§ Mr. John Browne (Winchester)
I beg to move, That this House takes note of the Reports of the Committee to Review the Functioning of Financial Institutions chaired by the right honourable Member for Huyton (Cmnd. 7937 and 7503).
I express my gratitude for winning the Back Benchers' ballot. It is a great privilege to be able to move this motion.
First, I declare my interests in some financial institutions. I am a banker and I have worked in the City 548 for a decade as a banker and as a merchant banker. My training and work experience have involved discount banking and working on the Stock Exchange. I have a financial interest in Lloyd's insurance and I am a member of the Worshipful Company of Goldsmiths.
The House will wish to thank the right hon. Member for Huyton (Sir H. Wilson), the chairman of the committee, all its members and the staff for producing such an outstanding report. Thanks are due also to the many witnesses who gave valuable time to research and to give evidence to the committee. The committee made a sound decision to permit the publication of evidence as it was presented. Clearly, knowledge of that fact tended to sharpen the opinion and the quality of evidence, so that it far exceeded the standard of evidence in the two other major reports of the subject—the Macmillan and Radcliffe reports.
In preparing evidence, many of the financial institutions and their governing bodies undertook some beneficial and self-searching analysis. That was a great help. As a result, the report will have helped not only the House and the country but the internal and external efficiency of some financial institutions.
Under the chairmanship of the right hon. Gentleman, the committee achieved the difficult task of presenting a non-partisan, clear and lucid report on the functioning of our financial institutions. Many institutions tend to shroud themselves in mystery and to assume a degree of self-importance. Financial institutions are—or, certainly, were—no exception. Far from being part of the stock-in-trade, that mystique served to conceal and confuse some of the valuable services offered by these financial institutions. By lifting the veil of mystery from much of this specialised and largely undocumented industry, the report has served not only to help our debate today but to improve the public awareness of our financial institutions and the services that they provide. It has also served to challenge any tendency to smugness. I believe that less of that now remains.
In short, the report is a most authoritative and clear account of the functioning of a modern financial system. It is a rare textbook and will serve as a model, even outside this country.
When I first entered Wall Street as an investment banker for three years' training in the 1960s, the only authoritative description of the industry was contained in the legal opinion of Judge Medina. Entrants to the City of London will certainly have a much more authoritative and descriptive document to examine when they start their careers in the City and other financial institutions. The report will become recommended reading for all students of the functioning of financial institutions in general and of those in Britain in particular. As a junior Back Bencher, I sincerely thank and congratulate the right hon. Member for Huyton and his committee.
The aim of the committee, which is contained on page (i), is clear and is constantly referred to throughout the report and in the interim report on small businesses. I shall not waste the time of the House by reading it out, but I shall draw the House's attention to the five key points that start in paragraph 11 on page 2. I wish to emphasise especially the distinction between the terms "the City" and "financial institutions". I apologise in advance if I inadvertently confuse the two during the debate. It is an important distinction. The City is by no means synonymous with the financial institutions of Britain.
549 The report is particularly interesting in relation to the difference between internal and external efficiency and how we should judge the financial institutions. It also distinguishes between real and financial investment. In relation to venture capital, the key observation is that a change in the conditions of credit might lead to a change in the demand for that credit.
The report contains some epic observations about the history of British economic decline and the influence on that decline of the policies of past British Governments, of all parties. The report contains some interesting statements about entrepreneurship and an interesting description of investment decision, particularly the relatively modern type of investment decision made on a present value or discounted cash flow basis. It contains statements about the importance of the business environment to investment, industrial relations and the attitude to work.
The report contains an interesting argument about inflation, although it makes no recommendations on that subject. It contains good descriptions of the enhanced role of the financial institutions and the encouragement of more effective real investment.
In paragraph 1018, the report makes the key observation that the financial institutions simply cannot stand apart from the generation of economic growth. They are part of that economic growth and their internal efficiency depends upon it. They cannot stand aloof.
On page 362, the report comes out against any extension of the public sector in banking or insurance. In short, the report explodes many myths, the most important of which is that there has been a strike of capital.
I have tried to provide a brief outline of this vast and comprehensive report. I shall now comment upon certain subjects in it which I believe are of particular importance. I agree with the report's recommendation that an English development agency should be established, similar to the agencies that have been established in Scotland, Wales and Ulster.
The report's argument about indexation is fascinating. Personally, I believe that indexation itself is grossly inflationary. It builds inflation into the system. It is also grossly discriminatory, particularly in its early stages. Indexation is a pain killer. It makes inflation easier to live with, but it is no cure for inflation. On the contrary, the worst aspect of it is that by shielding people from the ravages and pains of inflation, indexation not only kills the will but kills the wish even to try to cure inflation. I hope that my right hon. Friend the Financial Secretary to the Treasury will not extend indexation but will help to roll back that indexation which now exists.
§ Mr. Browne
I shall, but I do not wish to try the patience of the House too much, since I have a lot to say.
§ Mr. Browne
I am opposed to any form of indexation. It is grossly discriminatory. The issue of "Granny" bonds is a prime example of the Government's being forced by indexation elsewhere rightly to protect a vulnerable 550 section of the community and to accept an extension of indexation. However, I believe, as I have said, that we should not accept any indexation.
The report deals with fiscal and statutory neutrality and with the argument that all financial institutions should suffer the same tax laws and legal obligations. Surely pension funds, building societies, trade unions and other similar institutions should be subject to the same types of laws as are companies. For instance, should not those institutions be made to publish audited accounts and financial statements? I believe that obligation to be long overdue. The rules governing pension funds in the Trustee Investments Act are way out of date and totally unsuitable for modern pension funds in general.
The report deals with discriminatory tax. By favouring the institutions over the individual, as comes out clearly in the report, savings are diverted from the individual and pushed into massive institutions. The savings institutions tend to be risk-averse. They are the wrong places to put the savings of those who wish to take business risks with their savings. If taxation were more nearly equal, people would keep more of their own savings and invest them themselves, often being prepared to take more risk and to follow their investments in detail.
I turn to pension funds. Funding is most important and should be required by the Government to protect the promises made by the pension funds. In France, where pensions are not funded, great difficulties are being experienced. The protection of the interests of the eventual pensioner should be supervised by the Government. The £80 billion now contained in pension funds should be used not merely in the gilt market and in low equity investments but for project financing.
I agree with the recommendation to abolish the composite tax rates in relation to building societies. Building societies should be encouraged to lend against property for business purposes rather than exclusively for private property.
I turn to the subject of liquidity—the ability readily to buy and sell shares. That is a major factor in the flow of capital to industry. It is important to the entrepreneur. The big problem is that the entrepreneur does not want to give up too much, or even any, equity when he starts his company, but if he had liquidity and he could buy shares back, perhaps he would. Lack of liquidity also stultifies investment in new companies because the investor feels that he is locked in and that it will be 10 or 20 years before he can get his money out to be used in further new, high-risk investment opportunities. It also affects normal share dealings. People like to have some form of liquidity to sell their shares when the need arises.
I shall work from the liquid end downwards and begin with the Stock Exchange. It offers high liquidity but largely only in listed shares and bonds. It is the third largest share market in the world. It should be given credit for its ability to evolve in difficult times, for much of the self-policing that it carries out and for its standard of ethics. But is self-regulation in today's world, without statutory backing, really credible? I throw that in as an open question. For instance, I believe that the takeover code should be made statutory and that the matter should be made clear in law. It should be an extension of the Prevention of Fraud (Investments) Act 1958, and we must accept that as a result there will be more competition, especially from outside banks, other merchant banks and overseas investment banks. But that is what the City, as 551 opposed to financial institutions, has always accepted. It has made the City more and more competitive and successful.
As the report suggests, another major question facing the Stock Exchange is whether it is necessary, in terms of external efficiency and for the good of the country, for the Stock Exchange to hold a monopoly. I am undecided on that matter. I shall be interested to hear what right hon. and hon. Members have to say. But I am certain that a court of law is the wrong place to try the case of restrictive practices by the Stock Exchange. The court has a definitive and narrow view of the subject before it. It is unable to look at the whole of the Stock Exchange and its role in the financial community. The correct place to hear that case would be before the Monopolies and Mergers Commission, or even before a special Royal Commission established specifically for the purpose. I shall be interested to hear whether the right hon. Member for Huyton has any specific views on that matter.
On the question of gilt-edged securities, I agree that the flexibility of the Government broker should be extended to another method of issuing gilts to the market by an underwitten tender system. Flexibility tends to absorb potential volatility. It tends to reduce the volatility of new issues of gilt-edged stock.
I turn to the over-the-counter market in unlisted securities. It is a large market in the United States and plays a significant role in providing liquidity for new and small businesses before they become large enough to make a proper listing worth while. It allows venture capitalists who have invested in new companies to take out their investments and put them into more new companies. It prevents the lock-in. As is stated in the report, the Government should actively encourage the growth of an over-the-counter-market.
The Government should review the special privileges of the Stock Exchange compared with the over-the-counter market. Is it fair that a jobber may trade on a 50p nominal stamp while a licensed dealer in unlisted securities has to pay 1 per cent? Is it fair that stamping facilities are offered on the Stock Exchange but not outside? A licensed dealer has to go to the stamp office. Is it fair that the jobber has special rules about insider dealing that do not protect a licensed dealer in unlisted securities? There should be a thorough review of the special privileges held by the Stock Exchange, even in its unlisted tradings, under rule 163(2). Many of the privileges should be extended to licensed dealers in the over-the-counter market. Once again, I should be interested to hear the views of the right hon. Member for Huyton on that subject.
Working down the scale, I believe that anyone in Britain who is able to sell or buy shares or bonds from the general public should be licensed and qualified but that he need not necessarily be a member of the Stock Exchange. That is the position in the United States with the National Association of Securities Dealers, which deals closely with the New York and American stock exchanges. The same thing should happen in Britain. The Stock Exchange could set the examinations and everything could be carried out under the auspices of the Stock Exchange, but the licensed dealer could set up on his own in unlisted securities without necessarily being a member of the Stock Exchange.
Discount houses are an important element in financial liquidity. They have been valuable to the Bank of England because they provide a marvellous liaison service between 552 the Bank of England and about 400 banks and financial institutions. I agree with the new method whereby the Bank of England deals with the discount houses at market rates. While that system may create more volatility in short-term rates, it gives the Bank of England a more accurate feel for real market rates. Most important of all, it helps to take politics out of the minimum lending rate, and I heartily support that.
My final question on liquidity relates to Treasury stock, or the ability of companies to buy their own shares on the open market with post-tax profits. That has been practised in the United States for many years. It is a major factor when an entrepreneur begins his own company, when he considers whether—and, if so, how much—he is prepared to yield equity to the initial investor. If he feels that at some time he can buy out the investor—either wholly or in part—through Treasury stock of his own company, it would provide a major incentive for him to allow equity to go into outside hands. That is one of the largest brakes in Britain upon the growth of new companies. How do we persuade entrepreneurs to look for more outside investment? I realise that the whole of that subject is currently under consideration in Britain, but the process is slow. I wonder cynically whether it is a genuine concern about creditors and the protection of shareholders that slows down the process or whether the Inland Revenue is more worried about the system than anyone else. I urge my right hon. Friend the Minister to realise that the matter requires urgent action.
I turn to the City itself. It is an international institution, the raw materials of which are the talents that it attracts, including people from overseas. That is important. In controlling the City, there is always a subtle balance between control, regulation and supervision against the freedom to innovate fast and flexibly, and therefore to succeed in highly competitive and rapidly moving international markets. That has been the great strength of the City. An example is Lloyd's of London (Insurance), which depends on the many companies, such as shipping companies, that use its services. One of the many problems that it is facing from the Inland Revenue is the subject of deemed domicile. This is tending to push ship owners and operators outside the United Kingdom, and with them go earnings from Lloyd's and the jobs that they create, not only in the City but throughout the country, from ships' chandlers to film makers.
I wish to refer to the new Lloyd's Bill. The Government should support clause 11, which relates to the ability of the council of Lloyd's to have some limitation from complete liability, so that it is liable only for criminal fraud and negligence. Otherwise, the council will tend to over-regulate within Lloyd's and damage its underwriters' ability to insure competitively in the world market.
I deal next with the Securities and Exchange Commission and the Committee on the Securities Industry. I am extremely glad that the report did not recommend a British version of the American Stock Exchange Commission. I worked under that for three years on Wall Street, and I saw the way that it caused delays, often creating marketing problems for new issues of bonds and shares and huge bills for companies in terms of legal expenses. Also, and most dangerous of all, there is a tendency for the responsibility for due diligence to be removed from the lead manager in a new issue of shares or bonds. Despite all formality and the disclaimers on the prospectus, an investor tends to feel that if the issue has 553 been through the SEC it is all right and he does not have to look at the prospectus. The responsibility for due diligence is removed from the lead underwriter. That is a dangerous trend.
On the Committee on the Securities Industry, all the main activities for the financial institutions should be governed by statute, which would set the framework, and from then on each activity should be self-regulatory, like the Stock Exchange. The Committee on the Securities Industry should act as a general strategic co-ordinator and appeals body and should not be involved in the day-to-day tactics of running the varied and very complex operations of financial institutions.
I cite as an example the Nightingale case in the over-the-counter market. That could have been heard by a CSI, rather than having to fight in a court which had a vested interest. Whatever the rights and wrongs of the case, I believe that this avenue should have been open.
On the problem of forming a CSI and increasing the number of laymen on the committee, I point to one difficulty. It is extremely difficult to find laymen who really understand the complex issues that such a body would oversee. Unless they understand the real workings of these financial institutions, they can easily be led off on the wrong track.
I turn to the Bank of England, which in my view provides one of the finest examples of supervision and freedom. It is an institution that has the admiration of the world in terms of its expertise, its integrity and its wisdom. This has been shown most recently in the Iranian hostages deal.
The Banking Act 1979 was very unpopular in certain banking circles. Some bankers even described it as the end of free enterprise and the beginning of a Nazi era. I myself believe that it was necessary, first, to replace some of the regulations that were lost in the abolition of the Exchange Control Act, particularly with regard to foreign exchange dealing. Secondly, we needed some legislation to enable us to take a step along the route to harmonisation with the European Economic Community. Thirdly, there was legitimate pressure for more prudent supervision in the Euro-markets, in respect of which there is some $250,000 million based in London alone.
To draft the legislation was an enormous challenge. To appreciate that, one has only to consider how many banks there are. There are clearing banks, savings banks, merchant banks, discount banks, foreign banks in London and near-banks, all with different activities. Even in one type of bank very different emphases are placed upon product lines. It was a brilliant Act and, although far from perfect, it was a major exercise and well achieved. The key to it is the classic way in which the Bank of England appears to be operating the Act. The Bank of England has not abandoned its direct personal contact with the banks. This is very important. It still maintains its quarterly prudential meetings and spot checks. These provide great flexibility and supervision and an atmosphere in which bankers themselves can exercise their own judgment with confidence and trust.
Before leaving the City, I mention one other matter. I see in this country—and I have seen more of it since entering Parliament—a tremendous void between the way that people in the City and in financial institutions think and the way that company directors and treasurers in 554 industry think. It is a real void, and it must be filled with a good dialogue. The report has helped, and I think that the Bank of England is very conscious of it.
In the hope of filling up some of that void, I turn now to the clearing banks and answer some of the criticisms levelled at them.
First, in looking at the criticisms, we should remember that the prime duty of a clearing bank is the protection of depositors' deposits and the maintenance of liquidity to service the demands of those depositors. Not all, but many, of the criticisms of the banks come from the one in three people in the country who do not have a bank account and have never even been inside a bank.
The first criticism is that of size. I believe that it is quite possible to be large and efficient. What is more, size offers security. If there is a city bank operating, say, just in Liverpool and Liverpool declines, that tends to make the fortunes and security of the local bank decline, whereas geographical distribution gives security. This was shown in the lifeboat exercise, when the large banks salvaged many of the small ones. Furthermore, British banks are no bigger in relation to our ecomony than are other major banks in other countries, such as Japan, Germany and France. The larger banks can offer a much wider range of services. They become like financial supermarkets.
The second criticism is that the banks fail to sell their services. That is not for want of trying. One has only to look at television advertisements to see that. But there are still 36 per cent. of the population who do not have accounts at clearing banks and 17 per cent. of the population who do not have accounts at any type of bank. A lot of this is deep-rooted conservatism. It stems from the wish to continue to be paid in cash, possibly so that wives do not see the exact earnings. However, I believe that we are changing and that when we come to the introduction of point-of-sale terminals, and so on, the British banks will be at a great advantage, with a 33 per cent. open new market.
The third charge is that the banks are not lending enough long-term. It may be that the banks have not been very aggressive. It may be that they have lent mainly on the strength of balance sheets, without looking towards future earnings, and so on. But until recently there was no need for the banks to lend long-term. We in Britain had a highly developed capital market, with very good equity and very good long-term debt sectors. The clearing banks needed only to fulfil their legitimate role in the short-term debt or working capital end of the market. It was not until the Government took most of the long-term debt money that the problem really started.
The trouble is that the banks have to remain prudent. We saw how the fringe banks moved into long-term lending operations on the back of short-term deposits. The result was that the lifeboat had to come in in 1973. The report mentions a re-discount scheme, which is extremely interesting. However, I worry slightly about its effect on the public sector borrowing requirement and, therefore, its chances of success with this Government's laudable immediate aim of killing inflation.
The fourth criticism is that the banks invest a large amount of money abroad. There is no evidence to show that these overseas investments are detrimental to United Kingdom banking. The aim is to gain overseas earnings or exports and to smooth out the cyclicality of their British earnings. Another aim is to give full international coverage, like other major international banks in other 555 countries, and to obtain a dollar deposit base to underpinthe Eurodollar operations and services that these banks are carrying out in London.
The fifth charge is that the big four banks are a cartel. However, we should remember that rate fixing was abolished in 1971. One has to understand that the headquarters of the big four banks are located fairly close to each other. They tend to watch each other fairly closely. When there is an MLR change and a divergence in bank base rates, the banks watch each other for the most successful new rate, and then all rates tend to move towards it. It is rather like Sainsbury's or Tesco's with food prices. It is a perfectly natural occurrence.
Then there is the criticism that the banks have made excess profits. In 1973 and 1980 there were very high earnings, usually related, in this country, to high local interest rate levels. However, when one looks at profit as a return on capital one sees that it was about 8 per cent., and the average return on capital over this time was 4 per cent. to 5 per cent. I do not find such a return outrageous for efficient companies.
It must be remembered that many of these profits come from overseas and are therefore export earnings. One must also consider the use to which those profits have been put. Profits in 1973 went very much into securing the lifeboat. Profits in 1980 are already being used to lend to British industry and to help companies through these times of trouble.
In an inflationary age, one must also pay attention to the need to protect the capital base of our banks. Some people argue for a windfall profits tax, but why have a windfall profits tax now when it would reduce the international competitiveness of our banks and hamper their lending to industry, which has been particularly generous, amounting to between £250 million and £300 million extra lending? Why allow the Government to waste money that is now being well spent in an extremely efficient manner?
The charge is also made that the banks have not lent enough to small businesses. But at Barclay's, for example, 35 per cent. of total lending is to companies with a turnover of less than £1 million. Barclays pioneered arrangements such as start-up loans and expansion loans.
I agree with the proposal of one of my hon. Friends for a loan guarantee scheme. If that were started, it would be useful. It would be useful at the margin, but all hon. Members should be aware that it would not be a panacea for capital problems in new and small businesses. It would help only at the margin.
I now come to the most important subject of all, one in which I specialised when I was at the Harvard Business School. That is the subject of venture capital, or the flow of equity capital to new and small businesses, particularly those that are just starting up.
The technological revolution in this country is the key to our survival as a developed nation, as is already happening in the United States, Japan, West Germany, and possibly Switzerland. The healthy growth of new and small businesses is vital to our achievement of this technological revolution and the creation of profitable jobs. We must boost companies, to enable them to grow from one employee up to 200 employees.
In the past, our agricultural and industrial revolutions were achieved in a climate of nil or low taxation. Today, we must achieve a technological revolution in a climate of 556 high taxation and low growth—a mammoth task in itself. However, the same conditions face many of our competitors.
There are many reasons for our economic decline, which can be traced back to this Chamber. This is where much of the blame must lie and where the solutions must be found. I believe that the key solution is the restoration of incentive—the incentive to work and the incentive to invest. The Government must run fast if the nation is to catch the train of the technological revolution before it leaves the platform. I therefore urge the Government to take bold and fast action to boost new and small businesses. They must be made the privileged darlings of this nation if our country is to retain the privilege of remaining a developed nation.
The Government have done many things, but, I fear, small things—too small, too undramatic, and making little impression. We need a bombshell to make a fundamental change in our attitudes. We must ensure that once again it becomes just as acceptable socially for someone to make £1 million profit from his company as it is for him to win £1 million on the football pools.
No doubt there are massive savings in this country and risks of a sort are taken. The North Sea is an example—indeed, the report cites it. However, we should remember that the North Sea is a special case. Oil was a vogue industry, like a gold rush. It was a mature industry—we all knew Exxon and the Hamilton Brothers drilling company, and so on. It was the risk end of a mature industry, so it was a known factor. It was resource financing, and the leaders in that industry who were raising venture capital had sophisticated financial contacts. That is not the case for most new and small businesses.
We need risk capital for investment, not so much in resources as in high technological ideas. That is the big difficulty. Unfortunately, in this country there is a large gap, which I call the invention-exploitation gap. How many times, after an invention in this country, do we end up paying the United States dollars to buy the production model?
Behind this invention-exploitation gap I see two further gaps—the well-known Macmillan financial gap and another which I call the education gap. I turn first to the education gap. In the United Kingdom there is a high level of technical skill but a low level of skill in general business administration. Most technicians who break away from large companies to start new businesses have no idea how to run them.
That is not so in the United States, where basic accounting and basic typing—the bridge between man and machine—are taught at school. In the United States, many people take both science and business administration degrees. People in that country are brought up to be aware of business administration, simple finance and the true meaning and implication of equity share ownership. I urge my right hon. Friend to ask the Secretary of State for Education and Science to give urgent thought to correcting that matter, with the allocation of high priorities for those subjects to be included in school curricula.
I turn now to the Macmillan financial gap. That, in turn, has four gaps. The first is the basic high-risk start-up equity gap. The second is the first production funds gap, when models have been tested and patents have been checked. That gap is usually met by bank lending. The third gap is the first equity expansion gap, which should 557 be filled by the over-the-counter market. The fourth is the major equity expansion gap, which is filled by a merger or by a Stock Exchange listing with a public issue.
The high-risk equity gap is the most difficult to fill. Why should that be, especially when there is much opinion in this country—also contained in the report—that there is plenty of money available but simply no demand? I agree with that bald statement of availability and demand on the surface, but I question whether it is the right type of money. Is it the right product? Is it in the right hands? If so, who knows whether or not there is demand for the right product?
Most money is available in the form of debt or loans, but what is needed is high-risk equity. Thanks to the discriminatory taxation that favours institutions against individuals, most money savings are in the hands of those institutions that like lending money and investing in gilts and low-risk equities. They are not good at taking high risks in their equity investments. Those institutions also tend to be far removed from personal contact with budding entrepreneurs and do not have the investment staff available to follow up on small investments.
I well understand there being little demand for start-up debt, particularly with these high and volatile interest rates and with banks historically asking for personal guarantees. How can we solve that problem?
In the report, there is the interesting observation that a change in the nature of credit leads to a change in the demand for that credit. Thus, could we, by changing the nature of investment money for start-up from debt into high-risk equity, actually create a demand for it? My answer is definitely "Yes". The market for hula-hoops—or skateboards, as mentioned in the report—did not exist, apparently, before it was created by the product. Surely that can be done here, with money.
However, how can we change debt in the hands of low-risk-taking institutions into equity in the hands of high-risk-taking individuals? How can we break the classic savings cycle, from individuals to institutions which invest in gilts, which means the Government, or into loans to companies? The answer is a massive programme of tax incentives and tax equality.
First, we must remove the tax privileges from institutions to ensure fiscal neutrality. Individuals will then take control of their own savings, and individuals with personal contact with future entrepreneurs are the best high-risk equity investors. Second, we must give massive tax incentives to individuals—with upper limits, of course. Investment in equities in new companies should have a 100 per cent. deduction for income tax purposes in the year of investment, regardless of loss. How pessimistic we are—we give that right only if the company loses. We should give it immediately on investment as an offset against income tax.
All gains in investment in new and small businesses, particularly new businesses, should be free of capital gains tax and a privileged rate of capital transfer tax should be adopted. I hope that the Minister will realise that these incentives must be clear and dramatic. They must mean more. That is why I use the word "free". I do not believe that people calculate at the margin. They see either that they pay tax or that they do not pay tax.
If new businesses were given these incentives, I believe that the investment in new and small businesses would 558 become the vogue in this country—a vogue in which we could all participate. Massive funds would become available as high-risk equity and demand would rise. However, it will take time and the matter is urgent, so in the meantime we must make use of small firm investment companies similar to the SBICs in the United States, as mentioned in the report.
We should also make use of the loan guarantee scheme and of trade organisations. For instance, my company, the Goldsmiths Company, is closely in touch with the jewellery business and so on. Why cannot people of great judgment and integrity who run such companies be used in this flow of money to new companies and be given incentives?
Use should also be made of the commercial banks, which have a vital role to play. There are 13,000 retail outlets in this country, and their managers are in personal contact with people, with the entrepreneurs of today and tomorrow. Many commercial banks are often the main, and sometimes the only, point of contact that small firms have with the financial institutions. Local bank managers may not be the best people to make high risk equity investments, but at least they are the best available: they have the contacts and they have financial judgment.
The Government should first require and secondly encourage the banks, with tax incentives, as they do for leases, to establish pools of high-risk capital up to a certain percentage of their capital, for the banks to invest in high-risk equity in the United Kingdom. Create the right product and distribute it, and I am sure that demand will materialise.
On a split vote, the report recommended the formation of a new investment bank to invest in new and small businesses. We already have 28 agencies or companies doing just that and we definitely should not have another such institution or quango. It is not institutional investors but individuals who are good at taking high-risk equity decisions. We must set those individuals free with liberal tax incentives, by which I mean large amounts of money.
I therefore recommend to the Minister that the Small Business Counselling Service, for instance, in the Department of Industry, should be merged with CoSIRA in the Department of the Environment that they should be made independent but jointly funded to ensure that rural areas are properly taken care of.
On the other side of my suggested tax incentives is the expense side. But we must remember how much money is going to British Steel and British Leyland. I am thinking in terms of large tax incentives. Bold and dramatic action must be taken urgently to boost new and small businesses.
I apologise to the House for having spoken for so long. I remind the Minister of my requests. Finally, may I say that I believe that the House and, indeed, our nation owe a great debt of gratitude to the right hon. Member for Huyton and his committee for this outstanding report.
§ Sir Harold Wilson (Huyton)
I am grateful to the hon. Member for Winchester (Mr. Browne) for what he has said, and I think that we are all grateful to him for having chosen the opportunity granted him by success in the Ballot to enable the House to debate this somewhat voluminous and difficult report.
The historians have told us that there have been 22 inquiries into the City of London and the financial institutions since the days of Walpole. In the memory of 559 older Members, there was the Macmillan committee, under Lord Justice Macmillan, not Harold, which reported in 1931, and the Radcliffe committee, which has been referred to, in 1959.
The Macmillan report, although produced by a small committee, became a classic, mainly through the working together of Keynes and Ernest Bevin. Radcliffe was the first articulate presentation of the doctrine and the mysteries of money flows. That was a report which I came to know well—I could bore the House with it at length—in my days as Shadow Chancellor many years ago.
The Committee to Review the Functioning of Financial Institutions was set up by my right hon. Friend the Member for Cardiff, South-East (Mr. Callaghan), then Prime Minister—a decision which he announced on the eve of the 1976 Labour Party conference, where a number of resolutions had been tabled in favour of nationalising the clearing banks and some insurance companies. My committee of course considered those aspects and proposals, although, as the report shows, our priorities went much wider and deeper than that particular issue and at the end of the day our decision as a Committee against the nationalisation proposals was a unanimous one.
The report makes clear the tremendous changes which in less than 20 years have made the Radcliffe report as dead as the dodo. It highlights in particular three differences from those days, although it is easy to identify well over a dozen. Of the three that are highlighted, the first is the rise in the importance of the building societies, now the major channel through which individuals accumulate liquid deposits, outstripping the clearing banks. The second is the increase in the ownership of securities by the financial institutions, especially by the pension funds and insurance companies. Of course, part of the insurance total as recorded reflects the fact that insurance companies manage some of the pension funds.
Thirdly, the report picks out the great changes in the banking system and the nature of the methods of inter-bank competition which have been referred to, especially, of course, the arrival of so many of the foreign banks in the 1960s. There are also all the implications of the decision of a previous Conservative Government to introduce competition and credit control in 1971, one of the consequences of which was the abandonment of the interest rate cartel.
Despite the somewhat languid performance of the British economy under successive Governments, what has been significant is the large inflow of foreign banks and the increase in their share of domestic sterling deposits with the banking sector—from less than 2 per cent. in 1964 to nearly per cent. in 1978—and their share of market loans and advances, both in sterling and in foreign currencies, which have increased over the same period from 7 per cent. to 28 per cent. of the total.
At the end of 1978, the foreign banks, mainly American, had gained a 31 per cent. share of bank lending to British manufacturing companies. I think that there were two reasons for that. The first was the time factor. It is well known—it is in all the textbooks—that the London market is conveniently placed for timing. It opens before Singapore and other Far Eastern markets close and it is still functioning when New York begins to get going.
When the American banks gave evidence to the Committee, their report was a rather arrogant one. They were less arrogant under questioning by my colleagues. I am thinking of one or two, particularly Sir Kenneth Cork, 560 in this context. When I asked them why, in view of what they regarded as the fuddy-duddy attitude of everone in this country, they had come here in such numbers, they replied that it was due to British expertise in financial matters. Britain was the only financial centre capable of handling the job that they felt they had to do. So they accepted our apology and went on.
These three are not the only changes since Radcliffe. These past 20 years have seen the end of the Bretton Woods system, floating—or rather intermittently managed floating—of exchange rates, British membership of the EEC, with some ill-informed and doctrinaire attempts on the part of some EEC countries to try to teach London to suck eggs, in certain respects where we know better. They have seen the five-fold increase in oil prices and the commodity boom, the growth of the regulation of trade and the rise of protectionism in country after country. During that period have emerged the problems of regional assistance, competition and credit control, price controls and pay policy, the decline of the private investor due partly to inflation and partly to policies, the growth in pension funds, now accounting for over 60 per cent. of the ownership of the equity of our major institutions and businesses. We were looking at a world as different from that of the Radcliffe report as that which Rip van Winkle perceived when he produced his report on the state of the world around him.
The committee held 55 meetings at plenary level and 18 of those took oral evidence. The committee accepted my suggestion to visit Edinburgh to take evidence from the Scottish Development Agency and the Scottish clearers, who were unanimously congratulated on having produced the best evidence of all and who got the prize—which was purely honorary. We operated in sub-committees. Many of our busiest members from every walk of life were set to work in afternoons, if we had been meeting in the mornings, simply to identify the questions. They were not allowed to make reports even to the main committee as to the answers—that was for the main committee. But they could, at least, try to see what the questions were to the answers, which, as everyone knows is sometimes a more difficult problem than trying to find the answers to the questions.
We were gratified by the quantity and the quality of the evidence, not only for the evidence for our own use but because of the wide response to our suggestion that anyone submitting evidence might consider publishing it, as a process of general education, for everyone else to read. That helped to fuel a useful debate outside the committee and in financial and industrial circles which was of great value to us.
The House will be familiar with our interim and specialised reports, to which reference has been made. The first was on small businesses and the Andrew Bain report on North Sea oil, where the committee—and no doubt some hon. Members when they read that report—were surprised to find that the clearing banks north and south of the border were operating on an equity basis. Considering the delays in yield of the North Sea operations, and the sigh and speculative risks, that was remarkable. It was not that oil was not there. Of course it was. But there was no guarantee that it would be found in the particular hole that had been bored in the sea bed. That goes far beyond the usual practices of clearing banks.
I have referred to the vast fluctuations before and during our hearings in, for example, money stock, as broadly 561 defined by M3, which grew by more than 25 per cent. in 1972 and again in 1973. Between March 1971 and May 1972, which was the peak month, equity prices rose by over 75 per cent., while from 1971 to 1973 house prices doubled and commercial property prices probably trebled, not to mention the boom in commodity prices. There was all this and the Middle East war with the trebling in oil prices and the tremendous burden placed on our balance of payments, which members of the incoming Government of 1974 will recall. The commercial and industrial company sector in the early 1970s was in deficit by £1.2 billion per quarter, more than twice the deficit of any previous year, although it was in deficit for six out of the seven years preceding our report.
I have referred, as did the committee, as one of the most fundamental issues, to the development of savings through insurance and, more particularly, pension funds. I am not claiming that the committee discovered this manifestation, but it was little realised in the country, the House and the press. For example, for my last 25 months in Government, 1974 to 1976, I discovered in Hansard, which is usually accurate in its index, but not 100 per cent., that only four questions about pension funds were asked by any hon. Member. Three of those were about the benefits. The fourth, which was for written answer, was so difficult to penetrate in its significance and meaning that I failed to do so. I gather that the Department also failed because it gave an equally meaningless written reply to the question. That measures the interest that we took in pension funds or perhaps it showed the lack of knowledge that we had of pension funds on both sides of the House.
But now the facts are no longer questioned. In 1978 the net inflow to long-term insurance company funds, plus the self-administered pension funds, was amounting to nearly £9 billion and steadily increasing year by year. Up to that date £31 billion had been stashed away as a cumulative total, and in the next year or two it will reach nearly £100 billion.
There is no doubt that pension funds now dominate the economy. On the basis of the criteria that their governing trusts require them to follow, they decide whether to support or to refuse to support a Government gilt-edged stock issue at a given rate of interest, to take it up or to boycott it, and in doing that—I am not saying this critically—the pension funds have no option. It is their duty. The duty laid on them by the trust, and by legislation, is to that boy or girl who left school in your constituency, Mr. Deputy Speaker, or mine last year. If that person has been successful in securing employment, which is doubtful in many of our constituencies, when he or she leaves employment in about 2028 he or she will have a pension, inflation-proofed as far as possible, which may be related to earnings during that time or to earnings on retirement.
Pension fund trustees have become a most powerful sector of the financial community, more powerful and more arbitrary then any Chancellor of the Exchequer of any party. There are exceptions, but they are virtually unaccountable in any real sense. At the end of 1978, 53 per cent. of the assets of pension funds were in company securities and they already own more than 60 per cent. of the equity in the principal 200 or more public companies.
It makes one laugh to consider the arguments we have had in the House about nationalisation, one party in favour 562 of extending public ownership and the other party against. But it has been happening all the time without anyone mentioning it in the House. Some of those who have been advocating nationalisation of industry will wake up one morning and find that they have it. When they find that there is a pension fund running it they will wonder what they will do with it and how it will be managed. I do not blame the pension funds. They have their job to do in matters of money, and they have begun to encounter difficulty in finding areas in which to invest profitably and safely, as they must in discharging their duties. Their concern is, on behalf of the many millions of their beneficiaries, to maximise investment income. They have no other duty or responsibility. They have none to the economy, none to industry. Their only duty is to that boy or that girl that I mentioned of the 2028 vintage.
It is no good criticising the pension funds for purchasing works of art. If they and their advisers believe that those items will appreciate more in value than alternative areas of investment, it is their job to do that. What is more, there is some suggestion that they are being proved right. No one can be didactic and certain about these matters.
I met the National Coal Board trustees who, not uniquely, although it is fairly rare, include some trustees drawn from current mining employment or retired miners. Some boards of trustees contain no one from the employees' side. I was interested in their activities of social concern. As I have said, their first duty is to get a proper return, but, conscious that their industry has over the centuries despoiled the countryside and many small towns, they are devoting some of their pension fund investment to cleaning up the face of such areas. They are making a good job of it. They can do that, however, only if it is financially remunerative.
Another pension fund is going in for city centre development. It took a big decision to change its policy a year or two back and is now embarked upon some massive city centre development—in the area of the Rue Royale and the Champs Elysée. Certainly that is questionable, but if it promises a better yield for investment funds that is its duty—indeed, I think that it is its legal duty.
Some pension funds have recently been investing in agricultural land, which is probably a good investment for them. More recently we heard of an interest in investing in forestry—buying up vast forest areas. Apparently, the period from planting a tree to sale is not very different from the average industrial working life of the boy and the girl I was referring to. It is a very convenient investment form, but who would have forecast that?
I have referred to the pension funds revolution having occurred with no formal notice, and without debate or decision in this House. There have been arguments in this building for over a century about nationalisation, communal ownership of industry and the like. With hardly a question to Ministers or a clear debate there has been a massive takeover—a community takeover, not nationalisation, with scarcely a debate or any knowledge of what was happening. The only legislation on the subject was introduced by my noble Friend Lady Castle. It was regarded then as purely a development in social services. But it has proved to be the greatest revolution in the ownership of industry in our history, and, consequently, for urban development areas, agriculture and forestry, not to mention the great revolution in the gilt-edged market. 563 I do not think that any of the Ministers concerned or Members of Parliament of the time realised that this would be a consequence. I certainly do not remember it being raised in debate.
Inevitably this revolution has implications for our company law and structure. Should the pension funds, for example, nominate directors to those companies in which they hold 60 per cent. of the equity. Of course, they cannot all appoint directors to Unilever, ICI or whatever the firm may be, company by company. In practice, some managers keep in informal touch. That has developed a lot in recent years. When in trouble they invoke City institutions to advise them. In serious cases they call in the Bank itself and even the Governor of the Bank.
Our report emphasises that this ownership revolution in industry strengthens the case for independent non-executive directors, though once they are appointed their duty is not just to look after the interests of the pension fund. Of course they owe their loyalty and service not to any institutions, but to the whole body of shareholders.
I have no time, without trespassing further on the patience of other speakers, to go into such questions as stock relief, an issue which, as has been said, needs further examination, or the role of non-executive directors in banks. But hon. Members who have studied the report—and those who have read right through it have my sympathy—will have noticed a number of points on which the committee did not have a single agreed view but where nevertheless we felt it right to state the arguments.
That is more useful for the House than for us simply to make no reference because we could not agree. There is, for example, the topic of self-investment by pension funds in their firms. Should the pension fund of a particular large corporation be precluded from investing in itself—in its firm. There is a big argument on that matter and we did not reach agreement on it. I think that GEC is the leading company here. No one has questioned—so far, at any rate—its ability to guarantee ultimate payment in respect of its fund contributions.
Of course, major firms of great integrity and high repute have got into difficulties. One day they have been regarded as being as safe as the Bank of England. The next they have sent for a receiver. One must consider all the possible consequences for trustees. It was therefore a difficult matter for us to reach agreement about.
I have dealt with the question of pension funds at some length because, despite their importance and sheer weight, they have never been debated properly in this House. In spite of their accumulation of funds rising from £8 billion in 1978 to £100 billion in the very near future, their holding 60 per cent. of the equity of major companies, to say nothing of other investments in industry, agriculture, town development, forestry and the rest, the funds we are talking about involve not much more than 40 per cent. of the working population. They do not cover a complete area of industry or services.
Civil. Service pensions, of course, are not funded. There will always be a Civil Service. Parliament over the centuries will, I have no doubt, vote the pensions involved. In between private industry and the Civil Service is a hinterland which is neither one nor the other, and which was created by this House. That is the whole area of publicly owned industry and services. The question is whether pensions practice in these industries should be based on the Civil Service—these industries have something in common with the Civil Service and are dealt 564 with on a pay-as-you-go basis—or whether they should be regarded as industries or services which are comparable with and, in most cases, historically derived from private industry? It is easy to generalise.
When my colleagues and I met the British Rail pension fund we discussed the similarity of its industry with the Civil Service and asked whether it should be treated on the same basis. It replied, however, that it was comparable with private industry, for example in its vulnerability to redundancies. It quoted figures showing that over quite a short period in the 1970s the number of jobs in British Rail fell by more than a half. Therefore, should it and can it fund?
I have no time to go into other areas of investment—unit and investment trusts, and so on—or into our analysis of the financial market or the great changes and massive figures involved in public sector, government, local authority and public corporation activities. I must, however, refer briefly to building societies where our recommendations have been much criticised—certainly by the building societies and by some commentators who are sympathetic with them.
Between the end of 1957 when Radcliffe was at work and the end of 1978 building society assets rose sixteenfold. The figure went up from £2.5 billion to £40 billion. For individuals they had becomethe major source of borrowing and one of the principal avenues for savingmainly at the expense of national savings certificates and bonds and the savings banks. The share of the deposit market held by all forms of national savings fell from 33 per cent. in 1964 to 16 per per cent. in 1978—more than halved in 14 years.
I shall refrain from going fully into our findings and recommendations on building societies, controversial as I know them to be. I recognise that, historically, they arose from the creation of a new instrument for the workers' savings, not to mention the workers' housing. For that reason, they have been historically regarded as belonging more to the friendly society movement than to any part of the economy, and they are still supervised by the Registrar of Friendly Societies. I recognise that there is strong criticism of their spread in the high street. There are far more building societies than any other organisations to the detriment of the rents charged to people who want to set up shops, and to the annoyance of the banks. The building societies reply that they are open on Saturdays when they are most needed.
We have suggested a different form of accountability for building societies, and I am in no doubt that the merger movement, which has been picking up speed in recent years, will continue. The building society movement is less than enthusiastic about our proposals on taxation, but that matter has now been passed to the House.
§ Mr. Leslie Spriggs (St. Helens)
In view of my right hon. Friend's comments on the financial institutions—we are grateful for the information that he has imparted to the House this morning—and in view of the large public funds, would it not be more reasonable to adopt a policy by law to give all shareholders voting rights?
§ Sir Harold Wilson
That raises a very big issue, as my hon. Friend will see from studying the report. We have stressed that some of the pension funds should be more answerable to the people for whom they were set up. My hon. Friend knows more about the railway industry than 565 I or many other hon. Members. I referred a few minutes ago to the fact that there seems to be, or has been in the past, little employee participation in these matters. I do not think that it is still true, but we were told at the time that the railway unions were not represented on the pension fund but only on investment committees. That is a matter for the unions with which my hon. Friend has been associated.
On the question of the reference of the Stock Exchange to the Restrictive Practices Court, involving the dual capacity issue and the question of the division of duties between brokers and jobbers, and the vital issue of the over-the-counter market, including the issue of statutory parity and equality before the law in respect of such dealings, I hope that a lot more thought will be given by all concerned to the problems.
The reference of the Stock Exchange to the Restrictive Practices Court was criticised by the committee on pages 105 and 106 of its report. We do not believe—I doubt whether the House believes—that those matters, including the question of dual capacity, are properly justiciable issues. There is, in any case, no corpus of law—decided by this House, by Parliament—on which a court of judges can base a verdict or ruling, or even a volume of relevant case law. It is a question of what works best in the interests of the market, industry and all who are served by the institutions involved. I have not found that judges are used to giving their decisions purely on the basis of the evidence put before them. They are not necessarily the most flexible people in dealing with rapidly changing industry and industrial practices. However, the reference has been made and we shall all learn much from it one way or another.
To my mind, there is a need for the Government and all concerned with our financial institutions to examine an issue with which we were concerned and on which more needs to be done: the whole question of extending to the independents outside the Stock Exchange proper—the British Association of Security Dealers—the main statutory concessions that have been granted to the Stock Exchange.
I hope that the Government will look seriously at what the committee said on that matter. The issue is one of statutory parity for the over-the-counter market with the established Stock Exchange. We have a clear recommendation in the interim report about the financing of the small firms. The House will be aware from the report, and more nerally—many hon. Members will know of it directly—of the work done by firms such as Nightingale's in respect of the launching and, frequently the expansion, of fairly small firms.
But compared with those firms, the Stock Exchange has a number of statutory advantages. For example, it has no licensing requirements under the Prevention of Fraud (Investments) Act 1958. It is able to grant exemptions from the prospectus requirements of the Companies Act 1948. It has a simpler stock transfer system under two Acts. Only Stock Exchange listed securities qualify as trustee investments under the 1961 Act. It has various taxation benefits, including exemption from close company provisions under the 1970 Act. It has various securities valuation benefits, including that insurance companies may value Stock Exchange listed securities only at market price while over-the-counter or unlisted 566 securities must be discounted according to a formula set out in the 1976 Act. There is insider dealing exemption for Stock Exchange jobbers under the 1980 Act, and so on. That should be examined. Parliament made one important amendment in the Finance Act 1980 to assist over-the-counter dealers. It widened the stamp duty concession of section 42 of the Finance Act 1920 to include market-makers other than Stock Exchange jobbers. That is obviously welcome, but there are other areas in which advances could be made.
This matter should be pursued. It is not in any way a party matter, and on the question of a possible secondary market I should like to suggest that one or two Members from both sides of the House who are concerned with this vital issue of competition and small firms might get together informally to see whether between us we could agree on any proposals to put to the Treasury. I do not wish to leave all the work to the Treasury. There is a great expertise in this House that could be mobilised for this purpose. I would also have a chance to spell out in greater detail what my committee had in mind under the headings that I have just given.
I should like to mention one particular recommendation affecting England. As I said, we were impressed by the work of the Scottish Development Agency and the Welsh Development Agency. England is left out from the operation—apart from the operations of COSIRA in rural areas and small towns with a population of not more than 10,000. For that reason, in our small firms report we recommended an English development agency to operate in industrial areas—obviously called COSURBA. It would begin by extending COSIRA's activities to urban areas and building on them. COSURBA, like COSIRA today, would operate—at least at the start—under the guidance and motherly care of the Development Commission that was established by Lloyd George at the beginning of the century.
I refer to one issue in our report where the Government have already begun to move—the question of index bonds. That is dealt with fully in the report and the arguments are set out in chapter 17. Obviously, we do not recommend a totally index-linked economy, but we agreed that, as an experiment, the impediments that made it difficult for companies to issue index-linked securities should be removed. We were divided half and half on a recommendation to encourage experimentation, not only on index-linked gilts to help the private sector to provide index-linked pensions but also on index-linked mortgages to help first-time borrowers and to encourage investment in housing. The Government have now begun to move with "Granny" bonds, and to that extent they rejected the argument that index-linking not only recognises but intensifies inflation. In my view, there is now a case for generalising the principle beyond the "Granny" sector. I hope that the Government will consider this very seriously.
More widely, I hope that the Minister can tell us today of some progress on implementing some of our key recommendations, and that he will not be slow on future occasions, as the Government's inevitably careful and thorough consideration of our proposals will enable still more of our recommendations to be turned into reality.
§ It being Eleven o'clock, Mr. Speaker interrupted proceedings, pursuant to Standing Order No. 5 (Friday Business).