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Financial Services Regulation

6.5 p.m.

Lord Desai rose to draw attention to the need for effective and comprehensive regulation of the market for financial products and financial services in the light of recent developments; and to move for Papers.

The noble Lord said: My Lords, perhaps I may at the outset immediately say that my purpose in introducing the Motion is not, as it were, to bash the City of London. I am concerned that the City of London is an efficient part of

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the economy. My purpose today is to ensure that it continues to be efficient and competitive. To that end, we may need a number of changes to be brought forward.

The Motion as set out on the Order Paper could involve many issues. In recent days we have had the paper from the Office of Fair Trading on endowment mortgages. We know the problems about personal pensions and there have been warnings about insurance. Moreover, the Consumers' Association recently stated that the financial advice which people receive is not quite right and that something needs to be done in this respect. No doubt other speakers will deal with various issues, but I shall concentrate entirely on derivatives. I do so especially because the topic of derivatives is much misunderstood. It also raises the very complex issue of regulation and supervision. That is all the more so in the light of the failure of Barings to which I shall return later.

I am also aware that there has been much international discussion about derivatives and what regulatory or co-ordination policies are required in relation to them. In recent years, we have had the Bank for International Settlements, the Group of 30 and the Derivatives Policy Group convened by the SEC in America. Moreover, the US Treasury, the US General Accounting Office and several other bodies have reported on the question of derivatives. There is also a large and growing academic literature on the subject. Last December, the Financial Market Group at the London School of Economics convened a conference on the regulation of the derivatives market. I shall have occasion to say something about that later.

What are derivatives? With your Lordships' indulgence, perhaps I may do a little pedagogic work in that respect. The most interesting thing about derivatives is not that they are new but that the market for them has grown enormously. Derivatives enable us to go one stage further from commodity and stock markets. They basically turn the prospect of changing prices into something which one can buy and sell. Because one can bet on either side of a price which is likely to change, anyone who is worried about the possibility of price changes can hedge against that price change as long as he or she hedges properly. The person can minimise, although never eliminate, the risk of a surprise or of a loss in whatever basic asset is being traded in—be it stocks, bonds, interest rates or whatever.

Basically, what a derivatives market trader does, in a sense and if he or she is sober, is to place an each-way bet. That is what hedging really means. Because one is placing an each-way bet on the outcome of a price change, one always plays both sides of a possibility. The margins of gain on any one particular transaction will be very small. There are no enormous profits to be made on a single transaction in derivatives. Therefore, people have to trade in large volumes; in other words, the transactions are in large volumes. Indeed, we hear of tens of thousands of options being bought or of millions of barrels of oil being traded, and so on. That makes sense because, unless one trades in large volumes, one does not make an appreciable gain for all the work put in.

In a market like that, for every loser there is a winner. However, we are only told when people make a lot of money. We are never told about the people who are losing

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money. Sometimes a false impression is created. Quite a few people are surprised to learn that in relation to the basic market production, the volume of derivatives is seven or eight times—or perhaps four or five times—the size of the product market. The daily activity in oil derivatives is about four times the annual production. That is not surprising in that each person in the market is indulging in at least two transactions at the same time. As his expectations of price movements change, he constantly hedges and adjusts his position. Therefore, it is not surprising that volumes of trade are large. That is due in part to the creative effect of the derivatives market which minimises, or rather divides and shares out the risk.

We have to be careful as regards taking a superficial view of the derivatives market. It is not really a case of the Gnomes of Zurich or anything like that. The people who are involved in that market are all professionals. They either represent corporations, institutions or, on the dealers' side, they represent banks or securities firms. The ordinary punter does not become involved in the derivatives markets. When we discuss the problem of regulation, we are really considering the welfare of the financial system as such, or the prospect of large banks going bust, rather than individuals losing their money.

However, it must be said that the volume of transactions in this market is large and has grown quite a bit. In 1989 it amounted to 7 trillion dollars and by 1992 it had grown to 18 trillion dollars. Today it is somewhere in the region of 30 trillion dollars. Why should derivatives cause us problems? Quite a few people think that derivatives may cause volatility and thereby harm the financial system. I wish to quote from the evidence given to the Treasury and Civil Service Committee in another place by my colleague John Board and three others. The evidence stated:


    "The overwhelming evidence (including that for the UK) is that derivatives markets are not destabilising, either in theory or in practice. In particular, the evidence is not consistent with the view that derivatives cause undue volatility in the underlying spot market".

Why is there a great fuss being made about derivatives? I believe that in a sense people make a fuss about derivatives not because they are worried about individual losses but because they believe there may be what is called systemic risk, and that the failure of one bank through overtrading may spread to other banks and interrupt transactions and that may cause problems. When Barings collapsed the Bank of England took the view—as it turned out, quite correctly —that there was no systemic risk involved. However, one must consider the Barings case with care because the reason Barings collapsed had nothing to do with the volatility in the derivatives market. The collapse was caused by someone doing something that was surprisingly unprofessional. The trader in question took an unhedged position—he did not take a two-way bet, but a one-way bet—to the extent of 7 billion dollars. That was one of the largest transactions, by a margin of several multiples, transacted on the Osaka and Singapore markets.

What the Barings case tells us is that we have to rethink how banks conduct themselves as regards derivatives trading. There is clearly a failure of internal controls within banks. A parallel could be drawn with the way that children and adults react to computers. Children take to computers immediately; they have absolutely no

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problems with them. However, adults react to computers gingerly—they are too afraid to ask questions. I believe the same thing has happened in banks. The top managers of banks do not quite understand what these young people are playing at in the derivatives market but they are too afraid to ask. If a trader says he is going to do something, the manager may say, "Go ahead, as long as you make money we do not mind".

After the revelation of the crisis at Barings, Mr. Peter Baring gave an interview to the Financial Times. That interview showed that there was a clear lack of understanding as regards what had happened and the nature of the market in which large losses were occurring. There is also the question of whether Barings had sufficient capital to cover the losses. Therefore one might ask whether banks and securities firms of a certain size should be allowed to trade in derivatives. How should we consider this question of having sufficient capital?

Often banks and securities firms hold positions in derivatives but they may not know what risk they are taking. An internal risk measurement for a bank or an institution is a newfangled thing. Techniques to measure these risks are being developed and while some are now available we do not know whether Barings had access to them. Should it not be made a rule that we ensure that institutions and banks have some internal risk measurements and that these should be transparently known, while protecting the confidentiality of operations?

The Barings case illustrated the fact that the incentive structure in this market is completely perverse. If a trader makes a large profit, he receives a big bonus. If he does not make a large profit, he is fired. However, if one stands to receive a bonus of £1 million and one risks being fired from a job with a salary of £30,000, only, in that case, to be re-engaged by another bank, there is great incentive to take risks. I do not know what one can do about that, but it is a matter that is bound to be referred to today.

I now wish to mention another rather interesting case whereby a German company, Metallgesellschaft, got into problems because, although it was acting in a professional manner, it was surprised by market movements. That company made a big loss and again it was because the top management of the German head office did not understand what its American affiliate had done. The American accounting procedures showed that the affiliate was making a profit while the German accounting procedures showed that it was making a loss. Clearly there is a lack of co-ordination in accounting practices which is causing a great problem in what is essentially a global market.

Although there may not be a systemic risk to banks from the derivatives trade, large clearing banks, especially banks which are large retail deposit takers, and in whom ordinary punters must place their trust, should be subject to some ring-fencing as regards their derivatives activities. They should have explicit, separate companies for derivatives trading. The profits can be channelled into a holding company. I do not believe that the banks themselves should indulge in derivatives trading because if a large clearing bank was to go bust, that would cause many problems. It was quite correct for the Bank of England not to act as lender of last resort in the Barings

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case. However, there is a question mark over why the Bank of England, in its supervisory capacity, did not know that these problems were going to arise. Clearly, the information requirements or the staff in the Bank of England are insufficient to perform these tasks in what is now an increasingly sophisticated and global market.

Therefore, I wish to raise one issue although I have not given the Minister notice of it. Should we not now be thinking about a separation of the supervision activities and other monetary policy activities of the central bank? We are unique in this country in having a central bank which performs both those functions. The time has now come to consider the question. If in future we move to an autonomous central bank it will be doubly necessary to make sure that the supervision aspect of central banking is publicly accountable and answerable to Parliament, although monetary policy activities may not be. My Lords, I beg to move for Papers.

6.20 p.m.

Lord Blaker: My Lords, the noble Lord, Lord Desai, whom I congratulate on initiating the debate, said that its scope was wide. He was right about that, and I do not propose to follow him into the subject of derivatives. Nor would I shed very much light for the House were I to do so. I propose to speak about pension transfers and opt-outs. I have to declare an interest as chairman of a small company of independent financial advisers. The company does not rely on commission but takes fees. It specialises in giving investment advice.

As noble Lords know, there is great concern about what are believed to be a very large number of examples of mis-selling of personal pensions. I have no wish to underplay the size of the problem, but I believe that there is a genuine question about how big the problem really is.

As noble Lords will recall, the problem goes back to the KPMG report published at the end of 1993, which received great publicity and was generally understood to have judged that there were hundreds of thousands of cases of mis-selling of pension transfers. Those were cases of people who had left the employment of a company in which they had been entitled to a company pension and had transferred their money from the company pension to a personal pension. As I recall, the Securities and Investments Board estimated that of the cases surveyed over 90 per cent. had involved non-compliant advice.

However, on examination it became clear that the KPMG survey had not looked into the substance of each case but had merely examined the paperwork to see whether the appropriate forms had been properly filled in. The question of whether the investor had been well or badly advised was not examined. Indeed, Mr. Godfrey Jillings, the former chief executive of FIMBRA, believed that only 3 per cent. of the investors concerned would be found to have received bad advice. What is more, he has said publicly more than once that when FIMBRA was asked by the Securities and Investments Board to provide a selection of files for the KPMG team to examine it was asked expressly to provide not a random selection of files but a selection of bad cases.

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That casts serious doubt on the SIB's estimate that over 90 per cent. of cases involve bad advice. Therefore, as the PIA will confirm, no one knows how many cases of bad advice there have been. It may turn out—and I hope it does—that the figure is a good deal less than the 90 per cent. which the SIB has mentioned.

A similar situation exists in connection with opt-outs—cases where people have opted out of a company pension scheme while remaining employed by the company. There must be some doubt on whether there have been 387,000 opt-outs, as the SIB suggests, since someone applying for a personal pension during the relevant years did not have to say whether he or she was choosing to leave a company pension arrangement. It is not, therefore, clear to me how the SIB's estimate has been made.

I have a number of questions to put to the Minister. First, how can it be possible by taking a snapshot now of the present situation to make a sure judgment on whether or not the advice which an investor has been given to transfer or opt out of a company pension scheme has been good advice? The stock market is down from its peak; therefore the investor's pension fund is down in value. Interest rates are low, so it takes more to buy a pension than it does when interest rates are high. What is certain is that the level of the stock market and interest rates will be quite different in 10 or 20 years' time when the investor's pension comes to be bought.

Surely the only time when one can make a certain judgment of the validity of the advice given is at the point when the pension is bought. What is the position of the adviser who is obliged to pay compensation to the investor on the basis of today's circumstances and who then finds when the investor buys his pension that the advice given was sound after all? Indeed, what is the position of the investor in that situation? If he has been put back into an occupational pension scheme he may find in the end that he is worse off.

I shall be asked whether I am suggesting that one should have to wait 10 or 20 years to see whether the advice was bad. The adviser may well have gone out of business by then. I can see that there may be cases in which it may be possible to make a fair judgment now but in many cases it will not. I suggest that consideration should be given to bringing in a policy fee or product levy, which would be a small fee added to the cost of a pension or life assurance product, which would go towards providing a fund out of which future compensation should be paid. Such a suggestion is not far-fetched; it has been made by Miss Colette Bowe, the chief executive of the Personal Investments Authority.

My next question is this. The SIB and PIA require that independent financial advisers take the initiative in contacting their clients in order to re-examine the arrangements for them to transfer or opt out of their company pension schemes. The independent financial advisers are required by the PIA to have professional indemnity insurance, but the insurers are advising the independent financial advisers that if they take the initiative, as required by the regulators, it will invalidate their professional indemnity insurance. That, of course, would be bad for the investor, among others.

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The PIA says that in such a case the independent financial adviser can place the case in the hands of the PIA's pensions unit and that will avoid the problem. But will it avoid the problem? Will not the insurers still claim that for the independent financial adviser to act in that way will still invalidate the insurance? And would that not leave the independent financial adviser unprotected unless he were to go to the expense of suing the insurer? If he successfully sued the insurer, could not the insurer on the next renewal of the policy simply alter the policy wording to suit himself?

Would not the simplest solution, and a fair one, instead of requiring the advisers to contact every client, be to conduct a countrywide advertising campaign to alert the public to the fact that if they have any doubts about the wisdom of the advice they have received about their pension transfer or opt-out they should contact their adviser? That would not invalidate the professional indemnity insurance.

I have one further suggestion. It concerns the cost of reinstatement to occupational pension schemes. The guidelines issued by the SIB included a recommendation that, where possible, those who have suffered financial loss from transferring or opting out of an occupational scheme should be reinstated into the scheme. Reinstatement will require the payment of a lump sum into the scheme which will be calculated by the scheme actuary.

A report commissioned by consulting actuaries on behalf of insurance companies was sent to to the PIA in January this year and suggests that advisers may face reinstatement costs of up to 10 times the original sum transferred from occupational schemes. I shall give your Lordships two examples. The first is the case of a teacher who was given a transfer value of £22,000 when he opted out. Fifteen months later the reinstatement cost was £84,000. Secondly, a staff nurse was given a transfer value of £5,000; two years later the reinstatement cost was quoted as £53,000. Those are absolutely staggering differences. Since those two cases concern a teacher and a nurse, presumably those two calculations would have been made by the Government Actuary, so the Government have a responsibility.

In some cases there may be particular reasons for the differences. But one suspects that one of the reasons is that the actuaries used different criteria for reimbursement than those that they used to assess the sum for transfer out. Thus, they are using a calculation of the likely increase in earnings instead of the likely increase in the retail prices index; and they are taking account of discretionary benefits whereas no account was taken of those in assessing values for transfer out. In any event, it looks as though the difference between the transfer-out value and the transfer-in value is wholly unjust.

The PIA, in answer to this problem, said that where the adviser considers the transfer in value unreasonable he can, as an alternative, top up the personal pension. But since he would still need to use an actuary to assess the amount of the top-up, the problem might still exist. My suggestion is that the PIA could lay down a rule that the actuary should use the same criteria in assessing the amount of the payment-in as were used in assessing the payment-out.

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I have put some points which are of concern to the IFAs and to life assurers. They are serious points and they deserve to be answered. The IFAs and life assurers have no wish to escape their legitimate responsibilities. All they ask is fairness from the Government and the regulators. No one knows the size of the problem. Certainly the regulators do not know it.

There have been such widespread scare stories that the business of the life assurers has suffered a severe drop in the past 18 months. That is not good for the country. It means that many people who should in their own interest have life assurance do not have it. It means that national savings are down, and this at a time when I understand the Government have set up a committee to consider how to increase national savings. The Government played a major role in the promotion of personal pensions. I urge them to pay attention to the points I have made.

6.32 p.m.

Lord Barnett: My Lords, I, too, congratulate my noble friend Lord Desai on introducing this debate. I should like to have followed the noble Lord, Lord Blaker, on the issue that he raised. It is very important. However, I propose, like my noble friend, to concentrate on the issue of derivatives. It has been, and is presently, a major issue. I do not propose to concentrate on Nick Leeson or even Barings, although Barings will feature in my remarks. The action—or rather lack of action—by the Barings board is clearly relevant to what I have to say. It is hard to believe that the Nick Leeson affair was as unique as the Governor of the Bank of England told the Chancellor, and through him the House of Lords and House of Commons. Given the Governor's lack of knowledge—after all, we are told that he heard about the affair only on 24th February, and the House was told on the 27th; I shall say a little more about that in a moment—it is difficult to know how he could have known that it was unique. I hope that he is right in stating that it is unique. But it is difficult to see how he could have known that.

The real issue is how we can protect the public. In the case of Barings, I know some major institutions which very nearly lost a great deal of money because they invested in Barings on the best possible advice of major trustees who thought it was a wonderful bank. In practice it turned out to be something different. There are still people who lost a great deal of money in Barings. I hope that they will take the appropriate action against those involved.

Many companies can lose money. I declare an interest: I have lost money on share investments that I have made where the companies have not done too well. Fortunately, more recently they have begun to do well again. But that has had nothing to do with derivatives. At least, I do not think that it had anything to do with derivatives. One can hardly be certain. There was a small piece in the Financial Times on Monday which stated:


    "The Accounting Standards Board, the UK financial reporting body, has been criticised for not producing guidance on accounting for derivatives."

There are very few firms which report on how much they have lost—or made, for that matter—on derivatives. In the case of Barings it is quite clear, at least to me, that one of the reasons that the bank stayed with Nick Leeson was

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that he made the bank a lot of money last year. I should therefore like to know from the Government what they propose to do about ensuring that companies make greater disclosure on derivatives in their annual report and accounts, if not half-yearly report and accounts.

One could mention many other companies, including insurance companies, as the noble Lord, Lord Blaker, did. Today, however, I want to concern myself mainly with banks. My noble friend Lord Desai gave one definition of derivatives. There are others. C. J. Woelfel, in The Dictionary of Banking, describes derivatives as,


    "Financial instruments that derive their value from the performance of assets, interest, currency exchange rates",

and so on. There are other definitions in the Dictionary of Money and Finance which go to considerable extremes. For instance,


    "Many bonds with commodity linked payments have been issued. One ski resort tied its bonds' payments to the reported snowfall".

In another case,


    "A Salt Lake City bank issued a certificate of deposit whose interest rate was linked to a number of victories by the local Utah jazz basketball team".

It might have been better if Nick Leeson had done that! But certainly, there are some very strange extreme cases of derivatives.

I have quoted some examples. But, as my noble friend said, they do not all involve risky gambles. They can be important hedges or attempts to minimise costs. For instance, if you buy or sell abroad in foreign currencies, it is perfectly reasonable to hedge against them. There is nothing at all wrong with that. As was stated in the House of Commons on 13th March not all derivatives are risky gambles. But in a Written Answer it was stated that the Government are reviewing the situation and proposing follow-up action. I should be very interested to know what action the Government propose to take in this matter. So far as I know, they have not done anything, and we are constantly told that the matter is being investigated and that we shall hear in due course. That is not satisfactory, and I hope that we shall hear rather more about it.

We were also told in the Written Answer on 13th March (holding an answer on 9th March):


    "Provided they have adequate controls over their use, insurance companies may prudently use derivatives".—[Official Report, Commons; col. 395.]

The relevant word is "prudently". The plain fact is that in the case of Barings it did not prudently invest. It was the very lack of prudence that ensured that there were problems. So again, what action do the Government propose to take?

We were also told in the other place on 13th March by the Treasury Minister, Mr. Nelson, that there was a meeting way back on 22nd April 1994. He said that it was a trilateral meeting—I assume that that means that three people were involved, a Japanese, a United Kingdom representative and one from the United States.


    "It was agreed to co-operate on a trilateral basis in further study".—[Official Report, Commons, 13/3/95; col. 359.]

What was that further study? It was rather a long time ago. It is over a year ago. What have the Government done about that? I shall be very interested to know, as I am sure will this House.

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The real question is: who controls ordinary clearing banks? As my noble friend Lord Desai said, Barings was a small merchant bank, albeit with a very high reputation and a name that led people to have confidence in it.

I must quote from an interview that the Governor of the Bank of England gave to William Keegan in July last year. I quote him exactly:


    "We now have an expert team monitoring derivatives who are getting even better every time they go in to see a firm. What they are reporting back from the most active players in the market is very reassuring. These people know what they are doing, whether it's at director level or the chaps on the desk".

That was in July last year. Yet in February this year we had the Barings case. The Governor of the Bank of England tells us that he knew all about it and it was unique. It is incredible that the Governor should have told us that. He said, "I don't want to be complacent", and yet he made that statement to a serious journalist from the Observer. When the Governor said in that context that the Bank was carrying out a serious monitoring job, I should be interested to know what was the job. Maybe someone told the Government; maybe they did not. I assume that the Government were interested to know what was the monitoring. In the Barings case, we heard and read—and I am naive in such matters, I assume it to be true—that large sums of money had been sent out to Singapore. It is hard to believe that the directors of Barings did not know about that.

When the Statement was made in your Lordships' House, I said that I found it incomprehensible that the directors did not know. I find it even more incomprehensible now. So what were the Bank of England's directors doing at that time about monitoring? Clearly, they could not simply rely on the completion of forms by the bank's directors because the forms could be falsified and all kinds of things. We are told how serious and reliable the monitoring was. What were the directors doing?

I make it quite clear that I know and like Eddie George. He is a lovely man. But someone has responsibility for it all. It is no use talking about the Board of Supervision; the Governor of the Bank was its chairman. What on earth was he doing to allow matters to continue? It seems to me that a resignation would not be entirely unjustified in those circumstances when we hear what the Governor of the Bank of England said in July, 1994, and what he did in February, 1994—that is nothing—when he allowed Barings to go bust. We know that it did not go bust because ING took it over and saved most of the investors—not all, quite a number lost many millions in Barings. I leave it to them to decide what action to take. I know what I would do if I had invested in it.

Apparently the Bank had previously issued a long list of notices to various banks. I shall not read them all out because the list is too long. In April 1983 a notice was issued on connected lending; accounts; large exposures; fraudulent invitations and floating charges. Another notice was way back in December 1990: implementation in the United Kingdom of the directive on own funds. Then again in December 1990 there was a notice on implementation in the United Kingdom of the solvency ratio directive. How was that followed up? It is a long time ago and nothing appears to have been done.

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In October 1993, a notice was issued on the implementation in the UK of the directive on the monitoring and control of large exposures of credit institutions. What was done about that? After the event, in March 1995, there was a further amendment to the 1990 paper on implementation in the UK of the solvency ratio directive. In April 1995, there was a notice on the implementation in the UK of the capital adequacy directive.

It all sounds good. However, on 6th March, in a Written Answer to a parliamentary Question (at col. 75 of Hansard in the other place) we were told by Mr. Nelson for the Government that there are no further plans in hand. However, there is a European Union-wide rule on the capital which must be held against market risks. Perhaps the Minister would tell us whether he is happy with that European Union-wide rule. Meanwhile, all we are told is that we are waiting for the analysis of the investigation. That is far too slow to prevent further Barings-type events happening. I hope that we shall hear tonight from the Minister that speedier action will be taken.

6.45 p.m.

Viscount St. Davids: My Lords, I have to declare an interest in the subject of today's debate as a non-executive director of a securities house. I believe that the subject raised by the noble Lord, Lord Desai, should be debated in the context not only of the financial services market but also in the context of the regulatory system governing the operation of financial markets. That is because the former, which is the retail market, is the product of the latter, which is a wholesale market.

The financial services market, ever ingenious, is constantly inventing new products to meet the demands of savers. Those products are sold under the surveillance of a multiplicity of self-regulatory organisations. But however they differ, the products have their major objective in common: the provision of a constant or increasing store of value which is ultimately taken as a stream of income or a capital sum. Financial markets, on the other hand, trade stores of value and their derivatives. Regulation of both markets must ensure honesty, transparency and the provision of value. While the wholesale market trades between professionals and permits a high degree of caveat emptor, the retail market needs a regulatory system which protects the consumer.

What has brought about the need for deeper levels of regulation in both those markets? There can be little doubt that the globalisation of markets, and with it the vast increase in volumes, has done much to change the nature of the market-place itself. The public's confidence in the financial market-place is daily shaken by reports in the press of vast sums paid to many of those employed in both financial markets. In the wholesale market, this needs to be of little concern, for it is a global professional market and its reward system does not impact on the retail product. Any excess of reward will be offset by competition.

The retail market is another matter and it is a major area in which SROs have failed. Charges made for the purchase of the financial product must be transparent. My own firm rebates all front-end charges to the client, then

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charges the client its standard rate of commission. This practice ensures that there can be no pressure on its staff to recommend products with high initial charges. I understand that we are not alone in following that policy and I know a number of other practitioners—and that includes accountants and insurance brokers—who follow it. It should become standard.

Another area which gives the public cause for concern is training. When one reads in the press of mis-selling, one must ask: what was the seller trained to do? What level of knowledge did the salesman have, not only of the product but other competitive products? It is not in the nature of SROs to train up to a common high standard. I have spent some 35 years in the City and I am convinced that much of the blame for the misuse of the reward system and mis-selling lies with the concept of SROs. They worked well before 1986, but then the financial world changed, for the deregulation of the London Stock Exchange had a knock-on effect throughout the financial services industry.

The regulation of the financial markets must be considered, however, in both the domestic and international context. A government cannot legislate for another country's government, so how do we operate an international standard? As recent events may show, high volumes of business will gravitate to the market-place where the lowest standards of regulation prevail. Our Government must not be drawn into placing our financial institutions at a competitive disadvantage in the international market-place by over regulation; but rather turn their attention to the development of reporting systems that ensure that the national entity of the institution maintains its financial integrity. The Government's problem is that they have a responsibility to protect depositors and creditors, but only the real power to maintain a regulatory system in domestic markets. The regulation of international market-places awaits an international solution.

The issue raised by the noble Lord, Lord Desai, concerns the regulation of all financial products that are sold to members of the public. It is in that area that the regulatory system has all too often failed. For regulation to work, it must have not only the confidence of the consumer but also the confidence of the practitioner in the financial products sector.

It is all well and good for us to be gathered here today in your Lordships' House debating these issues. We know the difference between a derivative, a unit trust, a pension plan and any other financial product; but out there in the world in which those products are being sold it is a very different matter. Further confusion is added when one reads on a letterhead "Member of IMRO", or SFA, or any one of a multitude of SROs and often more than one. SROs were established to ascertain by their rules, inspections and investigations whether member petitioners were fit and proper persons and firms to continue in business. They were not intended to carry out a quasi-judicial function to the extent that they have now established, in a role which increasingly denies the protection of the law to the practitioner.

For instance, once an SRO imposes a notice of investigation, the member has to co-operate with it and any information gained by the SRO in disciplinary

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procedures can be discovered in any civil proceedings which may be running in parallel with the SRO investigation or following it, thus placing the member in double jeopardy. In the majority of cases there is no suggestion of dishonesty. The wide publicity that SROs seek upon the results of disciplinary proceedings, since they appear to thirst for a justification for being seen to do their job, again tells against a member in any civil action. The SROs are losing the support of practitioners because of that and many other issues. The question is whether a system can work which is not transparently fair to both sides. The answer must be no.

The financial services industry is an area in which the Government, of whatever political party, must have an interest. The industry is a major provider of employment and creates close to 20 per cent. of GDP. Both major political parties recognise the problems of an ageing population and the implications for the nation's balance sheet, yet the regulation necessary for gaining public confidence is missing. Every time the Government are offered the opportunity to improve the system, they walk away from it. The recent OFT investigation into the mortgage industry is typical. Instead of a savage indictment for the mis-selling of endowment products, there has been a feeble response with all the seriousness of that great British institution the "Carry On" film.

The last sentence of the Financial Times editorial for 20th April sums it up:


    "Self-regulation is inadequate; only legislation will change behaviour".

It is now all too obvious that self-regulation does not work. The sooner that we move to a statutory system, the better. I do not advocate that we should replicate the United States SEC, for we have a different culture and tradition. The SIB in an expanded role, with some amendment to the Financial Services Act 1986, would do much to correct the situation. I am not sure where accountable responsibility should lie. Instinct takes me towards the Treasury for retail services and to the Bank of England for the wholesale sector, but not toward the DTI. What is certain is that responsibility should not be split, because that is where, in part, we have come from.

My own views on these matters mirror very closely those expressed in a recent speech by Mr. Alistair Darling, the Opposition spokesman for the City. Those views are not yet held by a majority in the City, but they gain ground daily.

In conclusion, if we expect our fellow citizens to make provision for their old age, to save and play a part in the financial economy, proper regulation is necessary. So, too, is an education system which starts at an early age to inform and instruct our fellow citizens in financial matters. But that is a debate for another day.

6.54 p.m.

Lord Haskel: My Lords, from the speeches that we have heard it is obvious that the Government are in a bit of a mess over regulating the financial markets. Regulation is about moderation. But when it comes to money, the Government's moderation seems to be in short supply. The absence of moderation in financial

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services leads to abuse; and abusing a good idea ruins it. Executive share options, endowment mortgages, pensions and other forms of savings are good ideas. By allowing those good ideas to be abused, the Government have disturbed the delicate balance between regulation and market incentives. People have become wary of the products. The noble Lord, Lord Blaker, told us about that.

That puts the Government in a bind. They say that they want to encourage thrift, savings, home ownership and planning for old age, but the excesses have made people wary. Currently, the Government are in dogmatic deregulation mode and they are not quite sure what to do. In addition, many of the excesses, such as the mis-selling of private pensions, were encouraged by the Government. So, again, the Government are a victim of their own excesses and mismanagement.

We should, therefore, all be grateful to my noble friend Lord Desai for having introduced this debate about the need for better regulation of financial products. Despite the excesses, the products are needed. The market for financial products and services has many sectors. An important distinction is between the wholesale end of the market, which deals with relations between institutions and about which my noble friend Lord Desai spoke, and the retail end of the market, which deals with relations between institutions and individual customers. I should like to speak about the retail end of the market.

The noble Viscount, Lord St. Davids, told us that the principle of caveat emptor can apply to the wholesale end of the market, where institutions are dealing with each other, because they have equal knowledge. However, that will not apply, for example, to a man or woman who wants to buy a life policy from an insurance company, because there is manifestly unequal knowledge. This is where it is important to have sufficient regulation to maintain public confidence, while avoiding too much regulation, which means that we lose sight of what we are trying to achieve and innovation is stifled.

The purpose of the regulation is not only to create fairness but also to promote high standards and integrity at all levels. That will give people confidence to deal with the institutions. High standards of integrity and management will also produce world class financial services companies and those are the firms that London needs to maintain. Better regulation is needed now because the situation is becoming more complex. The nature of financial services companies is changing. There is a blurring of the distinction between different types of institutions. Building societies are becoming banks; banks are setting up life assurance companies, which sell policies to their own customers and to others; building societies are doing the same; and both banks and building societies are competing with each other and investing in each other. In addition, there is a thriving independent financial adviser sector and its relationships with the banks and building societies are also changing.

To add to those complications, there is a growing number of directives coming from Brussels which speak of a European financial industry. Those directives set out a general framework for investment services as required for the single market, which means that financial companies can trade anywhere within the European Union. There are also directives which set out the

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framework within which the supervisory authorities will co-operate with each other, including a harmonised set of reporting rules. Our regulatory system, then, has to be operated Europe-wide and maintain public confidence.

My conclusion is the same as that of the noble Viscount, Lord St. Davids; namely, that it is a task too great for self-regulation. It calls for world class statutory regulation. The public now believe that self-regulation equals self-interest, which equals a lowering of standards. Self-regulation Europe-wide would be impossible. The reason self-regulation will have to go is that it is very difficult to serve two masters—the public interest and the trade interest. The self-regulating organisations are membership organisations and their obligation is to their members. I know that they make valiant efforts to maintain standards, but it is a simple fact that self-regulation is really a fiction. The public are not convinced that if something goes wrong, self-regulation will produce an impartial view.

The payment of compensation illustrates that. The SIB decreed that there will be compensation from the mis-selling of pensions, as the noble Lord, Lord Blaker, told us. He may question the number of cases, but there is no doubt that compensation is disputed by the independent financial advisers. The compensation over the mis-selling of home income plans in the late 1980s depends on whether one's independent financial adviser was regulated by FIMBRA, by LAUTRO or by an insurance company, in which case one would go to the insurance ombudsman. As might be expected, the ombudsman takes a much more generous view regarding those claims. The OFT said that there has been mis-selling of endowment mortgages, yet compensation is uncertain. The PIA is not yet in full operation and compensation in its sphere of influence is unclear.

Confidence in the integrity of the financial services industry is essential if people are to be encouraged to do business with it. That will only come where statutory regulation replaces self-regulation. People should be encouraged to make provision for themselves over and above the basic state pension. People should be encouraged to buy their own homes. People should be encouraged to insure themselves against misfortune affecting their income. Therefore I believe that we need a new statutory Securities and Investments Board that will be responsible for overall regulation of the financial services industry. It will be responsible for the prudential supervision of the industry and the elimination of products which are manifestly unsuitable. That is not to say that I am in favour of a "box ticking" approach to regulation which vets all products. No; that would stifle innovation and commercial judgment. Perhaps the main task for a reformed and strengthened SIB would be to work in conjunction with the criminal law increasingly to play a positive role in enforcing and policing market offences. The public interest is served by getting those who offend out of the market. It does not really matter whether they appear before a crown court or before a regulator.

I am for statutory regulation because I want to maintain London as an important financial services centre. Despite some notable difficulties, London still enjoys a reputation as a good place to do financial business. It is important

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that that reputation should remain. Another reason why I am in favour of statutory regulation is the City of London's fascination with deals. Foreign banks have flocked to London to trade in shares while leaving their businesses back home to get on with creating wealth and building the economy.

Self-regulation seems to be a poor way of maintaining standards in London's more frantic atmosphere. Only last month Ernst & Young called for the proper statutory regulation of the accountancy profession because lax self-regulation had enabled accountants to adapt to the casino atmosphere instead of exposing it. My noble friend Lord Barnett touched on the inadequacy of auditing regulations. Indeed, many in the City go further and say that self-regulation has led to the difficulties at Lloyd's. They tell me that self-regulation has also led to the takeover of well-known UK banks such as the Midland, Morgan Grenfell, Warburg and of course Barings, by the foreign banks which have come to London.

From the consumers' point of view, if we are to ask more and more people to make provision for themselves—pensions and insurance—over and above the basic provision provided by the state, it is crucial that the financial services industry enjoys the confidence of the public. Indeed, people need somewhere safe to put their savings. The tightly regulated mutual building societies have been such a place for generations. They are now rushing into becoming banks to gain more freedom, perhaps freedom to speculate in the derivatives market or the betting on indices market. Other noble Lords have told us all about the dangers of that. The Minister needs to give careful consideration to the need for unadventurous, secure deposit-takers for the savings that we wish to encourage.

At the moment the public are wary. World class statutory regulation with effective enforcement and proper compensation, which is independent, will help to overcome that wariness. It will also enable us to play our full part in the European financial services industry. Statutory regulation will provide the moderation and the high standards that the industry needs.

7.5 p.m.

Viscount Massereene and Ferrard: My Lords, first, I thank the noble Lord, Lord Desai, for bringing this important subject to our attention. I should also like to declare an interest. I have worked in the securities industry as a stockbroker for 30 years and continue to do so. I was a member of Lloyd's but resigned some three years ago after an unsatisfactory but not totally disastrous 14 years.

The regulation of the financial institutions in this country is, frankly, somewhat of a "dog's dinner". We have IMRO, PIA, SFA and the SIB over them. LAUTRO and FIMBRA are now deceased after a comparatively short life. In America they have but one regulatory body, the SEC, which has now been going for some 60 years and I think everyone will agree that it does a pretty good job. It is my opinion that all those various bodies should come under the Treasury rather than the DTI which in fact hived off those responsibilities in the first place. Self-regulation

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means self-interest and has been shown not to work. Lloyd's, that once great institution, is a perfect example and one to which I shall turn later.

When I started in the Stock Exchange it was a small and exclusive club with fixed commissions. To be a member of the club one had to be elected and known by one's fellow members and sponsored by one's firm. Any misbehaviour, questionable conduct or sharp practice against fellow members or clients was dealt with instantly and severely by the Stock Exchange Council. There was a compensation fund which protected the public 100 per cent. against losses caused by default or dishonesty, Stock Exchange members having unlimited liability.

Today, under the Financial Services Act, compensation is limited to only £48,000, and it takes years to get paid. Since the so-called "big bang" swept away fixed commissions, the industry has been thrown open to all-comers. Partnerships have become a rarity and Stock Exchange firms are either owned by international banks or outside shareholders and the standards of behaviour imposed by what was the "old boy" network are now enforced by draconian regulations under the SFA. Security firms are now so tightly regulated that they have, in effect, to go to trial balance every month to check their liquidity and base capital requirements. Large sums of capital have to be kept on deposit which would be much better employed in industry. The whole exercise has turned into minute record keeping, some of which is a waste of time.

To give an example, every time I do an advisory bargain I now have to write a little history as to why I either bought or sold that specific stock and what relevance it had to that specific client. The alternative is to have every call recorded and logged. The cost of the army of bureaucrats needed to monitor all this regulation falls, of course, on the clients. The regulations have by and large worked although the burden of compliance is onerous and scandals still occur on occasions.

I should like to turn to derivatives. They are a newish financial animal on the scene and are in effect options or bets on the future movement of stocks, currencies or commodities. In their more extreme form they can even be bets on options, thereby getting double gearing. It goes without saying that their volatility can be considerable, as I am sure any of the ex directors of Barings can confirm.

Derivatives are traded worldwide over the full 24 hours by all the major international banks and securities houses. A touch of a button can open or close positions which can either win or lose millions of pounds. It is obvious that reporting these open positions on a monthly, weekly or even daily basis is a complete waste of time because by the time any regulatory body can work out anything is amiss, the stable will be well and truly empty and probably on fire as well, as has been so amply demonstrated recently.

The only hope is to devise a method of reporting on a real-time basis direct to a central computer which will have set limits for each securities house commensurate with its liquidity, and if this limit is broken the alarm will sound automatically. I believe current technology can

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cope with that and a program could be written for it. The moral on derivatives is simple: if you do not understand it, do not buy it.

The rule on traded options is that all clients who wish to deal have to read a booklet on them and sign a statement saying that they understand what they are getting into, so if the tears come later there can be no excuses.

I now come to the one City institution most in need of rigorous hands-on regulation—Lloyd's of London. Currently it is operating under the Lloyd's Act 1982 which in effect means it is self regulating. The corporation has lost to date some £8 billion for its members and the final bill is unquantifiable but could go to £12 billion or beyond. The losses of the deposit holders of BCCI, the pensioners of the Maxwell group of companies and Barings Bank pale into insignificance beside this staggering sum. To date 9,000 people have been totally ruined and 30 suicides have been directly attributed to this appalling débâcle and yet there has been no political fallout, the reason being that Lloyd's names are seen as rich gamblers who deserve all they get. The reality is that the qualification for membership is only to have free capital equivalent to the most modest of starter homes.

The reason for these quite incredible losses is, first, the initial gross incompetence of the underwriters, compounded by the infamous LMX spiral, where the risks are passed round and round the market at ever smaller premiums with heavy commissions being paid each time until the greatest fool is finally landed with it. This would have been fair enough if the names who were supporting this merry-go-round had known what they were letting themselves in for. From the information I have had, none of them had the slightest idea and most certainly were not told. They all thought they were either on marine insurance or general insurance. There are also motor and aviation syndicates, which one would have thought were self-explanatory. In actual fact they found themselves taking insane risks for tiny premiums. It is as if they had asked the bookmaker to put £10 on a horse running in the 2.30 at Cheltenham over the sticks and ended up putting £1,000 on a total outsider at Ascot on the flat four months later. That is the best illustration I can think of to explain some of the insanity which has been going on at Lloyd's.

The market insiders knew about the asbestosis risk as early as 1982. Their solution to the problem was to instigate a massive membership drive to raise the membership from around 10,000 to 32,000 in 10 years in order to cushion the problems they knew were coming. The management has used every known device to massage and disguise the losses, always giving false forecasts of future profitability. This is a proven fact as CHATSET has consistently been able to give accurate forecasts of future losses which have, without fail, been hotly denied by the Lloyd's management. Four of the past chairmen have been personally involved in questionable dealings in past years. Need I say more.

As regards the present, there is considerable doubt as to whether or not the corporation will be able to pass solvency this year, but I daresay creative accounting will come to the rescue. Bearing all this in mind, there is no doubt that the Lloyd's Act 1982 should be repealed and the corporation brought directly under the SIB. There should be rigorous efforts to root out the malefactors, who

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should be prosecuted for, at the very least, criminal negligence. To add insult to injury, the sums of money these people have been paying themselves make the directors of our national utilities look positively abstemious.

To sum up, the current state of affairs is not satisfactory and we should eventually have in this country an equivalent of the SEC. Furthermore, trial by jury for complicated fraud cases has also been proved not to work and some other system should be carefully considered. For instance, any fraud case investigated by the SFO should be tried by a specialist court of experts rather than by lay persons. But that is a whole different subject.

7.16 p.m.

Lord Monkswell: My Lords, we are all indebted to the noble Viscount, Lord Massereene and Ferrard, for that marvellous contribution. One of the interesting points about the debate is the theme running through it of gambling. In my few remarks I want to try to give a simple explanation of the financial system as I see it. I want to talk a little about the "casino" economy and then try to suggest some ways in which we might go forward.

I am just an ordinary engineer and I am not terribly sophisticated. However, I wish to set out my understanding of financial services. It is probably easier if I explain it in terms of banks. One puts one's money in a bank for two purposes—either to keep it safe until tomorrow or to have some savings which will be invested and which can provide a rate of return for the future. On the other side, one takes money out of the bank to pay day-to-day bills or one borrows a capital sum to invest in a chunk of machinery, a building, land or a fixed asset. That is a simple way of looking at the matter.

The banks have the money when it is not in our pockets or being used for transactions. It would seem from the expert contributions we have had so far in the debate that what the banks do with our money while they have it is to operate a grand casino. They play with our money. They pass it among themselves and lay bets on various things. Someone said that it does not matter and that banks or financial institutions are all professionals and big guys who know what they are doing. But these guys are playing with real money. When someone has a large salary or makes a terrific windfall gain on the betting, they take that money away from you and me. They spend it instead of us spending it. Because they are spending it and we are not spending it, that effectively distorts the economy. Quite large sums of money are involved. The salaries of people working in the financial institutions in London alone add up to a large chunk of money.

The situation then reaches a greater magnitude. One thinks in terms of Black Wednesday when George Soros effectively took about £9 billion out of the UK economy. He spent it again so it was recirculated, but effectively there was a massive transfer from the pockets of ordinary British people into those of some eastern European people. That may have been a very useful thing to have done, but it was done without our consent, knowledge or agreement.

If the banks were being dishonest they would say to us, "Yes, put your money in the bank and we shall cream off a certain amount of it and play with it. We shall lend it to

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other people and then pass it back to you. But that will cost you because of all this sort of casino activity. It may cost you big or little". That is the reality. But the banks do not say that. They say, "We are professionals looking after your money. We have to do these things like operate the derivatives market as a hedge against price movements. It saves us being subjected to the implications of those price movements. We have a little bit here and there and it is all hedged and very nice".

It may be very nice for the professionals operating within the financial institutions. They have nice, well-paid jobs, but what about us ordinary people? It is we who are subject to the vagaries of the market and who are thrown out of work, have short-term contracts or part-time jobs because of the vagaries of the market. These players and financial experts have a lovely time paying themselves large salaries, occasionally making a windfall on the casino economy or occasionally they may take a big loss. What happens if one has a big loss? It is not the directors of Barings who suffer as a result of the collapse of their bank. They are well off people who have assets, and all the rest of it. It is ordinary people who have invested their money in a safe bank who suffer.

It is not just their money, but the effect on industry of all the short-term significant price movements. It means that people who worked in the shipbuilding industry, for example, no longer work there because we have not got such an industry. That is because there is no incentive in this country, operating a casino economy, to invest in the long term. The guys in the financial institutions can make more money by gambling among themselves than they can by lending to industrial concerns which are going to produce goods and services for the community. So we have schools crumbling because it does not make sense to invest long term. As I said, we have virtually no shipbuilding industry now.

The situation does not affect just this country but the whole of the western world. When we look at the steel industry in Europe, we see that Britain, because of nationalisation and massive investment by the state, has one of the most efficient steel industries in Europe. But in other countries, because of the financial casino economy, there is no incentive to invest in modern steelmaking capacity. Who in their right mind in a private market orientated system, will invest in a steel industry that is going to feed into a shipbuilding industry, for example, when people are not investing in modern ships? There is no long-term incentive. It is easier to make a quick buck out of operating a broken down old ship than it is to invest in steel mills and ships for the long term future.

So we have a problem which affects all of us. What can we do about it? Apart from clever kids in the financial services market making money out of it, part of the reason for the derivatives market and for all the other financial services that we are offered, is because of price movements. It may be that not only in this country but worldwide we can think in terms of how we can dampen down price movements.

One has to look at how those fluctuations in price movements are caused. By and large one of the key factors is the fluctuation in currencies and exchange rates. When I worked in industry, one of the things I had to do was to calculate the reimbursement rates for warranty

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claims in different countries throughout the world. Every time I did the calculations, I had to look at the exchange rates for the different currencies around the world in which we were operating in order to arrive at the figures showing what it would cost us in terms of warranty. If there had been much more stability in those currencies, the calculation I had to do and the impact which was felt throughout the books in terms of costs to the company and in the exchange rate movement, would have been minimised. If one considers that the operation I was involved in can be multiplied a million times around the world—there must be an army of people making all these calculations—some of the more astute ones make a terrific living out of it when operating in the currency markets within the financial services.

It may be sensible for governments around the world to sit down around a table and ask, "How can we agree the relationship between our currencies to save these fluctuations in prices which create all sorts of problems for our communities because of the operation that it leads to; namely, the casino economy and the financial services?"

It is interesting to realise that this problem has been experienced before. The problem we are experiencing now is very similar to that experienced by the world in the 1930s. Then there was mass unemployment as there is now. There was instability around the world and, unfortunately, it led to a world war. Now we have instability around the world causing conflagrations. Once the conflict had finished 50 years' ago, the governments of the nations around the world agreed to the Bretton Woods Agreement, the fixed relationship and parity of currencies. It may be that something of that kind needs to be done—not just to save people worrying about the impending collapse of Lloyd's. Maybe we should take that step before the next world war rather than afterwards.

7.28 p.m.

Viscount Chandos: My Lords, I should like to thank my noble friend Lord Desai for introducing this subject and for making such an excellent speech. My noble friend has stimulated a debate which must have led the Minister to question whether the fire from behind his own lines was more frightening than that from across the House.

I start by declaring an interest. I am a director of a small investment banking company regulated by the Securities & Futures Authority Ltd., which has no activities in the derivatives market. However, in the past I was a director of a large merchant bank and at times was responsible for swaps and derivatives activity in the bank. As a result, in the late 1980s I served a term as a director of the International Swaps and Derivatives Association. That position once gave me the dubious privilege of introducing a debate on ethics in the swaps market on the day that the losses of the Hammersmith and Fulham Council were announced.

My noble friends Lord Desai and Lord Barnett concentrated on derivatives. Although I should like to touch on a few other points later, as a past practitioner I should like to address that subject. I have already argued in your Lordships' House that the ownership structure of

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Barings and the lack of proper accountability to outside shareholders contributed centrally to the breakdown of proper management control which led to the failure of the bank. We should remember that that is a special case and we should be careful not to design future regulations which will cover different cases where there is a proper relationship between the shareholders and the banks concerned.

Linked to the ownership structure of Barings was a remuneration system that encouraged both inappropriate risk-taking on the desk, as the Governor of the Bank of England would have said, and an overly relaxed attitude on the part of senior management to what was going on below them. I agree at least in part with some of the arguments of the noble Viscount, Lord St. Davids, about the question of remuneration in the wholesale financial markets. It is inescapable, if London is to thrive as a financial centre, that successful financial traders should have the potential to earn what are, by any standards, large amounts of money. But—these are important caveats—first, it is essential that the calculation of bonuses should be based on broader, rather than narrower, profit centres and bonus pools. Many of the most successful and technologically advanced trading operations in the United States now ensure that all their traders understand that their individual remuneration is not based on the individual profit that they may claim to make.

A second condition should be that the calculation of profits (and probably the payment of bonuses) should be spread over a longer period than one year. Salomon Brothers, by any standards one of the great trading houses of the world, in the past six months has announced an adjustment of profits amounting to many hundreds of millions of dollars as a result of accounting adjustments to trading positions over the past six or seven years in its London operations. Many of those trading positions, whether in derivatives or in the underlying cash markets, are far too complex for income necessarily to be recognised accurately in a single accounting period.

Finally—in my view, most importantly—the performance-linked compensation which is, as I have argued, an essential part of a thriving financial market should be paid in shares or other securities of the bank or securities house for which the traders are operating. In that way, after a period of time, the traders would suffer if the bank or trading house got into similar difficulties to those of Barings.

My noble friends Lord Barnett and Lord Desai both raised the issue of ringfencing the derivatives and, arguably, the other trading activities of a bank—I am referring to the issue of connected lending—to ensure that the privileges that are accorded to an authorised bank cannot be abused for over-aggressive and speculative trading. We shall have to await the report on the collapse of Barings from the Board of Banking Supervision before we can judge whether the existing rules were broken by Barings. I agree with my noble friend Lord Barnett that it is difficult to believe that what has happened could have occurred without the breach of those existing rules. But I believe that there is a strong case for a far greater separation of securities trading activities and related derivatives trading activities of banks from their deposit-taking activities.

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On the other side of the Atlantic, we are finally seeing the prospect of the reform of the Glass-Steagall legislation which separates commercial banking from securities trading and investment banking. It is perfectly clear already that the Federal Reserve Bank and the SEC will ensure rigorous ringfencing between the securities and derivatives trading activities of the banks and their deposit-taking activities. There is some difficulty with derivatives trading relating to money markets and foreign exchange operations because they can be argued to be much more integral to the treasury operations of an authorised bank. I believe that that ringfencing should focus, at least initially, on derivatives trading based on securities and securities trading itself.

The Motion moved by my noble friend Lord Desai refers to:


    "effective and comprehensive regulation of the market for financial products",

and that is my excuse for raising a few other points. In terms of the Financial Services Act and its roots in a self-regulatory system, the noble Viscount, Lord St. Davids, said that he did not support a move towards an SEC system because the culture in the UK was different from that in the US. We should remember that the deregulation of the financial markets that occurred in the 1980s was intended to change the culture in the direction of more competitive and efficient markets. Many noble Lords on this side of the House argued at the time of the Bill's passage through your Lordships' House that there was a fundamental inconsistency in moving to increase competition in the financial markets while basing the regulatory system on a sense of gentlemanly self-restraint. In trying to reconcile an essentially self-regulatory approach with statutory backing, the Government created an horrendously complex system—a camel designed by a committee of camels. I therefore join other noble Lords in urging for simplicity and rigour, and for a determined move towards a regulatory system rooted much more strongly in the statutory principle.

Another vivid memory of the passage of the Financial Services Act was the Government's vehement arguments as to why the Lloyd's insurance market should fall outside the provisions of that Act. It is difficult to match the noble Viscount, Lord Massereene and Ferrard, in my indictment of that market, but we should remember one thing. I would rather try to sell a signed photograph of the committee of the Rugby Football Union than membership of Lloyd's, but I suspect that others may be more robust than me. We must ensure that, whatever other reforms are introduced, individuals are not solicited for Lloyd's membership with the cynical irresponsibility with regard to their assets which occurred in far too many cases in the past.

I am struck by the unanimity among noble Lords on both sides of the House on the need for reform and on the need to have a more statutorily led, not statutorily backed, system, and I therefore commend to your Lordships' House the Motion which stands in the name of my noble friend Lord Desai.

7.40 p.m.

Lord Ezra: My Lords, this has been a most important and timely debate, so ably introduced by the noble Lord,

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Lord Desai. As the noble Viscount, Lord Chandos, said, it has given rise to a number of extremely well-informed speeches, some of the noble Lords contributing to the debate being practitioners and therefore knowing what they are talking about. Indeed, I must say so did the other noble Lords who spoke.

The financial products and services about which we are talking affect many millions of people. They affect those making pension arrangements; taking out insurance policies and mortgages; and investing in other financial products. They affect also vast numbers of depositors, some of whom, as we have seen recently, might be dealing with banks which get into serious financial difficulty and therefore threaten their deposits.

The Motion must be seen in the context of the broad developments in financial markets which have occurred since the war. Two major factors, as some noble Lords have said, transformed that market in the post-war period. The first was the abandonment of the Bretton Woods regime of stabilised currencies, thus introducing much more risk in the monetary markets. The second was the liberalisation of financial dealings, to which the noble Viscount, Lord Massereene and Ferrard, referred, thus introducing more variety and competition in financial products and services.

The Financial Services Act 1986, in which a number of noble Lords took part—I personally spent a great deal of time debating that measure—was intended to provide safeguards for investors in the liberalised market through a regime of self-regulation. I agree with all noble Lords who said that the time has now come for a fundamental review of the situation.

At the retail end of the market, there has been an alleged substantial mis-selling of private pension schemes—I introduce the word "alleged" because of what the noble Lord, Lord Blaker, had to tell us—which is the subject of an ongoing inquiry by the SIB. Doubts have also been expressed about the over-promotion of endowment mortgages, and until recently there has been a lack of disclosure of commissions on insurance policies. Overall there has been increasing complexity in the financial products, which the average consumer has found difficult to understand.

At the wholesale end of the market, as we have been well informed, there has been a massive expansion of derivative trading, the scale of which was described by the noble Lord, Lord Desai. That trading was intended originally to minimise forward risk in currency and other transactions, but has led in a number of cases, as we know, to a large degree of proprietary trading, such as occurred in the case of Barings.

In the retail sector a number of steps have already been taken. In the case of personal pensions, the SIB has sought to identify the scale of the mis-selling to prevent a recurrence and to provide compensation. That, of course, is a lengthy process, and in the meantime there is widespread public uncertainty and wariness—I am using a word introduced by the noble Lord, Lord Haskel—about private pension arrangements.

As a means of restoring public confidence in personal pension plans and life insurance, the SIB has laid down rules on disclosure of commissions and other essential information, which took effect from 1st January this year.

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In addition, the Private Investment Authority, which is the new regulator for the majority of, but not all, firms conducting investment business with the public, has established an ombudsman scheme to resolve complaints brought against PIA member firms by the public. The complaints procedure has been streamlined, and the PIA considers that it should provide a valuable service for private investors who find themselves in difficulties.

All those are undoubtedly steps in the right direction. I thought I should mention them to show that something has already been done in this sector. However, there are a number of weaknesses in those arrangements. First, not all financial products available to the public are covered. The details which have to be revealed in the case of personal pension plans and life insurance do not, for example, apply to mortgages, protection-only products, and deposit-based products such as TESSAs. So there is a gap in the products which are covered by the regulations introduced by the PIA.

Secondly, the PIA does not cover all firms conducting investment business with the public. It appears to be up to individual firms whether they subscribe to the PIA or not; and there have been some notable exceptions, such as the Prudential, over which there was a great deal of publicity in recent months. Presumably member firms can withdraw whenever they feel like it, and the complaints procedure and other regulations issued by the PIA would no longer apply to them. We should know whether that is the situation. If that is so, it is most unsatisfactory for the investor.

In the light of those limitations in the existing system, and despite the measures taken, it must be asked—as a number of noble Lords have done—whether there should be a statutory body along the same lines as has been proposed in the case of occupational pension schemes, which we have debated at some length in the Pensions Bill and which was widely acclaimed in that connection. So it would seem appropriate that serious consideration should be given to a statutorily backed body. Many noble Lords have referred positively to the work of the SIB, so a strengthened SIB with greater statutory backing might be introduced into the financial services sector. It would be interesting to have the Minister's views on that issue. So many noble Lords have referred to it that I am sure he will let us know what he thinks.

If a statutory body is not acceptable to the Government, will the Minister indicate how the gaps in the present arrangements—there are notable gaps, as I have shown, despite all the measures taken—could be filled?

With the wholesale end of the market the main problem has arisen with the trading of derivatives. I must warn that in some future years there might be an issue over some other aspect. For example, during the recent recession a number of difficulties were encountered by banks as a result of over-lending to sovereign states or on property deals. That was an equally excessive venture by some banks. At the moment we are concerned with the trading in derivatives which has been brought to the fore by the recent failure of Barings.

Derivative instruments, as many noble Lords have said, provide a means of transferring and spreading risk and accommodating risk management, particularly for those

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engaged in foreign trade. It is a desirable and, indeed, necessary form of financial management which has become very much more important since the break-up of the Bretton Woods system to which I referred earlier. However, while it is desirable for derivatives to be used for risk management against the possibility of unexpected movements in interest or exchange rates, the problem arises when banking institutions use them for proprietary trading in addition to risk management. That is the point which causes concern.

The trouble is that large profits can be made from that trading. We know that in the past year Barings made such large profits. Substantial inducements are offered to the practitioners. I read somewhere that the team of 14 derivative traders at Barings, had their recent venture succeeded, could have shared up to £24 million between them, so the stakes are very high and incite traders to take considerable risks.

The real problem is the way in which that could affect the depositors. The proposal put forward by the noble Lord, Lord Desai, and supported by the noble Viscount, Lord Chandos, merits serious consideration. It is the ring fencing of this type of operation. People who place deposits with banks consider that they are doing something that is gilt-edged. A reputable bank should be able to take care of one's money. The banks give one virtually no interest on that money and, in fact, make several charges for any services that are requested. One should be able to get the money back intact at the end of the day. If that same institution ventures into other activities involving considerable risk those risks should not extend to depositors' money.

The main point about derivatives is that they are global and therefore it is vital that not only should the internal procedures be tightened and some form of ring fencing be introduced but there must be more effective international co-operation. That appeared to be lacking in the case of Barings.

Our debate has shown that there is much to be done to safeguard the public interest in the retail and wholesale financial markets. The two markets, because of their special nature, require different solutions but the solutions should be identified and applied quickly.

7.51 p.m.

Lord Peston: My Lords, we are indebted to my noble friend Lord Desai for introducing this fascinating debate. All noble Lords have made useful and interesting contributions. Only the time constraint—I intend no discourtesy—prevents my commenting on all of them; I must limit myself to a few topics.

I begin with derivatives and more generally with financial instruments. Obviously, they are about the reduction of risks via optimum portfolio management. Risks are reduced in the usual way by pooling, sharing and making use of the covariances between the different assets and so forth. A typical example is buying a share and selling call options on the same share, assuming that the prices of the two instruments are positively related. That is a straightforward way of hedging the risk.

Financial markets exist to ensure that risks are borne by those with the least risk aversion and shared by those with the most. We can make similar remarks about insurance

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and other financial activities. Nothing I say—and nothing that has been said by other noble Lords—is meant to oppose financial markets and financial instruments and say that intrinsically derivatives are a bad thing. They are not. The real question is whether abuse can arise and in what way. I believe that noble Lords have clearly demonstrated that abuses certainly can arise.

Perhaps I may refer to a comment made by my noble friend Lord Desai. A classic question in economics is whether speculators in particular financial instruments can so dominate a market as to add risk rather than reduce it. I know that students of economics are taught that that cannot happen in the long run if speculators are to make a profit. I may have misunderstood my noble friend but I believe that he said that colleagues at the London School of Economics carrying out research claim to have shown that speculation does not destabilise in the real world. If they have shown that, I do not agree. My examination of the data and the research literature shows that there is a great deal of evidence of destabilising speculation. I can draw my noble friend's attention to some of the theoretical literature which supports that. In my judgment, markets are unduly volatile; I believe that of all financial markets relative to the real underlying forces at work. I have little doubt about it.

I now go on to consider what scope there is for corruption and other forms of illegality. The evidence shows that there is too much scope. In recent years—whether we refer to BCCI, Barings, Lloyd's, the mis-selling of pensions or suggestions of something being wrong with the sale of endowment mortgages—there has been sufficient evidence to give grounds for disquiet. Noble Lords have gone into the details of that. I shall not go over the Barings case with which my noble friend dealt more than adequately. The noble Viscount dealt more than adequately with the Lloyd's case. I have a slight disagreement with the noble Viscount. He used the words, "derivatives are, as you like, bets". They are not "as you like, bets"; they are bets. There is no argument about what derivatives are; they are akin to spread-betting, as noble Lords who visit betting shops will know. I do not recommend that to potential gamblers as an open-ended commitment.

The real point about possible corruption and illegality is the excuse that is made. It is made either in terms of uniqueness, as described by my noble friend Lord Barnett, or in terms of, "That was the past and everything is okay now." I am not convinced. Logically, it is just as valid to say that the cases discovered, although few in number, are the tip of the iceberg. I believe that regulation is so poor, notably by the Bank of England, that we are unable to assess the scale of the problem. That does not make me any happier.

I should like to ask a particular question. In practice, can the regulators obtain enough information to do their job effectively? A particular aspect of that occurs in connection with Barings. Recently we read that a number of Barings executives were fired and given a rather generous pay-off. I hope that I am not being too cynical in asking whether they signed a confidentiality clause which would mean that they lose their redundancy payment if they speak in public about what they know. That leads to

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the more important question of whether that will limit the investigations of the Board of Banking Supervision into what happened at Barings. That is a most serious matter.

The general question is whether the regulators are interested in finding malpractice and exposing it. Your Lordships should not forget that in any market, and more generally in the City of London, any example of illegality or corruption casts doubt on the probity of all. I must ask whether there are many instances of sweeping things under the carpet rather than—using the word of the noble Viscount, Lord St. Davids, in another context—transparency. In my judgment, transparency in all financial dealings is of the essence—and that includes the investigations into corruption and so forth.

I agree that the issue is immensely complicated. It was easy when we were dealing with forward markets, stops, futures, options, caps, flows, collars and goodness knows what else. The spellcheck on my word processor refused the word "swaptions". I had to put it into the dictionary. I learnt the word only a few years ago and for all I know it has been replaced.

I wish to emphasise the point that I am not against financial instruments per se. I am against their use. I was intrigued by the remarks made by my noble friends about whether there ought to be more ring fencing as regards who can enter the markets. I do not believe that banks and insurance companies can rely on the Hammersmith and Fulham Council case, believing that the House of Lords will bail them out saying that they were ultra vires if they managed to get themselves into serious trouble.

I do not wish to go to the other extreme, however. I have said that abuse exists and that destabilisation is impossible. But I am not convinced that, for the most part, the ordinary consumer is ill served by the financial community at the detailed level. In other words, I do not want us suddenly to say that this is nothing but a disaster. That would be a terrible mistake. The real point is that the consumer is not always well served by the financial community and is too easily aggrieved on specific occasions. The insurance companies, banks, and so on, always say that that is a minority of cases; and of course, they are right. But the problem is that for the individual concerned, it is the 100 per cent. of cases and for most people they are major cases relative to their total financial assets.

That is true not just of the insurance companies. An extraordinary state of affairs has occurred in our community. I read in a recent article in the Financial Times that the banks, on which we have relied for so long and which have been referred to in the past for their standards, are about the most unpopular and least regarded institution in our country. The banks spend a fortune on public relations and I should have thought that they should learn a different lesson; namely, not to spend any money at all on public relations but to concentrate on giving a decent service. I find that that is the best form of public relations. Therefore, the point is that it is a minority of cases but they are cases which matter to the people concerned. That is why we cannot ignore them.

I turn to the question of self-regulation and regulation generally. I believe that self-regulation has certainly failed in one sense. But in our country it has the most arcane statutory underpinning. Therefore, to call it

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self-regulation and not statutory regulation is absurd. The legislation is so enormous and the regulations are so complex that I cannot believe now that the institutions of the City, which were against statutory regulation, would not now vote unanimously for what would be called statutory regulation because, as my noble friend Lord Chandos said, it would be simple. It is extraordinary that practically no one understands the regulatory system and I am not convinced that the regulators do. Therefore, I do not doubt that we must move to something different.

I know what my party's policy is. But we cannot start from scratch. We have an existing set of institutions and activities. If things are as bad as I think they are, we shall eventually need a new financial services Act. Merely saying that and the thought of going over all that ground again makes me feel slightly sick, especially if I am sitting on the Benches opposite at the time, which looks now to be what used to be called a racing certainty. I do not mean that I shall be sitting on the Front Bench, but I shall certainly be sitting on the Benches opposite. Therefore, we must make changes but I do not believe that we should assume that it will be easy.

My final remarks echo something said by the noble Viscount, Lord St. Davids. He may remember a debate, which I believe was introduced by the noble Lord, Lord Carr of Hadley, on aspects of financial education in schools. We all agree on how important that is. I do not believe that these matters are too difficult for young people to understand. When one thinks of what young people manage to do with computers, I am sure that they will have no difficulty with "swaptions". I hope that, quite independent of anything political, we will take seriously that if our young people are to cope in the modern world, the world of the next century, while many other matters in relation to the national curriculum need to be taken seriously, financial matters cannot be neglected.

I conclude as I began. I have found this debate extremely interesting. I wish that we had had more time to go into details but there will be other occasions on which we can do that. I look forward very much to the reply from the Minister.

8.5 p.m.

The Parliamentary Under-Secretary of State, Ministry of Defence (Lord Henley): My Lords, I begin by agreeing with the noble Lord, Lord Peston, that this has been an extremely interesting debate. A great many detailed questions have been raised in the course of it. I hope that noble Lords will understand when I say that it would be inadvisable and, I suspect, wearisome to the House were I to try to answer all the points that have been put to me in the detail which they deserve. However, I shall certainly write to noble Lords—in particular my noble friend Lord Blaker and the noble Lord, Lord Barnett—on some of the points that have been raised. I must say in apologising to the House that, necessarily, some of my answers will be broad-brush.

I suppose that one could say that the intervention made by the noble Lord, Lord Monkswell, was broad-brush. It is a very brave man who tries to give a simple explanation of the financial system in barely 12 minutes. It will not

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surprise the noble Lord to hear that I did not find myself in full agreement with him on many of the points that he made. However, I have no doubt that the noble Lord, Lord Peston, is fully in agreement with many of his points and would like to take them up on another occasion.

Obviously, we accept the need for effective regulation of financial services and products. It would be difficult to imagine anyone disagreeing in total with the Motion put before your Lordships' House by the noble Lord, Lord Desai. Although I do not accept all the apparent shortcomings that have been put forward during the course of the debate, there is no doubt that in a number of areas, firms have fallen short of the required standards.

Noble Lords have drawn particular attention to the collapse of Barings, derivatives—and I thank the noble Lords, Lord Desai and Lord Barnett, for giving such detailed explanation of what derivatives are—the mis-selling of personal pensions, and endowment policies. Lloyd's was mentioned by my noble friend Lord Massereene and Ferrard. In passing over Lloyd's I should say to my noble friend that many of those matters are now before the courts and it would be wrong for me to comment in detail at the Dispatch Box. However, I shall certainly draw the points made by my noble friend to the attention of my right honourable friend the President of the Board of Trade.

All of the issues raised are important and I shall endeavour to respond to some of them in the course of my speech. However, perhaps I may begin by explaining the Government's general approach to financial services regulation.

The financial services industry plays a crucial role in the United Kingdom economy. London's position as one of the world's three main financial markets requires a regulatory framework which maintains clean, well-ordered markets while allowing for innovation and avoiding unnecessary regulatory costs.

Of no less importance is the industry's role in enabling individuals to provide for their future financial needs. Here the first priority is to ensure a high standard of investor protection. Many investors find financial products complex and opaque. I noted the comments made by the noble Lord, Lord Peston, seeking education to cover those points. No doubt others will look at that in due course.

Regulation provides a framework of rules within which free and fair competition can take place. It is essential to create a system within which money can be invested with confidence. Without that, it is not only the investor who suffers but the reputation of the industry, with all that means for future growth and sales. However, we must recognise that the true test of a regulatory regime is not whether it ensures that every firm and every individual always maintain the highest standards. No system of regulation can provide an absolute guarantee that nothing will ever go wrong. Instead the true test is whether the system identifies shortcomings and provides a remedy.

Although the Government believe that the present structure succeeds in providing a high level of investor protection, they are in no way complacent. The regulatory system is always kept under review. The Pensions Bill

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and the creation of the Personal Investment Authority show that, where change is necessary, the Government and the regulators are ready to act.

Before explaining how the regulation of financial services is being developed and strengthened, I should like to deal with the idea stressed by my noble friend Lord St. Davids, the noble Viscount, Lord Chandos, and other speakers that we should move to "fully statutory regulation".

The suggestion that we face a simple choice between "statutory regulation" on the one hand and "self-regulation" on the other is misleading. The present system is based on statute; but, very sensibly, enables those who have expert knowledge to play a key role in setting the rules and ensuring that they are enforced.

The Government believe that the case for a major change to the system has not been made. The costs of such an upheaval are clear: they would be a burden for the industry and the cost would ultimately fall on individual consumers. By contrast, the benefits of a different structure are far from guaranteed. Instead, we believe that the best way forward is to use SIB's powers as fully and as effectively as possible.

We have recently seen SIB making increased use of its powers to expel individuals from the industry and publicly to reprimand firms for misconduct. In addition the front line regulators have imposed a series of substantial fines on their members. Some people—and I suppose that I must include my noble friend Lord St. Davids among them—believe that such fines are a sign of the system failing. I simply do not agree. On the contrary, the fines show how the regulators detect and punish wrongdoing while ensuring that investors who have suffered loss receive redress.

The system has also been strengthened by the formation of the Personal Investment Authority (the PIA) which is committed to a major change in the level of protection for investors. That is being achieved through rigorous monitoring of firms, stronger training—again, that is something for which the noble Lord, Lord Haskel and my noble friend Lord St. Davids asked—and competence requirements for financial advisers and better information for individual investors.

Better information is playing a key role in raising standards. The new requirements for disclosure of information about life assurance charges and commission have already led to increased competition, with new firms entering the market and existing firms cutting their prices. As the latest edition of "Which?" says:


    "The new rules are a real breakthrough for consumers".

As regards the remarks made by the noble Lord, Lord Ezra, about the gaps in the coverage of the Financial Services Act, I should point out that that legislation covers investment business and we could not extend those rules to cover all forms of insurance. As the noble Lord is probably aware, the Council of Mortgage Lenders is developing a code of practice for mortgages. Bank deposits are already covered by the banking code. We believe that it is better to have arrangements tailored to different products which have different requirements, rather than seeking something that covers everything.

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Perhaps I may say few words about Barings and derivatives. The word "derivatives" appeared in the original Motion tabled by the noble Lord, Lord Desai. Obviously, it is a matter of considerable concern to many speakers. First, I shall briefly mention Barings. I understand the concerns expressed by many noble Lords in the light of the collapse of the Barings Bank, but, as I believe all are aware—as, indeed, I believe was pointed out quite rightly by the noble Viscount, Lord Chandos—the Board of Banking Supervision is preparing a full report on the affair. As the noble Lord said, it would be idle to speculate and possibly wrong of me to comment, as the noble Lord, Lord Barnett, tried to make me do, on what her Majesty's Government propose to do before the report is released. However, I can say that my right honourable friend the Chancellor of the Exchequer announced in another place that he was determined, when the full facts are known, that all the appropriate lessons will be drawn and any necessary corrective steps will be taken. He expects to be able to publish the full report of the Board of Banking Supervision, subject obviously to the usual need to protect the legitimate confidentiality of innocent third parties and any other legal constraints.

I turn next to derivatives. I accept that many noble Lords have expressed concern on the way that derivatives are currently regulated. The noble Lords, Lord Desai and Lord Barnett, both gave their versions of what derivatives are and what they do. They provide risk management tools for businesses and other organisations. They can bring important benefits to those organisations, to individuals and to the economy at large. They exist and their use has grown because there is a demand for them. It is as simple as that. However, they can be complex and require risk management skills commensurate with that complexity. Derivatives in themselves were not the cause of the Barings collapse—we believe that the issue here is one of failure of management controls. As I believe the noble Lord, Lord Peston, pointed out, the misuse of derivatives—not their use—is the crucial point. The most that can be claimed is that derivatives often allow a greater exposure for a given cash outlay.

The Government obviously recognise the importance of an appropriate system of regulation to ensure that risks taken by financial institutions do not pose a systemic threat to the financial system as a whole. The Bank of England and other City regulators, for example, have rules and regulations in place to limit the exposure of market participants to the markets. Those participants are required to set aside capital against those positions. But it would be wrong, and dangerous, to have a special system solely for derivatives.

I believe the noble Lord, Lord Barnett, said that the use of derivatives should be disclosed in company accounts. The best way to regulate the use of derivatives would be to ensure that proper internal systems are in place, as the international authorities have done. That would be far more effective than any external exposure in accounts.

I move on now to the question of personal pensions, which was raised by my noble friend Lord Blaker, the regulation of which is a matter of concern to many noble Lords. Personal pensions have played an important role in the Government's strategy of bringing about a sustained improvement in the general level of income of those who

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have retired—a level of income that we have seen increasing quite dramatically over the past few years. Increasing affluence means that people will more often have resources available for investment. A strong foundation of privately funded pensions is good for the economy as a whole, just as a strong foundation of occupational pensions fully funded is good for the economy as a whole. I can assure the House that the total value of the United Kingdom's pension funds is now as great, if not greater, than that of the rest of Europe put together. That indicates the strength of our funded system.

I am glad to say that the Securities and Investments Board (SIB), the chief investments regulator, has taken a series of steps to act as an effective watchdog of the standards of professionalism of those who sell personal pensions. First, as the noble Lord, Lord Ezra, stressed, SIB identified a systemic problem and published a report in December 1993 which showed that many sales of personal pensions appeared to have fallen short of the required standards. Then it took steps to stop that happening again, introducing new, stronger rules for future sales of personal pensions in March of last year.

Finally, in October of last year SIB issued a statement setting out in detail how firms responsible for the sale of personal pensions should review their cases—I can tell my noble friend Lord Blaker that that will be on the basis of whether the advice was sound at the time based on the information that was then available—how mis-selling can be identified and the damage caused to investors by it; and, where mis-selling leading to financial damage has occurred, how appropriate redress should be provided. The Personal Investment Authority is now translating that into rules for its members. That will set the scene for pension providers to arrange redress for the victims of past mis-selling. I believe that that is a fine example of regulatory action.

My noble friend Lord St. Davids, the noble Lord, Lord Haskel, and I believe other speakers, expressed a degree of concern about the sale of endowment mortgages in response to the OFT report which was recently published. Obviously, a mortgage may be a family's biggest financial commitment. Therefore, it is important that borrowers get appropriate mortgages. The sale of endowments is regulated by the Financial Services Act which aims to ensure that the investor is sold a suitable investment product and receives the best advice about the choice of that product. The sales practices for endowments and other mortgage-related products were greatly improved from the start of this year with a new regime of product and commission disclosure.

That means that potential investors can get clear information in plain English about the implications of financial commitments such as endowments, including, crucially, the early surrender terms. Could I also say to the noble Lord that anyone who is unhappy about the advice he has received should complain to the company from whom he bought the product, and if he is not then satisfied, he can go to the regulator who obviously can award compensation if rules have been broken.

It is, of course, always easy to demand more regulation every time a problem arises. I suspect that is always the way of the party opposite. As I have sought to

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demonstrate, the regulatory system does seek to learn the lessons of experience. However, this is quite different from piling on an ever increasing number of regulations which would reduce the choice available and impose additional costs. We should all recognise that the regulatory system must provide investor protection in a cost-effective manner. Higher costs for firms inevitably mean higher charges for consumers and thus it is the investors themselves who ultimately meet the cost of regulation. What is required is not more regulation but appropriate regulation; regulation that is able to respond to new developments, that does not restrict innovation and choice; regulation that maintains high standards of investor protection and adequate remedies when these standards are not met, but does not pretend that any system can offer a guarantee against wrongdoing. The Government therefore believe that the way forward is to continue strengthening the existing system, giving consumers the information to choose suitable products, setting high standards for firms, and providing redress when those standards are not met.

8.21 p.m.

Lord Desai: My Lords, I thank all noble Lords who have spoken in this debate. As many have said, it has been a marvellous, well-informed debate that was full of interesting ideas. I was fascinated by the speeches of the noble Viscount, Lord St. Davids, and the noble Viscount, Lord Massereene and Ferrard. Their speeches showed that there is a consensus, as it were, jumping over the Front Bench from the other side. That is only to be welcomed. It is claimed that when the Conservative Party came to power it reformed the trade unions. Perhaps it will need the Labour Party to come to power to reform the City. I beg leave to withdraw the Motion.

Motion for Papers, by leave, withdrawn.


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