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Banking Bill

My Lords, I am grateful to the noble Baroness, Lady Noakes, for the way in which she introduced her amendments, explaining that she is providing the Government with an opportunity to explain their thinking and that, if that explanation is satisfactory, she will withdraw the amendments she has tabled. As the noble Baroness said, this group of amendments relates to events of default, also known as termination rights, and refers to Clauses 22, 34 and 38. I will speak to government amendments to Clauses 22 and 38. For the benefit of the House in debating these matters, I will speak briefly to the purpose of these clauses as I believe it sets a useful context. Clauses 22 and 38 set out certain provisions in relation to clauses in contracts which give a specified right to a counterparty if a specified event—an event of default—occurs. In particular, such a clause may specify that a counterparty has a right to terminate the contract should the event of default occur. Most modern contracts make heavy use of such provisions. The exercise of property or share transfer powers under the special resolution regime may, in future, be characterised as an event of default. This would give counterparties the right to terminate or modify contractual arrangements in the event that the authorities exercise the transfer powers. As I explained in Committee, this could lead to a wide counterparty flight from the deposit-taker, with severe consequences for the success of the resolution. Therefore, Clauses 22 and 38 make provision to address events of default which could impede resolutions under the special resolution regime. I should make it clear that the financial collateral arrangements directive, under which the Government must allow financial collateral arrangements to take effect in accordance with their terms, including by respecting terms which permit the counterparty to close out, is a dominant feature here. In debating these provisions, we are talking about the minority of financial contracts that are not protected under that directive. Government Amendments 7 and 13 seek to respond to concerns which have been raised by interested parties, including at a meeting arranged between Treasury officials, parliamentary counsel and the City of London Law Society, which was attended by the noble Baroness, Lady Noakes. A further meeting has since taken place between tripartite officials and the City of London Law Society. We have always been clear that the purpose of these clauses is not to prevent termination rights from being exercised where the transferee defaults in the obligations it has assumed. Let me illustrate this with an example which I hope will help. A services contract to supply IT is transferred from bank X to a bridge bank by the property transfer powers. The services contract contains two events of default. One says the contract terminates if the contract is transferred from bank X to any other company. Another provides that the contract may be terminated if there is default in payment on three consecutive occasions. Clause 38 is intended to address the first event of default, which would be turned off by this provision. But it is not intended to allow the bridge bank to default in paying its obligations under the services contract on three or more occasions. If it did, the service provider would be able to exercise its right to terminate. Interested parties have questioned the reference in subsection (8)(b) to things done, "““under or by virtue of””," a transfer instrument. It has been suggested that the entire contractual relationship following a transfer flows from the fountain-head of the transfer instrument, so the clause would catch even a second event of default mentioned in my example. The Government do not believe this to be the correct construction of this provision. ““By virtue of”” is an expression used in statutory drafting to refer, for example, to things that are not done directly under the order. However, the Government recognise the need clearly to indicate that the purpose of these clauses is not perpetually to immunise a transferee from ordinary commercial obligations. Accordingly, we have brought forward government Amendments 7 and 13 to dispel such concerns. The noble Baroness has spoken to her Amendments 4 to 6 and 10 to 12, for which I thank her. I realise that these amendments flow from concerns that the default event provisions that I have described could have the effect of interfering with financial arrangements, such as set-off and netting, with negative consequences for risk management and regulatory capital. Noble Lords will recall that the Bill already provides protection for such arrangements in the context of partial transfers, and so, as I made clear in Committee, it is appropriate that similar protections be provided for in the context of default events. The Government also recognise that such protection should be extended to third parties where they have entered into financial contracts with a counterparty of the bank, which are relevant for set-off and netting arrangements. But we do not think that protection for third parties should be extended to non-financial or service contracts, which, if terminated, could, for example, prevent the failing bank being able to offer continuous banking services to its customers. Nor do we think that the protections are needed in the context of ““whole bank”” transfers, as the market’s concerns have been expressed in the context of partial transfers. However, the Government believe that protection for financial contracts, such as those relevant for set-off and netting, including third-party contracts, should and can be provided under the existing structures of the Bill. Therefore, providing appropriate protection does not need any changes to the provisions of Clauses 22 and 38. To provide protection for the types of contracts I have described above, we intend to use the enabling power under Clause 47, which allows the Government to place certain restrictions on partial transfers. Therefore, under Clause 47, we will put in place a standing order which will protect, in the event of partial transfer, the termination rights of bank counterparties and third parties in relation, broadly speaking, to financial contracts with set-off and netting arrangements. To be clear, this will protect those who contract with the residual bank, with third parties not directly related to the failing bank, and those who would be transferred to the new company following a partial transfer. I believe that this will satisfy market concerns. However, for reasons that I listed in my introduction, the authorities believe that it is critical to provide the new company, be it a bridge bank or a private-sector purchaser, with certainty over what contracts are, or are not, being transferred. Otherwise, it will be difficult to ensure an effective resolution. In order to achieve this, we intend to have the flexibility to make conditional transfers. I will consider the details of these proposals when I speak to government Amendment 8. However, using conditional transfers will enable us to obtain a greater degree of certainty for the transferee, while fully respecting the safeguard that I have just set out. In short, the transferee will know what property has been transferred to it, without resort to close-out, within a period set out in the transfer order. The Government believe that this targeted protection balances the need for certainty in the financial markets with the authorities’ ability to effect a successful resolution. The early indication from consultation with stakeholders is that this approach will be supported. I turn now to government Amendment 8, which provides for the conditional transfers to which I have just alluded. Its aim is to prevent counterparties closing out against the transferee simply as a result of the transfer, while preserving their transfer rights against the residual bank. I emphasise that it does not prevent the counterparty closing out, should the transferee breach the obligations that it has assumed, as I made clear earlier. An unfettered right to close out against the transferee—or new company—carries potential risks for the resolution. The new company could immediately be required to pay crystallised liabilities, creating liquidity stress. Moreover, and importantly, should a counterparty close out on such a basis, it would have acquired a better right than it had in the first place, namely the right to close out not against a failing institution, but the more credit-worthy bridge bank or private-sector purchaser. This is not the same as the termination right for which the counterparty had contracted. The Government believe that the amendment to Clause 34 provides a way to overcome this concern, and is encouraged by a positive response from stakeholders. This amendment enables the authorities to transfer property, rights or liabilities conditionally. It could be exercised in two broad ways. First, it could provide that the transfer only ever happens if a specified condition is satisfied. Secondly, it could provide that a transfer is automatically reversed if a specified condition is satisfied. In either case, the condition could be defined as an event occurring or an event not occurring. Where a counterparty has protected financial contracts, the authorities could adopt either of the following approaches. They could provide that the transfer of financial contracts will only take place if a counterparty agrees to waive any rights to close out that might otherwise arise; or they could provide that a counterparty will be transferred but will be automatically returned to the residual bank should they attempt to close out. It is because the transfer can be made conditional on the waiving of termination rights that the time limit that I mentioned earlier can be contemplated. A time limit does not purport to interfere with termination rights. It merely creates a defined window in which the counterparty can elect to affirm the transfer to the new company. The protection that I have described, which will be put in place under Clause 47, remains fully effective. However, should the counterparty wish to close out, as a result of this amendment, the authorities can ensure that the counterparty will not be able to close out against the transferee. It will, instead, close out against the residual company with which it had originally contracted. This allows for a targeted approach. I hope noble Lords will see that it is entirely appropriate that the counterparty should not be able to acquire new and superior rights to those for which it contracted. I commend this amendment to your Lordships’ House as a way of achieving this result. Financial markets legal experts have indicated that they are satisfied that this approach meets their concerns. Therefore, the Government are proposing a package of measures that delivers protection for financial contracts with set-off and netting arrangements following a partial transfer. In addition to the broad protection already provided to financial contracts by the financial collateral directive, we believe that this will provide the legal and therefore market certainty. I can confirm that the Government intend to insert these protections in the safeguards orders that we will be laying on partial transfers at Royal Assent. Further, these provisions target only the precise concerns put to us by the market. Therefore, the Government can still exercise their rights to prevent default events for other contracts such as service contracts or financial contracts following a full transfer. The authorities believe that this will provide sufficient flexibility to effect a resolution and certainty for any new private sector purchaser over what property it will be receiving. Key stakeholders discussed the package last week at a meeting attended by the noble Baroness, Lady Noakes. During the meeting, we provided parties with initial drafting, which set out the protections that I have just explained. While, of course, the detail of these orders has yet to be agreed, I can report that the stakeholders appeared to believe that this broad package met their concerns. Balancing market certainty and confidence with appropriate powers for the authorities to effect a successful resolution has been at the core of a number of our debates. I believe that these proposals find that balance and are preferable to the alternative amendments. However, I would like to thank the noble Baroness for taking so much time to ensure that the House debates the matter and for attending sometimes lengthy and complex meetings dealing with stakeholder concerns on these important matters. I am sure all those who have concerns about this complex area will be indebted to the noble Baroness for her diligence in addressing these matters and helping us improve the legislation. I respectfully ask her to withdraw her amendment, so that I might press the government amendments to which I have just spoken.