Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 80-99)



Mr Tyrie

  80. Do you think that it might have been reasonable for the Government to have consulted the FSA prior to the decisions it took on 7 October? Were you surprised not to be consulted?
  (Sir Howard Davies) We were asked late on Friday afternoon, which was 5 October, for our advice on the listing implications of the decision the Government was contemplating making. It was very clearly put to us that the decision had not been made. We were asked the one question which it was right for us to be asked and on which I would have expected to be asked, which was what the consequences would be for the listing of Railtrack shares of such a decision. We offered our advice on that point. That is the one area where I would expect the FSA to be asked and that did happen.

  81. Do you think it might have been reasonable for you to have been consulted earlier than the Friday before the Sunday it was wound up?
  (Sir Howard Davies) No, I do not think so because, as I understand it, the decision had not been made. It was put to us very clearly that a decision had not been made, and we were asked about the possibility and what we would do. We were able to give a quick view. Frankly in these kinds of markets, that is pretty decent notice by the standards we normally get.

  82. You have made a distinction between where you will be under the new rules and where you are at the moment under the old rules and this of course is governed by the old rules. I have here the consultative document you put out, number ten on market abuse, which says on the question of the duty of disclosure and I more or less quote that there is a duty to disclose any information which concerns impending developments or matters in the course of negotiation which if they came to fruition would be required to be disseminated or in relation to a designated market or which is to be the subject of an official announcement by Government's central, monetary or fiscal authorities or regulatory authorities. Does this mean that under the new rules, after N2 you would have had a major role to play in establishing whether there had been any market abuse?
  (Sir Howard Davies) Once again the listing rules will apply to the company and therefore in that respect the position will not change. What will change is that we shall be responsible for considering broader issues of market manipulation and misleading statements to the market which are currently now a matter for the DTI.

  83. So the answer is broadly yes, you will have a locus and it would be reasonable for you to comment on areas on which at the moment you feel unable to comment.
  (Sir Howard Davies) I will follow you only with care on the issue of commenting because there are serious confidentiality constraints on the FSA in commenting on any investigation which may lead to any disciplinary issues. This is why Mr Fallon may have thought I was engaging in high pedantry, but investigation is a big word and if we launch an investigation it is clear to me that the constraints on us under the Financial Services Markets Act as such, that we may say nothing about that investigation until it is concluded; indeed in most cases we may not say that such an investigation is under way because it was felt in Parliament that for us to be able to comment on investigations when they are merely a gleam in our eye is prejudicial to natural justice. Therefore when you say "comment", it may still be frustrating to the Committee because the constraints on me in terms of offering views on what has happened are quite serious until such point as it has gone through the full disciplinary process and come out the other end.

  84. You sound as though you are disappointed that you are constrained. What I perhaps ought just to clarify is whether that is the case.
  (Sir Howard Davies) In the particular case of listing issues it is a matter of some frustration, I would accept that, that on occasions we are put in a position where we cannot say that we are carrying out an investigation into a company. Occasionally a company itself says that we are and we are put in the slightly daft position of not being able to confirm or deny whether we are or we are not. Frequently there is strong public interest in knowing whether or not we are picking this issue up. Therefore it is somewhat frustrating. What we may wish to do is to consult, as we consult on the listing rules in future, on the circumstances in which it is appropriate for the FSA to say that it is investigating a matter, what constrained circumstances there might be in which it was generally in the interests of everybody and in the interests of market integrity for us to be able to say that an investigation was under way. That is an issue we propose to raise for consultation in relation to our review of the listing rules. You can see that there are serious issues here in that you would not wish to prejudice an inquiry by announcing things. On the other hand there are some circumstances in which companies themselves say yes, we are being investigated by the FSA and we are co-operating with the investigations and they prefer to say that than to have nobody know whether it is happening or not. At the moment the rules I inherited constrain me in this way.

  85. I think you do have a statutory responsibility to offer opinions on whether a false market has been created. Am I not right?
  (Sir Howard Davies) Yes. The way that works in relation to —

  86. I am talking about existing rules.
  (Sir Howard Davies) Yes, that is right.

  87. I am not talking about where you will be after N2.
  (Sir Howard Davies) I understand fully, but in this respect probably the position is not so different in any case. We are able to say whether or not we think that there is a risk of a disorderly market and therefore that we believe that a suspension of company shares is appropriate because we do not believe that there is appropriate information in the market on which investors may make a reasonable decision for themselves about what these shares are worth. Essentially the suspension of Railtrack shares is in this category. This was not a point of controversy between us and the Government and the company. We all reached the same view that in the circumstances of the announcement such a degree of uncertainty was created by that in terms of the value of the shares that a suspension was entirely appropriate. That was our view, but it was also the view of those who were advising the company so there was no issue about it. Certainly there are circumstances in which we may say, we can say, that we believe that the lack of information is such that there is a risk of a false market and therefore suspension of the shares is a better course.

  88. The issue is not whether suspension was the right action on 7 October. The issue is whether you should have had the information available to you to make an assessment of whether there was a false market prior to 7 October. In an earlier response to me you said that you did not think the Government should have consulted you in the weeks prior to 7 October. How can you form that judgement if you are not given the information on which to base it?
  (Sir Howard Davies) Once again I say that the obligation is on the company itself to conclude whether it is issuing the right information into the market. The company did not come to us with that question beforehand. Clearly something we may want to look at is whether there is an argument for saying a company should have come to us at an earlier point but that obligation would have been on the company.

  89. I understand that you also have the power to launch indemnity proceedings for shareholders who have suffered a loss as a result of buying shares on the basis of misleading information. Are these powers which you may consider using in the light of the inquiry—if I may use that word rather than investigation—which you are now apparently undertaking?
  (Sir Howard Davies) I would not wish to comment on that possibility at this point. We are a long way from my having to address that point.

  90. Shareholders will be listening very carefully to that reply, as you can imagine. My last point is the issue of market confidence. You have a statutory duty, indeed two of your four key tasks which are laid down in the legislation which creates the FSA are to maintain market confidence and to protect consumers. Do you think that what has transpired over Railtrack has long-term implications for market confidence and the need to protect consumers in respect of other public/private partnerships?
  (Sir Howard Davies) It is very hard to answer that question. Obviously the question of public/private partnerships would go much more broadly than listed companies. We have looked at whether the announcements have had any discernible impact on the prices and yields of other regulated utilities or perhaps former utilities and we have found no evidence of that at this point.

Dr Palmer

  91. It has been rather obvious in recent days that some of the questions with which you have been bombarded by shareholders and politicians and members of the Committee are motivated either by the wish to increase the value of the shareholding or by political considerations. I just wonder in more general terms whether you are not worried that you will often in the future, especially after N2, become a proxy for anyone aggrieved with the Government or indeed with the workings of the stock market. Are you not going to be bombarded with pseudo complaints of that kind?
  (Sir Howard Davies) You are kind to raise the point and there probably is a risk of that which is why we have to remain very tightly focused on what is our responsibility and what is not. I believe that the regime we have is a perfectly manageable regime as long as we interpret our responsibilities within it with care. It does mean that we are unlikely to be all-purpose commentators on passing market events. We have to be very clearly focused on our responsibilities and on whom they bite and on whom they do not bite.

Mr Mudie

  92. Some of the shareholders out there might be unable to understand the difference between an enquiry from you and an investigation. In layman's terms can we just confirm from what has been said today that even if you found there had not been full disclosure, there are no financial penalties you can exercise upon the directors of that company? Secondly, is there anything you can do which would bring any financial comfort to the shareholders? I think the answer is probably no. From reading the papers there is clearly information I should have liked to have had, had I been a Railtrack shareholder, which was floating about. Have you and the appropriate authority had a look at the sales of Railtrack shares in the last few months and are you intending to do so?
  (Sir Howard Davies) Embedded in your questions were the answers to the first two questions which I would confirm. As far as the last one is concerned, it is something we have had a quick look at and at this point we have not identified any suspicious transactions.

Mr Laws

  93. Do you have any plans in the light of the discussion today to speed up the enquiries or investigations taking place into this issue so far, because they seem a little bit leisurely at this point? You did mention earlier that you did not have access to Hansard, but I was only quoting the Secretary of State's comments yesterday from the statement which he made, which presumably has been supplied to you already. There was some uncertainty in respect of your answers to Mr Cousins about how far back you are investigating. Do you think it would be reassuring to Railtrack investors if you were able to speed up these enquiries? When do you think you will be able to conclude your enquiries into this specific area of whether or not Railtrack notified investors early enough?
  (Sir Howard Davies) I agree that following Mr Cousins' questions I will immediately clarify the timing of our request or the time period which that covers. Mr Cousins makes some good points about that which I shall certainly follow up on instantly. As far as the rest is concerned, it would be implausible for me to give you an answer about timing because I depend at this point on receiving a reply from the company. In the light of that we shall consider whether there is a case for an investigation or not.

  94. Could we move on now to the question of split investment trusts into which there has been some inquiry recently and some concern expressed in terms in particular of cross holdings and cross investment. I do not want to plug the Financial Times too often in this particular hearing but there was a report in the Financial Times recently which said that between 25 and 30 of these trusts, in a sector after all which only has 125 of these, are in danger of breaching the ratio of assets to loans covenant agreed with their banks. Is that true? Do you have concerns about this particular area as well?
  (Sir Howard Davies) It is important to note that investment trusts are not authorised firms, they are listed companies. So we approve their listing prospectus through our listing authority function, but they are not financial firms and they do not have prudential requirements on them in the same way as a unit trust does, where we do have a responsibility for monitoring the prudential soundness. These are just listed companies and therefore our interest in them is in whether the prospectus is accurate, whether the disclosure to investors is accurate about what kind of trust they are going to be and what kind of risks they are going to take on. It may be, in relation to advisers, whether advisers are advising people sensibly within our suitability requirements, that we might possibly have a systemic interest in them if there is a risk of some kind of major market problem. They are not authorised firms in the way that a bank or a broker or a unit trust is.
  (Mr Tiner) Because of that our interest is perhaps more limited than it would have been had they been regulated entities. Having said that we have been watching the split capital trust investment market for some time for three reasons really. One is the one to which Howard referred. We want to be concerned about the selling process, making sure that there are adequate disclosures about the risks of these vehicles and that there is the right disclosure and suitability test for the people who are buying them. Secondly, we wanted to be sure that there would not be a systemic issue within the investment trust sector arising from the leverage, the gearing in which many of these investment trusts engage. Additionally, the fact is that there is quite a high level of cross holdings within the sector, so that the impact of those two, both the gearing and the cross holdings, could create quite a rapid spiral in the event of sharply falling markets, which of course is what we have had of late. We have taken quite an interest in the systemic implications. We have had a number of discussions with the Bank of England about that. We are now looking at what we should do about that because we do not have a direct interest in this. We do not have a locus over the investment trust community and we really are therefore doing analyses ourselves to see at what point the stock market would need to be at for there to be a systemic risk to this sector. We have discussions with the Bank of England about that. Beyond that it is really down to the companies and their bankers.

  95. Have you investigated whether any of these trusts are in danger of breaching their banking covenants or have any so far done that for any period of time? As a consequence of these concerns in relation both to investors and to sustaining risk, have you so far taken any action which would deal with those particular concerns, or has most of what you have been doing been investigated at this stage?
  (Mr Tiner) On the first point, we do not have a vires over whether the companies have breached their covenants or not; that is a matter for the company and their bankers to deal with.

  96. Does it not concern you for systemic reasons?
  (Mr Tiner) Then we look at the overall picture to see whether we should be concerned about the systemic area. At a stock market level of 4,500 we did have some concerns about that and we have had some discussions with the Association of Investment Trust Companies. At the moment I would say that our general posture is a watching brief over it rather than any direct action.

  97. It would be fair to say therefore that you do not know whether they are close to breaching their banking covenants.
  (Mr Tiner) No, not on a real time basis; no, we do not.
  (Sir Howard Davies) We have done a survey of the position as now. This is primarily an issue for the managers of those trusts and their bankers. They have chosen to construct leveraged vehicles in search of, and to structure them in such a way that they aim to deliver, high returns by taking on market risk. That is the deliberate intention. What they have done is not illegal, but it is risky and it is structured in such a way as not to be within our regulatory regime and not to be therefore subject to compensation schemes or prudential capital requirements or authorisation requirements. They have chosen to structure themselves in that way. Therefore primarily this is a matter for the investors and the bankers of those companies to come together to decide how they propose to proceed in the event of market circumstances which trigger these covenants, whether it would be sensible for the banks to pull the rug at that point or whether it would be sensible to seek some kind of reconstruction as you might with another company.

  98. You do not think that you have a duty to oversee or take an interest in that process for systemic reasons?
  (Sir Howard Davies) Systemic is a high hurdle I would say and I think I would speak for the Governor on this. One must be very, very clear why one should wish to step in as the public authorities. One would want to be very clear that there was a major systemic issue and there was a risk of collateral damage to others other than the investors who went in with a view to looking for high returns. Unless one takes a rigorous view of what is systemic, there is a risk of being dragged into providing support and comfort to high risk vehicles which have been structured to be outside our regulatory regimes. This would be a very high hurdle before one would wish the public authorities to step into this.

  99. Do you believe that it is not past that hurdle yet?
  (Sir Howard Davies) Certainly no, I do not believe it is.

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