HL Deb 22 November 2001 vol 628 cc1322-8

8.3 p.m.

Lord McIntosh of Haringey rose to move, That the draft regulations laid before the House on 22nd October be approved [8th Report from the Joint Committee].

The noble Lord said: My Lords, I beg to move that the draft regulations that were laid before the House on 22nd October be approved. This may be a farewell symphony.

The regulations set out the legislative structure for CREST, which transfers securities electronically without using certificates. The legal framework for CREST is currently provided by the Uncertificated Securities Regulations 1995. This new instrument would re-enact those regulations but with modifications. We had hoped that the changes could have been introduced by amending the Companies Act 1985, but it soon became obvious just how many changes were needed in both primary and secondary legislation. We did not think that that was helpful so we decided to revoke the 1995 regulations and to reenact them in the modified form that is before the House.

The regulations will improve CREST by bringing in two new reforms: first, the electronic transfer of title, which is known as ETT; and, secondly, delivery versus payment in central bank money, which is called DvP in central bank money. The main advantage of those changes will be that legal transfer of ownership of securities and fully secure payment occur together at the same time. That will bring the UK financial infrastructure to the forefront of international best practice.

There is strong support from the City to implement ETT and DvP because settlement is an important source of revenue and a determinant of the location of financial activity. Because issuers and investors nowadays have greater choice over where they do business, it is essential that the UK remains attractive to them. ETT and DvP will not only bring direct benefits but also be an important factor in maintaining the UK's competitive position.

In view of that widespread support and the highly technical nature of much of the legislation, I do not propose to detain the House with a lengthy explanation of the regulations. However, there are a couple of points that deserve a slightly fuller explanation, the first of which is the electronic transfer of title. When someone transfers an uncertificated security the operator—currently CREST—debits or credits accounts in the system. Notification of the change is sent down a secure network to the company registrar, who updates the register where legal title to the securities and membership of the company is recorded.

The draft regulations define a new concept—the "operator register" of uncertificated shares. In IT and data terms, the registers would be largely the same as the current CREST set of share accounts but would have the legal status of a register, so a change in the register would represent a change in legal ownership. That is the electronic transfer of title. The draft regulations would impose on CRESTCo certain responsibilities concerning keeping the operator register and set out in statute the relationship between CREST and companies and other issuers. They would also make changes for gilts and corporate bonds that are similar to those for shares.

The other main change involves payment for the security. Payment in CREST is made via a number of settlement banks. When the securities are delivered through CREST, the buyer's bank agrees to pay the seller's bank; final payments between the banks are made across accounts at the Bank of England at the end of the day. The buyer's bank guarantees the payment to the seller's bank. However, the seller's bank is exposed to the risk that the buyer's bank becomes insolvent during the day between delivery of the securities and the end-of-day transfers.

That system has served CREST well but it involves settlement in so-called commercial bank money. There is a better international standard—"delivery versus payment in central bank money". That removes the risk of the settlement banks being exposed to each other during the day; instead, they settle their payments to each other immediately on a gross basis. That process requires a higher level of liquidity: each bank must have more cash in its account at the Bank of England if it has to settle each of its customers' payments immediately than is currently the case. At present, payments are settled (on a net basis) only at the end of the day. The Bank of England has made arrangements to provide a higher level of liquidity for the buyer's bank to pay the seller's bank.

The Bank of England needs some collateral to support that liquidity. To provide that, the buyer's bank will "repo" the shares being purchased to the Bank of England, temporarily obtaining sufficient central bank money to enable the seller's bank to be paid. For DvP in central bank money, that repo needs to be automatic and the regulations have been modified to allow CREST and the Bank to set up such a facility.

During a debate in Committee in the other place, Howard Flight made a constructive and helpful contribution on some detailed legal points. A definitive answer was given in Ruth Kelly's letter to the Committee of 15th November, which was placed in the House of Commons Library. It may interest the House if I refer briefly to two aspects of that letter—they address significant points.

Howard Flight asked about what would happen if the operator's approval were withdrawn. First, there would have to be a consultation period of at least two months. The operator—and others—could make representations. The possible implications of a withdrawal would be assessed and decisions would be taken about what needed to be done as a result. If approval were then withdrawn, there would have to be at least three months' more notice. To make sure that the change took place in an orderly way, the regulations allow transitional provisions to be put in place.

Mr Flight also asked about the issuer's liability if the operator makes a mistake. Broadly, the draft regulations state that the issuer cannot be held liable unless he caused the problem. The regulations provide for no-fault liability on the operator in some circumstances but put a cap on that of £50,000 per instance. That £50,000 maximum broadly reflects the size of retail transfers.

I apologise for detaining the House with a somewhat complicated explanation. That is, however, inevitable given the nature of the subject and the importance of getting the details right. The regulations will enhance the competitiveness of the UK financial markets and will be greatly welcomed in the City. I commend the regulations to the House.

Moved, That the draft regulations laid before the House on 22nd October be approved [8th Report from the Joint Committed.—(Lord McIntosh of Haringey.)

Lord Hodgson of Astley Abbotts

My Lords, I am grateful to the Minister for the characteristically clear explanation that he has given and, in particular, for the additional information about the follow up to the questions posed by Howard Flight in another place.

This is a technical matter, but none the less, an important one as it affects the transfer of billions of pounds worth of shares every day which affect all of us, whether we are direct investors, pension fund members, or whatever. The public focus tends to be on the Stock Exchange, with lads in red braces, in front of flashing TV screens. However, the settlement procedures may be behind the scenes and appear unglamorous, but nevertheless they are vital to the economy and represent a substantial element of dealing in securities. I shall return to that subject later.

I welcome the regulations because they move the London settlement platform forward. They will bring it up to date, as the Minister has told the House, allowing electronic transfer of title and reducing the risks in the financial settlement of share bargains. I hope that the Minister will not feel that I am ungenerous if I say that I believe that he deserves two cheers and a third cheer will depend upon the replies that he may give to questions that I want to raise tonight.

I have two specific points. The first contains the structure. As I understand the matter, under Regulation 4, applications are made to the Treasury to become an operator and under Regulation 11 the Treasury has the power to delegate the oversight of a scheme to the FSA. I presume that that power will be exercised and I also presume that only one operator, CRESTco, is currently envisaged.

Does the Minister believe that there is likely to be more than one operator, one of whom may be based outside the United Kingdom? If one presumes that there is only one, the regulator will have one "regulatee"—one person to regulate. In those circumstances, it seems to me that the relationships between the two may change. The line between the regulator and an operator may become blurred. There could be a wash-over from the other sections of the financial service industry for which the FSA has responsibility. There are also concerns that there could, under certain circumstances, be conflicts of interest in regulatory duty.

I do not seek to criticise the FSA, but I ask the Minister whether the Government believe that any organisation, however well funded, managed and directed, can take on the increasingly diverse regulatory burden that currently is being laid upon the FSA. No doubt the Minister will recall the debate last night on the resolution put forward by the noble Lord, Lord Levene, during which there was reference to the resources of the FSA and its capacity to discharge them. Can the Minister tell the House whether he is satisfied that this particular approach—the delegation under Regulation 11, assuming it will happen—is in fact the right way to proceed?

My second concern is about shareholder democracy. The ability to hold to account is as vital in a company as it is in a legislature. In recent years there has been concern that shareholders have become more distanced from the companies in which they invest. That is partially because of dematerialisation and partially because of the effects of PEPs and ISAs, as individuals who hold shares in those do not receive interim and annual reports. Therefore, I seek reassurance from the Minister that, in the Government's view, these regulations do not pose further practical problems for shareholder participation. In a debate in another place, to which the Minister has already referred, Howard Flight raised this issue. Reading the transcript of those proceedings, I did not find the reply of the Economic Secretary to the Treasury wholly convincing.

I also want to raise a strategic issue. These regulations are not the end of the issue, but merely the beginning of the new world. If we are to bring about in Europe the efficiencies of the capital markets that have so benefited the United States of America, there is much more to do. The purchase and sale of shares has three stages: the exchange, which is the price agreement; the settlement, which is the payment; and the registration of title, which is the transfer of ownership. Very properly, the Minister drew attention to those in his opening remarks.

In the United States of America the approach has been to deal with those matters horizontally; that is to say, to create stand-alone organisations, competing with one another in each of those separate functions. In this country, in the City, we are attempting to follow that horizontal approach. Our fellow EU members are not all convinced of the rightness of that approach. They prefer to use the vertical model, combining exchange, settlement and registration in one organisation. Moreover, they combine those in one organisation with each country having its own separate organisation. That leads to duplication and inefficiency; it lacks transparency; and can lead to cross-subsidy.

It is no coincidence that the Deutsche BÖrse, the leading German exchange, is believed to make more out of its settlement activities than out of its trading. It also requires that its bargains are settled within the German settlement system, whereas under the horizontal model, these bargains could be settled wherever they are cheapest, easiest and most convenient to those involved.

The cost inefficiencies of that are huge. They are believed to approach 10 billion euros per annum—£7 billion per annum. That is a cost to the users of markets; it is a cost to the companies who have to operate with higher costs of capital than their competitors in the United States. The elimination of those barriers would be a major step forward for the creation of a pan-European capital market.

As I have said, I welcome these regulations because they strengthen the position of London and they move forward the horizontal model for securities, trading and settlement. But in doing so I ask for the Minister's reassurance on three points. First, are the Government aware of the strategic challenges? Secondly, do they support the horizontal model? Thirdly, will they take all possible measures to remove non-tariff barriers inherent in the vertical approach. If the Minister can give me assurance on those three points, I shall be pleased to give him my third cheer.

Lord Newby

My Lords, on these Benches we take account of the fact that the City institutions and stakeholders who have operated the system strongly support these regulations. Therefore, we are happy to support them. The Minister deserves at least one cheer for struggling through his speech with such a bad cold.

The Earl of Northesk

My Lords, I too thank the Minister for explaining these regulations to the House and for fleshing out some of the detail of the letter of the Economic Secretary.

CRESTco is a key component of the London financial market. Following the excellent debate initiated by the noble Lord, Lord Levene, yesterday, none of us can be unaware of the importance and significance of the City to the UK economy. Therefore, getting CRESTco and these regulations right is essential.

I am content to let the much greater expertise and knowledge of my noble friend Lord Hodgson serve as scrutiny of some of the wider issues of the measure before us. Indeed, I look forward to the answers from the Minister to the points raised by my noble friend. For my part, I recognise the accuracy of the observation that broadly the regulations are uncontroversial and have the confidence of the City of London. In those terms, we too support them.

Lord McIntosh of Haringey

My Lords, I am grateful to noble Lords for their welcome 2.6 per cent cheers. I shall deal with the points of the noble Lord, Lord Hodgson, in turn. First, it is paragraph 11 and not paragraph 12 which deals with Treasury functions. It is the intention that the Treasury functions should be delegated to the Financial Services Authority.

There is only one operator, CREST, at the moment. But we must and would consider applications from other organisations to add to or replace the CREST system—although in view of the history of that system and the enormous amounts of money that were expended on setting it up, I am not sure how attractive that would be. If the noble Lord is worried about the burden on the SFA, I can assure him that the burden of controlling one operator, or even two or three, compared with the many thousands of organisations which will be regulated by the SFA as from the end of this month—next week—is minimal. We do not foresee any particular problem.

Nor do we see any problem about the situation becoming too "cosy", as the noble Lord suggests. Again, the SFA regulates a large number of bodies and there have not been any accusations of the kind of relationship that worries him.

I do not see any problem with shareholder democracy. There is no difference between the proposed system and what happens now. The regulations do not alter the relationship between the shareholders and the company. They simply make it easier and safer to transfer shares.

There is no restriction—Howard Flight asked this question—on information to shareholders. Regulation 24(c) does not prevent someone from finding out if he or she is a shareholder. It is possible for other parties to inspect the regularly reconciled records of the operator register. In those circumstances, there is no threat to what the noble Lord calls "shareholder democracy".

The noble Lord, Lord Hodgson, told the House about the difference between the proposed UK system and the German or the European systems. He asked me whether we were aware of the challenge. Indeed, we are aware of it. We believe that these regulations strengthen us in our support—this is the answer to his second question of the horizontal approach. We favour whatever approach the market finds best. The market favours the horizontal model. So the UK follows that rule. I can assure the noble Lord that we take this situation very seriously. We recognise its importance for the future of business in Europe.

On Question, Motion agreed to.

House adjourned at twenty-four minutes past eight o'clock.