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The Bill makes many proposals that could be helpful: I will refer to just a few. First, I turn to the central case for the Bill. My noble friend Lord Myners, referring to the Council for Fiscal Stability, said that it was "not glamorous". I am sure that he is very fond of glamour, but the main issue facing the council will be getting the balance right between what is described in the Bill as growth in the economy, stability and firm regulation. It will not be easy, and I fear that much of the work of the Council for Fiscal Stability-and here I share the concern of the noble Baroness, Lady Hogg-will be talking about it. I am not sure that much will be done in practice by the council.

More important are the other measures in the Bill. There is concern about whether the council will be able to do what the Bill says it will-namely, to co-ordinate the response to risks. The response to risks, as we have seen in recent times with the problems that we have had with the banking system, is clearly essential to the Bill and to any action that we take to prevent the problems happening again.

En passant, many objectives are set out, but four are set out as the main objectives of the Bill. One is the need to promote awareness and educate the public. A new quango will be set up to do that. I am not sure that a new quango to promote awareness among the general public will do much good. Perhaps a special quango to make MPs and Peers more aware of the problems that we face would be more helpful.

The Bill gives great powers to the FSA, which is fine. Everybody agrees that the powers should be strengthened, wherever the FSA staff are. However, the problem is that they were not short of powers when they made the mistakes that they did, so there is no guarantee that the people who are now in the FSA, wherever they end up, will not fail again. It is not clear what will happen then, other than possibly to sack one or two people who have made the major mistakes of failing to regulate.

Let me refer to just one of the Bill's new powers-short selling. The case has been made strongly to stop excessive risk-taking. I can understand an individual-possibly an adviser-recommending it in certain circumstances. I make it clear that I have not engaged in short selling, but I understand the case for using it. Now the FSA will have many new powers, including short selling, which is referred to specifically in the Bill. It is fine to prohibit individuals who are working in the industry in that regard, but why are the banks being allowed to do it themselves? Something could be said about other potentially toxic assets used by banks, whether they are split or not.

Martin Wolf, a very good reporter in the FT, referred to Volcker's rule. We should all have regard for Volcker, as the noble Lord, Lord Lawson, pointed out. He said that banks would no longer be allowed to own, invest or sponsor hedge funds, private equity funds or propriety trading operations for their own profit unrelated to serving their customers. President Obama referred to it when he spoke of the separation of the banks.

The noble Lord, Lord Lawson, referred to the Glass-Steagall case at length. He made the strongest case yet for it, but of course he is never more certain of anything than when he is expressing his views, as he

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and I know all too well. The Volcker rule, including taking control from the banks of toxic assets generally, seems to me to be sensible. Whether or not we agree with the Governor of the Bank of England, who recently I have not agreed with too often, as my noble friend knows, the case for Volcker's rule is strong. Even if we do not go along with the main proposals of President Obama, that case has been strongly made, and I hope that my noble friend will give us good reasons if he is going to reject it. He has said before in the House that he supports much of what the Governor of the Bank of England said about President Obama's proposals, so maybe he agrees with this as well.

I shall now turn briefly to something else that the noble Lord, Lord Turner, said-I am not sure whether this was also in Davos. As I said, a lot of people spent a lot of time there recently. He spoke of valueless carry trade and talked about synthetic CDOs. Most of those who are speaking in this debate know what they are and the various other matters that have been dealt with by banks to our cost recently. Will we see some action on that as well as on short selling? There are calls by the noble Lord, Lord Turner, and others for fresh powers to curb bank lending. Will the new powers allow the control that is required?

The Bill could be very useful if the regulations within it are used properly and are properly controlled. I return to my earlier question: how do the Government propose to check what the FSA is or is not doing with regard to its huge additional powers that we are rightly giving to it in the event that it fails once more?

6.05 pm

Viscount Eccles: My Lords, it is a great pleasure to follow the noble Lord, Lord Barnett. I want to go a bit further on the subject of education, and certainly beyond the position of my own Front Bench.

I will confine my contribution to Clause 6, proposed new Clause 6A, which is headed:

"Enhancing public understanding of financial matters etc",

and to proposed Schedule 1A which selectively spells out the detail of the:

"Further provision about the consumer financial education body".

These arrangements are to replace the duty placed on the FSA in the 2000 Act to ensure public awareness of financial matters. In its annual reports, the FSA has faithfully listed that as one of its duties. We can speculate on what has persuaded the Government to drop the FSA's public awareness duty, as in Clause 6(3), and to substitute that at much greater length and expense the arrangements for a new body-the consumer financial education body. It may just be that the Minister considers that awareness is not enough, and instead we need the seriousness of education, which seems unlikely. It may be that the FSA has said that its awareness effort has been small but without more delegated authority, money and staff it can do no more about it, and that if we want education, we should give the FSA the responsibility and resources to deliver it through a body under its control.

The switch from awareness to education needs justification. The banking and credit crisis showed that it was not only the public who lacked awareness,

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but those in charge in the highest places as well-a point strongly made by the noble Lord, Lord Barnett. It remains true that members of the public are capable of imparting more awareness than was or ever could have been delivered by the FSA. Indeed, who operating from within the financial system was fully aware, or is aware today, dare I say it? What has been illustrated here is the mistake of legislating to give a duty to a public body which it cannot perform, and the reluctance of that body to say so.

We then move to the next fallacy, which is that it was not the policy but the chosen method of implementation that was wrong, and that it was not sufficiently rigorous and the resources put into it were inadequate. This leads to the, "If at first you don't succeed, try and try again" syndrome. It is a favourite response of this Government to policy failure, disregarding the fact that the premises on which the policy was based were faulty in the first place. How can the Government and their agencies expect to compete in the matter of financial awareness and education with all those whose livelihood depends on that? Surely it would be better to leave these matters alone securely in private hands.

I suppose the Minister will say that it falls to government to fill a gap because of market failure. However, my questions are as follows. How in the first place is this market failure described? Indeed, do we know how to describe it? And is there any credibility in the description of how the FSA and its subordinate body could correct this market failure, considering exactly what the history of failure has been, is and, as the noble Lord, Lord Desai, said, is likely to be?

Whatever history's full evaluation of our understanding of the financial system turns out to be, we need to be cautious when we claim a high degree of knowledge and certainty about it today. Nevertheless, there is to be this new, expensive and curiously funded body. Given its title, we are left to speculate on the switch from the public as a whole in the 2000 Act to consumers only in this legislation. Is that because the providers are beyond education or is it because there is top-down comfort in a role for the great and good as educators of members of the public in "how to manage their financial affairs"? This mechanistic approach replacing the broadly based "public awareness" is no improvement; it is just another decision to choose process with no measurable outcomes in sight.

What is also surprising is the decision to create yet another body with a chair, a chief executive and a board. There will also be a practitioner panel and a consumer panel. The body is bound to be bureaucratic and therefore expensive. That is the price paid for public accountability. This creation of yet another public body is evidence of the residual fly-wheel effect, whereby this Government cannot resist committing ever more resources to the public sector when we all agree that it is only growth driven by the private sector that can return our finances to long-term health.

The way in which this body is to be funded also looks curious. In paragraph 14 of Schedule 1, the Treasury is given the power to join in the funding by way of grant or loan, met out of money provided by Parliament. Perhaps the Minister will confirm that

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Treasury intervention should be seen as a reserve power unlikely to be called upon in the near or medium-term future.

However, in paragraph 12 the FSA may make rules determining who should pay the education body's costs and in what proportion. Now it is true that the FSA has rule-making powers under the 2000 Act but none of these powers has anything to do with payments to the FSA. Giving a public body an unfettered right to demand money cannot be right. Am I correct in thinking that the power in paragraph 12 sets a precedent? In paragraph 13, the OFT has a similar power to impose payments to meet the costs of the education body by general notice to consumer credit licensees. What is the justification for this power?

Both those powers seem to be an attempt to transfer the body's costs on to the private sector, which is an entirely inappropriate idea. We depend upon growth in the economy to restore our finances over time, and that growth needs to be driven by the private sector. It is, in any event, deeply irresponsible to burden the private sector with additional costs in support of an activity wholly unsuited to the public sector.

It is amazing to think that the Minister could possibly support these arrangements. Perhaps he will think again. Having, with typically bad husbandry, pulled up the bush of public awareness, he may conclude that it is not such a sorry case after all and so rapidly replant it. Even if the "public awareness" duty has not delivered much, at least it is suitably vague and inexpensive. Dropping the education scheme from the Bill would bring the advantage of shortening the volume of legislation by some nine pages. However, the main issue is the avoidance of yet another cost centre within which inputs will always be more beguiling than measurable outputs.

6.15 pm

Lord Blackwell: My Lords, before participating in this debate, I should draw attention to my interests as a director of Standard Life and as a board member of the Office of Fair Trading, which is referred to in this legislation.

As other noble Lords have said, financial services are extremely important and, although the sector has had its problems, we should not denigrate the important role that it has played and, one hopes, will play in creating wealth for the UK in international markets. As the noble Lord, Lord Myners, correctly said, the objective of this Bill should be to help financial services to work better. Against that test, I am in the camp that views the Bill as something of a mixed bag: there are certainly some good things but there are many things that require further consideration.

However, before we go further, we should note that the Bill is silent on perhaps the most important issue, which is what role national regulators will be left to play, whether located in the FSA or the Bank of England, under the evolving EU plans for pan-European regulatory supervision. The draft directive on hedge funds is a case in point. As we debate the powers in the Bill, it would be helpful to understand better what powers the Government believe the UK will have in

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future to set our own policies for the financial services industry or to represent our distinctive UK view in international forums.

To return to the Bill as it stands, I fully support the aim to strengthen what is called "macro-economic prudential regulation" in the UK. Whatever institutional arrangements are put in place, it must be right to ensure that consideration is given to the stability of the financial system as a whole, as well as to the soundness of individual institutions.

It is, with hindsight, an amazing case of myopia that ballooning levels of government and private debt prior to 2008 rang so few alarm bells, and that the multiplier effect of credit expansion outside the conventional banking system, supported on a very small base of capital, was not seen as a dangerous source of instability. It is hoped that this generation has relearnt those lessons, but going forward it is important that some institution is tasked with the responsibility of monitoring these macro-economic developments and that it has the tools to curb credit expansion and reinforce capital levels as required. That institution must be sufficiently independent of the Government of the day and independent of considerations to do with fiscal convenience and electoral cycles.

Alongside that macro-prudential supervision, we then continue to need effective supervision of individual organisations to ensure that the risks they run do not put the wider financial system at risk. I use the word "supervision" rather than "regulation" deliberately because I think that, if the FSA has a fault, it is that historically it has seen its job too much as applying and enforcing regulations in a detailed tick-box approach, instead of applying mature supervision based on understanding and making judgments about the situation of individual firms. That is one thing that was lost in the removal of the old supervisory system.

Having said that, there is one area where I think we need to question whether the Bill currently goes far enough in prescriptive regulation, and that is on the constraints around the activities and balance sheets of deposit-taking retail banks. In this area, I go part of the way with my noble friend Lord Lawson and the noble Lord, Lord Barnett. There is no getting around the fact that retail deposits are special because they form a core part of the nation's money supply. Because, in the interests of the wider economy, people need to have confidence in money as a form of payment, it is inevitable that Governments stand behind the value of money deposits in regulated retail banks and that they stand behind those banks. We have seen only too recently the level of panic and disruption that can occur if people start to lose confidence that their money on deposit is safe.

However, that government guarantee essentially means that the large retail deposit base of many retail banks is a subsidised, low-cost source of funds for those institutions. If and when those deposits are used to fund high-risk activities or assets, even on the margin, the risk and reward are asymmetric-the bank and its employees get the upsides but the Government, as guarantor, get the downside exposure. This inevitably encourages higher levels of risk-taking than would occur, for example, in a partnership where the principals

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took all the upside but also all the downside risk. The current regulatory approach seeks to redress this asymmetry by imposing higher capital requirements on riskier activities, effectively raising their cost of funds. To this the current Bill adds the requirements of creating recovery and resolution plans, which aim to set out how an institution facing financial difficulty in one area of activity could limit the damage so as to prevent the whole organisation becoming insolvent.

All these are sensible steps. However, I still believe there is a case for going further and requiring retail banks, where their deposits are guaranteed, to ring-fence those deposits and capital so that they are applied to prescribed assets and activities with appropriate matching risk characteristics. Unless there is that clear segregation -some kind of firewall, as it has been described-I find it difficult to see how one can avoid extreme risk events in the rest of an institution ultimately falling back on the funds and capital represented by guaranteed retail deposits. The fact that that backstop funding is available from the Government is inevitably reflected in the capacity of the institution to take on risks and counterparties that would not be available on equivalent terms without the government guarantee.

As this Bill goes through, the House should look at whether there are practical ways of achieving this ring-fencing of retail deposits and their capital backing. As the noble Lord, Lord Lawson, pointed out, it is this objective which lies behind the recent Volcker proposals in the US and the much earlier Glass-Steagall legislation. Where I differ from my noble friend Lord Lawson is that I do not think it is necessary or desirable to go as far as Glass-Steagall, which prohibited investment banking and retail banking activities being undertaken in the same institution. I am inclined to believe it should be possible to hold both a retail bank and what, for shorthand, I will call an investment bank as separate subsidiaries under the same group holding, enabling the holding company to combine the offerings as they see fit in developing integrated services for major corporate customers if those customers see fit to buy them.

That requires clear regulations that limit the ability to move funds from the retail bank to the investment bank so that recourse to the retail bank's capital is blocked. This may sound difficult, but it is not dissimilar in principle to the rules around corporate pension funds or to policyholder-owned with-profit funds in life companies where the bankruptcy of the ultimate holding company does not allow shareholders to have access to those protected funds. I am not convinced by the argument that, operated in this way, it would be impossible to draw the dividing lines. Equally I am not sure that the Volcker proposals have got it quite right in focusing on proprietary trading. We should be clear that the risks that retail deposits should be shielded from are not just speculative position-taking, but also-and perhaps more importantly-balance-sheet investments in high-risk securities.

As we now all understand, much of the crisis for many financial institutions was caused not by their own proprietary trading but rather by their willingness to invest in complex secondary and tertiary securities, where the underlying borrower risk had been masked and the risk exacerbated by complex and poorly

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understood derivative positions. In principle, therefore, the retail bank might be limited to investing its guaranteed deposits in primary loans-by which I mean loans to known customers where the bank had made its own risk assessment-together with government securities and transient exposures held to support customer transactions. All other activities could be funded in a separate legal entity where the suppliers of funds-whether depositors, shareholders or other counterparties-knew the risk that their capital was exposed to and understood that they would not be protected by a bail-out of the retail bank.

I have dwelt on this issue at length because it is complicated and because I would suggest it needs to be a major part of our ongoing consideration of this Bill. It may be that the Government can convince us that the provisions in this Bill are adequate, but if there is a time to get this right, that time is now.

While I am on the subject of omissions, let me briefly flag one other related area which I think is a missed opportunity. Under current accepted accounting conventions, banks are not allowed to make provisions against specific loans when they put them on the books. They can only make provisions when there is a recognised risk of default. It is assumed that all loans will turn out to be good loans, despite the historic evidence of average default rates. As a consequence, the impact of loan losses on bank capital levels serves to exaggerate the economic cycle. Capital is not held when things are going well but capital is rapidly destroyed in a downturn. I have never understood why the same principles that apply to prudent insurance risks-in other words, recognising and providing for expected outturns at the start of a contract-do not apply to lending risks. It may be that the Government feel they are not powerful enough to take on international accounting standards, but I would be interested to know whether the Government have considered this issue or whether it has just been ignored.

There is much else in the Bill I could speak to, but in the interests of time let me quickly pick out a couple of other points. First, there is what I feel is a rather strange set of provisions relating to remuneration reports. I should make clear that I have no problem with the regulator-or supervisor, as I prefer to call them-taking an interest in the structure of remuneration and wanting adequate reporting to ensure that remuneration did not incentivise excessive risk-taking, but I confess I do not understand what is special about financial services that requires additional reporting about the absolute levels of remuneration compared to any other sector. Why is it useful and appropriate to require more information about the levels of non-director remuneration in financial institutions than in other sectors with highly paid talent-for example, broadcasting, sports, advertising agencies, or even lawyers? We may or may not think individuals in any or all of these occupations are overpaid, but we need more justification from the Government before we legislate for this level of intrusion into the activities of private companies as to why they want to single out one sector for special treatment.

The noble and learned Lord, Lord Goldsmith, referred to the groundbreaking clauses around class-action suits. Like him, I have some concerns about the lack of

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clarity about how they will be applied. Again, I stress that these are personal views. Clearly, there is a difficult balance to be drawn between procedures which help customers get proper redress on the one hand and the risk of creating a costly industry in class-action suits where lawyers are the main beneficiaries on the other. The decision on whether and under what circumstances to allow the opt-out way of proceeding rather than claimants having to opt in is clearly crucial to this balance. While it may be sensible for the courts to have discretion in deciding this, I am not sure that we should legislate to give them a free hand without greater clarity about the criteria and filters which the Rules Committee may subsequently develop. I hope that when we address this part of the Bill the Government can set out on the record what kind of guidance they expect to be applied or, even better-as the noble and learned Lord, Lord Goldsmith, asked for-let us see the draft regulations as they might be developed.

I have not had time to address the many other issues covered by this Bill but these will all no doubt be part of the debate to come. Let me end where I started by welcoming the objectives of this Bill while believing that there is a great deal of work still to do before we can be satisfied that this collection of measures is best fitted to the task.

6.29 pm

Baroness Valentine: My Lords, I declare an interest as the chief executive of London First, a not-for-profit business membership organisation whose mission is to make London the best city in the world in which to do business. My perspective today is not that of the financial services sector alone, but that of business in general. This is the third piece of legislation introduced by the Government in response to the credit crunch, but it is right that this ground should be thoroughly tilled.

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