Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 765-779)




  765. Welcome to the Committee and apologies for keeping you behind but as you can see we are asking some interesting questions and we have a long road to travel in getting the answers. Could I ask you to identify yourselves for the shorthand writers please?

  (Mr Godfrey) My name is Daniel Godfrey, Director General of the Association of Investment Trust Companies.

  766. A common question to you. Is there anything in Aberdeen's evidence with which you fundamentally disagree?

  (Mr Godfrey) I think there were some aspects of what was said which could have led to some misconceptions today. Since we want to get to the end of this road as quickly as possible, I would like to try and make a few things clearer if I may. One of the first is that one of the areas where I think the Committee has really been virtually hitting the nail on the head but where perhaps some of the responses could have made you wonder if you were getting confused, is this distinction between what we might call traditional zeros, where the companies had no bank debt, and the way in which these companies, sometimes subtly, sometimes very obviously, changed over time. The fact is there were a number of different ways in which the structure became, as I would describe it, stretched. It is stretched because interest rates were falling, manufacturers were keen to deliver products to the market which had very high yields, obviously as interest rates fall it is easier to market and bring in new money which offers a very high differential between the rate you can get from a gilt or the rate you can get from a building society. The fact there were a number of different ways of stretching the product I think has confused the issue. The ways were, introduction of bank debt, introduction of more aggressive accounting policies, introduction of investment in very high yielding instruments, whether that be technology share bonds or telecoms bonds as we have heard today, or whether that be investment in other income shares. Some of these factors, sometimes all of them, sometimes some of them, are evident in all the trusts which have got into trouble. So whilst you can, it is true, have a trust which has no bank debt which has got into trouble, and you can have a trust which has no cross-investment in other income shares which has got into trouble, there are these factors. If you will forgive me for making an assumption, what you have been trying to get at is—

  767. Keep it simple.

  (Mr Godfrey)—the fact that the manufacturers, the sponsors of these products, are clearly telling us that they were not aware that these types of stretching made the zero dividend preference shares more likely to go belly-up. I think that does open a question as to whether they should have known, but the fact they are telling us they did not meant they were not in a position to warn their customers. That is what has led to the disastrous consequences.

  768. There was so much obfuscation this morning on that particular aspect but we are determined to get to the bottom of this. You have helped us an awful lot on that aspect. Really what you are saying, and you have put it in simple language for the consumers who are confused by the whole situation, is that gearing and other changes changed the product so markedly that we have ended up in dire situations in some cases?

  (Mr Godfrey) Yes.

  Chairman: Exactly.

Mr Plaskitt

  769. That is indeed very helpful to us but what about you as an association? When did you spot this change in the nature of the product?

  (Mr Godfrey) We have to separate the product from the zeros, because there are two elements to this. We began to spot changes in the product really quite early, probably in 1998-99, but that did not lead us, wrongly as it turned out, to consider the possibility that zero dividend preference shares would go belly-up. It did lead us to start having concerns that income shares were more likely than they had been before to pay out less than their initial subscription price, and we started writing to companies in about September 2000 asking them to provide details of all their holdings in other splits as we became more aware not just of the bank debt but also the extent of cross-holdings. I would say it was only really after September last year we began to become concerned that zero dividend preference shares might lose all their value.

  770. When that concern struck you, what did you do?

  (Mr Godfrey) We started writing to the boards of split capital investment trust companies trying to draw their attention to the sort of actions they could take which we felt would help to preserve capital for zero dividend preference shareholders, such as changing their accounting policy perhaps to more conservative practices, and also to look very carefully at the rescue rights issues which were taking place to ask themselves whether this could end up in destroying further value for the zero dividend preference shares.

  771. As those concerns grew in your mind and you started to take that action, did you contact any regulator to express to them your concerns?

  (Mr Godfrey) By that stage we were in contact with regulators. I have to confess—

  772. Which regulator?

  (Mr Godfrey) With the Financial Services Authority.

  773. When did you first notify them of your concerns?

  (Mr Godfrey) I think it would be contemporaneous, that they began to take an interest in the sector when funds started breaching their banking covenants, and we started talking to them probably in the summer of 2001. I would have to confess that by that stage it was too late, and I regret the fact that we became aware of the problems developing for zeros at a point at which it was actually too late to save them.

  774. So you are accepting you were too slow off the mark? You were aware of the structural problems here but you now, in retrospect, looking back think you took too long to take action on it? Is that what you are saying?

  (Mr Godfrey) When you say "took action", we have to remember we are not a regulator. I look back to ask myself what we could have done and I wish we had done something which would have stopped people losing a lot of money. Actually at that stage I had not worked out that bank debt was potentially dangerous because, as we have been told today, the cover was there and to somebody who is not a rocket scientist like myself I do not actually blame myself for not working out that the bank debt was as dangerous as it was. Perhaps the manufacturers should have realised this, perhaps not. That will be a matter for the FSA and perhaps the law courts and yourselves to pass judgment on. Had we had said publicly that this cross-investment could make these shares much less likely to return their initial subscription price, would it have made a difference? I am not convinced it would have done. We would have been two years too early, the market carried on going up, people would have been saying, "You said this and the market has gone up, you have really just stopped people making money by stopping them", so I do not think it would have made a great deal of difference. But I do, with the benefit of hindsight, wish there was something we had done which would have stopped it.

  775. Such as?

  (Mr Godfrey) Such as being able to predict that the markets would not enable the funds to deliver on what they were promising to do for people in a way which would have been believable at the time. I think we would have been ignored, in other words.

Mr Ruffley

  776. Mr Godfrey, you have been commendably clear in your analysis. Tell me this: where on earth was the regulator when all this was going on? I ask you as a trade association, where was the regulator? What were they doing?

  (Mr Godfrey) There are a number of aspects that the regulator has control over, they have control now through the listing authority—

  777. No, I do not want any retrospection. At the time this was going pear-shaped and just before it went pear-shaped, when people should have known but did not, what I want from you is a very simple account of what the regulator was doing, whether or not indeed they had the powers. We have just heard from witness after witness that the regulator did not have the powers, nothing could have been done. I want your version of what the regulator or regulators could and should have been doing at the material time, not after the event, when it should have been reasonably foreseeable.

  Chairman: Stick to the material time, and we can come back to the issue of regulation later because we have not got time now.

Mr Ruffley

  778. When it should have been foreseen. Tell me where the regulator fits in on that.

  (Mr Godfrey) As I say, I think by the time it became clear that the problems were intense, which was after September last year, there was very little the Regulator could do to prevent it and I think the Regulator before that point in the early part of 2001 issued guidance to advisers to ensure that they understood the risks. They issued new guidance on the way in which the risks should be described and I believe—I cannot remember verbatim—they said if you were selling income shares (none of this applied to zeros, it applied to income shares and splits) that you had to bring the small print warning which says you may not get back the amount invested from the small print into the main body copy either of the advertisement or the sales letter. That applied both to investment managers and to advisers.

  779. What about zeros?

  (Mr Godfrey) It did not apply to zeros. As I said, given that the manufacturers of these products clearly had not understood the impact of what they were doing to the structure, it is not surprising that neither the trade association nor the Regulator worked that out for themselves given that the so-called rocket scientists did not.

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