216: After Clause 71, insert the following new Clause—
“Limitation on the powers of the PRA
The PRA may not accept an application from any insurance undertaking, reinsurance undertaking or third-country insurance undertaking for the application of a matching adjustment to a risk-free interest rate term structure for a portfolio of assets with a rating of less than BBB by Standard and Poors Global Ratings or its equivalent.”Member’s explanatory statement
This amendment seeks to prevent a matching adjustment being applied to a portfolio of high-risk and/or illiquid assets.
My Lords, I start by thanking your Lordships for your patience in putting up with me being gone over the past few weeks following surgery. Noble Lords from all sides of the House have been so kind; I have appreciated it very much. It is lovely to be back in this company today. Special thanks go to my colleagues who have carried the burden that I should have been here to carry.
In a way, it is almost ironic that the three amendments in this group are all in my name. Amendment 216 deals with insurance and matching adjustments; Amendment 241C deals with the ring-fencing brought in following the 2008 financial crash; and Amendment 241D deals with the senior managers and certification regime, which is also a feature of the remedies proposed after the financial crash. When I tabled these amendments, a number of people pointed out to me that they did not seem particularly pertinent to the time—what a difference two weeks make. We have had three mid-sized banks fail in the United States and HSBC has had to step in and take over Silicon Valley Bank’s UK arm. Of course, we have also had the debacle of Credit Suisse, now part of UBS.
All that underpins the consistent jeopardy and risk that exists in the financial services industry and, to my mind, underlines the importance of having proper regulatory mechanisms in place to remove that risk in the first place, deter risky behaviour and provide a resolution mechanism for when things go wrong, as they always will. I regard the three amendments in my name in this group as rather crucial.
Earlier in Committee, we discussed the concern that the new secondary objective of international competitiveness could compromise the primary objective of financial stability. However, in many ways, that was an abstract discussion. These amendments in these three crucial areas of the financial services sector—all are areas where the Government have clearly signalled both their intention to allow, indeed incentivise, a significant increase in risk and their determination to use the law to prevent regulators limiting that risk—provide us with something much closer to real-life examples.
My Amendment 241D also prevents anyone but Parliament, in primary legislation, throwing away the lessons of the 2007 crash by changing key elements of the senior managers and certification regime. As I have said earlier on the Bill, the PCBS was utterly frustrated by the failure of any senior managers to take personal responsibility for the failings in their institutions, to the point that the commission recommended a new criminal offence of
“reckless misconduct in the management of a bank”,
which came into law initially with a reverse burden of proof, although that was later dropped. The centrepiece of the enforcement regime against incompetent or abusive bank leadership has been the SMCR. Like my noble friend Lord Sharkey, who spoke earlier on the Bill, I have been utterly frustrated by the FCA’s hesitancy to use this power and its continuing attitude of deference to high-status bankers.
The regulators will review the more granular details of that regime—I do not care about tidying up and efficiency; that is an entirely different issue—but the Government will be calling for evidence on the fundamentals, including the principles and framework. It is here that the industry is confidently relishing the expected dilution of the principle of individual responsibility, which it argues puts off new business from coming to the UK. If we go back to a much murkier collective responsibility where nothing can be pinned on anyone, as happened in 2007, that would draw in the kind of business that we would apparently like to see in London.
I cannot stress enough the degree to which many of the abuses that led to the 2007 crash were enabled by the absence of an effective individual responsibility rule. To quote again from the PCBS:
“Too many bankers, especially at the most senior levels, have operated in an environment with insufficient personal responsibility. Top bankers dodged accountability for failings on their watch by claiming ignorance or hiding behind collective decision-making”.
My Amendment 241D would require any modification or revocation of the relevant principles established in the Financial Services (Banking Reform) Act 2013 and FiSMA 2000 to come before Parliament in primary legislation. This decision is so fundamental that it is one that Parliament should make.
My Lords, the banking commission did sterling work in the years after the banking crisis, helping shape the content of the banking reform legislation. However, I cannot support these amendments because they are trying to set the findings of that conclusion in concrete, to apply for all time. One thing we know is that times change—sometimes for the better, sometimes for the worse. Having constantly to hark back to what the banking commission said before any sensible changes can be made under the existing available rules seems the wrong direction of travel.
If there was one thing that the HSBC/Silicon Valley Bank episode showed, it was the rigidity of the ring-fencing rules, which were effectively one of the great successes of the banking commission in making sure that rigid rules were set in statute. What had to happen to facilitate HSBC’s acquisition and takeover of Silicon Valley Bank were special statutory exemptions via a statutory instrument. The result was that HSBC now has permanent changes to the ring-fencing regime for it alone, which may well end up with it having permanent competitive advantage over its other rival ring-fenced banks in the UK.
We need to learn lessons from what has happened over recent weeks; the noble Baroness, Lady Kramer, is absolutely right about that. I would be interested if my noble friend the Minister could give more of an idea on the timing of when we might get a lessons-learned report—I think she spoke about that when she first spoke at the Dispatch Box about the HSBC takeover. The answer is not necessarily that we should be taking less risk and making things more difficult to happen, as that is not necessarily the right conclusion from what went wrong.
I hope that the Government will not be frightened by the recent events into not carrying out some reforms of ring-fencing. They have shown themselves willing to consider some sensible reforms to make sure that ring-fencing works well, particularly with regard to small and medium-sized banks. Only a few weeks ago in Committee the noble Baroness, Lady Kramer, agreed that the MREL rules caused a particular problem in the UK; indeed, she said that she constantly reminded the chief executive of the PRA about that. There is an issue about how the rules apply to small and medium-sized banks in the UK. We have to remember that the thresholds used to establish what is a small and medium-sized bank in the UK are way below the thresholds which were increased by the Republicans and which may well have contributed to the problems with Silicon Valley Bank in the US.
The Archbishop of Canterbury
My Lords, I have added my name to Amendments 241C and 241D tabled by the noble Baroness, Lady Kramer, and wish to speak briefly in support of them here. I am particularly grateful to the noble Baroness, Lady Noakes, who made some very helpful and powerful points.
As the noble Baroness, Lady Kramer, said, this marks 10 years since the publication of the Changing Banking for Good report from the parliamentary commission, on which I sat with her. The two amendments to which I have added my name are probing amendments to stress the importance of not forgetting the lessons of 2008-09, because people and sectors entirely can have very short memories.
As the noble Baroness has explained, the amendments seek to prevent alteration to two elements of the banking reform Act 2013 by statutory instrument without proper debate in Parliament, and to prevent changes which go against the recommendations of the parliamentary commission. Our memories have certainly been refreshed this week. If the debate on this group had been held when it was first scheduled two or three weeks ago, I think we would have had a very different reception. If one is grateful for anything in the present crisis, it is that we have been so warmly reminded of why we need a clear memory.
The ring-fence was first recommended by the Vickers commission in 2012, and it was “electrified”—in the words of the noble Lord, Lord Tyrie, in the Parliamentary Commission on Banking Standards report—to address the issue of banks seeking to test it. In our first report in 2012, we commended the coalition Government’s intention to introduce the ring-fence but said, as has been quoted, that it would be worn down in time, and that it had to be
“sufficiently robust and durable to withstand the pressures of a future banking cycle.”
After 10 years, we are now in a future banking cycle. We have gone through a long period of very easy money in which the banks have been able to make a great deal of money and to recover and increase their capital to much better standards than were around in 2008.
The very rapid increase in interest rates right across the western economies—particularly in the United States, which has the fastest increase for 50 years—has resulted in, as usual, the exposure of risks being taken that had not been foreseen. It is the “had not been foreseen” and possibly the “unforeseeable” that are important to stress when looking at this.
Electrification gives banks a disincentive to test the limits of the ring-fence. It is human nature—especially in a corporate entity—to test the limits of any regulation and see if they hurt when you hit them. But 2008-09 hurt far more people than simply the banks. It caused a global recession, and it hurt the poorest in the land more than anyone else. At that time, I was working in Liverpool and living in Toxteth, and we saw the impact on those who were least able to live with it. It is still hurting the whole economy, because for at least a generation after a financial crisis, as opposed to a normal economic recession, there is a deep fragility in confidence. The ring-fence and the other regulation of banks and higher capital are all about maintaining confidence, not about making it impossible for people to go bust.
The ring-fence exists to protect the taxpayer when a bank that is very large and has the functions of a utility—in other words, it is big and simple—runs into trouble through its other activities. Secondly, the SMCR, the senior management regime, reflects the fact—as does the ring-fence—that in almost every banking crisis on record, the banks have privatised profits and socialised losses. It happened back in 1929, 1932, 1906 and in the Barings crisis in the 1880s. If we look around, we see that it is happening now.
In 2008-09, we heard evidence from the former Labour Chancellor of the Exchequer, who spoke of the moment in the autumn of the crisis, when, the weekend after Lehman failed, he was told at 2 am that he had to put in £180 billion by 6 am, or no bank would open for business. He said that the new regime must ensure that that is impossible in future.
The Libor scandal had no impact on top management. One dealer went to prison; no one else took responsibility. The commission heard about the “staggering” ignorance of bank bosses about what was going in their banks under their management. We found:
“Individual incentives have not been consistent with high collective standards, often the opposite.”
The aim of the SMCR is to ensure that those responsible carry responsibility. I support—perhaps unlike the noble Baroness, Lady Kramer—the abolition of the cap on bonuses because it seems that that is part of the idea that if you do very well, you get a bonus, and if you do very badly, you get a malus: you lose what you have gained, which should be awarded only over the very long term. You lose what you have gained in the past because the long-term impact of your management has been poor. In case anyone is wondering, I am quite against bonuses, let alone maluses, for Archbishops of Canterbury—given our figures over the last 70 years.
If we reward people with vast salaries for the risks they carry, they should not be allowed to pass that risk down the line and, ultimately, to the taxpayer. Events of the past few weeks have shown the turbulence in the banking and financial sectors going back to the autumn last year, when we had something that was not the Budget but something with a funny word that I keep forgetting.
Noble Lords
Fiscal event.
The Archbishop of Canterbury
Going back to the fiscal event, a lot of the pension funds almost went bust. We learned a lesson from that, quite rightly, and I think it is a lesson that will be kept.
The ring-fence and the SMCR have been important for encouraging—not solving—improved standards and culture in the banking sector and for protecting the public from bearing the brunt of future banking failures. We cannot forget the lessons learned with such pain for so many outside the banking sector, who had no idea what goes on in banking but found that life suddenly just did not work any more.
I hope that the Government take a further look, certainly through the consultation, at the lessons of the last few weeks, and that the ring-fence is strengthened, not weakened, and improved. I agree with the noble Baroness, Lady Noakes, about both the ring-fence and the SMCR. Both are cumbersome and need rethinking, but not abolishing.
When asked why he had changed his mind, John Maynard Keynes—apocryphally, I think—replied:
“When the facts change, I change my mind. What do you do, sir?”
Given that the facts have changed over the last few weeks, the Government need to ask themselves whether they are going to change their minds and think harder about adequate protection for the basic financial structures that protect the weakest in our society.
My Lords, these three amendments project a peculiar background, which is an issue that this Committee debated in an earlier session—that of accountability. The first amendment of the noble Baroness, Lady Kramer, Amendment 216, is too detailed for primary legislation. On the other hand, I sympathise entirely with the noble Baroness’s goals. In a principles-based system, I would have expected these goals to be expressed in the principles and achieved by the rule-making regulator but, given the lack of accountability with which the Government seem so comfortable—I was impressed by the noble Baroness’s argument on Amendment 216—we cannot be confident that changes will be made at the necessary points. There is no vehicle for Parliament to ensure or inspect the rule-making of the regulators.
I think Amendment 216 is necessary because the Government are so weak on accountability. If we had strong accountability, whereby we could hold the rule-makers to account—both positively, in the sense that you are doing something that you should not be, and negatively, in the sense that you are not doing something that you should be—amendments such as this would not be necessary. Amendment 216 is necessary in the way so carefully described by the noble Baroness, Lady Kramer, simply because of the lack of accountability in the system.
This also applies to the other two amendments in this group. The noble Baroness, Lady Noakes, powerfully pointed out that, because of the peculiar circumstances in which it took place, the resolution of SVB UK required a relaxation of the ring-fence. I am entirely sympathetic with the goals of these amendments, which address the overall structure of the industry and therefore the overall risk appetite of this country for banking and financial services. That is what the ring-fence and the senior managers and certification regime are about.
The “but” is the important case highlighted by the noble Baroness, Lady Noakes, where some modification was necessary. If we had proper accountability, this could come to Parliament, which could then examine this example of relaxation to discuss whether it is appropriate to extend it to other banks, so that there is this mythical level playing field in the competitive relationships between them.
My Lords, I again declare my interest as a director of two investment companies, as stated in the register. I will speak about all three amendments.
In Amendment 216 the noble Baroness, Lady Kramer, seeks to prevent a matching adjustment being applied to a portfolio of assets with a Standard & Poor’s rating of BBB or less. Does this mean a portfolio of assets comprising at least one holding of BBB paper, or a portfolio consisting exclusively of holdings rated BBB or worse? Either way, I welcome the Government’s proposal to remove the disproportionately severe treatment of assets with a credit rating of BBB or below, which will reduce the incentives for insurers to sell BBB assets in a market downturn. These reforms would encourage insurers to revise their investment strategies and risk appetites for investing in sub-investment grade assets, increasing funds available for investment in beneficial infrastructure projects, for example.
In any case—here I agree with the noble Lord, Lord Eatwell—is this attempt to constrain the powers of the PRA not too specific, and the kind of very precise regulation that we want to get out of primary legislation so that we can give discretion on this kind of thing to the regulators? I therefore cannot support this amendment.
I tremble in my shoes to disagree with the good intentions expressed by the noble Baroness, Lady Kramer, the noble Lord, Lord Tunnicliffe, and the most reverend Primate the Archbishop of Canterbury in seeking, in their Amendments 241C and 241D, to make it very difficult to weaken the ring-fencing provisions or change the senior managers and certification regime. It is clear that she and her co-signatories are among those who believe that the introduction of ring-fencing has reduced the risks to which bank customers’ deposits are exposed and that it is therefore important to make it very difficult to weaken the ring-fencing regulations in any way.
It is argued, for example, that universal banking is unsafe because of the volatility of the cash flows from risky investing and investment banking activities. The noble Baroness talked about investment banking as “casino banking”. I worked at Kleinwort Benson for 23 years, which, unusually among accepting houses, had quite a substantial commercial banking business. I am certain that there was never any suggestion or possibility that our customers’ commercial banking deposits could be diverted or invested in dodgy or risky investment banking activities.
Actually, research has found that investment banks’ revenues are indeed volatile, but there is no positive correlation between the two cash flows of retail and investment banking. It follows that universal banks are in fact gaining diversification benefits. The global evidence that splitting up the banks will make them less likely to get into, or be the source of, trouble is pretty weak. In any case, is it credible that the Government would let a major investment bank fail, having seen the disastrous effect that the collapse of Lehman Brothers had on the US economy? Is it not interesting that the US Government did not go for an updated version of Glass-Steagall this time round?
I have one further criticism to make of the market distortion that ring-fencing can cause: it can make it harder for smaller banks to grow. Small domestic banks inside the ring-fence need to compete for a small pool of permitted assets against the capital of the larger banks, which is also trapped in the same pool. This negatively affects the small banks’ profitability, creating a glass ceiling to growth. Can my noble friend the Minister say whether the Treasury has any real evidence that ring-fencing has actually reduced risk, and does she not agree that its continued application negatively affects the competitiveness of our financial markets? I not only cannot support Amendment 241C but urge my noble friend to conduct a review of the effectiveness of ring-fencing. Indeed, events of recent days perhaps support that view. The relaxation of the ring-fence in the case of HSBC’s acquisition of SVB UK indicates that the Government do not think that it is that important or significant.
The senior managers and certification regime was introduced following the report of the banking standards commission, chaired by the noble Lord, Lord Tyrie. It aimed at increasing both responsibility and accountability within the professional financial services sector. To a large degree, it was intended as an enforcement tool—a mechanism through which senior individuals could be sanctioned for systemic failings and serious misconduct that occurred on their watch. Although I would not advocate its removal, and it is arguable that it has contributed to improving standards of behaviour across the industry, many are sceptical as to whether it has been effective, because there is no hard evidence that it has been used as the stick which was originally intended. I therefore regret that I am also unable to support Amendment 241D.
My Lords, in rising to follow the noble Viscount, Lord Trenchard, I have to comment on a couple of the points that he made. When he referred to Amendment 216 and suggested that we could rely on the discretion of the regulators, I regretted that the noble Lord, Lord Sikka, was not here, because I am sure that he could have given some extensive account on that basis. We have cause for concern about the actions of the regulators. The noble Viscount also suggested that the relaxation of the ring-fence in the case of SVB, allowing its purchase by HSBC, was not important or significant. Of course, relaxation of rules under emergency weekend conditions is reminiscent of stopping contagion—rather like the kind of emergency steps we took in the face of the Covid-19 pandemic, where lots of things were done that would not be seen as viable under normal conditions.
On Amendment 216, I confess that I can see the arguments for why this should be considered too technical. However, the points made by the noble Lord, Lord Eatwell, about the fact that we do not have sufficient controls otherwise make the case for it.
On the points made by the noble Baroness, Lady Kramer, we have a problem where the primary purpose of insurance companies and pension managers has been chasing after massive profits, not looking to long-term security. While we are in that situation, we need find rules to manage it.
Responding to the comments of the noble Baroness, Lady Noakes, again suggesting that what has happened in recent weeks suggests that the ring-fence is not working, I think that a military analogy might be quite useful here. If you are in a city under attack and your walls are very nearly overtopped by the enemy, you do not at that point pull the walls down and start reconstructing them. You reinforce those walls. The events of the past couple of weeks have demonstrated that what we have now is not enough of a security system—that is patently obvious—but the answer is reinforcement rather than pulling everything down and starting again, because we saw fit to take actions after 2007-08 which we are hoping will make those defensive walls hold this time.
My Lords, I did not prepare a speech on this, but recent events and the speeches have moved round to what a fundamental issue we are approaching here. One important issue, which underlines the Government’s changes on Solvency II, is how to get investment into our economy. That is a fundamental need that we have. It is possibly intertwined with how much national risk we are prepared to take. I do not intend to try to solve that now.
If we look at recent events and the responses to them, we see that we have different risk appetites in different countries, in how they will accept failure and what, in essence, they are prepared to bail out. As my noble friend Lady Kramer said, it appears to be the assumption that the Canadians would bail out the pension fund. Maybe they think that is a decent quid pro quo for getting a large amount of infrastructure investment and other investments. That is a balance that it is legitimate for a country to make, but I do not think it is one that we have made here in the UK. We have said “No more bailouts”. That may be something that can never be absolutely held to, as we know, but we do not operate on a principle that it is going to be the case.
Let us look at what happened with Silicon Valley Bank in the UK, where there was not really a great deal wrong other than it suffering the repercussions of what happened in the US and a bank run through co-ordination and a loss of confidence. What does that say about our challenger banks, if people are not prepared to rely on the amount of the deposit guarantees that we have? For industry, we have next to nothing. The Americans are talking about raising their amounts of guaranteed deposits because they realise that businesses will not trust smaller banks with large deposits if there are not higher guarantees. That worries people in the United States, because they do not want to lose their regional banks and to have everything go into large systemic banks. It should worry us that we have lost a challenger bank and that it has gone into a large systemic bank.
We may have to re-examine what our risk appetite is around things such as deposit guarantees. It is not pertinent to these amendments, but we have the same kind of risk issues when we expand and try to get insurance money into more risky investments. The same can be applied to what we want to do with pension funds. I suppose I had better declare my financial services interests as in the register again, just for the record. The recent history is that our institutions are not very good at investing in UK assets. Of the fallout from LDI, one of the things that is already under way is that pension funds will invest less in gilts. They will want to invest in something else—something that they can repo. They will therefore invest in corporate bonds but, to get the liquidity to be able to repo, they will be US corporate bonds. We will have yet another shift from investing in something in the UK. Even if that was the systemic risk concentrations of gilts, nevertheless it is a shift away from investment in UK assets, or not taking an opportunity for a switch in assets to be able to invest in those in the UK. Some of this is to do with our size. Maybe the Canadians have thought about that; I do not know. I am just sort of tossing these thoughts in. They are not hugely relevant to these amendments, but they are hugely relevant to the big issue that underlies the change on the matching adjustment —that is, how do we get investment into the UK economy? I should think absolutely every person in this Room wants that. It is hard to do it in a piecemeal way by changing the eligibility to the matching adjustment.
We do not have a proposal that meets the needs of the risk dial or the compensation dial, as we have them. Therefore, I do not think that we should make these changes until a bigger conversation has been had about the many more ways in which we can get investment into the UK economy, so that UK financial services and their profitability are about the profitability of the nation because of how investment has gone, rather than about the profitability of financial services firms. We focus a lot on the latter and what we gain in tax from it, but we really want to know how this hugely benefits the rest of our industry, which is failing and dwindling because of a dreadful lack of investment. There is no other way to explain it: it is almost impossible to get any kind of government backing, and now it is shifting to riskier ways with insurance. Truth be told, many would prefer to invest in something from the United States. We have a lot of homework to do and a lot further to go.
For that reason, my noble friend’s amendments are right in saying, “Hold on; there is a lot more to look at here. You have to come back properly to Parliament, with primary legislation, if you are going to mess around with such a monumental thing as the outcome of the Parliamentary Commission on Banking Standards.”
My Lords, I thank His Majesty’s Treasury for sharing its policy on the Edinburgh reforms last month. This Government, following their initial floating of the HMT intervention powers, have given parliamentarians serious cause for concern regarding their judgment. We should be slow to trust that they have the judgment and operational competence to implement the changes in the Edinburgh reforms safely and effectively. Could the Minister give an indication of the Government’s intentions and/or direction of travel concerning both ring-fencing and the senior managers and certification regime?
We heard from the Bank of England governor this week that the Government’s version of Solvency II reform increases risks for insurance firms by 200% more than the Bank’s preferred option. I think we are vindicated in our general concern about the Government’s gung-ho approach to financial stability. Sweeping changes to ring-fencing and the senior managers and certification regime are too important to be left to statutory instrument. The amendments from the noble Baroness, Lady Kramer, are sensible safeguards that the Government should consider thoroughly.
We have seen chaos in two banks this week—Silicon Valley Bank and Credit Suisse. What is the Government’s assessment of whether other systemically important banks are safe and sound? Did we see SVB and Credit Suisse coming? Did the regulators? What are they proactively doing to protect UK consumers and investors?
My view on Amendment 216 is not yet fully formed; I want further discussions with colleagues. I agree with the general view on Amendments 241C and 241D that the issue is really about scrutiny and accountability. In my view, it is impossible to argue that a relaxation of either ring-fencing or the senior managers and certification regime is other than very significant. The present method of accountability through an affirmative instrument is clearly insufficient and I commend the device of the noble Baroness, Lady Kramer, which she has included in these two amendments. The Government should support them.
My Lords, I will speak first to Amendment 216, which pertains to the Government’s announced reforms to Solvency II, made possible through the Bill’s revocation of retained EU law.
The Government are reforming Solvency II, the rules for prudential regulation of the insurance industry currently set by the EU, to reflect the UK insurance market’s unique features. These reforms will provide incentives for insurers to increase investment in long-term productive assets by more than £100 billion. They will also benefit consumers by increasing insurers’ ability to provide a broader range of more affordable products.
The Government have committed to make changes to the matching adjustment, an accounting mechanism whereby insurers can match their long-term liabilities with long-term assets and hold less money to pay out claims. These reforms will incentivise firms to invest significantly more in long-term productive assets such as infrastructure. This investment will support growth across the UK and the Government’s climate change objectives.
The noble Baroness’s amendment would instead result in a stricter treatment for some assets than under current rules. I reassure noble Lords that the Government’s reforms to Solvency II strike a careful balance between boosting growth across the economy and maintaining high standards of policyholder protection. Insurers will still be required to hold extra capital to safeguard against unexpected shocks, they will still have to adhere to high standards of risk management, and they will still be subject to comprehensive supervision from the PRA, our world-class independent regulator.
The noble Baroness, Lady Kramer, asked whether we would replicate the Canadian Government’s position with regard to pensions and insurance firms in this context. She referred to statements in the Budget about pension funds—although I think they were focused more on defined contribution pension funds than defined benefit pension funds. I do not know the detail of the specific Canadian regime, but the reforms proposed here do not pose risks to financial stability. As I said, each insurer must still hold enough capital to survive a 1-in-200-year shock over one year. Insurers will still have to adhere to the high standards of risk management. The Government and the PRA have announced a series of additional supervisory measures that the PRA will take forward to ensure that policyholders remain protected. For example, the PRA will now require insurers to take part in regular stress-testing exercises.
May I comment on the issue of stress tests, which the Minister also raised during Questions this afternoon? You can stress test only risks that you know are there. It depends on the underlying model that you create to examine in your stress tests. Thus stress tests did not pick up the LDI problem at all because it was not there in the models that were used. In financial services, risks appear in entirely unexpected places, and relying on stress tests is, and has been demonstrated to be, a very weak answer. She should reconsider her reliance on this argument.
Since it is related, I also question the readiness for a 1-in-200-year shock. We have seen very similar kinds of mathematical approaches, if you like, taken to issues such as flood risk and other climate risks, and they have been found to be very ineffective in dealing with problems. They only increase the failure to understand risks.
I would point to stress tests as one of the tools that the Bank of England, including the PRA, has in its toolbox for securing financial stability. It is not the only tool that it uses. The noble Lord is right that it tests against certain scenarios, which are updated each year to take into account the changing picture around the world and look at different risks, but it can test for only the risks that we have thought about. It is a tool in the toolbox, not a solution to everything.
The noble Lord mentioned LDI. The picture there is mixed. It was identified as a source of risk by the Financial Policy Committee but the extent of movement in gilt prices that it was then stress-tested against was far greater in the scenario that we saw unfold. It may be a good example of the benefits of being able to horizon-scan and look for risk—risk was identified—but also of the limits of some of that work. I completely acknowledge that. The same applies to the point made by the noble Baroness, Lady Bennett.
Amendments 241C and 241D relate to important regulatory reforms introduced following the global financial crisis and the recommendations by the Parliamentary Commission on Banking Standards. I pay tribute to the important work of that commission and to its members who are here today. It has had a lasting legacy in improving the safety and soundness of the UK’s financial system.
Amendment 241C relates to the ring-fencing regime, which, as we have heard, is a major post-crisis reform separating retail activities from investment banking activities in large banking groups. As required by the Financial Services (Banking Reform) Act 2013, the Treasury appointed an independent panel, chaired by Sir Keith Skeoch, to review the ring-fencing regime. The legislation required this review to take place after the regime had been in operation for two years; that review concluded in March 2022. I say to my noble friend Lord Trenchard that the Skeoch review looked at the questions about the effectiveness of the ring-fencing regime, and it is in the context of that review that we are discussing the way forward.
The proposed amendment would impact the Government’s ability to revoke or modify aspects of the ring-fencing regime. It would also introduce a new statutory test for the Treasury as well as a requirement for the PRA. The core features of the ring-fencing regime are set out in primary legislation; the Government can develop the regime using secondary legislation, providing for further detail and allowing it to evolve over time. When the ring-fencing regime was introduced, Parliament included clear statutory tests and objectives that the Treasury and the PRA must satisfy when making changes to the regime. The statutory tests continue to reflect the underlying objectives and purposes of the regime; the Government are of the view that they remain appropriate and that no further requirements are necessary.
Finally, on Amendment 241D, all noble Lords will agree on the importance of high standards of personal conduct in financial services. The senior managers and certification regime was introduced based on the recommendations from the Parliamentary Commission on Banking Standards. It was introduced to encourage staff at all levels to take personal responsibility for their actions and to ensure that firms and staff have clearly defined accountability. The regime has been in place since 2016 and has since been extended across all firms regulated under the Financial Services and Markets Act.
Several reviews of the regime have concluded that it is delivering on these aims. UK Finance’s 2019 review and the PRA’s 2020 evaluation noted that the regime had a positive impact in encouraging senior managers and individuals to take greater responsibility and accountability for their actions. However, it is right to review how a policy as significant as the SMCR has performed since its introduction. As the noble Baroness, Lady Kramer, will be aware, the Government have committed to bring forward a call for evidence on the senior managers and certification regime this year, alongside a joint review from the FCA and the PRA.
The Government remain committed to the core purpose of the regime. These reviews will ensure that the Government and regulators have evidence as to the most effective ways for the regime to continue to deliver on its key objectives. The Economic Secretary was clear on these points in his appearance before the Treasury Select Committee on 10 January, where he was asked about the purpose of the review. It would not be appropriate to implement these suggested changes ahead of the Government’s call for evidence on the regime and the regulators’ discussion paper. These reviews will provide a proper evidence base informed by the firms that have to operate within the regime for identifying what, if any, reforms should be considered.
The legislation establishing the SMCR is contained within FSMA; amending that already requires primary legislation. However, Amendment 241D would also bind the hands of the regulators, restricting their ability to amend their respective regulatory handbooks. The Changing Banking for Good report was crucial. It paved the way for this important regime but regulation must be able to respond to changing circumstances. The proposed amendments would make the regime less flexible and leave the regulators less able to respond to emerging issues or risks.
My Lords, I thank everyone who has spoken. When I originally drafted these amendments, they were genuinely probing amendments. I felt that I had stumbled on some issues that, if I was correct, would surely be of such significance that they would have been brought before the House and widely discussed. They changed two of the absolute pillars of our financial regulatory regime: ring-fencing and the senior managers regime. It is evident to me that this is a relatively new topic for most noble Lords here, who are the core of those in this House who engage on these issues. I am therefore very troubled that this has not been part of a broad, in-depth discussion between the Government and Parliament.
I very much agree with the noble Lord, Lord Eatwell. If we had a working accountability system, there would be a mechanism to help deal with all this, but we do not have one. Frankly, I do not want to wait until we do, unless we agree something on that in this Bill, because these fundamental changes have such a possibility of putting our financial stability in jeopardy that we cannot simply sit back and treat them as if they are fairly minor adjustments. They are fundamental to changing the guard-rails that have protected us for the past several years.
I very much agree with the noble Lord, Lord Eatwell. Stress testing is not a litmus test; it is simply a tool to try to expand one’s thinking and to try to identify potential possibilities. The Government have treated it as if it was some kind of litmus test: if it comes up red or blue, or whatever else it is, you have passed and everything is fine. That is not what it is about—in fact that is an abuse of the whole concept of stress testing.
I am extremely worried about the changes to Solvency II as it moves to become Solvency UK. I should say to the noble Baroness, Lady Bennett, that I do not have a quibble with the regulator—the regulator has been shut out of this process. This is a government decision that the matching adjustment will be allowed to apply to illiquid high-risk investments because those are the kind that the Government wish to see increased in our economy. I am happy to see them too but, frankly, I would like somebody in the financial capital market who understands the risk and is willing to take the risks to put money in, whether it is scale-up or infrastructure. The idea that this will now become the norm for pension funds, where basically the policyholders will have absolutely no say and I suspect very little understanding of the level of jeopardy in the fund to which they are contributing on a regular basis, bothers me hugely.
218: After Clause 71, insert the following new Clause—
“Digital identification
(1) Within six months of the passing of this Act, the Secretary of State must publish the Government’s plans for the development and deployment of a distributed digital identification (“Digital ID”) for individuals and corporate entities in the financial sector.(2) The digital IDs should be—(a) scalable,(b) flexible, and(c) inclusive.(3) The Secretary of State must also undertake a public engagement campaign around Digital IDs to raise awareness and participation in the process with regard to the financial sector.(4) In this section—“digital ID” means a set of attributes related to an entity, as according to the International Organization for Standardization and International Electrotechnical Commission framework 24760-1;“flexible” means capable of resilience and workable as technologies develop and evolve;“inclusive” means capable of including all entities and individuals, not least, in respect of their protected characteristics as set out in the Equality Act 2010;“scalable” means capable of national deployment.”
My Lords, it is a pleasure to move Amendment 218 in my name and to speak to this group of amendments. In doing so, I declare my financial services and technology interests as set out in the register. I will speak to Amendments 218, 220 and 221 in my name and will also speak briefly to the remaining amendments in the names of my noble friends Lord Bridges and Lord Forsyth respectively.
Amendment 218 is about perhaps one of the most significant things that we could do to transform financial services in the United Kingdom. Whether we are talking about fraud, operational efficiency or whatever measure or element of financial services we are considering, to have a form of digital ID would transform the current situation. It is vital that the Government strongly consider and move forward with such a system of ID and, in doing so, fully engage the public on this. Understandably, if the public one day wake up and find that they need a digital ID to access their banking services, why would they think that is a good thing if they had not been involved at any stage in the creation and the deployment of such an ID?
To put it in a non-financial services frame, if I wanted to have a pint—not now, obviously, although the previous group perhaps took longer than we were expecting—I might be asked for a passport. What is the purpose of that? Why should the bartender see my name, my date of birth, my passport number, where I was born, et cetera? All that is required for that pint to be put in front of and consumed by me is that, at the point when I order and consume the pint, I am over the age of 18. Nothing more needs to be known.
The same credential-led approach is what we require in financial services—not a huge giveaway of data with the potential for businesses to grab everything about us, as has happened in other sectors of the economy. Put simply, we need a particular credential that is within an individual’s control and can be put across to enable a transaction or inquiry, whatever it may be, to take place. I ask my noble friend the Minister to comment on the need for the Government urgently to engage and to increase the work that is happening in other departments on a general digital ID to be particularly applicable to the financial services sector.
Finally, I wholeheartedly support the intention of the two amendments concerning central bank digital currencies. It is such a significant and potentially positive move for the UK, but certainly a move where Parliament should have a say through primary legislation. The Bank of England has done good work so far and I believe it can have even more pace in its CBDC deliberations.
If one is sceptical about whether this is going to happen, one only needs to consider the two ends of the spectrum with Facebook/Meta already going through Libra then Diem—Zuckercoin or whatever one calls it. If it is considering this a significant play, and if we have the People’s Bank of China similarly in this space, there must be something pretty significant going on, particularly with the People’s Bank of China launching a prototype at last year’s Beijing Winter Olympics for Olympians around the world. That shows its significance. It also enabled me to get the headline in an article “CBDSki”—but we will move on from that quickly. There is clearly a slight delay on the feed.
This is incredibly significant, but what is the Treasury’s view of how a CBDC should be enabled in the United Kingdom? Are we talking wholesale, in which case that is clearly the low-risk end of it? Does that do anything more than the current omnibus arrangement? Going retail is where some of the key gains could be made, but it is an extraordinarily complex landscape. Does the Minister believe that the current pace of CBDC deliberation is where it is at? Where does the Treasury see the key advantages and key potential use cases from an effective CBDC or, if you will, Britcoin in the UK?
If we have an effective system of digital ID and ethical AI deployed to drive operational efficiency and effectiveness, consumer protection, reduced fraud and a true, personalised, enabling, financially including agenda, that could be a key pillar within this Bill. I beg to move.
I apologise for not being able to attend the Committee last week because I was not in the Lords. I have been asked to speak to Amendment 241F, which was tabled by the noble Lord, Lord Bridges, who is currently in the Economic Affairs Committee interviewing the Chancellor. I shall speak also to my Amendment 241FD. I am grateful for the support of my noble friend Lord Holmes for the idea that there should be primary legislation in respect of any CBDC.
The Committee might be relieved to know that I am not proposing to go through the merits of CBDCs. I am very happy to do so if the Minister would like it, but the arguments are well set out in the paper, which was produced by the Economic Affairs Committee that I chaired, published on 13 January 2022 and entitled Central Bank Digital Currencies: a Solution in Search of a Problem? That might give noble Lords an idea of the conclusions of the committee.
The Government and the Bank of England are not convinced. They are still in search of the problem and the solution and a lot of work is being carried out on this. I do not propose to get into whether they are right or wrong about that, but I commend the committee’s report and the Government’s response, which was a letter to me dated 9 March 2022 which ran to all of seven pages—a commendable example of brevity from the Treasury.
On the first page of the letter, the then City Minister, John Glen, said:
“No decision has been taken by the government and the Bank of England as to whether to issue a UK CBDC, which would be a major infrastructure project.”
Indeed, it would. He went on:
“A decision will be based on a rigorous assessment of the overall case for a UK CBDC and will be informed by extensive stakeholder engagement and consultation. Exploring and delivering a UK CBDC, if there were a decision to proceed, would require carefully sequenced phases of work, which will span several years.”
My Lords, I rise briefly out of a sense of obligation and with a sense of déjà vu because on the previous financial services Bill I recall that I was the only Back-Bench speaker addressing a group of amendments from the noble Lord, Lord Holmes of Richmond, on digital issues associated with the financial sector. As then—having written a thesis on artificial intelligence 20 years ago, when we were said to be almost reaching it—I argue that we are no closer now than we were 20 years ago. We now have big data, not genuine, rich artificial intelligence. If noble Lords do not believe me, they should try putting mathematical questions into ChatGPT and see how far they get. What they will get is plagiarism and statistics, not understanding.
I do not agree with the noble Lord, Lord Holmes, on Amendment 218, but I will park that one as I strongly agree with his Amendment 220 on the ethical use of artificial intelligence—putting the definition to one side—and Amendment 221 on a designated artificial intelligence officer. It is worth noting that the Equality and Human Rights Commission has made discrimination in AI a major part of its current three-year work plan. There are huge issues with the prejudices that go into data collection and are written into original algorithms and are then multiplied as algorithms feed into each other. The noble Lord, Lord Holmes, brings up these important issues very regularly, but we do not debate them much in the House. We need to engage with them much more.
Finally, and perhaps unusually, I agree 100% with the noble Lord, Lord Forsyth of Drumlean. His Amendment 241FD makes a crucial point of democracy that should be written into the Bill. Another thing to add to his list of concerns about digital currencies in general, which also applies to CBDCs, is their potential environmental impact.
My Lords, I will speak briefly to the amendments in the names of the noble Lords, Lord Bridges and Lord Forsyth. I agree with the analysis by the noble Lord, Lord Forsyth, of the dangers of having Parliament bypassed in the creation of a CBDC, but I will mention two things to which he may not have given enough weight.
The danger crystallises in the possibility of the disintermediation of the retail banking system, which would have incalculable consequences. Given the difficulties people have in dealing with their own banks at the moment, imagine the difficulty of trying to deal with the Bank of England about your personal account when things go wrong or you do not understand what things are doing. Given banks’ habit nowadays of closing people’s accounts without notice or reason, I wonder whether the Bank of England would take the same view if it had that power.
Like the noble Lord, Lord Forsyth, I would prefer any such creation—although I am not sure that I want one—to be via an Act of Parliament rather than regulation. However, regulation is tempting because I notice that proposed new subsection (3) of the amendment tabled by the noble Lord, Lord Bridges, finds a way of amending secondary legislation. With a bit of luck, we will deal with my amendment tomorrow, which does exactly the same thing in exactly the same kind of words but with broader application.
It is dangerous in the extreme to have Parliament excluded on the central bank digital currency, as the Government clearly intend at the moment. We ought to be very careful about that. When it comes to Report, where we need to think about what amendments we press, I would be very tempted to suggest to the noble Lord, Lord Forsyth, that he presses his amendment.
My Lords, I will make two general comments about these amendments—first, on Amendment 218 in the name of the noble Lord, Lord Holmes.
When I was chairman of the Jersey Financial Services Commission and therefore the regulator in Jersey, I was continually lobbied about the issue of digital identification simply because of the high cost of repetitive KYC investigations that institutions had to go through. It seems that the possibility of having a system of digital identification which would be generally acceptable and generally accepted within financial services would significantly reduce the costs of KYC and would provide a much sounder foundation for the credibility and respectability of the individuals attempting to transact within financial services. So this is broadly a good idea. It is very complicated, as I discovered when I tried to introduce it in Jersey, and it raises very important privacy issues, but, none the less, this is the way that the world is going and we need to think this through extremely carefully. It could be of great benefit to the whole KYC problem.
With respect to digital currencies, the one comment I will make is to remind the Committee of the debate that we had about the decline in the acceptance of cash and the fact that a significant number of people in our country are being deprived of money, since cash no longer works as money—it is no longer generally acceptable in discharge of a debt, which is the definition of money. Therefore, there will be a responsibility for the state to provide a digital form of money, because digital payment, as the noble Baroness, Lady Noakes, argued strongly at the time, will become the standard form of payment and cash is basically going to disappear —apart, perhaps, from the Tooth Fairy.
The issues of digital currency and digital identification are both hugely important for our future and, as the noble Lord, Lord Forsyth, argued—I agree with him most strongly—they require very careful parliamentary consideration.
My Lords, on the digital pound, we support the Bank of England’s work exploring the potential benefits of a safe and stable central bank digital currency, but the Government’s overall approach to crypto remains unclear.
With the collapse of FTX, it is clear that crypto can pose a real threat to normal people in the real economy and therefore may pose a systemic risk in future. The approach HMT has taken to the digital pound is a welcome contrast to this Administration’s eagerness to lean into a crypto Wild West in the recent past. We need to get serious about attracting innovative fintech companies to the UK by safely harnessing the potential of new technologies. How will the Government do this?
On the amendments in general, the issue of accountability has come up once again. The concept of using primary legislation to have a check on these ideas is clearly practical and therefore very attractive, but it will have problems. If the Government would only embrace our concerns about accountability and come forward with a proper and comprehensive accountability structure, perhaps we would be able to develop a more sophisticated approach than the rather raw power of primary legislation. However, as a fallback it is very attractive.
My Lords, the Government have been transparent about their plans to enable the use of digital identities in the private sector, including in financial services, and we are committed to ensuring the scalability, flexibility and inclusivity of secure digital identities.
The Government initiated their digital identity programme following industry calls for the Government to take the lead in developing common standards for digital identity across the whole economy. We continue to believe that a whole-economy approach is the right way forward, and we are working with stakeholders to deliver this at pace.
For example, the UK digital identity and attributes trust framework has already enabled right to work, right to rent and criminal record-checking processes to be digitised, making these checks quicker and more secure. In addition, measures in the Government’s Data Protection and Digital Information (No. 2) Bill, which was introduced to Parliament on 8 March, go further by securing the reliability of digital identity services across the economy for those businesses and consumers who wish to use them. The Government also recognise that greater clarity with respect to how digital identity services certified against the digital identity and attributes trust framework support requirements under the Money Laundering Regulations will be key for market uptake. As set out in the Government’s 2022 Money Laundering Regulations review response, we have committed to considering this too.
I hope that I have reassured my noble friend Lord Holmes that the Government remain committed to enabling the use of secure, reusable digital identity products across the UK economy and that Amendment 218 is therefore not necessary.
Turning to Amendments 220 and 221, also from my noble friend, the Centre for Data Ethics and Innovation guidance has not been designed to form the basis of regulatory requirements relevant to financial services and is unlikely to address AI risks specific to that sector. Appropriating CDEI guidance for the basis of regulation that is aimed at the wider governance of AI through non-regulatory tools and industry-led techniques is therefore likely to lead to unintended consequences; however, I appreciate my noble friend’s point that he used the CDEI for illustrative purposes.
As I said, the approach we take will be determined alongside the consideration of any design of a central bank digital currency. The decision to move ahead with a CBDC has not yet been taken; however, we do believe that it is likely to be needed in future. Although it is too early to commit to build the infrastructure for one, we are convinced that further preparatory work is justified. Therefore, that definition will become clearer as the design of the approach also becomes clearer—but the commitment at the outset to parliamentary engagement is there.
The Minister just made a statement that it is likely to be needed in future. Can I ask a very simple question: why? Why is a CBDC likely to be needed in future? That seems a fairly bald statement.
My Lords, we may not wish to repeat the debate that we had in the Chamber earlier this year, but I was going to address my noble friend’s question about retail versus wholesale and the point from the noble Lord, Lord Vaux, about the use case for a CBDC.
The noble Lord, Lord Eatwell, made one of the points in relation to a CBDC. We want to ensure that central bank money, which is currently available to the public only as cash, remains useful and accessible to the public in an ever more digitalised economy. We have heard about access to cash in our debates earlier in Committee.
My Lords, I am sorry to interrupt the Minister but there is a Division in the Chamber. The Committee will adjourn for 10 minutes, after which we will resume and allow the Minister to finish what she had to say.
My Lords, I was explaining why we think that the UK may need a digital pound in future. The central point is that we want central bank money, which is currently available to the public only as cash, to remain as useful and accessible as ever in an ever more digitalised economy.
I was going to address my noble friend Lord Holmes’s question about whether the work we are taking forward is focused on a wholesale or retail central bank currency. The proposal being considered is potentially to introduce a retail CBDC at some point in the future. With regard to a wholesale CBDC, banks have access to electronic central bank money in the form of reserves; we are open to exploring innovative ways in which wholesale firms could use reserves. There is a programme for reform under way on electronic central bank money in the form of reserves that will bring similar benefits to those that we see for CBDCs in the retail space.
Is there going to be a limit on the amount that people can hold in this retail central bank digital currency? Does the Minister accept that, if there is no limit, that will have major implications for financial stability?
These are some of the questions that we want to consider through the consultation that is currently open and any further work. That consultation recognises the financial stability implications of developing such a proposal; we will want to consider them as we take this work forward.
I hope that the Minister anticipates consultation and research. To me, “consultation” means coming back to the industry. The industry comes from a perfectly respectable position but it is one position. We need basic research, modelling and all the various techniques to explore the potential risks.
The noble Lord is right that the public consultation phases of this work are one element of the work that will be done by the Treasury and the Bank of England in developing this concept. There are many other strands of work that will also be undertaken. As we discussed in the previous debate, any such project would be a significant infrastructure project with significant financial implications so we would need an appropriate approach acknowledging that.
We are at an early stage of this work. As I said, we have not taken the decision to go ahead with a CBDC but we think that there is sufficient evidence to justify further exploratory work. At this stage, it would be premature to include any provision in the Bill. I reiterate my previous statement that the Government expect to keep Parliament fully engaged in this work as it progresses. I therefore hope that my noble friend Lord Holmes will withdraw his Amendment 218.
I can look to write to noble Lords on this question but I am not sure that I would be able to add more to my response at this stage, which is that the Government expect to fully engage Parliament, including through any possible legislation, in an open and transparent manner to ensure that there is full and proper scrutiny of any proposals over the coming years. As the joint consultation paper set out, the legal basis for the digital pound will be determined alongside consideration of its design; that is subject to ongoing work. If I wrote to noble Lords at this stage, I think I would be saying exactly that but, if there is anything further to add, I would be happy to do so.
I just want to make sure that I understand exactly what the Minister is saying. If the Government decide to bring in the digital pound, will they commit to bringing it in via legislation?
I am afraid that I have gone as far as I can in detailing the approach that we would take to Parliament. We expect to engage Parliament fully. However, the legal basis for the digital pound will be determined alongside consideration of its design. Work is not yet at the stage where we can provide that further clarity.
I thank all noble Lords who have participated in this debate and my noble friend the Minister for her response. At this stage, I beg leave to withdraw the amendment.
223: After Clause 71, insert the following new Clause—
“Money laundering regulations: exports to Ukraine
(1) Within three months of this Act being passed, the Treasury must take all reasonable steps to make regulations to amend the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (S.I. 2017/692) so as to secure that they do not prevent a supplier of financial services to a relevant person from supplying financial services in the relevant conditions.(2) For the purposes of this section, a relevant person is a small or medium-sized enterprise which exports armoured vehicles or other military equipment to Ukraine for the use of Ukrainian defence forces, or the agent of such an exporter.(3) For the purposes of this section, the relevant conditions are that an export licence has been granted to a relevant person under the Export Control Act 2002 for the export of items on the United Kingdom Military List of controlled goods to Ukraine for the use of Ukrainian defence forces, and the relevant person is in the process of supporting the export of those items for which the licence has been granted.(4) Regulations under this section are subject to the affirmative procedure.”
My Lords, in moving my Amendment 223, I will speak to my Amendment 241FB. They both deal with the unintended and undesirable effects of the anti-money laundering regime in the UK. I do not profess to have any expertise here; my relevant experience is in defence and security.
I fear that I am obliged to weary the Committee with a little detail. Russia has launched an unprovoked attack on Ukraine and, presumably, HMG have an absolute minimum strategic objective of preventing Ukraine being defeated. Failure to achieve this would result in significantly increased world insecurity and the need at least to double UK defence expenditure. EU and NATO Governments have been providing Ukraine with a range of armoured fighting vehicles—AFVs—through Government-to-Government arrangements. Armoured personnel carriers and armoured reconnaissance vehicles allow troops to move around the battlefield without unnecessarily falling victim to artillery or small arms fire.
To supplement Government-to-Government arrangements, the Ukrainians, through commercial agents and UK SMEs, have also been buying up privately and commercially owned AFVs in the UK. There are only a few businesses and individuals in the UK who can efficiently acquire and export these privately owned AFVs. They are generally small. To undertake this activity, they need to have the necessary technical knowledge, workshop facilities, ingenuity, innovation and contacts; have finance and premises; be seen as a fit and proper person to be granted an export licence for controlled goods on the military list; and, most importantly, be trusted by both Ukrainian buyers and UK private sellers.
The Committee needs to understand the facts of the real world. These small businesses simply do not have the resources to perform due diligence on Ukrainian businessmen and their intermediaries. Even if they could, the Committee will recognise that they would soon find red flags galore. However, the Government have the ability to check that the export of these AFVs is in line with their overall strategic objective.
My Lords, I support my noble friend Lord Attlee in his amendment. His story about Peter reminded me that I have had considerable time-consuming discussions—not with my noble friend’s Peter, whose acquaintance I have not had the pleasure of making, but with another Peter. He is a person like Peter, a former military officer in the British Armed Forces of some distinction who now operates an SME and is closely connected with manufacturers of arms that the Ukrainians are importing from other sources and which they badly need, arms which our own Ministry of Defence is happy to assist in the Ukrainians receiving.
I have listened to my Peter—he is not called Peter; let us call him Jonathan—who has had a nightmare time. He is approved and holds an export licence with the SPIRE system in what is now the Department for Business and Trade; I think that the SPIRE system is the same as the export control system.
Thank you. So, Jonathan is licensed—and has been for many years—with the SPIRE system, formerly under DIT. This means that the security services have carried out a considerable amount of due diligence on him. Nevertheless, he found it completely impossible to persuade any bank to open an account to handle the funds necessary to enable him to assist the Ukrainians in this way, not just at the working level. The moment you fill in a form that suggests any military connection in the goods, red flags fly and bells ring all over the place.
However, these anti-money laundering regulations are considered so important that it is difficult to find any way of obtaining exemptions to go round them, even in situations such as this. It is just a pity that, even at the senior director level, banks are completely prevented under any circumstances—even when the individual is approved under the SPIRE system, as my noble friend Lord Attlee explained. I have sympathy with and support his amendment.
My Lords, I will speak to Amendment 238 in my name. Does my noble friend the Minister agree that “know your customer” and anti-money laundering—KYC and AML—are not working optimally? There is a plethora of examples that we could look at; I will not do so. The simple truth is that they are not fit for purpose and are not achieving their aims. They are not providing the environment that we would want to conduct our financial services in. Does my noble friend the Minister not agree, therefore, that it is high time we had a thorough review of the regulations to put in place a system that works and is inclusive, efficient and effective?
If we look at some of the practical elements, to put it in terms, is it not time that we stopped messing about with gas bills? That takes us to an amendment in a previous group on digital ID, which would go far in resolving many of the issues around KYC and AML. Does my noble friend the Minister not agree? The difficulties that we have heard about and which many members of the Committee may have experienced in all areas of the financial services landscape could be effectively resolved if we resolved the current situation with KYC and AML. It is resolvable; when she comes to respond, my noble friend the Minister could simply say, “I will resolve it”.
My Lords, on the point made by the noble Lord, Lord Holmes, surely these regulations are derived from the Financial Action Task Force. We would usurp international agreements if we modified our regulations in a way that was outwith the positions established by the FATF.
I completely accept that we need to comply with the Financial Action Task Force regulations but, as we discovered the other day when we were discussing PEPs, the regulations we have in the UK have in some instances gone beyond what is actually required by the Financial Action Task Force. The issue with the KYC regulations is one of immense bureaucracy and great irritation for people to no particular end. It is worth looking again at whether the way we have drafted our regulations, to the extent they go beyond what we are required to do, has in turn led to more problems for individuals.
I am sure we have all had problems but I will share one with the Committee. My husband had a very small investment—way below the level at which it would have to be declared as one of my interests in your Lordships’ House—and there was periodic updating of the know your client regulations. Because of the way that firm’s forms were comprised, it refused to accept my noble friend Lady Neville-Rolfe’s signature attesting that the document was a fair copy, because she could not tick a particular box on the form. It was completely ludicrous.
That permeates the way many financial service institutions have come to apply these rules in practice. They have become highly bureaucratic, operated by people who probably have no common sense and possibly not even a brain. To go back to the regulations and see what is absolutely required and then follow it on through the FCA seems a really important thing.
My Lords, although I agree with everything my noble friend Lady Noakes said, I point out that I have discussed Peter’s case at a very senior level with his bank and I can absolutely understand the decision the bank made. It looked at it very carefully, but it cannot take the risk because it is dealing with Ukrainian businessmen of whom it knows very little.
There is no official Labour Party position on this, but I feel enormous sympathy for the position of the noble Earl, Lord Attlee. I hope the Minister will take this away, not as a legislative proposal but as a problem to be solved, and ensure that it is considered at a very senior level in the Treasury.
My Lords, before I speak to his Amendments 223 and 241FB, I first thank my noble friend Lord Attlee for his engagement and for bringing to my attention the specific example he has raised today as context for his amendments. I commend his staunch support for Ukraine, and the Government remain fully committed to supporting Ukraine in the face of the relentless Russian bombardment.
I reiterate to the Committee that the money laundering regulations are a vital part of the UK’s comprehensive economic crime response. The regulations are designed to combat illicit finance but should not be barriers to legitimate customers, including those connected with the export of military equipment to the Ukrainian defence forces.
As the Prime Minister has set out, the Government are fully committed to helping Ukraine emerge from the war with a modernised economy that is resilient to Russian threats. Of course it is important that those contributing towards this are not prevented unnecessarily from carrying out their business, but this needs to be balanced with the existing controls which protect this country, and international partners, from risks of money laundering.
It is important that we do not take steps that might allow the money laundering regulations to be circumvented by bad actors, even in circumstances such as this. It is therefore right that financial services firms continue to be empowered to carry out their own, risk-based due diligence when financing the export of armoured vehicles or military equipment, or individuals who are engaged in the international defence industry.
The money laundering regulations are purposefully not prescriptive and are designed to allow firms to make their own decisions about how to comply, balancing their understanding of the risk with proportionality. The Government do not and will not involve themselves in commercial decisions of individual firms but we can be clear that, where all the correct licences are in place, the money laundering regulations should not be a barrier to the financing of legitimate export activity.
I am sorry to interrupt my noble friend, but I would like to make it clear that Peter does not need any financing. The other cases that I have come across in the aerospace and defence sector are very well financed; that is why their businesses are not very attractive to the banks, which can withdraw financial services because there is no money in it. Peter does not need finance; all he needs is the bank to process the money, but the bank has a real difficulty processing money from Ukrainian businessmen.
My Lords, I was making the point that there is a wider context here that there should be no barrier to the financing of legitimate export activity.
Turning to the point made by my noble friends Lord Attlee and Lord Trenchard, the government process for the granting of export control licences focuses on the end use of goods rather than the source of funds paying for them. It is therefore distinct from the due diligence checks that a bank would carry out before conducting the transaction. I assure noble Lords that, through the Government’s engagement with my noble friend on this, we have engaged with the Export Control Joint Unit, the Financial Conduct Authority and other partners on this issue. While I appreciate the frustrations of individual cases, we are not aware of a systemic issue. The Government will continue to monitor reports of similar problems; if we identify a systemic problem, we will act to address it.
I turn to the solutions suggested by my noble friend. The noble Lord, Lord Eatwell, and my noble friend Lady Noakes are right that our obligations around anti-money laundering regulations stem from our international obligations to the Financial Action Task Force. The approach set out in these proposals would very likely be in contravention of those obligations. My noble friend Lady Noakes is right that the current version of our anti-money laundering regulations reflects our membership of the EU, which is consistent with those obligations from the Financial Action Task Force, but in some areas goes beyond them.
I turn to Amendment 238, tabled by my noble friend Lord Holmes of Richmond. The Government undertook a review of the money laundering regulations, which was published last year. This was a comprehensive assessment of the effectiveness of their implementation and whether they had led to unintended consequences for businesses or consumers. It explicitly assessed whether aspects of the money laundering regulations remain appropriate and proportionate in light of the UK’s exit from the EU and the additional flexibilities that affords us. It identified a number of areas for reform to make the regulations more proportionate and reduce unnecessary burdens on legitimate customers, which we will take forward through future updates to the regulations. These reforms will further tailor the regime to the UK’s risk profile, following the removal of specific European requirements from the money laundering regulations last year.
My Lords, I am grateful for the attention that my noble friend the Minister has paid to my concerns. One thing I would like to pick her up on is that she seems to have been briefed that there is not a systemic problem with the money laundering regulations. I have found out very quickly that there is, and have been briefed by the ADS, which is the aerospace and defence sector trade association and was the Defence Manufacturers Association.
The problem is that where they are exporting around the world, especially outside the OECD, they are immediately coming into contact with money laundering problems. In fact, I had a meeting with a gentleman in Portsmouth who deals in helicopter parts and helicopters. What tends to happen is that he might spend 24 months organising a deal, and then he suddenly gets a cheque for quite a large sum of money from some far-flung part of the world; that is a huge risk for the banks. When we come to Report, I will come back with further examples from the ADS briefing, where sadly this is a systemic problem that is not going away.
I am particularly grateful for the support from the noble Lord, Lord Tunnicliffe, and do hope that the Minister pays attention to what he said. In the meantime, subject to the usual caveats, I beg leave to withdraw my amendment.
241B: After Clause 71, insert the following new Clause—
“Freedom of expression protections for payment service users
(1) Within six months of this Act being passed, the Secretary of State must, by regulations, make provision preventing payment service providers from refusing or discontinuing access to payment services on account of a person exercising their freedom of expression.(2) In this section—a “payment service provider” and a “payment service” have the meanings given by regulation 2(1) of the Payment Services Regulations 2017 (S.I. 2017/752), anda “person” means a payment service user as defined by regulation 2(1) of those Regulations.”
My Lords, I rise to speak to Amendment 241B in my name. After the US fintech company PayPal’s deplatforming of UK political campaigns—the Daily Sceptic, the Free Speech Union and UsforThem—last September, there was a debate about payment processing and censorship associated with this Bill. There was an amendment in the other place that received quite a lot of attention, and it led the Minister, Andrew Griffith, to note that he shared the concerns of the principal issue and potential risks of protecting customers’ freedom of expression when it came to payment providers. He assured us that it should not be possible for service providers, especially those with significant market position, to terminate customer relationships based on those customers’ views.
I was delighted when the Government confirmed that they will include this issue about the role of payment service providers in delivering services without censorship in their consultation about financial regulations enforced by the FCA. However, as I argued at Second Reading, I am not convinced that this is enough. Rather unusually for me, I would like to see more legislative guarantees.
The definition in this amendment is deliberately expansive. It goes beyond the likes of PayPal in order to cover banks and payment processers, whether they are card providers such as Mastercard and Visa or companies such as PayPal and Stripe. There are several reasons for this. The first relates back to important discussions on earlier amendments that I have sat in on and participated in. The ubiquity of electronic systems in an increasingly cashless society, and the emergence of the ubiquity of online payment, means that someone being deprived of those services or cut off from any source of funds would be akin to British Gas refusing services to a household on account of their beliefs or views or free speech that they had exhibited. We would not accept that.
Of course companies can make their own policies and contracts, and that would allow them to remove users without explanation. I understand that, but I am trying to explore whether the law can be used to prevent payment providers closing accounts on the basis of political beliefs. If we do not, global firms are likely to put their own interests—financial, reputational and political—before any moral duty to act fairly or without discrimination. I do not think we can have global tech firms, online payment services or banks deciding who they can censure or cut off from financial services because of the views they express.
My Lords, I rise briefly to support Amendment 241B, moved by the noble Baroness, Lady Fox of Buckley. I declare at the outset for full transparency that I am a paid-up member of the Free Speech Union. To be fully topical, I am also a graduate of Royal Holloway, which has been in the news today along with the noble Baroness on similar free speech issues. We debated this matter in the Chamber earlier.
This is a very gentle nudge by way of an amendment. Like the debate we had earlier this month on politically exposed persons, in this case, we see that a regulatory regime does not work and that we sometimes need a legislative nudge by way of something like this amendment. We could have a sterile debate about EDI/ESG and woke and cancel culture, but that is perhaps for another day. My concern is that untrammelled free speech should not be a monopoly; it is a relative concept because we have laws in this country to prevent egregious offence against certain people who have protected characteristics under the Equality Act 2010. Free speech within the law cannot be the preserve of a plutocratic, wealthy elite as represented by big financial institutions and big tech companies.
I never thought I would quote the comedian Jack Dee but, when the decision was taken by PayPal on 15 September last year to throw off the Free Speech Union, the Daily Sceptic blog and UsforThem, he quite rightly said:
“Big Tech companies that feel they can bully people for questioning mainstream groupthink don’t deserve anyone’s business.”
The offence of UsforThem was to question the efficacy of a policy of the teaching unions and, by inference, the Government not to force or even encourage children to go back to school. UsforThem felt that there was a serious public policy issue around that; it was well within its rights to debate that on the basis of empirical evidence and a well-argued case but PayPal took against it and threw it off the platform for breaching its rather Orwellian-sounding “acceptable use policy”. I do not think that is at all right.
My Lords, I thank the noble Baroness, Lady Fox, and my noble friend Lord Jackson of Peterborough for raising the important issue of freedom of expression and, within that, the role of payment providers.
Following PayPal’s temporary suspension of some accounts in autumn last year, to which both the noble Baroness and my noble friend referred, the Economic Secretary met PayPal and the FCA, as well as interested Members of Parliament. He subsequently set out the Government’s position on this matter on Report during this Bill’s passage through the Commons.
The Government fully recognise the importance of protecting free speech and the crucial role of payment providers in delivering services without censorship. The Government are committed to ensuring that the regulatory regime respects the balance of rights between users’ and service providers’ obligations, including in relation to protecting freedom of expression for anyone expressing lawful views. My noble friend made that distinction in his remarks.
I draw noble Lords’ attention to the letters from the Economic Secretary, the Financial Conduct Authority and PayPal regarding this issue, copies of which have been deposited in the Commons Library. The letter from PayPal explains that it re-evaluated and reversed its decision in a number of the specific cases raised. It made clear that it was never its intention to be an arbiter of free speech and that none of its actions were based on its customers’ political views.
While welcoming this clarification, the Economic Secretary expressed his concern about the importance of protecting free speech and recognising the crucial role of payment service providers in delivering payment services without censorship. As a result, he pledged to take evidence on the adequacy of the existing legislative framework through the statutory review of the Payment Services Regulations. This was published on 13 January 2023; the Government look forward to responses from all interested parties. I note for the Committee that that consultation is open for 12 weeks, meaning that it will close on 7 April. The Economic Secretary will promptly update Parliament through a Written Ministerial Statement following this review. He has committed that, if it emerges that there is a problem with the existing regime, the Government will act swiftly to address it.
When the Minister analyses the results of the review which is concluding next month, will he also look at the slightly wider issue of barriers to entry and the possible oligopoly behaviour of payment services? That is a linked issue which is pertinent to the debate we have had today.
My noble friend makes an excellent point. I will certainly feed that back to the department in terms of the review.
To conclude, the Government already have the means to act on this issue and have made a clear commitment to do so if necessary. We are clear that we first need public consultation and an evidence base before determining the right course of action on this matter. I therefore request that the noble Baroness withdraws her amendment.
I thank the noble Lord, Lord Jackson, and the Minister for that response. I will not keep noble Lords long. What the noble Lord, Lord Jackson, said about self-censorship was important. I mention that because I am worried that the Government are underestimating the climate that financial services providers are embroiled in relating to ESG and EDI. This is a warning shot that we recognised around PayPal, but I did not confine it to PayPal. It is just one example. There are sadly lots of recent examples, with organisations such as GoFundMe refusing to accept certain people because of their views and so on. I know that is not strictly within the remit of this Bill, but I know that the Government understand that there are tensions here. I do not want them to be too narrow and technocratic in the way they approach it by saying “Oh, there are only three examples, so what is there to worry about?” We have seen this internationally. I note that the Chinese social credit system lurks around this debate as something we want to be careful of. Big tech financial companies do not have regard for free speech as their terms and conditions will often cut against what is required in equality legislation here. That was the point I was making.
I hope that this short debate will be taken note of in that consultation. I also hope the Government do not feel that they can just deal with it simply through the consultation but will keep a close eye on what could be a dangerous and nasty situation of financially powerful organisations having an impact on individuals, frightening them into thinking that if they say the wrong thing they will not get banking. That is not the sort of society that we would like to end up with. I beg leave to withdraw the amendment.
241E: After Clause 71, insert the following new Clause—
“Regulation of factoring companies
(1) Within one year of the passing of this Act, the Secretary of State must by regulations make provision for factoring companies to be regulated by the FCA.(2) Regulations under this section are subject to the affirmative procedure.”Member’s explanatory statement
This new clause would bring factoring companies, those which provide, arrange or facilitate invoice discounting or factoring, into FCA regulation.
My Lords, I rise to speak to Amendment 241E in my name. Start-up and scale-up businesses, especially small and medium-sized business, occasionally face the issue of managing their cashflow, especially when expanding. Traditional funding through banks has diminished since the 2008 financial crisis and often, in looking for a more flexible, less onerous solution, businesses look to factoring or invoice-discounting companies. I used many factoring companies when I started my businesses and when we ran into a bit of a cashflow situation.
The model for this is straightforward: the factoring or discounting company pays the client typically 80% to 90% of the value of invoices they have raised for goods or services supplied and then either assumes responsibility for the debt itself or bills the client for the amount given, plus a percentage fee, when the invoice is settled by the customer. This enables the client company to operate and expand with limited capital. It effectively does not have to wait for the normal 30, 45 or, in some cases, 60 to 90 days settlement period, which is typical for larger companies and many public sector organisations. This model is typically used in sectors with long payment cycles that require the purchase of goods or raw materials to create products and in international transactions.
However, there has been considerable growth in this sector in recent years due to the uncertainties and disruptions caused by the pandemic, Brexit and the war in Ukraine. Like any well-run financial services, when times are good, such arrangements are mutually beneficial, but if the financial crisis of 2008 has taught us anything—and I hope it has—it is that the money ultimately must come from somewhere, and problems with financial instruments often become apparent only when things go wrong.
Factoring as a concept has existed for a very long time, but its use has grown rapidly in recent years. UK Finance, the collective voice for the banking and finance industry, maintains an independent standards framework setting out and enforcing standards for its members that clients can expect from providers of invoice finance or asset-based lending. However, companies do not have to become members to operate in this sector. This is why I have tabled Amendment 241E as a probing amendment. There are concerns that factoring and invoice discounting risk becoming a scandal for small businesses equivalent to the payday loans rip-off for consumers. Unscrupulous companies can obfuscate fees, and interest rate charges of 2% to 4% for a period of 45 to 60 days seem low but equate to 18% to 24% per annum, which is a relatively expensive way to finance a business in the medium to long term.
My Lords, I support the amendment from my noble friend Lord Leong. I was a bit shocked to discover that factoring companies are not regulated through the FCA. My discovery of this through my noble friend’s initiative reinforces my view, which he very clearly expressed, that this is the business equivalent for SMEs of payday loans in the consumer retail sector. Given the importance of small and medium-sized enterprises to the growth of the UK economy, which he quite rightly pointed out, one of the most important elements of public policy is to ensure that they receive the best, most appropriate and well-regulated financial services, which provide them with a firm financial platform on which to grow. I hope that the Minister takes this amendment away and has a serious think about it, because this is a serious gap in the regulatory framework.
I rise briefly to support this amendment. It was with some surprise that we also discovered that this sector is unregulated, but we entirely understand how important it is to the small business community. In that respect, it is hard to see why it is not regulated and why it should not be regulated. It is hard to see how any Government could resist the force of the noble Lord’s amendment—but we may see a demonstration of that in a moment or two.
My Lords, I first welcome my noble friend Lord Leong to this very special club, the Financial Services and Markets Bill club. I am sorry that it is a little thin on the ground. I will say no more than that the case, as presented and supported, seems strong.
One of the sad things about occupying this position is that, every time credit comes up, you get abusers. The large companies are frequently the abusers, and payday loans are a classic example of that. Anywhere there is credit, you end up with pockets of abuse. I unashamedly believe in regulation. I do not believe in bad regulation; I believe in good regulation and I think it should enter this field. But that is not a formal position, so we will listen to the Minister before concluding our point of view.
My Lords, I thank the noble Lord, Lord Leong, and others noble Lords for their contributions on this amendment headed “Regulation of factoring companies”.
As noble Lords know, invoice factoring is a type of invoice finance where suppliers effectively sell their invoices at a discount to a finance provider in exchange for an advance. This means that suppliers can receive payments sooner, helping them to manage cash flow. Invoice factoring is an important product for British businesses, helping them to grow sustainably when they might otherwise struggle to do so. It is a relatively standardised product designed to help businesses manage their cash flow and support growth.
Businesses benefit from a diverse finance market made up of high street banks, smaller banks and a range of non-banks to ensure that they can continue to access suitable finance. This is particularly important to ensure that UK SMEs are accessing finance to support their goals and contribute to the UK’s growth agenda. We have discussed the approach to regulating small business lending in an earlier debate but, as noble Lords know, invoice factoring is not considered credit, because it is an advance on invoices already generated; therefore, any small businesses using these products do not benefit from protections such as those under the Consumer Credit Act, which apply to the smallest businesses taking out loans.
However, invoice factoring is generally used by larger SMEs that would not benefit from protections under the Consumer Credit Act in any case. UK Finance estimates that its members advanced invoice finance and asset-based lending facilities to just 35,000 firms in 2022, representing less than 1% of all UK businesses; in comparison, according to the SME Finance Monitor, 36% of SMEs—nearly 2 million of them—were using external finance in 2022.
However, the Government believe that businesses using invoice finance are well protected in other ways. The banking and finance industry has recognised that businesses should be able to use invoice factoring with confidence, so has taken steps to ensure that businesses have adequate protections. UK Finance members, representing between 90% and 95% of invoice factoring by volume, are subject to a standards framework and code, which set the standards that firms should meet when supplying invoice factoring facilities. They include an independent complaints process focusing on the requirements of those smaller businesses using invoice factoring, which might otherwise be reluctant to raise concerns about their treatment. For invoice factoring among larger firms, these businesses will have the financial and legal resource available to take action through the courts.
I thank all noble Lords who have kindly supported this amendment. Access to finance is vital to start-ups and small companies; it is one way in which they can easily get money without any security. The number of small companies that have to resort to factoring invoice discounting is on the rise because banks are becoming more and more demanding as far as security is concerned. As I said in my speech earlier, my amendment is a probing one. I want to take this opportunity to ask the Minister this: can we do some more work to see how many companies access this form of finance and how many companies go bust because they cannot afford to pay some of the rates that are being asked by these companies?
On that basis, I beg leave to withdraw my amendment.
241FA: After Clause 71, insert the following new Clause—
“Defined contribution and defined benefit pension funds investment review
(1) The Treasury must publish a review of how to incentivise defined contribution (DC) and defined benefit (DB) pension funds to invest in high-growth firms and a diverse range of long-term assets in the United Kingdom, which must include green infrastructure.(2) In carrying out the review, the Treasury must consult—(a) the Department for Work and Pensions,(b) the Department for Business and Trade,(c) the Pensions Regulator,(d) the FCA,(e) the PRA,(f) pension trustees, and(g) relevant financial services stakeholders.(3) The review must consider the merits of—(a) amending the definition of “specified scheme” within the meaning of the Occupational Pension Schemes (Scheme Administration) Regulations 1996 (S.I. 1996/1715) so as to increase the threshold of such DC schemes in respect of which trustees and managers are required to produce a value for members assessment under regulation 25 of those Regulations;(b) adjusting the terms of reference for DB Local Government Pension Schemes (LGPS) funds to consider regional development as an investment factor;(c) establishing frameworks to enable DB pension funds to invest in firms and infrastructure alongside the British Business Bank.(4) The Treasury must prepare a report on the outcome of the review, and lay it before Parliament within one year of the passing of this Act.”Member’s explanatory statement
This amendment would compel the Treasury to publish a review within a year of Royal Assent on how to incentivise pension fund schemes to invest in high-growth firms and green infrastructure. The review would have to consider requiring DC schemes to assess the merits of: consolidation, establishing frameworks for British Business Bank investments (so that DB pension schemes will be able to invest alongside them), and adjusting the terms of reference for Local Government Pension Schemes (so they consider regional development as an investment factor).
The Grand Committee is scheduled to run until 7.45 pm, which gives us half an hour. However, in the usual way, if the debate has not concluded by that point, the debate on this group will continue into the next day of Committee.
Thank you. I rise to move Amendment 241FA. Patient, long-term capital is crucial for both the growth of innovative companies and investment in green infrastructure to support the transition to net zero. One of the key sources of patient and venture capital is institutional investors, in particular pension funds in the City. Compared with our peers, such as Canada, the Netherlands and Denmark, the UK sees relatively little patient capital funding coming from pension funds; while around 70% of venture capital funding in the US comes from pension funds, in the UK, the figure is under 20%. The Government must do more to enable pension funds to invest in the British economy.
I have tabled Amendment 241FA, which would compel the Government to review how to incentivise defined contribution and defined benefit pension funds to invest more in high-growth firms and diverse long-term assets in the UK. The review would cover three areas. First, we know that a significant barrier to increasing DC pension fund investment is the relatively small size of many UK DC funds. The Government could raise the threshold at which schemes are required to produce a value for members’ assessment; they previously legislated to do this for schemes smaller than £100 million but a review could explore raising the threshold significantly —up to £5 billion, for example—to deliver real change. I would appreciate the Minister replying to the merits of this particular point, if possible, but this figure is something that the review could explore.
Secondly, we know that Local Government Pension Scheme funds have around £340 billion of assets under management, of which £30 billion is already invested in alternative asset classes such as VC. In order to mobilise some of this capital into regional green infrastructure and business, a review should look at adjusting the terms of reference for LGPS funds so that they could consider regional development as an investment factor.
Thirdly, a review should explore how the British Business Bank could put the necessary framework in place to allow DB pension funds to invest alongside it. DB pension funds have nearly £3 trillion in assets under management; unlocking even a small proportion of this would be a substantial boost to the amount of additional financing available to British companies and projects.
My Lords, I thank the noble Lord, Lord Tunnicliffe, for introducing this amendment. I have chosen to address simply the green infrastructure parts, and at this time of the evening I shall park the high-growth debate in the interests of not sidelining the main issue.
The idea of a review is useful here, because the evidence we have of other measures the Government have tried to take to encourage green investment is perhaps mixed—that is the charitable description. I refer to a survey published this month by Pensions for Purpose, which looked at the first wave of obligatory reporting of the scheme introduced in October 2021 based on the Task Force on Climate-Related Financial Disclosures being done by the larger occupational pension schemes and authorised master trusts. That study found that this introduction by the Government was having very limited effects and that it was, to a large degree, being treated as a tick-box exercise. Where it was having an impact on investments, it was not driving towards green investment but rather to a portfolio decarbonisation—a stepping away from things rather than into the kinds of investments we need. This is something we are also seeing implicitly, in that the pension regulator is about to launch a publicity campaign for pension trustees, stressing the need to look at ESG responsibilities, particularly around climate issues—that has been its responsibility since 2019. It is clearly thought necessary to have a publicity campaign about this.
We really need to see steps forward and to see things joined up here. I am reminded of a debate last week with the same Minister, when we finally finalised the UK Infrastructure Bank Bill, which, of course, is looking at another source of investment going into green. I am very encouraged by the Government’s decision to include nature-based solutions there, which is obviously a cross-reference to our need to see much more private investment in nature-based solutions as well. Dare I say it, it would be nice to see some circular economy as well—if I can just put that in there.
My Lords, it is obvious that the issue of pension funds investing in equities and longer-term growth prospects was highlighted by the LDI crisis in the autumn. I hope that, when the Government come to consider the consequences of that crisis, they will look at the letter that your Lordships’ Industry and Regulators Committee sent to Andrew Griffith MP, the Economic Secretary to the Treasury, setting out the reasons it saw for the peculiar financial structures that led to the LDI crisis and the lack of long-term investment in equities and growth stocks by British pension funds. They traced this to the accounting regulations that are imposed on British pension funds—particularly the way in which liabilities are assessed—and noted that, since those regulations were introduced maybe 15 years ago, there has been a dramatic reduction in the investment by British pension funds in long-term equity assets and a focus mostly on rather low-yielding government securities instead.
The LDI scandal was produced by the development of a peculiar financial device using repos, which were then used to make some investment in equities. There is clearly a fundamental problem in the regulation of British pension funds, which has both reduced the returns on their investment and limited the sort of investments they might be able to make in growth assets to their benefit and that of the economy as a whole. There needs to be a major review on the regulation of pension funds, both to make them more secure—to avoid them resorting to very unstable financial constructions to try to increase their returns—and for the overall benefit of the economy.
My Lords, I agree with everything that the noble Lord, Lord Eatwell, has said. We are happy to support this amendment. I simply have two questions and one observation about it.
The amendment says that we must include “green infrastructure”. Is there a practical, generally agreed working definition of what that actually means? I also notice that, in carrying out the review, the Treasury must consult a list of organisations. The final group of organisations is “relevant financial services stakeholders”. Is the intention also to include professional advisers? They would be a vital addition; perhaps that should be made explicit as we go forward.
My observation is that proposed new subsection (3)(c), which talks about
“establishing frameworks to enable DB pension funds to invest in firms and infrastructure alongside the British Business Bank”,
is an extremely good idea. We should make sure that this happens as soon as we can.
My Lords, the Government remain fully committed to the objective of unlocking pensions capital for long-term, productive investment, where it is in the best interests of members. High-growth sectors developing cutting-edge technologies need access to finance to start, scale and stay in the UK. The Government are clear that developing the next generation of globally competitive companies in the UK will require unlocking defined contribution pension fund investment into the UK’s most innovative firms.
That is why, in the Spring Budget last week, the Chancellor committed the Government to working with industry and regulators to bring forward an ambitious package of measures by this autumn. He also set out a number of initial measures to signal the Government’s clear ambition in this area. They included increasing support for the UK’s most innovative companies by extending the British Patient Capital programme by a further 10 years until 2033-34 and increasing its focus on R&D-intensive industries, providing at least £3 billion in investment; spurring on the creation of new vehicles for investment into science and tech companies tailored to the needs of UK defined contribution pension schemes by inviting industry to provide feedback on the design of a new long-term investment for technology and science initiative; and leading by example by pursuing the accelerated transfer of the £364 billion Local Government Pension Scheme assets into pools to support increased investment in innovative companies and other productive assets. The Government will shortly come forward with a consultation on this issue.
This builds on a significant amount of exploratory work already undertaken by the Government to review issues affecting investment in long-term assets, including government policies. The Government have worked with industry on this issue over a number of years, leading projects such as the pensions investment task force and the Productive Finance Working Group, which have systematically reviewed the barriers to investment in a range of long-term assets. This collaboration has led to important regulatory changes, including the proposed introduction of the long-term asset fund structure and the reforms to the defined contribution pensions charge cap through the Occupational Pension Schemes (Administration, Investment, Charges and Governance) and Pensions Dashboards (Amendment) Regulations 2023, which are currently undergoing parliamentary scrutiny. The Productive Finance Working Group has also developed a suite of practical guides to long-term investment, which offer support to pension schemes and others looking to move into illiquid or private market investment.
I hope that the noble Lord, Lord Tunnicliffe, is reassured that the Government wholeheartedly share the ambition to see more pension schemes investing effectively in the UK’s high-growth companies for the benefit of both the economy and pension savers. Not only do we share that ambition; there is also a wide range of work under way to look at how we can turn it into real action, with a deadline of the autumn fiscal event to bring forward more specific proposals.
The noble Lord asked specifically what the Government are doing about raising the threshold of the value for member framework and about the Government’s recently published consultation on a new value for money framework. It is my understanding that the two are linked as the new value for money framework will build on and, in time, supersede the value for member assessment, with the threshold of £100 million. The new value for money framework will apply to all defined contribution occupational schemes and require them to report on wider value metrics to ensure that they are providing long-term value for members. He was right to pick up on the value for member framework and the possibilities there but we believe that we are taking forward an option to apply similar reforms even more widely through the value for money framework.
Therefore, the Government agree with the aims of the amendment but, given the work under way and our clear ambition in this space, I hope that the noble Lord will withdraw it.
My Lords, I thank all noble Lords who have spoken in this debate.
The noble Baroness, Lady Bennett, went banging on about the green issue again. In many ways, I cannot think of a better day to do so, with the report from the United Nations that came out yesterday. This is the challenge not particularly of my lifetime but of the community’s lifetime and younger people’s lifetimes—our children, grandchildren and so on. This green issue is not optional. It is central to our survival and the survival of our civilisation as we know it.
I thank my noble friend Lord Eatwell for his support. Getting this right is not trivial; you have to get the balance right. The LDI issue, as I understand it, was essentially about pension schemes wanting to nudge in this direction, discovering that they could not do it in a straightforward way then finding a way around the back without actually realising how destabilising that scheme was. We need good-quality thought in moving this forward so that we get growth, yield and safety all in the same package.
I agree with the noble Lord, Lord Sharkey, particularly on the definition of “green”. This brings me to an adjacent issue, which is the whole concept of the green taxonomy. I hope that this will develop and grow and that it will become an international standard; it will provide a basis for the development of this type of initiative and, of course, all sorts of other initiatives.
As for the Minister, I cannot see why she is not accepting my amendment. I know that the Government like to chew them up so I am looking forward to a government amendment coming forward on Report to embrace this useful and sensible thrust. I beg leave to withdraw Amendment 241FA.
Amendment 241FA withdrawn.
Amendment 241FB not moved.
Committee adjourned at 7.36 pm.
I start with Amendment 216, which addresses the insurance industry. Of course, this also encompasses many people’s pensions; in a sense, that was clarified in the Budget by the Chancellor, who talked about, in essence, opening up defined benefit pension plans to holding illiquid high-risk assets, in the same way as he anticipates Solvency UK opening up insurance companies to holding a far greater portfolio of illiquid high-risk assets. Under the EU regime, Solvency II, insurance companies are required to build a capital buffer based on the risks in their investments—their asset portfolio. The provision is designed to provide a safeguard if an insurance company fails, protecting both policyholders and the taxpayer. Solvency II allows an insurer to reduce its buffer where the insurance company is holding long-term assets that match the cash flows of its life and annuity insurance and its reinsurance obligations. That relief is called the matching adjustment. It allows adjustment to the discount rate that the firm is required to use to value its cash flows in order to determine the size of the buffer.
With Brexit, Solvency II is being replaced by Solvency UK. No one, including me, denies that Solvency II is probably overly restrictive and requires a degree of reform. I have not objected that Solvency UK is reducing the level of capital—the sort of raw capital buffer—by 65% for life insurers and 35% for general insurers. But the Government are now choosing to go much further. At present, the matching adjustment, which, as I said, has the effect of reducing the buffer even further, applies only to long-term assets held by the insurance company that qualify as investment grade. The change now proposed allows long-term, high-risk, illiquid, sub-investment grade assets—subprime is another word that is often used—to get the benefit of the matching adjustment. There is nothing that the regulator can do about it.
Why would the Government take such a risk? I think the answer is sheer desperation. They are hoping that the insurance companies and the defined benefit pension funds, to which we now know that this will extend, if they do not need to hold much of a buffer, will invest much more in the scale-up of innovative businesses, because scale-up money is hard to find in the UK. Unfortunately, scale-up is the phase at which many companies fail. The standard rule of thumb is that 40% of companies scaling up fail.
The Government are also hoping that the money will go into infrastructure. I should explain that many infrastructure projects are investment grade. TfL bonds, for example, are investment grade, as are the bonds for the M6 toll road; they qualify for the matching adjustment. But many infrastructure projects are high-risk and the bonds they issue are very illiquid. Just look at the pattern for most major infrastructure projects, and small ones as well. There have been delays and overruns in Crossrail, HS2 and pretty much every nuclear power project anywhere in the world. The worst part with infrastructure is that you rarely know that it is in trouble until it is very close to its official completion date. The matching adjustment would apply a far more extensive range of sub-investment grade investments. I know from talking to many companies that they see this as their way to get back into subprime mortgages and subprime property arrangements.
I am very old-fashioned. I believe that the primary purpose of an insurance company is to pay its policyholders on time and in full, and the primary purpose of a defined benefit plan is to pay its pensioners on time and in full. As I said at Second Reading, many people point out that these are pools of money and that the equivalent pension funds in Canada invest heavily in global infrastructure. I point out yet again that, if anyone reads the comments of the rating agencies on those Canadian pension funds, they will become very aware that the Canadian Government are regarded as a backstop should those funds collapse.
That is very different from the situation that we have in the UK, unless the Minister is about to tell me that the UK taxpayer is now willing to become a backstop for pension funds and insurance companies in the UK. The only example that I know about is one that we discussed earlier—Equitable Life. We know that nearly a million policyholders lost more than three-quarters of their investments when Equitable Life failed and that the Government did not bring them back to full recovery, even though the financial ombudsman found serial maladministration by both the Treasury and the regulator. I would very much like to know from the Minister, as we look at Solvency UK, which is enabled by the Bill, whether the Government now propose to give an equivalent backstop to that provided by the Canadian Government.
My amendment basically says that:
“The PRA may not accept an application from any insurance undertaking”—
I will not give you the rest of the details—
“of a matching adjustment to a risk-free interest rate term structure for a portfolio of assets with a rating of less than BBB by Standard and Poors … or its equivalent.”
This is my attempt to stop that reduction in the capital buffer for illiquid, high-risk investments.
I will try to be briefer in dealing with the other two amendments in this group. I shall take Amendments 241C and 241D together. These amendments sprang from the Chancellor’s speech on the Edinburgh reforms. I have referenced before my concerns, which are shared by many who, like me, sat on the Parliamentary Commission on Banking Standards, that we are seeing the rollback of the safeguards that followed our commission’s report Changing Banking for Good. Let me quote from it:
“An important lesson of history is that bankers, regulators and politicians alike fail to learn the lessons of history … measures that are implemented while memories are fresh will be at risk of being weakened once the economic outlook improves, memories fade, and new, innovative and lucrative approaches to global finance emerge.”
That is exactly what we are seeing today, and the past two weeks have illustrated it in spades. The failure of three significant mid-sized banks in the United States was enabled by the rollback of regulation, a rollback that had been sought by the siren voices of the industry. Those same siren voices are currently extremely influential in the Treasury, and I am hoping that we will hear from the Minister that she will go back and look at the decisions to weaken that regulation in the light of the reality that we have seen over the past two weeks and the experience in the United States. Many of these regimes, particularly the senior managers regime, are now to be carried over into the shadow banking world. I am sure that is a good thing, but it is very concerning if those projects are watered down before they are carried over.
I am very concerned about the watering down of ring-fencing. Today, I asked some questions in the Economic Affairs Committee, and it is clear that the Chancellor intends to make changes to the ring-fencing regime. I accept that there are times when one could claim that ring-fencing has been overzealous with small and medium-sized banks and there are some arguments for the need to change MREL, but it is shocking to see that the Government are backing the recommendation of the Ring-fencing and Proprietary Trading Independent Review that if a bank is deemed “resolvable” its ring-fencing features can be removed.
The proposition behind ring-fencing was that retail banking is an entirely different animal from the casino banking of investment banking. It is essentially in many ways a utility, and it needs to be kept safe and separated by the virtues of the ring-fence. On the commission we also saw constant cross-contamination—in other words, risks being taken within the retail bank because of the impact in the universal banking model of their investment banking colleagues. Things such as PPI and various other forms of general abuse of customers clearly sprang from the internal pressures that were created by the overall culture of the combined firm. We could also see that many of the risks that the investment bankers tended to take were fuelled by their access to retail bank accounts that paid no or very little interest and were protected by insurance and which almost, in a sense, provided a honeypot that incentivised the taking of undue risks and played a very significant role in the kind of failures that led to the crash.
To quote Paul Volcker,
“it is the damage that it does to the culture of the whole institution … Trading operations and impersonal proprietary trading operations are simply different from a continual banking relationship.”
In other words—of which there were many—the linkage between retail banking and investment banking contributes fundamentally to all kinds of abuse of customers and small businesses, from PPI, the asset stripping of RBS GRG and the mis-selling of interest rate swaps. It also lay behind the complete collapse in credit standards and the short-term funding strategies that sank HBOS. Ring-fencing is a vital tool to provide for financial stability. With the plans to remove the cap on bankers’ bonuses, which the Government and industry treat as one of their highest priorities, it is even more important that this protection stays in place. My Amendment 241C would prevent any such destruction of the ring-fence without a decision by Parliament in primary legislation.
I hope that the Government will press on with their consultation on ring-fencing and on the senior managers regime. Having been on the receiving end of the senior managers and certification regime for the nine years that I was on the board of what is now NatWest, I know that it is very bureaucratic and inefficient, and it does not necessarily target the kind of things that people thought it was going to be targeting at the time. It is therefore time to step back and ask whether this is the best way of achieving the objectives, which are to ensure that people take responsibility for their actions. What this has ensured is that there is a whole industry of chopping down forests, in order to fill files of evidence that you have taken reasonable steps to carry out your responsibilities, and I do not think that was the intended outcome of the reforms at the time.
I therefore make a plea: let us not get panicked by what has happened in recent weeks into not accepting that there is a good case for reviewing both the ring-fencing and the SMCR rules. I have nothing to say on insurance because it is not my specialist subject.
The recent failure of SVB in the US, and the ease with which what is by global standards a major bank was reclassified as a systemically important bank and thus eligible to be rescued—even though there is a system for resolving banks which is meant to be robust—demonstrates that the issues of systemically important banks are very difficult to handle. Again, the problem is one of confidence: we are talking about the contagion of a lack of confidence, and not simply about the failure to observe rules and regulations.
The resolution of banks is part of the system in the USA. It applied to SVB and to Credit Suisse, but it was not enough to protect the taxpayers of the US or Switzerland from having to put in significant implicit and explicit support. This is all about confidence. If we go on bailing out the system as it is, one of the unintended consequences is likely to be further damage to confidence.
For me, one of the most memorable moments of the banking standards commission was hearing the very broken and tragic testimony of a former head of a global bank outside this country. He was a man of absolute integrity who had been brought to the point of complete breakdown—I suspect my colleagues remember it—by the impact of the failure of the bank he led. Right at the end of his testimony, I asked him, “When you wake in the night, what do you remember and wish you had done differently, because we all do that over events in our past?” He said, basically, “That’s easy. I remember that you can run a small, complicated bank safely, or a big, simple bank safely, but you cannot run safely a big, complicated bank”.
I am enormously sympathetic to the goals of these amendments: to the first because it is a practical issue of excessive risk-taking by insurance companies and, as we have seen, pension funds; and to the other two because they refer to the structure of risk which Parliament has decided is appropriate in this country’s financial services industry. It should not be modified wilfully—I am thinking of the marriage ceremony—and without due consideration of the consequences. Therefore, the Government would once again be well advised to reconsider the issue of accountability, which they have brushed away so casually, because it would provide the flexibility for Parliament to be involved in changing the risk appetite of the country as a whole.
I would have attached my name to Amendments 241C and 241D had I been able to keep up with the flood of legislation we have before us. In reflecting on them, I want to quote an economist on the New York Times, Ezra Klein:
“Banking is a critical form of public infrastructure that we pretend is a private act of risk management.”
That is the context in which I hope the Minister can today reassure us that, as we come towards the end of Committee and in the new environment in which we find ourselves, the Government will seriously rethink this Bill, particularly key elements of it such as competition and ring-fencing, before we get to Report. I have to borrow from a letter in the Financial Times this weekend —I am relying on this as a source—the fact that apparently the correct name for a group of black swans gathered on the ground is a bank.
I do not fully trust the consultation process that we have in this country, because the pre-consultation process is dominated by an industrial lobby which knows what it wants. The consultation responses are weighed, and they are inevitably heavy with what the industry wants and why, and there is much less that comes in to counteract that. Therefore, we go down the track of accepting the proposals of the Government and getting what the industry says—but where is the backstop? This is where we come to the backstop that my noble friend has put in. The backstop is that it is for Parliament, through primary legislation. She does not say in her amendment, “Thou shalt never amend ring-fencing” or, “Thou shalt never amend the things that the Parliamentary Commission on Banking Standards did”. It says that it requires primary legislation. It says that this should go back to the body—albeit different people at a different time—and that there should be that analysis. This is the same sort of thing that the noble Lord, Lord Eatwell, was saying. Maybe you could get legitimacy from Parliament through a better accountability mechanism but, absent that, the only one we have is that it has to come back to primary legislation. With a Whip system and a government majority, that does not necessarily guarantee anything, but it will get at least a thorough airing and, in normal circumstances, you would get some toing and froing and some reasonable amendments if necessary.
In December, as part of the Edinburgh reforms, the Chancellor announced a series of changes to the ring-fencing regime. These broadly follow the recommendations made by the independent review. It concluded that the financial regulatory landscape has changed significantly since the last financial crisis—a point made by my noble friend Lady Noakes. UK banks are much better capitalised and a bank resolution regime has been introduced to ensure that bank failures can be managed in an orderly way in future, minimising risks to depositors and public funds.
In the light of these considerations, the independent review concluded that changes could be made in the short term to improve the functionality of the regime. Crucially, the panel stressed that these could be made while maintaining financial stability safeguards. The panel also recommended that, over the longer term, the Government should review the practicalities of aligning the ring-fencing and resolution regimes. I assure noble Lords that the Government remain firmly committed to the objectives of the ring-fencing regime: to protect core banking services, such as retail deposits, from risks elsewhere in the financial system while minimising risks to taxpayers in the case of a bank failure. As recent events have shown, it is critical that the Government and regulators have the necessary powers to act decisively in pursuit of these objectives.
In response to the review, the Government have announced their intention to consult later this year on a series of near-term reforms to the ring-fencing regime to implement the independent review’s recommendations. The proposed reforms will make the regime more adaptable, simpler and better placed to serve customers, while maintaining important protections for depositors and financial stability. Alongside this, and in response to the review’s longer-term recommendations, the Government recently published a call for evidence that explores how better to align the ring-fencing regime with the resolution regime. I assure all noble Lords that, in the context of that longer-term call for evidence, no decisions have been made on the longer-term future of ring-fencing. The call for evidence is seeking views on a wide range of options including the possibility of disapplying the regime where banks are deemed resolvable, which was one of the Skeoch review’s recommendations. It also seeks views on retaining or further alternative options for reforming the regime.
I will be very glad if someone else can come up with some mechanisms. The mechanisms that I used here of parliamentary accountability have been my attempt to deal with what seemed like a problem that was not being discussed. However, the excellent speeches that we have heard today, and indeed the Minister’s reply—it did not suggest that we have been exaggerating the situation, but confirmed the problems—mean that we will have to try to find some mechanism, and quickly, to deal with this range of issues. The last two weeks have made it clear that it is complacency to think that we have in place the kind of structure that genuinely protects us from financial risk, and complacency is exceedingly dangerous. I beg leave to withdraw the amendment.
Amendments 220 and 221 concern artificial intelligence. It is worth me making a few preliminary points before I go into the specific elements of the amendments. A helpful Bank of England paper on this subject was put out on 11 October last year, lest anybody think that AI is something for the future and not for us to worry about in the Bill. In the paper, 72% of financial services businesses said that they already use, or are about to use, AI. None of them said that they believed that the current way in which they used AI was high-risk, while more than half said that they were currently constrained in their ability to deploy AI fully because of current regulations on the PRA and FCA approach to the subject. That is some of the backdrop. To put my own cards on the table, lest anybody think otherwise, I am neither Panglossian nor po-faced about AI or, indeed, any of the other new technologies that we have in our hands. Yes, they are incredibly powerful technologies, but they are in our human hands in terms of how we design and deploy them. Thus I describe myself as rationally optimistic about their potential.
Amendment 220 brings this to life, I hope. It is a real opportunity for the UK, not just in financial services but across the whole of our economy and society, if we have an approach to ethical AI. The UK could be world-leading in the deployment of ethical AI; financial services is as good a place as any to have such an approach. I reference the Centre for Data Ethics and Innovation in this amendment; I am not wedded to it. Other organisations, such as the Alan Turing Institute, also have a role to play but the key is that there is an agreed underpinning.
For example, when we did the Lords Select Committee AI report in 2018, we set out five ethical principles; I do not want to give them any more concretion, to reference a previous group, but I say to my noble friend the Minister that one of the key architects of those ethical principles was the right reverend Prelate the Bishop of Oxford, who was a member of the committee. One therefore understands that they have behind them more than just the weight of the mere mortals here today.
Amendment 221 seeks to build on the ethical AI deployed in financial services institutions, and to have in every such institution a member with a responsibility for AI, in the same way that we have a money laundering reporting officer. Obviously, specific to the size of the organisation, it does not need to be an individual who performs only that role, but somebody in every financial services institution in the UK needs to be a designated AI officer. Does my noble friend the Minister agree?
Noble Lords will note that there is no mention whatever of Parliament in those considerations.
In their response, the Government acknowledged that there was
“a broad range of opportunities and risks, which require careful evaluation.”
In response to the committee’s request to get a commitment from the Government that this would require parliamentary approval, the sentence which stands out is:
“The government expects to fully engage Parliament—including through any possible legislation—in an open and transparent manner to ensure that there is a full and proper scrutiny of any proposals over the coming years.”
I am prepared to bet any Member of the Committee a bottle of champagne that, when the Minister replies, we will hear exactly the same words.
The problem with those words is that they are not a commitment to parliamentary scrutiny; they are not a commitment even to secondary legislation, which my noble friend Lord Bridges’s amendment calls for. They are certainly not a commitment to introduce primary legislation to implement something of this scale and importance, which is what my amendment calls for.
My noble friend Lord Holmes mentioned that the Chinese were keen on CBDCs. I am not surprised: they are a means of controlling and knowing what every citizen is doing with their money and how much of it they have. Although the Bank of England will say that its system would be devised in a way which acknowledges the privacy issues arising from CBDCs, I do not for a moment imagine that there will be any such undertakings in China. I can see the attractions of it; there are huge civil liberty and privacy issues at stake here.
There are also substantial risks to financial stability arising from a CBDC and how it is constructed. On the one hand, if you go the whole hog and everyone’s cash holdings are held digitally by the central bank, that clearly has all kinds of implications for privacy and stability. If, on the other hand, it is argued that the commercial banks will carry this out and you would be allowed to hold only a certain amount in a central bank digital currency, it rather defeats the object of doing it in the first place.
If there is the ability to move money into your CBDC account on any scale, in circumstances such as those that have occurred in recent days with some banks, where people fear stability, they will move their money out of the banks into the central bank digital currency, which is clearly a safer haven. That could create huge liquidity problems for the banks. Depending on how it is designed and operates, we could see ourselves moving towards the nationalisation of credit. At this point, I should declare that I have an interest as chairman of Secure Trust Bank.
All of this, we are told, is going to take a lot of time and require a lot of consultation. However, it seems to me that something as fundamental as this cannot be left for the Bank of England and the Treasury to cook up without proper consideration by Parliament, given the issues that are involved.
In paragraph 13 of its equally lightweight response to the committee’s report, the Bank of England states:
“The Committee cites privacy and identity as key considerations related to CBDC and points out potential reputational risk to the Bank of being drawn into controversial debates on these issues. The Bank recognises that these are important topics for the design of any CBDC system and that appropriate safeguards must be ensured if CBDC is to command users’ trust and confidence. These matters are being looked at as part of the Taskforce’s exploratory work and will be taken forward in the Consultation Paper.”
Then there is the important part:
“The Bank also recognises that these issues extend beyond the remit of the central bank. As such the Bank will closely support the work being undertaken by, and take its lead from, HMG”,
not Parliament. Once again, as with the previous set of amendments and as so often in this Committee, we are wrestling with the question of accountability and accountability to Parliament. Here, we are looking at a major change with huge risks to personal privacy, financial stability and the cost and availability of credit. The notion is that this can all be done without proper consultation by Parliament.
In speaking to these amendments, I am a reasonable person. My noble friend Lord Bridges’ Amendment 241F simply requires a vote in Parliament and looks to secondary legislation. I would support that, but I would prefer that if the Bank of England and the Treasury decide, having carried out their consultations, that they wish to proceed with this it should be the subject of primary legislation and subject to extensive debate.
Again, we have not made a lot of progress today, so all I ask of the Minister is for her to fill in the blanks in the undertaking that was given to the committee of this House. It was an all-party report, supported by the members of the committee. They included the noble Lord, Lord King of Lothbury, who knows a certain amount about central banking, and several members of the committee have great experience. I hope that the Minister will be able to say that she can give an undertaking on behalf of the Government—if not at this stage, certainly at a later stage, but ideally at this stage so that we will not have to discuss it again later—that there will be primary legislation and that the Government will instruct the various committees of the Treasury and the Bank of England to proceed on the basis that it will require primary legislation, a draft Bill and an undertaking to deal with the many issues that arise from a central bank digital currency, which I will not bore the Committee with now.
There has been a lot of talk about what caused the financial crisis in 2008 and the risks that occur. In my experience, the really dangerous thing in financial services is groupthink and belief in models. This is an absolutely classic example of thinking, “The Chinese are doing it and others are doing it so perhaps we need to do it as well. What is going to happen in future?” That is fair enough—have an eye to the future—but just because everyone else is going to do something that might increase risk is not a reason to copy them.
I have a simple request for the Minister: will she please give an undertaking that we will have legislation should the Government decide to go down this course in future?
I assure my noble friend that the newly created Department for Science, Innovation and Technology is already developing a cross-economy, pro-innovation framework for AI regulation, underpinned by a number of cross-sectoral principles to strengthen the current patchwork approach to regulating AI directly. Further proposals for the new regulatory framework will be published in a White Paper in the coming weeks. Through our proposals for a new AI regulatory framework, we are building the foundations for an adaptable approach that can be adjusted to respond quickly to emerging developments. The vast majority of industry stakeholders we have engaged with agree that this strikes the right balance between supporting innovation in AI while addressing the risks.
Furthermore, the FCA, the PRA and the Bank of England recently published a discussion paper on how regulation can support the safe and responsible adoption of AI in financial services. Therefore, to avoid unintended complications with the use of digital identities and artificial intelligence in the financial services sector, I hope that my noble friend will not press his amendments.
Finally, I turn to the important topic of central bank digital currencies and Amendments 241F and 241FD, both ably introduced by my noble friend Lord Forsyth. The Government have been clear that they consider that Parliament will have a vital role to play in the future of any digital pound. As I set out to my noble friend Lord Bridges in a previous debate in the Chamber, when we discussed the findings of the report to which my noble friend referred, the Government expect to fully engage Parliament, including through any possible legislation, in an open and transparent manner to ensure that there is full and proper scrutiny of any proposals over the coming years. As the joint Treasury and Bank of England consultation paper published on 7 February set out, the legal basis for the digital pound will be determined alongside consideration of its design; this is the subject of ongoing work.
The Export Control Joint Unit at the Department for International Trade grants export licences for controlled goods on the military list, among other things. So far as I can discern, it is doing a very good job. It is important to note that the Export Control Joint Unit has all the facilities of HMG at its disposal to determine whether military equipment should be exported to a certain customer or not. The money laundering regulations add nothing useful to this process.
I now turn to the mischief which my amendment seeks to address. During our debate on Ukraine on 9 February, I explained the problems that “Peter”—not his real name—is experiencing with the provision of banking services in the context of his exporting AFVs to Ukraine. I will continue to use his pseudonym for continuity reasons. I understand that Peter has export licences for around 100 AFVs and has already delivered a considerable number. Although the high street bank’s name is in the public domain, I will not name it, as it has done nothing wrong and has been extremely helpful. Apparently, in these circumstances, MPs will just get stonewalled by the banks, but I have very good relations with Peter’s bank.
On 20 December 2022, Peter’s bank wrote to him, closing his accounts with the bank without any explanation why. Peter was going to completely lose his banking services on 20 February. This would have put him out of business, as he cannot secure banking services from any other provider, and he would not be able to export any more AFVs to Ukraine. Other banks will not step in because they will have the same difficulties as Peter’s current bank. Peter’s bank made it clear to him that it was not prepared to discuss the matter further. This is standard practice, and I understand why. However, I have found out that the problem is that Peter’s current bank cannot accept the regulatory risk of supplying banking services involving large sums of money when Peter does not have the correct anti-money laundering systems in place. But even if he did, he would surely find red flags, as I have already mentioned, because he is dealing with Ukrainian businessmen. Fortunately, I managed to negotiate with the bank an extension to 20 March, which was yesterday.
Initially, I thought that the problem lay with an overzealous junior bank official and that a quick engagement at a senior level in the bank would get it sorted. I then discovered that it was a money laundering problem, as described, but the problem could be solved if a Treasury Minister wrote to the bank relaxing the money laundering regulations in a specific and minor way. I thought all this could be done discreetly and behind the scenes. How wrong I was. Ministers have refused to relax the money laundering regulations because, as I understand it, they believe that the complete integrity of the regulations is more important than facilitating the export of armoured fighting vehicles to Ukraine.
I repeat the question that I asked my good and noble friend Lord Ahmad on 9 February. Is it settled Government policy that the complete integrity of the money laundering regulations is more important than facilitating the export of armoured fighting vehicles to Ukraine? I look forward to the Minister’s reply. The reality is this: each and every additional armoured fighting vehicle that we send to Ukraine will give another group of Ukrainian soldiers protected mobility on the battlefield. Conversely, stopping the export of AFVs will result in avoidable loss of Ukrainian lives, which is quite immoral.
My Amendment 223 works by requiring Ministers quickly to amend the money laundering regulations so that banks do not have to suspend provision of banking services to SMEs that are exporting AFVs or other military equipment to Ukraine under a relevant export licence granted by the Export Control Joint Unit—in other words, a relaxation under very limited circumstances. Of course, my amendment is unnecessary because Ministers can simply write to the bank asking it to relax the money laundering regulations in the way that I suggest.
On my Amendment 241FB, during my investigations it became apparent that there is a wider problem with banks withdrawing provisions of financial services from aerospace and defence SMEs, for two reasons. The most important reason is again the money laundering regulations. In addition, there is a reluctance within some banks to have anything to do with the defence industry, particularly with things that go bang. However, these are highly regulated businesses, and they are dealing with other businesses and Governments, often outside the OECD. Thus the regulatory risk is far too high for the banks when the potential income is often quite small. It is simply not worth the bank’s while to accept the regulatory risk. I accept that my Amendment 241FB is imperfect and does not necessarily solve the problem. At this stage, it is only a probing amendment. I have been briefed by ADS Group, the relevant trade association, on this problem, and it is clear that it is a growing problem that will not go away.
On my Amendment 223, this is a serious and urgent matter. Clearly, the Minister intends to resist, or she would already have relaxed the regulations and saved a lot of the Committee’s time. I am afraid that thus far, I have not been able to generate much interest in this issue. His Majesty’s Opposition in your Lordships’ House do not appear to be very interested, and neither are the media. It does not currently look as if I will be able to win any Division at Report. In view of these circumstances, I was not in a position, nor was it my role, to seek a further extension of service from Peter’s bank when I could not offer any evidence that the policy was likely to be changed. As a result, Peter lost his banking facilities yesterday and will have to stop exporting AFVs to Ukraine. No one can step in, because they will experience the same problems.
The sense of the Committee will be unusually important on this occasion. Your Lordships can merely listen to an interesting debate or make it very clear to my noble friend the Minister that the Committee will not tolerate the money laundering regulations that are causing avoidable loss of Ukrainian lives by preventing the export of AFVs to Ukraine. I beg to move.
While the Government remain committed to ensuring the proportionality and effectiveness of anti-money laundering regulations and the regime around it, and monitor the effects on financial inclusion, the review required by Amendment 238 would largely repeat the exercise conducted last year, of which we are still to implement the full results.
My noble friend referred to the previous group on digital identity. He is absolutely right; we recognise that greater clarity on how digital identity services are certified against the Government’s digital identity and attributes trust framework would support requirements under money laundering regulations that will be key for market uptake, so we see the opportunity there and the role for government in providing assurance on that process of uptake as a potential technical solution to make some of these processes easier. As set out in our 2022 money laundering regulations review response, we have committed to consider this fact too.
For the reasons I have set out, I hope that my noble friend Lord Attlee can withdraw his amendment and that my noble friend Lord Holmes will not move his when reached.
This is a matter of some concern, not least because—this is the other focus that I want your Lordships to consider—at the moment, environmental, social and governance, or ESG, targets and equality, diversity and inclusion, or EDI, policies have been embraced zealously by many financial services companies. We have seen from recent controversies around failing banks that they were arguably far more concerned about ESG than whether they were banking well. We have a situation in which corporates have taken to moralising about how their customers should behave and think, which is a real and present danger.
Currently, the big tech companies in the US that deal in financial services have adopted political positions and are regulating the speech of their customers. That is considered a growing problem, as identified by a wide range of civil liberties organisations that I reeled off at Second Reading. Sadly, we know from broader cultural trends—for example, the way that cancel culture at universities started in the US—that what happens in the US should often be seen as a warning of what is likely to come.
Here in the UK, under current law, ESG has become a vehicle for companies to baldly state their right to block the accounts of those whose politics clash with their corporate values. Payment providers such as PayPal, but also high street banks, may terminate the accounts of groups on the basis of lawful speech—as long as they give adequate notice—according to the law. They can terminate accounts where views they deem unpalatable clash with those values if they include such provisions in their terms of service. Acceptable use policy often proclaims, “We will take action when we deem that individuals or organisations are involved in promoting hate or intolerance”, but “hate or intolerance” is increasingly seen as and understood to be a rather vague tagline which can be interpreted in a wide range of ways.
This was illustrated last year when Halifax was involved in a controversy after announcing its staff pronoun policy on social media—I do not know whether your Lordships remember this. We were shown a picture of Gemma wearing a “she/her/hers” staff badge; the idea was that this was a campaign that would stop any “misgendering” by the customers of Halifax. There was something of a customer backlash online, which led to Andy, the person who seemed to be in charge of Halifax’s online communications at the time, berating critics with the rather shrill
“If you disagree with our values, you’re welcome to close your account.”
As it happens, lots of people did close their accounts, because they were so outraged at being talked to in that fashion. Telling customers where to go is an unusual policy for growth for any financial service provider.
However, I think this was more than an overzealous EDI employee, because on its website Halifax says that any customers it deems to be transphobic could have their accounts closed down. Indeed, underneath the page entitled “What we stand for” it says:
“We stand against discrimination and inappropriate behaviour in all forms, whether racist, sexist, homophobic, transphobic or ableist”—
and, wait for it—
“regardless of whether this happens in our branches, offices, over the phone or online on our social media channels.”
The actions that it threatens customers with include account closure or contacting the police. Note that HSBC shared the Halifax post and tweeted it out to its 101,000 followers, saying:
“We stand with and support any bank or organisation that joins us in taking this positive step forward for equality and inclusion.”
Customers, it seems, are the target of political campaigning by financial organisations, rather than being seen as those who need to be given the very best financial services. We should also note that in 2022, when that tweet went out, Halifax cut 27 branches across the country. Never mind encountering Halifax staff wearing pronoun badges; the problem is that you would be lucky to encounter a Halifax staff member at all, badgeless or not, and there is certainly very little in the way of physical branches.
In a recent report Matthew Goodwin, politics professor at Kent University, noted that a growing number of companies and corporations are now “adrift” from the wider public by
“lecturing them about political issues and being seen to stifle their free speech and expression.”
Professor Goodwin also warns against potential discrimination against consumers and customers in this context, and account holders
“deemed to hold ‘controversial’ beliefs.”
However, as one Halifax customer noted:
“I don’t want to be having conversations about gender when I go into my bank. Frankly, I’d rather they be focused on lowering interest rates.”
Of course, we need to respect the right of private companies to choose whom they do business with, as I said. However, this rather modest amendment seeks to ensure that they are not free to discriminate because of political, philosophical or religious beliefs within the law any more than banks or online service providers would be allowed to discriminate against people on the basis of the colour of their skin. We therefore need robust measures in place to protect organisations and individuals from being punished by being cut off by those financial service providers whose EDI or ESG commitments have made them rather cavalier about going far beyond their financial remit. They should be prevented from acting against people for otherwise legal speech. Remember, we have laws in this country such as the equality law, which should not be undermined by the terms and conditions and values designed in Silicon Valley—which in many instances is what we are talking about and is exactly what happened when PayPal punished the Free Speech Union by removing any financial services from it.
I hope that this amendment urges the Government not to kick this regulatory duty into the long grass or suggest that some other piece of legislation would be appropriate. I put it forward in the spirit in which the Minister in the other place spoke about the importance of this issue, rather than it being trivial. I hope the Minister will consider accepting the terms of this amendment in any amended Bill that is brought back on Report.
The point that the noble Baroness, Lady Fox, made is right. In a competitive market where you have perfect competition—that is, lots of participants and allowing people to enter and leave the market—people can pick and choose which banks and tech companies they go to. However, when there is an oligopoly, as in this case, with a small number of providers of technical applications, perfect competition falls down. There is effectively a situation where people have no choice. That is why people who are not exactly conspiracy theorists, including me, worry about the idea of a cashless society because it puts absolute power in terms of business into the hands of the powerful, the influential, the wealthy, the well-connected and those who believe in and articulate groupthink.
The other thing that slightly worries me is not necessarily the overt idea of censorship, which is itself very worrying in an advanced liberal democracy such as the UK and the United States, but the concept of self-censorship—that is, you do not debate these important issues of public policy that might push against vested interests because you know that the battlefield is so asymmetrical that you do not have the funds to fight big tech or to engage civil litigation, and you run the risk of criminal penalty and sanctions should you do so. That is important. You cannot afford to take the risk so we get into this cul-de-sac of self-fulfilling beliefs and views, which were represented by PayPal.
I am glad that PayPal capitulated and surrendered, and said that it was wrong, but it did a lot of damage to the Free Speech Union, its membership base and its cash flow. Not surprisingly, Toby Young, the founder and CEO of the Free Speech Union, made it absolutely clear that he would not go back to PayPal because it had egregiously ruined his business model.
However, that is not as important as the general principle that, unless you have a bit of stick with these tech companies, they will not voluntarily eschew the concept of EDI and their fixed beliefs. Only the power of legislation can force them to comply with the basic tenets of a decent, liberal society: that free speech should be available to everyone; and that people should be able to voice unfashionable opinions. The mark of a mature and sensible society is that we allow people with whom we vehemently disagree to have a say in the public square.
To an extent, this a probing amendment, but my noble friend the Minister—incidentally, she has done extremely well in a very long and difficult Bill; I give her that plaudit, having given her a hard time the last time I was before this Committee—should reflect on it and come back with some sanction to defend the long-standing commitment that all of us, as parliamentarians and legislators, should have to the concept and practice of free speech.
In terms of going further to protect the importance of free speech, we have to understand that the Government do not believe there is evidence of a potential issue with payment services regulation beyond these few PayPal cases. The existing legal regime includes statutory minimum notice periods, rights of appeal to the Financial Ombudsman Service and the FCA’s principles on fair treatment. Users of payment services, in common with all UK citizens, benefit from a safety net of legislation such as the Human Rights Act, criminal law and court decisions, which balance the rights of people to express their ideas in a public space with the necessary limits of a democratic society, for example, to protect people from hate speech. More specifically, the Equality Act 2010 prohibits service providers in the UK denying services to users on the basis of their beliefs, including philosophical as well as religious beliefs.
Noble Lords talked about going further in this Bill. The Government’s view is that making legislative change just for payment services would not be proportionate or correspond with the requirements placed on other essential service sectors. The Government need evidence if there is a problem given the existing protections in the current legal regime for payment service users. Today I am aware of the concerns raised in relation only to PayPal, which re-evaluated and reversed its actions in several cases. The FCA has explained that it has the tools to regulate in a further specific way through its authorisation processes if there is a problem.
Many companies offer their service “with recourse”, which asserts the lender’s right to be paid their fee even if the customer defaults on their invoice. This means that small companies could become liable for fees and interest charges on invoices that they have never been paid if, for example, their customer goes bankrupt. This is a rising concern, as there has been a sharp rise in insolvencies in the past 18 months and we are approaching levels not seen since the 7,000 insolvencies per quarter at the peak of the 2008 financial crisis, with almost 5,995 declarations of insolvency in the quarter ending January this year.
Dependency on the factoring model can develop; debts which have been purchased by a factoring company cannot be counted in the company’s balance sheet when applying for other financial products such as a bank loan. There is a danger that a company may find it difficult to move on to cheaper and long-term finance. There are a lot of companies operating in this space and, while many are entirely credible and reputable, we must recognise that, without FCA regulation, small businesses particularly are at risk of being exploited or taking on excessive fees or risks in their eagerness to survive and grow.
Of course, we cannot mitigate against all risks. As the very well-known fellow book publisher and former Member of this House observed, “Events, dear boy, events.” We know from recent history that clear, strong and effective regulation, such as that which can be provided and enforced by the FCA, can prevent excess and exploitation, and help us build a stronger economy in turn, with the passion, flexibility and innovation of SMEs at its heart. I beg to move.
Bringing invoice factoring into regulation would likely increase costs for businesses. This would negatively impact the ability of these businesses to manage their cash flow in a flexible, cost-effective way at a time when it is important that they have the confidence to invest and expand. There is a fine balance between the costs and benefits when bringing activities into the regulatory perimeter. It requires careful consideration to ensure that there is an appropriate balance between several factors, including ensuring that consumer protection is in place and that businesses are allowed to innovate.
Overall, the Government believe that the current approach—enforcing standards through industry bodies and voluntary codes while facilitating innovation and competition—is more likely than new regulation to drive positive outcomes for businesses that rely on invoice factoring. I therefore ask the noble Lord, Lord Leong, to withdraw his amendment.
It is helpful that the Chancellor referenced exploring unlocking pension funds’ potential in his Budget speech. I would appreciate an update from the Minister on HMT’s work in this area. I am aware that the FCA is currently consulting on the value for money framework for DC pension schemes, for example, but does that work fit into a wider government strategy to incentivise DC schemes to invest in UK firms and green infrastructure?
I beg to move.
On the idea of a review, we desperately need to see money going into green infrastructure. All the evidence we have says that is simply not happening. I also note that the Government need to create the frameworks in other areas of policy to make this happen. I was sitting here, thinking of when I was in this very same Room a few weeks ago with the Energy Bill. One of the things that could be a very good target for investment would be that if we are to get community energy schemes up and down the land—if we get delivery of the widely-backed Local Electricity Bill, as it is in the other place—that would be a great area to see pension funds investing in and supporting. I was at an event this morning debating social value and the importance of that in procurement.
We need to tie all these things together. All these things are running off at different angles, but we are still not creating an environment where people who are putting money into their pensions, seeking to invest in their own future, will have a liveable future for that pension to pay out in.