§ 3.13 p.m.
§ The Earl of Gowrie rose to call attention to the economic value of the international work of the City of London and to the case for City firms establishing systems of corporate governance which can maintain confidence throughout the world; and to move for Papers.
§ The noble Earl said: My Lords, I am delighted that my noble friend Lord MacLaurin has chosen this debate for his maiden speech and that so many on all sides of the House with City experience have put down their names. 1 want to set out some parameters for our discussion, which is an ecumenical one. The value to the British economy of the financial trading and services industry, generically called the City—although Edinburgh is also very important—is now common ground between the political parties. That is welcome. Even rhetorically political threats undermine confidence at home and abroad. Confidence makes the lives of Chancellors of the Exchequer a lot easier.
§ The House will have noticed that I seek principally to draw attention to the international value of the City. I do not underestimate the importance of the City to our domestic economy, but London is, with New York, the twin capital of the open societies financially. Therefore its health is vital to the international economy on which we all depend.
§ The modern-day success of the City was founded by a Labour Government, as it happens. In the mid-1970s my noble friend Lord Richardson of Duntisbourne, then plain Governor Gordon, persuaded the late Lord Wilson of Rievaulx, then plain Prime Minister Harold, to undercut European and American practices, notably the United States equalisation tax which then paid dollar deposits net, not gross. Would that successive administrations had liberalised fund management as well. Britain now manages a third of all funds managed in Europe but we are starting to lose out to Luxembourg and to my own dear native Dublin, which pay gross, not net. The Eurodollar market was born; other trades thrived. Under the benign regime of my noble friend Lady Thatcher the financial sector grew hugely and 690 now employs over a million people. It contributed over £20 billion in 1995—a poor vintage year—to our balance of payments and it represents more than 3.5 per cent. of GDP. In my view, Britain must remain a low tax, liberal, partially offshore service economy; nor should we frighten foreign residents and investors whose capital we will never get our hands on in tax terms in any case.
§ That said, over the past few years a number of unfortunate incidents and scandals has started to worry people at home and abroad. They are small against the scale of City activity. However, we live in a world of mass communications. The public, in public relations terms, are now global. I shall not deal with cases in any depth. However, it would be wrong to ignore danger signals. If people feel problems are not being addressed, there will be a real threat to the City's health. We have experienced the Lloyd's disaster, BCCI, Maxwell, the fall of Barings, the copper scandal and, most recently, two helpings of trouble—however, I think only one of them is serious—at Morgan Grenfell.
§ With the exception of Lloyd's, those troubles are relatively minor, and nor is London unique. There have been great difficulties in Sweden; a damaging banking incident—Herstatt—in Germany; the Credit Lyonnais affair in France; and huge dents in confidence on Wall Street, notably the Savings and Loan, junk bond and Salomon Brothers upheavals. There have been political, financial and even Church scandals in Italy; serious questions about Switzerland now that more information about the years immediately after the war is coming to light; and dangerous continuing shocks in Japan. In general, Britain comes out of a period of unprecedented change very well. Our present regulatory framework, both statutory and voluntary, shows that we are prepared to move quickly. However, vigilance is a 24-hour cafe and vigilance is what we are here, as I see it, to discuss.
§ The legislative and self-governing framework is the corporate governance, so to say, of the sector as a whole. There is overlap with corporate governance in its usual sense: the habits and practices of individual firms in respect to their reputation and the interest and confidence of those who buy shares in them. At firm level, corporate governance is important for domestic confidence and public relations. Declaring my interest as one who earns his living as a non-executive chairman of a quoted company, Development Securities, and who sits on the boards of several others, I believe that good corporate governance is critical to the reputation and health of the City generally.
§ I recognise that financial regulation is different from corporate governance. Nor will good corporate governance always prevent intelligent but corrupt individuals from pitting their wits, sometimes successfully, against the system. The aim is to load the dice against them. Laws, as we well know, do not prevent crime just as religions do not stop sin. However, it is a moral and political duty to load the dice in favour of good.
§ The present legislative framework was introduced by the previous Conservative administration shortly after I left it. I hasten to say there was no connection between 691 these great events. The Financial Services Act 1986 quite rightly leaned heavily on the concept of self-regulation. It was also concerned with protections for many new individual investors, particularly the PEPs generation which has succeeded the Pepsi generation, so to say. Acronyms rose like tower blocks over the City. The Act created the SIB, or Securities and Investment Board, funded by and with regulatory responsibilities over the industry. Smaller tower blocks on the SIB estate are: the SFA, or Securities and Futures Authority, which nannies stockbrokers and dealers in financial futures and derivatives; and IMRO, the Investment Management Regulatory Organisation—not to be confused with an earlier IMRO this century, the International Macedonian Revolutionary Organisation. Alas, the Balkans are ever with us. IMRO regulates fund managers themselves.
§ There is also PIA, or the Personal Investment Authority, the tallest of all the blocks. The PIA regulates the sale of financial products, large and small, to the genera] public. It includes products sold by insurance companies, the big clearing banks, and, increasingly and very interestingly, the big supermarket chains. The clearers and all the banks are under the supervision of the Bank of England. As a director of a merchant bank, Guinness Mahon, owning fund management and stockbroking businesses, I was rightly vetted by the Bank. The Financial Services Act decided not to cover general insurance, which still comes under the Department of Trade and Industry.
§ In general, and so long as we are ever vigilant in monitoring a fast-changing international financial culture, I am very much in favour of as much self-regulation as possible. It is faster than bringing in legislation. Consultative processes and the parliamentary timetable, we know, mean delays. Legislation also has a tendency to bolt stable doors after horses have fled. In my younger days, clumsy legislative reactions to the disgraceful practices of a bad-hat landlord called Rachman led to the effective destruction of the small, privately rented, housing sector. Think what that has implied for job mobility in our economy, my Lords! Codes of practice and "ombudspeople" are surely a better way. There is also the problem, as we have seen in a number of financial cases recently, of securing convictions, or consent to prosecutions, in respect of financial misdeeds of great complexity. Civil prosecutions involving compensation would in my view be a more effective method of seeking redress. But there must be a legislative underpinning, as is the case, to a system of self-regulation if it is to put on muscle. We also need a lot less of what Mr. H.R. Haldemann of Watergate fame called "situation ethics". Human beings require moral codes and disciplines as well as legal sanctions against misbehaviour. R. H. Tawney's great book Religion and the Rise of Capitalism deserves re-reading in this context.
§ There are also fair trading issues. Perhaps the noble Lord, Lord Borrie, will draw on his great experience when he comes to speak. The American Securities and Exchange Commission (SEC) is still, with the Federal Reserve Bank, the twin peak of US regulation. It has big teeth. Here, perhaps too many bodies cause 692 jurisdictional or cross-boundary difficulties, leading to delays. We must monitor our own structure closely. Sir Ronnie Hampel's committee is considering important aspects at present, as well as revisiting the often inflammatory pay issues originally considered by the Greenbury Committee. But the structure needs time—and Sir Ronnie is reported as taking this view—to settle down. Then again, malpractices which have been averted do not hit the headlines, a sure sign that the system is working.
§ I should like to see the SIB and the PIA market themselves and their work more aggressively here and abroad. The City has an interest in funding them to do so. I am not against collective bodies like the TUC and the CBI. But the regulatory bodies are nowadays more important. Their heads need to become household names: people respected, and, like the Fed's boss, Mr. Greenspan, a little feared.
§ I believe that sometimes it may be necessary for Ministers and the regulatory authorities to work together speedily in order to defend overriding national interests. Lloyd's was too pervasive a difficulty for that to apply. It had to put its own house in order and I think that Sir David Rowland has done a very good job. Maxwell revealed simply the dangers that lie in a concentration of powers and the weakness of his board of directors. The Cadbury Inquiry made recommendations about the division of power. These are now widely observed and in any case are under review. Maxwell also revealed in effect the expense and folly of trying to bring criminal charges against the horse when it not only has bolted but died in the bolting. BCCI was a clear failure on the part of the Bank of England, but there is evidence that it has learned from it.
§ Barings is to my mind the case where the Ken and Eddie squad should have moved, and moved fast. It would have been intolerable for taxpayers to pick up Mr. Leeson's devastating bill or cover up any shortcomings by his supervisors with taxpayers' money. But Barings was the City's big brand name in the tiger economies. We all need credibility on the Pacific Rim. Frankly, our name is now mud and our French, German and American competitors are smiling. I do not believe that the Chancellor and the Governor could not have waved a few fiscal sticks and a few financial carrots at the clearing banks with the purpose of achieving purchase or rescue. Sanctions on individuals would still have obtained.
§ Let me close with a brief word about the role of non-executive directors. Our absolute responsibility is directed not at the management, however close we become to it, but at the interests of the individual and collective shareholders of the business. These take precedence. I am sometimes depressed at the pervasive unanimity of resistance by some boards to takeover. If I were convinced that the taking over of a firm where I worked was in the interest, other than a very short-term interest only, of shareholders I would say so and take my chances with the management if the bid failed. Non-executives should be vetted by the SIB; we are not. Fund managers and investment trusts should exercise more influence on boards. Often they do not do so because their parent or agent merchant banks want business from those same boards. I have even negotiated 693 with most of my firms that they pay a fee to a vetted outsider who is given access to financial information but reports only to me. This is common in the US and I recommend it. The regulatory body with shark's teeth is the Gaming Board. When I was a director of Ladbroke's, the firm applied for and won a casino operating licence. The personal disclosures that I and others had to make were terrifyingly extensive, but I was all for them. This is because non-executives have a role in maintaining credibility and acceptability in the ecology of legislation, regulation and good practice which I have sought to describe. The system may appear remote from the concerns of most people. But indirectly it touches each and every one of us in our pocket. The system lies at the core of our economy, our international credibility, and this afternoon's debate. I beg to move for Papers.
§ 3.27 p.m.
§ Lord Eatwell
My Lords, the whole House is grateful to the noble Earl, Lord Gowrie, for having introduced this important debate. The prosperity and success of the financial services industry in this country are a vital component of the prosperity and success of the British economy as a whole. And the continuing success of the financial services industry rests to a degree greater than in any other industry on its reputation—not just the reputation of individual firms, but of the industry as a whole. A few bad apples can indeed spoil the whole crop.
That is why there is a clear collective interest within the industry, and an equally clear public interest in prudential management, transparency and accountability, whether it be in investor protection, in the maintenance of confidence, in the integrity of markets or, most important of all, in the management of systemic risk.
Today we are faced by a considerable challenge, for the very factors which are behind the enormous success of much of the financial services industry over the past decade are exactly the same factors which pose the greatest threats to its future prosperity.
Liberalisation at home and abroad has resulted in a veritable avalanche of financial innovations: old boundaries have been broken down; the distinctions between markets, institutions and products have become blurred and even disappeared. Today highly geared derivative instruments blend product markets and national markets which were previously totally distinct. Markets are more integrated, and yet at the same time more varied and more complex. While that has occurred, the scale and speed of trading have grown exponentially.
These changes have created great opportunities and the City of London has been highly effective in grasping those opportunities. They have also created massive risks. In intensely competitive markets in which the pace of innovation is swift and accelerating, the fear of being left behind can easily undermine even the best prudential practice.
As familiar markets stagnate and old products wilt, the fear of being left behind can easily undermine even the best prudential practice. As familiar markets stagnate 694 and old products wilt there is an insistent demand to move into new, unfamiliar territory. The more rapid the process, the more likely it is that the maintenance of high standards will be lost in the quest for high performance. Ill-judged risks will seem to be necessities in the struggle to keep ahead.
Sir Andrew Large, chairman of the SIB, argued in a speech last October that firms competing in such an environment can suffer what he calls cultural dislocation. The ethical principles that permeate good firms can come under extreme pressure in the pursuit of good performance.
We all know what can happen: astronomic salaries for so-called "stars" that end in the creation of perverse incentives to behave in a manner that is ultimately damaging to the long run interest of the firm; rushes into high-performing funds which result in the discovery that they are indeed "too good to be true"; and commitments made to individuals who claim the Midas touch, with little understanding on the part of the management of the true risks involved.
So in today's rapidly changing financial world more than ever there is a vital industry interest, and a clear public interest, in the maintenance of good practice. That is why an effective and flexible system of regulation is vital to the future success of the financial services industry.
But regulation is the second line of prudential defence, not the first. It is the management of the firms themselves which has prime responsibility for ensuring that proper practices are maintained. It is indeed striking that some of the most spectacular problems in recent years have involved management failure as well as regulatory failure. In the case of Barings, for example, the management did not understand, perhaps did not even care, what was happening in its own business; and the Bank of England did not understand the business that it was supposed to be regulating. In the disgraceful and terribly sad case of the mis-selling of pensions, irresponsible management was egged on by an irresponsible Tory Government.
Sound corporate practice and effective regulation should be two parts of the same seamless process. We may say that corporate governance and effective regulation are the two pillars on which the strength of the financial services industry is built. If management is irresponsible, if it is not transparent, and is imprudent, then of necessity regulatory processes become intrusive, prescriptive, rigid and expensive. If management sees its role as working with the regulatory authorities in an open and responsible manner, then regulation can be flexible and can contain a modicum of sound judgment rather than mechanical rules and regulations.
The need for a ceaseless dialogue demands that a clear and well-defined balance be maintained between the responsibilities of the regulators and the responsibilities and interests of the regulated. I believe that everyone would agree that one of the great strengths of the regulatory system that has evolved under the terms of the Financial Services Act has been practitioner involvement. The expertise and commitment of 695 practitioner-regulators has played a vital role in developing regulatory expertise and spreading best practice.
However, I do not believe that there is any benefit in maintaining the present distinction between the SIB and the SROs. The regulator should not be a membership organisation operating by contract. Instead, the SIB should be directly responsible for the regulatory system covered by the 1986 Act.
Within the reformed structure the SIB should continue to be a free-standing agency, established by statute. And it is vital that the blend of public interest and practitioner influence should be retained on its board, and on the boards responsible for particular parts of the industry. These evolutionary changes will enable Britain's regulatory system to adapt more effectively to new market structures, eliminate duplication and provide the simplified structure of regulation for which the industry has called.
In a rapidly changing world, an efficient regulatory system should be flexible, non-discriminatory, and deliver value for money. As I have said, that is possible only if the industry itself is committed to supporting the regulatory regime, and also if the regulator is well informed and up to date.
If the regulator is to be capable of exercising judgment and not simply applying mechanical rules, regulatory staff must be of the highest quality: they, like practitioners, must be at the cutting edge. They, perhaps even more than the practitioners, must understand the dimensions of market and systemic risk involved in the latest innovations.
That is a tall order when many chief executives have considerable difficulty in keeping up with what is happening in their companies. The notion that we can have the very best staff in regulatory organisations is difficult to achieve. However, a proposal of considerable benefit might be for it to become customary for high-flying staff to spend periods on secondment to the regulatory authorities. In other words, a period working for the regulator should be regarded as part of the normal career pattern of the very best in the industry.
The obvious objection to that proposal is that it will be expensive; that the best talents should be making money for themselves and their firms, rather than playing gamekeeper. But consider the cost to the industry of a regulator staffed with other than the best; consider the cost in consumer confidence, in market integrity and even systemic risk. The mutuality of interest demands a mutuality of commitment.
Ultimately, the reputation and success of the financial services industry depend on creating an open, accountable culture of good corporate governance, allied with a knowledgeable, flexible, highly skilled and creative regulatory structure. Neither is possible without the other.
§ 3.36 p.m.
§ Lord MacLaurin of Knebworth
My Lords, the day of my introduction to this House was one of the most remarkable experiences of my life. I felt a sense of real humility being among so many noble and learned Lords 696 who have contributed so much to our society. I hope that in turn I can make a small contribution to the deliberations in this House on those issues of which I have some experience.
I should like to use this opportunity to say how conscious I am of the many kindnesses already shown to me by officers of the House and by noble Lords. I am very grateful for the advice and encouragement that I have received, which is helping me to overcome my natural nervousness when making this, my maiden speech.
I know that my remarks should not be particularly contentious or controversial. I cannot promise that any contributions I may make on industry and the economy in the future will always follow that precedent.
As some noble Lords may know, I have recently been given responsibility in connection with the other Lord's in an area of great importance to our country, if on a somewhat different level from this House. I have been appointed chairman of the newly formed England and Wales Cricket Board. I am sure your Lordships will join with me in wishing our team every good fortune in the forthcoming Test series in New Zealand. I can assure cricket lovers present that I intend dedicating a great deal of energy in the future to both "Lords'".
My noble friend Lord Gowrie has chosen for debate an issue that is crucial to our international reputation and economic wellbeing; namely, that of the economic value of the City of London and the integrity of the people who hold power within the City.
In recent months there has been much discussion on the issue of corporate governance. The Cadbury, Greenbury and Hempel Committees have worked to examine the issue in a thoughtful way. I do not want to dwell too much on their work now. I merely observe that we must be careful to ensure that we do not draft overly-bureaucratic procedures which create too much paperwork and prove counter-productive.
I know that my own company has benefited considerably from avoiding too much bureaucracy. It is, of course, all a question of the right balance. We need flexibility. The best of British industry manages to combine flexibility with accountability and corporate governance. My experience at Tesco and as a non-executive director of the National Westminster Bank, Guinness, Vodafone and Enterprise Oil makes me believe that it can be achieved and has been achieved by many companies.
The skills of British retailers now create economic value throughout the world. Tesco, the company with which I have spent most of my adult life and of which I am chairman until June of this year, now also operates stores in Hungary, Poland, the Slovak and Czech republics, as well as in France. Such expansion would not have been possible without the combination of flexibility, accountability and good corporate governance.
I believe that we need light but effective regulation, driven by those at the top of an organisation. As so often in life, responsibility must rest at the top; that includes chairmen and chief executives and, of course, non-executive directors.
697 I believe the role of all directors, including non-executive directors, to be very important to good governance. Well informed and well resourced non-executives can, and do, add real value to companies. I believe that they perform a similar role in City institutions. It is, of course, important that there is transparency of appointment. Non-executive directors should not be appointed on the basis of old friendships; they must be qualified for the job in hand.
Well resourced and well informed non-executive directors help to foster understanding between sectors and emphasise that much of our industry is a chain. Economic value can be created by this interdependency. I have always encouraged colleagues to take on other directorships. If those appointments are in the public sector or perhaps in a small business, so much the better.
I believe that such an approach will help to confirm Britain's position as the enterprise centre of Europe, which is a goal that I hope we can all share. I believe that the City of London has already played a real role in helping to bring this to reality and that non-executive directors have a role to play now and perhaps an even greater role to play in the future. Those at the top of organisations have a responsibility to make sure that good corporate governance is strongly reinforced.
§ 3.42 p.m.
§ Lord Haskel
My Lords, perhaps I may, on behalf of the whole House, congratulate the noble Lord, Lord MacLaurin, on his thoughtful maiden speech. What he said demonstrated not only his successful business career but an important business career. He joined Tesco in 1959 when it was a modest business and spent his working life building it up to the major international business that it is today. I am sure that all noble Lords will join me in welcoming this breadth of experience to your Lordships' House. We look forward to hearing the noble Lord in the future, perhaps when we are debating the important matter of cricket!
Today we are debating the Motion of the noble Earl, Lord Gowrie. Perhaps I may also welcome the conversion of the noble Earl to the cause of corporate governance. I congratulate him on introducing this debate. It has always seemed to me that the City consists of two sectors. One provides business and industry worldwide with valuable and important banking, insurance and financial services and an orderly market for shares, currencies, shipping and commodities and managing risk; the other is the facility which the City provides for speculation and gambling. I certainly join the noble Earl in applauding the first sector; and I am glad that he joins me in condemning the damage inflicted on business, industry and society by the errors and excesses of the second. The line between risk and speculation is a fine one; good corporate governance helps to control the risk and to avoid the speculation.
The noble Earl, Lord Gowrie, spoke of corporate governance being about vigilance. I believe that corporate governance must also be concerned with encouraging companies to be competitive in today's markets. Businesses should be about building and 698 creating, not just about accounting and short-term profits. Corporate governance must encourage creativity and innovation; it must encourage businesses to invest in people, markets and technology. Directors must build up long-term relationships with employees, investors, suppliers and customers and the society within which they operate. In short, they should create what the RSA recently referred to as the inclusive company.
All companies, not just City firms, should practise that kind of corporate behaviour because it creates good companies which are the building blocks of our competitive economy. By providing financial services and helping to manage risk, the City contributes towards those building blocks, and that I applaud. The speculative sector of the City contributes towards the destruction of those building blocks by encouraging dishonesty, sharp practice and incompetence, and that I denounce.
The noble Earl mentioned Rachman. A more modern example is pensions. Providing and managing pensions is of great value in creating inclusive companies and organisations; mis-selling pensions by cowboy and opportunistic behaviour helps to destroy them.
Another example is the London Metal Exchange. I was under the impression that the purpose of the metal exchange was to provide an ordinary market in basic metals; but obviously that has become corrupted into a market for speculating in metals. The laxity of control in the market is such that one trader was able to lose 2.6 billion dollars in unauthorised trading. The irrelevance of the exchange to the real economy is surely proved by the fact that those huge losses remained undiscovered for several years. Indeed many actual producers and users of metals in the real economy trade outside the exchange.
The recent SIB report on the London Metal Exchange makes it clear that the concept of corporate governance is entirely alien to the board. Virtually all board members had a conflict of interest; they allowed themselves excessive credit, light regulation and obviously little supervision. That was partly explained in the name of self-regulation. The Prime Minister was obviously not entirely unhappy with that as the chairman of the exchange was honoured in the New Year's honours' list. I also look forward to welcoming him to your Lordships' House.
I agree with the noble Earl, Lord Gowrie. Good corporate governance would have made all the difference. Good corporate governance requires not only that there should be outside non-executive directors but also independent non-executive directors. There is a difference, as the noble Earl and the noble Lord, Lord MacLaurin, pointed out.
There should be an audit committee made up of those directors who, together with the accountants, keep a sharp eye on the internal financial controls and pay special attention to the risk of clients losing money due to speculation. The accountants and all the directors—executive and non-executive, independent and those with a conflict of interest—should be scrutinised not only from the point of view of what they do but also from the point of view of what they fail to do.
699 Perhaps I may say in passing that I am encouraged by how, in recent years, I have come across some firms of accountants and some company secretaries who do an excellent job of advising and assisting audit committees by making them aware of, and helping them to carry out, those responsibilities. That is of even greater importance when there is self-regulation.
The ethos of corporate governance needs to be established in the many markets within the City: the currency market, the Stock Exchange, the commodities markets and most especially the derivatives market. Those markets seem to operate in a world of their own away from the real economy, and it is the real economy that matters.
So I congratulate the noble Earl, Lord Gowrie, and join him in calling attention to the economic value of the City of London when it is working in co-operation and partnership and sharing risks with the real economy. Good corporate governance will only enhance that.
§ 3.50 p.m.
§ Lord Stewartby
My Lords, I ought to begin by declaring some interests. In recent years I have found myself in certain different roles which enable me to come to this subject from a number of different angles. Wearing one hat, I am chairman of the audit committee of an international bank; I am also a member of the Securities and Investments Board; and a few years ago I was the Minister responsible for introducing the Banking Act and the Building Societies Act in another place.
I think it is unquestioned that London is and remains the leading financial centre in Europe and one of the leading financial centres—if not the leading financial centre—in the world. Equally, I have no doubt that that is very substantially due to the fact that it is an open marketplace. It is not shackled by unnecessary restrictions and is not hampered by unnecessary distortions of free market processes. I see no reason why that should not continue, provided that we have the balance between regulation and flexibility in the markets as they change and continue even now to change so rapidly.
There is no question but that a formal structure of regulation and supervision needs to be in place in financial markets. I have no doubt of that, either as a regulator or a practitioner. When one looks at what happened at Lloyd's, where there was an inability to identify a conflict of interest, let alone deal with it, one realises that unrestricted self-regulation is no longer appropriate in today's financial world.
But it is also important that regulation and supervision should not be too intrusive. I very much agreed with my noble friend Lord MacLaurin when he said in his excellent maiden speech that regulation must not become too bureaucratic. If regulators and supervisors feel drawn into concentrating on detail, the chances are that they will give insufficient attention to the overall quality of governance and accountability of companies in the field. They must satisfy themselves that businesses are properly run. I agree very much—I was pleased to note that the noble Lord, Lord Eatwell, 700 endorsed it—that regulation and supervision must involve a blend of practitioners' experience and professionals exercising the public interest.
But that is not an easy balance to achieve. We need to be constantly vigilant about how it is done. I believe that there will be a need for some revision of the legislation before too long. That is no criticism of what was put in place 10 years ago because the markets have changed dramatically in that time. It is one reason why the law needs to set out general principles and not become too detailed about specific requirements. I know that your Lordships sometimes become uneasy about Henry VIII clauses. But if it is impossible to update legislation with secondary legislation when there are changes—when new derivatives are invented and structural changes occur in the market place—and do it quickly and one has to resort to primary legislation all the time, the processes will be hindered.
But the general framework needs to concentrate in particular on the way in which companies are run. It is not the role of regulators or supervisors to tell companies what to do and in effect try to take commercial decisions by proxy. It is their duty to see that companies are properly run and that their governance is effective and suitable for the type of business that they conduct. That is the natural bridge to the other part of this argument, which is the responsibility of management itself. Any substantial company needs to have lines of accountability clearly understood within the organisation. Responsibilities need to be carefully defined and high level controls need to be put in place and monitored by the board and by the audit committee as well.
I regard the greater prominence of audit committees which has followed the Cadbury recommendations as one of the major developments in corporate governance in recent years. It is absolutely essential and is working reasonably well in practice in most cases. As chairman of an audit committee, I can say that it has greatly increased the degree of responsibility and the amount of time which needs to be devoted to the tasks, but it is essential.
We have to ensure that non-executive directors, who generally should carry out those tasks, remain independent but at the same time do not separate themselves from their Companies Act responsibilities to ensure that the companies on whose boards they sit are effective commercial enterprises. Unless a business is successful and profitable, it does not have the financial stability which is one of the great protections against systemic problems and, indeed, against abuse of process with customers.
I believe that the greater prominence of non-executive directors is not without problems. The people required to do those tasks need to be very experienced and if they are very experienced, they are likely to be very busy. Whether in fact there is a sufficient supply yet—it is a process which has only been developing over the past five years or so—I am not convinced at the moment. I believe that non-executive directors have a fundamental role in ensuring that processes of corporate governance are correctly established. They will thereby 701 undoubtedly make a contribution to the profitability of the enterprises. If bad organisation exists or if controls are inadequate, the first intelligent, dishonest person who reaches any position of responsibility in that organisation will take advantage of that laxity. Therefore, the contribution of those who ensure that controls and processes are properly exercised makes a positive contribution to the business itself.
My last word on this matter will be that we have to be not only vigilant within the processes of regulation and supervision and in running companies but vigilant and flexible in the way in which in Parliament we address these issues and keep the framework up to date. For example, in the Financial Services Act, the Securities and Investments Board is not given all the powers that it needs to carry out its overall responsibility for the regulatory system. Anomalies of that kind have become apparent as that Act has been seen to work in practice. But, generally, I believe that it is the right foundation on which to build.
I conclude by thanking my noble friend Lord Gowrie for having raised this extremely important subject at a very topical time.
§ 3.59 p.m.
§ Lord Clark of Kempston
My Lords, I congratulate and thank my noble friend Lord Gowrie for introducing this debate. I have felt for a long time—I am sure that some of your Lordships will agree with me—that the City is sometimes overlooked in regard to our economy. The City and invisibles are just as important as manufacture trading abroad. In 1993 invisibles from the City amounted to £2.7 billion. This past year, the figure is likely to be £12 billion. That shows the scope and the increased value of the City in relation to our economy.
As my noble friend Lord Stewartby has just said, we are an international centre. Thirty-six per cent. of world foreign exchange dealings are conducted in the City—more than in New York and Tokyo put together. I do not intend to say much about the single currency but we must keep it at the back of our minds that trading in European foreign exchange amounts to only 4 per cent. of our foreign exchange dealings. The red herring of the single currency should be put into perspective.
My noble friend Lord Gowrie referred to the assets in the City. He mentioned Lloyd's. Some time ago there was controversy as to whether Lloyd's was trading properly. I can tell your Lordships that the finance committee of another place initiated an independent inquiry into Lloyd's under the chairmanship of Sir David Walker. I happened to be a member of that committee. Many of your Lordships will have read the report. The committee found that there was no question of criminal activity and its recommendations were immediately implemented by the Lloyd's Council.
In the City, we have legal expertise, accountancy expertise and financial consultancy expertise. Those are some of the reasons why there is so much inward investment into this country. There was some £23 billion of inward investment last year. That is a tribute to our expertise in the City. Why should this 702 country, through the City's expertise and so on, attract so much European inward investment? We get investment from the United States, from the Far East and from the European Union. One must realise that 98 of the 100 top companies in the world are in this country. That is the extent of the confidence foreign investors have in Britain.
Why do these foreign investors come to this country? I am sure your Lordships will agree with me that the labour on costs in this country are much lower, our corporation tax is far lower and personal taxation at the moment is much lower. Dealings in domestic equity are three times as high as they are in Paris and Frankfurt. One must not overlook the fact that there is a certain amount of envy on the part of Paris and Frankfurt of the City of London. We have to guard against trying to blacken the name of the City. The City's name for integrity and so on must be paramount.
My noble friend Lord MacLaurin referred in his excellent maiden speech to regulation. I was in another place, as were many of your Lordships, when the Financial Services Act was passed in 1986. Some of us sounded the alarm bells that we had to avoid over-regulation of the City. Let us consider the amount of regulation. There is FIMBRA, LAUTRO, IMRO, the SIB and the PIA. Many of those organisations overlap and that overlapping means that in some cases compliance costs are penal. I happen to be a consultant to the Life Assurance Association. It is pressing for a financial services council so that organisations such as the SIB, the PIA and so on can come together and try to work as a unified body.
I remind the House that some years ago the Stock Exchange abolished the unquoted securities market. The market provided capital for small but growing companies. When the USM was being abolished a committee was set up in the City. It was called CISCO. As a result of the activities of CISCO we got the alternative investment market. I must declare an interest as president of CISCO.
Our competitors would like a share of the world trading carried out in the City. What we have to do—I am sure your Lordships will agree with me—is to speak of the City's achievements, because the City is the jewel in Britain's economy.
§ 4.6 p.m.
§ Baroness O'Cathain
My Lords, the Motion states:To call attention to the economic value of the international work of the City of London".I am grateful to my noble friend Lord Clark, who concentrated on just that aspect. The first four speakers, with the honourable exception of my noble friend Lord MacLaurin, who made an excellent maiden speech, seemed to concentrate on the areas of our failures. There is a tendency in this country to concentrate on our failures. We fall into the trap of concentrating on bad news all the time. Perhaps I may make a few salient points to try to lift the tenor of the debate.
First, no fewer than 500 overseas banks have thought fit to establish themselves in the City of London. If we were seen as a failure-oriented country, I am sure that 703 would not happen. Secondly, there is a massive turnover in the City of London. It brings huge earnings to the economy. The figures are so mind boggling that they are measured in trillions, although I am not quite sure what a trillion is. Thirdly, perhaps I may share with the House a little gem of information. The London International Financial Futures Exchange—LIFFE—has a greater share of the German bond market than Frankfurt. The banking and financial services in the City are world leaders. There is also the insurance industry, which is regarded as a City of London institution. When we talk about the European single market, I sometimes wonder whether we realise that there is no such thing as a European single market, because our insurance industry is still prohibited from playing a proper active role in the European insurance market. With its great expertise, I guess that if it played that role it would probably meet great resistance from the insurance markets of other European countries, which would suffer in the comparison.
I fell into something of a trap when I was preparing my notes for this debate by concentrating all the time on corporate governance. I wish to make three points. First, the City works remarkably well. That is not to say that there have not been problems from time to time, but, on balance, the culture of good practice is there. For centuries the City has operated on the slogan, "My word is my bond". That works. In any organisation, be it a company, a university or a local authority, there will always be the recalcitrants. However, whatever draconian measures of regulation, surveillance and monitoring are suggested to deal with such miscreants, the occasional unacceptable situation will arise. That is what we have to accept. It is human life.
Secondly, I firmly believe that the regulatory processes in place, albeit for the most part self-regulatory, with non-statutory codes of conduct or acceptance of 19 of the 20 Cadbury recommendations, should be allowed time to settle down, to become accepted practice and, in effect, to become second nature to all involved in the running of the City until we overload still further with more regulation.
Just as an aside, the adoption of the Cadbury recommendations has spawned a whole new industry of consultants offering all types of advice; lawyers running corporate governance seminars; acres of printed matter purporting to give advice to chairmen, executive directors and non-executive directors, company secretaries and legal advisers all of whom have been getting huge mail bags telling them how to do it.
What I am sure business and the City do not want is an increase in all this activity. Any such increase could lead to really massive indigestion and also tend to take the eyes of the operators off the goal that they should be fixed on; namely, to increase our activity trading both in the City and elsewhere and particularly on the international financial markets.
My third and final point is this. I have already referred to the fact that there will always be some who will misbehave anywhere. But if that should happen, may I make a plea that the subsequent investigations are speedy. Any delay brings a huge area of uncertainty.
704 It causes reputations to fall. In fact, it is a great opportunity for the press to castigate both institutions and individuals. With the City's position as a leader in the world of international finance we really cannot afford that. It is quite unacceptable that an investigation into a certain well-known case involving City institutions started in December 1986. I believe that the investigation has been completed, but certainly the results have not been published. During that period all the uncertainty has been compounded. That is not good.
To recap: self-regulation is working. It has engendered a culture of the recognition of the need for compliance. Let us not forget that the City is a very worthwhile economic feature in this nation. It has a huge international reputation and let us not sell it down the river.
§ 4.12 p.m.
§ Lord Ashburton
My Lords, this is a broadly drafted Motion on which it would be all too easy to speak for 20 minutes. It is peculiarly difficult to speak for eight minutes. There is also the ever present danger that one may be only repeating what has already been said by previous speakers. I should like to add my congratulations to the noble Lord, Lord MacLaurin, on an admirable maiden speech. Perhaps I may also congratulate the noble Earl, Lord Gowrie, with whose speech I found very little to disagree.
I also found a great deal to agree with in the speech of the noble Lord, Lord Eatwell. I am sorry that he is no longer in his place because there was something that I was extremely sorry to hear him say. He did in fact cast what I thought was a most unworthy aspersion on the management of Barings in saying that he was not aware whether it actually even cared about the business. I stopped being chairman of Barings seven years ago or so. I remained a non-executive director but ceased being one some time before the disaster happened. I can assure him and other noble Lords that I do not believe there was a management in the City of London that cared more strongly about the sort of business it did than the management of Barings.
The danger of trying to cover too much ground is particularly great for somebody like me who spent the best part of 40 years in the merchant banking world, and who was for a time particularly involved in the setting up of the arrangements for what became colloquially known as Big Bang. The House also has the opportunity of hearing from a number of individuals who have been involved, or who are still involved, in the affairs of the City whose views are by definition much more up to date than mine.
At the time I first became involved in the City few would have confidently foretold that the earnings of their activities collectively would become such an enormous asset to this country. But it has so become and it is perhaps worth a glance to see why. I believe that the consensus has it that London has provided a particularly attractive environment for international financial activity. Its legal system, as it relates to commercial activity, has proved to be better than those of other places and particularly adapted to 705 international trade. We work of course in English, which largely because of its use by the USA and the ex-Commonwealth countries, is widely accepted nowadays as most people's second language. And shaming it is to compare the linguistic ability of most British people with the idiomatic fluency that one now encounters in others. We are neatly placed between Far Eastern and American time zones and we had, and still have, a relatively lightly regulated financial system. It is too light, I hear, in the eyes of some. I was interested in the noble Lord, Lord Haskel, trying to make a distinction between speculative and legitimate activity. I tried during all my life in the City to discern where the dividing line was. I do not believe that it is actually discernible.
Some of these advantages, it seems to me, will endure. The legal system, the language, the time zone even if its utility is somewhat eroded by the breakneck advances in global IT. Of course, London remains at least as pleasant and safe a place to live for expatriates as any of its competitors.
But there is no guarantee that in such a fast changing world as we now inhabit the economic asset that the City represents will remain uneroded. If we want it to survive—and I suggest that it would be sensible, nationally, to want that—there is probably little that we can do in respect of what one might term cataclysmic events—fundamental changes probably affecting financial activities worldwide. But against the more foreseeable threats I believe that we can be vigilant.
There is always a danger, particularly to those who are critical of the way financial markets operate, that those of us who have City backgrounds can sound far too uncritical. The City certainly has its blemishes. There is always room for improvement and to pretend otherwise is stupid and it can be offensive.
But what are the imperfections and blemishes and how big a threat do they represent? I do not propose to waste time on the question of very high earnings. Organisations which over-pay the wrong people soon find out and pay the price. There is a high degree of self-correction built into the system, as there is in the equally highly paid world of pop stars and top athletes. The subject nevertheless seems on occasion to obsess the media as do the shenanigans of those particularly highly paid when they lose their jobs. I regard the latter as being part and parcel of the trivial concern with personalities, which seems increasingly to obtrude in the press.
I do believe, however, that the regulatory regime is important. I also believe the effectiveness of the legal system in dealing with those who commit fraudulent acts has to be a part of any self-respecting financial system.
Because we believed it worked, we strove so far as possible in my day to maintain a self-regulatory system. It has since been refined and made a great deal more comprehensive. It clearly has shortcomings and I have always believed that the likelihood was that we would in the end, eventually, be pushed into a statutory system if only because of an increasing tendency to litigation.
706 I have no doubt that the City would live with such a system and it would certainly be different. But the big doubt in my mind is whether it would be better. It would certainly raise costs of doing business and slow activity down. It would certainly give a further boost to the legal profession and some would say it would be visibly more just. I wish that I was sure, but those who are still involved in the City will have clearer views.
As far as fraud prosecution is concerned, all I can say is that I do not believe that the present position seems adequate. It is not for me to say whether the fact that so few of the prosecutions are successful is right or wrong, though I am amazed at the results. But the system does not seem to work consistently as between one case and another and reversals on appeal seem to make that aspect even worse. I should be very sorry to be told that things cannot be improved as I feel that it is important.
The last matter on which I want to touch is the importance of our membership—or otherwise—of economic and monetary union. I do not believe that the issue of whether we join EMU at the first opportunity is a matter of huge moment for the continued prosperity of the City. As I have said before in this House, the important thing is how we conduct our part in the setting up of that momentous step. It is, in my view, vital that we should not carp and that we should wish well those who decide to participate. However, if EMU comes into being and if its disciplines do not prove too difficult and divisive politically for its members and we continue to remain outside, I believe that the City's position would start to be eroded—and quite possibly very quickly.
I leave your Lordships with these three points: what I hope to see is the most pragmatic possible regulatory system; the swiftest possible bringing to book of those who commit fraud; and, finally, if EMU really takes off and succeeds, we must be a part of it.
§ 4.20 p.m.
§ Lord Swaythling
My Lords, it goes without saying that the economic value of the international work of the City of London is immense for this country and one only has to look at the record of invisible earnings and those attributed to the City of London to know that that must be the case. My noble friend Lord Clark of Kempston discussed just that. But the debate calls for a discussion of the case for City firms establishing systems for corporate governance which will maintain confidence throughout the world and this in turn calls for a view as to whether the immense strides taken in this area have, in the first case, been adopted by responsible companies in the City of London and also whether they are in themselves adequate.
I believe that a further issue lies behind this discussion—this has been mentioned by enough noble Lords for me to be confirmed in my view—which is that people are concerned about whether the much publicised financial accidents of the past few years would have happened had corporate governance and best practices been more stringently observed or more emphatically stated. It is for that reason that I wanted to say a few words in this debate.
707 First of all, I believe that the financial services area of the City has welcomed and responded positively to the many recommendations both in the Cadbury report in 1992 and in the Greenbury report in 1995. As we all know there are many further initiatives which have also been welcomed in the main by the City of London and acted upon.
The unwritten question about whether financial accidents would have been prevented with a stricter code is somewhat more complex. One thing that a bank can never do is to protect itself 100 per cent. from fraud. The only thing that can be said is that the earlier that this fraud is detected the better, but that is an obvious platitude. If a dealer in the sophisticated range of financial instruments now available takes a view and is proved wrong and he compounds that view by hiding it from his superiors, if he is adroit he can enter into a series of transactions which increase the exposure of his employers to protect himself or, rather, to justify his judgment. If after the first transaction or even the second he had explained to his superiors what he had done and cut his losses, he would not have needed to embark on this dangerous path. Seldom are those actions taken for personal gain; they are nearly always a reflection of his conviction that his view of the market is right and that the market has got it wrong. Of course, some involve fraud for personal gain; but these acts are usually rarer than those I have described.
Would corporate governance, even if it were far more complex than we have today, have identified these problems earlier? I very much doubt it. There is a strong argument that the success of the City of London has been very largely due to the arrangements for self-regulation and the imposition of extremely tight and legally binding rules would dampen and ultimately damage the entrepreneurial and flexible management of companies within the financial sector. I would argue personally very strongly this case. That does not mean that I do not support and appreciate the changes which have been made.
The audit committee of a company and especially of those companies operating in financial services—Cadbury recommended that such a committee should be chaired by an independent, non-executive director—should be independently minded and able to take action supported by the executive management of the concern. I do not think that in the financial field there are people who still doubt the adoption of best practices and sound corporate governance in the case of UK financial institutions and I think at this stage to attempt to bring in more stringent and complex requirements might defeat the object. It would seem that a period of consolidation is called for.
I base my judgment on these matters on 40 years' experience as a banker—the same 40 years as those spent by my friend the noble Lord, Lord Ashburton—and the six and a half years that I was a member of the Board of Banking Supervision at the Bank of England. Those six and a half years covered both the collapse of BCCI and the tragic failures in Barings. It is always the job of senior management to be alert to things which are going wrong and they cannot unfortunately—or fortunately—escape the responsibility but, in the case of 708 the Barings situation, not enough attention was paid by the top management to the grotesque level of profits alleged to have been made in one offshore office. It was believed by management in London that those profits were being made from what was described as "risk-free arbitrage". There is no such thing as risk-free arbitrage. What might have been relatively risk-free would have not been so profitable—indeed, might have been barely worth doing for a very small return. Management in London should have been deeply suspicious of such profits and should have paid more heed to the recommendations of its own audit committee to separate the functions of the front and back offices in that offshore branch. But this is only a part of the story.
The City of London will have great opportunities whether or not this country joins the single currency mechanism and should be helped to take advantage of these rather than be shackled with even further controls of corporate governance. I felt it important that these points were made in this interesting and worthwhile discussion which my noble friend Lord Gowrie has introduced at such a timely moment.
§ 4.26 p.m.
§ Lord Selsdon
My Lords, it is with great pleasure that I follow my noble friend Lord Swaythling. I had the privilege of being a director of his family merchant bank for many years—sadly, after he had left. Many there wished that he had never left and I feel sure that we would have done better had he remained.
I remember looking with envy at the family bank of the noble Lord, Lord Ashburton. We admired it as a bank of utter credibility with a remarkable range of customers and great loyalty. I pay tribute to the services of the noble Lord in helping to promote the interests of the United Kingdom way outside the banking world.
I have had to say "Plus ga change" to myself in connection with this debate, because many years ago I had the privilege of moving a similar Motion to that moved today by my noble friend Lord Gowrie but on the subject of invisibles. My noble friend Lord Limerick was the Minister who replied to that debate. I think also of the remarkable man who was chairman of my noble friend's bank. I refer to Sir Cyril Kleinwort, who effectively started the Committee on Invisible Exports, and was the first to focus attention on the potential of the City of London as a foreign exchange earner.
One of the comments that one always heard when attending such meetings was, "We must always concentrate upon our integrity. Our image for honesty and integrity is far above any financial manipulation". I remember my pride when I was a member of the board of an accepting house. I remember also the nervousness that one felt at the possibility of being questioned by one's colleagues, or even the partners, about whether a particular company that one had taken on as a new client was the right sort of company for the bank to have as a customer. I remember with pride being introduced one day as a "financier"—we somehow thought that financiers were people who sailed too close to the wind. We thought that they were of doubtful origin.
709 My noble friends will recall that not so many years ago similar situations arose, with major bankruptcies occurring only a moment or so after the publication of the auditors' report or the annual report. I refer to Metal Traders, to Rolls-Royce and to the numerous scandals with investment funds. As I said, "Plus ça change". The problem was unfortunate. We suffered from success.
I have had the privilege of working for two merchant banks and for one of our clearing banks. The internal controls were positively frightening. Many of us thought that we could never have any growth business ever again. Those internal controls were good; and we were brought up to believe that there was one principle of banking, which was, "Know thy customer", and if you had the wrong customer that was your fault. If you had the chance of being a customer of a good bank, you would be proud if you were a customer of an accepting house. People were judged by the company they kept.
Now I fear, with regret, that the merging and the loss of accepting houses, the merging of brokers and the acquisitions by foreign banks have all reduced standards, not necessarily in the rush for growth, but because the changes are there and the morality has gone. The lawyers used to come in long after a deal had been consummated because we knew that we could not afford to pay for them; we still cannot afford to pay for them. But what worries me is not the success of the City of London, but the growing concern about liability.
I come to the question of corporate governance. It was right that one should know one's customer and, if one had a bad customer, one would be responsible for having taken him on. He too would be taken on by a stockbroker and an accountant and a lawyer. If a stockbroker resigned because he was not happy with a company, usually the shares would go down and there would almost be an internal investigation, asking what was wrong and wether there were adequate controls. Suddenly, people said, "You must have outside directors to control things". When I was in the banking world we were not allowed to be outside directors; we were not allowed to have an account outside the bank; we were not allowed to buy or sell a share other than within the bank. We were watched almost day and night, although I have to say that the days were much shorter than they are now. Perhaps when Big Bang came and internationalisation and the globalisation took place, it was not possible to control or to watch people 24 hours a day. However, I still believe that an employee has a responsibility to his employer and an employer has a responsibility to his employee.
These remarkable changes of units moving from one bank to another, solely in the cause of greed, gain and glory, are worrying. Glory? Many years ago public relations was not a major event of hitting the front page. In fact, if your bank was in the newspapers at all it was a matter for concern, and sometimes grave concern, because you were meant to be quiet and respectable.
The changes that have occurred lead me to wonder about what, if I remember rightly, Galbraith said—that banking may be a career from which no man really recovers. I have been and still am a director of public 710 companies. I worry rather when I am on a supervisory board of a bank and I find that no foreigner wants to be a director of a big British company. They are worried about the liabilities. It is interesting, too, that an awful lot of retired civil servants do not want to be a director of a public company.
The remarkable speech of my noble friend Lord MacLaurin makes me think about a comment I heard the other day asking what is a non-executive director? Basically, I was advised that he is really a supermarket trolley that gets pushed in the direction the chairman wishes to go, occasionally going off course. One advantage, of course, is that he can hold more food and drink and another is that he will be blamed for the faults of others.
Today, a worry that I have concerns the liabilities that are facing accountants, lawyers, non-executive directors and all forms of adviser, in particular those in partnerships who have to incorporate within the costs or the fees that they charge not only over-expensive office buildings but the personal liabilities that can follow. Although it is undoubtedly a good idea to encourage the growth of the supervisory role of the non-executive director, as my noble friends and others have pointed out, one of his roles is to help expand the business in a respectable way. It is extraordinarily difficult to be able to keep an eye on all aspects of a company, not just the financial aspect or the remuneration committee, but on contracts which they may take which may suddenly go wrong. A bridge may collapse on the bus of a football team and the following litigation is out of all proportion to the damage caused.
It is a worrying time and I believe that, while growth in business is such that some form of greater control is necessary, I wonder very much about the trend that there is at the moment of trying to place too much responsibility upon the individual, who often lacks adequate protection.
§ 4.35 p.m.
§ Lord Currie of Marylebone
My Lords, I am grateful to the noble Earl, Lord Gowrie, for introducing this debate on the City. Enough has probably been said about the dominant position of the City internationally, and that is to the great benefit of our country.
Having said that, one has to say that the competitive pressures are increasing. Hitherto, Paris and Frankfurt have not mounted any serious challenge to the position of the City, but Maastricht and the preparations for a single currency have spurred them to greater competitiveness. Yesterday I attended a conference organised by the Bank of England to discuss the preparations that the City has to make ahead of the introduction of the euro, whether the UK is in or out. It became quite clear that enormous work will be required for the City to be competitive in the future euro markets that are likely to develop. The representatives from the City were quietly confident that they were prepared, but they were under no illusion but that there was significant competition ahead.
The position of the City is not helped in that by some of the failures that have occurred over the past few years. I remember going to Spain on behalf of 711 British invisibles with Peter Baring to promote the City of London in the Spanish markets. We had a very good reception, but three weeks later the Barings collapse occurred, and I have no doubt that that was a thousand times more damaging than any promotional effect that we had.
If one looks at the collapse it is natural to look at the regulator and point to regulatory failures, but that is not where the root of the problem lay. My noble friend Lord Eatwell was absolutely right to point the finger at the management and the management structure. The top people did not know their business. The noble Lord, Lord Swaythling, made the point that top management should have known that they could not make those enormous profits from the activities that were supposedly going on in the Far East. That was simple ignorance, and it is ignorance which is not excusable.
There is the additional point that the structure of the Barings equity arrangements created incentives for that collapse to happen: the bulk of the equity was owned in a non-voting form. Top management received a large part of their rewards in the form of bonuses. Their incentive was less concerned with looking after the future of the bank than with those large bonuses. I am not saying that people were consciously doing that, but the structure was such as to encourage poor management throughout the organisation, throughout the bank. Internal politics within the bank did not help.
Barings was an unusual case, but I have no doubt that similar problems, less acute, lie elsewhere. Management structures must be appropriately tightened and the auditory function enhanced in order to ensure that these difficulties do not arise. Management has to be enhanced. To plug a local interest of mine, management education in the City also has to be enhanced.
There was one element in the opening speech of the noble Earl, Lord Gowrie, with which I profoundly disagree. He suggested that the "Ken and Eddie show" should have come to the rescue in the Barings case, perhaps waving some taxpayers' money to rescue Barings.
The Earl of Gowrie
My Lords, as we are in time, perhaps I may correct the noble Lord. My point was that the individuals and the disaster could not or should not be rescued by taxpayers' money, but that there should have been pressure on and incentives for the clearing banks to take it over.
§ Lord Currie of Marylebone
My Lords, I apologise to the noble Earl for misunderstanding his point. I certainly agree that the leading City institutions should have been encouraged and should have moved in. Had they done so, if it was so critical to the interests of the City, they would have shown the leadership that was appropriate.
712 In terms of regulation, it should be light-handed, but it must also be effective. In emphasising the management aspects, we should not underplay the regulatory framework. I believe that the debate so far has made it clear that the regulatory landscape which has grown up is unsatisfactory. It is a patchwork quilt. Regulatory bodies and responsibilities overlap in an unusual way which few fully understand. One trading house explained to me that in trading a repo of below £5 million one regulatory body had responsibility, but if it were above £5 million then a different regulatory body had responsibility. That is not an arrangement that makes sense when those two trades go over the same desk. We need to rationalise that.
It was correct to make the point, as the noble Lord, Lord Stewartby, did, that the SIB lacks the powers over the self-regulatory organisations that it needs. It does not have sufficient powers in those areas; it needs them. The structure needs to be overhauled. We need to find a way in which the regulatory structures can focus on controlling systemic risk in wholesale markets and in retail markets emphasise customer protection. We do not have a rational structure that corresponds to the functions of regulation. We need to put that in place.
In an international world, we also need to think about the relationship between European regulatory bodies and international ones. The challenge will be to foster high quality and efficient management and a better informed and more discerning public. I repeat that we cannot expect too much of regulation in a world where one can move risk. The risk profile of an organisation can be shifted in seconds through a single trade. Monitoring is not the answer. The right structures and the right incentives are the way to regulate. That requires and depends upon the quality of management. If that is in place, the City will flourish. However, we need to be cautious to ensure that scandals of mismanagement and criminality do not place that reputation at risk to the disadvantage of us all.
§ 4.42 p.m.
§ Lord Birdwood
My Lords, I am delighted to be following a few speakers on from my noble friend Lord MacLaurin whose maiden speech we heard today. I hope that we can regard it as a loss leader, with future products with an extremely long shelf life.
My contribution to this valuable and timely offering by my noble friend Lord Gowrie will be extremely brief. For the moment I am accepting his focus on the City of London as a catch-all for the financial community. But it is a bit of a tabloid shorthand, as he has already agreed. From the granite authority of the Edinburgh establishment, through some of our northern cities, where I believe up to 10 per cent. of the workforce is in financial services, the mesh of the markets is as pervasive and immediate as the weather.
Two huge evolutionary processes have occurred while the present Government have been in power. The first is the total capitulation of the world's markets to electronic systems. A result of that, years ago, was that the time-scales of the markets far outpaced the time-scales of any political response. When a whole 713 country can be altogether taken out of play by market sentiment in an hour's trading, it is quaint of politicians to pretend to their electorates that they can even delay, let alone block, the process.
One of the few logic-based arguments for European financial unification is that the firepower of a whole continent's currency could deter the aggression of all but the most buccaneering of market manipulators. I say only "could"—and not in the teeth of the whole market collectively.
The second deep change which has taken place while this Government have presided is much closer to home and has had a huge and positive effect on the City's standing and wealth, which it is almost impossible to overstate, and that is the principle of privatisation. I should like to think that the Treasury's strategists had planned that beneficial consequence, but, as we now know, the political ideology, as well as the need for a bit of extra cash in the kitty, was largely met with scepticism by the upper reaches of the Civil Service. I do not believe that anyone foretold that the whole world would watch the process in this country and latch on to the idea that what worked for the UK would work for it too.
There has been something purely Darwinian in the way that the agile, flexible, commercial creatures of a demand economy have replaced the lumbering beasts of a command economy. The process has been more or less painful, depending upon the historic political cultures of the country in question. In some cases, the dinosaurs have fought back or just disguised themselves for a while. The privatisation evolution is completely irreversible on a world view, and Britain's banks—the merchant banks in particular—found out how to do it first. They cut the template which every privatisation episode everywhere has largely followed. One City name alone has, for instance, been involved in 32 such exercises in Latin America.
I need to draw the distinction between relationship banking and transaction banking. In that context one would broadly rank privatisation deals as relationship banking. A direct consequence of that is that the Government and the Treasury bosses have made the effort over the past decade to understand the way the City works. That effort has been rewarded in that a deeper understanding now exists than could have been predicted in a political culture where the politicians themselves have become more professional in the pursuit of their trade. The consequence of that, as well as a supportive ideology, is that political restrictions in other parts of the world have opened major opportunities for the London operators. Just one example is sufficient: the position of the Eurobond market here which would probably not have migrated so successfully if the Swiss had not imposed a turnover tax of 1.25 per cent.
The message is clear. A government who offer a sympathetic environment to the financial markets and to the people who work in them find themselves with a whole flock of golden geese in their backyard. Of course a government wedded to ever more complicated tax regulations in a perverse way add to City income as specialists proliferate to cope.
714 This is not the time or the place to blitz your Lordships with numbers. The actual value to the UK economy is enormous, incessant and critical, but it is not a divine right of this or any other regime. The golden geese must be cared for and every vigorous financial sector in the world—some very close to home—look with greedy eyes at London.
In the second strand of his Motion my noble friend airs the case for systems of corporate governance for the purpose of maintaining confidence. Who could disagree with such a proposition? However, in defence of the financial sector as a whole, and, in particular, the innovation drivers in London, the principle of compliance is already taken seriously. From my observation it is not a charade or an empty activity. Perhaps while the regulatory structures were settling down in the early days some fish wriggled through the nets. They always will, but very few as the regulatory authorities themselves grow in professionalism and sheer knowledge of the territory.
One hears that we need an authority such as the SEC—but there may be less to that body than meets the eye, at least in usefulness. In London, for instance, if something is not working we can change the listing rules in six months. Because the SEC is a unitary body, it is obliged to consult universally—a process which can take up to three years. I cannot see how an ideal transparency can yet be imposed on the City of London. After all, the impetus for transparency in quoted companies has come primarily from the need to protect shareholder rights. This means a lot less when ownership is outside the UK or private. We do not need to be told that these, too, have their dangers.
To what extent will the sense of progress be jeopardised by recent City scandals? Is a system of corporate governance necessary for the City to retain its place at the forefront of the investment world? To make the point is to heighten awareness of what is at risk in terms of lost reputation, but perhaps also to obscure the process of surveillance and controls which are already in place.
Managers now live in a climate of great rigour, where analysis and recommendation must be traced to source; where dealing processes need to be seen to be accurate and honest; and where penalties are genuinely punitive. I believe we are getting it about right. Please note that the ultimate market test is there for anybody to see. Companies and the people who give them validity are voting with their feet and the nation is the richer for it.
§ 4.50 p.m.
§ Lord Lyell
My Lords, I thank my noble friend Lord Gowrie for giving us the opportunity to discuss this subject and to hear the extraordinarily good and memorable maiden speech of my noble friend Lord MacLaurin.
I may offend my noble friend Lady O'Cathain by concentrating on the unglamorous side. She referred to one or two failures. I may flicker over them, but I shall attempt to put a gloss on the defensive side, which is the subject of the second half of my noble friend's Motion. Usually I am the tail-end Charlie in such debates as this, 715 but today I am somewhat higher up the batting order and there is a particularly distinguished list of speakers to follow who will be able to outline the enormous advantages of London and the City and what the Americans call the "can do attitude".
I believe that the three advantages of London and, as my noble friend Lord Gowrie pointed out, Edinburgh, are, first, the English language, secondly, the time zone and, thirdly, a concept of flexibility. The third advantage is the key point, but like all wonderful buzzwords and concepts it introduces various items such as derivatives, packages and strips, which I have read about in the Financial Times but have not taken too much notice of. I believe that they are connected with income. They are far from my chartered accountant training in the late 1960s.
That is the glamorous side of the City of London, but I should like to reflect on the unglamorous side; on what I call "the back office". Often, the back office is seen as a euphemism for, "No. It is disallowed. It is dull. It is unimaginative". However, almost all today's speakers have pointed out that if the City of London does not improve, insist upon and update its high standards on control and vigilance there are plenty of other financial centres in Europe and elsewhere which will be keen to seize its business.
In my little office within the precincts of your Lordships' House are six or seven fairly large and heavy tomes. They decorate one of the shelves and go under the name of Department of Trade and Industry Inspectors' Reports. They are fascinating, but there are two sides to them. The first is the boring, red-tape explanation of why the reports were published and why the circumstances reached such a pitch. Usually it starts with a tiny detail either from the Companies Act, the Yellow Book or the Takeover Code which was missed. That leads to another compounding error and soon an increasing amount of time is spent putting management on the defensive and on the back foot. That leads to a DTI report or, far worse, criminal proceedings.
There is a second side and a fascinating aspect to many of the reports. It is the unexpected benefits; the story of what has gone right with the City and what is unique to it, in particular as compared with other financial centres such as Tokyo. I refer to the success, flexibility and speed of controls. When something goes wrong it is put right very quickly. I have been greatly impressed with the success of the audit committees and the controls as regards the financial scene in the City.
This week your Lordships' House has discussed various pieces of legislation. It is relevant to sound a note of caution; that is, the more rules, regulations and complications there are, the more difficult are the controls and the more time management must spend on defensive duties rather than on the constructive side of its work. I am lucky to have sitting next to me my noble friend Lord Rockley. I remember reading in a 1990 DTI report, in which he was mentioned, that things happen very fast in the City and that one must take quick action. We shall hear from my noble friend later, but it has been said of him that "he has got his knees brown".
716 He has 35 or 40 years' experience of the City and the DTI report to which I have referred shows that he got it right. I do not believe that compliance is dull or sinister. I believe that of all the speakers in today's debate I am unique. I do not have enormous experience of the City but I have 10 years experience of "the back office"; that is, the Whip's Benches in front of your Lordships. Working as a Whip in your Lordships' House is greatly akin to being a top class auditor and a top class back-office operator. One must know what is going on at all times, as must any good back-office operator in the City, as my noble friend Lord Ashburton will know. I hope that my noble friend Lord Gowrie will grant me some forgiveness. I remember one glitch in 1976 when we worked together, but I think we got it entirely right. That experience marked me and has given me great admiration for the back-office operators.
In conclusion, I draw your Lordships' attention to a recent interesting debate initiated by the noble and learned Lord, Lord Hoffmann, on takeovers. Paragraph 125 of the report of the European Communities Committee of your Lordships' House made one or two startling comments about the 13th directive and its possible impact on the controls and what we are delighted to see are the benefits of the City of London. Without the controls to which I have referred, which work extraordinarily well, all those benefits and others mentioned by my noble friend Lord Gowrie will be worthless.
§ 5 p.m.
My Lords, I add my congratulations to those of other noble Lords to the noble Lord, Lord MacLaurin, on the excellence of his maiden speech. Having known him for a few years now, I look forward to the noble Lord's next intervention when he will feel free to be controversial.
The noble Earl, Lord Gowrie, in his very welcome Motion today, lays stress on the need to maintain confidence in the City of London throughout the world. To my mind, that is extremely important in terms of invisible earnings, as many noble Lords have said, and, indeed, for the economic well-being generally of this country.
I ask myself how confidence in the City is to be maintained and, if possible, enhanced. I believe that it requires that firms and institutions in the City should be efficient, competent, stable, well managed, and to follow the noble Lord, Lord Selsdon, have a reputation for scrupulous honesty and the highest standards of ethical behaviour, for—and I use this one word for my several—the principle of integrity.
Perhaps I may say, in parenthesis, that those qualities are essential to maintain confidence in the City not only throughout the world, but among the people of this country. The misselling of some 2 million private pension schemes by UK companies to UK citizens is as much a shameful failure of the City as those scandals of international significance, such as Norton Warburg in the 1980s and BCCI in the 1990s.
But, to return to what is needed for international confidence to be maintained, I want to emphasise first the value of ensuring that markets are competitive.
717 As in other markets, fair competition between rival firms in the various markets for investments and investment advice is the key effective spur to efficiency and competence. We cannot expect confidence in the City if competition is restricted or distorted.
In the late 1970s and early 1980s, the Stock Exchange in the City was in great danger of losing business abroad, particularly to the New York Stock Exchange. This was because our Stock Exchange was riddled with restrictive practices, particularly the rule that fixed commissions must be charged. Member firms could not compete on price. Following the pressure put upon the Stock Exchange by litigation, it was pushed into agreeing reluctantly to abandon these practices. I believe that the City's operations and reputation in the world would have been seriously in jeopardy had it failed to give up the old ways of the London Stock Exchange.
But—and this is a very big 'but'—the more competitive environment in the City arising from these events and others to which noble Lords have referred, such as the ending of exchange controls and globalisation generally, involved the growth of financial conglomerates and the arrival in the City of outsiders from the US, Japan, the Continent of Europe and so on inevitably had the consequence, as night follows day, that the old club-like atmosphere of the City that might have been relied on to combat, by way of peer group pressure, misbehaviour and conflicts of interest and to temper other excesses of the competitive spirit, disappeared.
Hence, as we all know, there was the need for the Financial Services Act 1986, to which many noble Lords referred. It has a complex web of practitioner-based regulation, and, in addition, we have had the three angels—Cadbury, Greenbury and Hempel—who followed up with detailed provisions for codes of practice on corporate governance.
The philosophy of the Financial Services Act, to my mind, is that, while competition is certainly necessary to ensure that firms are efficient and competent, in itself, that is not enough. At present, there are regulations to require high levels of staff training, transparency of costs and other information to clients and high standards of ethical behaviour, and to satisfy prudential requirements and provide for the security of one's investment. We have a great deal of regulation under the Financial Services Act and the SIB and the self-regulatory organisations have achieved much in their efforts to maintain standards in the City, although they have not always succeeded.
One problem arises that regulations designed to achieve high standards can go too far. The imposition of standards that are higher than necessary for the protection of the investor can work to the investor's detriment, because potential new entrants to the market can be discouraged and kept out by an overwhelming amount of regulation. One must always ensure that regulation does not go over the top. It is as well that the Office of Fair Trading has a statutory duty to monitor Conduct of Business Regulations and other regulations, and to report to the Treasury as to whether they unduly restrict competition. Trust and confidence in the City 718 require a proper balance between regulation and reliance on the market. Regulation must not go over the top so that it strangles business, imposes undue costs or damages the very interests of the business and private clients it is meant to protect.
Ten years on from the Financial Services Act, it is time to review our complex regulatory structure. There is confusion on the part of the public and even within the City. This afternoon a noble Lord referred to FIMBRA. There is obviously confusion in that regard, because it no longer exists. But some rationalisation is needed. After the General Election, I do not expect the new government to wish to go back to square one and revise the whole of the Act, with its 212 sections and 17 schedules. I doubt whether a new government would give priority to such a huge task. But Mike O'Brien, Labour's Treasury spokesman in another place, spoke in October about making the Securities and Investments Board a statutory body and said that the various self regulatory organisations should be—and I like the phrase—"folded into" the SIB. He sparked off a useful debate in which the regulators and the Deputy Governor of the Bank of England have had their say. It is a timely debate, just as is the debate we are having in this House today.
§ 5.9 p.m.
Viscount St. Davids
My Lords, I stand in awe of the maiden speech of my noble friend Lord MacLaurin. I am sure that his will be a valuable addition to the collective wisdom that is your Lordships' House.
I thank my noble friend Lord Gowrie for giving us the opportunity to debate this very important subject. I must declare an interest. I am a non-executive director in a securities house and have spent close to 40 years in the City.
The pre-eminence of the financial institutions of the City of London in world markets has been a feature of our national economic life for many years. What is laudable and should be highlighted in any debate on those matters is the manner in which the City has increased its market share as capital markets have developed in mainland Europe and the Far East. Of course, that is against the background of intense competition. It should be remembered that our large participation in the growth of the Japanese and neighbouring markets which started in the 1960s was achieved by skill and not by the weight of capital, any lack of capital being more than compensated for by the recognition of one of our greatest strengths—integrity. The motto "My word is my bond" today raises a smile but not so long ago, it was our greatest asset.
If today's debate is to achieve anything, it must recognise that corporate governance, regulation and related matters are not just abstract concepts for they have to exist in the real corporate world, which has no boundaries of time, nation or moral culture. The deregulation of the London Stock Exchange in 1986, which came with fundamental changes in its rule book, brought about a situation whereby the whole financial services industry would require a new regulatory regime. Unfortunately, those changes coincided with 719 a major change in the political and economic culture. They were soon to provide their own caricature but their damage to the system is still with us.
Big Bang in 1986 introduced not only new market members, but also brought with it a clash of working cultures. I am sure that one of the prominent scandals of that time was, in part, due to this culture clash. That the City has been able not only to maintain but also to increase its share of financial trade during the past decade, despite very fundamental changes to its former working practice, shows that we have in it a national asset which must be encouraged and not overburdened with unnecessary—and I repeat the word "unnecessary"—regulation.
The City's international reputation does not exist in isolation to its domestic business which, in turn, relies on the confidence of our nation in its financial institutions. The multiplicity of SROs without common standards works against a coherent and viable system. Their number must be reduced. The current debate among practitioners in the industry on the structure of regulation in the United Kingdom is: should there be a "Twin Peaks" approach? That is to say, two commissions established on functional lines: one for capital adequacy and the other for the conduct of business and the care of customer issues. Others favour a "super SIB", with all the current SROs being merged into an SIB operating through two divisions, wholesale and retail.
A merger of IMRO and the SFA would also find favour. The present system is too expensive to operate and let us not forget that the customer pays. Any new regulatory body needs to be closer to the marketplace. That point was mentioned by the noble Lord, Lord Eatwell, who suggested that more senior members of the City institutions should be brought into the regulatory bodies.
Reports in the press that Lloyd's of London would like to join an external regulatory system, if true, would I understand require primary legislation and allow the whole question of regulation to be revisited. The quasi judicial nature of the SROs needs to be re-examined for, let us not forget, the system requires not only the confidence of the customer but also that of the practitioner.
When an investigation leads to criminal proceedings, all evidence should continue to be available to the prosecuting authorities. But where an investigation, occasioned, say, through a lack of due diligence or best practice, leads to a fine or other disciplinary action such evidence should not be available in subsequent civil proceedings. If practitioners are to have confidence in the workings of an SRO system, they must not be subject to a risk of double jeopardy. Evidence should not be available for a civil court because of membership of an SRO. At least one legal system requires the victim's family to pay for the executioner's bullet. It is not a system that I recommend.
The introduction of order-driven trading as opposed to quote-driven trading in the most liquid stocks will bring our practice into line with the main exchanges in most overseas markets. The United States 720 and European investment houses have long said that such a change would encourage even greater use of London as a financial centre by overseas investors. There are concerns within the City that if the UK does not participate in the single currency it could be discriminated against by those who do. Non-participation may also have an impact on the very sizeable values of business which the City undertakes in foreign exchange.
If the City is to continue to prosper, some sanity must be restored to the application of EU directives. It has been shown to be the case that, in applying certain directives—I give as examples the Investment Services Directive and the Capital Adequacy Directive—our regulators have taken a "super-equivalent" stance and have made use of the implementation of such directives to enhance their requirements, thus placing an increasing burden on UK-based companies in contrast to their mainland European competitors.
Let us not only praise the work of the City of London; let us also do all that we can to enhance its position. Let us reconsider the whole structure of regulation. One important point that I should like to raise and which I do not believe has been covered in today's debate is that of education. Nearly all our citizens have an interest in financial matters, whether it is through savings or as contributors to pension funds. Surely it is time for some education in such matters to be brought into the national curriculum. Today's young people are tomorrow's savers and they are the providers for their own old age.
§ 5.15 p.m.
§ Lord Rockley
My Lords, I must first add my congratulations to those already expressed by other speakers to my noble friend Lord MacLaurin on his maiden speech—my only problem being that the quality of his speech makes me somewhat nervous about my own contribution. However, I am equally delighted to have the opportunity to participate in this debate on corporate governance with a particular emphasis on the City of London.
Corporate governance has, I believe, become a rather loose expression and is regarded in some quarters as a panacea for all evils. But we know that it is much more complex than that. At its basic level, I believe it means that we ensure that a business is run by and through its board and that that board is properly accountable to its shareholders for its actions. The installation of structures/mechanisms will not create a well-managed business—the converse is undoubtedly true. There are problems in the installation of controls in international service businesses.
In a financial service business the most important feature is its people and their attitudes. The cult of the individual and the super-stars is to my mind an exceedingly unhealthy development. It is vital that the firm and its values are bigger than the person.
I have spent most of my working life in the City. A great many changes have happened during that time; indeed, it is almost unrecognisable from the place where I started some 30 odd years ago. Not all of the changes have been for the good, but they were inevitable if 721 London was to maintain its position in the financial world. It has undoubtedly done so; in fact, it has enhanced it, as witnessed by the size of the market, the number of international participants and the business done. That has happened through the perceived efficiencies of London, its transparency, the regulatory environment and the confidence of participants to deal there.
So the City has done something right. But, regrettably, fraud and dishonesty are fellow travellers within the financial world and have been since time immemorial. If anything, London's success has increased its exposure. Its expansion has meant that there are potentially more rotten apples in the barrel. The position of the City, its connotations and its international scope mean that, whenever there is a sensation, the City always has an involvement—peripheral or otherwise—and it is always in the public eye.
Therefore, it goes without saying that it is vital for firms operating outside the City of London to be seen to conduct their affairs to the highest possible standards in their own market. In that respect, it is very healthy if disciplinary actions are well publicised. They have an unfortunate spin-off for the firms concerned. There is adverse publicity at the time and there may even be criticism from the regulator which, if the firm itself unearthed the transgression and dealt with it internally, may seem marginally unfair. That is corporate governance at work. That is the way it goes.
The regulatory system and its environment are vital. The regulators set the scene. They occasionally blow the whistle; but, fundamentally, it is the companies which create the tone and reputation of a marketplace and obviously of their own firms within it. A City firm has three major assets—its capital, its people and its reputation. Those are the tools with which management has to work for the shareholders. Capital is perfectly straightforward and we can all see whether or not it is there. But people and reputation are much more delicate subjects. The cult of loyalty is something that does not sit very readily in the international financial world of today.
Self-importance of individuals knows no bounds, and they seem to forget how they developed their skills, who taught them those skills and why they have those skills today. There is no shortage of management effort to try to promote that feeling of loyalty throughout every firm in the City, of that I am sure. Whenever there is what one might term a disaster, every management will re-examine its physical procedures and controls to see what it can improve. It will ask itself: could it possibly happen here?
As a result of those reviews, I am equally sure that every firm tightens up some aspect of its controls and processes. But the fact is that what went wrong in the first place was a fundamental breach of trust and an organised cover-up by others, be it within the organisation or externally. That is the case with all those well publicised sensations in recent years, whether they 722 have emanated from Tokyo, New York, London or other centres. In the final analysis many systems are only as good as the people who operate them.
One can speculate why individuals go off the rails. It has been suggested only this afternoon that it is not necessarily for personal financial gain. With that I concur. I think that in many cases it is a question of prestige with their peers, of being important in the community and of appearing important in themselves. When that is the case, it is much more difficult for a management to detect. Technology is a wonderful thing; it is how the business is run. It is how the derivatives work. They have almost become a dirty word these days, but they produce cheaper funds for industry. But, equally, that technology can be manipulated for malpractice. Given the size of the marketplace and a period of non-detection, when those misdemeanours are uncovered they can be spectacular.
I refer noble Lords to a chairman's nightmare. However confident one is in one's firm's structures and its people, there is always a nagging worry that some link in the chain, somewhere along the line, is being surreptitiously weakened. There is only one way that that can be countered, and that is through the vigilance of management, using not only the controls but also the human touch of experience. In the modern competitive world everyone is striving for super-performance—when that occurs everyone is delighted—but there will be many instances where success against the trend will make management's tentacles twitch in considering whether it has found the Holy Grail or whether there are other reasons. It is for management to achieve this difficult task of control. I believe the responsible City managements are only too well aware that their own livelihoods depend on getting it right.
§ 5.23 p.m.
§ Lord Desai
My Lords, I join other noble Lords in congratulating the noble Lord, Lord MacLaurin, on his excellent maiden speech. We look forward to hearing many more of his speeches in this House, but we shall entirely understand if his work at the other Lord's, which is very important, keeps him away now and then. We want our cricket team to achieve as much success as the noble Lord has achieved at Tesco's. That would be the day to celebrate!
I am almost one of the last speakers in the debate and unfortunately almost everything that I wanted to say has been said. However, there is one point that has been mentioned by many people which I wish to emphasise; namely, that the City is the only seriously competitive global level industry we have. It has been a global level, top-class performer for about 250 years. That is something to note. It has withstood many shocks and many innovations and has adapted and grown. As it has grown, problems have arisen. As new products and new innovations emerge, so do new opportunities for fraud. That is a sort of dialectical process. As these processes occur, one has to invent new forms of regulation. I do not think there will ever be a time when we shall have perfectly accident-proof financial markets, any more than we shall ever have risk-free arbitrage. It is inevitable that a fast-growing, innovative industry will 723 occasionally experience these problems. Regulatory organisations will always be a little behind in catching up because many of these cases consist of shutting stable doors after the horse has bolted. However, that is part of the process.
As many noble Lords have already said, the choice we face today is to look at the patchwork quilt of self-regulatory organisations and some statutory bodies and to decide whether there are gaps now, or that we can anticipate in the light of forthcoming innovations, which ought to be filled. Should they be filled by self-regulatory organisations spontaneously arising in the City, or should we appoint a co-ordinated, overarching body? That body can either be a statutory or a non-statutory one. There are delicate questions of advantage and disadvantage on either side. I am not sufficiently expert on that matter to make up my mind about it. Some people like the model of the SEC, whereas other people have pointed out that it is somewhat slow in its operation. I used to be much more sceptical of the SROs, but their performance in the past year or so has improved considerably. Much learning is taking place. As my noble friend Lord Borrie pointed out, if we established a statutory body by means of a vast piece of legislation, how quickly could we change it when the next innovation emerges? How could we allow room for that regulatory body to adapt, change and grow? Those are important questions.
As my noble friend Lord Borrie also pointed out, a debate has already started on this matter. There ought to be a systematic formal response to that debate from practitioners in the City. Do they think that they can create a co-ordinated body of inter-connected, self-regulating organisations which would reassure retail consumers and those who worry about systemic risk that if problems arise they will be quickly taken care of; or is it the case that practitioners themselves think that in the light of all the problems we have experienced, and in the light of the European climate which is much more formally legislative than self-regulatory, we shall have to adapt ourselves to that sort of culture? That is an open question. We need to have much more discussion on that than we have had so far.
I now wish to discuss a matter which worries me much more than either corporate governance or regulation, and that is the level of competence in both management personnel and regulatory personnel. As the noble Lord, Lord Ashburton, said, I am sure that the management of Barings cared immensely about its business. I do not doubt that. What I doubt is that it knew what the business was all about. An age gap arises as financial innovations take place and as "rocket" scientists deal with derivatives and new products. Do the members of top management, who come from a different generation, understand the nature of the business they are in? Have they been retrained? Have they returned to the London Business School, where my noble friend Lord Currie could teach them a thing or two about the latest innovations? We should insist that top management occasionally retrain in this fast-changing business. Although it may appear that money makes money, money makes money in different ways nowadays than it did in the past. I am sure that as 724 regards Barings and other companies which traded in derivatives there was serious misunderstanding about what they were doing and they could not unwind the deals. They could not understand the nature of the business.
I am not surprised at that. I work in the quieter field of academia but I need constantly to retrain. Even the quiet world of economics changes. At seminars I find that someone gives a paper which I do not understand because I have been out of touch for the past two years.
From the report of the Treasury Committee in another place on the Barings issue published last month, I am not clear that at the crucial weekend the Bank of England knew precisely what was going on. I am not sure that our regulatory personnel knew the nature of the exposure to which Leeson had subjected the bank, or whether the liabilities were unlimited or could be capped. There were all sorts of rumours.
I conclude by referring to this serious point. Our top management and top regulatory personnel need continual retraining. We must insist that that be done.
§ 5.31 p.m.
§ The Earl of Limerick
My Lords, the Motion of my noble friend Lord Gowrie is timely in both its parts. It is timely in drawing attention to the past and present contribution of the City of London to our economy. It is timely in drawing attention to the reinforcement, the basis of trust upon which its success must depend.
I declare an interest, which is more past than present. A greater part of my working life, starting 43 years ago, was spent in and around the City: first, in accountancy, then substantially in merchant banking and latterly in fund management. During that time I was able to take a broader view from two perspectives. There is nothing like seeing yourself as others see you. For two years in the early 1970s, I was a Minister in the DTI, having responsibility for company law from which time I bear the scars of two notorious insurance company collapses—Maxwell-Pergamon, "Mark I", and others. From around 1980 I was chairman of the British Overseas Trade Board and, until 1991, of British Invisibles. I was charged with selling internationally the excellence of British goods, and latterly especially of British services.
It is upon success in trading in services, mainly financial, that the prosperity of the City of London depends; and with it a good part of our overall national prosperity. The numbers have moved onwards and upwards since I had them at my fingertips, but the headlines are worth remembering and highlighting.
However, first, I have a historical reflection. The City of London grew and prospered as British trade followed the flag around the growing Empire around the world. Some might say that it was the flag which followed trade. But it was based on the foundation of the Industrial Revolution from the heart of England.
Let us consider the remarkable transformation that we have seen in the wake of two world wars. As late as 1939, the UK share of world trade was still approaching 30 per cent., and, correspondingly, about 30 per cent. of world trade was financed in sterling—a burden to which 725 manifestly a currency as small as ours could not aspire nowadays. This country now accounts for only around 6 per cent. of world trade in goods, and yet the part which the City of London plays in its share of those international services has been maintained and in some parts enhanced.
During that time the City of London exercised imagination and energy, increasing its market share in financial services as the underlying trade shrank relatively. I mention the example of the eurodollar market in the wake of the US interest equalisation tax in the early 1960s; our retention of the lion's share of international markets in insurance, foreign exchange, equity trading, ship and aircraft broking and external bank lending; and the development of new techniques for which an international demand is discerned.
Where do we stand in the markets on the most recent figures? We have 28 per cent. of marine insurance premiums globally, with 38 per cent. of aviation risks. We have the largest share of external bank lending. Our foreign exchange turnover (to which I have already referred) exceeds that of Japan and the United States combined. We have around half the fixtures in marine and aviation for charters on the Baltic Exchange; we have the contribution of Lloyd's List and international consultancies, and almost 60 per cent. of the world turnover in foreign equities. That adds up to a contribution from UK financial institutions exceeding £20 billion a year, and is still growing.
There is no questioning the national importance of these activities. What are the threats to the continuation of that success? I am not too worried by the looming single currency, whatever may be claimed in Frankfurt. The risks, I believe, are rather more internal than external. That success depends upon our reputation for fair as well as for efficient dealing. That in turn rests on confidence to sustain the reputation for fairness; and confidence is a tender plant.
As I see it, threats will include these matters. Technology was referred to by my noble friend Lord Birdwood. The dominant share that we have in the forex markets, and, alongside it, forward markets, derivatives, caps, collars, options and the rest, are a useful and valid means of avoiding or minimising risk for traders. But they also offer opportunities for speculation. Indeed, they offer invitation to speculators and opportunities for abuses. One has only to reflect that the turnover in the foreign exchange market globally is a multiple of—I understand that it is currently in excess of 20 times—the turnover in underlying trade. So an awful lot of buying and selling of foreign exchange is going on which is not used for the fundamental and obvious purposes of paying for goods and services. The sheer volume of money that moves around and the speed with which it can move can lead to destabilisation.
Technology in good part contributed also to the post-Big Bang problems of the late 1980s. Too much capital was injected with too little strategic thought into an overpriced sector at the end of a 14-year bull market.
The last risk to which I refer is greed, both corporate and personal. I refer to the cult of the star, the star salaries, and especially the large bonuses which follow.
726 Every man is a debtor to his profession and there is a loyalty which should attach to that. I am very much in sympathy with the comments made by my noble friend and colleague Lord Rockley on that subject, and, I have to say, a little less sanguine than the view expressed by the noble Lord, Lord Ashburton.
I am clear that over-regulation would clip the wings, if not actually kill, the golden goose, and would cause certain golden goslings to refrain from coming from overseas to nest in London.
I am also clear that the answer must lie in the only form of discipline that works; namely, self-discipline. There are systems that have been developed which should be followed and which help that process. But self-discipline it has to be. It is incumbent upon those who run City institutions to introduce, monitor and insist upon, in detail, codes of conduct which ensure the high standards upon which the great name of the City was built and on which its future prosperity must depend.
§ 5.40 p.m.
My Lords, I am grateful to my noble friend Lord Gowrie for the chance to talk about my part of the City, the London insurance market, of which, I suggest, some 70 per cent. of the premium comes from abroad. It has a good track record in terms of balance of payments. The latest figures I have seen suggest that in 1993 it produced £5 billion; in 1994 £4 billion; and in 1995 £6 billion. If I understood my noble friend correctly, that is the sixth part of the £20 billion he mentioned, or 30 per cent. of the invisibles. The split of that £6 billion in 1995 was some £4.1 billion in respect of investments of one sort or another, including overseas trading; £1.1 billion to the brokers in terms of commissions and fees; and only £0.8 billion in respect of underwriting, which was split roughly 50: 50 between the insurance companies and Lloyd's.
The position of Lloyd's is quite interesting historically. Despite the crisis between Lloyd's and the capital providers—its Names—the capital deployed across the years has remained remarkably stable. I find for 1988 the highest number of Names ever—around 32,500. That may be compared with 1996, when the number was down to 12,800; but there are also 168 corporate vehicles. The capacity between those two years is almost identical. The premium income—significantly, because premium varies according to whether rates are high or low—was less in 1988 than it was in 1996. Lloyd's reputation for never failing to pay a claim remains untarnished. But, sadly, its reputation for financial strength is probably lost for ever. That is partly a result of the gradual demise of unlimited liability and partly because Names, although many had good reason, walked away from their losses and imperilled cash flow. The regulators, advisers and sophisticated clients of the world will be checking Lloyd's financial position evermore.
However, this was not just a Lloyd's problem; it merely seemed that way from the publicity. During the same period (since 1989), although nobody seems to realise it, 17 insurance companies have failed.
727 The settlement at Lloyd's has been an enormous relief to all those of us who want to see the City flourish. Lloyd's is the hub for a very tight-packed market where face-to-face negotiations in respect of large or complex risks are not just in the opinion of most of us essential, but differentiate us from so many of the other markets around the world which try to deal by telephone.
In 1994 the London insurance market accepted £15 billion of premium income, which demonstrates what an important employer it is. It is believed that the City of London, Camden and Tower Hamlets between them currently employ some 37,500 people directly involved in insurance. It is estimated that there are another 15,000 employed elsewhere around the UK who are employed only as a result of the existence of the London insurance market.
I turn to corporate governance. As we have heard many times today, no news is good news. We have had too much news of the bad variety recently. Like others, I should like to start at the bottom. Although I have been retired for five years now, I have retained my copy of my company's Group Operating Policies. I turn to that document. On page 1, I find, "Our Business Principles", dated July 1986 (over 10 years ago). It states:Our success depends on our ability to command the confidence of our clients and our markets. This confidence must be earned"—simple Anglo-Saxon words of not more than three syllables. It continues:Specifically we must strive to … Understand our clients and their needs … represent them properly in the marketplace … treat underwriters fairly and develop long term relationships with them … ensure the highest order of technical back up … maintain highest standards of communication—external/internal".That was not just "apple pie"—it was followed by 20 pages of more detailed advice.
For most of my working life I have been regulated by the Insurance Brokers Registration Council. It has a code of conduct which begins:Insurance brokers shall at all times conduct their business with utmost good faith and integrity. They shall place the interests of their clients before all other considerations. Subject to this, they shall have proper regard to others".That is marvellous stuff. I note that the insurance brokers' interests very properly come last.
The Insurance Brokers Registration Council regulates all brokers; but there is one terrible flaw in its activities. If you do not like the disciplinary committee, if you find the cost too great or the rules too onerous, you simply leave. The only penalty is that you can no longer call yourself a broker—so you call yourself an intermediary, and any insurance company will deal with you. Brokers have been trying to get legislation to close that gap for years but no government ever have time to pay attention to them.
I should like to refer briefly to practice at Lloyd's. The Lloyd's by-laws include a comment that, "failure to comply with the Lloyd's code of conduct is not in itself a disciplinary offence but may be taken into account by any disciplinary committee". That is sensible. Governance requires discretionary powers, flexibility to take account of character, attitude and track record. I am not ashamed to use the word "flexibility" for the umpteenth time this afternoon.
728 A recent article in the Financial Times interested me. It stated that foreigners take the long-term view and accept lower profits than the UK. UK governance is held to be short-term and risk adverse. We perhaps need to think about that.
I received a letter from Barclays, as I dare say did other noble Lords. It was very brief and very sensible. It stated that corporate governance develops and matures through the development of best practice, not through regulatory and legislative change. I agree, as I believe do many other Members of this House.
The Association of British Insurers (ABI) reminds me that it represents 440 companies which manage £550 billion of funds. It has played significant roles in Cadbury, Greenbury and Hampel. It has published guidelines on areas such as composition of board directors, service contracts, share options and long-term incentive schemes. It established IVIS, which monitors resolutions by the top 800 companies and advises ABI members if they are inconsistent with Cadbury et al. Last year, it organised the first international conference on corporate governance; 21 companies came to London to participate. It is much involved in this year's conference in Paris.
So let the individual be taught high standards and be monitored by his company. Internal audit is valuable as a tool to improve company efficiency as well as to keep up standards. Let the company proclaim its standards and be monitored by the market regulator; and let that regulator use his nose and make unscheduled visits, rather than the forward advised routines that are usually practised. Let the law take a back seat and act only with care and restraint.
§ 5.48 p.m.
§ Lord Ezra
My Lords, we have reached the stage in the debate when we may start to sum up the important points made. We are particularly indebted to the noble Earl, Lord Gowrie, for having so effectively introduced it. The debate has been remarkably well-informed. Every noble Lord who spoke brought to bear on the subject his own personal experience, be it from banking services or academia, as in the case of the noble Lord, Lord Desai. It has been a contemplative debate of the sort at which this House excels.
We have been able on all sides of the House to take a dispassionate view of the situation which relates to the remarkable success story achieved by the City of London; and it is a remarkable story. As the noble Lord, Lord Desai, reminded us, it goes back 250 years. It started with the sense of innovation and has continued with it. Indeed the greatest era of innovation has been in recent times.
The noble Earl, Lord Limerick—whom I am glad to see here because I served with him for many years on the British Overseas Trade Board—itemised some of the great achievements of the City leading up to the present massive earning of £20 billion per annum and rising. Had it not been for the earnings from the City, from financial services and investments abroad, we should be in dire straits in terms of our balance of payments. I need hardly remind your Lordships that since 1983 729 our visibles balance—for various reasons which we have debated elsewhere and which I shall not go into—has been in serious deficit. That has been made good by the remarkable achievements of the City.
What is important in the context of our debate is how we can ensure that this great achievement is maintained in the future and see what are the problems, challenges and difficulties which we might meet ahead. I should like to refer to a few of those as they emerged in the course of the debate.
The question of confidence in the City was raised. The City was built on a sense of confidence, a shake of the hand being all that was required in the most important financial transactions. That confidence is of prime importance in dealing with the kinds of products with which the City is concerned. It has unfortunately been somewhat shaken by a limited number of cases that have arisen in the recent past. I emphasise that it is a limited number. Nonetheless they have done some harm to that feeling of confidence. It has been important that those few cases have been very carefully inquired into.
It has emerged in those cases—I refer particularly to the derivatives and fund management cases—that there was a confusion, if not a weakness, of management controls, particularly at the higher level. That seems to have emerged from the reports that I have looked at.
That raises the question to which the second part of the Motion relates—namely, the question of corporate governance. It is sometimes felt that, because the City is regulated, corporate governance should not be a necessary feature of its operations. But, as the noble Lord, Lord Eatwell, pointed out, corporate governance almost comes first and is possibly almost more important than regulation. The noble Earl, Lord Gowrie, is to be congratulated on having linked his Motion with the concept of corporate governance.
I very much hope that there will be a determined effort to ensure that, where the principles of corporate governance are not yet fully applied in City firms, they will be applied.
The concept of corporate governance is being reviewed by the Hampel Committee. I hope that that review will be on a wide-ranging basis. I have had experience of what happens on the Continent, having for some years been on the supervisory board of a Dutch company. I have also been a non-executive director of British companies and am therefore able to compare the roles of the two. Speaking from the point of view of the Dutch company, the benefits that I saw from their regime are as follows. First, the role of the non-executive directors was absolutely clear; there was no doubt about it. You were on the supervisory board; there was a chairman of the supervisory board; there was the management board, the chairman of which was effectively the chief executive of the company. The positions were clearly defined. When board meetings, which were presided over by the chairman of the supervisory board, took place the non-executives sat on one side and the executives on the other. The meetings always started with a report from the chief executive 730 officer and the other executives which was debated and then we jointly discussed financial matters, strategy, and so on. We had our own meetings when it was appropriate and we met jointly with the executives when that was appropriate. At the annual general meeting it was the chairman of the supervisory board who presided and who was regarded as responsible to the shareholders for seeing that the company was properly managed.
That system is not a panacea; no system of that sort can be. Companies run into difficulties for all kinds of reasons. This particular company ran into difficulties because it carried out capital projects abroad during the boom years for which it had difficulty later in obtaining payment when there were sovereign debt problems. However, the benefit that the Dutch regime introduced was that we found out about the problems earlier than we might otherwise have done; and, secondly, we were able to deal more effectively with the consortium of banks which provided the facilities we operated on than might otherwise have been the case.
I do not suggest that we adopt that system here. However, I have found in the literature that the idea of a two-tier board, as recently in a CBI document, is pushed on one side in a rather cavalier fashion. I believe that we should look seriously at this option as we examine the structure of companies.
The question of regulation has been referred to. I believe that there is a consensus here that we should review the regulatory regime. I was surprised to learn that there are 20 bodies which report to the SIB. Some are big, some are small. It seems to me that that is a very large number of regulatory bodies to be operating in the financial services sector. If for no other reason than that, I believe that the regime ought to be reviewed. It is now 10 years since the Financial Services Act. I hope that before long there will be such a review, in which the practitioners must, of course, play a leading role.
Finally, I should like to refer briefly to the prospect of a single currency and the euro. Whether we are in or out, it is of vital importance that the City of London should remain the leading centre for trading in the euro, as it is now in the dollar, the yen and other world currencies. I applaud the initiative taken by the Bank of England in ensuring that financial institutions are kept fully aware of what is going on and prepare themselves for that eventuality.
In conclusion, I believe that this has been an extremely useful debate. We are agreed on the remarkable achievements of the City. I believe we are also agreed that it is very important that we should take steps to ensure that those achievements multiply in the years ahead and acknowledge that there are certain problems which must be addressed in order to achieve that.
§ 5.59 p.m.
§ Viscount Chandos
My Lords, I start by adding my thanks to the noble Earl, Lord Gowrie, for his introduction of today's debate and for his wide-ranging and stimulating opening remarks, demonstrating once more his claim to be Renaissance Man. His noble 731 friend Lord MacLaurin, on whose maiden speech I congratulate him, has an outstanding record as a businessman. Your Lordships' House should therefore welcome him and look forward to his future contributions, even if they do from time to time coincide with the policies of the party to which he belongs.
Like other noble Lords, I should declare an interest as a director of a small investment banking firm pursuing corporate finance advisory work and private equity investment, both in the domestic sphere and internationally. For many years I was no doubt an exasperating pupil of the noble Lord, Lord Rockley, and the noble Earl, Lord Limerick, whose speeches I enjoyed and to whom, as an author would say in his foreword to a book, all credit should flow for what I have learned and no responsibility should be attached for my mistakes, which are my own. I have also served on the board of the International Swaps and Derivatives Association in New York and remain a strong believer that derivatives, for all the new risks that they present, represent the most significant and broadly valuable development of the financial markets in the past two decades. That is a subject to which I shall return.
I have also been a non-executive director of several public companies, in one of which I recently tested to destruction the role of a non-executive director in trying to enforce good corporate governance. One interesting point emerged from that experience. Despite considerable publicity attached to my resignation and that of a better known fellow non-executive director, not one institutional investor in the company concerned made any attempt to discuss our concerns with either of us. So much for institutions' diligence. Perhaps the recommendations of the business commission in this field have a great deal of merit.
I reiterate the support of these Benches for the City of London, its work, domestic and international, and for the employment and earnings that it generates. It was no coincidence that my right honourable friend the Leader of the Opposition chose to make one of his keynote statements on the Labour Party's economic policy last year at the lecture sponsored by the Corporation of London and the London International Financial Futures Exchange. Perhaps I should not have reminded your Lordships of that, for fear of provoking the Deputy Prime Minister for the time being into labelling those bodies also and their members stooges of the Labour Party.
We should protect and enhance the position of the City of London and cherish the international earnings within it, so long as in doing so we do not jeopardise or neglect the other interests, even stakeholders, of our economy and our society. For that reason, notwithstanding the carefully explained focus on the international value of the City by the noble Earl, Lord Gowrie, I find that I cannot avoid considering some domestic issues at the same time, for they are two sides of the same coin. However, I do not intend to add much to the debate about regulation, other than to support most strongly the comments of my noble friend Lord Eatwell.
732 The danger of a subject such as the one we are debating and at least a partial mitigation of its merits is that it risks over-emphasising the City of London's role as an end in itself. I am, as a quintessential member of New Labour, nonetheless unrepentant in my belief that financial markets and centres are a means to an end and not an end in themselves. They are the servant of every other branch of the economy and the community, domestic and global, and not their master. To believe that is not for one moment to undervalue or undermine the direct benefits to employment, prosperity and the balance of payments derived from the City. It is merely to acknowledge that there is a delicate and complex balance between the various roles and functions of the City. In vigorously defending it, we should not allow any one aspect of it to be disproportionately weighted.
I was delighted that the noble Earl, Lord Gowrie, linked the success of the City to a past Labour Government. As I have argued, a future one will protect and build on that established success. Even the late Lord Wilson of Rievaulx would have acknowledged, I suspect, that Britain's imperial history and, until the Great War, its role as a dominant exporter of capital to every other continent of the world were useful starting points. Moreover, it was during the first government of the late Lord Wilson that the pioneering innovations of Sir Sigmund Warburg in the Eurobond market established London's central role in that huge market. By the mid-1970s, the removal of interest equalisation tax in the United States led to barely a moment's pause in the development of the international money and capital markets in London. While the differing tax and regulatory regimes on opposite sides of the Atlantic contributed to the emergence of London's pre-eminence, we should not underestimate the importance of the innovative intellectual contribution by the pioneers of the international capital markets, like Sir Sigmund.
While the current skills in the City remain considerable, we should not be complacent about whether the innovatory cutting edge that existed in the 1970s and 1980s remains unblunted. It is striking that the driving force of the derivatives market and the state of the art trading techniques and technology are overwhelmingly derived from the United States and from American or American-trained individuals. We should worry that the education of the leaders of British merchant banks—in many notable cases in the Gymnasium of pre-war Germany—has been overtaken by that prevailing in the gymnasiums attached to the trading floors of Chicago and New York.
The overriding commitment on these Benches to the long-term improvement of education and training is as relevant to the City as to other areas of industry and commerce. Whatever established advantages London enjoys, which noble Lords have listed—location, time zone, language and supporting services—they will inexorably and inevitably be eroded by an under-educated and inadequately trained workforce in the next century. The PhDs that man the trading desks of the US banks are known as "rocket scientists". We should beware that our rocket scientists do more than grow a fancy sort of lettuce.
733 If the international activities of the City could be threatened in the longer term by under-investment in education and the intensified global competition to which my noble friend Lord Currie referred, are there grounds for concern that currently the strong commitment to the development of international business is at the expense of any of the market's domestic obligations? In the short time available, I should like to suggest to your Lordships that there is at least one area where there seems to be an unsatisfactory imbalance. London has been enormously successful in channelling investment funds into emerging markets—from Russia to Vietnam, from Peru to Zimbabwe—but there remains an undeniable failure to provide venture capital funds to hi-tech and other early stage enterprises within the UK and indeed the entire European economy. In marked contrast, the United States has a vibrant and expert venture capital industry, with a strong but discriminating appetite for risk, as well in the over-the-counter NASDAQ equities market, which is another huge source of risk capital for hi-tech and high growth companies.
This is not a peripheral issue. In the period from 1980 to 1995, 25 million net new jobs were created in the United States, a growth of 1.6 per cent. per annum; whereas in the same period, the comparable net job creation in Europe was a mere 4 million, a paltry growth rate of 0.2 per cent. per annum. While there are obvious factors, such as labour market regulation and mobility, which in part explain that disparity, there is strong evidence, as produced by the American economist Horace Brock, that the dynamism of the equity markets is at least as important a factor. In that regard, writes Professor Brock, perhaps the most important lesson to be learned from the US experience is the importance of taking seriously the dreams and ambitions of young people, regardless of their economic or social background, and taking those dreams seriously entails both sociological encouragement, such as role models, and funding.
This is not something the Government can legislate for. Nor do I believe that tax concessions are effective, as demonstrated by the consistent failure of business start-up, business enterprise and enterprise investment schemes to fund productive, innovative investment, not least because investors attracted by tax shelters are throughout the world fundamentally risk averse. What is needed is a cultural change, achieved perhaps by self-starting, not just self-regulation, on the part of the City, that instils the same willingness to take risks in Newbury and Newcastle as in Lima and Lagos.
I hope therefore that, as the leaders of the City gird themselves for the fight over the coming years to maintain an increased London share of international capital market business, they will direct the same energy, commitment and risk capital to the financing of the new industries to be created by the creative and technologically skilled generation of young people. Only then can we be confident that the employment and prosperity enjoyed by those in the City is replicated throughout the United Kingdom and European economy.
§ 6.10 p.m.
§ The Minister of State, Department of Social Security (Lord Mackay of Ardbrecknish)
My Lords, this has been a most interesting debate initiated by my noble friend Lord Gowrie. The collective expertise of all the speakers is an eloquent reminder to us of the wide range of experience found in your Lordships' House. It was Ernest Bevin who, in a different context, said that he did not want to go naked into the conference chamber. I feel a little naked of non-executive directorships, chairmanships, consultancies and the like in this present company. But that is probably just as well as perhaps the noble and learned Lord, Lord Nolan, might have something to say about it.
We particularly welcome the maiden speech of my noble friend Lord MacLaurin. My noble friend started with Tesco in 1959. Since 1985 he has been its chairman, and in one guise or another has presided over that company's steady climb through the supermarket league to its position today as one of its leaders. I am not surprised. He shares his surname, which is not a common one, with a certain Colin MacLaurin. Indeed, I think he is quite fortunate. He must be the first "Mac" to have got into your Lordships' House for a long time who has not been a member of the clan Mackay. Colin MacLaurin was born at the end of the 17th century. My noble friend may be aware of this; in fact, he may well be related. He was raised in the Manse of the Kirk at Kilmodan in a place called Glendaruel. Some of your Lordships may have heard of it. At the age of 11 he left the glen and went to the University of Glasgow to study mathematics. By 19 he was the professor of mathematics at Aberdeen and at 22 became professor of mathematics at Edinburgh. Those noble Lords who managed to hold on to mathematics for a little time in their school careers may remember that he gives his name to one of the fundamental theorems in calculus. His success in academia in the 18th century has been well echoed by his fellow clansman in business today. We very much look forward to other speeches from him, which perhaps will be a little more controversial than his maiden speech today, on all matters concerning business and commerce and the prosperity of our country.
Perhaps I may stick to the Celtic fringe for a little time because I feel that I cannot allow the debate to conclude without saying that there is a little more to this than just the Square Mile. Many other parts of our country have excellent and profitable financial businesses. For example, Scotland—I cannot think why I draw it to your Lordships' attention—is a financial services centre of international standing. It employs 200,000 people and accounts for 15 per cent. of Scotland's GDP. Its success story is terrific and it has been the fastest growing sector in the Scottish economy over the past decade.
It has important clearing banks. Two operate internationally. Assets have increased from £26 billion in 1986 to £85 billion in 1994. Scottish insurance companies have well-established markets overseas and Standard Life is the largest mutual life company in Europe. Funds under management in 1995 were almost 735 £94 billion. Scotland ranks third in the European Union after London and Paris and 14th in the world in terms of institutional equity funds under management.
Many of the Scots I meet in London when I go about my business wearing my other hat as Minister responsible for pensions in the Department of Social Security are in the pension management field, which is a tribute to Scottish education, particularly mathematics, if I may revert to Colin MacLaurin, and underlines the importance of the Union for our countries.
There is one ominous and threatening cloud on the horizon. I wondered how I was going to get this in because politics have been very much absent from the debate, but I knew I could rely on the noble Viscount, Lord Chandos, to introduce some party politics. I have to say to my noble friends Lord Rockley and Lord Limerick that, while I am sure they taught the noble Viscount banking well, they somehow missed out on the political education.
One threat to the Scottish position is the impact of Labour's plans for a Scottish Assembly with separate tax raising powers. Any increase in taxation arising from a "tartan tax" would make it more difficult for those important companies which operate north of the Border. In this highly competitive world, with the majority of customers living in England or indeed overseas, we could easily become uncompetitive and all those excellent jobs could simply migrate south of the Border or elsewhere.
Although this debate has concentrated on financial services—banking, investment and securities services and insurance—considerable earnings are generated from many other services, not least tourism and transport. My noble friend Lord Limerick drew particular attention to this with regard to the maritime sector. The UK maritime sector's contribution to our balance of payments has been estimated as at least £2.5 billion. The Baltic Exchange is the only organised market for ship broking in the world, handling half the world's ship sales and purchases.
The work of the City encompasses business directly transacted in and through the City. As my noble friend Lord Birdwood rightly reminded us, during the past 20 years we have seen a major expansion in the equity markets through privatisation, which was led in this country, and indeed around the world, by my noble friend Lady Thatcher, who I am pleased to see in her place today.
The work of the City also includes the business of subsidiaries and affiliates abroad. Its prosperity depends not only on the prosperity of this country and the markets here but also on the markets and performance of international firms operating around the world. In this context it is important to emphasise that it is not the origin or ownership of firms which counts but their ability to do profitable business here. The more profitable the business, the better for everyone.
My noble friend Lady O'Cathain suggested that we should not dwell just on some of the difficulties that the City has had in recent years but should look at its success. As I have marginally longer to speak than most of your Lordships, I should like to put on record as 736 quickly as I can what that success shows in terms of earnings for this country. In 1985 the net overseas earnings of the UK financial sector were £10 billion. By 1995 those net earnings had doubled to £20 billion, equivalent to 3 per cent. of GDP. The figures essentially comprise earnings from the export of services and investment income from overseas assets. The banks were responsible for £6 billion of that; securities dealers for £1.7 billion; commodity traders for £500 million; and insurance institutions for £6 billion. My noble friend Lord Chelmsford drew our attention to that, as he has done in speeches on the Social Security (Recovery of Benefits) Bill, which successfully passed its final stages in your Lordships' House last evening. The pension funds have earnings of £2 billion and funds in trusts have earnings of £1.5 billion. This is big money, and a remarkable success story for the City.
These international activities create significant employment opportunities. The City Research Project commissioned by the Corporation of the City of London and carried out by the London Business School estimated in 1995 that international wholesale activities employed some 150,000 people. These figures underpin the City's justifiable claim to be the world's leading financial centre. New York and Tokyo owe their positions partly to the size of their domestic markets. The important distinguishing feature of the City is the size and range of its international business. It is the world's largest centre for the trading of international securities, with more foreign companies—530 out of 2,800—listed on the London Stock Exchange than on any other exchange. As my noble friend Lord Clark of Kempston pointed out, the City is the leading global foreign exchange market, with an average daily trading volume of £291 billion, almost twice that in New York and almost three times that in Tokyo, and representing 30 per cent. of the world's foreign exchange deals. It has more foreign banks than any other city in the world, including New York and Tokyo. It is the largest international insurance market, as my noble friend Lord Chelmsford pointed out, and its business continues to grow.
Perhaps I may turn to one point made by my noble friend Lord Gowrie. I do not believe that his fears that we may be losing markets to Luxembourg and Dublin are justified. The tax position of UK retail collective investment vehicles, which invest in the shares and securities of UK companies, compares very favourably with that of a UK equity fund established in either Dublin or Luxembourg. We actually changed the rules for authorising unit trusts in 1994 to provide the facility for them to pay distributions in the form of interest to overseas investors without the deduction of UK tax. That facility will also be available to open-ended investment companies. The noble Lord, Lord Eatwell, who has debated these matters with me, will recall that we decided to call them "OEICs", which is rather an unfortunate name. They will come on stream shortly and should provide a major plus to the marketing of such schemes. We have a huge success story here and we must not be fearful of trumpeting it both in this country and around the world.
737 There is always a need to keep up with the game. Ten years ago Big Bang brought in tremendous changes, but the pace of change continues. The Stock Exchange continues to evolve. The City of tomorrow needs to develop institutions have to be one step ahead of the game. They have to be innovative in developing new products and new markets as well as responding to changes in existing ones. The noble Lord, Lord Ashburton, with his long experience, drew attention to the size of the change and, just as important, to the speed of change. Whether we are in or out of EMU—and I am not going to debate that tonight because I have many other opportunities to do so—I am confident that the City will respond positively and successfully. I am sure that the same will be true of the City's response to technological change in all its forms mentioned by my noble friends Lord Birdwood and Lord Limerick.
For their part, the Government have to ensure that tax and regulatory structures are effective and flexible and that they can adapt to rapid global change and to new products being developed while continuing to provide the right level of investor protection, prudential supervision and limitations on anti-competitive practice.
I now turn to regulation, which formed one of the main themes of almost every speech made by your Lordships. Regulation is about many things. It is about improving investor protection, promoting market efficiency and fair competition, so lowering the cost of raising finance for investment, and about encouraging high standards among practitioners, thus bolstering the reputation of the financial sector and promoting confidence among customers and clients.
The regime introduced by the Financial Services Act involved the least possible change from the previous regime. The chief regulators, the Bank and the SFA, deal largely with professionals who are familiar with the business in hand and, moreover, have access to specialist advice. That has made it possible to go for a relatively light regulatory touch, which a number of noble Lords, including my noble friend Lord Swaythling, with his considerable experience, highlighted as one of the important factors of success in the City.
I believe that the noble Lord, Lord Eatwell, had an interesting point when he suggested that there was a danger that the people who staffed the regulators would be second rate—I do not believe that he used those words, but I paraphrase them for the sake of speed. I know he will forgive me when he hears the rest of what I have to say—and the people who are really top class will go off to be high fliers and earn the kind of salaries that we read about and which I at least envy. He suggested that perhaps secondment of some of these high fliers would be a good idea. I shall certainly draw that to the attention of my right honourable friends in the Treasury who look at these matters. I am sure that other people and, hopefully, some of the companies involved employing such people might read what we say and contemplate the good sense of that arrangement.
My noble friend Lord Stewartby and the noble Lord, Lord Ezra, both suggested that there was a need to update the 1986 legislation and that we needed to keep 738 up to date. My noble friend Lord Stewartby also suggested that perhaps we should concentrate on principles in primary legislation and leave the details to secondary legislation. I know that that does not usually meet with the agreement of the noble Earl, Lord Russell, but I believe that in this case there is an argument because in that way the legislative framework can keep up with change in a very fast-changing world without the need to find time for primary legislation.
I believe that the noble Lord, Lord Currie of Marylebone, agreed with the need for that kind of approach. I also believe that he wanted to go a bit further in bringing together the various regulatory bodies. But he emphasised again the need for good, informed management. I am not entirely sure whether he was beginning to edge towards statutory regulation. The noble Lord, Lord Ashburton, posed some questions about statutory regulation which I found interesting. He asked whether it would work; whether it would be more costly and would it slow up business—that is a point which my noble friend Lord MacLaurin made—and, lastly, whether it would boost the legal profession. I do not know about the last point. Sometimes I believe that we are only here to do that by passing laws to keep the lawyers in business. We have to guard against that.
It is important that regulation is seen to work. As a number of your Lordships have said, we have not experienced more problems than other people. When we have experienced them we have put them right and we have not tried to hide them away. We have also learnt lessons from what has happened and that is very important. My noble friend Lord St. Davids made some points about the regulatory system. I know that he has a deep interest in that. I say to him that we have no plans to change it. The twin peaks approach which he mentioned, like other proposals for change, has some merit, but, like other proposals for radical change, it needs to be balanced against the disruption it would bring to industry, consumers and to the regulators.
The noble Lords, Lord Borrie and Lord Haskel, mentioned pension mis-selling. There is no disagreement between us on that. The damage that has been done has been caused not just to individuals, but also to the case for people taking out their own pension provision. That is a point that my noble friend Lord St. Davids underlined. I am pleased to see in the press that the PIA is pushing hard for these issues to be settled.
It was a little interesting that noble Lords did not mention the Maxwell pension scandal, although my noble friend Lord Limerick reminded us of his involvement as a Minister when, as he called it, the Maxwell-Pergamon Mark I business took place. I have always been very puzzled as to how, after that, the second affair was ever allowed to happen, but somebody may be able to explain it to me one day.
My noble friend Lord Cuckney deserves all our thanks for the success of the Maxwell pension unit. The pension Act should go a long way towards preventing abuse. I often wonder how Maxwell did it, because it was not just the pension funds but the governance of the companies as well. I believe that it was quite simple: he 739 had politicians for his friends, newspapers for his mouthpiece and lawyers for his writs. I am happy to think that he cannot give me a writ now.
Despite these high profile cases, as the noble Lord, Lord Desai, mentioned, the City, if it is actually to do its business, cannot be entirely safe. Indeed, I believe that the noble Lord was actually echoing a point made by Allan Greenspan, the president of the Federal Reserve Board, who said,We should not forget that the basic economic function of these regulated entities [the banks] is to take risk. If we eliminate risk taking in order to reduce failure rates to zero, we will, by definition, have eliminated the purpose of the banking system".A number of points were made about corporate governance. I thought that the most interesting one was by my noble friend Lord Lyell, who compared the Whips' Office in your Lordships' House with the back office of a City firm. Those who work there have to have an eye on everything and know about everything. To paraphrase, my noble friend may say that from his position now, but I do not believe that I could possibly comment from the Front Bench.
Undoubtedly, the responsibility for managing companies is firmly on the shoulders of the managers of those companies—that is a self-evident statement—the board of directors, the chairman, the non-executive directors and the like. Their responsibilities are underpinned by legislation through the Banking Act 1987 and the Companies Act 1985, which respectively define the duties of directors of banks specifically and directors of companies generally. That reflects the seriousness with which all governments of all parties have taken these matters.
The essence of corporate governance is to make sure that companies are managed and run in a way that meets the objectives of their owners and of the Acts. My noble friend Lord Chelmsford read out some interesting extracts and my noble friend Lord Rockley underlined the importance of structures, controls and management—all of which are most important. My noble friend Lord Swayfhling, from his great experience, welcomed the reports of both Cadbury and Greenbury, who looked carefully into such matters. We are now consulting on amendments to the Companies Acts to bring the disclosure requirements into line with Greenbury's recommendations to provide a measure of statutory underpinning and to avoid the unnecessary overlapping of requirements. We very much welcome the announcement of the new committee on corporate governance, chaired by Sir Ronald Hampel.
Good systems of corporate governance are crucial. My noble friend Lord MacLaurin spoke about how he encouraged his directors to be non-executive directors of other companies. That is most important. My noble friend Lord Gowrie explained how he had persuaded companies of which he was a non-executive director to pay for an outsider to give him reports about the financial information with which he had to deal. As always, my noble friend Lord Selsdon cautioned us against expecting too much from non-executive directors and from other professionals.
740 The motto of the London Stock Exchange is, "My word is my bond". That old motto is as valid for the City as a whole as for the London Stock Exchange. It signals the confidence with which people from around the world can come and do profitable business in the City. They have done so for hundreds of years. I am sure they will continue to do so for hundreds more. Technological advances will only add to that business. But underlying it all will be the people who work in the City, whose skills, commitments and talents are the envy of the world. They make a significant contribution to the prosperity of this country.
Given the enormous volumes of business being transacted, there is bound to be some dealing which is not done to the highest standards of integrity. Where problems arise, the causes are rigorously examined and steps are taken to ensure that they cannot and do not arise again. But, as many noble Lords have pointed out, the City knows that its reputation, and therefore its future, rests on high standards of knowledge, professionalism and competence. The City itself therefore has a strong internal interest in reacting positively to these problems. Each firm will say to itself, "Could that happen here, and how can I ensure it does not?"
We are all grateful to my noble friend Lord Gowrie for introducing a debate on this important asset to our country. We in the Government are committed to encouraging the City by freeing up enterprise at home and overseas to ensure that the City remains in the big league by being attractive to international business; that it continues to make its contribution to national and European prosperity—for the City is a European asset—and that it remains the safest and soundest of market places in which to do business.
§ 6.32 p.m.
The Earl of Gowrie
My Lords, I sought a thoughtful and ecumenical debate—I must say to the noble Viscount, Lord Chandos, that although I did indeed give a bouquet to the late Lord Wilson, I positively showered them on my noble friend Lady Thatcher—which in the build-up to an inevitably charged political atmosphere did not risk the health of what my noble friend Lord Birdwood called "the golden geese".
I sought the maintenance of an open and liberal system of regulation with legislative underpinning but principally self-governing.
Lastly, I sought for indications that no one should take the success of our financial industries, and all the benefits that that brings, for granted. My only quarrel with the otherwise admirable speech of the noble Lord, Lord Desai, is that the City is not our only industry with international dominance. We have another—it is called "the arts". We should cherish that as well.
I was reassured on all those important questions by nearly all the remarks made by those who took part. I thank them and beg leave to withdraw my Motion for Papers.
Motion for Papers, by leave, withdrawn.