Joint Committee on Financial Services Minutes of Evidence

Examination of witnesses (Questions 160 - 173)



The Committee suspended from 16.33 pm to 16.40 pm for a division in the House of Lords.


  160.  Lord Eatwell's question about systemic risk.
  (Ms Johnstone)  I have to say it is not an issue that we have thought about a great deal but having looked at the definition of market confidence I think I would rather agree with the Committee. It does seem rather strange that it is not there because the market confidence definition seems quite narrow. We would have sympathy with that point of view.
  (Mr Heath)  We get rather blase in the United Kingdom about the stability of our various product providers. We have done very well with the DTI's covering of insurance companies and the Bank of England in the way of regulated banks. With the exception of the BCCI I could not think of too many occasions where there has been systemic collapse in the way we have seen in America. We have been extremely fortunate. I would think whatever this Bill says must continue that tradition. It not only comes in terms of straight preventative regulation being careful in that way, but there are things which could be done within the wholesale sector and the way the retail sector is regulated, which could destabilise providers. This is another area but we would agree. We also need to have a pretty clear definition of the regulation of the Bank of England and FSA. We would not want to see a situation where somebody fell down the middle somewhere. One of our great legacies, I have to say, in the United Kingdom, is that our tradition of regulation has been so good. It was quite interesting, the comment made that if you are a investor of a building society your money is safe. Not in America it ain't. It is because we have had that wonderful position that has gone on so long.

Chairman:  I would like to use the remaining time of this session to deal with the two issues—maybe we will roll them together—of competitiveness and competition and the whole question of the regulatory burden.

Mr Loughton

  161.  International competitiveness and competitiveness between firms in this country. The Treasury Select Committee looking at this subject did recommend that there should be a fifth objective to improve competition. What are your thoughts on the way the whole FSA structure and the rule book is going to impinge on the competitiveness of the City of London financial services institutions in this country? Are we driving out people? We have 550 foreign banks operating here already. Are they likely to diminish or expand as a result of what we are discussing?
  (Ms Johnstone)  I do not think we have views or are in a position to have a view on the impact on the industry although we have got views on competition.
  (Mr Heath)  I am looking at Robin actually but the point I would make is that people do not send money to London because Howard Davies is a good regulator. They send it because the City of London has a very good reputation, and because of the place and time zones and other reasons that is why markets and business is done here. So the cost of regulation can only drive out business. That is something we have to be careful of. In the retail side we have a similar problem, but we now have effectually two systems running, which was picked up by one of your earlier speakers. We have the full blown regulation, advice based research, and now we have CAT standards and attempting to move to benchmarks; where in one area we are trying to protect the consumer from everything and in the other area we are allowing the consumer to misbuy with confidence. These, if you like, are two separate strands. However you benchmark products it does not mean that your client is buying the right product for themselves in the first place. They may end up with a most suitably and cheap wonderful pension but actually need protection insurance more than they need a pension. There will be no-one under the benchmarking system to advise them of that.

Lord Poole

  162.  You have just said something I really quite strongly disagree with, so I would just like to hear you justify it. I think almost the whole of my life has been spent as one form or another of international operator in the City. I would say that one of the fundamental reasons, for many years, why business came to London, is that London was clean and well regulated. Now in some cases, of course, it came because it was not regulated at all, as in the case of the Euro markets. I do not think the quality of advice, as you suggest, is anything like as appalling to external holders of funds, so we are rather at odds.
  (Mr Heath)  I do not think we are at odds. The point I was making was that the City of London was built on reputation. As you say, a clean market. It was not based on regulation. Since we have had to have regulation, we have it. So my point really is, I do not think we are at odds in any way. If you look round at the magnificence of it, that was not built by regulation, it was built by a market which happened to be self-regulated. Now we cannot trust the market to be self-regulating, so we are told, so we have to bring in regulation. I do not think there are any odds in what we are saying. Purely we are all looking for a clean market.
  (Mr Hutton)  Could I add, I do not really see any problem with the wording of the clause 2.3. It summarises quite well what this regulatory legislation should try and achieve. As far as ensuring proper competition and conditions of competition are concerned, there are other pieces of legislation to deal with that and other machinery. I personally—and it is a purely personal opinion—find the drafting of those four sub-clauses to be very helpful indeed, in that they say it should not get in the way of competition. It should generally help the competitive environment which, it seems to me, is the best way of doing it.


  163.  In the principles rather than a separate objective?
  (Mr Hutton)  Yes.

Mr Loughton

  164.  Would anyone like to make a case, it says here "proportionate to the benefit". If we are all agreed that there is a cost involved in providing an appropriate product or financial service to a client, would anybody realistically suggest that there should be minimum commission, minimum cost to a product, as we used to have in the old days of the Stock Exchange, below which it would just not be physically possible to provide a product with best advice and best compliance regulation costs that went with it? Maybe we should be allowed to charge below that. Nobody is actually suggesting that.
  (Mr Hutton)  I see no justification for that.

  165.  Right, so how can we guarantee "with minimal cost" and at the same time comply with all these regulations that a financial company is providing the consumer with the most appropriate products?
  (Mr Hutton)  Could I just say that I think the word "guarantee" is the key to the whole thing. You cannot guarantee it. Competition in the market place will eventually weed out the ones who do not do the job. It seems to me that in a capitalistic system that is pretty fundamental.

Viscount Trenchard

  166.  The public awareness objective is fairly open-ended. It talks about the promotion of public awareness of the benefits associated with investment and the provision of appropriate information and advice. It seems to me fairly open-ended and could become more and more extensive. Do you think that, compared with the four regulatory objectives, there is enough about the maintenance of competition and international competitiveness in the Bill, whether or not the maintenance of competition were to be made an objective in its own right? It does seem to me that the Bill may not yet recognise fully how much consumers have benefited from competition in the United Kingdom market. The range of products that have been available to them and the opportunities that have been available have been much greater than would have been the case had we had a much tougher regulatory regime. I know it is a balance. I would like to know whether you think the Bill says enough about the maintenance of competition.
  (Ms Johnstone)  We would find it helpful if it did have improving competition as an objective. Whilst we have a competitive market, it has not always worked in the consumer's interest. If the regulator is looking to improving the market, as well as not distorting the market, that would be very helpful. The provision of comparative information is one of the things we have been talking about.
  (Mr Heath)  I think Viscount Trenchard makes a very good point and it picks up the point made earlier about Germany, which has had product regulation since the Second World War and has had—although it is beginning to improve now—a totally stagnating product development. There was very poor product development there. There was very poor value for money for the clients and consumers and a lot of money flows out of Germany, not only for fiscal reasons but because there is better value elsewhere, not least on the London market, I have to say. For things like death in service benefits for German companies, the Germans discovered some years ago that it was much cheaper in London than in their own area. So we do have to keep an eye on this. Whilst we have to have a regulator looking at particularly poor value products, because the previous regime allowed a poor value product, as long as it was sold correctly it was fine. There was some pretty ropey stuff being thrown about in some cases, I have to say, which really the consumer was very lucky to get a decent return on. But if it was sold correctly that was okay. Equally, we do not want the regulators marching through every product, attempting to second guess the product design, which is what happened in Germany and did their industry unaccountable harm.

Mr Heathcoat-Amory

  167.  At the heart of this subject seems to be a balance to be struck between the desirability of reducing risk, particularly for the ordinary public, as against the cost of doing so. I am interested in where these costs fall. Would I be right that the costs are ultimately borne by that same public or are they absorbed by the industry and reduced profit margins and shareholders? To the extent that they are borne by the public, is this a matter which concerns or should concern the Consumers' Council? Do you see yourself as the guardian of a savings culture, which will obviously be undermined if everybody had to pay excessive costs for savings products?
  (Ms Johnstone)  We assume the costs of regulation are borne by the consumers in the end. That would be our starting point. Obviously I am no expert in the industry cost structure, so I would not be able to say if it was otherwise. Clearly it is a concern to the consumer organisations and to the NCC, if the burden of regulation is disproportionate to the benefit to consumers. But it is very hard to make that kind of judgment because obviously the costs of inadequate regulation are borne by consumers. Those costs can be very heavy indeed when you get to retirement age and your pension is not able to keep you. What do you do?

  168.  The taxpayer has to provide a social security system to pick up the pieces.
  (Ms Johnstone)  Yes, that is another issue. You pay for it as a taxpayer instead. But as the intention of Government policy is to move people more and more into making provision for themselves, to relieve the burden on taxpayers, if the regulatory system does not work that policy will not work. It will come back to the taxpayer. It is very hard to make a judgment about what is excess costs; apart from the accidents, the casualties, which is not a particularly good way of measuring the system.
  (Mr Heath)  From our point of view, we have a problem because we have no access to shareholders' money, so our costs find their way back. It does give an imbalance in the market, particularly if regulators are allowed to have free will as to what they can do. There is a tension here that the Government, in the form of Treasury, is not paying for this system, yet could find itself under very significant pressure to do things. One can think of a Dangerous Dogs Act situation without needing to go to legislation. Effectively, from now on, the Treasury will own this regulation in some form or way. But it does not have to pay for it. The regulator does not have to pay for what is going on. As we have seen previously, product providers can and do accept these costs, whilst sometimes maybe putting up a fight on behalf of the shareholders and policy holders. There is this tension in the whole system. This is why when we go back to our perspective—and the NCC is coming from the same place in a different way—we are coming back to defined regulation; to knowing where we are and to making sure that what we are doing now is actually acceptable. If I can just pick up the kettle analogy for a second because it is a good one, although I do not think it takes us very far. The kettle works on water, which remains the same, and on electricity, where the voltage remains pretty much the same. To give you an example we work in different products. Mortgages in 1992 were 16 per cent and are now down to 6.5 per cent. Returns on pensions fell from 23 to 11 per cent between 1990 and 1999 and between 1991 and 1999 annuity rates of 12.6 per cent were down to 6 per cent. What I am saying is in inventing this kettle we have to invent it in such a way as to ensure that the voltage goes from 100 volts up to 240. In reality we are not buying a thing. When a consumer buys a pension he is not buying a kettle. He is buying a promise from the pension company that they are going to do the best they possibly can for his retirement in the light of 101 different things that can change, not least fiscal policy, Government policy, changes in welfare benefits and a million and one other things. Although the kettle analogy is an interesting one I am not sure it takes us very far because it is very difficult to say at the time you purchase a product that it will be fit for purpose right the way through changes not only in business rates but a thousand and one other things the Government chooses to do.

Lord Taverne

  169.  In these circumstances is there any role for a league table of costs and charges?
  (Mr Jones)  There is a culture at the moment that hangs on to this idea of charges being the mythical answer to all investment problems. In the part of the world I originate from there is a saying that you do not get owt for nowt. You basically get what you pay for. I would much prefer rather than have league tables of charges, interesting though they are, to look at performance because at the end of the day it is performance that matters and I could cite you cases from my operational days where pension plans maturing now are coming out at something like three times the original projection. Whilst ever you have got this artificial projection where you are projecting at a given rate which is laid down by the regulator, charges obviously are the major concern, but in the real world out there you will get some funds that massively out-perform others and that is really the role of the adviser to actually sort out the sheep from the goats. Again, you have to do this based on the information you have gleaned about the clients and the amount of risk that the clients can cope with, but I think to link everything to charges is a very dangerous approach to investment. The other danger is that if you have league tables of charges there will be a tendency, and I am sure that there are those out there thinking about it already, to set up their insurance divisions out in Dublin or somewhere like that where they can avoid all this regulation but still operate on the mainland under EC regulations. So it is a difficult one. I can understand why people want to look at the costs and charges of things but, as I say, that is very much only one side of the equation. The other side is just as important. On the question of competition we would like to see polarisation written into this Bill because the retention of polarisation is an effective means of ensuring competition in the market place. If there is a healthy IFA community out there that is the surest way of ensuring that the providers remain competitive than any other way. If we abolish polarisation we will run into the problem of multi-ties and you will see a consolidation of the market where the biggest providers, effectively, ultimately operate a cartel. The only healthy way as far as the investor is concerned and to ensure competition for the future is that polarisation should actually be written into this new Bill.

Mr Beard

  170.  What does polarisation mean in this context?
  (Mr Jones)  The adviser has to declare when speaking to a client for the first time whether he is totally independent and therefore can offer contracts right across the market place or whether he is tied and can only sell the products of one particular provider.

Lord Taverne

  171.  That is not in the Bill at the moment?
  (Mr Jones)  No.


  172.  Does the NCC have a view about this?
  (Ms Hall)  We have always supported polarisation. If we have any concern about it, it is that it does not necessarily help those who were not able to go to independent financial advisers. Nevertheless it is not a principle that we would want to lose precisely for the competition argument.

  173.  Mr Roe, where are we on polarisation?
  (Mr Roe)  Polarisation is, of course, a very important part of the existing regulatory structure although it is not set out in primary legislation. I think it is quite right that these sorts of things should be examined from time to time and, indeed, I understand it will be examined, but it demonstrates quite an interesting point which is I do not think it would be consistent with our general approach to write these kinds of specific rules into the legislation because there are views on the investor protection aspects of polarisation and also on the competition aspects which need to be looked at in a way which means that they are not necessarily rules set in stone for all time. So I do not think we would want to write polarisation into the Bill, which is not to say we do not recognise the importance of the issue.

Chairman:  I will bring this session to a close because, as you know, we are under tremendous time pressure in terms of reporting for this Committee. We are having to try and fit in an awful lot of witnesses in a very short time. We are very grateful to you for coming and helping us through this. Could I say if there are any points that you would have wanted to make but you have not had a chance to make this afternoon, we are very happy to receive them in writing. We are very grateful for your contributions.

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