The Financial Transactions of Certain Companies and Other Bodies Bill 1992 which is now before Seanad Eireann has the largely technical purpose of confirming the legal powers of semi-State bodies to engage in swaps and certain other financial transactions in the treasury management area.
I would like to begin this debate by explaining how the legal doubts which this Bill addresses arose. In January 1991, in the UK, the House of Lords found that in the absence of express statutory authority the council of the London borough of Hammersmith and Fulham did not have the legal power to enter into swap transactions. While the legal position of UK local authorities is not directly analogous to that of Irish semi-State bodies, it has prompted banks and their legal advisers to take a very close look at the legal powers of Irish companies, both private sector and public sector.
As those legal powers were generally set down before the emergence of swaps and other similar financial instruments, it is not surprising that express authority covering them is rarely found in the memoranda of association or the governing legislation. While specific statutory provisions exist in the case of the National Treasury Management Agency and the building societies, it had previously been generally assumed that in the case of companies and semi-State bodies the necessary powers could be implied as incidental to the pursuit of the activities that were expressly authorised, especially where the transaction was part of a bona fide hedging strategy, as is the case with the treasury transactions concluded by the semi-State bodies. In this regard it is worth noting that in arriving at its decision the House of Lords overturned an earlier UK Court of Appeal decision that swaps entered into for debt management purposes were valid.
In any event, consideration of the UK House of Lords' decision led banks in this country to the view that the legal powers of Irish companies, both private sector and public sector, needed to be updated by providing specific authority to undertake swaps and other hedging transactions. This view was endorsed by the Attorney General in so far as the commercial semi-State bodies are concerned. In the case of companies in the private sector the necessary changes can be made by the relatively straightforward procedure of amending a company's memorandum of association. However, for the majority of commercial semi-State bodies — those whose borrowing powers are set out in legislation — a statutory provision is needed. The Bill now before the House makes that provision.
As I have just outlined, the Hammersmith case in the UK centred on the "swap". This is probably the best known treasury management or hedging instrument currently available in the market. In its simplest form the swap allows a borrower to convert a floating-rate loan into a fixed-rate loan, or vice versa. The relative flexibility of the swap market enables borrowers to take advantage of changing market conditions so that, for example, a company wishing to fix its interest costs could borrow on a standard floating-rate basis at any time and then use the swap market to fix the interest rate when fixed rates have fallen to a level acceptable to the company. Use of the swap market can also give borrowers access to funds at rates below those otherwise available. Outside of the State owned banks, who deal in these transactions in the normal course of their banking business and are, therefore, provided for separately in this Bill, the commercial semi-State bodies have entered into £1.3 billion of swaps in various ways. About three-quarters of this amount is accounted for by the ESB and Bord Telecom Éireann.
Hedging transactions such as swaps are undertaken principally in order to minimise certain risks. They can also reduce the cost of borrowing and provide a means of insuring against certain losses. These transactions make a positive contribution to the management of commercial semi-State bodies.
Many of us who may not previously have had much acquaintance with swaps or other technical treasury instruments will nonetheless be very much aware of the considerable growth which has taken place over the last decade or so in the financial services area, both in Ireland and abroad. We have benefited from that growth already and hope to continue benefiting from it through the establishment of the International Financial Services Centre in particular. The growth in the financial services industry worldwide reflects the development of new complex and sophisticated financial instruments. These have been developed in response to the requirements of borrowers for new ways to reduce debt service costs and to minimise the risks associated with fluctuating interest and exchange rates and in general to increase flexibility.
Internationally and here in Ireland the industry has been boosted by factors such as deregulation and the development of new technology. The gradual removal of exchange controls here, and their complete elimination before the end of this year, has also encouraged the development of a more global market. The growing complexity of the whole financial services area, with its potential for achieving savings, was one of the underlying reasons for the Government's decision in 1990 to establish the National Treasury Management Agency with the specific purpose of exercising the borrowing and debt management functions of the Minister for Finance.
I referred earlier to the fact that the commercial semi-State bodies currently have some £1.3 billion of swaps outstanding. This has to be seen against the background of a total debt level of some £5.2 billion for all the commercial semi-State bodies. Some 46 per cent of this debt is accounted for by the ESB, Bord Telecom Éireann and Aer Lingus. Another 39 per cent is accounted for by the three State-owned financial institutions — ACC Bank, the Industrial Credit Corporation and the Housing Finance Agency — and this reflects the large scale of their financing of private sector operations. In summary, these six companies account for 85 per cent of the debt of the commercial semi-State bodies. About two-thirds of the remaining 15 per cent is accounted for by Bord na Móna, CIE and NET.
Some 43 per cent of the debt of commercial semi-State bodies is in foreign currency with 57 per cent in Irish pounds. However, over two-thirds of the foreign currency debt is in EMS currencies and, because of this and the strength of the Irish pound within the EMS, these debts carry little exchange risk. The relatively large foreign currency exposure of the semi-State bodies reflects the fact that not all of the heavy capital investment needs of the early Eighties could be met at a competitive cost in the relatively small domestic capital market at a time when the Exchequer's own borrowing needs were also high.
With this high level of debt it is essential that the commercial semi-State sector has available to it the full range of treasury management instruments which the domestic and international financial markets can offer. Indeed, for the larger companies in particular, the emphasis has shifted markedly over recent years from new borrowing to active debt management. With annual debt costs of the commercial semi-State sector amounting to about £450 million, this approach can only be strongly encouraged. It is a fair measure of the progress of our semi-State bodies in this area that some of the larger companies are successfully offering treasury management consultancy services to other companies both at home and abroad. In the light of all this, Senators will appreciate just how important it is to confirm the powers of semi-State bodies to enter into the kind of transactions which are universally accepted and which underlie their treasury management operations.
Before turning to the specific provisions in the Bill, I must mention that discussions have been held with the main commercial semi-State bodies to ensure that this legislation would meet their requirements and achieve its purpose of removing all legal doubts in this area. The Irish Bankers' Federation were also consulted and are satisfied that these provisions meet their concerns about the legal powers of semi-State bodies in this area.
As Senators can see, the Bill is a short one. Its provisions are broadly based on section 34 of the Building Societies Act, 1989, which allows those bodies to engage in hedging transactions under the supervision of the Central Bank.
Section 1 provides a number of definitions needed for the interpretation of the Bill. Section 2 contains the main provisions of the Bill. It confirms the legal power of bodies whose borrowings are subject to the consent of the Minister for Finance to engage in financial transactions for the purposes of reducing or eliminating the risk of loss arising from fluctuating interest rates, exchange rates, commodity prices or similar factors affecting their business or the business of another company in the same group; reducing borrowing costs or the costs of other transactions carried out in the course of their business; and increasing the return on an investment. This provision confines these bodies to transactions of an essentially hedging nature. Broadly, the Bill covers commercial semi-State bodies and their subsidiaries but does not apply to local authorities as it is not appropriate to the nature of their operations.
The section also provides that after this Bill is enacted the powers confirmed by it can be exercised only in compliance with specifications issued by the Minister for Finance after consultation with the relevant parent Minister. The requirement for ministerial specification as to the type or types of contract that may be entered into is designed to ensure that only instruments which have a primarily hedging function will be allowed. The requirement for prior ministerial specification is also designed to preclude bodies for whom such transactions would not be appropriate. The Minister for Finance is also given discretion to lay down such other conditions as he considers appropriate. I would stress that this provision does not involve a major extension of the existing degree of Department of Finance control in this area. As far as swaps are concerned, the existing requirement for ministerial consent will remain, though this will generally, as at present, be administered on the basis of an annual swaps programme. As far as other contracts are concerned, once a list of types of contract has been approved there will be no further requirement for ministerial consent.
I would also like to emphasise that specifications issued under section 2 (2) will emphasise the prohibition of speculation and require treasury transactions to be operated under board control and supervision. This is important because in the Hammersmith and Fulham case which I mentioned earlier, the heavy losses arose because they engaged in swaps for purely speculative purposes unrelated to their debt.
The protection for third parties which is set out in section 2 (4) is directly linked to the restrictions which the Bill places on the operations of the non-financial semi-State bodies, namely, that contracts must be for essentially hedging purposes and that they must comply with ministerial specifications. It would not be reasonable to expect that third parties should be aware of the purpose for which each contract was done or whether a body was in compliance with ministerial specifications. Therefore, section 2 (4) gives third parties dealing with semi-State bodies in good faith protection against a claim that a contract was not valid because it did not comply with the provisions of this Bill. This provision is analogous to section 12 of the Building Societies Act, 1989.
As institutions providing a banking service ACC Bank plc and the Industrial Credit Corporation plc are provided for in section 2 of the Bill separately from other semi-State bodies. Their power to enter into the transactions covered by the Bill for the purposes of their banking business is confirmed. Specifications are not required in the case of these bodies because they are providing a banking service under the supervision of the Minister for Finance. Sections 3 and 4 are standard sections.
Finally, I would stress that the instruments covered by this Bill are not borrowing instruments, though they may be indirectly linked to borrowing instruments. Any borrowing by semi-State bodies requires ministerial consent under existing legislation or, in the case of a small number of companies, under their memoranda and articles of association.
I commend this Bill to the House.