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BRIEFING PAPER

Number 7476, 28 January 2016

The Bank of England and Financial Services Bill [HL]

By Tim Edmonds, Dominic Webb and Djuna Thurley

Inside: 1. Introduction 2. Governance and financial

arrangements 3. Financial services 4. Pensions guidance and advice

Number 7476, 28 January 2016 2

Contents Summary 3

1. Introduction 4

2. Governance and financial arrangements 5 2.1 Background 5 2.2 The Bill 7

Clause 1: Membership of court of directors 7 Clause 2: Term of office of non-executive directors 8 Clause 3: Abolition of Oversight Committee 8 Clause 4: Functions of non-executive directors 10 Clauses 5-6: Financial Stability Strategy and FPC 10 Clauses 7-8: MPC membership and procedure 10 Clause 9: Audit 11 Clause 10: Activities indemnified by the Treasury 12 Clause 11: Examinations and reviews 13 Clause 12: Prudential Regulatory Authority 15 Clause 13: Prudential Regulation Committee 16 Clause14: Accounts of Bank of England 17

3. Financial services 18 3.1 Background 18 3.2 The Bill 18

Clause 18: recommendations by the Treasury 18 Clause 19: Diversity 19

3.3 Authorised person’s regime 20 Background 20 The Bill’s proposals and Lords’ Debates 22 Cl 20: Extension of relevant authorised person regime to all authorised persons 24 Clause 21: Rules about controlled functions 25 Clause 22: Administration of senior managers regime (SMR) 25 Clause 23: Rules of conduct 25 Clause 24: Misconduct 26 Clause 25: definition of insolvency for failed institutions purposes 27 Clauses 26 & 27: consumer credit 27 Clause 28: Transformer vehicles 28 Clause 32: Resolution planning 28 Clause 34 Banknotes in Scotland and Northern Ireland 29

4. Pensions guidance and advice 31 4.1 Background 31 4.2 The Bill 38

Clause 29: Pensions guidance 38 Clause 30: Advice requirement 41 Clause 31: Independent advice: appointed representatives 44

Contributing Authors:

Dominic Webb, Governance & financial arrangements; Djuna Thurley, pensions guidance & advice; Tim Edmonds, All other sections

Cover page image copyright: Threadneedle Street, City of London by Keith Braithwaite. Licensed under CC BY 2.0 / image cropped.

3 The Bank of England and Financial Services Bill [HL]

Summary The UK’s system of financial regulation has been thoroughly reformed following the financial crisis of 2008, with the Bank of England (“the Bank”) being given a central role. The Financial Services Act 2012 gave the Bank wide responsibilities for financial supervision through a new body – the Prudential Regulation Authority. These increased responsibilities mean that the arrangements for the governance, accountability and transparency of the Bank have become more important. The Bill aims to make improvements in these areas. The Bill also makes some changes to the procedures of the Bank’s Monetary Policy Committee (MPC). It covers:

• Internal governance and oversight of the Bank • Extension of the senior managers’ regulatory regime • Pensions guidance and advice; and • Measures in respect of bank note issuance by banks in Scotland and Northern

Ireland.

Some of the main measures contained in the Bill include:

• Making the Deputy Governor for markets and banking (currently Dame Minouche Shafik) a member of the Bank’s court of directors (“the court”).

• Giving the Government the power to make further changes to the membership of the court by secondary legislation.

• Abolishing the Oversight Committee and transferring its oversight functions to the

full court.

• Making changes to the MPC’s procedures including faster publication of its minutes and reducing the number of MPC meetings from 12 to 8 a year.

• Alllowing the National Audit Office (NAO) to undertake value for money studies of

the Bank, subject to some limitations.

• The supervisory body the Prudential Regulatory Authority becomes a committee of the Bank – the Prudential Regulation Committee

• The Senior Managers and Certification regime, which ascribes personal responsibility

for controlled functions within financial service firms, is extended to all regulated firms, rather than just deposit takers. As part of this change, however, the ‘reverse burden of proof’ of the previous regime is revoked.

• The remit of the guidance service Pension Wise is extended to cover people with annuities, and provision is made to require people who want to sell an annuity income stream above a certain value to take professional advice before doing so.

The Bill was introduced into the House of Lords. There, it was the abolition of the Oversight Committee, the extent to which the NAO would be allowed to scrutinise the Bank and the abolition of the reverse burden of proof in the Senior Managers and Certification regime which received particular attention. A number of Government new clauses were introduced in the Lords covering the financial services regulation aspects of the Bill. More detail on the Bill’s stages in the House of Lords are in a separate Library note, The Bank of England and Financial Services Bill [HL]: Lords Stages.

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1. Introduction This paper provides background and commentary on the main parts of Bank of England and Financial Services Bill. It is intended to inform the Second Reading debate in the House of Commons on 1 February 2016.

The Bill was introduced into the House of Lords on 14 October. It had its Second Reading in the Lords on 26 October 2015. The Committee stage took place on 9 November and 11 November 2015. Report stage was on 15 December 2015 and Third Reading on 19 January 2016. Commentary on the debates in the Lords can be found in another Library Paper, The Bank of England and Financial Services Bill [HL]: Lords Stages.

Successive versions of the Bill can be found on the Bill page of Parliament’s website. The Government’s Explanatory notes can also be found here.

Prior to its publication, the Treasury had consulted on various technical aspects of the Bill (see consultation document and Government response). In addition, the Treasury Committee held three oral evidence sessions on the Bill.

The Bill’s provisions extend to the whole of the UK, except for clause 31(2) which relates to England, Wales and Scotland and clause 31(3) which covers Northern Ireland.

5 The Bank of England and Financial Services Bill [HL]

2. Governance and financial arrangements

The Bill makes changes to arrangements for the Bank’s governance, the Monetary Policy Committee and the role of the National Audit Office in scrutinising the Bank. The role of the court, the Oversight Committee, the Financial Stability Strategy and the MPC are discussed in section 2.1 below. Section 2.2 looks at clauses 1 to 14 in detail.

2.1 Background The court and the Oversight Committee The court is the Bank’s Board of Directors. Its function, as laid down by statute, is to “manage the affairs of the Bank”, with the exception of monetary policy which is the responsibility of the Monetary Policy Committee.1 The court is responsible for the Bank’s strategy and budget and is accountable for the Bank’s performance against its objectives. Day-to-day management of the Bank is delegated to the Governor by the court. The court retains certain responsibilities, set out in a document, Matters reserved to Court.

The current membership of the court is the Governor, three Deputy Governors and seven non-executive members.2 The non-executives therefore have a majority. The court is chaired by one of the non-executives (currently Anthony Habgood).

The court has undergone a number of changes in recent years as a result of legislation. For example, the Banking Act 2009 reduced the number of court members from 19 to 12 with the number of non-executives being reduced from 16 to 9. The chair of the court was to be appointed by the Chancellor from among the non-executives.3 The Bank’s Oversight Committee was established by the Financial Services Act 2012. This committee is made up of the non-executive members of the court. Its role is defined by the Act and includes keeping under review the Bank’s performance in relation to its objectives and strategy. The Financial Services Act 2012 requires the court to publish its minutes.4

The Treasury Committee made a number of recommendations about the court in its 2011 report, Accountability of the Bank of England. The Committee found that the Bank’s governance arrangements needed strengthening and recommended that the court be “transformed into a leaner and more expert Supervisory Board.” This body would have powers “to conduct retrospective reviews of Bank policies and

1 Sir David Lees and John Footman, The Court of the Bank of England, Bank of

England Quarterly Bulletin, 2014, Q1 2 Dame Minouche Shafik, Deputy Governor markets and banking, is not currently a

member of the court. Clause 1 of the Bill makes this post a member of the court. 3 See Treasury Committee, Accountability of the Bank of England, 8 November 2011,

HC 874, 2010-12, para 53 and Sir David Lees and John Footman, The Court of the Bank of England, Bank of England Quarterly Bulletin, 2014, Q1, p32

4 These are available on the Bank of England website.

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conduct.”5 The Committee recommended that the Supervisory Board have eight members with the non-executives in a majority and a non-executive chair.6

In December 2014, the Bank made a number of recommendations about the court and the Oversight Committee. These were largely accepted by the Government and have been included in the Bill. These are discussed in more detail below (see comments on Clauses 1 and 3).

The Financial Stability Strategy and the Financial Policy Committee Under the Bank of England Act 1998, the Bank’s Financial Stability Objective is to protect and enhance the stability of the financial system in the UK. As it currently stands, the Act requires the Court to determine the Bank’s strategy regarding this objective in consultation with the Financial Policy Committee (FPC) and the Treasury. The Financial Stability Strategy was set out in the Bank’s 2014 Annual Report (see page 38).

The Bank’s Financial Policy Committee (FPC) is responsible for “policy to meet the Bank’s statutory objectives for financial stability.”7 The Committee’s primary objective is “identifying, monitoring and taking action to remove or reduce systemic risks with a view to protecting and enhancing the resilience of the UK financial system.”8 The Committee’s secondary objective is to support the economic policy of the Government. At the moment, there are ten members of the Committee: the Governor, three Deputy Governors, the Chief Executive of the Financial Conduct Authority, one member appointed by the Governor after consulting the Chancellor and four appointed by the Chancellor. There is also a representative from the Treasury who does not vote. The FPC is currently a statutory sub-committee of the court.

In December 2014, the Bank made a number of recommendations relating to the FPC. These included changing its status from a sub-committee of the court to a committee of the Bank. This would put the FPC on the same footing as the MPC. It also recommended adding the Deputy Governor for markets and banking to the FPC and also adding another non-bank member to preserve the balance of the committee between Bank and non-Bank members. These changes are included in the Bill (see clause 6).

The Monetary Policy Committee The Monetary Policy Committee (MPC) is the body which sets interest rates in the UK. It has nine members, five of whom are from the Bank and four of whom are external.

5 Treasury Committee, Accountability of the Bank of England, 8 November 2011, HC

874, 2010-12, p3 6 Treasury Committee, Accountability of the Bank of England, 8 November 2011, HC

874, 2010-12, para 54 7 Bank of England website 8 Bank of England website

7 The Bank of England and Financial Services Bill [HL]

In April 2014, the Bank of England commissioned the Warsh Review to look at various MPC practices, particularly in relation to transparency. The review published its report in December 2014.9 The Bank accepted the report’s findings and announced a number of changes to the MPC’s procedures. These included:

• simultaneous publication of the MPC’s decision, minutes and, in relevant months, the Inflation Report.

• Publication of written transcripts of meetings at which interest rates are set.

• Moving to eight meetings a year from the current twelve. • Holding four joint meetings of the FPC and MPC in 2016.

The MPC does not need to wait for legislation to change the timing of publication of its minutes. It has already moved to simultaneous publication of decision, minutes and Inflation Report. Clause 8 of the Bill amends the requirement on the number of MPC meetings a year.

The Bill’s provisions affecting the MPC have been relatively uncontroversial. There is further information on them in a House of Commons Library Note, Improvements to Monetary Policy Committee Transparency.

2.2 The Bill Clause 1: Membership of court of directors Membership of the court of directors is determined by Section 1 of the Bank of England Act 1998. This says that the court is composed of the Governor, the three Deputy Governors for financial stability, monetary policy and prudential regulation and not more than nine non-executives.

Clause 1 makes the Deputy Governor for markets and banking a member of the court. Dame Minouche Shafik was appointed to this newly-created post with effect from 1 August 2014. Announcing this appointment, the Treasury said that this would initially be on a non-statutory basis, but would be put on a statutory basis in line with the other Deputy Governor posts, “as soon as a legislative opportunity arises”.10

The clause also gives the Treasury a power by order to alter the title of a Deputy Governor or add or remove a Deputy Governor from membership of the court.

At Lords Committee stage, the Minister (Lord Bridges of Headley), said:

Clause 1 makes the deputy governor for markets and banking a member of the Court of Directors. Following the expansion of the Bank’s responsibilities through the Financial Services Act 2012, a deputy governor for markets and banking was appointed, as noble Lords will know, with responsibility for reshaping the Bank’s

9 Kevin Warsh, Transparency and the Bank of England’s Monetary Policy Committee,

December 2014. See also Bank of England News Release, Bank of England announces measures to bolster transparency and accountability, 11 December 2014

10 HM Treasury, Chancellor announces three senior Bank of England appointments, 18 March 2014

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balance sheet, including ensuring robust risk-management practices. This important position, currently filled by Dame Minouche Shafik, is not a statutory member of court. This clause amends the Bank of England Act 1998 to make this position statutory, ensuring equal status for all the Bank’s deputy governors and simplifying the Bank’s governance structure.

In addition, Clause 1 provides enhanced flexibility to add or remove a deputy governor or to alter the title of a deputy governor. Correspondingly, it provides the ability to make changes to the composition of the court, the FPC, the MPC or the new PRC where a deputy governor is added or removed. It should be noted that this power will not permit the Treasury to remove a deputy governor or change his or her title while that deputy governor is in office. This is a measure to ensure flexibility for future need. The Government will be able, by order—a point I will return to—to adapt the size and shape of the court to bring in new expertise when necessary. Thus the Bank’s senior management team can be easily adjusted to meet future requirements.11

In December 2014, the Bank said that it wanted to move to a slightly smaller court, while preserving the non-executive majority and chair. The Bank proposed reducing the number of members of the court to a maximum of 12, of whom no more than 5 would be Bank executives.12

While the Bill does not change the current requirement for up to nine non-executives on the court, the Government has said that it intends to reduce the number to seven. This would bring the membership of the court into line with the Bank’s 2014 proposal.

A number of concerns were raised about this when the Bill was debated in the House of Lords. For example, Lord Sharkey said that the change in the balance between executive and non-executive directors on the court would reduce external scrutiny of the Bank. This would be of concern, especially if the Oversight Committee were also abolished (see Clause 3 below). Lord Eatwell said “the Bill reeks of the feeling that non-executive directors are a nuisance. Everywhere, we find the role of the non-executive directors in the Bank being reduced.”13

Clause 2: Term of office of non-executive directors This Clause allows the term of office of a non-executive director of the court to be extended once for up to six months. If re-appointed, that person’s subsequent term of office is reduced by the length of the extension (but may itself be extended by up to six months).

Clause 3: Abolition of Oversight Committee Clause 3 allows for the abolition of the Oversight Committee. This committee is a sub-committee of the court and is composed of the non-executive members of the court. The Oversight Committee was created by the Financial Services Act 2012. Its role is defined by the Act and includes keeping under review the Bank’s performance in relation to its objectives and strategy.

11 HL Deb 9 November 2015 c1868 12 Bank of England, Transparency and Accountability at the Bank of England,

December 2014, p5-6 13 HL Deb 9 November 2015 c1862

9 The Bank of England and Financial Services Bill [HL]

Clause 3 also transfers oversight functions which were previously delegated to the Oversight Committee to the full court. Oversight functions are listed in section 3A of the 1998 Act which is amended by the Bill.

The Bank had proposed moving the oversight function to a single body, the court, in its 2014 report. This said:

The Bank sees a case for simplifying the current structure. The Oversight Committee is not a continental-style supervisory board, but even as a sub-committee of the main board it does detract from the role of Court. In practice it has been found necessary to hold joint meetings of Court and the Oversight Committee for most purposes, with the executive withdrawing when appropriate, as would be normal in a unitary board.

[…]

In the light of experience we suggest that, in due course, the functions of management and oversight should be vested in a single governing body - Court – which should retain an independent Chair and a majority of non-executives. Nothing in this would alter the rights of the non-executives to meet separately from the executives: indeed it is desirable and good practice that they should do so.14

For the Government, Lord Bridges argued that oversight would be carried out better by the executives and non-executives working together rather than in “silos”. Furthermore, he said the Bill was in line with the recommendation of the Treasury Committee’s 2011 report and the Parliamentary Commission on Banking Standards for a unitary board. Parliament would continue to see the performance review reports commissioned by the court.

A number of concerns were raised about this clause when the Bill was debated in the Lords, in particular, that it would reduce the ability of the non-executives to hold the Bank’s executive directors to account.

For example, Lord Sharkey argued that it was a “significant weakening of the oversight of the Bank”.15 He said that the Oversight Committee had been established by Parliament as an important part of the Bank’s governance. Lord Tunnicliffe agreed saying that the “the Government’s proposals significantly reduce the power of the non-executives to hold the executives to account.”16

A Government amendment was accepted at Lords Report stage so that a performance review could be initiated by a majority of non-executives of the court. In other words, a majority of the whole court, including the executives, would not be needed. This was in response to concerns that the non-executives might be blocked from initiating such a review by the executive members of the court.

14 Bank of England, Transparency and Accountability at the Bank of England,

December 2014, p6 15 HL Deb 9 November 2015 c1870 16 HL Deb 9 November 2015 c1870

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Clause 4: Functions of non-executive directors This clause requires the Governor’s and Deputy Governors’ remuneration to be determined by a sub-committee of the court made up of at least three non-executive directors. A Government amendment was accepted at Lords Report stage. Originally the requirement was for a minimum of two non-executives on the remuneration committee.

This clause had originally allowed the court to delegate oversight to a sub-committee of two or more non-executive directors. The clause was amended at Lords Report stage to remove this provision.

Clauses 5-6: Financial Stability Strategy and FPC Under the 1998 Act, the Bank’s Financial Stability Objective is to protect and enhance the stability of the financial system in the UK. The Act requires the court to determine the Bank’s strategy regarding this objective in consultation with the Financial Policy Committee (FPC) and the Treasury.

Clause 5 allows the court to delegate the powers and duties conferred on it in relation to the financial stability strategy. The court retains responsibility for any power or duty delegated in this way.

As originally drafted, this clause moved responsibility for the financial strategy from the court to the Bank. This was to allow the court to delegate production of the financial strategy to those best placed within the Bank.17 The court would retain ultimate responsibility for the strategy.

This clause was amended by the Government at Lords Report stage. The old clause was replaced by a new Clause 5. The Minister, Lord Bridges of Headley, said that the amendment did not change the substance of the clause. The amendment restores responsibility for the financial stability strategy to the court (the original Clause 5 had transferred it to the Bank from the court).

Clause 6 makes the FPC a committee of the Bank rather than a sub-committee of the court. It specifies that the four Deputy Governors (for financial stability, markets and banking, monetary policy and prudential regulation) are all members of this committee. This has the effect of adding Dame Minouche Shafik, Deputy Governor for markets and banking, to the FPC. The other three Deputy Governors are already members of the FPC.

This clause also increases the number of FPC members appointed by the Chancellor from four to five to maintain the balance between external members and Bank officials, following the addition to the FPC of the Deputy Governor for markets and banking

Clauses 7-8: MPC membership and procedure The Monetary Policy Committee (MPC) of the Bank is the body which sets interest rates. It has nine members. Under the current legislation, these are the Governor, the Deputy Governors for monetary analysis and financial stability, two members appointed by the Governor, after

17 HL Deb 9 November 2015 cc1882-83

11 The Bank of England and Financial Services Bill [HL]

consultation with the Chancellor, and four members appointed by the Chancellor.

Clause 7 adds the Deputy Governor for markets and banking as a statutory member of the MPC. As a result of this clause, the number of MPC members appointed by the Governor falls from two to one. This person is to be known as “the Chief Economist of the Bank” and is required to be a person who carries out monetary policy analysis within the Bank. There will be no change to the current membership of the MPC as a result of this clause as both the current Deputy Governor for markets and banking (Dame Minouche Shafik) and Chief Economist (Andy Haldane) are already on the MPC.

The clause also introduces a requirement for the Chancellor to consider whether a person appointed by them “has any financial or other interests that could substantially affect the functions as member that it would be proper for the person to discharge”.

Clause 8 relates to a number of aspects of the MPC’s procedure, including the number of MPC meetings each year, the timing of the publication of the minutes of MPC meetings, the quorum for MPC meetings and conflicts of interest. A number of these changes follow the Warsh Report published in December 2014 (see section 2.1 above).

This clause changes the timing of publication of minutes of MPC meetings. Under the Bank of England Act 1998, the minutes must be published within six weeks of the MPC meeting. Clause 8 amends this requirement to so that the minutes must be published “as soon as reasonably practicable” after the MPC meeting (or where the meeting related to a decision to intervene in the financial markets, after publication of that decision). The Bank has already moved to simultaneous publication of the MPC’s decision, minutes (and, in relevant months, the Inflation Report).

Subsection (4) reduces the number of times the MPC is required to meet each year. The current requirement is to meet “at least once a month”. The Bill changes this to at least eight times a year and at least once in any ten week period.

Subsection (5) changes the rules for a quorum on the MPC. A meeting will only be quorate if either the Governor or the Deputy Governor for monetary policy is present. If only one of these is present, the meeting will not be quorate unless either the Deputy Governor for financial stability or for markets and banking is present.

Subsection (6) relates to the procedure where an MPC member has an interest in a matter being considered by the MPC. It requires the Bank to have a code of practice on the way the MPC is to deal with conflicts of interest.

Clause 9: Audit This clause inserts a new section into the 1998 Act. It requires the Bank to consult the Comptroller and Auditor General (C&AG) about the appointment of the Bank’s external auditors. The clause also requires

Number 7476, 28 January 2016 12

the auditor appointed by the Bank to consult the C&AG about the “scope, timing and direction of the audit” and on any audit plan.

In addition, the C&AG will be entitled to see information held by the Bank relating to its audit which is reasonably required. The C&AG will also be entitled to attend any meetings of the Audit and Risk Committee of the Bank where these deal with any aspect of the audit of the Bank’s accounts.

At Lords Committee stage, Lord Bridges said:

Clause 9 gives the Comptroller and Auditor-General a new role in the financial audit process of the Bank. The Comptroller and Auditor-General will be consulted on the appointment of the financial auditor and on the work programme that that auditor sets out to deliver. The Comptroller and Auditor-General will have the right to attend the relevant parts of the meetings of the Bank’s audit and risk committee. This is intended to assist the NAO in conducting value-for-money examinations of the Bank under Clause 11.18

Clause 10: Activities indemnified by the Treasury This clause inserts two new sections into the 1998 Act.

The first provides the Treasury with a power to require the Bank to prepare a financial report for any Bank activity where the Treasury has given a guarantee or indemnity (and which therefore represents a risk to public funds). This report may be sent to the C&AG for review. The clause gives the C&AG rights to access documents which may reasonably be required for the purposes of this review.

The second applies in cases where the Treasury has given an indemnity or guarantee to a company which is a subsidiary of the Bank (or in which the Bank has a minority interest). The Treasury may require the subsidiary to send its accounts to the C&AG for audit. The C&AG must make a report and the accounts and report must be sent to the Treasury and laid before Parliament.

At Lords Committee stage, Lord Bridges said:

Clause 10 provides for increased public scrutiny in circumstances where a Treasury indemnity has been granted to the Bank, or to a company of the Bank. Fortunately, times when a Treasury indemnity is deemed necessary are rare, but it is right that where there is a direct risk to public funds the Treasury can require the Bank to prepare a financial report on any activities that have been indemnified, so that the extent of the risk to public funds can be assessed, and that this report is subject to review by the Comptroller and Auditor-General. I agree that in both of these contexts the question of access to information is critical. It is central to the ability of the Comptroller and Auditor-General, assisted by the National Audit Office, to carry out effectively the roles defined for him in the Bill.19

18 HL Deb 9 November 2015 cc1895-6 19 HL Deb 9 November 2015 c1896

13 The Bank of England and Financial Services Bill [HL]

Clause 11: Examinations and reviews This clause relates to value for money (VFM) studies of the Bank by the National Audit Office. It was one of the more controversial clauses during the Bill’s passage through the House of Lords. It has not proved easy to balance the interests of two independent bodies: the Bank and the NAO. The proposed arrangements have been changed a number of times.

Lord Bridges explained the purpose of the clause at Lords Committee stage:

I begin by emphasising that by extending, for the first time, the NAO’s ability to conduct value-for-money reviews of the Bank, the Bill will deliver a significant increase in the transparency and accountability of the Bank to the public and Parliament. The Government are strongly of the view that enhancing the accountability of the Bank of England is in the public interest but it is also in the Bank’s interest—strengthening public trust in the Bank will only add to its credibility.20

In its consultation paper on the Bill, the Treasury said “one consequence of integrating the PRA into the Bank will be the need to unify audit arrangements across the organisation. The Government intends to use this opportunity to bring the entire Bank within the NAO’s oversight: in future, the NAO will have freedom to initiate value for money studies in relation to the whole of the Bank, following consultation with Court”.21

In its response to the consultation, the Government said that the Bill would go further than the consultation in strengthening the safeguards of the Bank’s independence by giving it the final say on what counted as a “matter of general policy” and would therefore be outside the remit of the NAO’s VFM studies. The consultation response said:

The consultation document stressed the importance of safeguarding the Bank’s independence while extending the scope of NAO value for money studies. As proposed, the Bill will explicitly exclude consideration of the merits of the Bank’s policy from the NAO’s remit, but will provide a stronger mechanism than the exemption detailed in the consultation document to ensure confidence in this protection. The Bank will be able to notify the NAO of concerns that a proposed study would question the merits of its general policy. The Bank would be required to consider the views of the NAO, but ultimately it will be for the Court to determine what constitutes a matter of general policy for these purposes. When such a difference of opinion prevails, the NAO must make public the disagreement. This provides continued assurance of the Bank’s critical policy-making independence. The NAO will continue to have independence in determining a value for money programme within this framework. [bold added]22

It has been suggested that this strengthening of the court’s position was in response to concerns about the NAO’s role raised in September 2015, by Anthony Habgood, chairman of the court, when he gave evidence

20 HL Deb 9 November 2015 c 1903 21 HM Treasury, Bank of England Bill: technical consultation, July 2015, para 4.23 22 HM Treasury, Bank of England Bill: response to the consultation, October 2015, para

2.34

Number 7476, 28 January 2016 14

on the Bill to the Treasury Committee.23 The C&AG criticised this limitation of his role. In an article in the Financial Times, the C&AG said that these arrangements placed him under “unacceptable restrictions”.24

During the Bill’s passage through the House of Lords, there was considerable criticism of this clause. The concerns were that it gave the Bank an effective veto over the C&AG’s value for money studies. For example, Baroness Noakes said “Public audit can be effective only when it is unfettered, and the concept of fettering the Comptroller and Auditor-General is, frankly, unacceptable.”

Clause 11 was amended by the Government at Lords Report stage in response to criticisms of the Bank’s veto. The clause gives the C&AG power to initiate VFM studies of the whole Bank, after consultation with the court. The Treasury has an equivalent power in relation to the Bank’s PRA functions. Some areas may not be examined by the C&AG. The C&AG may not consider the Bank’s policy objectives or the merits of policy decisions taken by the FPC, MPC or PRC. According to the Explanatory Notes:

In addition, the Comptroller and Auditor General may not examine the merits of policy decisions on the supervision of financial market infrastructure (such as payment or settlement systems or clearing houses) taken by the body within the Bank responsible for the Bankʹs supervision of financial market infrastructure. Nor may the Comptroller and Auditor General consider the merits of policy decisions relating to resolution taken by the body responsible for the exercise of the Bankʹs resolution functions. However, where the Bank has used its powers under the 2009 Act, or Part 6 of the 2013 Act (which provides for special administration for infrastructure companies) to resolve a bank or other financial institution the Comptroller and Auditor General may consider any policy decision on resolution which is relevant to the resolution of that institution.25

Clause 11 requires the Bank and C&AG to prepare a Memorandum of Understanding about VFM studies. This is to set out how disputes will be resolved and identify those functions of the Bank which the C&AG would not usually want to examine. Where a dispute cannot be resolved, the views of the Bank and the C&AG will be published.

The clause also contains provisions to ensure that those carrying out these VFM studies have access to the necessary information. Finally, the clause requires the C&AG and NAO to treat as protected any information relating to monetary policy, the Bank’s financial support operations or the provision of private banking services and not to disclose any such information.

23 “Proposal to open BoE books to auditors causes unease”, Financial Times, 10

September 2015. “. See also Treasury Committee, Bank of England Bill, 9 September 2015, HC 445, Q3

24 Auditor calls Bank of England regulation bill ‘unacceptable’”, Financial Times, 15 October 2015

25 Bank of England and Financial Services Bill [HL] Explanatory Notes, 20 January 2016 para 52

15 The Bank of England and Financial Services Bill [HL]

The Minister said that the amendments to Clause 11 removed the Bank’s veto over VFM studies carried out by the NAO. Lord Bridges said: “the court will no longer have a veto over the scope of the NAO value-for-money reviews.”26 Baroness Noakes questioned whether the arrangements for cases where the Bank and C&AG disagreed amounted to a “backdoor power of veto” for the Bank.27

Clause 12: Prudential Regulatory Authority The Prudential Regulation Authority (PRA) was created as a part of the Bank of England by Section 6 of the Financial Services Act (2012) . It is responsible for the prudential (as opposed to conduct) regulation and supervision of around 1,700 banks, building societies, credit unions, insurers and major investment firms. It is a company in its own right and is a subsidiary of the Bank.

The PRA’s objectives are set out in the Financial Services and Markets Act 2000 (FSMA). The PRA has three statutory objectives:

1. a general objective to promote the safety and soundness of the firms it regulates;

2. an objective specific to insurance firms, to contribute to the securing of an appropriate degree of protection for those who are or may become insurance policyholders; and

3. a secondary objective to facilitate effective competition.

The difference between the Financial Conduct Authority (FCA) and the PRA is that the PRA is concerned with the safety and solvency of firms whereas the FCA is concerned with their day to day conduct. There are overlaps of interest and many firms are supervised by one and regulated by the other. Another area of joint interest is the work by both organisations in the approval of new banks. One of the stated goals of Government policy has been to encourage competition in the banking market and in particular to see ‘challenger banks’ become established.

When it was established the PRA was a subsidiary of the Bank of England. This clause ends that relationship and the PRA will be subsumed by the Bank and become a committee of it.

On Second Reading in the Lords the Minister Lord Bridges of Headley, described the Bill’s provisions ending the PRA status as a Bank subsidiary as being in support of the Governor’s strategy, “to conduct supervision as an integrated part of the central bank and not as a standalone supervisory agency that happens to be attached to a central bank”. The Government, however, recognised the “PRA’s strong brand” and that its operational independence needed to be protected.28

The Minister returned to testimony from the Governor as justification for the change in reply to questions on the lines of “if the PRA was not “broke”— if it wasn’t broke, why change it” raised by several Peers.29 26 HL Deb 15 December 2015 cc1997-98. 27 HL Deb 15 December 2015 cc2001-02 28 HL Deb 26 October 2015 c1043 29 HL Deb 11 November 2015 c2001

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The Bank is currently engaged in a ‘One Mission, One Bank’ strategy exercise which promises to:

promote connectivity across Monetary Policy Committee (MPC), Financial Policy Committee (FPC) and Prudential Regulation Authority (PRA) Board, through sharing of information and analyses, and more frequent joint meetings, while respecting external committees’ statutory rights and the Governors’ decision rights on Bank policy matters.30

More commentary on this clause can be found in the Library Paper on Lords’ proceedings here. More generally The Treasury Committee held an oral witness session with Andrew Bailey, then head of the PRA in October 2015, where he was questioned closely about the impact the Bill might have on the PRA and its successor.31

The functions of the PRA will now be exercised through a new Prudential Regulation Committee established by clause 13.

Clause 13: Prudential Regulation Committee This clause transfers the functions of the PRA onto a new Prudential Regulation Committee (PRC).

The best guide to the role of the PRC remains the webpages of the PRA here. Much of the PRA’s/PRC’s supervision is to a large extent determined internationally, both at a global level and within the European Union (see below) by relevant EU Regulations, including binding technical standards that apply directly to UK firms. It operates closely with the European supervisory bodies such as

• The European Banking Authority (EBA)

• The European Securities and Markets Authority (ESMA)

• The European Insurance and Occupational Pensions Authority (EIOPA).

The clause introduces three new Sections into the Bank of England Act 1998 legislation that is more notable for establishing the monetary policy committee and taking from the Bank supervisory functions and giving it to the then new Financial Services Authority.

The three new sections are described fully in the Explanatory Notes. Briefly, the first creates the PRC and establishes the governing Board –which mirrors the existing arrangements. The second (mirroring a later new provision with respect to the FCA) requires the Treasury to make recommendations to the PRC about the matters of Government economic policy it wants the PRC to take into account. The third ensures the PRC complies with aspects of the capital requirements directive and the recovery and resolution directive.

It is argued that as a Committee of the Bank, as opposed to a subsidiary company the organisation will be able to focus more closely on its policy work rather than its IT procurement or the many things common to all companies.

30 Bank of England Strategic Plan: Background information 31 See Treasury Select Committee, Evidence Session Q105-Q110, 20 October 2015

17 The Bank of England and Financial Services Bill [HL]

Clause14: Accounts of Bank of England This clause makes consequential changes to the Bank of England Act 1998 with respect to the accounts the Bank has to produce, to reflect the change in status of the PRA.

UK financial regulatory and supervisory bodies are financed by way of a levy on the regulated firms. The levy, currently set by the PRA will be determined in future by the PRC. According to the PRA’s 2015 Accounts, “enforcement fines collected in the year of £14m, of which £12.6m is payable to HM Treasury and the remaining £1.4m to fee‑payers. The PRA’s budget for 2016 is £255million.”32

An external auditor will “report on whether the Bank has properly complied with the requirements applying to its power, in its capacity as the PRA, to impose penalties and raise the levy from industry”.33 The latest PRA Report and Accounts can be found here.

Clause 15 transfers property from the PRA company to the Bank as a result of the organisational change of PRA to PRC.

Clause 16 and Schedule 2 make changes needed to the various parts of the Bank of England Act, the Banking Reform Act and FSMA caused by the changes to the governance framework of the Bank contained in Part 1 of this Bill. Although of considerable length it, along with clauses 13, 14, 15, and 17 and Schedules 1 – 3 were agreed to without debate during the Lords’ proceedings.

Clause 17 are savings and transitional provisions relating to Part 1 of the Bill.

32 Prudential Regulation Authority, Annual Report and Account 2015 33 Explanatory Notes

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3. Financial services

3.1 Background The second main theme of the Bill is concerned with aspects of the UK’s financial supervisory and regulatory system.

A significant amount of legislation in this area has been passed since the start of the 2008 financial crisis. Much of this legislation is outlined in another Library note Banking Services: reform and issues which describes the move from crisis legislation – giving the authorities practical means to rescue banks – to the new structure of regulation and new regulatory bodies, via various high profile Commissions and enquiries.

Inevitably, after such a huge wave of primary legislation, much of it introduced quickly in response to events, there has been a general ‘pause’ and review of where we are. The current head of the Financial Conduct Authority (FCA), Tracey McDermott, recently called for a “sustainable model of regulation” that avoids the “‘regulate; de-regulate; repeat’ cycle that has, over my time in regulation, seen us swing from one extreme of approach to another”.34

Much of the debate on this part of the Bill in the Lords touched on the issue of whether the legislative changes had embedded a new culture in the financial services sector: had they gone far enough, or did the regime need to be pulled back?

In the background to the debate was the resignation of the then head of the FCA, allegedly brought about by official displeasure at his perceived anti-City approach, and the cessation of the sector wide investigation into banking culture, has raised the temperature of this particular debate.

This Part of the Bill is significantly changed from when it was introduced in the Lords due to a number of government new clauses introduced on Report.

3.2 The Bill Clause 18: recommendations by the Treasury This clause was one several Government new clauses introduced during the Lords’ Report stage.

Whilst under the founding legislation - the Financial Services and Markets Act 2000 (FSMA) - the regulator is independent of government, government (by statute) still has a role in:

• extending (there have only been extensions) the regulator’s remit (widening of mortgage regulation and consumer credit for example),

• giving the regulator new powers – against financial crime for example, or

34 Speech 2/12/2015

19 The Bank of England and Financial Services Bill [HL]

• amending its statutory objectives – to include competition for example by virtue of the Financial Services Act 2012.

Although independent, the issuance of Treasury ‘remit letters’ as they are described is fairly common. Andrew Bailey speaking in evidence to the Treasury Select Committee noted:

We are reasonably familiar with receiving remit letters in the Bank of England. It started with the MPC; there is now an FPC remit letter and, as you know, there is an exchange of letters between the Governor and the Chancellor, and it is a pretty well-established routine. We take remit letters seriously. It is not something that we would ignore.35

This measure formalises such interactions. At the heart of the measure is a request that the FCA have regard to government economic aims.

On Report in the Lords, the Minister outlined the remit letter’s purpose. He said:

As to the remit letter’s content, the productivity plan outlined that remit letters will provide information on the Government’s economic policy and will make recommendations about aspects of that policy to which the FCA should have regard. The recommendations in the letters will not be binding and will not compromise, modify, or override the FCA statutory objectives in any way; neither will they relate to individual firms or cases.

As to the timing and frequency of the publication of the letters, we are aiming to publish the first FCA remit letters following Royal Assent for the Bank of England and Financial Services Bill, after which they will be published at least once per Parliament. The letters will be used to provide a steer on the Government’s economic strategy over that period, but letters could be sent more frequently if particular issues arise.36

The Explanatory Notes state that recommendations will not relate to ‘individual firms or cases’ though it gives no examples of what they might relate to. For example, would an issue like ‘bankers pay’ be something they would make recommendations on, or would it be something more macro-economic still?

Discussion on the clause as introduced in the Lords can be found here.37

Clause 19: Diversity This clause was a new clause tabled on Report by a Conservative Peer, Lord Naseby and accepted by the Government. It encourages regulators to consider how regulations will affect different business forms. Its aim is to encourage and support organisations such as the mutual or co-operatives. Discussion on the clause as introduced in the Lords can be found here.38

35 Treasury Select Committee Q24 Evidence, 17 November 2015 36 HL Deb 15 December 2015 c2005 37 HL Deb 15 December 2015 c2005 38 HL Deb 15 December 2015 c2007

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3.3 Authorised person’s regime The clauses in this part of the Bill (clauses 20 to 24), were the most contested in the Lords’ debates.

Background One of the least attractive aspects of the financial crisis, from the public’s point of view was that no one at the top of the various banks faced formal punishment from the regulators or courts. Most were, eventually, forced to resign but there appeared to be no way of linking their actions and decisions to the fate of the institutions they had led.

Before the financial crisis, individuals had to meet certain personal standards and there had been elements of personal assessment and fitness required for senior positions, however “individual accountability was often unclear or confused”.39

It was the Financial Services (Banking Reform) Act 2013 (normally referred to as the Banking Reform Act) which introduced new ‘personal responsibility’ rules or Senior Managers Regime.40 This imposed a set or requirements on certain officers in a company where named individuals were responsible for specific functions. Part of this regime was that individuals could be challenged by regulators on charges of misconduct and it would be up to the individual to prove their own innocence. This is called the ‘reverse burden of proof’ and is to be found in Section 66A of FSMA (introduced by S32(2) of the 2013 Act.).

These provisions, and others surrounding the issue of conduct in banking were principally discussed during the Lords stages of that Bill where the provisions were first introduced. A long debate on several aspects of the new senior management regime began here.41 The measures received broad approval from Peers of both sides and the issue of ‘reverse burden of proof’ was barely mentioned.

The new rules (due to come into force by March 201642) differed from the existing rules in the following ways:

A new ‘Senior Managers Regime’ (SMR) for individuals who are subject to regulatory approval, which will require firms to allocate a range of responsibilities to these individuals and to regularly vet their fitness and propriety. This will focus accountability on a narrower number of senior individuals in a firm than the Approved Persons Regime (APR) which it replaced.

A ‘Certification Regime’ which will require relevant firms to assess the fitness and propriety of certain employees who could pose a risk of significant harm to the firm or any of its customers.43

Under the Act, the PRA and FCA can specify a function as a Senior Management Function (SMF). Individuals in such posts will require pre-approval either by the PRA or FCA depending on the specification of 39 FCA/PRA; Strengthening accountability in banking: a new regulatory framework for

individuals; CP 14/13; July 2014 40 Library Papers on the Bill can be found here and, for the committee stage, here. 41 HL Deb 15 10 2013 c386 42 FCA press release/CP15/9 43 FCA/PRA; Strengthening accountability in banking: a new regulatory framework for

individuals; CP 14/13; July 2014

21 The Bank of England and Financial Services Bill [HL]

the post. As part of the pre-approval process firms will be required to include a Statement of Responsibilities concerning the individual. The expectation is that executive committee members (or equivalent), i.e. the layer below the board, would also be within the scope of its regime. As well as board members, a number of other individuals will require approval as Senior Managers. These include:

• heads of key business areas meeting certain quantitative criteria

• individuals in group or parent companies exercising significant influence on the firms’ decision-making, and

• where appropriate, individuals not otherwise approved as Senior Managers but ultimately responsible for important business, control or conduct-focused functions within the firm.44

Below this level of responsibility will come a Certification Regime for jobs that pose a “risk of significant harm to the firm or its customers”. It will be the responsibility of the firm to certify its staff. There is potentially a wide pool of people this applies to due to the ‘harm of customers’ criterion:

• customer-facing roles that are subject to qualification requirements (e.g. financial advisors)

• any individuals who supervise or manage another Certified Person, and

• any other [important] roles under the current Approved Persons Regime not otherwise covered by the SMR, for example benchmark submitters.

Following the FCA/PRA consultation process, the then Economic Secretary to the Treasury, Andrea Leadsom, announced the statutory steps to be taken to implement the changes in a written statement in March 2015. She described the changes as “a major reform with significant implications for the firms concerned—banks, building societies, credit unions and investment firms regulated by the PRA and for the individuals, particularly senior managers, who work in those firms”.45

A further Treasury Paper on changes to the Senior Managers and Certification Regime was published in October 2015.

One feature of the new rules was that individuals would have to prove to the Regulator that they had not broken the rules, rather than the Regulator having to prove wrongdoing. A recurring theme of comments by the regulators when they looked at personal responsibility issues post crisis, was that it had proven to be impossible to prove direct links between individual actions and the failure of the institutions they ran.

44 FCA/PRA; Strengthening accountability in banking: a new regulatory framework for

individuals; CP 14/13; July 2014 45 HCWS336; 3 March 2015

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Note, the rules have not yet come into force and includes small institutions like credit unions in their scope.

The Bill’s proposals and Lords’ Debates The clauses in the Bill do two main things.

• Extend the regime to all financial service providers • Reverse the ‘burden of proof’ requirement.

It was not the extension of the regime which caused such debate in the Lords but the ‘watering down’ of the burden of proof requirements which is brought about by clause 24.

At the same time as the Bill extends aspects of personal responsibility to all financial service providers, it also requires the regulator to prove misconduct rather than under the current system where the individual needs to prove to the regulator that they acted properly.

The main argument for the change is that it would be unfair to require small financial service firms, to have to prove they had done nothing wrong. To make the system fair between all institutions the standard of proof was reduced to the lowest common denominator. The argument against was that it makes the prosecution of individuals at the top of organisations highly unlikely. Actual personal culpability was one of the central recommendations of the Banking Commission.

The proposal to change the burden of proof was seen as backtracking on one of the core recommendations of the Parliamentary Commission on Banking Standards.46 The Government regard it as being a necessary step if the rules were to apply to relatively small financial institutions, though why credit unions were included in the original list of top level organisations is unclear.

On second reading in the Lords, the Minister, Lord Bridges of Headley, outlined why the burden of proof should be reversed:

In the interests of fairness and regulatory coherence, it is vital that the regime is rolled out consistently across the industry. Otherwise, a senior manager in a small building society would become subject to the reverse burden of proof, but one in a large investment firm that did not quite meet the criteria to be PRA-regulated would not. That is not fair, nor is it proportionate. While misconduct by firms of any size can seriously impact on the welfare of consumers or on market integrity, the potential impact is larger in the case of the large investment firm than the small building society.

Secondly, it would clearly not be proportionate to apply the reverse burden of proof across the financial sector, including to the small organisations that will now make up the majority of firms which will come under the regime, and which pose more limited risks to market integrity and consumer outcomes. The reverse burden of proof makes it much harder for such firms to recruit senior managers, since they cannot offset the personal risk attached with high remuneration. This is particularly problematic

46 See Chapter 6: A new framework for individuals

23 The Bank of England and Financial Services Bill [HL]

for credit unions, for example, which provide vital services to vulnerable people.

Our solution is a tough statutory duty for senior managers to take reasonable steps to prevent regulatory breaches in the areas of the firm for which they are responsible, applied consistently across all authorised financial services firms and coupled with the other elements of the regime. This will deliver the intended benefits of the reverse burden of proof in a much more proportionate way. I draw your Lordships’ attention to my phrase “coupled with other elements of the senior managers and certification regime”. It is important that we do not underestimate the step change that the other reforms recommended by the Parliamentary Commission on Banking Standards, and those noble Lords who were part of that, will deliver.

As I pointed out earlier, the SM&CR marks a move to a situation where firms and senior managers must take responsibility for how a firm conducts its business. Crucial among the provisions that deliver this are the statutory statements of responsibility that each senior manager must keep up to date, sign and submit to the regulators, setting out clearly the areas of the firm’s business for which they are responsible.47

In Committee Lord Sharkey had proposed a two tier solution. Big firms would need to prove their innocence, smaller ones not:

[The Government] singled out credit unions as an example of the kind of small firm that would suffer disproportionately under the reverse burden of proof regime, which I remind the Committee has not yet come into force. Here, I entirely agree with the Minister. Credit unions should never have been in the category of relevant authorised persons in the first place and should be removed. However, I disagree with all the other aspects of the Minister’s argument. It entirely ignores the different risk potentials of the major institutions and the about-to-be newly regulated firms, except to say that it would not be fair to impose the stricter regime on the whole sector. It would not be fair, but the stricter regime for relevant authorised persons was made law for all the good and necessary reasons advanced by the Parliamentary Commission on Banking Standards and accepted by Parliament and the Government. These good and necessary reasons, well rehearsed at Second Reading, are still entirely valid. The facts have not changed. The reverse burden of proof is still needed.

In evidence to the Parliamentary Commission on Banking Standards in January 2013, Tracey McDermott, then director of enforcement and financial crime and now acting CEO of the FCA, stated that the inability to impose sanctions on senior executives was first and foremost due to the evidential standard required to prove their liability. She said that,

“the test for taking enforcement action is that we have to be able to establish personal culpability on the part of the individual, which means falling below the standard of reasonableness for someone in their position”.

That regime produced no convictions or charges against senior managers, and that is exactly where we will be again if we scrap the reverse burden of proof for senior managers in banks, building societies and PRA-regulated investment firms. The extension of the regulatory regime to less risky firms requires a

47 HL Deb 26 October 2015 c1081

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lighter touch, but this does not imply that this same lighter touch should apply to much riskier organisations currently subject to the reverse burden of proof regime.48

The Minister’s response to the two tier proposal was that it would introduce unfairness:

Furthermore, the arguments put forward by noble Lords who support a two-tier system are focused on financial stability and the risk that deposit takers and the large investment firms pose to it. However, the reverse burden of proof cannot discriminate between regulatory breaches that threaten financial stability and others. Therefore, its application to deposit takers and not to other firms is arbitrary and would pose serious risks to fair competition within the industry. The risks again would fall mainly on small firms. How easy would it be for a small deposit taker to attract high-quality senior staff in competition with a large insurer or FCA-regulated investment firm where, as well as being able to offer a higher salary, the reverse burden of proof would not apply?49

Cl 20: Extension of relevant authorised person regime to all authorised persons This clause extends the authorised person regime to cover anybody working in an institution which is authorised to carry out regulated activities under the Financial Services and Markets Act 2000.

It is helpful to remember that an authorised person in the regulatory nomenclature can mean a firm not just a human person.

In Committee, the Minister, Lord Bridges of Headley, outlined the totality of the new personal responsibility regime:

Under the current approved persons regime, the regulators can take action only against those individuals whom they pre-approve if they breach one of the statements of principle set out by the regulators—enforceable standards of conduct that apply on an individual level—or if they are knowingly concerned in activity that causes the firm to breach regulations. The range of approved persons covers significant influence functions, such as the chief executive and directors, and customer-dealing functions, such as sales staff. The new SM&CR focuses pre-approval activity much more closely on those at the top of the firm with enhanced powers for the regulators to impose conditions and time limits on these approvals. This is supported by an ongoing requirement for the firm to assess senior managers’ fitness and propriety annually. The regime requires these individuals to have statements of responsibilities to give absolute clarity about who is responsible for which parts of the firm. It will not be as impenetrable as the noble Baroness, Lady Kramer, said. Beneath the senior managers layer is the certification regime. This puts a statutory responsibility for ensuring the fitness and propriety of key staff below senior managers clearly on the firm both at the point of hiring and annually thereafter.

The new regime also enables the regulators to apply enforceable rules of conduct to all employees if the regulators judge that this

48 HL Deb, 11 November 2015, c2016 49 HL Deb 11 November 2015 c2034

25 The Bank of England and Financial Services Bill [HL]

will advance their objectives. For senior managers, this includes a rule on effective and responsible delegation, which addresses the “nothing to do with me” argument that the noble Lord, Lord McFall, eloquently talked about and the noble Lord, Lord Tunnicliffe, mentioned. The rule states:

“You must take reasonable steps to ensure that any delegation of your responsibilities is to an appropriate person and that you oversee the discharge of the delegated responsibility effectively”, as well as requiring them to ensure that the area of the firm for which they are responsible can be controlled effectively.

Overall, this creates an enhanced regime where accountability is stronger and clearer, where firms must take responsibility for ensuring the ongoing fitness and propriety of senior managers and other key staff, and where the regulators are able to hold relevant individuals at all levels to account if they do not uphold proper standards of conduct. Therefore, I reject the allegation that that is going back to an old regime. It is in this context that I ask the House to consider the role of the Government’s proposed duty of responsibility. I have mentioned that currently the regulators can take action against an approved person if they break one of the statements of principle or are knowingly concerned in a breach of regulations. The combination of the statutory duty and the statements of responsibilities I have described adds a significant third limb to the regulators’ existing enforcement powers with regard to senior managers.50

Clause 21: Rules about controlled functions This is a technical clause which was approved without debate in the Lords in Committee.

Controlled functions are part of the approval process for authorisation by the FCA. Examples of controlled functions include:

• being a director of a regulated firm

• overseeing the firm’s systems and controls

• being responsible for compliance with our rules

An individual can hold more than one controlled function, eg, a director can perform the director function and the compliance oversight function. A more detailed list of controlled functions can be found in the FCA Handbook here.

Clause 22: Administration of senior managers regime (SMR) Clause 22 introduces elements of flexibility in the administration of the SMR, both to regulators and the regulated. For example it becomes easier to extend a period of approval or to vary permissions more easily. It applies especially when a person is regulated by both the FCA and the PRA. It was agreed to without debate in Committee.

Clause 23: Rules of conduct The clause extends the power of the two regulators to make rules of conduct to apply to directors and requires the authorised person to

50 HL Deb 11 November 2015 c2033

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make other employees aware of relevant conduct rules that apply to them.

It was paragraph 3(c) of the clause which removes the duty on firms to report to a regulator when they know or suspect someone has failed to comply with conduct rules that prompted debate in the Lords’ Committee stage.

Lord Sharkey thought that the requirement was a “perfectly straightforward, reasonable and clear duty”51 and Baroness Kramer declared herself to be “outraged” that a firm would not be required to report misconduct.52 Defending the measure the Minister, Lord Bridges, said that firms would retain certain responsibilities for reporting misconduct to regulators but that:

the Government believe that a blanket requirement to report all known or suspected breaches of the conduct rules is disproportionate. In particular, an obligation to report suspected breaches is potentially open-ended and wide ranging for it forces firms to work out the point at which possible indications of breaches of rules of conduct would amount to a genuine suspicion.53

More information on this measure can be found in the accompanying Library Note here54 or in Hansard here.

Clause 24: Misconduct This clause includes the measure which provoked such debate in the Lords (at all stages) about the reversal of the burden of proof. More information on this measure can be found in the accompanying Library Note here55 or in Hansard here. An opposition amendment to the clause was defeated by two votes (198-200) in Grand Committee.

As a result of the clause change senior manager of any authorised firm (person) will be guilty of misconduct only if the regulator (FCA or PRA) can prove clause24 2(f) “that they did not take such steps as a person in the senior manager’s position could reasonably be expected to take to avoid the contravention”.

Most examples of misconduct, which can cover a very wide range of acts or omissions, when they result in fines and other disciplinary action are recorded on the FCA fines table. The table lists the name of the authorised person, the types of behavior and the punishment. The fines table for 2015 can be found here.

51 HL Deb 11 November 2015 c2053 52 HL Deb 11 November 2015 c2054 53 HL Deb 11 November 2015 c2055 54 HC Library CBP 7338 55 Ibid

27 The Bank of England and Financial Services Bill [HL]

Clause 25: definition of insolvency for failed institutions purposes One of the Reforms introduced by the Banking Reform Act 2103 was the offence of running the institution in a way that there was a high probability of failure:

at a time when S is a senior manager in relation to a financial institution (“F”), S—

(a) (i)takes, or agrees to the taking of, a decision by or on behalf of F as to the way in which the business of a group institution is to be carried on, or

(ii)fails to take steps that S could take to prevent such a decision being taken,

(b) at the time of the decision, S is aware of a risk that the implementation of the decision may cause the failure of the group institution,

(c) in all the circumstances, S's conduct in relation to the taking of the decision falls far below what could reasonably be expected of a person in S's position, and

(d) the implementation of the decision causes the failure of the group institution.56

As stated above, the Act introduced several new ‘personal responsibility’ rules of which this was one of the most far reaching. This clause, which was approved of without debate in the Lords, explicitly extends the scope of the financial institution to which this measure might apply to include building societies or investment banks.

Clauses 26 & 27: consumer credit The FCA took on responsibility for regulation of the consumer credit industry in April 2014. There is now far greater scrutiny and closer supervision of regulated firms than before as well as wider enforcement powers.

The Government introduced two new clauses at the Lords’ committee stage. They make minor changes to the rules regarding the enforceability of contracts. Introducing the amendments the Minister said:

[clause 26] This amendment makes it clear that a consumer credit agreement may be enforced by anyone who is able to carry on a credit-related regulated activity lawfully under the FSMA. This includes firms that are exempt from the need to have FCA authorisation to carry out these activities either because the firm has an individual exemption or because it is entitled to an exemption as a member of a designated professional body.

[…]

[clause 27] provides that an agreement made by an authorised person carrying on a regulated activity is unenforceable where it is made in consequence of something said or done by a third party in circumstances where that third party should have had, but did not have, permission. In the case of consumer credit and hire agreements, this could potentially cover any credit broker in what

56 Financial Services (Banking Reform) Act 2013 s36 (1)

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could be a long chain of multiple brokers, even if the provider is not aware of the particular third party or their involvement in the transaction.

Both new clauses were approved without debate.

Clause 28: Transformer vehicles This clause was introduced as a new clause in the Lords’ Committee stage and amended on Report. Transformer vehicles are insurance entities designed to assume risks of a specific event. They attract investment and pay dividends to investors. Risks are not pooled as with conventional reinsurance. The Minister, Lord Ashton, outlined the thinking behind the clause:

In an insurance-linked securities transaction, an insurer contracts with an entity specifically established to take on insurance risk. These entities come within the definition of “transformer vehicles” in the amendment. The insurer transfers risk to the transformer vehicle and the vehicle raises collateral to cover that risk by issuing securities to capital market investors. The vehicles exist solely to transform risk into capital market instruments and to compensate the insurer should the insured event take place. Investors receive a return from the premiums paid by the insurer and the collateral is returned to investors if the insured event does not take place. Unlike conventional reinsurers, ILS transactions do not pool risk. The transformer vehicle takes on a specific risk and typically holds collateral that is at least equal to the risk transferred. This key safeguard will be a firm requirement in the UK framework. The framework will ensure that insurers can rely on the protection they arrange through ILS deals.57

The Minster claimed that

In London Matters, a report by the London Market Group on the competitiveness of the London insurance market, the UK’s out-of-date regulatory framework for insurance-linked securities was highlighted as inhibiting London’s ability to compete as a reinsurance hub

The clause defines a ‘transformer vehicle’ but leaves much of the regulation of them to forthcoming secondary legislation by the Treasury (to be approved by the affirmative procedure). The ‘non-exhaustive list’ of matters which the regulations might touch upon indicates that they will be subject to FCA and PRA regulation and supervision and presumably those bodies rules.

Clause 32: Resolution planning One of the main recommendations to emerge from the review of the financial crisis was that the then state of insolvency law was unsuited to the circumstances of bank failure. As a consequence the only practical option was for government to bail them out. Determined not to be in that position again, banks should not be ‘too big to fail’, one strand of the post-crisis response has been new ‘recovery and resolution’ legislation which would enable even a large bank, to fail safely. Part of this was a requirement that a bank has a pre-planned resolution policy –

57 HL Deb 11 November 2015 c2070

29 The Bank of England and Financial Services Bill [HL]

commonly called ‘living wills’. These proposals can be found in the Banking Act 2009.

Another part of the post-crisis reformation of ‘failure’ procedures involved clarification of who did what, which was to be the body responsible for deciding an institution had failed? Which was to be the main administrator of failure? Who paid? The precise roles of the Bank, the Regulator and government were set out more clearly. The legislation gave the Bank various options to either rescue or wind down a failed institution. These options will almost certainly involve public support or guarantees if not actual capital injections.

This clause introduces two new sections which govern the accounting and governance of the commitment of public funds:

New section 57A provides the Treasury with a power to require the Bank to provide the Treasury with specific information identified by the Treasury, and held by the Bank ‐ which the Treasury considers material to understanding the implications for public funds as assessed by the Bank of a bank or other financial institution failing.

And

New section 57B imposes a duty on the Bank to give the Treasury information about some resolution plans it prepares in relation to certain banks and other financial institutions. The ʺresolution planʺ sets out what action the Bank may take if a particular bank fails, and in particular which of the Bankʹs powers under Parts 1 to 3 of the Banking Act 2009 it may exercise in relation to that bank. The information the Bank must give the Treasury includes the resolution plan itself; and an assessment of what impact the failure of the relevant bank or institution would have on the financial system, and what costs the Bankʹs proposals for resolving it would impose on public funds.58

Clause 33 is a technical measure to correct a previous convoluted legislative error. It was explained during the Lords’ proceedings here.59

Clause 34 Banknotes in Scotland and Northern Ireland Alone amongst developed economies, the United Kingdom does not have a unique banknote issuing source. Several banks in Scotland – Bank and Royal Bank of Scotland and Clydesdale Bank can, and the Bank of Ireland, First Trust Bank (previously Allied Irish Bank), Danske Bank (formerly Northern Bank) and Ulster Bank do in Northern Ireland.60

One thing that came out of the banking crisis in 2008 was that there was no statutory protection for non-Bank of England banknotes if the issuing bank became insolvent. Since several of these issuing banks came very close to insolvency in 2008, this lack of protection moved from being a theoretical oddity to a cause of practical concern.

New legislation can be found in part six of the Banking Act 2009 and by the subsequent order – The Scottish and Northern Ireland Banknote

58 Explanatory Notes 59 HL Deb 11 November 2015 c2052 60 Bank of England website

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Regulations 2009.61 The Act abolished the previous authority for bank note issuance and restricted it henceforth to existing issuers. Further, under the Order, the issuers now had to place deposits with the Bank of England as ‘backing assets’. The Bank of England website outlines the arrangements:

To back their note issue, authorised banks may use a combination of Bank of England notes, UK coin and funds in an interest bearing bank account at the Bank of England. Bank of England notes held as backing assets may be held at an authorised location or at the Bank of England. Notes held at the Bank may include £1 million notes (Giants) and £100 million notes (Titans), which in physical terms are permanently held at the Bank. These backing assets would be used in the event that the Bank had to implement a Note Exchange Programme.

Clause 34 amends the legislation further. The general thrust of the new provisions is the same that any new issuer of banknotes would be at the expense of an existing one from the same banking group. Further, the issuer would face the same geographical restriction as the bank it was replacing. The provisions were agreed to without debate in the Lords.

61 SI2009/3056

31 The Bank of England and Financial Services Bill [HL]

4. Pensions guidance and advice

4.1 Background In the past, roughly three-quarters of people with defined contribution (DC) pension savings used them to purchase an annuity.62 This was strongly encouraged by pension tax legislation, which applied a 55% tax charge on lump sum withdrawals, except in limited circumstances. The advantage of annuities is that they provide a guaranteed income throughout retirement. However, in more recent years their popularity declined, in part due to falling annuity rates, but also because of emerging evidence that parts of the market did not work well for consumers.63

In Budget 2014, the Coalition Government announced that from 6 April 2015 it would allow people aged 55 and over more flexibility about when and how to draw their DC pension savings, and allow them to do so at their marginal rate of income tax, rather than the 55% rate. Chancellor of the Exchequer, George Osborne, said that people “should be trusted with their own finances”.64 The relevant changes to pension tax legislation were made in the Taxation of Pensions Act 2014.

Pension Wise Although many welcomed the increased flexibility for DC pension savers, there were concerns that it would place a significant burden of responsibility on individuals, requiring them to make complex decisions, taking account of a mix of longevity, inflation and investment risks, and the implications of any withdrawals for tax purposes, entitlement to means-tested benefits and help with social care.65 The Government recognised that in expanding the range of choices available there was a corresponding need to help consumers navigate these choices, so that they could make good decisions which suited their needs and circumstances.66 It therefore proposed to introduce a new ‘guidance guarantee’, so that from April 2015 “everyone who retires with a defined contribution pension will be offered free and impartial face-to face guidance on their choices at the point of retirement.”67 The then Pensions Minister, Steve Webb, explained that the new service would provide guidance, not advice:

The thing that we are talking about is free to the consumer. There is no charge for it. It is what we call “guidance”, rather than independent financial advice, so it is not formal, detailed, or product-specific; you can go and buy that if you want to, but this

62 HM Treasury, Freedom and choice in pensions, Cm 8835, March 2014; A defined

contribution pension is one in which contributions are made to a fund which is invested and can be used to provide an income at retirement

63 FSCP, Annuities: Time for Regulatory Reform, December 2013; See also Annuities and the annuitisation process: the consumer perspective – A review of the literature and an overview of the market ; FCA, Thematic Review of Annuities, TR 14/2 February 2014, p30

64 HC Deb 19 March 2014 c793 65 See, for example NAPF comments on 2014 budget, 19 March 2014 66 HM Treasury, Freedom and choice in pensions, Cm 8835, March 2014, para 4.7-9 67 HM Treasury, Budget 2014, HC 1104, March 2014

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is familiarising people with the options they have and some of the concepts, even. Most people do not even know what an annuity is. It is getting them up to the starting gate.68

The Government set up Pension Wise to provide guidance to people with DC pension savings approaching retirement.69 The service is delivered by the Pensions Advisory Service (TPAS) (telephone) and Citizens Advice (face-to face) and there is a website.70 To complement this, there is a ‘second line of defence’ in the form of a Financial Conduct Authority (FCA) requirement on firms to ensure that they “give consumers appropriate retirement risk warnings at the point they decided to take a specific action to access their pension savings.”71

In October 2015, the Work and Pensions Select Committee published its report Pension Freedom: guidance and advice. Among other things, it expressed concern about the lack of data on the use being made of ‘pension freedoms’ and Pension Wise.72 In its response, the Government said it was taking steps to better understand the effect of the reforms, including procuring external research and would start to publish data on Pension Wise. The FCA is publishing data on the uptake of the new rules. 73

In October 2015, the Government launched a review of public provision of financial guidance, which is due to report back ahead of Budget 2016 alongside the FCA’s Financial Advice Market Review.74

For more detail, see HC Library Briefing Papers SN06891 Pension flexibilities (November 2015) and SN07042, Pension Wise: the guidance guarantee (November 2015).

Creating a secondary annuity market People who have already purchased an annuity do not currently have the option to exit from that arrangement. At present the purchase of a lifetime annuity is a one-off and generally irreversible one.75 It is a contractual agreement between annuity holder and provider.76

68 HC 1248, 30 April 2014, Q23 and 30 and 41 69 Financial Services and Markets Act 2000, as amended by the Pension Schemes Act

2015, s47 and Sch3 70 HM Treasury, Delivery pensions guidance: January 2015 update, 12 January 2015 71 FCA, Retirement reforms and the guidance guarantee: retirement risk warnings,

February 2015, para 1.6; FCA website, CP15/30 Pension reforms – proposed changes to our rules and guidance, 1 October 2015; For the requirements on trust-based schemes, see HM Treasury, Pension freedom advice and guidance: the Governments response to the first report of the Work and Pensions Committee 2015-16, Cm 9183, December 2015, para 2.15

72 Work and Pensions Committee, Pension Freedom advice and guidance, HC 371, 14 October 2015

73 Work and Pensions Committee, Pension freedom guidance and advice: Financial Conduct Authority Response to the Committee’s First Report of Session 2015-16, HC 716, January 2016, para 2.4; FCA, Retirement income market data: July-September 2015, January 2016

74 Gov.UK, Consultation: public financial guidance 75 FCA, Retirement income market study: Interim Report, Executive Summary. 76 HM Treasury and DWP, Creating a secondary annuity market, Cm 9046, March

2015

33 The Bank of England and Financial Services Bill [HL]

In its last Budget before the 2015 General Election, the Coalition Government proposed allowing people in receipt of an annuity to sell that income to a third party:

1.229 This government has already introduced major reforms to allow people entering retirement much more flexibility over how they use their defined contribution pension pot, instead of being required to purchase an annuity. The government now wants to allow people who have already bought an annuity to also enjoy flexibility in how they access the value of their annuity, without interfering with binding contractual requirements.

1.230 From April 2016, the government will therefore change the tax rules to allow people who are already receiving income from an annuity to sell that income to a third party, subject to agreement from their annuity provider. The proceeds of the sale could then be taken directly or drawn down over a number of years, and would be taxed at their marginal rate, in the same way as those taking their pension after April 2015.77

It launched a consultation on how to implement this. The main reforms would be to:

• Change the tax treatment in relation to annuity holders wishing to realise the value of their annuities. This will include the removal of the “unauthorised payment” tax charge of up to 55% (or even 70%) that deters annuity holders from assigning their annuity. Individuals will, upon agreement with their annuity provider, have the opportunity to assign their annuity to a third party in return for a lump sum. Individuals can take this lump sum directly, or transfer the lump sum to an alternative retirement income product, drawing income down over a number of years and being taxed at their marginal rate.

• Work with the Financial Conduct Authority (FCA) to ensure appropriate consumer protection is in place for annuity holders as they consider their options. This may include the provision of guidance to annuity holders or the requirement to seek advice so they are in a position to consider fully the impact of their decision and ensure they are receiving a competitive price.78

There would be no interference with contractual agreements:

Instead, where annuity providers agree, it allows the annuity holder to access the value of their assets where they can find a willing buyer. The annuity provider would continue to hold the underlying assets and pay the annuity income to the third party for the lifetime of the annuity holder.79

The third party buyer would offer a price to the annuity holder, which would reflect a number of factors “including their estimate of the actuarial value of the annuity, transaction costs and a profit margin.”80

77 HM Treasury, Budget 2015, HC 1093,18 March 2015, paras 1.229-31 78 HM Treasury and DWP, Creating a secondary annuity market, Cm 9046, March

2015 79 Cm 9046, para 1.7 80 Cm 9046

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The Association of British Insurers (ABI) expressed its support in principle but thought there were “considerable challenges in establishing a functioning market and ensuring adequate protection for consumers, especially access to advice and guidance.”81 The Pensions and Lifetime Savings Association expressed concern that the “creation of a secondary market may be so expensive as to greatly reduce the value available to most annuitants”82

In July 2015 the Conservative Government said it would proceed with the proposals but that implementation would be delayed until 2017:

1.229. The government wants existing annuity holders to have the freedom to sell their annuity income. The government will set out plans for a secondary annuities market in the autumn, and agrees with respondents to the recent consultation that implementation should be delayed until 2017 to ensure there is an in-depth package to support consumers in making their decision.83

The decision to delay implementation was welcomed by the ABI and the Pensions and Lifetime Savings Association.84

In December 2015, the Government published its response to the consultation. It would remove the relevant tax restrictions from April 2017, effectively opening up the ‘pension freedoms’ to annuity holders. It said that with more choice, it was “right that there should be appropriate support”:

So the government is expanding Pension Wise to cover all those who hold annuities. For those with an annuity above a certain value, the government will put in place a financial advice requirement to make sure they have the support to make the right decision. The government will work closely with the Financial Conduct Authority (FCA) to consider how this will work in practice. The FCA will also consult on other measures that are designed to both protect consumers and promote competition during 2016.85

Supporting decision making The Government said that for many, continuing to hold an annuity would be the right decision. However, reasons for wanting to assign their annuity to a third party could include: freeing up value where the individual had other retirement income streams sufficient to meet daily needs; providing a lump sum for relatives and dependants or to meet particular needs or goals; responding to changes in circumstances; or being able to purchase a more flexible pension income product

81 ‘ABI sets out what is needed to make secondary annuity market proposals work for

consumers’, 26 June 2015 82 The PLSA was previously the National Association of Pension Funds; ‘Value hard to

find in secondary annuity market’, says NAPF, 18 June 2015; NAPF, Creating a Secondary Annuity Market: a response by the National Association of Pension Funds, June 2015

83 HM Treasury, Summer Budget 2015, 8 July 2015, HC 264, para 1.230 84 Summer Budget 2015: ABI response on pension tax reform and delay to secondary

annuity market timetable, 8 July 2015; NAPF comments on 2015 Summer Budget, 9 July 2015

85 HM Treasury and DWP, Creating a secondary annuity market: response to the call for evidence, December 2015

35 The Bank of England and Financial Services Bill [HL]

instead.86 In coming to a decision to assign their annuity, individuals would need to consider a range of factors including:

[…] their health, their current financial needs, what other income they will receive, their saved wealth and their aspirations for future needs. Individuals will also have to consider dependants’ needs – both now and in the future – and the implications for their own future welfare and social care needs.87

The Government was considering requiring people seeking to assign annuities valued above a set threshold to take financial advice.88 For those to whom this did not apply, guidance might be provided either by extending Pension Wise or through providers.89 A ‘second line of defence’ could also be introduced

[…] as a requirement upon the original annuity provider to protect their customers looking to assign their annuity income to a third party, with annuity providers being required to provide warnings of the risks and factors consumers should be considering when making this decision.90

In December 2015, the Government concluded that any advice requirement should reflect wider advice measures which emerge following the recommendations of the Financial Advice Market Review, which is looking at how financial advice could work better for consumers.91 In the meantime, it would legislate for an advice requirement, the details of which would be in secondary legislation. In addition, it would expand Pension Wise to cover all those who hold annuities and ask the FCA to consider what risk warnings might be appropriate as a second line of defence.92

Consultation issues

In its March 2015 consultation document, the Government said individuals were likely to find it difficult to judge the value of their annuity, for a number of reasons:

• accurate calculation of the net present value of an annuity is relatively complex – and beyond the capability of most consumers if they do not have access to expert help

• many people apply a high effective discount rate; with a strong preference for payment now over future payments

• people consistently underestimate their own predicted life expectancy, leading to the risk that they will have too little saved for future needs. Conversely, people in poor health may feel under pressure to assign their annuity payments in order to pass on money to relatives93

The Government identified two options for helping consumers determine a fair value for their annuity: a requirement for annuity

86 Cm 9046, 87 Cm 9046, para 4.2 88 Ibid 89 Ibid para 4.12 90 Ibid para 4.13 91 FCA, Statement on the Financial Advice Market Review August 2015 92 HM Treasury and DWP, Creating a secondary annuity market: response to the call

for evidence, December 2015, chapter 4 93 Cm 9046

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providers to offer a benchmark selling price; and a requirement for individuals to obtain a number of quotes.94 However, responses to the consultation suggested significant practical difficulties associated with both:

4.17 Broadly, responses to the consultation suggested that placing a requirement on annuity providers to offer a benchmark price would not be appropriate. In particular, industry felt this would place a burden on providers and add costs that would be passed through to prices which purchasers would be able to offer consumers. This would also potentially impose reputational risk on the annuity provider if their benchmark proved too low.

4.18 Responses to the suggestion that individuals should be required to obtain a number of quotes were more varied. Some thought that this would be a good way to ensure that annuity holders find a fair value for their annuity as it would effectively require individuals to shop around. Others disagreed, suggesting that this would be administratively burdensome and could result in extra costs for the consumer because extensive medical underwriting would be required to support each quote to ensure they are realistic.[…]95

Taking these objections into account, the Government concluded that instead, it would work with the FCA to develop an online tool:

4.20 However, on the whole, responses were supportive of some method or tool to help individuals determine a fair value for their annuity. As such, the government will work with the FCA to develop an online tool whereby annuity holders can enter their details and receive an estimated range around what they might expect to receive for their annuity income in the secondary market.96

Another issue would be how to prevent aggressive sales practices. In its report on pension freedoms, for example, the Work and Pensions Committee expressed concern that the reforms had “increased the prospects of people being conned out of their life savings.” It recommended that the Government “redouble its publicity efforts around pension scams.”97

In the context of its proposals for a secondary annuity market, the Government said it was important that promotional material was “clear, fair and not misleading and that people do not feel forced into a decision”. It would also be “important to ensure that the reforms were delivered in a way that prevents and tackles scamming.”98 In its response to the consultation, it said that UK-based purchasers of annuity rights would be regulated by the FCA and therefore subject to its rules and enforcement powers. To protect consumers where the

94 Cm 9046, para 4.16-8 95 HM Treasury and DWP, Creating a secondary annuity market: response to the call

for evidence, December 2015 96 Ibid para 4.20 97 Work and Pensions Committee, Pension freedom and advice, October 2015, para

24-5 98 Cm 9046

37 The Bank of England and Financial Services Bill [HL]

purchaser was based outside the UK, it was considering whether at least one party in every transaction should be FCA authorised.99

The Government also looked at whether people on means-tested benefits should be prevented from assigning their annuity. This was because it did not intend to “compensate individuals through welfare for any loss of income resulting from assigning their annuity to a third party”. 100

Under current rules, changing an income stream for capital could change the level of support an individual was entitled to:

4.24 The means tests for welfare, social care and council tax reductions take into account levels of income and capital. Based on the current rules, where an individual decides to assign their annuity to a third party, thereby exchanging income for capital, this may change the level of support they are entitled to through these mechanisms, and the deprivation of income or capital rules would apply.101

‘Deprivation of income and capital rules’ provide that a household may be treated as possessing income or capital they no longer have if they have been found to have deliberately deprived themselves of that income or capital to gain additional support or benefits.102

In December 2015, the Government said it had decided that people on means-tested benefits or in social care would not be prevented from assigning their annuity. However, clear information on the impact that assigning annuity income could have on entitlement to means-tested benefits or social care support would be essential. Changes to guidance would be needed to make clear how existing rules might apply in relation to people taking advantage of the new secondary market for annuities. The Government would keep the rules under review to ensure that they were operating effectively.103

The consultation paper also pointed out that there would need to be measures to protect the dependants and beneficiaries of annuity holders:

4.19 Many people will hold annuities that contain rights for more than one party to receive an income. Most typically, they include the rights for a dependant to receive an income after the principal holder’s death. This may also include the commuted value of a guarantee period or the continuation of the original annuity for a guaranteed period.

4.20 Beneficiaries of contracts are generally protected by third party rights legislation which restricts the ability of the contracting parties to reduce or sign away their rights without their consent, though this legislation allows parties to “contract out” of these

99 HM Treasury and DWP, Creating a secondary annuity market: response to the call

for evidence, December 2015, para 4.12-3 100 Cm 9046, para 4.27 101 Cm 9046 102 DWP, Decision Makers Guide, para 85408-30; (SI 2002 No. 1792) reg 18; (2006 No. 214), reg 41 103 HM Treasury and DWP, Creating a secondary annuity market: response to the call

for evidence, December 2015

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protections, and in many cases these statutory rights are dis-applied by the terms and conditions of annuity contracts.104

The Government made two suggestions to address this question: to require the written consent of any dependants before rights under an annuity could be assigned; or to prevent the rights of the dependant from being assigned.105 In December 2015, it said it would ask the FCA to consider “whether a requirement could be placed on the annuity provider or other relevant parties to ensure that the dependant or beneficiary of an annuity has consented to its assignment, enforced through FCA rules”. In addition, it was asking the FCA consider challenges including obtaining consent where a dependants or beneficiaries are unnamed and ensuring appropriate protections are in place where former spouses or civil partners have rights following divorce or dissolution. It was also asking the FCA to “consider the potential for putting in place further rules protecting consumers (including dependants and beneficiaries) who show vulnerable characteristics.”106

4.2 The Bill The Bill contains three clauses relating to pension advice and guidance. Other measures needed to create a secondary annuity market, such as changes to pension tax legislation, will be legislated for separately.107

Clause 29: Pensions guidance The remit of Pension Wise was legislated for in the Pension Schemes Act 2015 (s47 and Sch 3). This introduced a new section 333A into the Financial Services and Markets Act 2000 defining ‘pensions guidance’ as:

[…] guidance given for the purpose of helping a member of a pension scheme, or a survivor of a member of a pension scheme, to make decisions about what to do with the flexible benefits that may be provided to the member or survivor.108

Initially, it was intended to cover people aged 55 or over, but in the 2015 Summer Budget, this was extended to those aged 50 and over.109

In its March 2015 consultation, the Government said it was considering whether to legislate to extend the remit of Pension Wise, as a “universal offer” to complement other safeguards, such as a requirement to seek advice, which might only apply above a certain threshold. An alternative could be to allow guidance to be offered through the annuity provider or independent and impartial third parties.110 In December 2015, it reported that the vast majority of respondents to the consultation thought Pension Wise had a role to play, although there was some

104 Cm 9046 105 Cm 9046, para 4.27 para 4.21-22 106 HM Treasury and DWP, Creating a secondary annuity market: response to the call

for evidence, December 2015 107 Ibid, Chapter 6 108 Pension Schemes Act 2015, Sch 3 109 HM Treasury, Summer 2015 Budget, 8 July 2015, HC 264, para 1.227 110 Cm 9046, para 4.12

39 The Bank of England and Financial Services Bill [HL]

differences as to what the service should look like. Respondents who expressed a view on whether guidance could be offered through the annuity provider tended to argue that this would not be impartial enough.”111

A number of responses to the consultation questioned whether guidance alone would be enough in this context. The ABI said a personal recommendation might be needed, which Pension Wise could not provide:

We would expect access to Pension Wise to play a part, but they will only be able to provide generic guidance about the options available, and not a personal recommendation, which may be required for assignment. We agree they will need to be resourced; both in terms of headcount and levels of expertise, to take on new commitments, and that levy will need to be reconsidered to take account of a different group of firms benefiting from the service.112

The Financial Services Consumer Panel did not think guidance was enough in this context:

So how will the government work with the FCA to support people? One answer might be to extend the scope of Pension Wise so that free, impartial advice (and it is advice – not guidance) is provided through this service. This would mean existing Guides being equipped with the same level of knowledge and experience that regulated financial advisers possess in order to assess an individual’s position correctly and provide a recommendation for action. Consumers would also have to have access to redress in the same way they would if they took regulated advice. Guidance with no responsibility and the absence of a clear recommendation – as with the current Pension Wise service – will not do for this decision.113

The Association of Consulting Actuaries agreed:

We agree that expansion of Pension Wise would be a start but doesn’t go far enough, because the issues involved are so complex and require tailored advice – the best Pension Wise could do is highlight the issues and list the questions a member must ask. We certainly agree that risk warnings are a sensible requirement.114

Clause 29115 would provide for the remit of Pension Wise to cover individuals with a “relevant interest in relation to a relevant annuity.” It does this by amending s333A of FSMA, so that the definition of ‘pensions guidance’ is extended to include:

[…] guidance given for the purpose of helping an individual who has a relevant interest in relation to a relevant annuity to make

111 HM Treasury and DWP, Creating a secondary annuity market: response to the call

for evidence, December 2015 para 4.7 112 ABI Response to the HMT/DWP Consultation on the Creation of a Secondary

Annuity Market, June 2015 113 Response by the Financial Services Consumer Panel to the call for evidence on

creating a secondary annuity market, 18 June 2015 114 Association of Consulting Actuaries, Response to consultation on creating a

secondary annuity market, June 2015 115 Clause 24 in the Bill as introduced in the House of Lords (HL Bill 65)

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decisions in connection with transferring or otherwise dealing with the right to payments under that annuity.116

At Report Stage in the Lords, the clause was amended to enable members of pension schemes that had transferred to the Pension Protection Fund (PPF) to obtain guidance from Pension Wise in respect of money purchase benefits. This was necessary because:

[…] the current scope of Pension Wise is only able to provide guidance in respect of flexible benefits to a member, or the survivor of a member, of a pension scheme. The PPF is a compensation fund, not a pension scheme, meaning that individuals whose schemes have transferred to the PPF are not able to obtain guidance from Pension Wise in respect of their money purchase benefits. This is an unintended gap in the provision of guidance.117

The Impact Assessment to the Bill says that the Government expects the additional ongoing costs associated with expanding the Pension Wise service to be passed on to firms through the FCA levy. However, it goes on to say that it is ‘difficult’ to predict the level of costs at this stage as it would depend in part on what the Government decides should qualify as “a relevant annuity and what amounts to a qualifying interest”:

170. There will be additional ongoing costs associated with operating an expanded Pension Wise service. It is expected that ongoing costs will be passed on to firms through the FCA levy. In 2015/16, the levy collected for the Pension Wise service was £39.1m.

171. The key driver for additional ongoing costs will be an increase in the number of consumers accessing the service to obtain information and guidance relevant to the secondary market in annuities. Costs associated with offering guidance to eligible Pension Protection Fund members is estimated to be negligible due to the small numbers affected.

172. In addition, there may be some transitional set-up costs for the expanded service. Set-up costs for Pension Wise have, in the past, been met from public funds.118

(NB. The impact assessment for the current Bill does not cover the expected impact of the tax changes, which will be included in a Tax Information and Impact Note to be published in due course.119)

In debate in the House of Lords, Shadow Work and Pensions Minister, Lord McKenzie of Luton said that while the extension of Pension Wise was “in principle unobjectionable,” it provided an opportunity to reflect on how the pension flexibilities and the guidance service were working in practice. He referred to the concerns expressed by the Work and Pensions Select Committee in its recent report, regarding “the dearth of information on the use being made of the new pension freedoms, and

116 Clause 29 (2) 117 Bank of England and Financial Services Bill Impact Assessment, January 2016, Para

169; HL Deb 15 December 2015 c2042; The Pension Protection Fund was set up under the Pensions Act 2004 to provide compensation to members of defined benefit schemes that wind up underfunded on the insolvency of the employer.

118 Bank of England and Financial Services Bill Impact Assessment, January 2016 119 HM Treasury and DWP, Creating a secondary annuity market: response to the call

for evidence, December 2015, chapter 5

41 The Bank of England and Financial Services Bill [HL]

in particular a near complete lack of data about Pension Wise itself.” He said these should be addressed before “loading the service with further obligations arising from the secondary market.”120 At Committee Stage, Baroness Drake said it would be important for Parliament to understand the nature of the guidance that would be provided in this context.

This is not going to be a proposition without problems. Some people have suggested introducing a requirement to take independent advice but even that is not a simple proposition, not least if a requirement to take advice significantly reduces the value of the transaction to the seller. Lastly, the complexity of a secondary annuity market means it is essential that the pension guidance that is provided is of a high quality, delivered by people with the necessary skills and expertise.121

For more detail on the debates in the House of Lords, see Library Briefing Paper CBP-07338 (January 2016).

Clause 30: Advice requirement People with ‘safeguarded benefits’ (such as defined benefits or some other form of promise or guarantee) who want to transfer them to a scheme able to provide ‘flexible benefits’ are required to take independent advice first.122 The rationale is that safeguarded benefits provide a “particularly valuable and secure retirement benefit that an individual should be informed of before they gave up.”123 The requirement only applies where the value of the safeguarded benefits exceeds £30,000.124 This is discussed in more detail in Library Briefing Paper SN06891 Pension flexibilities (November 2015).

In its consultation on secondary annuities market, the Government said there was a strong case for requiring holders of annuities above a certain value to seek advice from an Independent Financial Advisor before assigning their annuity to a third party, and for requiring annuity providers to check this before they enable the annuity to be assigned:

4.9 Regulated advice would ensure that individuals receive help tailored to their circumstances and a recommendation on whether assigning their annuity to a third party would be in their best interests. People would still be at liberty to choose not to accept a recommendation. 125

However, because regulated advice could be expensive, it might restrict the requirement to people with annuities valued above a certain amount:

4.10 Regulated advice can be expensive, as individuals could have to pay several hundred pounds or more, which might be a

120 HL Deb 26 October 2015 c1069-70 ; Work and Pensions Committee, Pension

freedoms advice and guidance, HC 371, 14 October 2015 121 HL Deb 11 November 2015 c2081 122 Pension Schemes Act 2015, part 4, chapter 2 123 HM Treasury, Pension transfers and early exit charges: a consultation, July 2015,

para 4.3 124 Pension Schemes Act s48 (3); HM Treasury, Freedom and choice in pensions: the

government’s response to consultation, Cm 8901, July 2014, para 4.24; For the debates in Parliament, see SN 7105 Pension Schemes Bill 2014/15 – House of Lords stages (February 2015), pp 29-32

125 HM Treasury and DWP, Creating a secondary annuity market, Cm 9046, March 2015

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significant proportion of the value of their annuity. However, following on from the FCA’s recent clarification of rules around simplified advice and new business models for online and telephone advice, there are new, expanded opportunities for the advice sector to meet the growing demand for advice on pension issues; the government believes that this could be a potential new market for advisors.

4.11 This requirement could be restricted to those looking to assign annuities that are valued above a given threshold (bringing the requirement into line with the conversion from a defined benefit scheme). A means of approximating the value of the annuity in advance of advice would be needed under this approach. Consideration would also need to be given to what support is provided to those with annuities valued below this threshold.126

The Pensions and Lifetime Savings Association supported this approach:

33. There is a rationale for linking this amount to the £30k limit for DB to DC transfers; however this will depend on Government being confident that smaller value annuities are being priced fairly. It could be argued that those with smaller annuities who do not receive advice are at greater risk of being offered an unfair value for their annuity, and may be under greater pressure to realise the capital. They are also more likely to have interaction with the means-tested benefit system, either now or in the future and need to understand the implications of selling their annuity. An alternative might be to set the advice requirement at the small pot level of £10k as annuitants can currently surrender their annuity if it falls below this amount.127

The ABI said an advice requirement was logical and consistent but that there were would be challenges that came with it:

There is a lack of affordable advice and we are aware that many advisers feel unable to service customers with smaller pots seeking help on the new pension freedoms. Regulated advice can be expensive and may outweigh the benefits for a large proportion of annuity-holders. According to ABI statistics, in Q1 2014 the median annuity purchase price was around £20,000, rising from less than £10,000 in 2004. Therefore, while a de minimis threshold would be logical and consistent, it could miss out a potentially significant number of annuity holders with smaller annuity values.

A close look at the effectiveness of similar advice requirements in the broader freedom and choice environment, and the advice market in general, is needed before considering the options here. The advice requirement in relation to safeguarded benefits has led to some frustration among insistent customers who wish to proceed with a transaction after being advised not to do so. Related to this, many advisers choose not to offer this type of advice at all and there is some concern about adviser capacity. It will be difficult for advisers to contradict the Government’s statement that continuing with the existing annuity will be the

126 Ibid 127 PLSA, Creating a Secondary Annuity Market: a response by the National Association

of Pension Funds, June 2015

43 The Bank of England and Financial Services Bill [HL]

right choice for the vast majority of people but that is a reasonable test to pass to protect customers.128

In December 2015, the Government said that any advice requirements would need to reflect the outcome of the Financial Advice Market Review, due to report in March 2016 (although it is unlikely that the recommendations will be fully implemented by April 2017). In the meantime, it would legislate for an advice requirement:

This will ensure that individuals receive help tailored to their circumstances, a recommendation on whether assigning their annuity would be in their best interests and, potentially, assistance in the sales process. The government will set out in secondary legislation who will be required to take financial advice. The government is further considering whether the threshold should also take into account the individual’s wider circumstances.129

Clause 30 would provide for a requirement to take advice for individuals with an annuity of a specified type or value:

153. This clause places a requirement on the FCA to make rules to require certain authorised persons (to be specified in rules made by the FCA) to check that an individual with an annuity of a specified type or value, who is considering transferring or dealing with the income stream from that annuity on the secondary market, has taken appropriate financial advice. The clause includes powers for the Treasury to make secondary legislation:

a. exempting some people from the requirement to take advice;

b. specifying which types of annuities are caught by the advice requirement (by reference to their type, value or otherwise, including by reference to a person's financial circumstances), and

c. specifying what is meant by appropriate advice.130

The threshold will be set in secondary legislation and will be preceded by a detailed impact assessment around the costs of the requirement. The Impact Assessment accompanying the Bill says that “an indicative analysis suggest it will have a total business cost of considerably less than £1m in the first years of the market”. 131

This clause was added to the Bill by a Government amendment at Report Stage on 15 December. Lord Bridges explained that consultation responses showed there was “broad support from both industry and consumer groups for requiring advice above a threshold”. The new clause would therefore:

[…] place an obligation on the Financial Conduct Authority to make rules requiring certain authorised firms to check that advice has been received before annuity holders may sell their annuity income stream. The FCA will determine which businesses will be required to make these checks, what the checks will entail and

128 ABI Response to the HMT/DWP consultation on the Creation of a Secondary Annuity

Market June 2015 129 HM Treasury and DWP, Creating a secondary annuity market: response to the call

for evidence, December 2015, para 4.5-6 130 Bill 120 – EN 131 Bank of England and Financial Services Bill Impact Assessment, January 2016

Number 7476, 28 January 2016 44

when they will be carried out. We expect that the FCA will be consulting on its proposed rules during 2016. 132

The Delegated Powers and Regulatory Reform Committee had recommended that regulations exempting individuals with annuities below a certain value from the advice requirement, should be subject to the affirmative procedure in Parliament. This was because:

The proposed secondary annuities market is novel and as yet untested, and brings with it fresh opportunities for mis-selling, so that effective protection for consumers will be extremely important. We believe that the House will wish to give careful scrutiny to regulations that would in effect reduce the available protection afforded to certain individuals by exempting them from the new checking arrangements.133

The Government is to consult on regulations to be made under the clause in 2016.134

Clause 31: Independent advice: appointed representatives Clause 31 would allow ‘appointed representatives’ to advise on the conversion and transfer of safeguarded benefits. The Explanatory Notes say:

154 This clause makes a technical amendment to Pension Schemes Act 2015 to allow 'appointed representatives' of authorised financial advisers (a class of persons exempt from direct regulation by the FCA or PRA pursuant to section 39 of FSMA) to advise on the conversion and transfer of safeguarded benefits – features of certain pensions, such as defined benefit pensions, and pensions with Guaranteed Annuity Rates – to flexible benefits for the purposes of the 'advice safeguard' established in sections 48 and 51 of the Pension Schemes Act 2015. The clause also amends the Financial Services and Markets Act 2000 (Appointed Representatives) Regulations 2001 to the same end.135

This clause was added to the Bill as a Government amendment at Report Stage in the Lords. Treasury Minister Lord Bridges of Headley explained that the amendment was technical in nature, intended to put “beyond doubt” the eligibility of ‘appointed representatives’ to advise on these transactions:

This amendment is technical in nature and allows appointed representatives of authorised financial advisers to advise on the conversion and transfer of safeguarded benefits, which are the special valuable features of certain pensions, such as defined benefit pensions and pensions with guaranteed annuity rates, for the purposes of the advice safeguard established in Sections 48 and 51 of the Pension Schemes Act 2015.

These amendments to Sections 48 and 51 of the Pension Schemes Act 2015 will amend the definition of “authorised independent

132 HL Deb 15 December 2015 c2045-6 133 Delegated Powers and Regulatory Reform Committee, Sixteenth Report, 11

December 2015 134 HL Deb 15 December 2015 c2045-6 135 Ibid

45 The Bank of England and Financial Services Bill [HL]

adviser” to include appointed representatives. As a result, they will be able to give appropriate independent advice to satisfy the advice safeguard. They will also amend the Financial Services and Markets Act 2000 (Appointed Representatives) Regulations 2001 to the same end. Around two-thirds of financial advisers are appointed representatives who have a special contract to provide services on behalf of their principal, who will be an authorised financial adviser regulated by the FCA. This measure puts the eligibility of appointed representatives to advise on these transactions beyond doubt.

The amendment extends eligibility to advise on these transactions only to the appointed representatives of financial advisers. What this will not do is reduce consumer protections or weaken the accountability of financial advisers, or their appointed representatives. Where an appointed representative advises on these transactions, the directly authorised firm, as the principal, takes full responsibility for the quality of the advice and compliance with FCA rules.136

136 HL Deb 15 December 2015 c2043.

BRIEFING PAPER Number 7476, 28 January 2016

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