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Financial regulation
European Union Select Committee report
10 November 2009
A debate in the House of Lords on 10 November 2009 on the European Union Select Committee report
Lord Trimble: My Lords, I shall speak to the report of the European Union Select Committee Sub-Committee A, of which I have the pleasure to be a member. I shall not try to go into all the detail of the proposals for financial regulation and all the matters that are spun off from it: the de Larosière report and many other things. There were times when we were looking at this issue when I felt the need for a cold towel around my head in order to try to grasp what was going on, so I am going to keep clear of that detail. I intend to make four points with regard to regulation and will then comment on procedures and state aids.
My first point repeats what was said to us many times by the Government and by other witnesses. It is that regulation has to lie essentially with national regulators as they have the fiscal resources, they are the lender of last resort and only they can do a bail-out. To digress for a moment, I say to my noble friend Lord Renton, who commented on the amendments he proposed and the narrow vote that occurred, that I am very sorry to have to tell him that had I been able to attend that meeting, there would have been no need for the chairman’s casting vote. He might have been disappointed by the way I would have voted.
Returning to the necessity for regulation to rest with national regulators, that is why in the Explanatory Memorandum that the Government have produced on the proposed legislation that has now come out, they say that,
“the Government will seek to ensure that no European Supervisory Authority decisions can have a fiscal impact on a Member State”.
The Explanatory Memorandum continues, using language such as “seeks to ensure” and,
“some improvements to the fiscal safeguard”,
but that does not sound as though it emanates from someone drawing a firm red line.
As the legislation stands today, the European Supervisory Authorities could take a decision that impinges on our fiscal authority. As mentioned, we took evidence from the noble Lord, Lord Myners, earlier today, and were told that the Government are not content with this situation and continue to argue against that possibility. However, this matter will be determined by qualified majority voting, and I did not get the sense this afternoon that the Government were confident of the outcome or sufficiently determined to get their way. That is a matter of considerable concern, certainly to me.
My second point relates to the European Systemic Risk Board, which is there to try to avoid a future major crisis but which has no powers other than to make recommendations. I find the constitution of this board rather curious. It will consist of some 61 persons—all the governors of the national banks, national regulators and others—and will look at the weather and try to detect what is coming, as has been said. However, the size of the board militates against the sort of considerations that are necessary.
I am reminded that one of the reasons for the regulatory failure before the credit crunch—there is no doubt that there was regulatory failure before then—was that the FSA took the line that if one company was doing the same as all the other companies, nothing was wrong, even though it turned out that they were all doing foolish things that ended in disaster for some of them. This is the sort of herd instinct that occurs in the more exuberant stages of the boom and helps to contribute to the intensity of the subsequent bust. Is there any reason to believe that the 61 persons who will sit on the European Systemic Risk Board will be immune to that herd instinct? I think they are more likely to share it.
My third point is that although the proposals contain a lot of new structures—the European Systemic Risk Board, the European Supervisory Authorities and all the rest—there is a sense that simply creating new bodies solves the problem. It does not. The question is what they will do, what remedies they will have, what proposals they will bring forward, and what policies they will have to try to prevent or mitigate another crisis.
Our report recommends that there is,
“an overt counter-cyclical capital regime”—
namely, that banks should save money in the good times so that it can be used in the bad times. I am sure noble Lords will be familiar with George Osborne’s slightly different formulation of that principle. This does not require the structures which the EU proposes. We were told that this counter-cyclical approach was applied by the banks in Spain, which is why they came out of the crisis so well. Before they did this, however, the Spanish Government had to disapply an international accounting standard that limited capital retention to known risks. I have not heard anywhere in the discussion—I may have missed it—whether there has been any change to that accounting standard or how one will bring about a counter-cyclical approach if we have the accounting standards that prevented other banks from building up capital during the good times if they so wished. I hope that the Minister can enlighten us about what will be done to promote a counter-cyclical approach, because everyone seems to be using that phrase and endorsing that approach.
My fourth point relates to a comment in chapter 8 of our report in which we recognise that,
“all regulation must be in coordination with global initiatives”.
A double perspective is essential. I rather share the view, to which the noble Lord, Lord Skidelsky, referred, that the basic underlying causes of the crisis were the global imbalances and the huge surpluses that were generated in eastern and far eastern economies but not reinvested in those economies or allowed to feed into higher domestic consumption there. Those surpluses were invested in America and in Europe, thus fuelling the asset price bubbles, the bursting of which triggered the credit crunch. Please note that in that view the so-called sub-prime issue was a symptom of the burst rather than the cause of the crisis.
We are now to have a global Financial Stability Board to work with the IMF, which is welcome. I hope that it can address those imbalances and the undervalued currencies that have helped to create those imbalances, which would be a benefit to the world’s economy. I hope that the European Union will work positively with the Financial Stability Board, but I am not encouraged by a comment from a Commission official, who is quoted in paragraph 204. He said that,
“you cannot deliver the global without the European”.
That seems to me to have got things around the wrong way. The financial system is global. Europe cannot isolate itself from it. It would be foolish to insist that European solutions come first or to say that you have to modify those global solutions in order to show that you are making a contribution to it or to add wee things to satisfy some localised interest rather than doing what is best from a global perspective.
I am left with the impression that the Commission’s procedures were not the best. In paragraph 68, we note,
“significant criticism from our witnesses for”,
the draft,
“being prepared and agreed at an unnecessary pace without adhering to the principles of Better Regulation”.
But worse was to follow. On 29 April, when the noble Lord, Lord Myners, was giving evidence for this report, he anticipated the Commission’s proposals for an alternative investment manager’s directive which appeared later that day. In that evidence he said:
“I have a fear that we are going to see something coming from Europe later on today which leaps at hedge funds and private equity as a source of instability in a way which is not necessarily as well informed as it should be”.
He referred also to the approach as being too speedy and to the dangers of a failure to think through consequences. He supported the view,
“that a proper process, careful consideration, evaluation and broad debate based on a consultation with published responses is the right way to handle this”.
On 14 July, while giving evidence on the AIFM directive, the noble Lord returned to this issue. He said that we were lobbying our colleagues in Europe,
“to address prejudice and a lack of understanding”.
Later in that evidence he described proposals for private equity funds as perverse.
The noble Lord is usually very measured and restrained in his language, but I thought that those terms, with which I entirely agree, were quite appropriate. But is it not a shocking situation that we were then describing, and are now describing, the procedures of the European Commission in those terms? I hope that we never see that sort of behaviour from the European Commission again.
I have to acknowledge that the Swedish presidency has worked very hard to get some sanity into the process and the Minister here today seemed content that the dragon’s teeth have been drawn, although we still have the one-size-fits-all problem. We have also learnt that the European Parliament has now to do an impact assessment. But such an assessment, risk analysis and proper consultation should have preceded publication in order to comply with better regulation. It seems that this was an old proposal, which had been lying around in the Commission for years, and, in the circumstances, was suddenly dusted off and rushed out without anyone bothering to think carefully or clearly about it.
In our final chapter we comment favourably on the operation of state aid in this crisis. The Commission recognised that the emergency justified state aid. It asked for an exit strategy for fundamentally sound banks and a restructuring plan for distressed banks. On the latter point we had evidence, at paragraph 220, which states that,
“restructuring plans are needed to ensure that banks return to ‘viability’. This ensures the capacity of a bank to operate profitably ... in some cases the viability of a bank could depend on some degree of retrenchment in certain areas to avoid risks and losses”.
We have seen the Commission’s requirements on these matters, and they have been touched on in the debate. I am going to comment on some aspects of the Commission’s requirements for the Royal Bank of Scotland. In doing so, I should mention that many years ago I was for a while with the Royal Bank of Scotland on an Industry and Parliament Trust attachment, but it was way back in 1995 and I did not complete it because I found myself bound up in other issues at the time. Just in case anyone remembers, I had better mention it, but I do not think that it has influenced my approach to this matter.
There are two aspects of the proposals for RBS that I find curious. It is required to divest itself of its insurance wing and to reduce its overseas operations. These are both highly profitable parts of the bank. If the object of the plan is a return to viability, how do you justify compelling the bank to divest itself of extremely profitable assets? The Government appear to be content with these demands, so I have to ask whether they were consulted in advance. Was there a discussion with the Government about it? If there had not been this process, would the Government through their shareholding have compelled the bank to behave in this way? Were they in favour of breaking up the bank? Press comments have referred to these measures as Europe punishing the bank for the receipt of state aid, but that is not compatible with the Commission’s objectives as quoted above, nor is there any sign of this being justified as a competition measure. Indeed, it may not be justified in those terms in any event because what barriers are there to entry into the market? I am not sure that there are any.
I do not want to labour the point, but I feel that we should have a further comment by the Government on this issue. Is there a detailed justification for these measures, and if they are thought to be inappropriate or disproportionate, is there any remedy, or do we end up concluding that this is another case where the terms “prejudice” and “ignorance” would be appropriate?
To read the debate in full click here
10 November 2009
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