UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE
To be published as HC 1896

HOUSE OF COMMONS

ORAL EVIDENCE

TAKEN BEFORE THE

TREASURY Committee

UK FINANCIAL INVESTMENTS 2012

WeDnesday 14 March 2012

Robin Budenberg, Keith Morgan and Jim O'NeIl

Evidence heard in Public Questions 1 - 159

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Oral Evidence

Taken before the Treasury Committee

on Wednesday 14 March 2012

Members present:

Mr Andrew Tyrie (Chair)

Michael Fallon

Mark Garnier

Andrea Leadsom

Mr Andy Love

Mr Pat McFadden

John Mann

Mr George Mudie

Jesse Norman

Teresa Pearce

Mr David Ruffley

John Thurso

________________

Examination of Witnesses

Witnesses: Robin Budenberg, Chairman, UKFI, Keith Morgan, Head of Wholly Owned Investments, UKFI, and Jim O'Neil, Head of Market Investments, UKFI, gave evidence.

Q1 Chair: Thank you very much for coming this afternoon. As you may imagine, one of the important issues we want to examine is the remuneration of senior RBS staff. I would like to begin by asking you when you, UKFI, were first involved in any way in discussions about Stephen Hester’s bonus.

Robin Budenberg: First of all, I should say our involvement is obviously in our role as a commercial investor in RBS, operating on an arm’s length basis. As such, the chairwoman of the remuneration committee sees us on a fairly regular basis through the year but in particular came to see us in, I think, early December, to talk about the way in which they were going to approach the whole issue of executive director remuneration through this year. I would say in terms of substance, which I think is probably what you are looking at, it was, I would guess, in the third week of January. At that point, again as you would expect, the chairman of RBS spoke to me about his assessment of Stephen Hester’s performance during the course of 2011.

Q2 Chair: Why don’t we focus in on these events in January just so we have a clear chronology of events? Do you happen to know when the remuneration committee of RBS took the decision?

Robin Budenberg: The final decision, I believe, was taken on or around 26 January, if I remember rightly.

Q3 Chair: So we need to look at the third and fourth week of January. I hope we are able to move on quite quickly from this, but let’s just try to clarify this chronology. You first met the chairman of remuneration to discuss specifically the decisions he would take on 26 January, in the third week of January, you say?

Robin Budenberg: The discussions with actually the chairman of RBS, because Sir Philip Hampton is the person.

Q4 Chair: Just the chairman? You did not see the chairman of remuneration?

Robin Budenberg: Not at that stage, because it is the chairman who carries out the review of Stephen Hester.

Q5 Chair: Did that meeting take place before or after the Prime Minister’s very well-reported intervention with his speech on moral capitalism on 19 January?

Robin Budenberg: It wasn’t a meeting. We had a series of telephone discussions in which he was getting our input, and certainly the first of those discussions was well before that, yes.

Q6 Chair: What did he say?

Robin Budenberg: We went through the five criteria against which Stephen Hester is assessed, as set out in the remuneration report in last year’s RBS annual report, and we went through each of those. He asked me for my views on Stephen Hester’s performance in each of those five areas. He then talked a bit about his perspective and, as we went through that conversation, clearly I got a good sense of where he was beginning to come out in terms of his views.

Q7 Chair: When did you first discuss this specific set of issues with the Government or with anybody who could represent the Government-that is, either a Minister or an official?

Robin Budenberg: We were discussing remuneration generally with the Government through officials throughout the run-up to this process. As you know, the Chancellor made it clear to this Committee that he was very interested in the RBS bonus process, so we were discussing those things with officials, so that they were kept aware with progress. In terms of the precise output from those discussions with the chairman of RBS, I would say it was later on that week, in the week before the 26th.

Q8 Chair: Did you form a view about the advice that you thought, as a shareholder, should go to RBS?

Robin Budenberg: Yes.

Q9 Chair: Did you communicate that view after the meeting that you had with them, a specific view on the advice you felt you should communicate with respect to the 26 January decision that was pending?

Robin Budenberg: Not a specific view, not in terms of an exact proportion of the bonus that we felt would be appropriate, but a general range, yes, we did.

Q10 Chair: What was that range?

Robin Budenberg: I think our view was that broadly our sense was that it clearly was not going to be close to 100%, based on what Sir Philip Hampton had told us, but would be more than 50%. That gives you a range of, I guess, 50% to 70%. We did not specifically say, "This is what we think the range is. We think it will be less than the maximum".

Q11 Chair: This is a per cent of-

Robin Budenberg: The way in which the bonus for last year was established was directly in relation to the value of a pot of shares.

Q12 Chair: This is a question of how much would be released?

Robin Budenberg: Exactly.

Q13 Chair: Roughly, what was the value of the 50% to 70% at that time?

Robin Budenberg: The share price went up 10% during the period of these discussions.

Chair: I just want to get a rough figure.

Robin Budenberg: It was, I guess, between £800,000 and £1 million.

Q14 Chair: When you spoke to the Government, what guidance did they give you?

Robin Budenberg: They were very clear that they wanted to make sure that this decision was made in the context of the climate on remuneration, and they wanted to make sure that it was substantially lower than the figure that was announced for Stephen Hester last year.

Q15 Chair: When was the figure of less than £1 million first discussed?

Robin Budenberg: I think the Chancellor always made it clear that this was a decision for the board of RBS. I think he felt in that meeting that it would be difficult for him to justify a figure of more than £1 million.

Q16 Chair: You had a meeting with him to discuss this?

Robin Budenberg: Yes.

Q17 Chair: Where he said he found it difficult to justify more than a million but it was a matter for the board?

Robin Budenberg: He focused on the fact that he understood that this was something that the board needed to decide.

Q18 Chair: When did that meeting take place?

Robin Budenberg: I think it was a week before the 26th, I guess. I am afraid I can’t be absolutely sure about dates, but broadly I am fairly confident with that.

Q19 Chair: There does seem to be, doesn’t there, a difference between what the Prime Minster said, when he said in response to a question he would act to stop bonuses over £1 million, and what the Chancellor said to you, which was that this was a matter for the RBS board?

Robin Budenberg: I can’t speak for what the Prime Minister said.

Q20 Chair: Do you think that your stance changed as a consequence of what the Government said to you, or were you merely able to say that this was confirmation of what you had already more or less decided among yourselves that you would take to the RBS board as your view?

Robin Budenberg: Again, I think it is important that as a shareholder we do not dictate what the level of bonus for Stephen Hester should be. That is absolutely a matter for the board. Our role is to be consulted in that, and if we think we have fundamental issues with that, our role is to make that clear to the board.

Q21 Chair: Did you consult other shareholders?

Robin Budenberg: No.

Q22 Chair: Do you think, were it to be fully put into the public domain-and clearly only some of what you have told us so far was already in the public domain prior to these exchanges-that any of what you saw or heard at that time could be challenged on the grounds that it was creating shadow direction?

Robin Budenberg: I do not believe so. I am very comfortable that the board of RBS, or particularly the remuneration committee of RBS through which this decision is taken, when it took that decision, was not aware-I did pass the Chancellor’s views on to Sir Philip Hampton but he did not pass those on to the remuneration committee during the time that the decision was made. The remuneration committee, which ultimately is the body that makes this decision, was not aware of the Chancellor’s views at that stage.

Q23 Chair: When your view differs, as it may from time to time, from that of the Government on how best to protect shareholder value, what are you going to do about it?

Robin Budenberg: If we think that something is in the bank’s commercial best interests, generally our sense is that the Government also wants to do what is in the bank’s commercial best interests and, therefore, we would seek to persuade them of our point of view.

Q24 Chair: When that fails, where are you going to come?

Robin Budenberg: Ultimately, our board is there effectively to protect our mandate, which is to act in the commercial best interests of the bank.

Q25 Chair: In your discussions with Sir Philip Hampton, did he say that any of the exchanges that have been taking place on all this constituted something that was forcing RBS to act on non-commercial grounds?

Robin Budenberg: No. He was entirely comfortable with the discussion that we had. He was clearly in a position where he felt that he knew what, from his point of view, the right outcome was, and none of the discussions we had interfered with that in any way.

Chair: Thank you very much for that.

Q26 Teresa Pearce: On 19 December 2011, the Chancellor told the House of Commons that RBS will make further significant reductions in the investment bank, scaling back riskier activities. Whose decision was that? Was that the Chancellor’s or RBS’s board?

Robin Budenberg: That was the board of RBS. Again, the question of the strategy for the investment bank is something that we have been discussing with RBS for well over 15 months now. It is clear from the whole development of capital regulations in international banking that the strategy for investment banking has to be adjusted. We had a series of discussions with the senior management of RBS about that. They felt that it was appropriate to wait for the outcome of the Vickers Commission, because clearly that could have an impact on the balance and structure of investment banking for banks owned by UK companies. The announcement was made in the third quarter results of RBS in November, effectively stating very much what the Chancellor stated in the House of Commons on 19 December.

Q27 Teresa Pearce: Do you think that that should have been announced officially by the board rather than the Chancellor?

Robin Budenberg: I think it was announced officially by the board in the third-quarter results in November.

Q28 Teresa Pearce: The Government has adopted an increasingly vocal role in terms of RBS’s corporate strategy. Where does that leave UKFI? Does that make you redundant?

Robin Budenberg: No, I don’t think so. I would say this, wouldn’t I?-but I think we play a very important role in three ways. First of all, I think just by definition our mandate is very important because we have a board that is charged with a formal mandate to act in the best interests of the banks that we own or we control the shareholdings in. Effectively, that is the one thing that we do. That creates almost a nuclear deterrent that if the Government feels that it wants to use the shareholdings to invoke a non-commercial outcome then they have to persuade our board of that. I do not think our board would be prepared to do that because that is the one thing that we are there to protect.

Q29 Teresa Pearce: In the shift of RBS’s corporate strategy, did you play a part in that?

Robin Budenberg: Yes. It is always very difficult to say, when you have had discussions over a long period of time, who did what. I am absolutely clear that it was the management of RBS, and ultimately the board of RBS, that made the decisions about that shift in strategy, but clearly we were involved in those discussions and had views and continue to have views, because I think this is an evolving issue.

Q30 Teresa Pearce: Given the huge risk to the economy that came with the near collapse of RBS and the fact that the public now, the taxpayer, is the main shareholder, how confident are you that there is no further risk in that business? Has there been any due diligence into any others areas where there could be substantial risk such as, for example, tax planning, EBTs? There is currently a lot of discussion in the financial press about the activities that surround LIBOR, and RBS has been mentioned. How confident are you there is not another time bomb in there somewhere?

Jim O’Neil: We did spend a lot of time on the investment banking business of RBS, and it is a natural question of a Government-owned institution, or an 82% Government-owned institution, having a position as an investment bank. It was part of RBS’s strategy in 2009. The benefit of the investment bank was it generated £10 billion of capital and profit over the last three years, which has been important in rebuilding the capital of RBS. But as Mr Budenberg says, the regulatory and market environment has changed, so they are changing their business models, as are Credit Suisse, UBS, BNP and some other European investment banks.

To get to the heart of your question, risk and controls at RBS was one of the things cited in the FSA report on RBS, and management, when they took over on their five-year plan, have instituted a plan to improve risk and controls as well. We are two and a half, three years into that plan and I think we would all note that progress has been made, but they are not all the way there to where they want to be and so they continue to invest in those risk and controls.

Q31 Teresa Pearce: There were risk controls before, but the problem was there were risks that they could not control that they did not know were there. Have there been any provisions within the accounts for a possible risk that could crystallise? What level of due diligence has been done? There are the areas that exploded, but there could be other little time bombs in there. Has everything been looked at now? Is there anywhere that I should be worried about my money?

Jim O’Neil: We interface as looking after the taxpayers as the shareholders with the board of management. We are not involved in day-to-day operational decisions as part of our job, but we do do business reviews of all businesses, including GBM. We regularly meet with the risk committee chair as well as the heads of risk at each of our banks. Inherently, all banks have risk and so I can’t say that banks won’t have areas that will have losses again, but what I would say is for RBS, as with many banks after the crisis, there has been a wholesale change in terms of how they do things. They are not just doing it on their own; the regulatory reforms are carrying them out there as well.

Q32 Teresa Pearce: Which brings me on to Lloyds Banking Group: they have announced a loss of £3.5 billion, largely because of the mis-selling of payment protection insurance. Do you expect Lloyds to set aside more money for that?

Jim O’Neil: They have instituted their framework for dealing with the PPI complaints, and that is ongoing now. That is one of the topics that we engage with Lloyds management on, because that can potentially be additional risk if they had losses in excess of that and they have to make more provisions. I think at this stage they stand by the original provisions that they made, given the responses that they have received to date. That is obviously something they monitor very closely.

Q33 Teresa Pearce: Final question. The FSA mentioned to us that the mis-selling of payment protection insurance produced large profits in an area of the business that would not necessarily have expected that large a profit, and when the board were looking at that they should have thought, "How is this?" and they did not. That really comes down to culture. Someone once said, "While the music was playing, we were all dancing," and I think people were too busy dancing to look at the risks. What power do you have over the culture of these organisations that were so important in the downfall?

Jim O’Neil: I think the most important influence is the management of the boards. The boards of both of those banks are entirely different than prior to the crisis and nearly 100% of the senior management team are different than prior to the crisis. The culture comes from top down. These are immensely large institutions. RBS has 150,000 employees, Lloyds has 100,000, and so disseminating that through an organisation takes time and these banks are in transition. There has been a large change since that time.

Q34 Mr Love: Can I come back to the issue of Stephen Hester’s bonus? It was widely described in the media, when it became public, as a fiasco. Do you agree with that summation, and can you reassure this Committee that it is not going to happen again?

Robin Budenberg: I think, as I tried to explain earlier, in terms of the process in arriving at that bonus figure, I feel very comfortable that the process was appropriate. Clearly, the outcome was not satisfactory, and I think it demonstrates that RBS remains vulnerable to issues and timing working against it. I think that is something that the more we can demonstrate that RBS is on the way back to recovery and on the way back to returning money to the Exchequer, the less that those sorts of instances will arise.

Q35 Mr Love: There was some suggestion in the media that resignations from the board of RBS were being threatened. Were you aware of any of that?

Robin Budenberg: I have only heard what Stephen Hester said in public, which is that he considered resignation but felt that that would be self-indulgent. I think as the chief executive-

Q36 Mr Love: No, I was not thinking about Stephen Hester; I was thinking about other members of the board.

Robin Budenberg: I am not aware of other resignations, no.

Q37 Mr Love: Is it acceptable that although the RBS bonus pool was significantly reduced because of the results, that was largely offset by increases in salary? Would that not be something you would be concerned about?

Robin Budenberg: We would if it was the case, but it wasn’t the case. There was only a very small proportion of offset in relation to increases in salary.

Q38 Mr Love: You are clear about that?

Robin Budenberg: Absolutely clear.

Q39 Mr Love: Let me go on to payment protection insurance. You will be aware and I suspect you had some discussions with Lloyds TSB about the action they have taken in relation to bonus incentive schemes. There does not appear to be similar action happening at RBS. Have you discussed this with them and what action are they likely to take arising from it?

Robin Budenberg: Yes, we have discussed that. In the Lloyds context, there were two actions that the Lloyds remuneration committee took. The first one was to look very hard at the bonuses of all the employees of Lloyds this year, and those were reduced by 30%. A significant proportion of that reduction was a reflection of the PPI provision. Then, of course, in relation to senior executives who had left the group, they took the view that they should seek to get some of their bonuses clawed back, which again came out in public.

As far as RBS are concerned, there was not the same change in senior management over the course of that time and, indeed, the PPI issue at RBS was much less significant. It was a very significant amount, please don’t get me wrong on that, but it was significantly lower than at Lloyds. Therefore, the remuneration committee took account of that in relation to coming out of the bonuses at RBS as a whole, which again, if you look across RBS as whole, were reduced by some 40% last year.

Q40 Mr Love: Let me remind you that the figure for Lloyds was £3.2 billion and the figure for RBS is just over £1 billion-a very significant sum of money. But if I can refer you to your own statement, issued on 24 February, regarding discussions with RBS and Lloyds, it said, "The introduction of share-based awards and stringent deferral and clawback"-I repeat that word clawback-"conditions". Why are you not insisting with RBS that they claw back?

Robin Budenberg: Clawback arises where you can show that circumstances existed at the time that you were awarded the bonus that would have made you change your view on the bonus. I think the case at RBS was that they were aware of the likelihood of the need to take a provision in relation to PPI and that was reflected in the views on the previous year’s bonuses.

Q41 Mr Love: In relation to RBS’s long-term incentive plan, the part that relates to total shareholder return appears to have been reduced from 50% to 25%. Is that not rather contradictory to your stated objective to get maximum return for the shareholders? Why has that happened?

Robin Budenberg: I think there has been a significant change in institutional investor attitudes to long-term incentives schemes. I think there has been growing concern among institutional investors that by focusing people significantly on share price they are incentivised to focus on the share price rather than building up the long-term value of the company. The RBS remuneration committee has responded to that by introducing a broader set of measures, particularly including one in relation to risk and one broadly covering a set of measures judging how well the business is performing-for example, in relation to customers. We have sympathy with the institutional investor attitude to that. We think it is very important that institutional investors are comfortable with the incentive arrangements at RBS and, therefore, we have agreed to those.

Q42 Mr Love: My primary interest, indeed this Committee’s primary interest, is the taxpayer as shareholder. It says on your website that your overarching objective is to manage shareholdings commercially to create and protect value for the taxpayer as shareholder. Do you think, by downgrading that particular part of the long-term bonus plan, you are protecting the value for the taxpayer in RBS?

Robin Budenberg: I do not think we would support that if we did not feel that the other objectives that were introduced would not lead to a long-term sustainable benefit for the share price. Certainly, elements in relation to reduction in risk and elements in relation to the long-term customer franchise should result in an increase in overall value and, we think, would be in the best interests of the taxpayers.

Q43 Mr Love: Let me ask one final question. It again relates to the statement about RBS and Lloyds that UKFI put out. You said that you do not intervene in relation to individual remuneration decisions except on directors through having a vote on the directors’ remuneration report at the annual general meeting. Is that something you have considered in relation to RBS?

Robin Budenberg: Excuse me, whether we should be having a direct impact on individuals?

Mr Love: On directors.

Robin Budenberg: No, we do. As we have discussed, because of the importance of our vote at the annual general meeting, the boards and remuneration committees of the banks believe it is important to get our views on the remuneration of executive directors and, therefore, they do involve us in discussions around that. We do do that and that is why we specifically excluded that from our input into individual remuneration decisions.

Q44 Chair: Do you agree that it would be more acceptable to the public if RBS made future bonus payments to senior staff conditional on the taxpayers having got their money back?

Robin Budenberg: I can see that it would be something that taxpayers would feel more comfortable about. I think with the-

Q45 Chair: Given the experience we have just been through in January, isn’t that something to take back?

Robin Budenberg: We will take it back, and it is something that we have considered. Clearly, where the share price is at the moment, we have to have incentives that have a realistic prospect of-

Q46 Chair: They can be large down the line when people have got their money back, but in practice pressure has been brought to bear that has resulted in the bonus being waived by the recipient.

Robin Budenberg: I accept that point. I would just say that all the bonuses are paid in shares that have to be kept for many years and, therefore, the management is extremely motivated.

Q47 Chair: I am suggesting the application of an additional condition.

Robin Budenberg: Thank you.

Q48 Andrea Leadsom: Mr O’Neil, how is the pool of shares, from which the base case for the bonus is calculated, established?

Jim O'Neil: You are referring to Stephen Hester’s bonus? In the case of last year, the shares were put in a pool. The share price at that time, at the end of 2010-correct me if I am wrong-was, I think, 42. It was much higher than it is today. As Mr Budenberg was saying, over the course of the year, as that share price went down, effectively the pot available for the bonus went down with the share price.

Q49 Andrea Leadsom: What I am asking you is who decides what the pot is to be. If the share price was 42 pence and a certain number of shares were set aside then clearly, had the share price not moved all year and had Mr Hester been eligible for 100% of his bonus, that would have amounted to-and I am guessing here-£3 million, let us say. Who decides that that is the base case and why? How is that calculated?

Robin Budenberg: It was based on the basis of Stephen Hester’s remuneration that was agreed by shareholders when he was recruited to the role, which is 200% of salary. The calculation was based on 200% of salary and then divided by the number of shares and that gave a number of shares. I should say that that system has not been retained for this year, partly because clearly the share price has gone up very significantly since the beginning of the year and the remuneration committee and Stephen Hester felt it would be inappropriate to base his potential bonus on something that has increased by 40%, I think is the figure.

Q50 Andrea Leadsom: That is not really answering the question. What I want to know is, why and how was it decided that the bonus for the chief executive should be 200% of salary? How was that decided?

Robin Budenberg: That was decided when Stephen Hester was recruited.

Q51 Andrea Leadsom: Yes, I understand when, but how? Why was that decided to be? What was the peer grouping? What was the measure? Was it McLagan data, for example, that I know is an industry standard for comparing pay groups and so on? Who decided that in a taxpayer-owned company that had had such obvious difficulties that 200% of salary is the right amount?

Robin Budenberg: How it was decided was definitely based on an international peer group and a UK peer group. Who decided fundamentally was, to begin with, the remuneration committee and, ultimately, that was approved by shareholders.

Q52 Andrea Leadsom: If Mr Hester was to receive 100% of his bonus entitlement next year, what would that currently amount to? What is the basis for next year’s bonus?

Robin Budenberg: That remains 200% of salary.

Q53 Andrea Leadsom: So, next year, if his salary is £1 million, his bonus, if he gets it all, is £2 million. How is it decided again that that salary and bonus for next year is the appropriate level? How do you take a peer group of state-owned, bailed-out banks and create a peer group for the bonus of a chief executive?

Robin Budenberg: I do not think we should take a peer group of state-owned, bailed-out banks, partly because there probably is not one and partly because I think it is very important that if we want to encourage outstanding management, as we have at RBS, into RBS, we need to be able to pay them competitively with the marketplace.

Q54 Andrea Leadsom: That is what I was really hoping you would say, so thank you for saying that. That brings me on to the point of if we now turn to, say, Bob Diamond in Barclays, when he was at Barcap, I think his last year’s total comp was something like £20 million. Why do you think he was willing to take a significant pay cut to only something like £6 million, the poor thing, to be chief executive of the Barclays Group? How on earth would he have been attracted to such a drop in pay if, as you say, the only reason we can get such outstanding candidates in a state-owned bank is if we pay them 200% of salary? It is illogical. I think you will agree it is just illogical.

Robin Budenberg: I do not think it is for me to comment on Bob Diamond’s pay.

Q55 Andrea Leadsom: Forget Bob Diamond. If the point you have just made, which is that to get outstanding candidates you have to be paying them sums that are 60, 70-I have not done the maths-80, 90 times what the average income is in this country, at what point is the cut-off for your outstanding candidate? Is it 50 times the average worker’s salary, or is it 1,000 times? Who decides that that is what you need to attract that outstanding calibre of candidates?

Robin Budenberg: I understand that it is very difficult, in the context of a bank that has been bailed out by the taxpayer, to talk about these sorts of numbers.

Q56 Andrea Leadsom: Let us just be clear, every bank was bailed out by the taxpayer-every single bank-because all of the central banks provided essential liquidity otherwise the banking system would have collapsed. There is not a bank on the planet, barring the few small retail domestic banks, that was not bailed out by the taxpayer somewhere. So, yes, do continue on that basis.

Robin Budenberg: We have a choice. We could either pay the employees of RBS on the basis of something that we or the board and the remuneration committee of RBS consider to be competitive, albeit that I think across the board at RBS pay is at the low end of the competitive range, or we could do away with any pretence of competitive pay. My own view is that that would not be in the public interest. We might find one or two people who would be prepared to do that, but I think across the piece you would find it impossible to keep and retain and attract the sort of quality of people that you need to run an incredibly complex, risky and challenging bank.

Q57 Andrea Leadsom: I completely disagree with you there, and I think there is some proof of the pudding because Stephen Hester forwent his bonus and he is still doing the job. As you said, and as he is widely reported to have said, he considered resigning and realised that he wanted to do the job more than he wanted to resign over the fact that he did not get his bonus. That completely undermines what you have just said.

I want to take you back to what you said when you came to the Treasury Select Committee last year. You said then, and I distinctly recall it-I do not have the quote here-what you really wanted to do was a revolution in corporate governance in these banks. You wanted to get them to take seriously their responsibilities and so on. It seems to me we have made absolutely no progress. I wonder if you have at your fingertips the statistics on how the shareholder dividend has been affected since the financial crisis versus the employee bonus pool. That would be a very interesting number to see whether there is any relation whatsoever with the fact that people who have their own pensions and their own life savings invested in banks and what has happened to their life savings, the share price and the dividends, versus the employees and the directors of the banks who got them into this mess and appear to have taken very little downside whatsoever. How is that in keeping with your goal of improving the corporate governance? Do you have those statistics?

Robin Budenberg: Well, the bonuses at RBS overall went down by 40% last year. Those in the investment bank went down by 60%.

Q58 Andrea Leadsom: What about the shareholder dividends and the share price since the financial crisis?

Jim O’Neil: There was no shareholder dividend, so it is very-

Robin Budenberg: The share price went down from-

Jim O'Neil: I think since the taxpayer investment the share price is down approximately 50% in terms of losses.

Q59 Andrea Leadsom: And the dividends were down 95%-

Jim O’Neil: There are effectively no common dividends.

Q60 Chair: You said a moment ago we could do away with any pretence of competitive pay. Are we pretending now?

Robin Budenberg: If you compare RBS against its peer group-and I think the main area to focus on is the investment bank-you can see that they do pay a significantly lower level than other banks. What they do is that they are very disciplined in making sure that what bonuses they do pay go to the people that really make the difference, and I think that is the right and the only strategy for them to follow.

Q61 Chair: Given what you have just said and what you have been saying over the last few minutes, is it really plausible to say this bank is being run on fully commercial lines?

Robin Budenberg: Inevitably, when you have an 80% Government shareholder, there are stresses and strains in that relationship. As Mr Love said, we came across a situation in relation to Mr Hester’s bonus.

Q62 Chair: So it is nearly commercial but not fully commercial?

Robin Budenberg: I think if you talked to the board of RBS, they would feel that they can run this bank and they do run this bank on a commercial basis, but there are some areas where clearly and appropriately they have to be, and are, more sensitive than other commercial entities.

Chair: You missed out on the diplomatic corps. That is very good, but I understand why you are saying what you are saying and I appreciate it.

Q63 Mr Ruffley: Mr Budenberg, just one question on the Stephen Hester bonus saga in January. There was a lot of speculation-I think, informed speculation-that the board of RBS had threatened to resign. Is that true?

Robin Budenberg: No, not that I am aware of anyway, I should say. But I would be surprised if I was not aware of that, because I think that our role is that if the board of RBS thinks it is being asked to operate in a non-commercial way we should, very clearly, be aware of that, and our board-

Q64 Mr Ruffley: You are saying you were not aware of it?

Robin Budenberg: Yes.

Q65 Mr Ruffley: That is fine. I want to turn to another issue, which is that the Secretary of State for Business has announced very recently that he sees attractions in breaking up RBS and from it forming a new bank specifically dedicated to business lending. Have you done any work on the proposition?

Robin Budenberg: Could I ask Mr O’Neil to answer that?

Jim O'Neil: I would not say we have done work on that specific proposition, but we do work and think about all kinds of propositions as relates to RBS as part of our role. I think at the heart of that question is do you want to turn RBS into some type of good bank that has some different type of purpose. What does one do with the other parts of RBS and how does one achieve that? I think, specifically related to any type of a good bank, what are the other assets and what does one do with those? There are a variety of those assets to think about in RBS, but I think in particular it would be the non-core division of the risky assets is about £100 billion, and what does one do with those assets? Presumably, the Government would have to intervene in some ways to take those assets on the balance sheet. In looking at a proposal like that, one would have to look at the benefits of turning it into this kind of bank and what are the potential costs to the taxpayer and the Exchequer in dealing with the bad assets. But I can’t say that we have been asked to look at that specific proposal.

Q66 Mr Ruffley: So you have not received anything from Mr Cable’s Department?

Jim O'Neil: No, not that I am aware of anyway, but I don’t think so.

Q67 Mr Ruffley: Not that you are aware of. Is it the case that-

Jim O'Neil: As I say, because we are in the role specifically as a shareholder and there is a lot of policy dimensions to that, they may more likely have reached out to Treasury on that.

Q68 Mr Ruffley: Yes, okay. Wouldn’t the hiving off of the investment banking activity within RBS make a Vince Cable-type proposal irrelevant, because isn’t the strategy in hiving off the investment banking business to focus on more business and personal lending?

Jim O'Neil: They are reducing the size of the investment bank, but they will still be in investment banking. They are particularly closing down their cash equities business, which they were losing money in and trying to grow, but their capabilities in fixed income, FX and rates would still be there. If that did not fit into whatever the proposal would be to create a new bank, one would have to think about how to address that as well. I think any time when there are various ideas of turning RBS into another entity, one needs to think about what one does with all the other parts. Some parts might be able to be sold or done something with, but other parts, it is not so clear what one would do with those.

Q69 Mr Ruffley: Could you indicate to this Committee, because there is quite a lot of public interest in this, which is favourite at the moment in terms of the possible futures for RBS?

Jim O'Neil: What is favourite? As the management has articulated, the UK core corporate and retail bank is the centre of RBS. They do have a retail bank in the United States. They have a wealth business. They have an investment-banking business, which they have announced a change in strategy to make smaller. The particularly challenging bits when one thinks about these ideas is what does one do with the non-core division, which is £100 billion of assets, which I think, by the way, the market widely agrees that the management has done a good job of managing those to the best that they can. There is also the Ulster Bank, which it is difficult to think what one would do with that.

Q70 Mr Ruffley: Do you think it is going to be sold off in its present form?

Jim O'Neil: What would be sold off in its present form?

Mr Ruffley: Are the shares going to be sold in this business in its current form?

Jim O'Neil: Would we be monetising shares in the business in its current form? I think the management has put on a five-year plan that includes those businesses in the fiveyear plan. There has been a change in strategy in GBM related to the change in market and regulatory circumstances. So I think when investors are buying RBS shares today, they are buying into that plan. Management obviously reviews that strategy in its portfolio of businesses and with the board on a regular basis, but that is the assumption, yes.

Q71 Mr Ruffley: Pretty much in its current form, selling the Government stake, the bank in broadly its current configuration?

Jim O'Neil: Yes. I think the investment bank is clearly something that is evolving, but broadly in its current form. That does not necessarily mean that an investor who buys those shares might consider that something might happen after he buys those shares, so the management may decide to do something different down the road, but I think that is the assumption.

Q72 Mr Ruffley: My final question, Mr Chairman. The Centre for Policy Studies put out last summer a proposal for the Government’s stake to be given as shares to the public. It would be an offering to the public. I think you are aware of that piece of work. Could you tell me something about the status of that? You have had discussions with the bankers involved, haven’t you?

Jim O'Neil: We discuss a wide range of proposals with a wide range of people. We have discussed this proposal with some of the people who have been thinking about it as well. What I would say is-and I will give you the short answer, because we do have a lot of thoughts about the proposal-at the core there are a lot of policy decisions of this proposal. It clearly has some attractions of giving potential value upside to the general public, potentially accelerating the disposal of the banks. At the heart of it, there are a lot of policy aspects to it that are not the core of our maximising value for money in the sense that our job is to get the most value for money back for the Exchequer. But we have engaged on it with various people, as we do with other proposals, and there are pros and cons with that proposal, as there are with others. I am happy to go through that in more detail, but it is hard to give a short answer or a very long answer.

Q73 Mr Mudie: Just a couple of questions on remuneration. Last year, over 300 people in RBS earned more than £1 million. Can you give us the comparative figure this year?

Robin Budenberg: I think that figure was 300 people with an average-that is the average figure.

Mr Mudie: Yes, sure.

Robin Budenberg: The average figure has gone down 30% from last year to this year.

Mr Mudie: Which means?

Robin Budenberg: Around £800,000.

Mr Mudie: How many people were involved there, though?

Robin Budenberg: The same number.

Mr Mudie: 300?

Robin Budenberg: Yes.

Q74 Mr Mudie: Can you send us the exact figures? We keep getting figures here that magic away the next time people come in front of us.

Robin Budenberg: Yes.

Q75 Mr Mudie: When you described your discussions with the chair of the board and then you mentioned, "They did involve us in discussions on remuneration," it seemed to me a very cosy chat between two civilised gentlemen who did not want to get overexcited about money. Is there an objective stated criterion for earning these large amounts of money in RBS or is it subjective; it is vague, so it enables yourself and the chairman to reach agreement without much difficulty?

Robin Budenberg: I think there are five very clear criteria, which were laid out in the annual report last year and against which the chairman assessed Stephen Hester’s performance. There is an element of qualitative judgment about that, I agree.

Q76 Mr Mudie: How big is that element? Or put another way, how big is the element that can be objectively studied?

Robin Budenberg: Well, of the five, I would say three are pretty quantitative and two are fairly qualitative.

Q77 Mr Mudie: When this business blew up, the press approached RBS and said, "Can you give us our criteria? This is public money. The public are outraged at it. They have a right to know," and RBS refused. They do put certain things in their annual accounts that seem fairly vague. Can you supply this Committee with the stated criteria for the bonuses last year?

Robin Budenberg: Yes.

Q78 Mr Mudie: Straightforward. Lovely. That is us finished on bonuses, you will be delighted to hear. On Vickers, which figures in your future strategy and so on, are you, RBS and the Government all singing off the same hymn sheet? Do you all have general agreement on where you are going?

Jim O'Neil: I think we all come at it from a different angle. We did interact with Vickers from our value mandate and we spent time with the Commission, obviously with RBS and Lloyds in terms of their thinking about it, and our role there was to make an assessment of the value implications of various proposals. When we did that, we did not know what the final proposal was, so that was a very wide range, but we come at it from strictly a value standpoint. I think Government obviously has other issues to balance as well, so I would not say we are disconnected, but we all came from a slightly different angle.

Q79 Mr Mudie: I am not bothered what your starting point is; it is your finishing point. We are fairly well into having an agreement. There are details to be clarified when the legislation comes through, but the general shape of Vickers in its final report the Government has accepted. Has RBS accepted, to your knowledge? Are they working with you and the Government in terms of getting ready for Vickers as much as you can at this stage in the proceedings?

Jim O'Neil: I would say they were working directly with the Government. We are involved in that, but I think RBS is working with particularly-

Q80 Mr Mudie: No, but you are aware of what they are doing. Are they, to your knowledge, working on a detailed strategy as much as they can, because the legislation has not been finalised, on Vickers?

Jim O'Neil: I do believe so. I do believe that there is still some important areas like primary lossabsorbing capital and a few other areas, but yes is the short answer to your question.

Q81 Mr Mudie: There is a strong rumour going round that, during last year, they paid a number of lobbying firms vast amounts to work for them on Vickers. Well, it will be vast to us but nothing to Stephen. Are you aware of RBS hiring lobbying firms to lobby against the Vickers proposals?

Jim O'Neil: The short answer is no. I know RBS does employ a huge range of consultants because it is going through so much.

Q82 Mr Mudie: Do you think you can make inquiries and tell this Committee what money was spent in how many companies to lobby over the Vickers proposals?

Jim O'Neil: We can ask them about their lobbying efforts.

Q83 Mr Mudie: That would be very good. Just the last thing in terms of where Mr Ruffley was-it is clear that the focus of the bank is shifting to mainstream stuff rather than investment and the investment arm is being run down. Do you see the public being able to get their money back if the investment arm continues to decline? In all the banks that went through the last crisis, the investment arm seems to be the one that causes trouble but the one that made the profits at that time. I think Diamond is having the same trouble at Barclays. If you run that down it affects your profits, but it also affects your value, doesn’t it? Do you see? If you continue to run this down at RBS, we have any chance of getting our money back?

Jim O'Neil: It is a fair question.

Mr Mudie: Thank you. Is that the first one I have asked?

Jim O'Neil: No, sorry, I did not mean to caveat that. It is a question we think about a lot, is what I meant, and it is not an easy question to answer. As I said before, the investment bank has generated £10 billion of profit in the last three years, so it has some issues associated with it, but if it did not generate that profit, where else would RBS have generated that for its capital position? I would not use the characterisation that they are running down their investment bank. They are making it smaller in the context of the changing market environment and the changing regulatory environment, Basel and Vickers. The management has come up with a plan. I think, like the management of other investment banks, they are going to have to monitor this as time goes on. I think the short answer to your question is the investment bank will need to be able to earn its cost of capital for it to be a profitable contributor to RBS.

Mr Mudie: So that means no?

Jim O'Neil: It is not now, but it is not for any of these banks and it is part of their mission to be able to do that.

Q84 John Mann: Can I ask a few very quick factual questions just for the record? I want to look at Northern Rock. The first is will the advice provided by Deutsche Bank be made publicly available?

Keith Morgan: You have probably seen the report that we have written here and what we have included in the report is all the dimensions of the considerations that we feel were appropriate to drawing the conclusions and the conclusions were in the report-

Q85 John Mann: All I have asked is will the advice provided be made available.

Keith Morgan: We were planning on making this advice available, which is contained within the report.

Q86 John Mann: Nothing more than that will be made available?

Keith Morgan: Yes. There are numerous other working documents that we received from Deutsche Bank, but it extends to hundreds and hundreds of pages.

Q87 John Mann: My question is, will they be made publicly available?

Keith Morgan: No. The answer is we were planning on making this available.

Q88 John Mann: No, it is a factual question. I heard the answer no. I just want to make sure for the record that is accurate. How much did the advice from Deutsche Bank cost?

Keith Morgan: £1.84 million.

Q89 John Mann: Thank you. Did you meet with the European Commission to discuss the option of delaying the sale of Northern Rock?

Keith Morgan: The European Commission have been closely engaged throughout the process, both before and during the sales process. The answer is yes, sorry, just to get to the straight answer. It is a very important dimension because the company was in receipt of state aid. Being in receipt of state aid, we have to satisfy the European Commission that the exit from state aid is appropriate. So, yes.

Q90 John Mann: Did you argue with the European Commission that the extension could or should be extended-the deadline could or should be extended?

Keith Morgan: I would like to give you some background to this point, because I think it is an important point and it is around about the timing of the sale. The EC state aid condition is a legally binding condition between the UK Government and the EC. It relates to the state aid grant to Northern Rock and the legally binding nature of that is enshrined in an EU treaty. Of course, there was a lot of attention devoted to the EC during this process. Before we approached the European Commission to discuss any extension of a deadline, we would have had to have shown that the sale process was not a success. In this case, the sale process that we had run was showing an outcome where the value was in excess of the market multiples at the time and the value was in excess of any other option to return the company to the private sector. In that context, HMT considered that they would not have been offered or granted an extension by the EC.

Q91 John Mann: You didn’t then press for that. Are there any penalty clauses built into the agreement with Virgin?

Keith Morgan: Sorry, in what respect?

John Mann: Any penalty clauses of any kind for the future?

Keith Morgan: We have upside built into the deal with Virgin, by which if Virgin successfully floats or sells the business then the taxpayer will receive an additional amount above and beyond the cash that we have received so far.

Q92 John Mann: Why did other bidders drop out of the second round of the sale?

Keith Morgan: The backdrop to the sale of Northern Rock is, I think, very interesting, as we have included in our report.

Q93 John Mann: It does not answer that question at all. There were only two bids at the end. There had been five, from your document, seriously interested, so why did the others drop out?

Keith Morgan: There are a number of different reasons for it. We were, first of all, very comfortable that we had maintained competitive tension throughout the process, and having five people involved at various points in the two rounds was important in doing that. If you went through the reasons why individuals dropped out-and, of course, this is only as they relay it to us because we only see the outcome of their deliberations, not the detail of what they discuss themselves-in some it was because they decided that they could not get the synergies or the benefits of the combination that they suggested with their own company. In others, it was because they felt that there was not the agreement with other parties that would need to participate in the overall outcome.

Q94 John Mann: Other parties that they had?

Keith Morgan: Yes, that is right. It is the general kind of, I suppose, cut and thrust of an auction process where people need to be comfortable with their own bids and they need to feel that they are going to get the value from the bid that they put forward.

Q95 John Mann: Did any drop out because of the question of the state aid rules and the European Commission deadline?

Keith Morgan: No, we did not make that-obviously, in our case, we wanted to keep that confidential, because if bidders had known that there was a deadline, then we would have been in a position where people may have felt that was a weakness and could have held out and pushed us into a situation where there could have been ultimately a forced sale as you approached the deadline.

Q96 John Mann: Did any drop out because of the staging of payments that you were requiring?

Keith Morgan: No, not at all. There were a variety of proposals that came forward through this process. Some of them were for upfront cash; others were for cash, as in the case of Virgin, with payment in some other forms along the way. Others that we considered during the period included HMT or the Government maintaining some ownership of the company.

Q97 John Mann: Why did no established building society make a bid?

Keith Morgan: Well, I think you would have to ask them specifically that question. I can offer a view on it.

Q98 John Mann: Why did they tell you they did not make a bid?

Keith Morgan: The view that I have on building societies is that there is quite a difficult circumstance at the moment for them to raise capital. We looked at this very closely because we were assessing the opportunities for Northern Rock to be remutualised on a stand-alone basis. The instruments that you would need to use to raise capital are currently not very well defined. I do not know for sure, but I think they probably felt it was uncertain to raise the money they needed to make the bid on Northern Rock.

Q99 John Mann: But you were keen to get a large amount of cash immediately, so that is a potential impediment then to those mutuals?

Keith Morgan: We were keen to get the best value for the taxpayer. In the case where cash comes immediately, that is something that is here and now. In the case where it comes later, it could be compensated. If you were offered a large amount of money later, then that might still be of value to the taxpayer.

Q100 John Mann: In any instance with any mutual was the question of the payment terms or the question of the EU Commission’s position raised as a significant factor in them not putting in a bid?

Keith Morgan: No.

Q101 Mark Garnier: Mr Morgan, how many individual mortgages does Northern Rock Asset Management have, both in terms of owner-occupier houses and buy-to-let mortgages?

Keith Morgan: The total number is approximately 400,000 mortgages.

Q102 Mark Garnier: How many of those have been the subject of repossession in 2010 and 2011?

Keith Morgan: This year a total of 8,800 possessions were-

Mark Garnier: When you say "this year" you mean-

Keith Morgan: This last year, yes.

Mark Garnier: From 1 January to now?

Keith Morgan: Sorry, for the full year of last year; for the full calendar year of 2011. By the way, sorry, that is for both Bradford & Bingley and Northern Rock Asset Management, the two mortgage businesses that we have put together.

Q103 Mark Garnier: And 2010?

Keith Morgan: In 2010, it was 10% lower than that, so it would have been-

Mark Garnier: So 8,100?

Keith Morgan: 8,000, yes.

Q104 Mark Garnier: That is about a quarter of the total repossessions. In 2010, there were 36,300; 2011, 36,200. You are doing about a quarter of the repossessions?

Keith Morgan: I think that is correct, yes.

Q105 Mark Garnier: That is an awful lot, isn’t it?

Keith Morgan: Yes. First of all, we are in the position where these banks, or these former banks, inherited a very difficult position. There are large quantities of the mortgages that are on the books of these banks that are in negative equity and the history, the legacy-

Q106 Mark Garnier: Yes, but that does not necessarily mean you should repossess them, does it?

Keith Morgan: No, but I would like to give you the full background to what is going on, because I do absolutely realise that repossession is a very difficult circumstance for the people involved in the houses. I think people should be interested in what steps the companies are taking to avoid that, but also what the backdrop is in terms of the situation that they face. The first point is that, unfortunately, there are customers in these banks who are at the worst end of the spectrum in terms of their ability to afford the payments on their mortgage. That is because the credit criteria of the banks when they were in the private sector were at the less reliable end of that spectrum. What we have is a situation where the companies are absolutely focused on dealing with the issues of customers. It is probably the single biggest issue they deal with day in, day out. They have probably 1,000 people devoted to this activity.

If you look and see what has happened over the period-and the information I would point you to is also not just the possessions but the arrears-the arrears are where people can’t make the payments on their mortgage, and those have come down by 14% over the year. There are 33,000 people who were in arrears at this point. In comparison, there was another 37,000 people who were subjected to or offered what you call mortgage arrangements. That is where people are offered an opportunity to change the basis of their mortgage payments, whether it is an extension of the term or whether it is a reduction in the interest payments. More people were offered these mortgage arrangements than went into arrears during the period. The point I am making is only that repossession is the very last thing that the companies have to do in the case where people are not able to make the payments on their mortgage.

Q107 Mark Garnier: In a very interesting example of MPs having the experience of real life, I have been a victim of repossession. My landlord in 2010 was repossessed and my family was subjected to Northern Rock’s activity, which I can tell you was not the sort of way that I would expect my constituents to be treated. Do you have children?

Keith Morgan: Yes, I do.

Q108 Mark Garnier: Imagine it being 10 December, happily sitting around a Christmas tree, and the letter comes through from I think it was Wallers are your agents acting on behalf of this, giving you two weeks’ notice to vacate the house. Being a Member of Parliament, of course, you are in a stronger position where you can just turn round and tell them to get stuffed, but for most people who are out there it is quite a scary thing. This is the company that you are running. What are you doing to try to support people who are in this position? The example that I have is it is extraordinarily unpleasant, and you are responsible for it.

Keith Morgan: First of all, I am sorry I can’t talk about the details of the personal circumstances because I am not really party to the individual detail.

Q109 Mark Garnier: No, sure, but we all have examples of this across all our constituencies.

Keith Morgan: But I think the point that we do wish to ensure is held very close inside our companies is they do treat customers fairly. That is what we attempt to do. We look very closely at the activities they take. We review at the board the activities they take in terms of the treatment of customers, the way in which they engage with customers, and all steps are taken to ensure that they are in line with what we believe to be best practice.

Q110 Mark Garnier: Well, I think you do need to review that, genuinely.

Keith Morgan: What I do not know are the details of the specific circumstances in which the landlord took-

Q111 Mark Garnier: There are one or two other Members of Parliament who I have spoken to. One is the Member for Chatham, and she has given me some research that they had from Medway District Council, which looked at Northern Rock repossessions that are at twice the rate of other lenders. I have spoken Wyre Forest District Council this morning; 114 cases this year. They have three or four times as much chance of having a Northern Rock repossession, be it either buy-to-let or residential mortgage, than they do of any other lender. There is quite an aggressive process going on with Northern Rock, and my question is leading to what are your long-term plans for Northern Rock Asset Management? Obviously, you have had the transaction with Northern Rock plc, which is great, but of course that does not have with it the loan book. You still have the loan book, which I think is 90% of the loan book that you took on at the time of the nationalisation. What are the plans for Northern Rock? Are you in the process of aggressively sorting out the bad loan book in order to tidy it up for a sale or are you just trying to wind it down as quickly as you possibly can?

Keith Morgan: These companies are held as closed mortgage books. Once again, under the European Commission conditions of state aid, they can’t enter into any new economic activity.

Q112 Mark Garnier: Sure. They are not extending, but that does not stop them winding down.

Keith Morgan: No, but in fact there is obviously, therefore, an inevitability to the wind down of these books because no new mortgages come on board but people over time repay their mortgages. They may move house or they may remortgage with another lender. The simple dynamic of it from our point of view is when people do repay the principal on their mortgages that cash comes back into the company. The company then needs to pay its running costs, and every pound that is left over is returned to the taxpayer. It is a simple rundown process albeit-

Q113 Mark Garnier: That is a long-term process?

Keith Morgan: It is a long-term process but, as we are making clear in our report, that is something that could last between 10 and 15 years. What we have done is we have created an organisation that can actually manage and hold these mortgages to their natural life and maturity. We are not in the position of having to sell these things quickly, which would put the customer relationship potentially under any kind of stress. We are not under any pressure to sell them. We are able to run these down in a very controlled way.

Q114 Mark Garnier: Yet there is four times as much chance of being repossessed by Northern Rock as there is of anybody else.

Keith Morgan: But I do think if you look back at that you would find a lot of that is because unfortunately the people who took mortgages from Northern Rock were taking mortgages at very high loan to value ratios. As you know, some of these loan-to-value ratios were in excess of 100% and we have just been through a very, very severe financial crisis.

Q115 Mark Garnier: I would be very grateful if you could let this Committee know what measures you are undertaking to ensure that those people who do find themselves in mortgage arrears and in trouble are being looked after properly and don’t have a repeat of the experience that certainly I have had and indeed many other people that I know have had.

Keith Morgan: Certainly. We would be very happy to lay that out for you.

Q116 Chair: Can you just clarify, is 14 days’ notice of an intention to repossess your best practice?

Keith Morgan: I confess I do not know the particular best practice days around repossession.

Chair: I think it is worth your taking a close look at this. It does not sound very good.

Q117 John Mann: Just going back, because you have cited again European state aid rules, when Sir Nicholas Macpherson came before this Committee he said, "Of course, there is always scope to try to renegotiate state aid agreements," so they are not set in stone. They are negotiable, according to the Permanent Secretary to the Treasury. I wanted to check whether you had made an estimate of the cost of extending the deadline in relation to Northern Rock.

Keith Morgan: The issue was explicitly addressed in terms of the decision that was taken. We made a recommendation to the Chancellor around the sale of Northern Rock, and within that there was a discussion as to whether there was the potential to investigate the timing of the deadline on the state aid. As I have mentioned earlier, the argument-

John Mann: You costed that?

Keith Morgan: Well, I think the view was taken that the EC would not have granted the extension, for the reasons I laid out, which is they would have to have known that the sale process was not a success.

Q118 John Mann: There is an inconsistency, Mr Morgan, because if you have not gone and negotiated then you do not know the conclusions, and if you do not have costs of what an extension would be, it seems very clear, it being decided without attempting to negotiate with the European Commission, that there would be no extension. I just wanted to get that confirmed on the record.

Keith Morgan: But I would like to say that in terms of all of the evaluation of the options with respect to the European Commission, we worked very closely with the Treasury legal adviser’s expert involved in the liaison with the European Commission. We had had many contact points with the European Commission. We knew the issues that the European Commission faced. HMT, which is responsible for this relationship, took the view that they did not believe that they would be granted an extension, for the reasons that I have laid out, which was that the case was not compelling, given that we had a sales process where the market values were well below the values that we had achieved. I think that is consistent with the statement that the Permanent Secretary said-there is scope to renegotiate, but one has to choose the ground upon which you look into those issues.

Chair: Well, we have had a good canter around that subject.

Q119 Mr McFadden: I would like to take you back to the area of disposal of the Government’s shares in RBS and in Lloyds, and follow on from the questions Mr Ruffley and Mr Mudie were asking you. Do you have any view on the timing issue? The taxpayer has now owned these shares for a few years. They want to know whether this sale might happen in the order of a year or two, or might we be talking about a decade or more. What is your view on that?

Jim O'Neil: I think the core is, when we think about disposals, value for money for the taxpayer. I guess there are two dimensions of answering that question. There is value and the timing question. I think it is very difficult right now to predict the value evolution of these banks. I do not think we can pretend that things have not changed materially since these investments were made. The macro-economic conditions are worse, and in low-interest-rate environments banks with large liquidity pools like this just earn less. The markets are very difficult; the Eurozone is in crisis. The regulatory environment has changed, and while that has been making the banks safer, it is additional costs on banks and the legacy issues are still there. Those issues have weighed down the value of the banks, and we are always trying to evaluate potential transactions-what value can be received versus fundamental value-but with all those issues out there, it is very difficult for investors generally to make fundamental value decisions on RBS, and for that matter Lloyds as well, but I think your question was particularly relevant for RBS.

In terms of the time scale, to get to specifics, we believe that it is very difficult to set out a specific programme of not only how long it might take but when one might initiate it. If the market gets a sense that there is a deadline in order to sell those shares, we worry that might create circumstances of the market would be waiting for that, it would hinder share price development and that in itself would not be value for money for the taxpayer. Sorry, they are not specific answers, but we do not think it is helpful to give a timeframe.

Q120 Mr McFadden: Do you think the political interference over the bonuses has helped weigh down the value of the taxpayer’ shares? As one commentator put it, no one wants to buy shares in a Government Department.

Jim O'Neil: I think it is a clear question. We interface with investors regularly, and investors have, in their dialogue, expressed their concerns about some of these issues that have come up. I think the short answer is if you look at the share price performance of RBS during some of these issues as they occurred, you could not detect, necessarily, that they traded fundamentally differently versus other banks. However, clearly, if investors felt that these issues would continue and this was not being operated in a commercial way then, yes, I think it would weigh heavily on the share price of the bank.

Q121 Mr McFadden: There is a danger that political interference ends up losing the taxpayer money?

Jim O'Neil: If investors feel that the banks are not being run in a commercial way, then that would reduce their incentive to buy shares but also the price that they might pay for shares.

Q122 Mr McFadden: You have been very clear about that. Your mandate is to protect the taxpayer’s interests in all of this. The taxpayer bought these shares at a certain price and you have just outlined several factors that you think have weighed down the value of the bank-general economic situation, new regulation that you mentioned, and so on. Is it the case that you would contemplate a sale at less than what the taxpayer paid for the shares because of those factors?

Jim O'Neil: I think our key assessment is what is the right value for money for the taxpayer relative to the fundamental value we believe in the bank. The end price that you are referring to on which the average price that the taxpayer paid is obviously a number that we all have in our minds, but in that fundamental value assessment that is not part of our value assessment. The key question is what is the right transaction not only for value for money to initiate the disposals, but what is the right transaction to set the platform for the subsequent disposals that we would like to undertake. The ultimate judgment of a programme will be what the average price is of a programme, we would like to think, other than any specific sale transaction. There is no fundamental constraint of selling the shares at any price. What I would say is that we monitor this all the time. We discuss this with Treasury. Ultimately, the decision is for the Chancellor in terms of what price is sold.

Q123 Mr McFadden: I am going to ask you to put this in more simple terms. I am interpreting your answer as a yes; UKFI would contemplate the sale of these shares at less than the price the taxpayer paid for them because, although that is a factor in your thinking, it is not the only factor.

Jim O'Neil: It is not the only factor. If there were appropriate circumstances that we felt would create value for money over the entire programme, I think that is how-

Robin Budenberg: I think it is very important to emphasise that decisions around disposals are for the Chancellor. These are not UKFI decisions. UKFI provides advice and co-ordinates its views very closely with Treasury, but ultimately decisions around disposals are the Chancellor’s decisions.

Q124 Mr McFadden: I am trying to get an insight into your thinking and your advice on this. Can I now ask you about the means of disposal? Is there a preferred option here? We had a little bit of discussion about this a while ago. Can you give us some insight into the kinds of options you are considering? Would you consider a general IPO? Would you consider an institutional sale to another bank? Mr Ruffley asked you about the option that has been put forward by Policy Exchange and Portman Capital of a distribution of shares without payment to the taxpayers who propped up the bank in the first place. Are there any others that I have not mentioned that you would consider?

Jim O'Neil: We look at the ideas in three categories. One is a broad-based distribution, I think, as you touched on; something that might look at a kind of modern update of some of the privatisations of the past with a large offering to institutions and retail. Another category might be more institutional private placement faster to the market transactions because those transactions take quite a bit of time, so there would be another category of more placement-type transactions. A third category is more structured transactions in the sense of exchangeables and derivatives. Mr Thurso asked us last year about the dribbleout trade that the US Government did with Citi, and I would put that in that structured transaction.

In terms of the distribution, as I said to Mr Ruffley, there are a lot of policy issues embedded in that and it is very difficult for us to assess that in a framework relative to those other transactions. It is kind of part placement because that transaction has at the beginning of it a placement to institutions. That is the first step of that transaction, so that would fall into the second bucket. On a broadbased distribution where the Treasury does not give proceeds, there is a lot of policy issues at the heart of that, so I am not so sure that fits into that framework. But those are the categories of how we look at things.

Q125 Mr McFadden: I will just end with this, which is a question about location. RBS’s headquarters is in Scotland, always has been. That is partly for historical reasons. It started life as a Scottish bank. It became bigger. It became a global bank. Would it be a condition of sale that the future headquarters of this bank needed to be in Scotland or, indeed, the UK?

Jim O'Neil: That is a policy question. It is hard for us to answer, I think. Our prospect and how we look at sales is all about value for money so, unless I have misunderstood your question, it is hard for me to answer.

Q126 Mr McFadden: Well, what I am asking is if there is a completely open mind on the future sale of the taxpayers’ shares in this, is it reasonable to contemplate a scenario whereby the bank would be sold in such a way that its headquarters left the UK?

Jim O'Neil: I think it is hard to imagine that, but I do not know what to say other than we look at it from a value for money perspective. I do not think we would look at relocating the headquarters as part of that analysis for value for money. It is just what value for money can we get.

Q127 Mr McFadden: You would not be instilling this as a condition of the sale?

Jim O'Neil: This is entirely a policy-the location of a bank is not our-

Robin Budenberg: It is probably most of all a commercial issue for the board of the bank to decide whether there is any basis for changing its headquarters. Certainly, at the moment we are not aware of any-

Q128 Mr McFadden: The board may well change with the new owner or owners.

Robin Budenberg: Well, again, that would depend whether we were talking about an institutional placement, or there is, of course, a possibility that somebody would want to buy it as a whole, and that is a different issue altogether.

Jim O'Neil: In that circumstance, I can see the nature of your question. You are right; I probably should have added that there is a fourth category of transactions, which are strategic, but I did not include that just because it feels so unlikely at this stage.

Q129 Chair: Are you engaging in a discussion with the Government about various ways of offloading the stock?

Jim O’Neil: Yes.

Q130 Chair: They are coming to you and saying, "Do you have any ideas?"

Jim O'Neil: Well, I would say we just have a very regular engagement with Treasury officials on all of these topics, but related to disposals, yes.

Q131 Chair: At ministerial level?

Jim O'Neil: Yes. We do have dialogue on occasion.

Robin Budenberg: I would not say that is a regular dialogue at this point, but it is something where we have had discussions.

Q132 Michael Fallon: Coming back to the location point, it is still true that Lloyds HBOS has its registered office in Glasgow, is it not? If Scotland voted for independence in 2014 and you were faced with disposing of them in 2016 or 2017, both banks would already be outside the UK.

Jim O'Neil: Again, this is something that we have not spent time on. If there was a big change then the board will have to decide where they think it is best for the bank to be. I presume that would be a shareholder vote, but I actually do not know that for a fact.

Q133 Michael Fallon: Let me take you back to your earlier point about your measurement of fundamental value rather than share price. How do you factor in the corrosive effect of a bank simply remaining in the state sector for a period of more than two, three, four years?

Jim O'Neil: I think it is a difficult fact to quantify. However, embedded-and you will be familiar with this as embedded-when we look at market multiples of other banks, you can try to look at that factor of value being eroded over time, but it is very difficult to do so. That fundamental value-the exercise that we do is very market-based, and assessing how policy issues might develop in Government is much more subjective.

Q134 Michael Fallon: But do you agree there is a corrosive effect?

Jim O'Neil: Well, as we were discussing before, it is a very difficult item to quantify, because as we look at some of these issues as they have happened and you try to look at the performance relative to others, it is very difficult to quantify. But, yes, if there was a sense that any bank was being run in a non-commercial way fundamentally, investors will be less likely to pay value for those shares than one that would be run commercially. I think that is a fair assessment.

Q135 Michael Fallon: There would be a bias, then, towards getting rid of some of it, to releasing a tranche quicker rather than later; is that right?

Jim O'Neil: I think it depends on whether there is an assessment that-and this goes back to the questions that were asked earlier-the banks are being run in a commercial way or not with Government ownership. If there is an assessment that the bank is being run in a commercial way, maybe there is not that pressure.

Q136 Michael Fallon: When you talk to us about average prices, it sounds as if you are already considering selling these shares in tranches; is that right?

Jim O'Neil: There was an implicit observation from what I said that just given the size of these stakes, at least where the market fundamentals are today, if you look at the trading liquidity of these shares-RBS trades like £45 million a day so to be able to try to sell all of that in a single transaction seems very hard to imagine.

Q137 Michael Fallon: Given that there may be a corrosive effect from keeping either bank within the state sector wouldn’t that point to getting the first tranche away as soon as you can?

Robin Budenberg: I would almost say quite separately-because as we discussed earlier, I still believe that the bank is capable of being run in a commercial way-you certainly could argue that actually, as Mr O’Neil says, the lack of liquidity at the moment does cause an issue in terms of sales and, therefore, a transaction that creates more liquidity is in itself helpful in terms of facilitating future sales. I think there are arguments that you can make around what an initial sale could do in terms of facilitating future sales that has an impact in terms of a value for money judgment that, as an accounting officer, myself and Nick Macpherson could take into account.

Q138 Michael Fallon: Are there any external constraints on you from the Commission, for example, as there were in the case of Northern Rock?

Jim O'Neil: In terms of disposing of shares?

Michael Fallon: Yes.

Jim O'Neil: There is a variety of EC remedies in the bank itself, but clearly where we are talking about potentially a strategic sale that would have anti-trust and considerations like that-but not that I can think of off the top of my head.

Q139 Michael Fallon: Are there any constraints that are likely to arise from the implementation of the Vickers report?

Jim O'Neil: Well, the Vickers report will have costs for the banks, and so in the sense of the discussion we were just having on value that is a cost. We have to make an assessment of, do the banks have an opportunity to recover that value loss or is that a permanent loss of value? I would say the costs of the Vickers report, which obviously have other social benefits of doing that, are something that affects the value.

Q140 Michael Fallon: Does the timetable of the implementation of Vickers also bear down on the decision as to how to proceed with these tranches?

Jim O'Neil: I would like to think no, but there are still some outstanding items on Vickers that if, for example, investors more broadly had concerns about the banks, for example on primary lossabsorbing capacity or something like that and investors did not want to invest because that was outstanding, there might be some issues like that. But I would like to think that, once it is clear, there would not be constraints like that.

Q141 Chair: If the buffer of UKFI did not exist, do you think that the banks would at the moment be being run differently?

Robin Budenberg: I have seen no indication from either Treasury or Ministers that they would want to do things differently, but I think-

Q142 Chair: I do not mean this pejoratively-

Robin Budenberg: No, I know what you are going to say.

Chair: But you are for display purposes only, aren’t you? You are there as a demonstration of independence rather than actually to have to do anything?

Robin Budenberg: I think there is an element, as I said earlier, that we do provide, if you like, a nuclear deterrent, yes, but I also like to think that in terms of what we do, in terms of acting in our stewardship role, we play a valuable role there that has an impact. I also think that other shareholders feel that our role is very important. We talk with them and they take, I believe, great confidence from the role that we play.

Q143 Chair: It is back to one of those very well-rehearsed replies. I don’t know that it is well rehearsed, but it is extremely fluent, if I may say so. You can, therefore, confirm to us that you have not had to resist any pressure from Government on any issue of significance so far?

Robin Budenberg: So far, there has been nothing that I believe has been imposed on the board of RBS that the board of RBS has a fundamental issue with. We have had discussions-

Q144 Chair: If there were, the nuclear option would be to come to us?

Robin Budenberg: The nuclear option would be for our board to consider that issue and to stand up and be counted, yes.

Chair: Okay, that is very clear.

Q145 Jesse Norman: I apologise for being slightly late into the session. Mr O’Neil, just a factual question. When did you leave Bank of America?

Jim O'Neil: I left in July, August 2010 and joined UKFI in October 2010.

Jesse Norman: July, August 2010?

Jim O'Neil: Yes.

Q146 Jesse Norman: When you were at Merrill Lynch, were you involved in either the RBS bid for ABN or the Lloyds bid for HBOS?

Jim O'Neil: I was on the team at Merrill Lynch that advised the consortium of RBS, Santander and Fortis, or worked with. I am not an M&A adviser; I am a financing specialist, and my work was with Fortis.

Jesse Norman: You were part of the RBS group acquisition team?

Jim O'Neil: Merrill Lynch advised the consortium, and I had a role in financing. We had different roles, and my role was with Fortis.

Jesse Norman: But you were not part of the Merrill group that advised Lloyds in relation to HBOS?

Jim O'Neil: No.

Q147 Jesse Norman: How much was Merrill paid for its advice to that group?

Jim O'Neil: I think it is a question for Merrill Lynch. I actually don’t know. I can’t recall. It was five years ago. The financing fees are public, so we could look them up.

Jesse Norman: Oh, they are? Okay.

Jim O'Neil: I think they would be in-for the work I did on Fortis with the rights issue, there is a prospectus with the fees covered in the prospectus.

Q148 Jesse Norman: Absolutely. Of course, it might not be the case that the total fees were disclosed. Often, the advisory fees do not get disclosed.

Jim O'Neil: I just cannot recall and, again, I was a financing specialist on that transaction.

Q149 Jesse Norman: Sure. Would you have expected them to be north of a couple of hundred million pounds? That was the level at which I think we had that estimated by the two independent assessors of RBS.

Jim O'Neil: It is five years ago, so I do not actually remember, but I think if you added all of the transactions done with those clients over a period of time, not necessarily just that, I am sure it would be a very big number.

Q150 Jesse Norman: Thank you very much. Final question-and I suppose it is to any of you, which is do you think there is a risk to RBS and, therefore, to the taxpayer-and, if so, how much-from the rapidly building civil lawsuits that we are seeing in respect of RBS? The scale of the cost is £3 billion to £5 billion, as it appears at the moment.

Jim O'Neil: It is very difficult. There are a lot of contingent liabilities for RBS, not just lawsuits but elsewhere as well, and there is a whole host at the bank. It is very difficult to assess what the payouts might be, so it is hard.

Q151 Jesse Norman: It could be huge?

Jim O'Neil: Well, if the suit was successful and they lost £5 billion that would be a big hole, but there is no way for us to assess whether it gets zero, or whether it is a large number.

Q152 Jesse Norman: Right, but you are monitoring it; you have legal people keeping an eye on the potential scale of the loss?

Jim O'Neil: As a commercial shareholder, we engage with management on issues but we do not have any separate legal advice on those issues.

Q153 Jesse Norman: You do not think the Chancellor might need separate advice in respect of-

Jim O'Neil: That would be up to the Chancellor. Certainly, for us as shareholder, we are not seeking separate legal advice.

Q154 John Thurso: I apologise for being late. As you know, I was chairing another Committee. Mr Budenberg, can I come to you? It is a follow-up on this issue of the relationship between Ministers, in particular the Treasury, and UKFI. There have been a number of suggestions as to the future of the current RBS group, which I know have already been discussed. To what extent, given that value to the taxpayer in the long term may be more than simply a monetary value ascribed to shares in the market at any given time-there may be other goods that the nation might wish-at what point are you in the discussion and at what point should Ministers take over from you in making those decisions?

Robin Budenberg: I think those sorts of decisions and discussions are for Ministers, frankly, from the outset. I do not think that is something that we should be driving, pushing or deciding on. Clearly, there may well be situations in there where they look to us for views on particular value implications, but those are fundamentally policy issues that do not come within our mandate.

Q155 John Thurso: Just to be clear, the thinking on that, which is, say, is happening between BIS and the Treasury and others, would not be something you would be expected to be consulted on if those decisions were being made?

Robin Budenberg: That would be up to the people who were considering it. If they felt that there were useful insights that we could provide, we would, of course, do what we can, but it is definitely something that is driven not by us.

Q156 John Thurso: One other question, if I may, which is your role in respect of the ICB proposals. Were you acting as advisers to the Treasury in that capacity?

Jim O'Neil: As we discussed earlier, our role primarily and our value mandate was to engage with the ICB and the banks to come up with an assessment of value ranges for the implication of proposals. We did not have the proposal then, so the range was fairly wide, and we provided that both to the ICB and Treasury. I would not characterise us as an adviser to Treasury.

Q157 John Thurso: The FT reports that said you were advising the Treasury are incorrect?

Jim O'Neil: We had a dialogue with Treasury and the ICB, so I do not know what the word "advisory" means but the ICB, for example-

Q158 John Thurso: I am sure it was not an after-dinner conversation.

Jim O'Neil: The ICB, for example, went and met with a wide range of people they felt would be useful in terms of giving input, and so we did meet with them as part of their work. Then we have definitely had dialogue with Treasury since.

Q159 John Thurso: What I am driving at is the key point: were you interacting with the ICB as the owners of a large number of shares in two institutions, or were you interacting with the ICB as the advisers to the Treasury?

Jim O'Neil: Very much the first rather than the latter. They did ask us a lot of questions on what we thought the implications of various proposals were on banks as people who I think they deemed might have some knowledge about banks, but they did that with a wide variety of people. I can’t tell you what context they were asking us those questions in.

Chair: Thank you very much for coming in front of us this afternoon. It has been quite a lively session in places. I think it has been quite enlightening, and we are very grateful to you for the work that you are doing. We may feel the need to see you reasonably often, given the salience of some of the issues with which you are having to deal. Thank you very much.

Robin Budenberg: We appreciate the support. Thank you.

Prepared 22nd March 2012