Amendments of the Law (Resolution of Silicon Valley Bank UK Limited) (No. 2) Order 2023

Considered in Grand Committee

Moved by

That the Grand Committee do consider the Amendments of the Law (Resolution of Silicon Valley Bank UK Limited) (No. 2) Order 2023.

My Lords, as the Committee will be aware, Silicon Valley Bank UK Ltd—SVB UK—was sold on Monday 13 March to HSBC. The aim of this sale was to ensure that customers of SVB UK could access their deposits and banking services as normal; to limit risks to our tech and life sciences sector; and to safeguard some of the UK’s most promising companies.

We have achieved these outcomes—the best possible—in short order, without any taxpayer money or government guarantees. There has been no bailout, with SVB UK sold to a private sector purchaser. This solution is a win for taxpayers, customers and the banking system. The IMF has said that the UK’s response to SVB UK restored market confidence and contributed to the UK’s upgraded growth forecast. It now expects the UK to avoid a recession this year.

On Monday 13 March, the Economic Secretary to the Treasury laid in both Houses a statutory instrument, using the powers under the Banking Act 2009, to facilitate the sale of SVB UK to HSBC. That instrument has now been approved by both Houses. It granted HSBC’s ring-fenced bank an exemption so that it could provide liquidity on non-arm’s-length terms to SVB UK on an ongoing basis. This was needed to facilitate the sale of SVB UK to HSBC, because it ensured that HSBC was able to provide the necessary funds—over £2 billion in the immediate days after—to its new subsidiary. The exemption also ensures that HSBC UK can provide liquidity to SVB UK as needed.

The Economic Secretary to the Treasury has now laid this second statutory instrument, which we are debating today, to provide an ongoing exemption from ring-fencing requirements for SVB UK, beyond the existing four-year transition period. This exemption is subject to conditions relating to the size of SVB UK’s core deposits, and the type of business it can undertake.

The first condition is intended to ensure that SVB UK, or its subsidiaries, will not be able to hold core deposits—typically, retail and SME deposits—above the existing core deposits threshold in the ring-fencing regime; that is, £25 billion. The threshold is used to determine whether a bank becomes subject to the ring-fencing regime. The second and third conditions are intended to ensure that SVB UK, or its subsidiaries, will be allowed to undertake only new business activities similar to SVB UK’s existing business at the time of the acquisition by HSBC.

These conditions are intended to ensure that the exemptions from the regime are limited to what was needed to facilitate the sale of SVB UK. Together, they minimise risks to financial stability and limit any competitive distortion.

Indeed, Sam Woods, deputy governor for prudential regulation and chief executive of the Prudential Regulation Authority, has confirmed the PRA’s support for the provisions in this instrument in a letter which the EST has laid in the Libraries of both Houses and which I sent to those who spoke in the debate on the first SI relating to SVB. It states that

My Lords, I support the order, but it raises some issues that bear significant further thought. The exemption from the ring-fencing requirement is clearly an issue, so it was discussed in the Chamber earlier in the week. The Government have said that ring-fencing is a key part of their package of banking reforms designed to increase the stability of the UK financial system and prevent the costs of failing banks falling on taxpayers—this was following the financial crisis. Clearly, it is important, and any decision to have some exemption needs careful consideration. I shall not deal with the issue in detail; I heard what the noble Baroness, Lady Kramer, said about it in the Chamber earlier in the week, so I can say in anticipation that I very much agree with her remarks.

I want to say something about the resolution process and what we learned about it during this episode. The Bank of England is responsible for taking action to manage the failure of financial institutions—the process known as resolution. The Bank said that the financial system needs an effective resolution framework, and that was one of the key lessons from the global financial crisis of 2008. Resolution reduces the risk to depositors, the financial system as a whole and the public finances which could arise following the failure of a bank. The object of resolution is to reduce the risk of bank failure as well as to limit its impact when it occurs. To be effective, a resolution authority needs powers that ensure that any losses will fall on a failed bank’s investors but without risk to financial stability or to the broader economy.

To achieve those objectives, the Bank has powers that affect the contractual rights of counterparties and investors in the failed firm, so there have to be statutory safeguards for creditors and counterparties. The requirement in general is that shareholders and creditors must absorb losses before public funds can be used. The Bank has a range of powers to enforce insolvency, which was the initial expectation in this case, or to transfer all or part of a firm’s business either to a private sector purchaser or to a temporary bridge bank established by the Bank pending a sale or transfer.

My Lords, I am delighted to follow the noble Lord, Lord Davies of Brixton. I am very glad that he has had an expanded discussion of resolution. I will refer to that very briefly in what I have to say.

I have a lot of questions for the Minister on this area. She will not be surprised by them because I and others had questions in March when we debated the SI that provided the temporary exclusion of HSBC from the ring-fencing provisions. This time we are looking at a permanent exclusion.

First, let us look at this permanent exclusion. A few moments ago, the Minister said that there are constraints and conditions. Indeed, when we discussed the first SI she led us to believe, I do not think with any ill intent, that when we saw the SI including the permanent exclusion we would find constraints and conditions on either the activities of Silicon Valley Bank UK or the ability of HSBC to transfer unlimited funds to it, in a way that would give us reassurance that this was a very limited busting of the ring-fence, not something with fundamental implications.

I am struggling to understand that because the Minister made it clear just now that Silicon Valley Bank UK could not expand into being a major retail bank. None of us ever thought that HSBC, as a major retail player, would be setting up Silicon Valley Bank UK to be a major retail bank. So long as Silicon Valley Bank UK does not become a retail bank, I cannot see how the PRA is in any way able to limit its activities. Presumably it would limit those activities under Section 55M of FiSMA—“Imposition of requirements by PRA”—and those would not apply if it was not engaged in regulated activities. I am struggling to understand quite how the role of the PRA would work to limit the range of activities carried out by Silicon Valley Bank UK.

Secondly, let us look at those activities. If anybody wants to know what they are, I suggest that they take a look at the Silicon Valley Bank UK website; they will see that it is heavily engaged in supporting both venture capital and private equity. That takes us into that investment banking, high-risk activity that has, since the changes post the crisis in 2007, been separated out from retail banking. We also know, just from discussions, that it is heavily involved in a range of derivatives.

Nearly all the kinds of activity that one would associate with an investment bank that sits outside the ring-fence are indeed already encompassed by Silicon Valley Bank UK. I am struggling to understand what the various constraints are that the Minister was talking about and how they apply—unless, as I say, Silicon Valley Bank has suddenly turned into a major retail player, which would not be logical and is not, I am sure, HSBC’s purpose. If the Minister could provide some clarification on that, I would be most grateful. I was looking to find the constraints within the SI itself. I may have misread the various clauses but I cannot see them.

My argument has always been that ring-fencing was an extremely significant decision by Parliament to provide a fundamental safeguard following the lessons learned from the financial crash of 2007-08, building on the work of the Parliamentary Commission on Banking Standards and its recommendations. The ring-fence had multiple roles; one was to separate the culture of retail banking from investment banking because their relationship with each other was clearly unhealthy. We saw retail banks trying to achieve far greater profits; that is how we ended up with mis-selling in a whole variety of areas and on a very large scale, and it is the reason why we saw HBOS lower its credit standards and begin to fund itself short in order to generate greater profits. We saw a lot of unfortunate behaviour within the retail sector because of this cross-contamination with the investment part of banking.

On the investment side, we also saw a very cavalier attitude towards risk-taking by quite a number of banks, which is how we ended up with the CDOs. They had that cavalier attitude because they knew that they could fund themselves, not by having to go to knowledgeable investors but because they had access to the funds in the current accounts of ordinary folk and retail depositors.

The decision was that the two had to be separated, so I am very concerned about an undermining of the ring-fence. As far as I can see, there is nothing to constrain HSBC from deciding that it wishes to use those retail funds that it has within its organisation to flow into Silicon Valley Bank UK to use for activities such as venture capital, private investment or exotic derivatives. That is exactly the issue that concerned the House the last time that we met to discuss this. At one level, even if you think it is a good thing that we should not have a ring-fence, it will give HSBC a very significant advantage over its various competitors. It is inevitable that those competitors would use pressure and precedent to make sure that they also get similar opportunities and a level playing field.

The sense is that the decision to provide this regime for our largest bank is effectively the death knell for most ring-fencing for major banks in the UK. I admit that there is a process that must be followed—we have the Edinburgh reforms—but the Government have always been very clear that they will come in through statutory instruments and regulation, not through Parliament.

I go back to Section 55M of FSMA, on the imposition of requirements by the PRA. Can the Minister explain how the application of Section 55M requires any kind of primary legislation, as I cannot see that it does? Even if the regulator said that it would try to limit the breach to just HSBC and Silicon Valley Bank UK, that is a decision by the regulator, not Parliament. The regulator could change its mind, go the other way and say, “No, we’re entirely comfortable with the idea of removing the ring-fence”. Essentially, we take the decision away from Parliament if we rely on Section 55M of FSMA as the control factor in whether the ring-fence remains in place. Perhaps the Minister can help me work through that. I am just trying to understand how the notion that primary legislation is required fundamentally to change the ring-fence remains intact now that this is in place.

I will talk for a moment or two about resolution. The Government put forward the argument—the Minister used it on Report of the Financial Services and Markets Bill—that the resolution plans for banks if they fail are an effective substitute for ring-fencing. I argue that they cannot be. We have had dramatic evidence of that over the past several months. Credit Suisse had in place a resolution plan in case it failed, but the Swiss regulators—I stress again that I do not think they are fools or inadequate in any way; they are excellent—made the determination that if they pursued the resolution plan, they would create an economic crisis for Switzerland, so they set it aside.

In the United States, the three regional banks that collapsed did not have resolution plans because the US had adjusted, after a lot of industry lobbying, the benchmark at which banks started to have to have them in place and these smaller regional banks had become exempted. However, under US banking regulation there is an option in these cases for the regulator to impose a resolution plan, even if one is not written and in place when the failure happens. In the cases of the three regional banks, the US made that same determination that it should not impose resolution because it would create too much risk to the economy. Instead, it found other ways to come to the rescue of the three banks that failed.

We now know from absolute experience that resolution, which may apply in some limited circumstances and may sometimes be exercisable, will be available only in relatively limited circumstances. That underscores the fundamental necessity not to harm the ring-fence, which has held the ground over the past several years and looks to be our best and primary hope of preventing the kind of mismanagement, misbehaviour and risk-taking that led to the 2007-08 crash.

I hope the Minister will help me through this, as I struggle to see where there are now realistic, meaningful limitations on HSBC’s ability fundamentally to avoid the application of the ring-fence to its activities, provided that it routes the funds through Silicon Valley Bank UK and also does not turn it into a retail bank, which I am sure is far from its intention.