Pat McFadden
MP for Wolverhampton South East · Labour · United Kingdom
“In his review Alan Milburn considered that issue and said that, “the UK’s NEET crisis is much more long-term and deep-seated than any decisions taken in the last few years.” As I said earlier, 400,000 more people are in work this year than last year, and the number of young people in employment is up since the election.”
“Since our last DWP questions, both Alan Milburn and the Pensions Commission have published their respective interim reports on young people and on the current state of saving for retirement. I look forward to receiving their final reports later in the year.”
“As Alan Milburn pointed out in his recent report, the UK’s NEET crisis is much more long-term and deep-seated than any decisions taken in the last few years. There are 400,000 more people in work than last year. The number of young people in employment is up by 74,000 since the election.”
“I thank the right hon. Gentleman and send him commiserations for whatever has left him reliant on his crutches today. I am happy to congratulate the businesses he mentioned in his constituency. He raises a serious point: it is important not only to come up with the right policy, but to make it simple for businesses to use.”
“My hon. Friend is right, and I thank Cardiff football club for being a partner. We are supporting nearly 1 million young people and creating up to half a million opportunities for jobs and training.”
“We are making strong progress on expanding youth hubs, with around 130 already in operation across Great Britain. In March, I announced the locations that we want to open in this year, and I have just announced a further 180 locations for the following two years.”
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“Q Thank you both for coming along this morning, virtually. Could I begin with you, Simon, and ask about onshoring and divergence? The Bill onshores significant bodies of EU legislation and directives. From the point of view of UK Finance, where would you like to see the Government and regulators diverge from that body of EU law in the future? Simon Hills: I am not sure that we would want the UK Government and authorities to diverge significantly, if at all, from other standards. We are not sure yet what Europe will do in respect of Basel 3.1. We do not expect draft legislation from the Commission until around Easter next year.”
“I think we will all want to understand how different regulators around the world—not just in Europe—look at the PRA’s implementation when it gets down to those technical standards, which is why it is important for both Parliament and UK Finance to make sure there is no inappropriate deviation from international standards. I can assure you that if UK Finance members see that there is, we will speak up about it.”
“Q We have had the Chancellor’s announcement on equivalence from the UK end of the telescope last week. Do you think there is a relationship between the degree of divergence we pursue in the future from the EU rulebook and equivalence decisions from the other end of the telescope, that is, by the EU or EU member states to UK companies selling into their markets? Simon Hill: Yes, I think there is likely to be work to be done there. Of course, one of the accountabilities the Financial Services Bill gives the PRA is to take financial services equivalence and international competitiveness into account, and, importantly, the banks’ ability to continue to provide finance to UK businesses and consumers on a sustainable basis.”
“Simon Hills: It is important to remember that individuals in banks who are responsible for benchmark submission and administration are classified as so-called certified persons under the senior manager certification regime and they have to be certified as fit and proper every year by their firm. If they are not certified as fit and proper, they will lose their job and will find it very difficult to find a role in financial services again.”
“That includes the FCA oversight of the LIBOR benchmark, the introduction of the benchmark regulations at a European Union level, and transcribed into UK law, and broader reforms since the financial crisis, including the senior managers regime to ensure that the issues with LIBOR are not repeated. As the Committee will be aware, the fundamental reason why it is important to move away from LIBOR is that the underlying markets on which the rate is based have largely dried up. Therefore it is right to move us on to robust reference rates based on markets that are highly liquid and not reliant on expert judgment.”
“Q May I ask you, Daniel, a question about LIBOR to fill in a small gap in the knowledge of those of us who have not followed every twist and turn of this? The measure became a scandal because it was being manipulated for the benefit of the traders who were submitting information. That information was based sometimes not on actual trades but on their estimates of what trades would cost. What changes have been made to the administration of LIBOR in recent years to stop those things? Daniel Cichocki: It is absolutely right to acknowledge the issues with conduct around LIBOR in the past and the reforms that have taken place to make sure that those things are prevented.”
“Q One more for you, Daniel. As things stand with LIBOR today, is it still possible for traders to submit information based on their estimates of what trades would cost rather than actual trades that have taken place? Daniel Cichocki: LIBOR as it is formed today includes both elements of actual transactions and expert judgments of firms. These expert judgments, as a result of the issues in the past, are subject to those very high levels of governance control that I have talked about being introduced as a result of the benchmark regulation—absolutely appropriate as a result of the issues with LIBOR in the past. The underlying reason why we need to move away from it is that we want to be internationally on rates that do not require that expert judgment.”
“A second difference is that LIBOR is a term rate—it is expressed over one month, three months or six months—whereas the liquidity in the SONIA rate is focused on the overnight market, which is therefore a much more representative selection and does not require expert judgment, unlike LIBOR. A third point, perhaps, is that it is not just a UK proposal to replace LIBOR with risk-free rates in SONIA. A similar change is taking place globally. In the US, USD LIBOR is being replaced by the secured overnight financing rate, which has a similar sort of construction, and the situation is similar around the world. Those are the main reasons for the change.”
“Q Thank you for appearing before us, Mr Richards. Can you set out for us, in as simple terms as possible, the difference between how prices are set under SONIA and how they were traditionally set under LIBOR? Paul Richards: LIBOR was set by a panel of banks. As the market no longer uses the underlying information that it used to use for banks, it has now changed, or will change, with the admission of SONIA, to a different definition. SONIA is essentially an overnight rate. It is a robust rate, because it is used widely in the market, whereas LIBOR is no longer used in the market as it was 30 or 40 years ago. That is one difference.”
“Q Can I just focus on the point about expert judgments? That is quite a polite term for some of things that happened with LIBOR. They were not really expert judgments in some cases, were they? They were effectively deals between different traders to put in submissions at particular prices, to the individual advantage of the traders, based on the trades that they were doing. To what degree is SONIA insulated against that kind of manipulation? Paul Richards: As you say, LIBOR depended on expert judgment in many cases, because the market was no longer using LIBOR in the way it had been constructed. With SONIA, it is a much more liquid market and there is no need for expert judgment at all. That is one of the reasons why it is being preferred as the replacement for sterling LIBOR, and similarly around the world in other currencies.”
“It is thought that it will consult the market before making a decision, but the end result will be that the rate that arises under the new definition of LIBOR will take over from the old definition of LIBOR, and there will be continuity of contracts between them. If that is emphasised in the Bill, that will give legal protection for all those involved, which is one of the main reasons for providing it. It needs to be accompanied by a safe harbour provision, which would protect all the different market participants involved. I would like to be able to tell you that this will eliminate the risk of litigation, but I cannot tell you that. What I can tell you is that it will minimise the risk of disruption and litigation that might otherwise occur because of the huge volume and value of transactions.”
“Paul Richards: A significant difference between LIBOR and SONIA is what is called the credit adjustment spread, which takes account of the difference between LIBOR and SONIA. In the consumer market, the proposals are, at a general level, to treat customers fairly. In the wholesale market, the aim is to have continuity of contracts between the old definition of LIBOR and the new definition that will be used for legacy transactions. This will be determined under the Bill by the FCA. It is not specified how it will determine it. There are market assumptions about that, but it is not decided yet how they will determine it.”
“Q Can I take you back to the second point you made about the danger of litigation? We might all agree that moving away from LIBOR is a good thing, partly because we do not want to see a benchmark manipulated in the way that LIBOR was. However, as a consumer, I might have agreed trades or contracts based on a particular price set by LIBOR. What is the situation with potential litigation from a consumer who says, “You’re telling me that SONIA is a more honest benchmark because it’s based on actual trades and actual prices in market transactions, but now I’m being told that instead of paying x%, I will be paying x% plus y%”? What does the Bill say about that kind of situation at the moment, and what would you like it to say?”
“The broader the safe harbour protection is drafted in the Bill—the Treasury, I am sure, could help on this—the better and more effective it will be in minimising disruption and the risk of litigation.”
“Q So how would this safe harbour provision that you are advancing work? Why is it needed beyond the FCA acting to ensure continuity for legacy contracts, as is I think is already envisaged in the Bill? Paul Richards: They are both needed, I think. The FCA’s judgment about treating customers fairly relates primarily to consumers. The protection that a safe harbour would provide, so that parties would not sue each other as a result of the change from the old definition to the new definition, is essentially designed for the international markets. So they are both needed. The FCA is already making statements about treating customers fairly, but the Bill should include both the continuity of contracts provision and a safe harbour protection to accompany that.”
“That is, of course, what we have done, with new issues in the bond markets and with the conversion of legacy contracts from LIBOR to SONIA. We have a tough legacy problem for the future, which needs to be dealt with. The Bill helps to deal with that.”
“Q Have you already made these arguments to the Treasury only to be rebuffed, or is this the first chance you have had to make them because the Bill was published only a few weeks ago? Paul Richards: These are points that law firms that work in the City are acutely aware of from their previous experience. The law firms have been looking at what needs to be done to ensure that there is continuity of contract and a safe harbour protection. Of course, I hope that the Treasury will take account of that, as your Committee will take account of it before reaching a final conclusion. We should do everything we can to minimise the risk of market disruption and litigation, within the context of the overriding point, which is that we do need to move away from LIBOR to risk-free rates.”
“We need to have a much more joined-up and mature discussion about how two major markets can keep on doing business together, particularly in investment management when, as I mentioned earlier, 37% of Europe’s assets are managed here in the UK and when, for certain member states, whether it is the Dutch pensions industry or something else, the quality of investment management conducted here in the UK is seen as a prized asset and something that they want to learn from and continue to enjoy the benefit of.”
“So I do not see equivalence and divergence as axiomatically pulling in different directions. I think what we will undoubtedly see is a period where the definition of equivalence needs to be—we need to have a thoughtful discussion, actually, about the substance of equivalence, moving away from its ephemeral nature and the fact that it can be granted or dismissed within a 30-day notice period.”
“It is still absolutely the case that the UK policy-making apparatus—the UK regulatory bodies—is seen to have considerable expertise to offer. So just because we start in different places, it does not mean that we should not see the UK taking a little leadership and the EU tacking towards us in terms of lessons learned because of the sophistication of the market that we can offer. That was one of the reasons why we in the IA, among many other organisations, through the Brexit process was keen to press for a regulator to regulate a dialogue, which could be technically oriented, focused on bringing market and regulatory understanding to bear and making sure that there was a no-surprises, keeping-markets-open focus through the process that we have been through.”
“Secondly, something that has become part of the discussion in terms of the future relationship of the UK and the EU, and which our industry thoroughly supports, is a much clearer focus on outcomes and outcome-based regulation. It is noticeable that across the EEA there are different approaches in different European jurisdictions, all of which have been judged equivalent so far. Recognising that different jurisdictions will walk up to the same issue from different directions, yet seeking to achieve the same thing, that is the material part. The third area I would just point to, if I may, is the depth of relationship between the UK authorities and those across the EU, not just in ESMA, our European regulator, but in the national domestic regulatory authorities.”
“We continually push for international standards as a global industry because that allows us to operate with reduced bureaucracy and by taking costs out of the organisation so we can really focus on looking after client needs. The UK has an outstanding track record of having its policymakers and regulators taken seriously in those international fora, because of the scale of the market that we have in the UK and the sophistication of our capital market in particular. At that level, if we can push for international standards in an international environment, that reduces some of the potential friction between the EU and the UK or other jurisdictions about where divergence may or may not be happening. That is the first thing we would like to stress—the international nature.”
“Do you see a relationship between that debate around divergence and the degree of divergence that the UK decides to opt for and the equivalence decision that we now need from the rest of the EU? Chris Cummings: It is worth reflecting on the good work that has been done so far in trying to bring the different regimes together and match equivalence. Looking to the future, there is a strong argument for the UK to continue to bolster its presence in the international standard-setting fora, whether that is the Financial Stability Board, the International Organisation of Securities Commissions, Basel, and so on. Our authorities can continue to play a very strong role in arguing for what our industry would prefer, which is global and international standards.”
“Q Chris, good afternoon and thanks for giving evidence today. I want to continue to ask about the same things. The Bill does lots of different things, but I would like to mention two. First, it onshores or incorporates a significant body of EU law through different directives into UK law and gives the governance of those to the UK regulators. Secondly, it sets up this overseas fund regime, by which it grants equivalence on a country-by-country basis. It says that the Treasury will make these equivalence decisions as well. The Chancellor announced the direction of travel last Monday. How do you see the relationship between these two different parts of the Bill? In theory, in future, having onshored the body of EU law and the directives, we are now at liberty to depart from them if we so choose.”
“We are giving much more thought to the companies that we invest in—everything from life sciences to technology, to transport and infrastructure, to make sure that those companies are well prepared for the Brexit outcomes, but from our industry’s point of view, recognising the equivalence decisions that have been made today, we are set as fair as any industry can be. I am trying not to over-promise, but suggesting to you that the industry has thought long and hard about potential outcomes, and we are as prepared as we can be for immediate issues.”
“Q What would be the practical implications for UK-based investment companies— your members—if we stayed where we are now, with the UK having granted equivalence recognition to EU-based companies but not having a reciprocal recognition in return? Chris Cummings: We have been helping our members prepare for all shades of Brexit outcome over the last four years. Firms have taken the decisions that inevitably they would take, so they have set up extra offices, they have recruited further staff, they have gained the necessary permissions and licences from the national competence authorities. At the moment, even with, perhaps, no deal or a rather thin deal, we are as well prepared for that outcome as it is possible to be.”
“Given the technologically advanced world that we are living in today—the greater use of mobile phones, applications and computers, and just understanding that people engage with financial services in a very different way—could we have a rounder discussion about how we can do the thing that we want to do as an industry? We want to have a more engaged client base and to help them understand the different funds that are available and the different risk profiles of those funds, so that they can invest with more confidence, and certainly with more clarity about likely outcomes, rather than having to give false performance scenarios that simply nobody trusted in the industry.”
“Secondly, having lost that argument and seen that that it was introduced only to closed-ended funds, we argued that it should be kept there until the wider implications were seen and not extended into the world of undertakings for the collective investment in transferable securities, because of the scale of UCITS and how many millions of people across the UK and Europe rely on them. We were genuinely heartened when the Treasury announced that, post Brexit, it would be undertaking a review of the PRIIPs KID. What we hope to see, actually, is a wider-scale review of disclosure, whereby we can start from a different position.”
“As an industry, we kept drawing this issue to the attention of the policy-making community in order to say that, if nothing else, when it comes to disclosure and investment, we have managed to convey the central message that past performance is no guarantee of future performance. Please let us keep on reminding people that past performance is no guarantee of future performance. Sadly, that requirement was taken away. The new calculation basis was introduced, which led to the industry ultimately being forced by its regulator to produce this pro-cyclical—and deeply misleading, in our view—information. We continued to lobby against the wider introduction of the PRIIPs KID, arguing first that it should not be introduced.”
“Because of the pro-cyclicality of how it had to report performance scenarios—looking to the future—it would have to present a potential investor with scenarios that were entirely positive and that generated levels of return that nobody in the industry would seriously put in front of a retail investor to suggest that this was what they could actually get. They were being forced to do it because of the methodology—the calculation basis—which reflected only that, if you had a few good years of performance, your fund would continue to have good years of performance. Similarly, if your fund had had a few bad years of performance, all you could project was that that bad performance would just continue and continue. That was because of the calculation basis and the way that the rules were written.”
“Because of how the methodology for PRIIPs was created—taking a rather avant-garde view of the calculation basis—it meant that we could have negative transaction costs. Somebody could trade in the market and it would not only not cost them any money; they could actually lose money by making a trade. That led to some perverse outcomes that were pro-cyclical in the presentation of the information they gave. Let me give you an example by reflecting back on a new fund that has had just two or three years’ experience. Imagine if, over the course of its life, that fund had had a very strong performance; it had done very well over a three or four year period.”
“Q Thanks. Can I slightly switch subjects now, to ask you about packaged retail investment and insurance-based products? The Bill removes the requirement for performance scenarios on PRIIPs. Could you just set out for us, in as simple terms as possible, what is wrong with these performance scenarios, and why there is a desire to remove them? If they are removed, what kind of information should be provided to consumers to help them make as informed an investment choice as people can? Chris Cummings: Thank you for the question. You have touched on such an important issue for our industry. Through the consultation on PRIIPs we highlighted to EU policy makers and regulators, to our own Financial Conduct Authority and others, the dangers that we saw in the PRIIPs key information document, the PRIIPs KID.”
“If you are a member of ours who trades across borders, you want similar or the same rules.”
“We have been calling for a technical outcome-based approach to equivalence for some time now. Within that, you could have different rules but the same outcomes. Even if there are pinch points around Solvency II—only some elements of Solvency II—you could have different rules in the UK that achieve the same objective. From now until 1 January, we will remain technically equivalent. Inevitably, over time, there will be some changes in regulation, both on our side in the UK and in the EU. The EU is currently reviewing some of its own directives, MiFID being a case in point, but there are others too. We do not want to see divergence for divergence’s sake. We would like to encourage a strong dialogue between regulators in the UK and the EU. There already is that dialogue, but we would like to see a framework for that plan.”
“The Bill does that, but it also has this overseas markets vision, which is granting equivalence on a country-by-country basis, to the 9,000 funds that are domiciled overseas but which operate in the UK. I want to talk a bit about these two different parts of the Bill. Starting with you, Emma, what do you think your members’ attitude is to onshoring this body of EU law? Do they broadly regard it as something that they would like to stick with or are there areas that they would quite quickly want to diverge from and, if so, what would be the most prominent areas? Emma Reynolds: We were delighted that the Government took the unilateral decision last week to grant the EU equivalence in a number of different areas. We are still hopeful that the EU might follow suit.”
“Q Good afternoon, Emma and Catherine. It is very nice to see both of you. Emma, I want to come to you first. You are the fifth panel to appear and there is beginning to be a pattern to the questions that we have asked. I feel that I have asked this of a few people. The Bill does lots of different things but two big things are that it transposes, or onshores, lots of different parts of EU regulation from many different directives. It gives powers to the UK regulators to govern all that. In doing that, as we come to the end of the transition process, there is greater freedom for either the Treasury or the regulators to diverge from that body of EU law.”
“There is no immediate appetite for great divergence from EU rules from our members. Does that answer your question?”
“Q You referred to the equivalence decision announced by the Chancellor last week. That is one end of the telescope; the other end is hoping—I am sure the Chancellor hopes, too—that this is reciprocated. Do you see a relationship between the degree of divergence, which may occur and the decision-making process from the other end of the telescope on equivalence for UK firms trying to sell into EU markets? In other words, Mr Barnier talks a lot about the level playing field, but if it looks like we are departing from a level financial playing field, will that impact on those equivalence decisions you hope for? Emma Reynolds: We are still hopeful that the EU might take a similar decision to what we saw last week. We would not like to see divergence for divergence’s sake.”
“Yes, when we speak to practitioners with the International Regulatory Strategy Group, it is their view that a joint Select Committee on financial regulation, which could look in detail at pieces of financial services regulation, would be a useful way of enhancing and embodying that scrutiny.”
“Q Yes. Catherine, can I turn to you on the question of regulators? This gives a huge amount of new powers to the regulators. I have a two-part question. One, do you think they can handle it? Two, returning to what you said about a new Select Committee on financial services regulation—or whatever the exact title was—do you think that is an important part of a new accountability regime for the regulators, given the enhanced powers that the Bill gives them? Catherine McGuinness: First of all, I do think the regulators can handle this, but I think it is important that we look at the right degree of scrutiny.”
“To answer your question, if equivalence determinations by the EU are not forthcoming, or not brought forward at pace or with the width that is expected, that will put limitations on the access of service providers—financial services companies and firms—to the EU market. This is really an issue of market access.”
“Q Thank you for coming today. I want to start with our current situation on equivalence, where we had an announcement from the Chancellor that the UK will grant equivalence recognition to companies based in current EU member states but we have not got a reciprocal equivalence recognition for UK companies selling into EU markets. What are the practical implications for UK-based financial services companies if that situation continues to exist for some time? Adam Farkas: Very briefly, equivalence determinations provide the major legal framework for different jurisdictions to provide access to service providers that are licensed and supervised in each other’s markets.”
“In other words, everyone is hoping for the best but preparing for the worst. AFME members—of course, our membership is tilted towards the large players—have made extensive preparations over the years to get ready for the worst outcome, which would limit direct market access from the United Kingdom to the EU, by way of setting up entities, moving activities across the border and making all necessary arrangements to allow them to continue to serve their clients across the European market. Of course, if equivalence is granted and access is provided on that basis, it would improve the general situation of market access between the EU and the UK, so we welcome the Chancellor’s announcement and the UK Government’s determination last week to grant equivalence within a certain scope to third countries, including EU countries.”
“Q Can you give us some practical examples of what kind of barriers companies could face and of what decisions they might have to take to overcome them? Adam Farkas: In very simple terms, if a company is licensed in the United Kingdom and does not have access, or loses access, to the EU—of course, that is completely free under passporting regimes—it will find limitations in serving clients or trading with counterparts in respect of the financial services that it provides in the other jurisdiction, which would be across the channel in this case. A lack of equivalence has been a risk throughout the process of the negotiations, so authorities have made significant efforts to prepare regulated entities—financial firms—and to force them to prepare for all eventualities.”
“Q So the main mechanism for preparation, as you put it, is to establish an operation inside the EU if you have not already got one. Adam Farkas: With a lack of equivalence. If no market access is provided on another basis, the main mechanism is to establish entities that are licensed, capitalised and supervised in the other jurisdiction, meaning that that entity can have access to the market, but that involves costs and operational implications.”
“Regulations were put in place, changes to methodologies were put in place and public institutions took a stronger role to make sure that benchmarks are more robust and not prone to manipulation or potential distortions. I think, in that sense, this issue of reputation and the credibility of these benchmarks has been very strongly addressed by the authorities globally, and also in the UK by the authorities. I believe strongly that this will lead to a much sounder and more credible framework once the transition is completed.”
“Q Can I ask you about LIBOR? We have heard that the Bill facilitates a move away from LIBOR. The weaknesses and manipulation of LIBOR are well documented. The L in LIBOR stands for London—it is the London interbank rate. Are there any implications for London’s status as a global financial centre from a move away from LIBOR towards different kinds of benchmarks? Adam Farkas: It is a very difficult question. We all know the history of what happened. What is important is what happened afterwards and how the authorities decided to move away from the possibility of manipulating these rates. There is a global co-ordination effort and a long-standing global discussion on transitioning out of the old way of setting different financial benchmarks.”
“Now, the bilateral co-ordination will change, because it will take the form of the so-called bilateral regulatory dialogue—or whatever similar term the EU uses—with third countries, which provide a platform. Inevitably, if two jurisdictions take a separate course in legislation, there will be some divergence between the rules. What is very important is that if that happens, it is transparent to this multilateral setting as well as in the bilateral context; it is well-explained and co-ordinated as much as possible; and it is only done if there is a real justification for it.”
“Adam Farkas: Before I answer the bilateral question, I think that there are other forms of international co-ordination of financial services policy. One is multilateral in the form of the FSB, IOSCO—that is on market rules—and the Basel committee, which deals with prudential rules. Both the EU and the UK are significant players and participants in this global co-ordination. In the interest of having open, transparent, and well-functioning financial markets and maintaining international flow in capital movement, allowing both banks and corporates to manage their risks cross-border, these multilateral engagements are extremely important. They actually provide a very good platform to co-ordinate the major direction of financial regulation globally.”
“Q Finally, I would like to ask if you a question about future direction. We have heard today about British influence on the EU directives that govern financial services—that there has been quite heavy British influence over the years in designing this set of regulations, which this Bill onshores back to the UK as a result of Brexit. That means that, come the end of the year, we will be very closely aligned with what has been developed over the years so far. What is your view of what will happen on the EU side, absent a British influence, as financial services regulation inevitably evolves and develops? We no longer have one table, if you like. We have two tables—a British one and a European one. Does that mean, inevitably, that the two sets of regulations gradually spin off in different directions, or is that not the case?”