Select Committee on Constitution Minutes of Evidence


Examination of Witnesses (Questions 880-897)

WEDNESDAY 9 JULY 2003

SIR HOWARD DAVIES AND MR ANDREW WHITTAKER, FINANCIAL SERVICES AUTHORITY

  880. That is very helpful. On certain aspects of this in terms of Parliament I know you have appeared in front of the Treasury Select Committee quite a bit on this already. Is that the main way in which you feel yourself accountable to Parliament?
  (Sir Howard Davies) Yes, I think it is. The Treasury Select Committee have been active in pursuing that responsibility both formally and informally and we meet members of the Committee who come in to see us and take interest in particular aspects and discuss particular interests and areas and, as you say, they have been active in holding a series of hearings both on the generality of regulation, hearings on our annual report, and also on specific issues like Equitable Life and split capital investment trusts, and that has been the prime focus although there have been a number of other committees in the Lords, for example, on the European financial services action plan, on globalisation and regulation of international financial markets where we have given evidence, and this Committee and the Overseas Development Committee as well. There have been a number.

  881. And you feel that works quite well?
  (Sir Howard Davies) Yes, it does. It is effective.

  882. I think you are more under scrutiny from Parliament than most others so far?
  (Sir Howard Davies) I like to think so. We feel that we have had effective oversight from the Treasury Select Committee. The reason for my slight pause is I do not always agree with them but I guess I am not supposed to. Yes, I think it is an effective process; I think the Committee has been sharp and focused in its questions and inquiries. Indeed the outcome of its inquiries, particularly on split capital investment trusts, was I think an entirely reasonable report to which we have reacted actively.

Lord Jauncey of Tullichettle

  883. Sir Howard, your remit covers a very wide range of financial activities, is that not right?
  (Sir Howard Davies) Yes.

  884. Before you take a step which involves a particular class of financial activity, do you consult with the people concerned? Supposing you are producing a rule which would affect, let us say, all sellers of life insurance or providers of life insurance. Would you consult with them in advance before you produced your rule?
  (Sir Howard Davies) Oh, gosh, yes. Indeed, at the moment we have been criticised for overconsulting, I would say. In the normal way, if we were going to make a significant rule change, we would almost certainly begin with a discussion paper and the discussion paper would explain why this area was one which we felt was worth reviewing, and we would discuss the pros and cons of different directions of change and would invite comments on that, and that would certainly elicit comments from trade associations and from individuals involved. We then would proceed to a formal consultation paper and that is the one that has to have clear proposals in it although it may not just have one, but two or three, but those would then have to include the cost benefit analysis and all the formal requirements. That would be at least three months' consultation. After that process we would produce a feedback statement which would say, "These have been the main responses to our consultation; here are the main points that people did not like about what we were proposing; here is the way we would change things or not, and if not here is the way we respond to criticisms that the people produce", and then after that we must formally consult on the rule change, and we then produce the documentary changes to the handbook, and that must be consulted on again for, say, three months.
  (Mr Whittaker) We tend to observe the Better Regulation taskforce three month guideline.
  (Sir Howard Davies) We are not statutorily required to—there is an emergency procedure if we believe it is crucial to make a change quickly—but that would be the normal process.

  885. We have heard evidence to the effect that you produce a very large number of consultation papers—one witness said about 19 flying around at the moment and suggested it was extremely difficult for the smaller firms to cope with these things. Have you any comment on that? An example we were given was a document entitled Less is More which ran to something like 250 pages. It was suggested it might be difficult for small organisations to have the time or the resources to go through it.
  (Sir Howard Davies) That is a nice story. There is not a document called Less Is More that is 250 pages long. There is a document on mortgage regulation which is 250 pages long and we have said in relation to insurance regulation that we believe we should cut back on our regulation and that is a Less is More project but I think they are two slightly separate things. But I take your general point. At any one time it is not right to say that there are 19 consultation papers which all affect small businesses. This is a very large sector and some of our consultation papers at the moment are related to alternative trading systems which are electronic platforms for trading bonds across Europe, and some are consultation papers on general insurance regulation about high street brokers under the terms of the Insurance Mediation Directive, and of course it is possible, given your very large organisation, to add all this up and say, "Gosh, is this not a large amount of consultation?" We do, however, recognise that at the moment there is a lot of change and just in the last few months the industry has begun to say, "Just a minute, there is a digestion process here", and I think that has been primarily because of the combination of three things, really: (1) a speeding up of the financial sector action plan in the European Community, because ministers in 2000 set a deadline of 2004 to complete the single market for the wholesale sector and 2005 for the retail sector, and in the way of that kind of law-making programme, guess what—it all comes in a rush at the end because it takes a long time to agree all these things. So at the moment there is a wave of European Directives under way which we are required to implement. So that is one track. The second track has been the outcome of the various government consultations, particularly on stakeholder pensions, particularly on the Sandler area, with the idea of new products and charge caps and all of that, and a great wave of consultation on that, and thirdly there is the change programme that we yourselves have under way. What the industry have said to us at the level of the Practitioner Panel who have sort of winnowed these things down is, "Please could you, in the area which you can control, focus on the must-dos rather than the nice-to-dos", even though some of the nice-to-dos the industry has asked us to do, because sometimes they have asked us to update the regime. So we have been pulling back and slowing down; we have lengthy consultation periods in some areas; we have deferred some changes that we were planning to make; in areas of money regime we are planning to change we have not done so yet, we will do so next year, so we are reacting to that. But I would say that we are not the only people at fault here and there are these three tracks coming together in a rather uncomfortable way.

  886. Moving to the question of appeals to your decisions, and I am looking at paragraphs 16 and 17 of your memorandum, in 16 you refer to the fact that your rules and practices are subject to independent competition and scrutiny by the Office of Fair Trading. Is that a matter which they do at their own hand, or are they scrutinised because you or someone concerned with the rule has referred the matter to them?
  (Sir Howard Davies) I think it can happen in either way. We would prudently, as you would expect, engage in a dialogue with the OFT about rule changes and our competition lawyers, of whom we have a small group, would talk to theirs about what we are doing, and they are a good open organisation and they will talk to you. They talk, of course, on the basis of saying, "We are not pre judging what our final view might be"—that is perfectly sensible and it is the basis on which we talk to people too—but nonetheless we would do that on a preparatory basis. As for a formal review that could come either from themselves, and indeed they have done that—the polarisation reforms were kicked off by an OFT review of the old Personal Investment Authority regime which they carried out on their own initiative in 1998-99—or people can go to them and complain and invite them to review an aspect of our rule which they could then do, or indeed the government could invite them to. I think the government can only invite, rather than instruct.

  887. I think from anything they determine there is or can be further reference to the Competition Appeals Tribunal?
  (Sir Howard Davies) Yes. They need to go to the Competition Commission in order to strike down our rule book. In the past, under the old regime, the competition regime only applied in the Financial Services Act area, not, for example, to prudential regulation carried out by the DTI or by the Bank of England. Now it applies to everything, so that is quite a significant change under the new legislation. The other change in the new legislation is that the reference goes to the Competition Commission, and it is the Competition Commission who are able to instruct us to change a rule, except there is a possible ministerial override if ministers take the view that our rule is nonetheless justified in relation to our statutory objectives, because obviously there is a theoretical conflict between the competition law and the Financial Services and Markets Act, so there can in extremis be an appeal to ministers, although the Competition Commission are required to take account of our objectives in their determination.

  888. Do you actually mean the Competition Commission or the Competition Appeal Tribunal?
  (Mr Whittaker) It is the Competition Commission, and it is the part of the Competition Commission that used to deal with monopolies references.

  889. Insofar as you deal with complaints in paragraph 17, you say you have appointed an independent Complaints Commissioner. If a body or an individual were dissatisfied with the ruling of the Complaints Commissioner, have they any further redress or appeal open to them other than Judicial Review?
  (Sir Howard Davies) No.

  890. So she is final then?
  (Sir Howard Davies) I believe so. They have already then gone typically through the firm, the Financial Services Authority, and sometimes through the Ombudsman maybe as well if it is an individual case, and then to the Complaints Commissioner if it is then about our regulation. I think that is the end of the line.
  (Mr Whittaker) I think it is important to draw a distinction between the role of the Complaints Commissioner and the role of the Financial Services and Markets Tribunal. If we were dealing with a disciplinary case where we had taken disciplinary action and the firm then referred that to the Financial Services and Markets Tribunal, from that Tribunal there is a right of appeal through the courts system but the Complaints Commissioner simply deals with complaints about maladministration, and is the final authority.

  891. Finally, is your Complaints Commissioner to whom you refer in paragraph 17—and I think we had a memorandum about this—part of the Complaints Commission which extends beyond financial services?
  (Sir Howard Davies) No, there is no Complaints Commission. Our Complaints Commissioner is appointed by a group of non executive members of our board and the executive has no involvement in the appointment. She then deals with, say, complaints from either firms or individuals about maladministration in the Financial Services Authority. So the kind of thing, for example, she is dealing with is if we have, for example, inadvertently left some firm off the list of authorised firms so somebody may have found they were not licensed to do business by an error, that may be a complaint and we may have inadvertently damaged someone's interest, or a consumer feels we have not properly regulated a firm and thereby has lost money because we should have prevented the firm doing some kind of business or whatever. That is the sort of thing the Complaints Commissioner deals with. It is not about disciplinary cases, and there is not a Complaints Commission specific to the Financial Services Authority.

Lord Morgan

  892. I wonder if I could follow up Lord Acton's question about the way in which you disseminate to helplines and so on. It seems to me, listening to you, that the ordinary small investor must feel quite vulnerable in these circumstances which can have absolutely catastrophic results for him. I have the report, which is only the overview and summary, of Equitable Life because we do not want to go over that in detail, I understand, but I would be interested in knowing whether there was a reference in the full findings to the relationship between the lack of understanding which is mentioned by the ordinary consumer about what the FSA might do and the extent to which they did consult or had available to them various helplines and so on.
  (Sir Howard Davies) I think it would be right to point out that the review of Equitable Life was about the Prudential regulation of Equitable Life, and was, of course, also about the old regime. Indeed, it was restricted to a period between 1 January 1999 and the point at which the company closed to new business in December 2000. I think that at that point—and in all cases even the end of that period was a year before the Financial Services and Markets Act came into operation—we were beginning in a very early stage way to plan our approach to consumer education and it probably was the case that there was a consumer helpline in operation at that point, even four years ago, but it was in a very experimental phase. Also, the point that has been particularly made in the Equitable Life report concerns the expectations of Prudential regulation and concerns the question of whether a Prudential regulator can make judgments about the viability of a firm even if that firm is meeting all the Prudential requirements. You have helpfully said that you did not want to get into the detail of the Equitable case, so let us take it away from the Equitable case. There is an issue as to what it means to say that a firm is authorised. The way the regulations work is that it is not judgmental on my part about whether a firm is meeting the Prudential requirements or not. There is a set of requirements and you meet them or you do not. You have an adequate amount of capital, and we determine what it should be, and then you meet it, and you have an adequate amount of reserves in the insurance sector and you meet them. We are not a kind of rating agency, saying, "Here are these authorised firms and some of them are better than others". We are not doing that. We are setting a hurdle over which you must jump to be authorised, and then all authorised firms are in that sense equal, even though, of course, it is true that some are more equal than others in terms of their capital standards. The regulator is not a rating agency, saying, "This is an approved firm but actually it is a CCC and I would not give business to it if I were you". We cannot do that; we cannot be a kind of rating agency. That was the specific point, I think, that people were saying, "You should have seen that this firm was weak". That is a different question from whether they were meeting all the statutory requirements. There are banks out there which are weaker than other banks but we police a level below which they feel they cannot go. If they go below that level, yes, we certainly do something about it, but if they are above that level then we may cajole and persuade, etc, but they are still authorised firms.

  893. Would you agree that a small investor, who might be somebody elderly, would need a certain amount of help, irrespective of his or her level of intelligence, to understand the particular approach?
  (Sir Howard Davies) Yes, and, of course, many people will go through and take advice and there were advisers who were advising people on the relative strengths and attractions of different investment opportunities, and there is a whole advisory industry to deal with this issue. The two questions you have to address yourself to in this area are: is it possible to have a Prudential regulatory system which is judgmental in this sense, and I personally do not believe it is, and I do not think there is a country that operates one that way; and, secondly, is it reasonable for a Prudential regulatory system to calibrate its regulatory requirements at such a high level that you eliminate the risk of failure, to which my answer again is, no, I do not think you can do that because at that point you have reduce the economic value of the whole financial services industry. It would be possible for us to reduce the risk of failure in a life insurance company to approaching zero by requiring it to hold all its assets in gilt edged stock or cash. It would then deliver a small negative annual return probably, given the costs of the operation. As soon as you allow companies to engage in taking on a risky portfolio of assets you admit of some possibility of failure. The Prudential regulator's reasonable objective, I think, is to minimise the incidence of failure consistent with, as our legislation says, maintaining competition, allowing innovation, delivering a cost benefit approach to regulation. That is the essence of the judgment: have we made that judgment appropriately? That is, I think, an area where reasonable men and women may reasonably disagree, but I think that is the territory and is not the territory of saying that there must be some absolute guarantee, that being regulated by the FSA must mean that it will not go bust. That I would strongly resist.

  894. Can I ask a final question connected with this? As you have explained it with total clarity it absolutely made sense, but I am also, as I say, concerned about the ordinary, perhaps untutored, investor, who perhaps might remain untutored even after advice because advice of financial terms varies considerably in quality in my experience. What do they actually receive? Again, I do not want to go into the Equitable Life case as such, but the author of this report mentions not merely what the FSA does but the philosophy underlying it, which is that market forces provide the best means of ensuring that an industry meets the needs of its customers and that therefore the role of the regulator should be a light touch, that he or she should not intervene with any great power. Does that come across in what investors are told also, that their false expectations might be based on the view that they do not altogether have access to this particular philosophy as well?
  (Sir Howard Davies) I think the Parliamentary Ombudsman was quoting from Government Ministers in the passage of the legislation, so that was the instruction to us in terms of the type of regime that we should be operating. Before we leave this point, it is important to note that the regime does envisage a safety net and there is one in the form of the Financial Services Compensation Scheme, and so there is a safety net for bank deposits where you get the first £2,000 100 per cent paid if the bank goes down, plus 90 per cent of the next £35,000, and in the case of life insurance companies there is a safety net through the compensation scheme which will give people 90 per cent of guaranteed policy values in the event that a company becomes insolvent. There is similarly for the Investor Compensation Scheme (as was) a safety net there if your advisor firm goes bust or your broker goes bust, etc. This point has not been ignored. We have a system which is calibrated to allow risk to be taken which we believe is economically sensible, but which does provide a safety net, particularly for small investors, for those who unfortunately happen to be in a firm where that risk taking has got out of hand.

Lord Elton

  895. I have a question on an earlier answer you gave to Lord Morgan, which gave a picture of you having clearly measurable standards which you apply before you authorise somebody in terms of capital reserves etc. How do you actually assess the fitness of the practitioners themselves to practise their knowledge of the work that they have to do? Is there now a recognised qualification in the various fields? How do you do it?
  (Sir Howard Davies) The fitness and propriety test is a combination. If I take you back to my explanation of authorisation and permissions, it will depend quite significantly upon the permissions you want and also your level in the firm, but it will be a combination of both negative testing, ie, have you got any county court judgments outstanding against you, and that sort of thing, or any regulatory offences in the past, so there is that kind of clearance mechanism, and there will in some cases (though not all) be particular examination requirements. There is not just one, Lord Elton. There are many. We approve them. We are not an examination setting body but we approve the curriculum content of different types of examinations. It is a competitive market out there and there are different professional bodies who will produce exams which will meet our requirements in particular areas, and in some cases there is an experience requirement. For particular serious senior jobs of overseeing a whole trading floor, for example, we would expect to see that person having had some experience of that business before they get to that role.

  896. My concern is more with the small IFAs. Is there now any recognised qualification that somebody has to have before they put a plate on their door and say they are authorised in the sense that they have done the mathematical side of it?
  (Sir Howard Davies) There are several that would meet our requirements. They do have to have a recognised qualification, yes, but it would not be just one which met our requirements. We are in the middle of an examination review to look at whether it would be possible to simplify the examination structure because it is certainly fair to say that the average consumer is a little bit puzzled by the letters after people's names which can mean the same thing but there is a whole set of them. We have had a positive response to that consultation, to the idea that there should be a rationalisation, but we expect that rationalisation to be led by the Financial Sector Skills Council. Our head of education and training has in fact recently been transferred. We have seconded him initially to become Chief Executive of the Financial Sector Skills Council, which is an industry-run body which will lead this review and, we hope, rationalisation of the qualifications system. We do not think it is appropriate for the FSA to set itself up as a kind of national examination board but we have been promoting rationalisation.

  897. Again, looking at the small practitioner, I was a bit concerned when you answered Lord MacGregor because you said something which gave me the impression that you really only tended to pursue breaches where there were very large sums involved. There was some sort of cost benefit analysis there, but, of course, for the small investor the misconduct of a very small firm can be a complete wipe-out. How do you oversee that field and how do you decide in those circumstances what to pursue?
  (Sir Howard Davies) We will always seek to pursue compensation where we can. The issue I was talking about was whether we then proceeded to go through the full disciplinary rigour and also engaged in the fining process or whatever. In quite a number of our enforcement actions, and this is what I was trying to convey, we will identify a breach, the firm will say, "Oh dear, oh dear, we will compensate the investor", and that is what we will always go for—compensation for the investor. Then the question will be, do we believe that this was a significantly serious breach for it to justify the full glory of our disciplinary process or was this essentially an accidental oversight which the firm has now corrected and when we look at the systems we think that they have improved their systems and no useful purpose would be served by making an example of them in the fining point. That is a judgment that we make, so we would always pursue compensation but we would not always necessarily pursue the discipline of fines.
  (Mr Whittaker) One particular context in which the cost benefit analysis does arise in relation to payment of compensation is that we have administered a pension review which has required those who have been involved in mis-selling of personal pensions to take the initiative in working out how much people have lost as a result of that and to pay them back. Through that process some £11.5 billion has been repaid to people who have been mis-sold personal pensions. We have operated a cost benefit process in deciding whether we should ever do that again and so, particularly in relation to, for example, mortgage endowments, we have concluded that the cost benefit analysis would not justify a similar exercise in that case across the whole industry. If we were to conclude that it would be justified then we would nevertheless need to go back to the Treasury and get approval from them in order to do such an exercise. That is, I think, the only context in which a cost benefit analysis applies to individual compensation.

  Chairman: Thank you very much. Sir Howard, you have been extremely generous with your time this afternoon. I am sure there are other questions we would like to have put to you but we have covered quite a wide range and you have been very full in your answers, for which we are extremely grateful. It has been very helpful to us. Thank you very much.





 
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