PARLIAMENTARY DEBATE
Compensation (London Capital & Finance plc and Fraud Compensation Fund) Bill (Second sitting) - 15 June 2021 (Commons/Public Bill Committees)

I beg to move amendment 1, in clause 1, page 1, line 5, at end insert—

“(1A) Within six months of this Act receiving Royal Assent, the Secretary of State shall lay before Parliament a report that considers the circumstances and impact of the payment of compensation to the customers of London Capital & Finance plc and that, in the light of that consideration, sets out the following—

(a) the circumstances in which taxpayer-funded compensation should be paid following the collapse of investment companies in future;

(b) the extent of regulatory failure necessary to trigger compensation funded by the taxpayer in future; and

(c) the limits to taxpayer exposure to investment failings.”

This amendment would require the Secretary of State to lay before Parliament a report exploring the impact of the payment of compensation to the customers of London Capital & Finance plc and giving criteria for when the taxpayer should compensate investors for investment failures.

Thank you for your guidance, Ms Ghani. Later, I will move amendment 2 and, with your help, my hon. Friend the Member for Reading East will move amendments 3, 5 and 6, which stand in the Opposition’s name.

Amendment 1 relates to the first clause of the Bill, which deals with the compensation scheme relating to the collapse of London Capital & Finance and which is based on the report published by Dame Elizabeth Gloster, on which we took oral evidence this morning.

Clause 1 enables a very significant Government decision to step in and compensate people for the collapse of an investment firm. The estimated cost given by the Treasury for that decision is about £120 million. As the Minister pointed out on Second Reading, it is rare that the Government do that. He told us that there have been only two other cases in recent decades—Barlow Clowes and Equitable Life—and even those decisions did not always bring matters to a close. With Equitable Life, some investors around the country remain dissatisfied with the levels of compensation that have been paid out. There is an all-party parliamentary group in this House, and we have my indefatigable hon. Friend the Member for Harrow West, who has led at least one debate, if not more, on these issues, on the Committee. Such decisions do not always bring the matter to a close.

The focus of the amendment is to try to bring some clarity to Parliament and the public about when the taxpayer should be on the hook for an investment collapse, and when not. This issue was raised in oral evidence this morning by the hon. Member for North East Bedfordshire. He used the well-known phrase “caveat emptor”, or “buyer beware”, which applies those who may buy investment products. The trouble at the heart of this case is that the investors did not think they were making a particularly risky decision. LCF sold mini-bonds on the basis of a guaranteed investment return. When those who suspected something might be wrong phoned the FCA, time after time they were reassured that nothing was wrong. To quote one of the FCA’s call handlers, “This is not a scam”. While the hon. Gentleman was right to raise the principle of caveat emptor, how can we blame the investors if the very regulator looking after the thing was reassuring them that there was nothing to be concerned about?

The Government have judged the level of regulatory failure to be so exceptional and egregious that they have decided that the taxpayer has a responsibility to compensate, or as it is sometimes put, to socialise the losses. The level of compensation set by the Government is 80% of the maximum level allowed by the Financial Services Compensation Fund. That maximum is £85,000, so 80% leaves investors with a maximum pay-out of about £68,000.

There is debate about that 80%. Members of the Committee will have been sent written evidence from various LCF investors who think that level is too low. They do not understand why they have been asked to forfeit 20% of their investment because of what the Government acknowledge to be a particularly egregious regulatory failure. The Government will have to debate that. Their justification for any compensation at all is that LCF is a unique case. Both Ministers spelled that out on Second Reading last week. In his opening speech, the Pensions Minister said:

“While other mini-bond firms have failed, LCF is the only mini-bond firm that was authorised by the FCA and sold bonds in order to on-lend to other companies.”

He went on to say:

“It is…important to emphasise that the circumstances surrounding LCF are unique and exceptional, and the Government cannot and should not be expected to stand behind every failed investment firm.”—[Official Report, 8 June 2021; Vol. 696, c. 905.]

We agree, and that is precisely what the amendment is about: to try to get some clarity on the Government’s thinking when the degree of regulatory failure is so exceptional that it warrants the taxpayer picking up the bill. When that is not the case, whatever losses there may be should be regarded as normal investment market failings.

My hon. Friend is right; the lacuna referred to in the report relates particularly to the allocation of ISA status. We asked Dame Elizabeth about that during the oral evidence session this morning. This is important because if there are two things that gave the mini-bonds the stamp of respectability, it would be that prominent in LCF’s advertising was the statement that it was regulated by the FCA, which at firm level was true but was not true of the mini-bonds being sold, and that they could be placed inside an ISA wrapper. Although it is, of course, true that people who invest in ISAs can lose money, for understandable reasons, the ISA wrapper has a certain cachet and a note of respectability.

Dame Elizabeth confirmed during oral evidence this morning that once the ISA wrapper status was allocated in 2017, the degree of investment in those mini-bonds rose markedly, because people would have thought they were investing in something safe. The adverts spoke, in fact, of a 100% record in paying out, when what we were really dealing with was a pyramid scheme where any pay-outs that did come came from other investors and not normal market returns. People thought they were investing in a safe bond. They did not think they were playing investment roulette.

The Economic Secretary also emphasised the uniqueness of the LCF case in his closing speech on Second Reading. He said:

“LCF is unique in that regard; indeed, it is the only mini-bond issuer that was authorised by the FCA and that sold bonds to on-lend to other companies.”—[Official Report, 8 June 2021; Vol. 696, c. 918.]

That is an exact replica, with both Ministers saying the same thing, and I suspect that that phrase has been very carefully honed inside the Treasury. A case had to be made for the uniqueness of this that could not be applied to other investment failures, so I think that form of words is very carefully chosen. However, the Minister may be able to tell us more when he responds.

The amendment is designed to tease out the following point, which I want to clarify with the Minister. Is it the case that even though a number of mini-bond issuers have collapsed in recent years, LCF is the only one that was authorised and regulated by the FCA? The Minister can intervene now or I am happy to wait. As I said to the Ministers on Second Reading, there must have been a discussion in the Treasury about developing a compensation scheme such as the one set out in clause 1. The question would have been asked: if we did this for LCF, what about investors in the Connaught fund or Blackmore Bond or any of the other investment schemes that were raised either on Second Reading or during the oral evidence session this morning? What was the nature of those discussions at the Treasury and what is it about LCF that makes the Government convinced that compensation is due in this case but not in the others? That is why our amendment calls for a report. Having taken the decision to compensate, we believe it would be in the public interest for the Treasury to set out the circumstances under which the taxpayer might be expected to pay when investors lose money. Is it about a firm being authorised by the FCA? Is it about commissioning a report by an eminent and independent figure such as Dame Elizabeth Gloster?

I am grateful to the Minister. I am just going through this series of things to try to clarify exactly what might place the taxpayer on the hook. Does it require the kind of report carried out by Dame Elizabeth Gloster and commissioned by the FCA into the collapse of LCF? Is there a clear threshold of regulatory failure to be passed? There was obviously regulatory failure in this case, but, as we saw from the witnesses this morning, people will argue that other regulatory failures have applied to other firms.

In this case, the regulatory failures were multiple. I do not want to go through them in detail because we will come on to other amendments in which they can be discussed, but I will mention a few of them briefly: misleading promotions by LCF using the halo effect have been regulated by the FCA yet not adequately dealt with by the financial promotions team at the FCA; a failure by the same financial promotions team to join the dots and alert other parts of the FCA, such as the supervisory team, on the implications of those misleading promotions; and multiple attempts to alert the FCA—more than 600 phone calls, according to annex 6 of Dame Elizabeth’s report. Yet, in the vast majority of cases nothing was passed up the line of pursuit, in large part because the mini-bonds were not regulated by the FCA, so the call-handlers’ instincts were, “You’re phoning us about something that we do not regulate, so we don’t have to pass it up the line”—even though the firm as a whole was regulated by the FCA.

My hon. Friend raises a very important point. There are many reasons why clarity about the limitations of Government responsibility and taxpayer responsibility, to put it another way, would be extremely helpful. The very fact of producing the Bill will mean that the Government have asked those questions anyway. As I said earlier, the cost in this case is expected to be about £120 million. The costs of clause 2, which we will come to later, are expected to be over £300 million. Over both clauses the cost will therefore be more than £400 million. That is a large sum of public money that will, in the case of clause 2, be recouped over a period of years from pension scheme members.

Of course, it is possible to have investment failings on an even greater scale. Is there any upper limit that the Treasury would see to such taxpayer exposure, or is it always to be on a case-by-case basis? In theory, investment failings could cost billions rather than hundreds of millions. Our amendment seeks to clarify the Government’s thinking on that, which would be beneficial to Parliament and the public.

Those are the reasons why we have tabled this amendment. We think that the compensation scheme and the whole story of the collapse of LCF demands such clarity and that reports such as the one we have called for would be beneficial.

I want to ask the Minister about the point he made about on-lending. What is the relationship between on-lending and the degree of regulatory failure? He is probably right that this was the only firm doing on-lending, but Dame Elizabeth’s report focuses on an egregious regulatory failure and she sets out all the different things that we will discuss. I suspect that the Government have found something about this case that is unique in order to insulate themselves from claims from other investment failures. I do not see the relationship between that uniqueness and the regulatory failures outlined in Dame Elizabeth’s report.

I am grateful for the Minister’s response.

I am not entirely convinced about the relationship between on-lending and the decision to compensate. I am sure that the Minister is correct in the literal sense that this was the only regulated firm that was selling unregulated mini-bonds. I am not saying that the Minister is wrong, but from reading the report I believe that Dame Elizabeth would have made the same findings. The mini-bonds were not doing what it said on the tin: they were not on-lending but pyramid selling.

The degree of failure, the degree of investment loss and the degree of regulatory failure are not directly related to the point about on-lending: it is more substantial than that. I am not convinced that all the elements of the Government’s case add up. It looks to me as though they have had to find a unique element to insulate themselves from court action or other claims.

We are trying to put ourselves into discussions that we have not been party to so, to some extent, I am speculating on the way that the Government have built their argument.

I have made the point and I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

I beg to move amendment 2, in clause 1, page 1, line 15, at end insert—

“(3A) Within six months of this Act receiving Royal Assent, the Secretary of State shall lay before Parliament a report setting out progress on the implementation of the recommendations in pages 47 to 49 of the Gloster Report.”

This amendment would require the Secretary of State to lay before Parliament a report setting out progress on the implementations of the thirteen recommendations in the Gloster Report.

Amendment 2 concerns the recommendations made in Dame Elizabeth’s report. It is a long report, but I am specifically referring to the series of conclusions and recommendations made on pages 47 to 49. As the Minister said a few moments ago, some of those recommendations are for the FCA and others are for the Government. We heard Dame Elizabeth say this morning that if she reached one overall conclusion that she wanted us to understand, it would be about the degree of culture change necessary for the FCA to fulfil its statutory duties. The fact that she judged that the culture that existed was so inappropriate that it stopped the FCA from doing its statutory job effectively is a serious charge. It is, after all, the body that we depend on to uphold the consumer interest and charged with ensuring proper conduct in the sale and provision of financial services. I do not need to tell anybody on the Committee how important those are, either to everyday life or to the UK economy.

One of the most telling parts of Dame Elizabeth’s report is when she discusses the loss of a letter sent to the FCA by a financial adviser called Neil Liversidge in November 2015, fully three years before the collapse of LCF. The letter warned in fairly graphic language, some of which I read out on Second Reading, what was going on at LCF and the financial adviser’s concern. Dame Elizabeth’s damning conclusion is that even if the letter had not been lost in the FCA, which appears to be what happened, so dysfunctional was the FCA that it would not have done anything about it anyway. She says on page 78 of the report:

“it is unlikely that it would have resulted in any”

action by the FCA. She found that degree of dysfunctionality to be deep and in need of urgent attention, as set out in the recommendations.

Every time there is a public failing, we hear some familiar things being said. In fact, we could almost play word bingo with them. People talk about lessons learned and new systems being put in place, and sometimes there is change of leadership or a change of the management team—all those things. In the report, there was a very well publicised disagreement about the nature of accountability and responsibility involving Dame Elizabeth and the now Governor of the Bank of England, who led the FCA at the time. That was all played out in front of the Treasury Committee over several hearings early this year. I want to focus on the 13 specific recommendations on pages 47 to 49. I am not going to go through them in huge detail, but I will mention a few.

The first recommendation is the desire to treat the regulation of companies holistically; that is, to deal with the halo effect of regulated companies selling unregulated products. That was at the very heart of the regulatory failures over LCF. It was a big part of why the many phone calls to the FCA alerting staff to investor fears about what was going on went unheeded. Indeed, Dame Elizabeth’s report records many instances where calls were not acted on because the mini-bonds concerned were not regulated. There is a whole annex containing the transcripts and I will not delay the Committee with them at the moment, but they are all set out in the report.

The failure to act exposed a major weakness in the FCA’s approach. Even if staff could tick a box that said that a phone call was about something that it did not regulate, the FCA was still on the hook at the end of the day if the firm failed, as the Bill now shows. The recommendation therefore requires a major change in how the FCA thinks about unregulated products.

The next two recommendations are about how the FCA deals with information passed on to it and how it is shared. Again, they highlight a failing in how the LCF information was handled. As we have said, the financial promotions team intervened several times to warn the company about the misleading nature of its promotions as it kept saying that it was regulated by the FCA. However, the financial promotions team did not escalate this information to other parts of the organisation that could have taken action.

The fifth recommendation deals with the financial promotion rules and what to do about breaches when red flags should be raised. Page 49 highlights recommendations more for the Treasury than the FCA. As we discussed a moment ago, the first of those deals with what Dame Elizabeth calls a lacuna in the allocation of the ISA-related responsibilities between the FCA and HMRC. The Minister referred to a working group—I think that is the phrase that he used—and I hope it reaches a conclusion quickly. Such a response is common in the catastrophe word bingo that we often hear. A working group is okay, but it has to deal with the lacuna that has been identified.

Just saying that something is regulated by the FCA gives it an aura of safety and respectability and so does saying that about investments in an ISA wrapper. As the report says, once ISA status was granted to these mini-bonds, investment in them grew markedly. Putting money into an ISA is thought to be a responsible thing to do. People believe that those operating ISAs are respectable companies and not those engaged in what are, in effect, pyramid selling schemes like the one that LCF was operating. That is why this issue is particularly important.

Recommendation 12 is about the optimal remit of the FCA. That matters because the failure of LCF sits so squarely on the boundary of regulated companies selling unregulated products. The FCA’s remit is known in the parlance as the perimeter. The Minister gave evidence to the Treasury Committee a few months ago and he said it was not an issue about the perimeter, but about the failure to use the enforcement and supervision powers that the FCA already had. I understand what he means by that. He is saying that if the FCA had acted on the reports that it had received, a great deal less damage would have been done and the taxpayer would not be faced with the compensation bill set out in the Bill. Even though I understand the point he made, the perimeter is still relevant because it informed attitudes inside the FCA on how alarmed it should be about calls reporting concerns about LCF and whether it should act. That behaviour was influenced by the fact that the calls were about products that were not regulated.

How should the Government and the FCA respond to the issue of regulated companies and unregulated products? In theory, one response could be to say that regulated companies can only sell regulated products, but that would involve a major extension of regulation. That is not to say that that is necessarily wrong, but it would be a big step. For example, foreign exchange trading is not regulated but it is carried out by every high street bank in the country and they are, of course, regulated entities.

If the answer is not a major extension of regulatory responsibilities, what is it? Is it the Government’s position that there is no need to look at this because this was such a one-off event that cannot be repeated? How can we be sure of that? We asked the FCA this morning whether this could happen again and, understandably, the witness from the FCA said that he could not tell us for sure that it could not.

My hon. Friend makes a very strong point. The question of the perimeter is inescapable. One of Dame Elizabeth’s recommendations is that the Government consider the FCA’s remit, and the Government have said that they accept all her recommendations. The Minister said in his evidence to the Select Committee that this cannot be pinned on the perimeter, as it were, but as a conclusion of what has happened the perimeter must be considered. The Government have accepted that.

One way to deal with this is to say that regulated firms and regulated products must be brought together—I shall be grateful for the Minister’s response on that—but if that is not deemed to be the right response how will the question of the remit and the perimeter be responded to? At the heart of this failure is the halo effect of a regulated firm selling unregulated products.

Recommendation 13 is about ensuring that the legislative framework keeps pace with the sale of products through technology platforms. This field of activity is growing daily. It is driven by technological innovation—the movement of more and more activity online—and perhaps by the increased time people have had during the lockdowns to invest online. I do not want to try your patience, Ms Ghani, by delving too deeply into that today, but I think that this issue will occupy the House and this Minister in particular over the next couple of years. We will have to return to it again and again in the House, but recommendation 13 is precisely about legislation on selling things through technological platforms, and the Government and the FCA will have to adapt to it or they will fall behind the reality of the market and of financial crime.

Most of these issues have been put in the hands of the new chief executive, Nikhil Rathi, and the trans-formation programme to which the Minister referred on Second Reading. How are we to know that the 13 recommendations have been implemented? It is easy when a report is published to say, “We accept the findings.” The key is: are they followed through and properly implemented?

Dame Elizabeth’s report should be more than a series of individual recommendations. As she said this morning, it should result in a culture change. Much more communication needs to take place between different parts of the FCA while, crucially, not dropping the ball on regulated firms and unregulated products.

It is unfair of any of us, in government or in opposition, to load more responsibilities on to the FCA if it does not have the resources to fulfil them. We are clear in our amendment that the resources of the FCA have to be covered. Does the FCA have the resources to meet the ever-expanding list of responsibilities, including those on-shored as a result of our departure from the EU? It is funded through a levy on the sectors for which it is responsible. Is the levy giving it enough resources?

The failure of LCF exposed such a degree of dysfunctionality that it prompted the question: can the FCA really do its job? If not, the Government have to act because the public need the protection of a powerful regulator. The imbalance of information between the sellers of financial services products and the buyers absolutely demands that. This amendment is aimed at our receiving a report on the 13 recommendations and on their implementation by both the FCA and the Treasury. Its acceptance would provide Parliament and the public with a mechanism to ensure that statements saying that the recommendations had been accepted had actually been followed through and action taken.

I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Question proposed, That the clause stand part of the Bill.

It is really just a question. The Committee has received a number of representations from LCF investors about this 80% level. What is the Minister’s response to those representations? If LCF investors were here and were allowed to speak, they would say, “Why is it that those who invested after getting financial advice get 100% of the FSCS level because financial advice is a regulated product and therefore covered by the FSCS in full but we are getting 80% of that level?” What is his response on this differential treatment of the two types of investors?