Financial Services Bill

My Lords, before attempting to contribute to this debate, I must declare a number of interests. I am chair of 3i Group, whose asset management subsidiary is regulated by the FSA. I am also an adviser to the FSA and, perhaps most importantly, in May I shall become chairman of the Financial Reporting Council, a very modest part of the regulatory architecture that we are discussing here. I am also chair of Frontier Economics, which has done a good deal of work in the field of regulation. I therefore rise not so much to oppose the Bill, which has a number of valuable elements, as many noble Lords have said, as to plead for full consideration of the options for change. This is not a time for half-cooked solutions. The reconstruction of financial regulation was rushed, as the noble Lord, Lord Lawson, said, by the incoming Government in 1997. In giving the Bank of England independence in the operation of monetary policy, the Government won many plaudits, although the real test of this will not come until we have successfully negotiated an exit from our current parlous fiscal position. That will require very close co-ordination between the Bank of England and the Treasury, in which neither can see itself as entirely independent. Meanwhile, the counterpart to a much applauded enhancement of the Bank’s monetary role was a deliberate demotion of its role in financial supervision. It was thanks only to Lord George fighting a doughty rearguard action that the Bank retained as much capacity in this area as it did. Despite his protests, the Bank’s crucial role as guardian of the financial system, informed by its knowledge of the different elements, was effectively demoted. With the supervision of financial institutions passing to the FSA, a gap opened up in our arrangements. Responsibility for macro-prudential supervision simply disappeared into that hole—how right the noble Lord, Lord Desai, was to say how difficult a role that is. As a result, it is now widely acknowledged that we have suffered particularly badly from what economists call "the fallacy of composition", whereby individual institutions were assessed, more or less well, but the aggregate effect of their actions was not. I appreciate that the Bill is intended to reverse this by bridging the gap with the creation of the Council for Financial Stability. I am sorry to say that I simply do not think that this is enough. A committee that meets quarterly to consider reports prepared by one or other of its constituent members is surely not a full answer to the crises that can erupt 24/7 in markets and that are characterised by rapid contagion. Like the noble Lord, Lord Desai, I think that those interactions are the real challenge for macro-prudential supervision and that we should not be distracted from it by focusing on the scope or breadth of individual institutions. I cannot, with the best will in the world, see what this part of the Bill really adds. I presume that the Treasury, the Bank and the FSA already hold high-level meetings at least quarterly; they do not need an Act of Parliament to do so. I presume that they already discuss reports prepared by one or other of them; they do not need an Act of Parliament to share views. The key point is that the Bill does not resolve the question of where ongoing institutional responsibility for macro-prudential regulation lies. Responsibility for rapid pre-emptive action cannot be blurred and is not resolved by papering over the current arrangements. Of course, however, there are many other extremely useful elements in the Bill, such as the strengthening of the FSA’s powers and implementation of some of Sir David Walker’s proposals. It is the key issue of responsibility for macro-prudential regulation that I believe deserves further consideration. Such consideration should surely include the proposal by the shadow Chancellor to bring macro-prudential and financial institutional regulation back together, reversing the actions of 1997. This will itself raise a number of inevitably difficult issues, so he is to be commended for saying that he would take time over such restructuring. He would not, in other words, repeat the hasty change of 1997. We cannot simply put the banks back under the Bank without creating a dangerous regulatory gulf between, for example, banks and insurance companies. We have to take care that a recognition of the interdependence of so many elements in our financial markets and the rest of the economy does not lead us to create a regulatory behemoth. Making a split between macro-prudential and financial regulatory parts of the FSA, on the one hand, and its consumer protection activities, on the other, is, in my view, a good answer, executing it successfully will take great care. As this part of the FSA became more of a micro-economic regulator, the boundary between it and the competition authorities would need to be redrawn if we were to avoid regulatory overload. However, the suggested separation makes sense; it would enable both sets of issues, macro-prudential and microeconomic, to be looked at more clearly. Lessons could be learnt from other regulated industries where similar issues of consumer protection arise and a similar reconciliation of the role of the sector economic regulator and the competition authorities can be achieved. Over the past decade the FSA has been bedevilled by a tug of war between those who believed it should focus all its attention on the treatment of customers and those who believed it should be focused on the risks to the financial system. While those objectives should be synonymous in the long term, in the short term they are not and may lead a regulator to be looking in the wrong place at the wrong time. I note that the Bill makes some recognition of the fact that one institution has been asked to do too much by spinning off the FSA’s educational role. I believe that we should give proper consideration to more radical change. This is not just a tidying-up job; it requires detailed consideration to create a regulatory system that is clear, focused and accountable. Perhaps I may end by noting that at the FRC we are fully cognisant of the responsibility to play our own modest role, with the review of the combined code in tandem with the Walker report; sponsorship of the stewardship code—for which I know the Minister has been such a moving force; and the constant review of the quality of financial reporting, accounting standards and audit quality. The key challenge here has been finding the appropriate dividing line between the FSA’s responsibility for regulating the practices of financial companies and the FRC’s responsibility for codes of corporate governance practice that apply to all companies. In reviewing the combined code—and here I pay tribute to the magnificent work of its current chairman—the FRC did not want either to create two separate classes of companies or to load non-financial institutions with inappropriate guidelines. It is important that the FSA can play a full part in seeking to get this balance right, not only in the UK but in European councils where so much is now decided with respect to standards affecting UK companies and their accounts, auditors and investors. A strong financial sector—on this I agree very much with the Minister—continues to be of inestimable value to the UK. Deep and liquid quoted equity markets have enabled many UK companies to survive the economic storms of the past year. Investors have stepped up to the plate with a long list of rights issues. The largest private equity industry outside the US, in proportion to our economy, will be an important source of growth capital during the recovery, the more so given that banks’ continuing need to rebuild capital will continue to constrain lending. However, we continue to rely on the banks themselves for the essentials of business recovery—trade finance and working capital—as well as for continuing to contribute substantially to GDP and tax revenue. We must beware of creating a regulatory system that inhibits their ability to do so, that is pro-cyclical or enmeshes the banks in so much regulatory interaction that lending continues to shrink. We face plenty of uncertainty about the health of the financial sector and the pace of the recovery, not just for the next few months but for years of economic convalescence. Designing the right regulatory framework for this should surely be undertaken in a new Parliament with full consideration and care.