Financial Services Regulation

David Gauke winds up a debate about the failure of financial services regulation and its contribution to the turmoil in the financial markets and financial services sector. He raises concerns about the rush to create new structures at European level.

Mr. David Gauke (South-West Hertfordshire) (Con): It is a great pleasure to serve under your chairmanship again, Mr. Olner. May I, too, congratulate my right hon. Friend the Member for Wells (Mr. Heathcoat-Amory) on securing the debate and on speaking so eloquently on this subject? The debate is well-timed for two reasons. First, we are clearly still living with the consequences of the turmoil of the past two years within the financial markets and financial services sector. It is easy to underestimate the importance of financial services regulation in this area and how the failure of such regulation has contributed to the problems we have faced. Secondly, the debate is well-timed given the rush to create a new architecture of regulation for financial services at the European level. All those who have spoken have raised concerns about that rush, and I shall make several comments on that. This is a good opportunity to raise this issue, and I am sure the Minister will set out the Government’s position on a number of the concerns that have been raised.

Several speakers have made the point that financial services are extremely important to our economy—perhaps too important. None the less, it is vital that we get the regulation of those services right. There has been regulatory failure. The tripartite system that the Prime Minister established in 1997 failed to spot the debt boom and the fragility within our banking system. An age of irresponsibility was allowed to occur in which UK banks became more leveraged than their US competitors, a credit boom built up and the Bank of England—the monetary authority—recognised some of the difficulties but had no powers to address them. Meanwhile, the Financial Services Authority, as the banking regulator, had no remit to monitor the entire picture. In addition, the FSA took a narrow approach to its responsibilities, focusing on conduct of business rules rather than prudential supervision.

The difficulties that we saw in 2007 and 2008 continue to live with us partly because nobody called time on the explosion of debt. When the problems occurred we saw a failure of co-ordination, and the question of who is in charge has never been adequately addressed. It is right that political parties think seriously about how to rectify that, and my party have set out detailed proposals on how to reform our financial services regulatory regime to ensure that there is no repeat of the problems of recent years, and we will do that by giving greater powers to the Bank of England, which must be in charge.

Several Members have referred to banks being too big to fail, and we have an ongoing debate on the divide within banks between utility functions and investment banking functions. The Governor of the Bank of England stated in Edinburgh on 20 October, only a few days ago, that there had been little real reform on that and that the system remains inadequate.

I turn specifically to European regulation, which was the essence of my right hon. Friend’s remarks. As we have heard, on 23 September 2009 the European Commission adopted legislative proposals aimed at addressing the regulatory weaknesses at the micro and macro-prudential level through the creation of a European system of financial supervisors and a European systemic risk board. The European system of financial supervisors will comprise a college of national supervisors and three entities collectively referred to as the European supervisory authorities: the European Banking Authority, The European Insurance and Occupational Pensions Authority and the European Securities and Markets Authority.

I debated many of those matters with the Minister in European Committee B on 29 June 2009. At the heart of the Government’s approach is an acceptance of a greater European role at a regulatory level, but not a supervisory level, and the Minister rather helpfully set out the distinction between the two:

“Regulation refers to the making of rules. Supervision relates to the processes that implement the rules and how they are applied to individual firms and markets. While it is important that we have a harmonisation of the rules across Europe, we stick to our point that the supervision and application of those rules, and how they apply in different countries, is down to national Governments. That is why we did not support EU supervision...The main thrust of our argument in negotiation was that supervision should be at nation state level.”—[Official Report, European Committee B, 29 June 2009; c. 5-8]

I will explore further the distinction between the rule-maker and the supervisor. One concern that has been raised with us relates to the legal powers of the ESAs, a point my right hon. Friend touched on. Having received advice from a leading lawyer in that area, I understand that the ESAs will not have the power to take decisions or make rules because European law requires that those powers are reserved to the Commission, but they can issue guidelines based on their interpretation of the rules. Competent authorities will be obliged to make every effort to comply with those guidelines. The ESAs can also take action against national regulators that do not currently apply relevant EU legislation correctly. I would be grateful for the Minister’s view on whether that interpretation of the ESAs’ powers is broadly correct.

There is a possible concern about the distinction between regulation and supervision. The ESAs have the power to settle disagreements between national regulators, which leads to a point that is similar to the issue of action being taken against national regulators that do not currently apply relevant EU legislation: whether ESAs will in effect make individual decisions on individual market participants. One can imagine a dispute on a particular matter between two regulators or between an ESA and a national regulator. When decisions are made on an individual market participant, that looks an awful lot like supervision of an individual institution, rather than regulation. The Government’s position on that is clear, and ECOFIN agreed that decisions that are specific to individual firms should remain the exclusive preserve of national regulators. There is a degree of uncertainty on the powers the ESAs will have, and uncertainty in that area is a real cause for concern.

Perhaps the most important red line the Government have identified is that the ESAs should not be able to take decisions that impinge upon the fiscal responsibilities of a nation state. The Governor of the Bank of England has said that banks are global when alive but national in death, because it is the national taxpayer who has to step in to bail out those banks. There is a concern that there would be no democratic accountability if an ESA took a decision that effectively required national taxpayers to step in, and the Government have rightly said that that should be resisted.

However, article 10 of the Commission’s proposals allows the ESAs to step in in an emergency, and article 11 allows them to step in when there is a dispute between regulators. The measures proposed by an ESA in such circumstances might have a fiscal impact for a nation state. Article 23 sets out an appeal mechanism, although it is not clear how that would work. That might take too much time, and we know from recent history how quickly we must step in when a bank is failing. If we are to step in, we must do so quickly, as we saw during the events of 14 months ago.

Also, the appeal mechanism set out in article 23 does not apply to article 21, which follows up on a recommendation made by the Economic and Social Research Council. The Government have said that it has been accepted all along that the fiscal position will be protected. If so, why has the Commission come up with proposals that seem simply to ignore what the Government claim has already been achieved in negotiation?

Regarding the Commission’s ability to declare an emergency, thus giving the ESAs greater powers, on what criteria may an emergency be declared and how would the ESAs use that authority? With financial services we are in a global situation, not just a European situation, so it could be important for the UK supervisors to co-ordinate not only within the EU, but with US regulators such as the Securities and Exchange Commission or the Federal Reserve. Could the emergency powers, if declared, prevent the FSA or the Bank of England from taking immediate steps to co-ordinate with other countries? The restrictions on communications, for example, could be significant. Could it prevent the FSA or the Bank of England from taking immediate steps with regard to a UK entity? Inevitably, European institutions are likely to move more slowly than national institutions, as is the nature of things, so if that happens the Commission’s proposals might slow down the ability of UK institutions to react and of UK financial regulators to co-ordinate with other institutions. The hon. Member for South-East Cornwall (Mr. Breed) spoke about unintended consequences, and there is a concern that an unintended consequence may arise here: in an attempt to strengthen prudential macro and micro-supervision, we may in fact inhibit regulators from taking effective action.

My hon. Friend the Member for Cities of London and Westminster (Mr. Field), as ever, spoke eloquently about the concerns of his constituents and of businesses located in his constituency. I am pleased that he discussed in some detail the alternative investment fund managers directive—again, I debated that point with the Minister in June. The proposals were poorly drafted and protectionist in nature, and they demonstrated a lack of understanding of hedge funds and private equity funds, and their significance. My hon. Friend was absolutely right to state that such funds were not the cause of the difficulties earlier this year. I would be grateful if the Minister discussed what progress has been made in addressing the concerns she outlined to the European Scrutiny Committee in June.

Finally, it is right that we explore the issue of the wider cost to the economy of the banking system’s failure in the past few years and its fiscal consequences. At the weekend, the Prime Minister set out four proposals to address that concern, one of which was a transactions tax, or a Tobin tax, about which we have heard nothing in Parliament. Over the years, the Prime Minister himself and the Treasury have been extremely sceptical about such a tax, but the Financial Times reported yesterday that, of the four options that the Prime Minister set out on Saturday,

“UK officials had initially suggested the transactions tax was the prime minister’s preferred mechanism out of the four options he had raised”.

The proposals were widely condemned by the US, the Canadians and the International Monetary Fund—I believe that all but the French condemned them. Indeed, the Treasury has recently been briefing against the proposal, and the Financial Times reported that, before the end of the weekend, officials had stated:

“We’re not that massively wedded to a transactions tax. We’re not saying ‘it’s this or nothing’ — we’re saying we need a deal”.

Never has a Government proposal been withdrawn so quickly. I would be grateful if the Minister took this opportunity to clarify the Government’s position. Was the Treasury even aware that the Prime Minister would come up with the proposal? I ask that because the Financial Times stated that the Chancellor was understood to be frustrated by the Prime Minister’s promotion of a proposal that he knew the US would have no choice but publicly to oppose.

This is an important area. This is not the place for short-term stunts that will get headlines, as the Prime Minister attempted to do at the weekend, yet further damaging his credibility. It is important that we have a Government who take a long-term view as to what is necessary for the financial services sector. It is also right that they fight our corner and ensure that European Union proposals are right for the UK. I hope the Minister can provide some reassurance that the Government have at least some of those attributes.

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