Financial Services Regulation

Mark made the following contribution to a Westminster Hall debate on Financial Services Regulation tabled by David Heathcoat-Amory MP:

Thank you, Mr. Olner. I am always aware that I am barely a householder in my own home, let alone anywhere else. It is a great pleasure to follow my right hon. Friend Mr. Heathcoat-Amory, who made a sensible contribution to the debate. As he rightly said, the issue of financial services regulation is of great importance.

One concern in the midst of many people’s continued lack of trust and confidence in our financial services world?a situation that I fear will continue for some years to come?is that we look on regulation as we do some sort of religion that holds sway, without thinking through all its implications. To be fair, that applies not only to the world of financial services but to much of the public sector. That is not to say that there is no place for regulation. Regulation is necessary, particularly in respect of financial products, in order to maintain confidence.

To go back two decades and more, I think we are all concerned that respect for the pensions industry and other categories of financial services products is so low in the public at large that all too often people do not save for their long-term future. People of my generation, in their 40s, have tended to put too much money into immediately stoking up the housing market, which obviously has negative effects. It is not just that the market might not be sustainable; we need to try to inculcate into the public mind the idea that people, for their own good, should invest for the longer term in a range of savings products, as well as the confidence that they can save in equities and other savings products. It is not an option, therefore, to suggest that there should be no regulation. Many of us have always promoted the idea of light-touch regulation, but I do not think the zeitgeist will favour that in the foreseeable future.

As my right hon. Friend said, these are troubling times for the City of London and our hitherto booming financial services sector. The second enormous cash injection into the Royal Bank of Scotland last week, along with incendiary tales of the return of big banking bonuses, is making the general public question whether anything has changed apart from the size of the ballooning public deficit.

Whether we like it or not, bank lending is unlikely to return to anything approximating normality until probably the second half of 2011. A huge number of toxic assets remain on all banks’ balance sheets and have yet to be identified, and they will need to be removed. The times will be troubled, and I think there will be a lot of concern for a considerable time to come among the public as well as in this place about the state of our banking industry.

My constituency houses the City of London and has hedge funds and alternative assets in Mayfair and St. James’s. As my right hon. Friend pointed out, the crisis has focused largely on the big banks, but it should not be forgotten that other elements of financial services and their products have remained relatively unscathed. Asset management?hedge funds and private equity?is one such industry, so it is perverse, to put it mildly, that we are going headlong towards signing up to the directive through the European Council.

I praise the relevant Minister, Lord Myners, who has put in a sterling effort in recent months, along with Conservative MEPs, to make the case for ensuring that the damaging aspects of such directives are kept to a minimum. It is clear that there are two distinct schools of thought on the matter, even within the European Council. However, it is very much a work in progress. My constituency also contains a residential population of fairly wealthy global business folk and a service and entertainment sector in the west end that has blossomed from the disposable incomes of a busy London work force that has, to a large extent, received the benefits of the financial services boom, as has been particularly evident in the past two decades.

The financial services industry also helps sustain a huge range of support industries, such as law, accountancy and consulting. It should also be said that the great global success of the City of London includes elements such as the insurance industry, many of whose difficulties arose through the near-collapse of Lloyd’s two decades ago. There are some important templates in that for learning how a service industry that looks as though it is on its knees can recover its global pre-eminence.

As London is the engine of the national economy, getting financial services regulation right is vital not just for my constituents but for the nation as a whole. We must accept that a crucial ingredient in regulation of the industry is a public perception of fairness, as my right hon. Friend made clear in his comments. Without that sense of fairness, there is little doubt that we risk allowing the current crisis to discredit capitalism and herald a new era of corporatism and ever more restrictive regulation in the long term.

That said, although irresponsible banking should and must be curbed, populist and rushed measures designed to rein in City excess should be avoided. After all, the Sarbanes-Oxley Act, introduced in the United States after the Enron and WorldCom scandals, taught us that additional regulation to protect consumers, as it was perceived in that country, may do little to stave off a crisis and that in a global economy, business will have no hesitation in relocating if regulation becomes too cumbersome.

Having learned from that, we must give the public greater credit and take them with us by explaining clearly how the taxpayer stands to gain or suffer from the regulatory choices that we make. One such way is to defend the UK’s position as a global leader robustly against EU attempts to curb the hedge fund industry via the draft alternative investment fund managers directive. I spoke about that problem in this Chamber recently, and the Minister was also there, so I shall not go over the ground again other than to summarise the issue briefly.

Most hedge funds are exempt from much of the regulation applying to investment banks and mutual funds. As pools of highly mobile capital, they have fast developed the reputation of being able to move mountains in the financial market by anticipating future expectations. Hedge funds, which are largely limited liability companies, thrive on volatility, so the crux of the controversy surrounding them is the degree to which they either cause or affect fundamental shifts in financial markets.

Alternative investment funds have accepted that in the new regulatory climate, they will be required to boost transparency and accept new curbs on disclosure and, most likely, on clearing, settlement and custody as well. The draft directive, however, goes a long way beyond that and may make it absolutely impracticable for funds owned by non-EU entities, which comprise a significant proportion of those operating in London, to distribute their products within the European Union.

That, combined with other regulatory and fiscal burdens here, may persuade hedge funds to relocate to other financial centres such as Switzerland, or indeed to return to the United States or emerging centres in the Gulf or the far east. As my right hon. Friend pointed out, such an outcome would be in the interests neither of the UK economy, which fundamentally concerns us, nor of the EU. Such protectionism in a global market would be fatal. At a supranational level, it would diminish competition, restrict flows of liquidity into the single market and be seen as protectionist at a time when barriers need to be brought down rather than erected. At a domestic level, it would also significantly diminish London’s critical mass as a financial centre and reduce individual and corporate tax revenue. At its most detrimental, it risks undermining London’s competitive advantage in the market for the professional services to which I referred.

The impetus for a European directive derives from panic in response to the economic crisis alongside a somewhat partisan vision of hedge funds and private equity as a wild west show of amoral speculators and asset strippers. However, I reiterate that there has been no crisis of asset management. Unlike the big banks that have been so troubled over the past two years, hedge funds did not leverage themselves to the hilt, having lacked the balance-sheet clout to do so even if they had wanted to. Whatever regulation exists should focus on the issue of leverage. Only in so far as it does so can it be justified.

Nor did hedge funds run down adequate levels of liquidity. Indeed, those that have failed?as of course some have done in the past two years?have not threatened the entire financial system in their failure. The public must be made aware of that or it will be harder to resist what may seem superficially to be reasonable attempts by the EU to curb reckless risk-taking, but are in reality dangerous moves that will undermine London’s competitiveness.

Thankfully, since I last spoke on this issue in Parliament the Swedish presidency has drafted a compromise text on some elements of the draft directive to reconcile British concerns. The important issues are scope, delegation, valuation, leverage, capital requirements and transparency. The compromise proposal is an encouraging step forward. I give credit to some Conservative voices in the European Parliament for that, as well as to the Government, who are belatedly making progress. I hope that we will make significant progress in the coming months. The directive might be revised further because several member states, notably France, are said to be unhappy with the compromise.

I support the broad objectives set out by the European Commission in other regulatory areas, such as a more efficient framework for financial supervision, enhanced financial stability and greater safeguards of the interests of consumers and investors. As my right hon. Friend said, the crux of the matter is an increased competitiveness of EU financial markets and more integration within those markets. We must make it clear to the public and the EU that British policy makers and financial experts are not against efforts to regulate, but equally will not give all regulation the green light simply because public sentiment dictates it. In creating new regulatory structures, it is essential that policy makers across Europe remain focused on the outcomes and keep on track with the key objectives of open markets, increased competition and consistent arrangements globally, regionally and locally.

The City of London believes that there is a clear and compelling case for the creation of a European systemic risk board to ensure that dangers to the stability of the financial system are caught early. The present crisis has demonstrated that monitoring risks at EU level is not enough. That should not deter us from closer co-operation and interaction with global organisations, such as the new systemic risk body in the United States. To have any credibility, such a risk board’s membership and voting structures should reflect the financial industry. There is concern that the banking sector will be over-represented on the board and other sectors under-represented. Given that the current crisis originated in the banking sector, the next is likely to start elsewhere. It is therefore imperative that national supervisors from all financial sectors, from securities to insurance, participate in the meetings and in setting up the framework.

On the chairmanship of the board, I support the European Council conclusions that require the post to be elected by the general council of the European Central Bank to ensure that it is viewed, and acts, as an independent body. Furthermore, the board should be able to raise concerns about financial stability stemming from across the EU financial system, including monetary policy, while respecting the independence of the central banks and the supervisors involved.

I support the principle of promoting convergence to ensure a consistency of rules. However, the European system of financial supervisors should not overrule supervisory decisions made by national regulators. The demarcation of powers between national and EU authorities must be clearly defined and any binding powers should be exercised only as a last resort. There is concern over the timetable envisaged for the development of all of the proposals, but the City recognises the pressure to deliver a workable solution for the future of the EU financial markets.

To return to British shores, in the aftermath of the banking bail-out I was deeply disturbed by the creation of financial institutions that became too big to fail. That relates to the issue of moral hazard that my right hon. Friend raised. In forming such institutions, we recognised implicitly?and explicitly in various Government statements of autumn 2008?that they were too big to regulate and beyond the scope of prudential sanction. That in-built lack of competition will continue to result in a remuneration regime that means high rewards for investment banking employees. Nobody objects to people earning a lot of money when there is genuine flair and innovation, but it cannot be right to reward quasi-monopolistic practices brought about by Government policy and organisations working in cahoots with one another or as a cartel.

I am not naive about these issues. Unravelling the recapitalisation arrangements of the past year will not be a short-term affair. We should not rush to a solution because we should strive to gain the maximum value from what is put in place. I am concerned about the idea of stakes being sold off. That might be politically expedient in the run-up to a general election and would bring funds into the Exchequer, but we must ensure that assets on the Government balance sheet are sold at a time that maximises their value for the taxpayer. I suspect that it will take many years?possibly as long as a decade?to unravel the recapitalisation arrangements. The deal was done without full political scrutiny and perhaps elements of it had to be done in that way. However, it is dawning on the public that there has been, and continues to be, a more extensive nationalisation of banking assets than was envisaged.

With the UK taxpayer propping up banks that are politically too big to fail and providing cover for many commercial enterprises that are part-owned by part-nationalised banks, our economy has a worrying dearth of competition. Given that the Serious Fraud Office has neither commercial nor industry respect, we lack a serious, tough and effective body to deter companies from engaging in fraudulent or market-distorting activity. It is critical that we put the restoration and promotion of competition and market fairness at the heart of future economic policy. Under any plan for sound banking, the SFO requires teeth alongside an all-powerful Bank of England, merged with the FSA.

The public will loudly demand more rigorous enforcement of regulation across business, particularly in financial services. Politicians need to demonstrate a seriousness of intent by outlining robust plans for a tough, not-to-be-messed-with agency that values strong competition and clean business dealings as essential parts of an effective financial system. Such an agency should be linked to or merged with the Office of Fair Trading. Its work should be a top priority for the Department for Business, Innovation and Skills, rather than a minor one in a Treasury that has its hands and its ministerial inboxes full. The United States provides a blueprint for the new SFO regime with its whistleblowing culture, the ability for deals to be cut if businesses show the willingness to change and a tough prosecutorial threat. The deterrents provided by healthy competition and stiff punishment must form the backbone of the brave new world of banking and business that lies ahead. Nothing less will restore the confidence of market professionals and the trust of the public.

We must accept that the spirit of the age favours greater, more stifling regulations. Unless those come about on a global basis, London and Europe risk being the losers. The public and political instinct today?and for some years to come?is to punish the banks. Everybody in the financial services industry risks being caught in the crossfire. Fund managers, insurers and other advisers risk losing out as Governments exert new control over the sector. It falls to those of us who recall London’s historical role as a global trading city, including my right hon. Friend who was a distinguished Minister in the last Conservative Administration, to make the case for extending the reach and influence of measures in this sector to markets beyond Europe’s shores.