legislation to ensure its effectiveness.
Further, we found that it was crucial to ensure that all regulation in the European Union was in touch with the global approach. If it was not, it risked damaging the competitiveness of European Union financial institutions. However, we did, and do, welcome the appetite in the European Union for reform of financial regulation, which the crisis proved was so badly needed. Carefully drafted regulations at European Union level can help reduce the level of systemic risk in the financial system and therefore help to prevent future crises. We said at the time that we would welcome
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Subsequent to the publication of our report, the Commission has published further revisions of the capital requirements directive, as well as proposals for the regulation of derivatives markets. We are considering all these items in detail as part of our scrutiny process. After we have completed the enquiry on which we are currently engaged, on alternative investment, we expect to undertake an enquiry on the Commission's proposals to regulate derivatives, which clearly played a huge part in the crisis.
The committee's examination of supervisory reform focused on the report of Jacques de Larosière on the reform of financial supervision within the European Union. His report proposed a more unified system of financial supervision within the European Union, consisting of two main components: a body to examine macro-prudential risk at an EU level and recommend actions to reduce this systemic risk; and a system of European supervisory bodies to co-ordinate national financial supervisors in the task of micro-prudential supervision.
As the implications of the financial crisis became clear, it was recognised that supervisors in the United Kingdom, the European Union and globally had failed to identify the impending meltdown and had failed to take preventive action. Not only did the crisis, very naturally, provoke a flurry of activity to strengthen regulation and supervision of financial services within the European Union, but it has perhaps been inevitable that colleagues in the European Union have tended to lay the blame principally at the doors of US and UK supervisors, Governments and bankers-rather tending to ignore the contribution of their own major banks, which are making the same mistakes and plunging into buying the same derivative products that have become utterly removed from any connection with the underlying assets.
There is a good deal of truth in the perception that it was the Anglo-Saxon capitalist model, carried to extremes, which brought the crisis on all of us. It is for this reason that it has been and remains difficult to make the case for financial innovation and freedom that has enabled world GDP and world trade to grow so substantially since the Second World War. Yet the case must be made. Innovation must not be stifled, or the whole of Europe will turn into a fortress and become markedly less competitive with the rest of the world.
We looked at everything we did against this background and against some considerable opposition and resistance from European colleagues. We supported the institution of a European Union body to assess macro-prudential risks as a welcome step to looking to prevent a future crisis. However, we noted that in order for such a body to reduce systemic risk, there must be structures in place to strengthen the likelihood of macro-prudential risk warnings leading to action from the supervisor at a member-state level.
On the structure of micro-prudential systems, we examined in detail the role of the current Lamfalussy level 3 committees. We agree with Mr de Larosière
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However, we recognised that while national Governments continue to bail out banks at an EU level, it will be difficult, if not impossible, to provide any micro-prudential body with actual powers of supervision. This was the point made by the FSA, that he who pays the piper inevitably has to call the tune. We also recognise that such a body would have to be instituted within the current European treaty, as there is currently little appetite for further treaty reform beyond Lisbon.
Subsequent to our report, the Commission has published both a communication, in July, and then legislative proposals, in September, based on the communication, to implement the recommendations of the de Larosière report. To summarise the proposals: a European systemic risk board will be constituted to assess macro-prudential systemic risk across the EU; and three new European supervisory authorities will co-ordinate national supervision, implementing a single European rulebook through decisions that will be approved by the Commission. These three new European supervisory authorities cover not only banking but also insurance and pensions, thereby closing, it is hoped, all the gaps through which systemic risk in the financial system might appear.
Not three hours ago, my noble friend the Minister discussed with my committee the different roles of these bodies and the powers that they will have. It is early days, but much is hoped of them. There remains a persistent concern about whether the European supervisory authorities will be able to impose financial conditions. In our report, we also examined the success of the Commission's state-aid policies in relation to the recapitalisation of banks. We found that the flexible, rapid and pragmatic approach of the Commission to the application of the state-aid rules had ensured that member states were allowed to support failing banks, but that risks to the single market have been minimised. However, we also thought that it was important for exit strategies to be devised for these banks to ensure that state intervention and the subsequent competition problems that this poses are kept to a minimum.
The Commission recently published its recommendations on the restructuring programmes of the Royal Bank of Scotland, Northern Rock and the Lloyds Banking Group. These, in effect, will reduce the size of all three banks and create up to three new high street banks, potentially increasing competition in the banking sector. These recommendations, agreed with the United Kingdom, show that appropriate importance has been placed on ensuring that state intervention does not inhibit competition within the banking sector. However, the taxpayer still owns significant parts of all these banks, and delivering viable exit strategies to return these banks-and other banks throughout the European Union-to private ownership
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Overall, we agreed that reform of financial supervision and regulation is necessary in the wake of the crisis. As well as installing systems to reduce systemic risk within the EU financial system, greater co-operation among national supervisors will lead to a stronger single market. However, all reforms must be compatible with regulation in other major financial centres to ensure that European Union financial players are not disadvantaged by burdensome and obstructive regulations.
We therefore welcome the Commission's proposals on reform of supervision and the subsequent movement to reach general agreement in the European Council in December as the first steps towards an interconnected system of supervision within the European Union which can help to prevent a future financial crisis. However, there remain some questions which have to be answered. My noble friend Lord Myners has been generous with his time at all stages of our inquiry and has answered all the questions that we have asked. However, I wish formally to put a few questions which I should like him to answer at the end of this debate.
Can my noble friend comment on the rapid speed of reforms at EU level and, in particular, is he happy that better regulation principles have been followed in the drafting of the legislation? Specifically, does he agree with the committee's recommendation that there should be explicit countercyclical provisions within the Basel rules and the capital requirements directive? How are the Government working to ensure that exit strategies are produced for banks that have been recapitalised-again-with taxpayers' money? What timeframe does the Minister envisage for the return of these banks to private ownership? Most vitally, given that decisions in the new European supervisory authorities are to be made by qualified majority voting, are these authorities able to force the adoption by the UK regulatory authorities of decisions which our own regulatory authorities voted against? Does he believe that the safeguards in Article 23 provide sufficient assurance that these authorities will not be able to impinge on the United Kingdom's fiscal autonomy? I beg to move.
7.49 pm
Lord MacGregor of Pulham Market: My Lords, the noble Lord, Lord Vallance, the chairman of the Economic Affairs Committee, cannot be here this evening and sends his apologies. It falls to me, therefore, to introduce our report. I begin by paying tribute to our chairman, who steered us with skill and patience through much evidence, many sessions and a highly complex and topical subject. The Economic Affairs Committee has a broad remit and normally enjoys a wide choice of topics for its inquiries, but in the autumn of 2008 the banking crisis chose itself. We were not, of course, the only parliamentary Select Committee in the field, as is shown by this joint debate tonight. The topic has also been a high-profile focus in the other place.
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We did not address directly the Government's action to recapitalise banks and stabilise the banking system. We selected instead banking supervision and regulation as an important area where the committee could bring its knowledge and expertise to bear. The inquiry was launched in December 2008 and the report was published in June this year. We are most grateful to all those who gave evidence, to our committee clerk and staff and especially to our specialist adviser on this occasion, Professor Alan Morrison of the University of Oxford, for his invaluable contribution.
Much has been said, written and analysed about the causes of the crisis and I do not have the time to go over that ground in any detail tonight. With the benefit of hindsight, we can see that the scene for the banking crisis was set by a long period of cheap money, plentiful credit and asset inflation in major western economies and by the explosive growth in debt securitisation and derivative trading. At the same time, the risks of new financial instruments were clearly not well understood. Perhaps, as in previous bubbles, the main players thought that the good times would keep on rolling and failed to see the danger until too late. It is fair to say that the ability of the authorities to respond was constrained because markets are now global, while supervision and regulation remain mainly national, as the noble Baroness pointed out. It is clear that in Britain, as in other countries, the system of regulation failed in its key role to prevent crises or to mitigate their effect.
In our committee, we tried to focus on drawing the right lessons. In particular, we looked at how the regulatory system worked before and during the crisis and at the policy responses that followed. We urged the Government to take the care and time necessary to get the changes right, including, of course, taking account of the vital European and international dimension. However, we welcomed the Government's swift introduction of the Banking Act 2009 and its special resolution regime, which puts in place new insolvency procedures for banks.
The Government produced a lengthy response to our report, for which we are grateful. We made a large number of recommendations over many issues; I can touch on only some of them tonight. I shall list briefly the areas of agreement between us and then focus on a few other matters of importance. My noble friend Lord Forsyth of Drumlean may want to raise others.
On the points of agreement, the Government and our committee both called for better macro-prudential supervision. We both favoured countercyclical measures, setting capital aside in the boom periods to see the banks through the downturns. We called for pre-funding of the Financial Services Compensation Scheme. The Government aim to introduce partial pre-funding, but not before 2012. They accept our observation that pre-funding would have a countercyclical effect. We both agreed that regulation of liquidity should be strengthened, that international macro-prudential supervision should be encouraged, that the Financial Stability Board announced in the G20 communiqué must be sufficiently independent and resourced and that changes in the EU must be aligned with global measures.
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I turn to a select few of the issues on which I believe the debate is still open. Time prevents me from dealing with them all-for example, on bank bonuses, I am as incensed as anyone at the rewards for failure and bonuses for immediate returns irrespective of the risks and losses that ensue. There are many important conclusions and recommendations that I have had to leave out, but I turn, first, to the disagreement between the Government and us as to how macro-prudential and micro-prudential supervision should be undertaken in the future. We spent a considerable time discussing the tripartite system; it was perhaps the area to which, in the end, we gave the most thought. We concluded:
"Without a clear executive role, the Bank"-
"A clear lesson to be drawn from the recent financial crisis is that the current arrangements failed to recognise the natural affinity between responsibility for financial stability and for macro-prudential supervision of the banking and shadow banking sectors".
We therefore believed that responsibility for macro-prudential supervision and systemic risk should be given to the Bank of England, which already has macroeconomic expertise. There would be senior representatives from the FSA and the Treasury on that committee. We urged the Government to carefully consider the case for and against giving more micro-prudential supervision to the Bank of England as well. The Government took a different view. I note, however, that it is now official Conservative policy to abolish the FSA-macro-prudential and micro-prudential supervision would switch to the Bank and there would be a new financial policy committee at the Bank including independent members-and to establish a new consumer protection agency, combining the consumer protection functions of the FSA and the OFT.
Without straying into controversial debate tonight-it is my task to report fairly the whole committee's conclusions-and without commenting on the possible outcome of next year's election, I simply observe that there are arguments on both sides of this issue. The present Government's decisions may well not be the end of the matter; they are not set in stone. If there are to be further reconsiderations after the general election, I believe that the discussion in our report will be worth revisiting and taking into account in future deliberations and decisions.
Secondly, we argued that contributions to the Financial Services Compensation Scheme should be at least broadly related to the riskiness of the business in which regulated firms engage. There are some similarities here with the way in which the Pension Protection Fund levy is calculated. There were also particular issues in this connection relating to building societies. The Government rejected this proposal and I would be interested to hear the Minister's response as to why they did so.
Thirdly, we took considerable evidence about the role of credit rating agencies, on whose ratings so many banking decisions relied. This is a complex area, which I personally believe has been much underrated in all the post-mortems on the crisis. There are conflicts-of-interest issues. There is a loss of market confidence
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Fourthly, on corporate governance, we received much criticism of the role of the non-executives on bank boards. I declare former interests as a non-executive in a number of companies, including one financial institution, albeit not a bank. There is no doubt that big mistakes were made, but such criticisms should, in my view, even more be levelled at senior executives. Did they fully understand all the complex instruments in which they were trading and investing? Yet by and large the non-executives in the major banks were highly skilled, experienced and dedicated people who, by all accounts, devoted considerable time to their role. There has been much discussion about "too big to fail" banking institutions. Is there not an issue sometimes about "too big to manage", particularly from the point of view of part-time non-executives? We put forward several recommendations to assist in dealing with this. Since then, we have had Sir David Walker's review of corporate governance in UK banks and other financial industry entities. I hope that the House will return to this and debate his final report.
We examined the "too big to fail" issue and the possibility of a Glass-Steagall type of solution. We reached no conclusion beyond the rather vague one of,
The Governor of the Bank of England, who gave evidence on the issue, said that there was a strong argument for legislation that would ensure a diversity of banking institutions. He noted that there were strong arguments both for and against separating commercial banking from the securities business. He went on to say that,
- "what I would encourage everyone to do, this Committee and other committees, is to take some time now to think our way through these issues. They are immensely important, we will not get another opportunity to restructure our banking and financial system in a hurry and it is very important that we take this opportunity".
We took his advice and concluded, perhaps because we could not reach an agreed view ourselves, that there should be no rush to write the legislation required to support new structures, and that it was more important to get the details right than to resolve them quickly. The governor, to judge from recent reported remarks, may be reaching towards a solution rather faster than we are.
The report of the Economic Affairs Committee is just one contribution to the debate on the banking system that has raged in the press, boardrooms,
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My committee colleagues and I found this a fascinating and complex inquiry. We gained much insight and help from the many experts and participants who gave evidence that will continue to assist us as we work our way forward. There have been many developments since we published our report, and we welcome them. The severity of the banking crisis and the depth of the recession that has followed call for a thorough review of the options so that decisions on the future of the financial system can be seen to be well grounded. I hope that our report will play a small part in that.
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