Joint Committee on Financial Services and Markets Minutes of Evidence



Examination of witnesses (Questions 400 - 419)

TUESDAY 13 APRIL 1999

MR DAVID CHALLEN, MR TIM HERRINGTON, MR KIT FARROW, MR DEREK WANLESS, MR MARK BOLEAT and MS ANGELA KNIGHT

Mr Kidney

  400.  My colleague is going to deal with complaints. I know you say if there is statutory immunity the complaints system needs to be robust and independent and have the power to award compensation but I will leave that to my colleague. Can I move on to the recognised investment exchanges where the Bill proposes a narrower statutory immunity but the exchanges are arguing that they should have the same one as the FSA. What is your view on that argument?
  (Mr Herrington)  That is quite a difficult one. The exchanges do not have it at the moment and it was considered inappropriate. The question is what is the role of the exchange? Is the exchange going to have a regulatory role? Essentially it is a market providing a facility for others to do business by and I think at the moment it is unclear in the way the FSA policy is working out how much regulatory responsibility is going to lie with the exchanges. Kit is shaking his head and it would be interesting to know why. I think it is not necessarily an inconsistent position to say that you would have one without the other but I suspect a degree of symmetry is going to be considered desirable here between the two bodies.

  401.  Not by the Government in the Progress Report who say they stand by the more limited statutory immunity for the RIEs despite the RIEs arguing they should have the same as the FSA. Kit Farrow has got a different view. Can we hear it.
  (Mr Farrow)  Can I first declare an interest as a board member of an RIE and I suspect the only person in the room who as an unpaid director of a recognised exchange had to go home and say actually we were in receipt of the threat of personal litigation in response to regulatory activity which I had been party to, given the regulatory responsibilities put on exchanges to maintain clean, open, fair, proper markets. It seemed to me quite inappropriate that whereas the other parts of the regulatory regime which are discharging very similar regulatory responsibilities were not open to personal suit for discharging those responsibilities but I was. I do disagree very strongly with what Tim just said in saying that it is not clear what regulatory responsibility exchanges will have in the new regime. They are very clearly specified. There are duties to maintain a proper market which are going to be spelt out in substantially greater detail. The exchanges periodically have to take regulatory decisions which have very big financial implications not merely for the members of the market but for the users of the market. In the case that I referred to it was not a member of the market who was unhappy at the regulatory decision, it was a customer whose activities had been interfered with. I wish to make my point of view known. Could I just say one thing further. I do believe that both for the exchanges and for the FSA that the immunity should not apply in the event of negligence or recklessness.

Chairman:  What I heard you all saying was although you had some doubts about statutory immunity, if statutory immunity was there you wanted to make sure that you had a very good complaints procedure which would back it up from the other direction.

Lord Fraser of Carmyllie

  402.  Just a question on statutory immunity. We have had one legal opinion submitted to us that even if the Government or Parliament wishes to confer statutory immunity on the FSA, under human rights requirements those will be set aside. What is not clear to me is whether that is a rogue view or whether you would share it?
  (Mr Herrington)  I am aware of it and it is a respectable legal view certainly. There is also a European issue, as I understand it. I believe there are issues on the European front as to whether it is appropriate for statutory immunity to continue for regulators. That would be a debate that we could have all afternoon I suspect.

Mr Beard

  403.  What kinds of arrangements do you see would be most appropriate for dealing with independent investigation of complaints against the FSA? In particular, do you believe that the Parliamentary Commissioner for Administration could have a role in such arrangements?
  (Mr Herrington)  Yes. I mentioned that as a possibility this afternoon in my opening remarks. What struck me was that I suddenly thought of something that said that the Government has brought into the ambit of the Ombudsman a large number of quasi-governmental bodies and non-departmental governmental organisations or whatever, a very large list, and I thought if it is good enough for the Competition Commission, as it is now called, why is this not something that has been thought of in the context of the FSA? One of the criticisms you might have of the proposals that are in the draft Bill, even as proposed to be strengthened, is that there is perhaps no real independence of this investigator, he is appointed by the FSA, and should we have somebody who is clearly independent of the FSA to carry out this task?

  404.  You are seeing the Parliamentary Commissioner as being the sole investigator of complaints?
  (Mr Herrington)  That could be the vehicle through which it operates, yes.

  405.  I wonder if other members of the panel would like to comment on the question.
  (Mr Boleat)  We would certainly see a role for the Parliamentary Commissioner.

  406.  What particular arrangements would you foresee before you reach those heights?
  (Mr Boleat)  Whether it is the only arrangement or additional is a second order question. I think it is important that there is that additional safeguard.
  (Mr Challen)  I agree with that. I take it we are talking about arrangements which actually could result in compensation in cases where recklessness or negligence have resulted in loss to either individuals or firms?
  (Mr Herrington)  The law allows the recommendation of compensation to be made but I think it is almost invariable practice for people to comply with the recommendations.
  (Mr Farrow)  If there is such a power to award compensation it should not be paid by the FSA out of fees that it has collected from the industry, it is inherent in the situation that it should be a charge on public funds.
  (Mr Wanless)  In the first instance it is important that the FSA organises itself internally in terms of the appeal system, as I said in the introductory remarks I made, and how in particular it keeps close to the various markets that it operates in and separates out the disciplinary proceedings for adjudicating. After that when those processes are exhausted then it is appropriate for the Parliamentary Commissioner to be involved.

Chairman

  407.  If that process was strengthened and it was of the nature that you are describing then you feel that you could sleep easier with the whole subject of statutory immunity?
  (Ms Knight)  No. I think we would still wish to see statutory immunity removed under certain circumstances, such as negligence.

Mr Sheerman

  408.  There is a lot of international experience here. The question we do not often get the chance to ask is here we have had a range of questions asked this afternoon but are there competitor markets that do it better? Are we missing something that we could change at this late stage of our consultation? We have tried to get more international information but some of us accept this is probably where we have been most limited. Is there international experience from the global companies that you are involved with to suggest that we are missing some aspect of it?
  (Mr Challen)  I am told, but I am afraid I cannot vouch for it, that the SEC do not have statutory immunity.

  409.  They do not have?
  (Mr Challen)  I am told not.

Mr Beard

  410.  Do you not accept the inhibiting effect there will be?
  (Mr Challen)  I do understand that.

  411.  If there is no statutory immunity there will be a great aversion to risk taking and a great deal of people looking over their shoulders rather than proceeding with things that ought to be proceeded with.
  (Mr Challen)  I understand that connection.
  (Ms Knight)  That is why you actually limit the areas from which statutory immunity is removed. We do recognise that potentially if statutory immunity was removed altogether there could be that concern which you raise, yes. There are certain circumstances where, for example, the FSA could potentially act negligently, somebody or a firm's livelihood being severely impaired or removed, they have acted negligently and there is no recourse. That does seem to us to be significantly unfair. That is why, recognising that there are difficulties, we still believe that in certain circumstances immunity ought to be removed.

Mr Heathcoat-Amory

  412.  Can I just follow that up. Sometimes it seems that we are trying to regulate a national market in this Bill but actually we are regulating an international market which happens to transact in London or the United Kingdom. I am interested in the sensitivity of this market to the regulatory regime. Presumably a good bit of legislation will act as a magnet for customers and suppliers but bad regulation, arbitrary or ambiguous regulation, might act as a deterrent. I would be interested if any of our witnesses have got a feel for how and whether these wholesale markets are sensitive to both the cost and what one might call the regulatory culture we are developing here.
  (Mr Challen)  Extremely sensitive.
  (Mr Farrow)  If I might suggest one of the great concerns of my association is the fear of the combination of uncertainty in the definition of offences allied to very stringent penalties. It has been part of the accepted wisdom that it is very important that the market should be flexible to adapt to new circumstances and to be innovative. If you are subject to a regime which says in the most general terms "you must not do anything which is not proper or which is not of high standard" that is such a vague requirement that if you find some innovative opportunity there is a danger that you will be worried that viewed after the event somebody may decide that you were not working to a high enough standard. You create a worry that people will not, in fact, innovate without actually going to the regulator and saying "look, I am thinking of doing things differently, is that all right?" In that way we could bring to the UK the regulatory tradition that in other markets has basically prohibited anything that has not been explicitly endorsed.

Mr Sheerman

  413.  It occurred to us that it is a very fine balance, is it not? We have your side coming here and they say we have got to be a competitive market and this is a global business. We understand that and all of us in this Committee want London and the United Kingdom to continue as a competitive place to do this sort of business. On the other hand, we have consumers coming in saying we need much more regulation and protection. What seems to be missing is surely what this Bill must deliver is a culture of integrity where business can be done and one knows it is an honest business with the right parameters and that the culture is right. I do not hear that word either from your side or from their side and it is important, is it not?
  (Mr Farrow)  I absolutely agree with you. In our earlier discussion one of the points we debated was the absence of any reference to "intent" in some of these very broad criteria about you must have high standards and if I disagree with you about what is high in a particular circumstance or proper in a particular circumstance, it would be an enormous help if there were some notion that behaviour that was innocent in intent was not at the same time criminal or subject to unlimited fines or whatever. I was very encouraged by our previous meeting because Andrew Whittaker indicated that the question of intent was not a yes/no thing. There is very relevant US experience where intent is an element of the offence but proving it is not as difficult as it might seem.
  (Ms Knight)  Because the need to balance good regulation against the competitiveness of the financial industry is a very sensitive issue, we believe that it ought to be an issue which is given prominent importance and the non-executive committee reporting on it annually we felt was a good way. Not only does one have to recognise that business of a wholesale nature could be lost out of the United Kingdom if we do not get this right but potentially business of a retail nature could be lost out of the United Kingdom and therefore the desire that consumers have which is to have a far more perfect regime, for want of a better description, than the one we have at the moment could well have the effect of moving the business out of the United Kingdom, using the passport regime back in. With all due respect, I have to say it would be much harder for Mrs Jones in Bognor South to get compensation from a Greek firm quartered in Piraeus because the business had moved out there than it would be if that business were kept within the United Kingdom. So we have to be very careful in balancing the cost of regulation, the certainty of regulation and the needs of consumers, which is what is of benefit to the United Kingdom's financial industry, and the problems that could be associated if we regulated ourselves out of the current scenario.
  (Mr Boleat)  May I support that, my Lord Chairman. It is more important for the wholesale markets but for the retail markets, particularly with a single passport, regulation is capable of pushing business outside the United Kingdom. In the last evidence I gave I mentioned Ireland as an example. At the moment I do not regard it as a problem but it could be.

Lord Poole

  414.  There has been a great deal of assertion that business can be moved out of the United Kingdom because of the mechanisms or the pressures of regulation. This is the first time that cost has been mentioned. I have circulated around the Committee responses from quite a large number of banks and others involved in the securities industry. Practically nobody could tell us in any meaningful way what the cost of compliance was to them and, furthermore, they find it very difficult, they said, to distinguish between the cost of compliance and what would have been proper management in any event. With only one or two exceptions people were not even prepared to try in great detail. I do not think it would be fair to name them because it was not a public correspondence but it has been shared with my colleagues. It ill becomes the industry to bang on too much about cost unless it is going to stand up and say, "Excuse me, we would like to present you with some really well thought through numbers on this because we are beginning to be extremely concerned about what is happening." I would just say that I am sure the Committee would find it very helpful were you able to go away and come back with something even if it were only from your area of the world to justify the assertion that these costs would be so great that they would risk pushing the business elsewhere because that is not what the correspondence delivered.
  (Ms Knight)  Chair, if I may respond. I think that is a perfectly valid question as is the point that has been made. Indeed, regulation is not just a burden, it is also part of operating a business in a proper and businesslike manner. However, where costs start to really cause a problem is rule changes, additional rules and in an incremental nature. We actually published, as an association, the results of a survey that we did of our members three months ago about the costs to them of a particular regulatory change that they were having to make. I made the information available to the FSA and I made the information available in the public domain and in fact it was quite widely reported. On a quarterly basis we are now surveying all of our members, we are listing whatever is the latest regulatory change which will impact upon them—obviously not all will impact upon them—because that enables us to get a cost against these specific items rather than in the areas of generality which I do not think would be helpful for the Committee in order to be able to form a proper view of what is the reasonable cost of regulation and where it is that it really starts to cause an adverse effect and a problem upon firms and consequentially to their customers.
  (Mr Boleat)  I think I said that I do not regard this as a problem at present. It is very difficult to produce general figures. It is not going to happen that an institution is going to say "we have had enough, we are going over there"; it is far more a business looking at expanding and it may be a British institution that is looking at expanding and it is looking at a range of issues—the regulatory environment, what might happen to it in the future—and as a result of this is it going to locate in London or Edinburgh or Dublin or Piraeus. It is very difficult to pin down. I am not certain that for competitive reasons an institution would necessarily say it is for this reason. I understand what you say, it would be helpful to have nice, solid figures but when we have tried to look at this it is very difficult to differentiate out what a company should be doing for itself and what the regulators require it to be doing.

Lord Haskel

  415.  If the wholesalers find that the cost of regulation is too onerous, is it possible for them to remain in London yet operate in another jurisdiction?
  (Mr Farrow)  Yes indeed. The more IT improves, the easier it is to have people who represent the British, the French, the Japanese and the German subsidiaries all actually sitting in the same office and deciding, as circumstances permit, which of those national companies is actually to be designated as the person who conducted the business. We have been discussing this in terms of companies but we are moving to a world in which competition between exchanges is becoming much more real. The cost of doing a transaction on one exchange is extremely easily compared with the cost of doing the same transaction on another exchange. I believe cost competitiveness in international competition between exchanges is something that we do need to be quite alert to.

Mr Beard

  416.  We have heard an awful lot about cost competitiveness in this respect. There must also be a price if the regulations are so lax that integrity is eroded and the reputation disappears.
  (Ms Knight)  Absolutely.

  417.  We do not seem to hear the same emphasis on that side of that argument.
  (Ms Knight)  With all due respect, we have all said that we need a balance. It is that balance that we are seeking to achieve, be it practitioners, be it yourselves as the Committee and I am sure the Government itself.

Viscount Trenchard

  418.  You have talked about the need to maintain the international competitiveness of London because that is clearly crucially important, and it has also been acknowledged that too much regulation will stifle innovation and put major international players off doing business here. On the other hand, the consumer representatives in the main are arguing for enhanced regulation in certain respects. Obviously it is a balance, but do you think in fact that the end consumer has gained from the relatively free atmosphere that has existed in London and restricting regulation in the long term is of benefit to the consumer because it encourages innovation which leads to a wider range of products? Whilst there may be dangers there may also be more to choose from? Obviously you need safeguards. Do you mind very much that the need to maintain the international competitiveness of London is not included as one of the statutory objectives of the Bill? Do you think if it were it would actually be in the interests not only of practitioners but also of consumers?
  (Mr Farrow)  If I might reply, could I recall that my earliest remark was that regulation needed to be appropriate for the particular area that was regulated. I think there is a very sharp distinction to be drawn between inter-professional markets and retail markets so that the costs that are properly put on the regulation of a retail market do not spill over to be subscribed to by people who are transacting in an international market which could just as easily be in another country but happens to be to our benefit located at the moment in this country. If I might comment from your own experience, my Lord, you have a lot of experience of the Japanese market and I think you will have seen there that stifling regulation can be a very, very considerable burden on competitiveness.

  419.  I would say that in Japan that is absolutely so and that whenever one sought advice from the regulator as to whether one could introduce some innovation or some new product, one never ever got a clear answer and the result was that one was so frightened that one did not do it and one told one's head office you cannot do it.
  (Mr Farrow)  You cannot do it here, it would be better to arrange it somewhere else.


 
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