As the noble Baroness, Lady Wheeler, outlined, the unanimity among providers about the facts are impressive so there is no doubt about the impact social care cuts are having on services. In a recent survey from the NHS Confederation, 99 % of NHS leaders said social care cuts are increasing the pressures on the NHS and the most prominent impact noted by four out of five of them was the increased time people remain in hospital. This is not new, and many noble Lords mentioned it. For a number of years now, the Government have been alerted to this and yet spending pressures continue to be tolerated. The 2015 spending review finally recognised the funding gap but the remedies are totally inadequate. The Five Year Forward View developed by NHS England and the other NHS arm’s-length bodies is clear that plans for addressing the NHS funding gap are based on an assumption of social care services being sustained. So the ability of the NHS to make unprecedented savings in this Parliament relies on the Government addressing the social care funding gap. If the Government choose not to close that gap, they are choosing not to support the delivery of the Five Year Forward View.

As my noble friend Lady Brinton said, directors of adult social services estimate a £4.3 billion gap by 2020-21. The spending review proposals are unlikely to cover this or the inevitable additional costs of the introduction of the euphemistically named “national living wage”. I absolutely agree with the comments of the noble Lords, Lord Turnberg and Lord Lipsey, about that. Neither will it meet the future growth of demand due to our ageing population. In addition, as we have heard, the Government have back-loaded the better care fund until towards the end of the Parliament. By that time the system will have collapsed—the money is needed now.

Local authorities and social care providers are somehow expected to fill the gap. Many local authorities have prioritised social care. We heard from the noble Baroness, Lady Redfern, about North Lincolnshire. I think that many of us will want to move to Utopia, otherwise known as North Lincolnshire, before we get much older. It currently accounts for 35% of its total budgets compared with 30% at the start of the last Parliament. Spending on adult social care has already been reduced by £4.6 billion, about one-third of the budget in real terms. There is a limit, which we are fast approaching, to how long this can go on.

While all this is happening, vulnerable people are missing out. The reduction in spending has resulted in eligibility thresholds being tightened so that often only the most severe needs are met through state-funded social care. In total, around 400,000 fewer people have their assessed needs met. If they reach crisis point, they will have no choice but to turn to the NHS for support. Then they are more likely to stay in hospital for longer because it is too risky to transfer them home

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without the support of social care services. A social worker I know said to me recently that the problem is that social care funded by the state is used mostly by poor people who do not have a voice, and Governments therefore feel that they can get away with not doing anything. That is the impression that the Government’s failure to act has given to people out there.

I wish to raise another issue relating to the quality in the sector. I agree with all noble Lords who talked about the importance of quality, especially most recently the noble Baroness, Lady Dean. It is about the new arrangements for funding student nurses. I understand that in order to remove the cap on student nurse places—and, by the way, remove the debt from the Government’s books—the Government plan to remove their bursaries and fees and offer student loans instead. We certainly need more student nurse training places since there are already four applicants for every place. However, any expectation that hospitals would pay off the debt of newly qualified nurses who would go to work for them is unrealistic in the extreme. I am told that while there is going to be some scope for NHS provider organisations to reimburse staff for their training, it will be completely at the discretion of that organisation. The group of HR directors that I heard from said that it would happen very infrequently, due to cost. This does not mean that the occasional exceptional candidate may not be reimbursed, but, without funding through the NHS tariff to cover staff training, it would represent an exceptional cost. The expectation is therefore that private healthcare providers and care home operators would not reimburse either, but, again, could do so at their own volition.

Given that the margins in social care provision are so tight, I am concerned that those nurses who would like to work in that sector will have a problem. I cannot see any care home providers being able to offer this pay-off, yet those who provide specialist nursing services really need well-qualified nurses to supervise them or they will not be safe. It is a matter of maintaining quality. What does the Minister suggest is done about this? Following the spending review, there are so many additional costs that will already have to be met by providers of all kinds that I would be very surprised if any of them were able to reimburse a nurse’s training costs. These vital professionals cannot expect to be highly paid when they qualify, so where does the Minister think they will get the money for, in effect, an additional 9% on their income tax after qualification? This is short-sighted and will do nothing to increase the number of UK nurses, especially in the lower-paid social care service, where I anticipate the highest impact of this change. If you add all this to the announcement in the spending review that care homes, along with other providers, will have to pay the full cost of their mandatory CQC inspections, you have a system that is ready to implode.

What steps are the Government taking to ensure that the proposed 2% levy per year on council tax in the form of a social care precept will deliver the money required to ensure the right levels of social care and do so equitably? The authorities that need the most additional money have the least ability to raise it through taxes. When will self-funders get some certainty enabling them to plan for their old age? I echo my

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noble friend Lady Brinton in asking where the £6 billion saved from the failure to introduce all the Dilnot reforms has been distributed. It certainly has not gone into the social care budget. I am just as curious as the noble Lord, Lord Warner, to find out where this amazing disappearing £6 billion has gone. How will the Government ensure that newly qualified nurses will not be deterred from entering service in the social care sector?

Finally, I am very puzzled about one thing and I wonder if the Minister can help me. All the acute hospitals are in deficit and somehow the Government manage to bail them out. I wonder why that is when they are not prepared to bail out the social care sector. Perhaps it is because they have already spent the money and, of course, next year some of the extra money already announced for the NHS will have to go towards next year’s projected deficit as well. Perhaps it is because local authorities and private and voluntary care providers cannot spend money that they have not got and therefore it cannot be refunded. However, it occurs to me that if the Government were prepared to spend that couple of billion pounds every year doing something about social care then maybe we would not have such a big deficit in the NHS at all.

5.31 pm

Lord Hunt of Kings Heath (Lab): My Lords, it is a great pleasure to wind up for the Opposition and to thank my noble friend. It has been an excellent debate; a number of very challenging questions have been put to the Minister and we look forward to his response. There can be no doubt that the viability of the residential care home sector, the failure to implement Dilnot and the failure to raise the means test are causing great anxiety to thousands of people and their relatives throughout the country. As the noble Baroness, Lady Walmsley, said, the lack of viability of the residential care sector is but one part of what one has to say looks increasingly like a dysfunctional health and social care system.

When the Minister replies—because he has done it recently—he will no doubt talk about the Autumn Statement, ministerial vision and the potential of the new models of health and social care that the Government are putting an awful lot of eggs into, without, I have to say, any evidence that they will be able to enable a response to the challenges. The gap between ministerial rhetoric and reality is striking. There is no problem with a five-year forward view. This vision is described as empowering patients, their families and carers to take more control over their own care and treatment. It is a future that truly integrates health and social care, at last puts mental health on a par with the rest of the system and, crucially, prioritises prevention. That is a fine vision and, in the absence of any vision for social care, I assume it is the Government’s statement of social care policy as well.

However, it is impossible for me to see how that will happen in the context of a Government determined to bring the share of government spending down from 41% to 37% of GDP. It is always good to wait until a few days after an Autumn Statement to get the real analysis of what is happening in spending. The analysis I have seen from the King’s Fund is that for the next

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five years the actual growth in the health service will be 0.85% per annum. So we are just continuing the misery of the last five years. We know that the historic growth level in the NHS is 4%, and that is what is needed to meet these challenges. It is striking that, of the much-vaunted extra £8.4 billion, £4.6 billion has come from other parts of Department of Health expenditure, including Health Education England, the nurse bursaries, capital and public health. You also have to add in the £1.1 billion of pension costs due to the changes in the pension rules from next April, for which no additional money has gone into the health service.

The King’s Fund projection shows that in this five-year period social care will be left with an annual cut of 0.3% per annum. Therefore, even though it is back-loaded, it is starting off with a very challenging situation. There is then the cost of the living wage to be added to the negative growth. I cannot possibly see how the health and social care sector can meet the challenges of the demographics that it is facing, with the huge population growth that we have seen in the last 10 years projected to increase by another few million over the next 10 or 15 years, as the noble Lord, Lord Filkin, said.

When it comes to the residential care sector, there is no need for me to repeat the figures that other noble Lords have referred to, but I thought that the ResPublica report got it in a nutshell when it talked about the unsustainable combination of declining real-terms funding, rising demand, increasing financial liabilities, a funding gap of £1 billion by 2021, the potential loss of beds and, of course, the knock-back impact on our national health service. I had not seen the advice from Care England. That advice is very sobering indeed when it comes to the whole viability of the residential care home sector.

It seems to me that the result of all this will be that, far from the models being implemented, we will see the perverse incentives mentioned by the noble Baroness, Lady Brinton, getting worse and worse because of the tension between the free-at-the-point-of-use NHS and means-tested social care. That is why integration is so difficult. Until we get to grips with that divide, we will never achieve integration of services. As my noble friend Lord Turnberg said, NHS hospitals are the providers of last resort. If the residential care sector goes down, residents will end up in NHS hospitals. I remember those dreadful long-stay wards that NHS hospitals used to have, and I am afraid that they will be recreated unless we can sort this problem out. Many reports are coming out but one report produced today by the Nuffield Trust shows that 3.6% of patients took over a third of all bed capacity in acute hospitals, and the trust expects the position to worsen in the years ahead. That is the challenge that our system faces.

There are about 10 questions from my noble friends to which the noble Lord, Lord Prior, is being asked to respond. The first, on the positive side, was asked by my noble friends Lady Dean and Lord Lipsey. Can we increase public awareness of the importance and success of many parts of the residential care sector and the good work done by the staff? My noble friend Lady Dean gave a wonderful example of the sector working at its very best.

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The second concerns the general view that, essentially, the care cap will never be implemented. Can the Minister say that it actually will be implemented, and when? Thirdly, does he agree with his noble friend Lord Lansley about the sense in going back to Dilnot’s original recommendation about the size of the cap? A number of noble Lords mentioned the £6 billion. Noble Lords look quizzical whenever it is mentioned, but that figure has appeared in government papers and projections. I think we are right to ask what on earth has happened to it.

The noble Lord, Lord Sutherland, asked what analysis the Government have made of the risk of closures. What are their contingency plans? How will we avoid the dreadful situation of very frail older people having to be moved from one home to another, which we know can have appalling effects on life outcomes? When will the means test limit be increased as promised? The Government made a deal. They made a deal with people that the care cap would come in in 2016 and that the means test would be increased. Many people made financial provision on that basis. Surely the Government have a moral responsibility here to deliver what was promised. Does anyone remember the Prime Minister saying no one would have sell their home? What has happened to that?

There are two final things. First, my noble friend Lord Bhattacharyya asked about incentives to encourage people to build up funds for their care. What has happened to the much-vaunted insurance market? It was supposed to come to the rescue and be complementary, in a sense, to the introduction of the care cap. Finally, and overwhelmingly, my noble friends Lady Pitkeathley and Lord Turnberg and other noble Lords talked about the need for a coherent, long-term strategy. Either we go into absolute crisis in the next year or two, with huge knock-on impacts on the rest of the provision of health and social care, or the Government have to get a grip and actually start going for a long-term strategy. I hope the Minister will announce that tonight.

5.52 pm

The Parliamentary Under-Secretary of State, Department of Health (Lord Prior of Brampton) (Con): My Lords, I am slightly relieved—the noble Lord, Lord Hunt, said he had 10 questions but he got to only six, I think.

I thank the noble Baroness, Lady Wheeler, very much, as other noble Lords have done this evening, for securing this important debate. I think we will be having this debate fairly regularly over the course of this Parliament, and we should, because lots of ideas come out of these debates, which I can assure noble Lords are taken very seriously. I shall pick out a few points at the beginning.

Many noble Lords, including the noble Baroness, Lady Wheeler, mentioned Four Seasons, about which there has been publicity. I cannot comment on that particular case, but the CQC’s market oversight function means that it is looking at the finances of all these large care providers very closely and if it has a concern it will liaise confidentially with local authorities.

The noble Baroness, Lady Wheeler, also talked about the spending round. I think it is worth saying,

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despite the apocalyptic comments from the noble Lord, Lord Hunt, that this was very much welcomed by Simon Stevens, chief executive of NHS England, who felt that it was a good settlement. Although the King’s Fund, the Nuffield Trust and others have been quoted, on balance, most independent commentators feel that this was a better settlement than we had a right to expect.

My noble friend Lord Lansley made an important contribution and reminded us of the importance of the Care Act. He thanked Paul Burstow, as did other noble Lords, for his important role in that Act. He talked about integration and personal budgets, which are a very important aspect of the future strategy. Noble Lords have asked about the future strategy. Personal budgets and integration will be very important parts of any future strategy. He also mentioned the Dilnot situation. I will come back to Dilnot, if I may, a little later.

The noble Baroness, Lady Brinton, talked with passion about the care her mother had received over 10 years. This is important, and others have mentioned it as well. In her mother’s case it was a combination of domiciliary care, residential care, respite care and NHS hospital care. When it works, it works incredibly well and we need to be careful in talking about the undoubted problems in this industry, which we all know of. Many providers of residential healthcare and many staff who work in that industry do a fantastically good job. The noble Baroness referred to the better care fund, which is a big stake in the ground and is bringing together funds from the health sector and from social care. Pooling those funds is the right way forward.

The noble Lord, Lord Turnberg, talked about the dependency of the healthcare sector on social care and vice versa, and how looking at the two in isolation made no sense at all. He asked about our response to David Dalton’s report on the development of chains and more integrated care. I can tell him that three of the vanguards are proceeding very much along the lines described in David Dalton’s report. I would refer also to the devolution that is happening in Manchester, where there are some serious comings together, not just within healthcare but between healthcare and social care. Devolution, again, will be a big part of any strategy as we go forward.

The noble Lord, Lord Filkin, had a number of concerns—in particular about the future supply of a skilled workforce. I believe that the national living wage and the care certificate that came out of the Cavendish report will both be helpful in improving the opportunities for staff in the sector. He referred to the hidden misery in social care, which other noble Lords have also mentioned, and I think that it is true that the NHS, because of its greater exposure and the love that the people of this country have for it, gets the lion’s share of available resources going into health and social care, which is something that we need to be conscious of. It is certainly something of which Simon Stevens is particularly conscious.

The right reverend Prelate the Bishop of Bristol importantly reminded us that statistics are all very well but these statistics are all individual people. He said that he looked out over Winterbourne View,

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where there was appalling care. Of course, that was not a result of lack of resources but the result of a rotten culture in that organisation. He also talked about family disintegration. He said that residential care is sometimes regarded as a place of last resort, whereas, as we know, much residential care, far from being a place of last resort can be a wonderful place for people to spend the end of their lives.

My noble friend Lady Redfern talked about the reality of the Care Act in north Lincolnshire and filled us all with some hope that it can be made to work and that the community can come together. She talked about the five community well-being hubs in north Lincolnshire and the better care fund being used to bring together social care and healthcare, and the importance of partnership working, including housing, which other noble Lords have mentioned.

Earlier this week, an interesting speech was given by Duncan Selbie, the chief executive of Public Health England, who said that when it comes to health the NHS touches just the top of the pyramid, but, actually, health comes from employment, education, a prosperous economy and, of course, good housing. The noble Lord, Lord Lipsey, raised with me separately his views on how we might be able to reallocate some of the money currently going through CHC, which is something officials are looking at. I can assure him that it has not been lost and we are looking at it. The noble Lord is very concerned about the postponement of Dilnot. I will come back to that subject in a minute. He also mentioned “Alive, Alive Oh!”—Diana Athill’s story of when she went into residential care, and how that is sometimes a remedy for loneliness and lack of support. Of course, good homes where there are good levels of activity and high levels of comfort can be wonderful places to live.

I think the noble Baroness, Lady Pitkeathley, said that she had been working, or involved, in the care industry for 40 years, and had been in this House for 18 years. She reminded us that, looking back on what those local authority homes were like 30 or 40 years ago, many of them were terrible. The split between commissioning, or purchasing, and provision has undoubtedly been a very good thing, in the main, and things are a lot better than they used to be. The noble Baroness also reminded us that for the 18 years she has been in this House we have been talking about integration—yet in her view we are still waiting for it. I respond to that by saying that the five-year forward view is a big step towards greater integration between health and social care.

The noble Lord, Lord Warner, raised a number of important issues. I shall have to pick out some of those and write to him later. In particular he talked about the fragility of the big providers and the problems in care homes. One of the things that the CQC market oversight does is to try to identify early some of the problems that may arise, such as those that arose at Southern Cross in the past. He also said that it is one thing to identify a financial issue ahead of time, but the question is: is there the capacity in the industry to pick up the fallout from the collapse of a major provider? The noble Lord, Lord Sutherland, also raised that point.

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The noble Lord, Lord Bhattacharyya, raised a number of points about the importance of the million unpaid carers. He also asked, importantly, whether we could be more imaginative about financial products—whether those be care ISAs or other savings and pension products—which could help to meet the undoubted need for more funding in this sector.

The noble Lord, Lord Bichard, who as chairman of SCIE has a profound knowledge of social care, also talked about integration. He said that a third of the places inspected by the CQC are deemed to require improvement. It is important that at least we know that fact. This has not suddenly happened. We know this now because of the CQC inspection regime, which, particularly in social care, has been very much welcomed by the industry. The noble Lord said that Martin Green was not someone who overstated his case. But I think that occasionally Martin Green has been known to overstate his case; he has certainly done so to me in the past. However, his words of warning about the local authority-funded residential care market, as distinct from the self-funded care market, are not to be dismissed.

The noble Baroness, Lady Dean, talked about Abbeyfield—a wonderful care group—and the joy she feels when she walks out of one of its homes. She also mentioned an investment in five new dementia care homes. May I write to her about the particular issue that she raised about funding supported housing? I cannot give her the answer today, but I will write to her after the debate. She also made the interesting point that since higher wages have been paid to staff, sickness absence and staff turnover have both come down. Low wages and high turnover of staff have dogged this industry for years, with all the knock-on effects on continuity of care and training, so there is quite an important message there.

The noble Lord, Lord Sutherland, referred to the usual suspects. This debate has been well attended by the usual suspects and a few others. I suspect that the band of usual suspects will grow, rather than diminish, over the next five years. He made an interesting point about the number of empty beds in the nursing home and care home sector at a time when there are so many delayed discharges or people who should not be in acute hospitals. It is overly simplistic to say that there are 10,000 empty beds in that sector so we could therefore have 10,000 patients out of hospitals who could go into those beds. The fact is that those beds are often not the right kind of bed. They do not have the right nursing care around them or they are in the wrong place. Nevertheless, there is plenty more scope for acute hospitals to work much more closely with the acute sector.

I will pick up the points made by the noble Baroness, Lady Walmsley, and the noble Lord, Lord Hunt, in my speech, but I will write to the noble Baroness on the nursing care issues in particular. I would rather do that.

First, why have we postponed Dilnot? I must say that it is a postponement. We will come back to Dilnot in this Parliament. To be completely frank with noble Lords, it was postponed because it was felt that it would be too expensive to implement it now and that it would put too much pressure on local authorities.

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One of the priorities of this Government is to reduce the budget deficit and start repaying the debt that has accumulated over the years. Noble Lords may not like that very much and might have a different view from that, although it was the view of the coalition Government. That is our view and that is why it has been postponed. It does not alter the fact that the Government believe that the Dilnot report was outstanding and we accept the vast majority of its recommendations. Indeed, our decision to delay those reforms was welcomed by many in the sector. The Local Government Association in particular and others welcomed our decision as a real example of the Government listening to their concerns about introducing significant reforms at a time of financial challenge for local authorities.

I think the noble Lord, Lord Hunt, said that we like to blame local authorities—he says it was not him; someone said it. On the contrary, part of the Government’s strategy is to devolve more power and responsibility to local authorities. By delaying, we allow local authorities time to focus on delivering the important reforms to care and support under the 2014 Act, which came into force on 1 April this year, putting in the necessary groundwork to implement the funding reforms as successfully as possible in 2020.

The grant funding of £146 million made available in 2015-16 to support implementation of the cap prior to delay will remain with local government. I assure noble Lords that the decision to delay implementation was not taken lightly. The recent spending review reaffirmed our commitment to implement these reforms in April 2020, making funding available in 2019-20 to help local authorities to prepare for implementation.

I turn now to quality and the workforce. Delivering the outcomes that people want and need would not be possible without a sustainable care home sector capable of delivering quality care. We are taking steps to support the sector to continuously improve in this area. Noble Lords will be aware of the Care Quality Commission’s new inspection regime and will know that we are investing £115 million this year to support the training and development of the care workforce, including a national programme of support for registered managers, who play such a vital role in ensuring the quality of care homes.

I have talked about the CQC’s market oversight role, which is an important new development, and at other times I have talked about the importance of the new vanguard programme. I refer in particular to the six enhanced health and care home vanguards, where we now see GPs doing ward rounds around care homes and a much more integrated model between healthcare and social care.

I will just say a little bit about the money. Noble Lords will know that the Government are giving local authorities access to £3.5 billion of new support for social care in 2019-20. From April 2016, councils will be able to introduce a new social care precept, allowing them to increase council tax by 2% above the existing threshold. This could raise nearly £2 billion a year for social care by 2019-20. A number of noble Lords, including the noble Lord, Lord Warner, asked about smoothing payments and we will have to address that

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issue. I must apologise that I do not have time to finish what I wanted to say because of all the issues that have been raised. I wonder if it would be acceptable if I wrote to all noble Lords who attended this debate with what else I wanted to say and just apologise that I am timed out.

6 pm

Baroness Wheeler: My Lords, I thank noble Lords for their contribution. I said in my speech that their experience and insight would produce a very thoughtful and thorough debate and a comprehensive picture of both residential care and the wider social care, and that proved to be the case. It is important to develop a clear view of the role we want the residential care sector to play in integrating social care and I hope this debate has helped that, particularly across the care pathway. There were a number of speakers on that theme. We have debated these things a number of times but this is the first time we have focused on residential care and I think that has been very helpful. Many noble Lords stressed that this debate was about people. My example of my local carer was very much in that vein and other noble Lords gave examples of good care in their own experience. That is very valuable and it is well to remember that. CQC underlines that there are many well-led homes that are caring, safe and efficient with trained and dedicated nursing and care staff, but equally it gives the other side of the picture and the problems that we need to address.

I thank the Minister for his thoughtful response. He did not have a chance to reel off some of the statistics I was expecting. I was particularly looking out for his comment on the assessment from the noble Lord, Lord Warner, that we have seen only £70 million of the £6 billion that was to be introduced for the social care cap. I did not hear that but he is going to write to us and that is very welcome. I was a bit disappointed that he was not able to give us some reassurances on the monitoring that is going on of Four Seasons and other care homes. I understand the need for confidentiality but I think we need to be reassured that the Government are keeping it closely under review, particularly the issue of replacement care. On the care cap, I am glad it is still a postponement. The Public Accounts Committee has called for an urgent and clear timetable on implementation and I think the Government ought to take heed of that. In my view the overall debate has shown the clear need for a strategic, ambitious, forward-looking strategy and I am pleased the majority of noble Lords supported that. With those comments, I beg to move my Motion.

Motion agreed.

Financial Stability: Central Counterparties

Question for Short Debate

6.02 pm

Asked by Baroness Kramer

To ask Her Majesty’s Government what assessment they have made of the possible threat to financial stability from the risks concentrated in Central Counterparties.

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Baroness Kramer (LD): My Lords, I have sought this debate in order to understand from Government their assessment of central counterparties, the extent to which CCPs mitigate risk, but also the extent to which their inherent character of concentrating risk can in itself amplify financial instability.

A CCP is an entity that interposes itself between counterparties to contracts traded in financial markets, becoming the buyer to every seller and the seller to every buyer and thereby guaranteeing the performance of open contracts. In a sense they act as a firewall, enabling multilateral netting among clearing participants, reducing credit exposure, offering operating efficiency and also providing anonymity, which some believe increases liquidity in the system. At the moment a transaction is initiated, the CCP has no market risk—the book is matched. But prices change rapidly and constantly and CCPs cover such exposures primarily by requiring collateral. I shall say more about collateral in a moment.

The primary use of CCPs is to clear derivatives contracts and one of the reforms by regulators following the financial crash of 2007-09 was to make the use of CCPs mandatory for the clearance of standard over-the-counter derivatives. I fully recognise that this has brought transparency and some order to an opaque and chaotic system and offers greater protection to counterparties. The last financial crisis was far worse because no one knew to whom anyone had exposure.

However, by definition, the concentration of risk within a CCP is itself a systemic risk. The daily global exposure in CCPs is estimated to be in the trillions of dollars but no exact tracking is available. Default potentially affects not only national but international financial stability. CCPs are linked by an extensive cross membership; the major global banks belong to virtually every CCP. Interoperability arrangements between CCPs enable members of one to clear transactions without opening accounts in the other. CCPs are often part of a larger financial group, and firewalls between group members are not necessarily complete. According to the Bank for International Settlements in its quarterly review this December, this growing interconnectedness raises the question of whether CCPs might spread losses in the case of defaults or intensify deleveraging pressures in ways that add to systemic risk.

As for the UK, the Bank of England, which took over supervision from the FSA in 2013, supervises some of the largest global players, including LCH Clearnet Group and ICE Clear Europe, while a number of major and minor CCPs incorporated overseas also operate in the UK. Our exposure is multicurrency and so requires the Bank in extremis to be able to access liquidity in other currencies, especially the euro. It is part of our global financial services industry rather than support to our domestic economy.

This House discussed CCPs and the risk they present in the debates on the Financial Services Act 2010. During that debate the Government took the position that default risk could be contained by a risk waterfall of cascading lines of defence. The first line of defence is collateral, required through both initial and variation margin calls. However, the noble Lord, Lord Sharkey, and I, in 2012, raised questions both about the inherent quality of collateral and the competitive pressures on

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CCPs to take a more lenient view of both collateral quality and margin requirements. There is not enough high-quality collateral in the globe to meet the margin requirements of CCPs. Therefore lower-quality collateral is improved by being bundled and then given a haircut—that is, discounted. This may remind your Lordships of some of the financial instruments implicated in the 2007-09 crash: it is susceptible to abuse. CCPs around the globe compete fiercely and there is always a risk that this can lead them to compromise the quality and levels of collateral.

The collateral demands of CCPs will, by definition, move with, not counter to, an economic cycle. This means that both initial and margin calls increase the volatility of prices of collateral, such as sovereign bonds, which in itself can amplify financial instability. CCPs hold vast amounts of their collateral in major banks. As we know, no major bank is ever totally safe from failure and so another risk is added. This risk increases because many clients, to reduce their costs, permit the CCPs to on-lend or invest the collateral. At present, these collateral related issues are not transparent. Are the Government attempting to remove the mask not only domestically but globally?

If collateral is insufficient, the second line of defence is a cascade of reserve or guarantee funds contributed or committed by members of the CCP as a condition of their membership. Your Lordships will understand that these are thinly-capitalised entities. The cascade varies by jurisdiction but essentially begins by tapping the defaulting member and, if that is insufficient, calling on the other members of the group. In the Financial Services Act 2012, the Government allowed members’ exposure to such mandatory contributions to be strictly limited—not unreasonable—on the assumption that no member could survive with unlimited liability. However, we do not know how sufficient the barriers really are. CCPs in the UK are also required to put in place recovery and resolution plans to protect the taxpayer in the event of failure. Can the Government tell us how advanced these plans are?

I am sure the Government would agree that, with so many questions and given the consequences of a failure, stress tests for CCPs are crucial. Will there be transparency around such stress tests? Will the criteria and performance results be public? Since a failure in one jurisdiction can so easily contaminate another, can we be assured of a global standard of risk protection and co-operation among regulators?

While I have raised the risks of CCPs, I recognise that there are significant risks in the non-standard transactions, especially the non-standard derivatives transactions, that sit outside them. Is the regulator succeeding in persuading the industry to deconstruct complex trades so that they can be cleared on the CCPs? I realise that the regulators are requiring banks to hold additional capital for unclear trades, but many of the players are commodity companies, especially oil companies, and these are just as capable of infecting the system. Additionally, these non-standard trades are increasingly taking place in dark pools. Are we sure that enough is happening in the light both for proper risk management and for proper price discovery to take place?

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We are also in an era where we begin to see the disintermediation of the traditional financial service players. Block chain will in effect dislodge all the current post-trade architecture and may well eliminate CCPs altogether, but block chain raises issues of its own. Transparency is particularly important in block chain, but we cannot see, for example, what is happening in a vital market like China—the great firewall of China, as I understand the industry calls it. That surely is untenable. While block chain has the potential greatly to reduce risk, its key feature, which is the dispersal of data, raises serious new jurisdictional issues. Who is in charge in a crisis? Will the Government update us on how they are addressing the development of block chain and the trading architecture, how they view the associated issues and how they are considering the transition from the current architecture to the new?

The inconvenient truth is that in a major financial crisis, if two or three major banks were to fail, all the defences offered by CCPs would be overwhelmed, rather like the flood defences in Cumbria this week. We need to know how high the financial flood walls are. I look forward to hearing much more from the Government on stress tests, on transparency and on recovery and resolution plans. I hope that in this debate, the Government will answer our questions on CCP governance, collateral quality, capacity for loss absorbency, potential for contagion and international co-operation. There is a danger that CCPs are a two-edged sword, dampening risk in modest crises but amplifying risks in high crises.

6.12 pm

Lord Sharkey (LD): My Lords, I am indebted to the Bank of England for its publication Central Counterparties: What Are They, Why Do They Matter and How Does the Bank Supervise Them?I am glad to see that the Minister is similarly indebted. This report sets out the merits of CCPs and it also sets out, very clearly, the risks associated with them.

There are three main risk areas. The first is the systemic impact of a CCP failing. The failure of a large CCP could act as a channel of contagion, resulting in significant failures elsewhere in the financial system. The second risk is that CCPs may act as amplifiers of other systemic shocks. In some cases, CCPs may produce procyclical effects by exacerbating other stresses. For example, increasing initial margin requirements in response to high price volatility may force members to liquidate positions. In an illiquid market, this would only increase price volatility. The third risk concerns inadequate solvency, the ability to meet short-term margin calls and the operational reliability of CCP members. All these risks are well known and appear to be well defined.

What is perhaps less clear from this rather bloodless and technocratic language is the potential scale of these risks, and the extent to which these risks are fully understood. In January this year, the IMF published a workshop paper entitled Central Counterparties: Addressing Their Too Important to Fail Nature. This paper estimated the market size of open, over-the-counter derivative trades at $293 trillion. Some 95% of these open trades were concentrated in the top five CCPs.

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These are truly gigantic numbers and truly gigantic interdependencies. It is easy to see how failure could bring down the financial system. It is easy to see why the IMF workshop paper describes these CCPs as “too important to fail”. In fact, it singles out LCH.Clearnet Group and CME in particular because they also operate CCPs in the exchange-traded or equity markets.

In fact, 59% of turnover in exchange-traded derivatives and 78% of equity trades go through the top five CCPs. This is concentration on a very grand scale. I acknowledge, of course, that the G20 bought about this concentration deliberately as a response to the post-Lehman events and that it did so for a very good reason. Nevertheless, the scale of the concentration certainly focuses the mind on the need to prevent failure or at least to properly mitigate risk.

In the view of the IMF workshop paper, four risks are not yet mitigated. The first is the composition of the risk waterfall, referred to by my noble friend Lady Kramer, and the fear that loss-sharing arrangements may be a source of contagion for surviving clearing members. Secondly, the dependency of CCPs on only a few commercial banks for liquidity, custody, settlement and other services can put the CCP and surviving members under severe pressure. The report notes:

“If the defaulting clearing member is one of the contracted service providers of the CCP, the surviving banks may have to step in, placing them under significant pressure. At the same time, the ability of the CCP to manage the default can be significantly weakened by its dependence on those banks”.

Thirdly, collateral sales by multiple CCPs may increase market volatility. Fourthly, the diverging interests of authorities in a globally cleared market may present a problem. If the authority in charge of supervising a CCP is not from the same country as the authorities in charge of the banks, international co-ordination would be very difficult to achieve during distress. Does the Minister agree that these risks are not yet mitigated? If he does, can he tell us how we are progressing towards mitigation? In particular, what progress are we making in reducing risks relating to the interconnectedness and interdependencies of CCPs?

As my noble friend Lady Kramer mentioned, the latest quarterly review from the Bank for International Settlements also turns its attention to the issue of risk and CCPs. It notes, almost in passing, that:

“The competitive dynamics in the CCP industry may work against a strengthening of capital buffers”.

It says that CCPs are for-profit companies and,

“are strongly motivated to generate revenues by expanding their product offering and capturing market share. However, new products could bring incremental risk, which clearing members may end up bearing if the CCP does not increase its capital commensurately”.

This worry is not raised explicitly by the Bank of England or the IMF workshop. Does the Minister think that this is a real concern? If so, what are we doing to mitigate it?

The BIS report concludes by restating some of the benefits of the very rapid shift to central clearing, but says clearly that this shift may give rise to other systemic risk, in particular that,

“the concentration of the risk management of credit and liquidity risk in the CCP may affect system-wide market price and liquidity dynamics in ways that are not yet understood”.

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It says:

“It is possible that CCPs can buffer the system against relatively small shocks, at the risk of potentially amplifying larger ones”.

This is obviously an absolutely critical issue. Does the Minister agree with these two points? If he does, can he say how we are working on these issues?

The concentration of risk into CCPs—its benefits and potential downsides—is clearly the focus of a great deal of thought and discussion. I have the distinct impression that there is a reasonably settled consensus about the questions that need to be asked, but no settled consensus as to what the answers may be. Clearly, the debate is still vigorously proceeding and has the air of a work in progress. For example, in September, a group of 24 US banks, rather confusingly calling themselves The Clearing House, wrote to regulators criticising inconsistencies in the risk governance of central counterparties and called for tougher minimum standards. Their letter set out demands in three areas. The first was that CCPs should maintain risk committees with consistent minimum standards. The second was that CCPs should be obliged to consider feedback from clearing members about material risks. The third was that the records of communication between CCPs and clearing members that are the subject of material risks should be properly maintained.

I find all this quite alarming, as the obvious implication is that none of that is in fact happening at the moment. I am conscious that I have asked the Minister quite a lot of questions already but I would like to ask one more. Does he agree with the banks’ three demands, or do we already apply these standards to CCPs in our jurisdiction?

There is, of course, always a tension between regulation and growth—too much of one; not enough of the other. Are we getting the balance right? There is a very old Woody Allen joke about this quoted, rather surprisingly, in the Financial Times. The joke is about a man who cannot have his brother—who thinks he is a chicken—treated by a psychiatrist, because the family needs the eggs. Is the regulation of CCPs somewhat in the same position?

6.21 pm

Lord Tunnicliffe (Lab): My Lords, I, too, thank the noble Baroness, Lady Kramer, for tabling this debate. Central counterparties are fast becoming one of the most central components of the financial system in the UK. I hope that the Minister will be able to reassure the House that the Government recognise this and are taking proactive, effective steps to alleviate systemic risk.

As has been highlighted, while there are clear advantages to central counterparties, there are also high risks. This is not a new phenomenon; indeed it describes the day-to-day practice of many involved in financial services. However, CCPs present a number of different challenges. While the finance industry is intrinsically a risk management environment, global markets are still incredibly vulnerable and the scale of expansion of CCPs, if not managed properly, could present a threat to the UK economy.

In 2009, the G20 made a commitment that all standardised, over-the-counter derivative contracts should

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be traded on exchanges or electronic trading platforms and cleared through CCPs. This was one of the many responses felt necessary in the light of the events of 2007-09. It has subsequently increased the recognition of the importance of the role of CCPs in the financial system the world over. In August this year, the European Commission gave the green light to the proposals which will be phased in over three years. Although I am encouraged that a deal has been done, can the Minister explain the five-year gap between the final decision and the Pittsburgh summit?

CCPs’ growing prominence in the financial sector is undeniable. As of January 2015, 50% of the global over-the-counter interest rate derivatives market were centrally cleared, compared to 31% in April 2012. Last month, the Governor of the Bank of England, Mark Carney, stated that the “too big to fail” era for banks had been solved. He announced reforms which meant that the world’s top 30 banks should ensure they hold enough capital to absorb any losses incurred.

In a working paper, the IMF states that we are getting to a point where, due to the highly interconnected nature of CCPs with financial institutions and markets, they are almost becoming too big to fail. Only a few weeks ago, a senior official at the Bank of England questioned whether clearing houses could rely on unfunded commitments from member firms. That would mean that funds would have to be replenished in a period of stress. While there are clearly mechanisms in place, most notably the “default waterfall”, there are obviously still key concerns about how CCPs can be better managed. I would be interested to hear from the Minister the Government’s assessment of how the “too big to fail” concept relates to CCPs.

We fully recognise that there have been a number of notable steps taken by this Government and by the Bank of England to mitigate the risk associated with CCPs, not least the decision to give the Bank responsibility for the supervision of CCPs. This has meant that it is more difficult for CCPs to underinvest in the migration of risks to the wider system. It is vital that the Bank continues to perform this function in the public interest. CCPs should never lose sight of the implications of what could happen if they went into insolvency.

The quality of those who manage CCPs must be beyond doubt. The Minister will know all too well that in this House we are currently debating the certification regime for senior managers in the financial sector. Has such a scheme, statutory or not, been considered in this context? The Bank of England acknowledges that one of the ways in which it can mitigate risks associated with CCPs relates to ensuring that there is a stronger user representation in financial market infrastructure governance. Surely that is another way in which CCPs would become more mindful of their broader remit. Can the Minister give me a breakdown of the various forms of representation, in particular the number of independent directors on both the boards and risk committees of the major CCPs?

I turn to the formal assessment structure in place to oversee the work of CCPs. While the Bank has a supervisory function, the CCPs are not bound by regulation. The Bank says that self-assessment is not self-regulation, as the CCPs’ self-assessment does not

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replace the Bank’s own judgment but is used as one input to its supervision. Can the Minister say what advantage the CCPs’ own assessment of their working brings to the Bank’s supervision?

The Bank of England states that:

“A CCP should demonstrate that its governance and decision-making processes reflect the risk management purpose of the institution. This means having adequate regard not only to the management of microprudential risks to the institution itself, but also the interests of the financial system as a whole”.

I would be interested to hear whether the Minister could ever conceive of a time when we move from “should” to “must”. Finally on this point, in the Bank’s incredibly helpful note outlining the CCPs’ function, which we have obviously all read, it states that it is in the process of introducing more structured reporting of CCPs. I was wondering whether the Government had any information on a timetable and what form these publications will take.

I will briefly touch on the importance of international co-operation, particularly with regard to our EU partners. In December 2014, clearing members established outside the European Economic Area accounted for 39% of the initial margin requirement at UK CCPs. Co-operation is key. As the Bank of England has acknowledged—rightly, in my view—there are terrific benefits to be had from,

“working with the relevant international authorities”,


“going beyond the minimum levels of co-operation”.

However, as the IMF white paper points out, one of the remaining risks is:

“Diverging interests of authorities in a globally cleared market”.

This means that we need constructive engagement with partners across international bodies, including in Europe. Do the Government agree and is this a priority for them?

European Market Infrastructure Regulation and the associated technical standards constitute a significant body of detailed standards against which supervisors must assess CCPs’ compliance and, related to which, they should report information and assessments to EMIR colleges. We understand that the Bank is continuing to implement the new CCP supervisory framework established by the EMIR. Given all this, and in light of the IMF’s warning that risks are increased when diverging interests are at play, what are the Government doing to ensure that these various regulatory regimes are working together?

As of March 2015, the Bank of England had exercised only its statutory powers to gather information over the last year, rather than using any sanctions. While it says that it intends to conduct reviews, I would be interested to know in what areas they will be conducted, who determines the topic, scope and content of these reviews, and how these reviews would help us to understand and pursue the means of lowering the risks?

I thank the noble Baroness, Lady Kramer, for bringing up this subject. It is one that does not have much saliency. It is very useful that this debate has forced the subject on to the agenda. The noble Lord, Lord Sharkey, was right in using the rather gentle word “concern” and then perhaps moving more realistically to the

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word “alarming”. This is an inevitable development of our ever-developing financial structure and it is important that the Bank of England and Government get on top of the issues as quickly as possible.

6.30 pm

Lord Ashton of Hyde (Con): My Lords, I think I shall have to talk quickly. I, too, thank the noble Baroness, Lady Kramer, for securing this debate and other Lords who contributed. It has been an important and rather select debate on a fairly technical subject. That being so, I will try to pick up a number of points made by noble Lords, but if I do not cover them I will check to see whether I need to write with a more comprehensive answer. In particular, I might have to write to the noble Lord, Lord Sharkey, on some of his points.

As today’s discussion has highlighted, central counterparties, or CCPs, are critical parts of the financial infrastructure. Their purpose is to stand between the counterparties trading a financial instrument, guaranteeing that if one of those counterparties defaults on its obligations, the other will receive what it is due. They perform the function of a firewall, preventing contagion and increasing market confidence. They are more important than they have ever been, as has been noted. In 2009, the G20 agreed to mandate the use of CCPs in over-the-counter derivatives as appropriate. Fifty per cent of the global over-the-counter interest rate derivatives market—the largest segment of the OTC derivatives market—is now cleared through CCPs.

This is one of the key post-crisis reforms, which the Government fully supports. Its implication, as noble Lords have recognised, is that CCPs are increasingly systemically important. Therefore, I would like to set out the steps that have been taken here in the UK to ensure their resilience and that—in the unlikely event of a CCP’s failure—the authorities have the powers to step in to minimise the impact on financial stability.

As noble Lords will be aware, the coalition Government acted as soon as it came into office to overhaul the UK’s regulatory architecture, and a key part of this was to put the Bank of England in charge of the supervision of financial market infrastructures, including CCPs. The Bank of England has met this new responsibility by creating a special financial market infrastructures directorate that reports directly to the deputy governor for financial stability, and a dedicated decision-making committee. The FMI function reports annually to Parliament on its work.

In supervising CCPs, the Bank holds them to exacting requirements that are consistent with international standards, as implemented in the EU through the European Market Infrastructure Regulation. Each CCP must collect sufficient collateral from each user to ensure that if that user defaults the CCP has ready funding to cover its obligations to its counterparties. Over and above this, CCPs must maintain a pre-funded “default fund” to cover any losses due to a defaulting user which are not covered by the collateral that has been posted to the CCP by that user. They must hold enough own-capital, collateral and default fund assets to enable the CCP to withstand, under,

“extreme but plausible market conditions”,

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the simultaneous default of the two users to which it is most heavily exposed.

That is already a tough requirement yet, as UK regulation requires, all UK CCPs go significantly further than this and have in place rules which ensure that if the default fund were ever exhausted, the CCP could require its users to make substantial cash contributions to ensure that the CCP continues to perform an uninterrupted service. A raft of other requirements covers CCPs’ risk management, operational capital, governance, liquidity and other arrangements. Noble Lords should understand that CCPs are regulated in this country to strict standards designed to ensure that they are highly resilient. For example, when Lehman Brothers failed, it went through only 35% of the margin held by its biggest CCP.

The chances of a CCP failure are reduced still further by the significant capital and other reforms that have been enacted here and elsewhere to enhance the robustness of global banks and to develop arrangements to resolve failed banks, the CCPs’ biggest users, in a way that avoids them defaulting on their obligations to a CCP.

However, it is, of course, not theoretically impossible that a CCP could fail and it is essential that the Government are prepared. For this reason, in 2012 the Government passed legislation to ensure that the Bank of England can intervene to resolve a failing CCP in a way similar to how it can intervene to resolve a failing bank by transferring a CCP or its property to either a private sector purchaser, a bridge CCP owned by the Bank of England or any other person. The UK moved ahead of the rest of the world in introducing this legislation. In answer to the question asked by the noble Lord, Lord Tunnicliffe, international work is seeking to ensure that the necessary powers and standards in this area are enhanced and adopted globally. The Government and the Bank of England are playing a leading role in these discussions at EU level, in the Financial Stability Board, of which the governor, Mark Carney, is the chairman, and through the CPMI-IOSCO group of global regulators. The EU Commission itself is represented on the relevant groups in the FSB.

International standards on recovery and resolution are critical to prevent UK banks being exposed when using overseas CCPs and to ensure a level international playing field for CCPs. There is also further work taking place in the areas of stress testing of financial resources, margin requirements, which I will say a bit about later in answer to the question asked by the noble Baroness, Lady Kramer, and liquidity requirements to enhance CCP resilience further.

Given London’s leadership in this area—we have globally significant CCPs here, such as LCH.Clearnet Ltd and ICE Clear Europe—noble Lords will understand that it is essential that these standards are developed in co-ordination with the other major jurisdictions to ensure that CCPs in the EU are not put at a competitive disadvantage to those located elsewhere. This is a key priority for the Government going forward.

The noble Baroness, Lady Kramer, asked about recovery and resolution on CCPs. UK CCPs are required to produce recovery plans. In addition, the UK has a resolution regime for CCPs allowing the Bank of

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England to transfer some or all of the business of a CCP to a private purchaser, as I mentioned, and to transfer ownership of the CCP to another person.

As far as international developments are concerned, in October 2014 international central banks and regulators published guidelines on CCP recovery and resolution: the CPMI-IOSCO report Recovery of Financial Market Infrastructures and the annexe on FMI resolution in the Financial Stability Board’s Key Attributes of Effective Resolution Regimes for Financial Institutions. The European Commission continues to work on the legislative proposal regarding CCP recovery and resolution, which has not yet been published. This will supplement the resolution tools already available to the Bank under the UK resolution regime.

The noble Baroness also asked about stress testing. In October, the Bank of England said that it is considering explicitly including CCPs in its wider stress testing of the financial system over the medium term. She mentioned dark pools, which are something that the Bank of England is thinking about. Previously, non-standardised OTC derivatives presented a significant potential risk to the financial system due to the leverage risk exposures they presented to market counterparties and to their opacity. International standards have been developed and are being implemented that require counterparties to derivative trades that are not subject to central clearing to exchange margin to cover those exposures. Uncleared derivative exposures are also considered in the higher capital leverage requirements European banks will be required to meet. With regard to the transparency of these products, all derivatives trades by EU counterparties have to be reported to regulated trade repositories.

As far as the use of block chain, which is an interesting new development, this distributed ledger technology may represent a change in how payment systems work—indeed, it does represent a change in how payment systems work—but the use of this technology is currently very small. The Bank of England as supervisor of payment systems would continue to monitor its application.

On risk of contagion and greater price volatility from CCPs’ actions, are the scale of risks and extent understood? Banks are now far more resilient and both they and their supervisors will assess the risk against the CCP, exercising its assessment rights in full. As far as price volatility is concerned, international policy developments on recovery and resolution in particular are considering the adequacy of tools, including the impact of these tools on clearing members and clients.

The noble Lord, Lord Sharkey, asked what progress we are making on reducing interconnectedness between CCPs. Of course the whole point is that they are interconnected, so the Financial Stability Board, a global body, is undertaking work on interconnectedness and how these risks may be mitigated. The FSB will report by the end of 2016.

The noble Lords, Lord Tunnicliffe and Lord Sharkey, asked whether there was sufficient co-ordination on international standards for CCPs. We think co-ordination at an international level is working well, which is obviously very important. It is important for both

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financial stability purposes and for the competitiveness of the EU that CCPs are able to operate on an international level playing field.

The noble Lord, Lord Tunnicliffe, asked about the Senior Managers and Certification Regime, which we are hoping to apply in the Bank of England Bill. This will not apply to CCPs because these bodies are not authorised persons under the Financial Services and Markets Act. They have always been subjected to a specialist regime. The SMCR will not apply to them, but governance is a key focus of the Bank of England in its supervision of CCPs to ensure that commercial objectives are not inappropriately prioritised over systemic risk management, building on the PRA’s work during 2014 on governance, banks and insurers. The Bank of England does have the right powers to hold CCP senior managers to account.

Lastly—I am running out of time—do we think that the concept of “too big to fail” applies to CCPs? Well, they can clearly be systemic. This is not only due to the significant exposures, but more importantly

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because of their critical role in the operation of markets. That is why we have introduced legislation to establish a resolution framework for CCPs, and why we support the international and EU reforms to enhance the resilience of CCPs.

I apologise for not answering all the different questions, and I will definitely write to all noble Lords who have participated. I would like to thank again the noble Baroness, Lady Kramer, for securing this debate. I hope that I have shown in the limited time available that we do have a robust regime in place, but that the Bank and the Government are not complacent and are still working to develop national and international standards.

Baroness Kramer: My Lords, I would like thank all the Members who took part in this—my noble friend Lord Sharkey and the noble Lord, Lord Tunnicliffe—and to say to the Minister that we appreciate the efforts that he made to respond and look forward to the further Written Answers.

House adjourned at 6.43 pm