Examination of witnesses
(Questions 1 - 19)
TUESDAY 16 MARCH 1999
and MR PHILLIP
1. Good afternoon. It appears that we have
under-estimated the demand for this event! Welcome to the first
public session of this Joint Committee which, as you know, is
part of what you described last week as the unusual and scenic
route from the Treasury to Buckingham Palace which this Bill is
taking. The Committee has decided to look at a range of issues
which we set out last week in the press release. The main text
is the Treasury's response to the consultation on the draft Bill
which is described as a "Progress Report". What we would
like to do is investigate how far this meets the concerns of those
people who commented on the draft Bill and to the extent that
there are outstanding issues we hope to be able to clarify them
or try to see if there is common ground in taking them forward.
One of the main objectives of this pre-legislative scrutiny stage
is to see if we can short-circuit some of the more contentious
issues. As you also know, we do not have very much time. We have
been asked to report by 30 April which is a very tight remit and
contrasts with the process that seems to have overrun most of
its timescales so far. After taking evidence from yourself and
the Economic Secretary to the Treasury we are proposing to invite
a group of witnesses to each session and to take the issues one
by one as set out in the press release. We are in new territory
and we are going to have to find our way as we go along. We are
very grateful to you for coming here today with your team and
also for the prompt delivery of the paper you put to us, copies
of which are available for people who want them. I would like
to begin, Howard, by asking you if you could introduce your team
and ask if there are any introductory comments that you would
like to make.
(Mr Davies) Thank you very much, Chairman. I apologise
for the crowd. I know that Queens Park Rangers are not used to
large crowds! The team I have brought with me is Mr Michael Foot
on my right, who is the Managing Director responsible for financial
supervision across the whole of our area of responsibilities.
Mr Foot was Executive Director for Banking Supervision in the
Bank of England and came out of the Bank to the FSA with me. On
my left is Mr Phillip Thorpe who is Managing Director responsible
for authorisation, enforcement and consumer affairs and in the
previous regime was Chief Executive of IMRO. We are the only three
executive members of the FSA Board which in addition has ten non-executives
and one ex-officio member. Thank you for giving me the
opportunity to make one or two preliminary remarks. I would make
six very brief points. First, in spite of my characterisation
of this as the scenic route to Buckingham Palace, I should say
that we do very much welcome the Joint Committee process. It is
clear to us that it is important to build consensus around the
new legislative framework for financial regulation. We want to
end up with legislation which is generally accepted by both practitioners
and consumers as fair and reasonable. To an important extent we
do regulate by consent and that consent will be facilitated by
a process which allows people to have their say. As far as the
timing is concerned we and the self-regulators are working on
the basis that the legislation will be through early next year.
If there were to be no new Act beyond the spring of next year
we could run into difficulties but between now and then the priority
must be to produce legislation which is workable and fair and
we are working to contribute to that process as far as we can.
Second, we have of course, put together in management terms a
single regulatory structure already, albeit within the constraints
of the different pieces of legislation within which we operate.
The main reason for that was that all concerned, particularly
the boards of the previous self-regulators, agreed that it was
necessary to preserve the integrity of the regulatory system.
We also of course have the Bank of England Act to contend with
and a body which consisted of the old SIB and the Bank of England
Banking Supervisors would not have made much sense. Third, our
experience of operating as a single regulator over the last nine
months has so far been very positive. The market reaction has
been enthusiastic and we have already begun to find many synergies,
not just in the obvious areas of cost but also in crisis management
where we can take a broader view than before and in handling issues
like pensions mis-selling where you need to integrate the views
of conduct of business regulators and the prudential regulators
of insurance companies. Also it has helped in handling new product
introductions like ISAs or stakeholder pensions which will be
sold by many different types of institutions. Furthermore, even
over the last two years since the Chancellor's announcement market
consolidation has reinforced the trend towards regulatory consolidation.
Groups like Citigroup or last week Prudential buying M&G cut
across the old sectoral boundaries and made it necessary to take
a view of them in the round. So we become keener on a single regulator
as time goes by. Perhaps we are conditioned to do so but it is
nonetheless true. Fourth, I think we are in the vanguard of international
regulatory developments but not out on a limb. We have supplied
the Committee with a review of the regulatory structures elsewhere
and how they are changing. Two general trends are observable.
First, banking supervision is increasingly being moved out of
central banks. In only three of the G10 countries does the central
bank now have sole responsibility for banking supervision. There
is also a general trend towards consolidation, sometimes banking
and insurance, often banking and securities. Not everybody is
going for a single body. There are single bodies mainly in Scandinavia
and the Far East so far but the trend towards consolidation is
gathering pace. Fifth, my Board welcome the overall shape of the
Bill, in other words the statutory objectives with provisos and
the flexibility within them to keep regulations up to date. We
think the balance of objectives and provisos is about right and
manageable in practice. We recognise that a balance must be struck
between flexibility and parliamentary accountability but if we
want a durable system there will have to be a good deal of flexibility.
One answer has been for us to try to illuminate the ways in which
we would use this as we go along through consultation papers,
etcetera, and we continue to do that. Also we think the powers
overall are broadly appropriate. In fact, for the firms we regulate
they are no more than a consolidation of the powers the different
regulators have now. Lastly, my Board are nonetheless very conscious
of the risks of an excessive concentration of power and responsibility
in one body and of their own role in holding the staff to account.
Perhaps that makes us excessively cautious about proposals for
the extension of the scope of regulation, although I have to say
I regard caution as a virtue in that context. It has also encouraged
us to introduce accountability measures such as a Consumer Panel
and Practitioner Forum which Ministers have now adopted as part
of the legislative framework. It has also pushed us towards a
very open style of consultation but we think that will pay off
in terms of improvements in the long run in the quality of decisions.
With that preamble we are very happy to take the Committee's points
Chairman: Thank you
very much. We are going to begin with the general issue of accountability
and Mr Beard is going to put the first question.
2. Mr Davies, the FSA are required to be
accountable to the Treasury and through it to Parliament and to
consumers and to the financial market industry itself who are
your supporters. Do you see any conflict between these various
strands of accountability?
(Mr Davies) I think we would see the prime accountability
route as being through Ministers to Parliament but that we have
to take account of the views of the consumers and of financial
institutions themselves. It is clear to us that the responsibility
we have is to Parliament for the way in which we interpret the
statutory objectives and the provisos on them but nonetheless
we have to recognise that it will have an impact either on consumers
if we do not exercise those powers in an appropriate way or on
institutions if we exercise those powers in an unbalanced way.
I think it would be wrong to think of there being conflict therefore
between these different strands. I can see that there could be
tension from time to time but I do not think there is conflict
because the prime accountability route is absolutely clear and
what we have tried to do in designing the architecture of the
system is to establish a Practitioner Forum which will keep us
honest, if you like, in terms of those objectives and provisos
that relate particularly to the regulated community and a Consumer
Panel which will keep an eye on how far we are delivering the
objectives that relate to consumers. Clearly the Board will have
to reconcile those points of view and I would not be surprised
if from time to time they did differ. I do not think that is so
much conflict as a way of ensuring we hear all points of view
as we deliver against this single prime line of accountability.
3. On this point of accountability, one
of the major mechanisms of accountability is the annual report
which will be driven by the objectives and principles of the FSA.
Obviously the devil is in the detail of that report. Will there
be any consultation as to the shape of the report and what will
be in it and the way that those objectives are measured?
(Mr Davies) We are already discussing with the
Consumer Panel and the Practitioner Forum as we call it, although
I imagine it will be called the Practitioner Panel now it has
been made statutory, about how we should measure what we do and
the Practitioner Panel in particular are likely to launch quickly
some surveys of industry opinion which will provide a sort of
benchmark about regulatory sensitivity and regulatory intensity
against which they can measure us in the future. We also would
expect the Practitioner Panel and the Consumer Panel to have their
own sections, if you like, of the annual report and so in that
sense we would be consulting them. We had not thought of consulting
on the overall shape of our report which is for our Board to determine
although of course there are also certain requirements imposed
by the Treasury on what we put in that report. We certainly could
do so, but we have primarily consulted on prospective things rather
than on retrospective things.
(Mr Thorpe) There is perhaps a point that influences
that. We have said in our terms of reference for the Consumer
Paneland I think this is mirrored with the Practitioner
Forum or Panelthat they should anticipate publishing their
own reports without interference from the FSA, so there is a check
and balance there in terms of their review of us and their unfettered
right to say what they feel about our performance on those objectives.
4. But they will have an opportunity to
comment in the report that goes to the Chancellor as well?
(Mr Davies) Yes.
5. It is a follow-on question from that
really. You have already indicated that the Government has said
that the Consumer Panel will be put on a statutory basis and the
model you used is that of the PIA Consumer Panel. Do you think
that is the correct model? Secondly, I would like you to say a
little bit about how you envisage you are going to act and relate
to the Consumer Panel. Can you give us some reassurance that you
are not producing an annual report, they are producing annual
reports, but that the two are never speaking to each other. I
want to know how you are going to react to them.
(Mr Davies) First of all, it is true to say that
we did build to some extent on the PIA Consumer Panel and we did
ask the current chair to chair our Consumer Panel through to the
point at which the legislation comes into place and we are pleased
she accepted, but in other respects we have changed it quite substantially.
The breadth of its remit is significantly wider than before and
we have also introduced Nolan procedures to appoint the members
of the panel so we advertised publicly and had independent assessment
of candidates, etcetera. We have moved it along quite a bit already.
What we have set up is a regular relationship between the Panel
and our Board whereby the chair of the Panel will attend our Board
periodically and so it is not just a question of reports going
off separately, there will be practical, face-to-face encounters
between the Consumer Panel and our Board. In fact, one of them
will take place on Thursday of this week. So we undoubtedly recognise
that we need to respond to the Consumer Panel in a clear way.
We would expect to produce reasoned response to points they made
Chairman: We will have to adjourn
at this stage for five minutes or so to allow some of our members
The Committee suspended from 16.10 to 16.17 for
a division in the House of Lords.
Chairman: Thank you all very much
for returning so promptly. We were dealing with the question of
the Consumer Panel. Lord Haskel has a question.
6. I do feel that this is a matter which
is absolutely central to the work that we are doing and the lines
of authority and as you explained them the manner in which you
are accountable seemed to me to be satisfactory if everything
is going well but you are going to be accountable to both a buyer
and a seller and when the buyers and the sellers fall out then
there is trouble. Do you think that the accountability as you
described it to us will be able to withstand the stresses and
strains of that situation?
(Mr Davies) I think that the previous regulatory
system, albeit with its flaws mainly related to the different
tiers of responsibility, has nonetheless shown itself to be capable
of dealing with that kind of problem. I am reluctant to pray in
aid pensions mis-selling as a shining example of anything since
it is an unhappy episode, but regulators have in the end been
able to get the agreement of the industry to a major programme
of compensation as long as their views were soundly based and
I think in that we have steered a course between the interests
of consumers and the interests of the industry. I think the other
point I would also add is that most of the time most businesses
are clearly trying to stay comfortably within the regulatory framework
and regard most of the regulatory requirements as simply good
business. Compliance with the law, good record keeping, good advice
to their customers is part of what good business ought to be.
I think there is a danger sometimes in seeing this as more confrontational
an activity than it typically is. Most of our work is involved
in a constant process of debate and negotiation with the industry
and with consumer groups to try to set the parameters appropriately
and most of it is not in fact highly confrontational.
7. I would like to ask, if I may, a question
about your own personal position as Chairman. I assume you have
some form of terms of reference. Could you tell us a little of
how your own performance is going to be judged and who that will
be judged by and whether there are formal criteria laid down?
(Mr Davies) The contract that I have is a five
year term which began on 1 August 1997 as Chairman of the SIB.
My office is, as they say, at the disposal of the Chancellor.
The arrangements for assessment of my own performance are at the
moment twofold. One is that there is a system of upward appraisal
in the Financial Services Authority for all our staff. With the
benefit of an external consultant my performance, as perceived
by the people who work for me, was assessed at the end of last
year and the results reported to the Board. In addition to that
there is a remuneration committee of the Board composed of non-executives
which is charged with assessing my performance from time to time.
They assess also the performance of my two managing directors
but in that case with my assistance. We have introduced also,
in the case of the managing directors, an arrangement whereby
the chair of both the Consumer Panel and the Practitioner Panel
will give their views to us on the performance of the Authority
as a whole and of the parts of the Authority which they control.
But I think that is probably best suited to their performance
whereas I think my performance is assessed by my non executive
8. Are there criteria we should know about?
(Mr Davies) There are absolute criteria in the
sense that we set out for the Board a budget and performance against
the budget. We set out objectives in terms of deliverables, at
the moment that is heavily based on getting the new regulatory
regime up and running. The Board also in addition to the regular
financial performance, they monitor staffing, performance, turnover
of staff which is quite a good indicator of whether we are managing
9. Mr Davies, I am fascinated by the often
quoted failure of the previous Act and I wondered whether when
you were making your introductory remarks pertaining to this particular
first question where you see the real improvement between the
old FSA system and the new? I would like just to draw your attention
to a City Editor yesterday who said that "the degree of bullying,
intimidation and seedy vindictiveness in the old system was the
greatest hidden regulatory scandal". Now, first of all, do
you think that is a fair criticism of the old system and do you
think the new system will meet that criticism?
(Mr Davies) No, I do not think that is in any
way a fair characterisation of the old system. I have not heard
that point of view advanced by trade associations or by city institutions.
I simply do not recognise it as a characterisation of the old
system. I think that where we are seeking to make improvements
in the old system are twofold. One is undoubtedly that there is
some genuine new change in powers in relation to market abuse,
which I am sure we will come on to in due course, but more importantly
it is in trying to ensure that the regulatory system is able to
take a view of the financial services market place which reflects
the structure of that market place. The old regulatory system
was built on a set of sectoral divisions which are no longer relevant
to the way in which business is actually done in that nowadays
you can buy life insurance from a traditional life insurance company,
from a financial advisor, from a bank, from a unit trust or a
company that owns unit trusts or indeed from a supermarket. These
old divisions on which the previous regulatory system was built
no longer apply. Also the old system had in the investment business
area an unsatisfactory two tier split which was put in place for
some understandable motives but which generated dysfunctional
conflicts but also complicated overlaps and underlaps within the
system, whose significance and importance became gradually apparent
during the course of the ten years in which the old system operated.
Lastly we think also, and this comes back to the remarks I made
at the beginning, that if you are interested in the integrity
of markets and in looking at risks to market stability overall,
then it makes sense also to be able to look at banks, securities
houses, insurance companies, fund management overall and to look
at the interactions between them in order to get an assessment
of the health of the overall financial system. In that, in the
old system there was a lot of coming together of regulators, undoubtedly
attempts were made to do that but it is much easier within one
organisation than it was before.
Chairman: Could we move on to the
question now of fine income and its definition and what happens
to it. That is one issue raised under the heading of accountability
in the progress report.
10. Mr Davies, the press has made good sport
about the costs of the new FSA structure and some criticism has
come of course by the potential capacity of the FSA to levy fairly
hefty fines. Now how are you going to assuage public perception
that one may be subsidising the other?
(Mr Davies) If I could say just on the overall
costs of the system, this year we are going to come in around
£10 million below our budget, and our budget for next year
is 1.9 per cent up on this year in budgetary terms and we put
out a consultation paper on our costs and on our fees. We have
had a very small number of responses and all of them have accepted
our fees and our budget for next year. So the controversy about
our costs in the market place I think can be much overstated,
certainly we have found that institutions have been quite understanding
of our cost base and appreciated our need to recruit good people
and indeed constantly say to us that what worries them is not
so much our out of pocket costs but the costs imposed on them
if we have poor quality people who do not understand their business
well enough. As far as the fine income point is concerned, we
have tried to present our budgets and our management accounts
in a way which demonstrates that we see fine income not as going
to the FSA but as going through the FSA back to the regulated
community. The way we present our budget is by publishing what
we call a control total which is mainstream regulatory cost and
that is for next year £158.5 million, and that includes all
of the in-house costs of supervision and the in-house costs of
enforcement but it excludes the case-specific costs of enforcement
when you hire in law firms, etc.. Then we show the outturn against
that control total and that is what we and our Board are managing
against. The enforcement costs are somewhat unpredictable depending
on the number of cases that arise during the year and the fine
income is also wholly unpredictable depending on the number of
fines which are levied during the year. So we present that separately:
the external enforcement costs and the fine income. Where there
is a surplus of fine income over out of pocket enforcement costs
there is then a discount applied at the level of the fees but
it does not run through our P&L, if you like, it is accounted
for quite separately to demonstrate that it goes back in the form
of lower fees and is not used retrospectively to justify a higher
level of budgeted expenditure than would otherwise be the case.
We hope that with this presentation we can make people see where
the fine income goes in and where it goes out and that it is not
used by us as a back door way of justifying an increase in our
budget or an increase in our salaries.
11. It sounds like a very good way of a
firm shopping the competition in order to reduce their own fees
if they go down, which I am sure is good competition. Are you
sure it is watertight in terms of appeals going to the independent
tribunal from firms trying to take just that tack but in fact
the fines are for other reasons?
(Mr Davies) Well, we think that operating in this
way it would be because there would be no benefit accruing to
the FSA from these fines except in so far as we are recouping
our enforcement costs but they would be related to the case in
question. We do not anticipate that being a problem. I am not
aware that it has been a problem in relation to the old system
which had the same arrangements for fines.
Lord Montague of Oxford
12. I think it is very important, and I
am sure you will agree, that the Consumer Panel has a feeling
of total independence. Have you given any thought to how you determine
the budget for the Consumer Panel and whether those who work for
the Consumer Panel can be the employees of the Consumer Panel
from that budget rather than your employees?
(Mr Davies) Yes, we have given some thought to
the budget for the Consumer Panel and we have set, from memory,
a budget of £420,000 for the Consumer Panel next year, about
half of which will be on consumer research which will be carried
out outside the FSA and about half of it is on the staffing support
and the costs of the Panel itself and its publications etc.. We
do have staff who spend most of their time working for the Consumer
Panel but I am slightly reluctant and I can understand the case
for a complete separation but also the point of having a Consumer
Panel which is inside the FSA is of course that it therefore has
a legitimacy within the organisation and its views are conveyed
through the organisation and not just in the form of points that
are lobbed in from the outside. Therefore we have taken the view
that it makes sense for the Consumer Panel to have exposure to
quite a number of our staff and for a number of our staff to go
and present to them, our regulatory staff, Michael Foot's staff
go and present to the Consumer Panel on the way they are doing
regulation of sales of personal pensions or whatever. We would
not want to see I think the Consumer Panel off completely separated
from the FSA, at which point I think it will lose some of its
13. Will they be independent?
(Mr Thorpe) That is one of those issues we have
looked at long and hard and discussed with members of the Consumer
Panel. The rather lame answer I suppose is the proof of the pudding
being in the eating. We have approached the matter on the basis
that the Consumer Panel should put forward a budget proposal and
a programme of work, that should be something that the FSA Boardwhich
at present is underwriting thisshould see and be content
with. The work then taken forward is a matter for the Panel. As
I was mentioning before, the Panel should be free to publish its
own reports without hindrance from us. We see the independence
coming more in its freedom of action within that published and
acknowledged budget. Going further away, as my Chairman suggests,
decreases our capacity to influence our own staff with the Consumer
Panel's thinking. In some senses it would create another public
consumer body which we are already aware of and already take note
of. For us this is an important informing aspect of our own structure.
Lord Montague of Oxford : I find
Chairman: We will have a chance to
speak to others about this in due course.
14. Just a supplementary following on from
Lord Montague, you said £420,000 was the budget allocated
to the Consumer Panel.
(Mr Davies) Yes.
15. Your enforcement budget is about £150
(Mr Davies) No, the total budget is £158
million, that includes everything. The Consumer Panel is £420,000
but that is not of course all of our consumer related work. Our
own work on consumer relations, consumer education, town meetings
around the country and all of that, that is separately accounted,
that is just specifically what the Consumer Panel itself is.
16. That is your consumer work but the Consumer
Panel at some stage may want to stand up to you and tell you off
(Mr Davies) Yes.
17. How do you arrive at that figure? It
is about a quarter of a per cent of the total budget you are talking
about. How do you arrive at that figure and are you sure it is
enough for the Consumer Panel to do a proper job?
(Mr Davies) I suspect that in the long run it
would not be but I ought to say that at the moment we are operating
of course primarily under the old powers and therefore while we
have broadened the remit of the Consumer Panel in terms of the
issues which it can cover, and we have changed the membership
of the Panel, essentially we are operating on the back of the
old powers we have through the PIA. We have taken therefore what
the PIA spent on the Consumer Panel and increased it a little
bit but I think until we have our full statutory responsibilities,
and in particular our new statutory objective of promoting consumer
understanding of the financial market place, we do not think that
we can justify to ourselves, therefore to our fee payers, spending
a large amount on the Consumer Panel where they might reasonably
say "You do not have statutory authority in some areas for
doing that". We believe that we do have in relation to the
old PIA areas.
18. Will you commit to an early review of
(Mr Davies) Absolutely.
Chairman: I think we need to move
on. Lord Haskel, you have a question about complaints.
19. You are required to consult on your
arrangements for independent investigation of complaints against
you, against the FSA. Can you tell us how your consultation is
going and when you expect it to be concluded?
(Mr Davies) When we brought the different regulators
together into the FSA we overhauled the arrangements for complaints
against regulatory staff both in the SROs and in the FSA. I should
have to say that in some cases in coming in there were no arrangements
at all in the past and we have painted those on, the Bank of England
did not have such an arrangement for a complaints commissioner
against the Bank of England in the past. The Board have approved
an independent complaints commissioner, Mr Jock Worsley, who has
terms of reference which have been revised to take account of
our new responsibilities and that is operating. I believe there
is only one current complaint which he is looking at but that
is an operating system. We do recognise however that for the full
new regime we will have to amend that because what we have done
is patch the old system on to the new. We will be consulting,
during the course of this year, we expect to complete that process
by the end of this year, that is on our critical path this year.