Third Standing Committee on Delegated Legislation


Tuesday 10 December1996



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1 Third Standing Committee on Delegated Legislation Tuesday 10 December 1996

[SIR DAVID KNOX in the Chair]

Financial Services Act 1986 (Extension of Scope of Act) Order 1996

4.30 pm

The Economic Secretary to the Treasury (Mrs. Angela Knight): I beg to move, That the Committee has considered the Financial Services Act 1986 (Extension of Scope of Act) Order 1996. (S.I., 1996, No. 2958). The order is being introduced to extend the coverage of the Financial Services Act 1986 to bring custody services and certain activities in relation to open-ended investment companies within the definition of investment business within schedule 1. Paragraph 2 of the order deals with investment companies with variable capital, or open-ended investment companies, to give them their more familiar name. I hope that members of the Committee will forgive me if, during the debate, I refer to them by their nickname, OEICs. In November, we debated the main regulations bringing OEICs, into being. These have now been made under the European Communities Act 1972. As a result of the creation of the corporate code of OEICs, two new activities will require authorisation under the FSA. Every OEIC must have a depositary and the regulations require the depositary to be an authorised person. The depositary, normally a large institution, such as a bank, will have a role similar to that of the trustee of a unit trust. The definition of investment business in schedule 1 to the FSA includes acting as the trustee of an authorised unit trust to be an authorised person. This order will add a similar provision in respect of the depositary of an OEIC. The regulations allow the board of an OEIC to consist of a sole director, but if there is only one director, that director must be a corporate body which is an authorised person. The order, therefore, adds acting as sole director to the coverage of paragraph 16 of schedule 1. The effect of adding these activities means that those involved in two key areas of the corporate governance of an OEIC must be authorised and, as a result, their activities can be regulated. This is an important element of the protection for investors that is built into the OEIC structure. The bulk of the order deals with custody, which is an international and very competitive business. It is carried out by a range of professional firms. The Treasury's decision to regulate custody services has not been taken lightly or, indeed, in haste. There have been widespread consultations both by the Securities and Investments Board and by the Treasury. In December last year, SIB formally recommended to the Treasury that custody should be made an authorisable activity. 2 The SIB also concluded that there would be no significant costs associated with making custody authorisable. The standards proposed would codify existing good practice and provide reassurance to users of those services. At the beginning of this year, the Treasury consulted a number of custodians informally. As a result, the advice was that I should accept the SIB's recommendation. On 9 May, I announced that decision to the House. We then issued a formal consultation document in June, setting out the way in which we proposed to put authorisation of custody on to the statute book. The document was circulated widely and there were just over 60 responses. Many of the points that were made are reflected in the instrument and the treasury's comments on these points have now been issued in the form of notes. The custody market is substantial. The top ten custodians in the United Kingdom hold around£700 billion of assets. Custodians come in a range of shapes and sizes. At one extreme is the global custodian. Typically, this is a multinational bank, not necessarily based in the UK, offering services to major businesses across the world. In turn, that primary custodian might employ sub-custodians in a number of markets around the globe. Then there is the fund manager and stockbroker, who may act as custodians. There is also the trustee of a fund, holding assets safely on behalf of a child. So the term custodian can apply to firms from the multinational bank, through fund managers and stockbrokers, to trustees. But it can also cover the small country solicitor, holding share certificates for an investor in his safe for safe keeping. So the definition requires that both safekeeping and administrative services are being provided before it will bite. It also covers firms that arrange or offer to arrange for such services to be provided. What constitutes safe keeping is clear enough, but the order does not define administration. That is deliberate. The term covers a wide range of functions which, over time, can change. It brings within the definition all firms that carry out particular functions relating to the investments held, such as the collection of dividends and the settlement of sales and purchases. That is not a comprehensive list, but gives an indication. The definition applies to assets rather than investments. Again that is deliberate. Our intention is to cover the situation in which a portolio may at times comprise a greater or lesser proportion of cash while the client makes his investment decisions. We do not want firms to move in and out of authorisable status depending on the composition of the portfolio at any particular time. For what is, in essence, a simple purpose, the order may appear complex. A series of notes explains the position of sub-custodians, dematerialised securities, stock lending, introducers and permitted persons and sets out activities that we do not regard as administration. Those are all proposed to ensure that the order is no nore extensive than necessary. 3 I am determined that the extension of scope should not impose additional major burdens on companies. The standards that the Securities and Investments Board published in the summer set out the safeguards that will be expected of the self-regulating organisations in regulating their members. The self-regulating organisations will consult on the way in which those standards will be translated into rules in the spring. At that time, the Securities and Investments Board will undertake a cost benefit analysis of the anticipated effects. Extension of the regulatory regime in that way will improve the protection provided for investors and will ensure a level regulatory playing field, enhance standards and boost confidence in the industry. I commend the order to the Committee.

4.36 pm

Mr. Mike O'Brien (North Warwickshire): I have three questions for the Minister. The issues surrounding OEICs were covered previously and the Minister has written to me on that. I should warn the Minister that my hon. Friend the Member for Huddersfield (Mr. Sheerman) is present because he is writing the diary for theThe House Magazineand he thought it would be amusing to listen to us discussing OEICs. The Minister may wish to explain what they are, but at this point I shall leave him in ignorance. Will the Minister elaborate on the consultation and the 60 responses and outline how she was able to assist the various organisations that responded? Will she assure us that the consultation was as wide as it appears to have been and that the Treasury took into account the anxieties that were expressed? Secondly, will the Minister elaborate on paragraph 13A, which refers to the custody of investments, and will she give practical examples of activities that were included in that and the practical impact of including those within the scope of the Financial Services Act 1986 as we are doing in the Order? Finally, there are seven exceptions. Will the Minister assure us that the balance is right. When there are many exceptions in a short order, there is concern that there may be too many escape routes from the scope of the Act and that the system will become so complicated that the industry will be burdened with red tape. Will the Minister assure us that the balance is right in the order and that she took account of those points when considering the details?

4.39 pm

Mrs. Angela Knight: Perhaps I can start by elaborating on the open-ended investment companies, otherwise known as OEICs. The name has caused much amusement around Parliament. People have tried to think of lots of different names for an OEIC, but an OEIC is an OEIC and the name has stuck. A posh unit trust would be one way of describing an OEIC—another word would be a thug, which we all come across in our streets from time to time. 4 On the serious point about what consultation the Treasury undertook in considering the regulation of custody services, consideration began back in 1992. The SIB announced that it would review the custody of investment assets. Its reasons for doing so included, for example, the loss of assets from the Maxwell pension funds. SIB published a discussion document at that time. It was debatable whether a case was made for regulating custody. What is now seen is that custody has developed and extended as a business. Therefore, in 1995, there was further dialogue with the industry and, indeed, international discussions took place. The SIB produced another consultation document, which proposed standards for the custody business of already authorised firms. At that time, the SIB also invited reactions to the proposal that custody services should be brought within the scope of the Financial Services Act. Thus, the consultation has in some way been going on for four years. Although it was decided in the first instance that the case was not made with an industry or part of the industry which was clearly growing rapidly, one had also to take proper account of the issue and continue to keep a watchful eye on developments to see whether there was a point at which custody should be regulated. We believe that we have now reached that point and in all our discussions with the industry, it agreed. On the issue of on whom the order will impact and in what way—the hon. Member for North Warwickshire (Mr. O'Brien) asked what the practical effects would be—it is likely that, overwhelmingly, those who offer custody services are already regulated under the Financial Services Act because they are undertaking another authorisable business. We cannot say how many people would come into authorisation for the first time, but we are anticipating that there will be very few. For example, custody could be offered by a fund manager, a stockbroker or an independent financial adviser. Those people are already authorised. Whether individuals will come along in great numbers offering custody only—the service that is not authorised until this order is accepted—we do not know. In many respects, we are saying, "A line is drawn in the sand here. This is a big business. Assets need to be secure. Thus, if you are going to offer custody services, especially stand-alone custody services, you have to be authorised." That is something that we have found that the real world considers to be a very good move indeed. The third point raised by the hon. Member for North Warwickshire related to exceptions or exclusions and whether we have the balance and the red tape right. In some respects, there are no new exclusions in the order. We are merely extending existing exclusions to cover new activity. That policy intention goes with the grain of the schedule. One of the reasons why we have also defined the intention as an administration function is to ensure that we do not, for example, catch a whole raft of small town and country solicitors who act in many respects as trustees and simply safeguard the assets in a strong box or 5 whatever. The hon. Member for North Warwickshire will know much more about the workings of a country solicitor than I, but one does not want to extend authorisation too widely and include people who should not be authorised for that function and, therefore, we have carefully defined what the function is. I said in my opening remarks that the SIB would be doing a cost-benefit analysis of the hows and wherefores that the self-regulating organizations 6 propose as to the detail of how custody will be regulated, to get the balance of regulation right. It is important that a cost-benefit analysis should be done so that we can get the regulation right. I am sure that everyone would welcome that.

Question put and agreed to.

Resolved, That the Committee has considered the Financial Services Act 1986 (Extension of Scope of Act) Order (S. I. 1996, No. 2958).

Committee rose at sixteen minutes to Five o'clock.



Knox, Sir David (Chairman)

Bates, Mr.

Day, Mr.

Fabricant, Mr.

Hannam, Sir John

Knight, Mrs. Angela

O'Brien, Mr. Mike

Sheerman, Mr.

Skeet, Sir Trevor

Spink, Dr.

Thomason, Mr.

Trotter, Mr.

Walden, Mr.