Exmination of Witnesses (Questions 163-179)|
TUESDAY 13 NOVEMBER 2001
163. Good morning, Sir Howard. Welcome back
again to another evidence session of the Committee. For the sake
of the shorthand writer, would you introduce yourselves, please?
(Sir Howard Davies) Howard Davies, Chairman of the
Financial Services Authority; accompanied by John Tiner, Managing
Director of the Authority, responsible for Consumer Investment
and Insurance affairs.
164. Thank you, Sir Howard. Do you think that
a good relationship between regulator and those you regulate is
necessary for the FSA to do its job properly?
(Sir Howard Davies) Yes.
165. If so, does this reliance on a good relationship
indicate that the FSA should have stronger powers in order to
avoid being bullied?
(Sir Howard Davies) The regime we have
established for the future rests on a set of principles, which
we think anchor the regime and give regulated firms an idea of
their responsibilities and the relationship they ought to have
with the regulator. Those principles, which begin with the simple
expression that a business should treat its customers with integrity,
also include the requirement to be open with the regulator; and,
indeed, in the case of international business, open with regulators
of other parts of the business. I think that general principle,
which we regard as being an enforceable principle, is and ought
to be for the future adequate to require firms to develop the
relationship that we would like.
166. I am thinking here about your answer to
question 8 at a previous session which I put, when you said with
regard to Equitable: "I am afraid here, Chairman, we were
dealing with a company which had an arrogant superiority . . .
and did not deal with the regulator in the way we would expect.
Quite out of character with the relationship that we have with
most firms, certainly with most banks and, indeed, increasingly
with most insurance firms". When I mention the word "bullying"
I took it from the answer to that question. Do you think more
powers are needed to deal with another Equitable Life?
(Sir Howard Davies) I do not think so for the future
because, as I have said, the new regime will be anchored in these
principles. These principles have been adapted from those which
were used by the Securities and Investments Board in the past;
they did not in the past, however, apply to insurance companies.
Therefore, what we have done, as we see it, is to take the best
bits of the different parts of the old regime and use them for
the new. I would hope that, resting on those principles, the new
regime and new sets of relationships we have with insurance companies
will be better than they were in the past and will avoid the kinds
of situations that we had with the Equitable developing in the
167. Could I take it then that the regulator
was impotent with regard to Equitable Life? The reason I say that
is you mention in your evidence that the company resisted your
attention; they went ahead with a court case without consulting
you; "the company resisted us at every turn, complained to
ministers, threatened judicial review". It does not seem
to me as if a regulator has much handle on a company that acts
and behaves in that particular fashion?
(Sir Howard Davies) I think that "impotent"
would be much further than I would be prepared to go; because
we were prepared to fight them on judicial review, would have
done so and, I believe, would have won that case (or I hope we
would have done), and the company backed down on that point. Also,
of course, the minister concerned gave them a dusty answer when
they attempted to use that route. I do not think one could use
those particular examples to say that the regulator was, in the
end, impotent. I think the question that is more relevant, and
where the Baird Report makes its strongest points, is that if
the regulator is to have a proactive relationship with companies,
and to act in an anticipatory and problem-solving way, which is
the way we like to do, then you need to have a relationship whereby
companies come and explain their problems to you and seek to discuss
sensible solutions to them. I think it is more speaking to the
character of that kind of relationship, to allow us to use our
problem-solving abilities to the full, that the report is speaking
to. That is typically the relationship that we seek to have with
banks and insurance companies now.
168. That is to the future; we are looking at
the moment, to the past, with Equitable Life. I would put it to
you that, to many people on the outside, the regulator looked
powerless and, indeed, vulnerable to being overtaken by events.
It is a matter of record that the regulator sat and watched three
court cases going through. No doubt they were alert to the problems
but you felt, from what I can gather, that you could not take
any action until the cases had been heard. With hindsight, as
a regulator, I would put it to you that you did nothing effectively.
It does not seem to us as if you had any contingency plans. Would
you do things differently in the future; and how could you avoid
another Equitable Life situation?
(Sir Howard Davies) I am afraid, Mr Chairman, I would
not wholly accept that characterisation. I do not think any scheme
of financial regulation will avoid the fact that there are aspects
of the regime which will go through the court system; and that
will be the case in the future as well. I think, as the Baird
Report explains, there is an interrelationship between the regulations
and the rules of the prudential regulators and the interpretation
the courts put on contracts, and that is just something one has
to live with. Indeed, the Report addresses the question directly,
which we have thought about ourselves, as to whether it would
have been possible for the regulator in some way to intervene
in the case to try to promote a more satisfactory outcome; but
the review team, with the benefit of their own legal advisors,
have concluded that that would not have been an appropriate thing
for the regulator to do; and it was not clear what the regulator's
locus would have been in an action which is essentially
about the interpretation to be placed on contracts. I think one
always has to live with the fact that there is that interrelationship
between regulation and the law: but what we hope to do with companies
is to seek to game plan how they can get through difficult positions,
and we do that all the time. We always have a number of companies
who are potentially in difficulty, and we normally try, certainly
from a prudential regulatory point of view, to seek ways with
them of managing them through that difficulty.
169. What did you do in the case of an Equitable
Life contingency plan?
(Sir Howard Davies) What I was coming to was, we did
look at what the potential outcomes of the case were; but, as
the report points out, when the case started, which was at the
time when the regulation was still in the Treasury, the company
did not discuss with the regulators whether it was sensible to
take the case in the way that it did, and how it should manage
the process through; it did not seek to do that and presented
the Treasury regulator at the time with a fait accompli.
That is not the way we like to operate with companies. Prudential
regulation is a matter where you have to be in problem-solving
mode; because, frequently, to precipitate a crisis in a company
can be very damaging for its depositors or its policyholders.
That is the character of the relationship we want. What I was
drawing attention to in the last hearing was that we clearly did
not have that relationship in this case; I hope that in the future
we will. Certainly I have been encouraged by the fact that a number
of insurance company chairmen have said to me that one conclusion
they have drawn, both from this episode but also from the fact
they have now looked at the way banking supervisors have operated
in the past, is that we should be having much more of that kind
of relationship with insurance companies; and that the remote
relationship there was in the past, which was a very distant one
with the government departments and with the government actuaries
department, is not one which is best suited to the uncertainties
and the difficult environment in which insurance companies work.
170. If I may say so, Sir Howard, I consider
that was an opaque answer to the relationship between the regulator
and Equitable Life. You have mentioned what you are going to do
in the future; but we still have no further idea about what I
consider to be the impotence of the regulator with regard to Equitable
Life. Notwithstanding that, you mentioned in your last session
that Equitable Life has always met its regulatory requirements.
Are you concerned, therefore, that the regulatory requirements
are a poor guide to the true financial state of a life assurance
(Sir Howard Davies) In some respects, yes, they are.
The Baird Report draws attention to the most obvious drawback
in relation to the Equitableand that is the way in which
guarantees are valued, or not valued, in insurance company balance
sheets: in that there was no value placed on these guarantees
unless interest rates fell below the level of the guarantee. Whereas
in the normal way, when one is thinking about valuing an option
in securities markets or in the banking industry, one considers
that the option clearly has a value, even if that particular day
it cannot be exercised, because there is clearly some probability
in the future that it may be valuable; therefore, you do attach
a value to a guarantee or an option. In a sense, these were uncovered
interest rate options that the company was writing. It is clearly
inadequate that the current rules for insurance companies do not
capture that kind of liability. We are determined that in future
they will, and that is a specific recommendation of the Baird
Report which we are carrying forward.
171. Are other companies complying with the
regulatory requirements yet, or could find themselves in a serious
problem like Equitable Life?
(Sir Howard Davies) There are certainly companies
who are complying with the regulations at the moment and where,
in the past, there have been no values attached to guaranteed
liabilities. I have to say that, since the House of Lords' judgment
has clarified that, those companies have put in reserves for those
guaranteed annuities. I am fairly certain there is not a company
at the moment that has an obligation in relation to guaranteed
liabilities which has not now been disclosed; but that certainly
was the case before the House of Lords' judgment.
172. There is nothing on the radar screen which
would indicate any alarm on your part with regard to any other
(Sir Howard Davies) That is a fairly strong statement.
173. It is a question.
(Sir Howard Davies) Certainly not alarm. There are
always a number of companies in the insurance sector and elsewhere
which we are watching more carefully than we are watching other
companies, because their solvency position may be close to our
trigger pointand that may be the case in banks. There is
always quite a number of companies which we are looking at carefully.
I certainly would not put that at the level of alarm at this point.
174. You did mention there were going to be
big changes to the regulatory regimethat would imply big
changes perhaps to the solvency regulations. If the FSA tighten
the regulatory regime, are you concerned that some life assurance
companies may find that they are unable to meet the new requirements?
(Sir Howard Davies) I think that, as we change the
regime, we would clearly want to do so with appropriate notice.
Indeed, we would almost certainly be obliged to do so in terms
of our EU obligations etc. Quite a number of the solvency requirements
are international in nature. I am quite sure that as we change
we will want to give companies time to adjust their balance sheets
and adjust their capital position in order to meet them. It would
not be fair to look at what we might do and look at the current
position, because companies would have time to reserve more appropriately
if we did not choose to change the solvency rules.
175. You mentioned earlier about Equitable valuing
its optionsif it had valued its options, as you would have
wished, would this problem now have been avoided?
(Sir Howard Davies) It would have been addressed earlier.
I think what would have happened is that, over time, the company
would have had to keep a reserve in relation to the cost of these
guarantees; and that reserve would have needed to be built up
over a period. I think that, as interest rates fell in the 1990s,
it would have been necessary for that reserve to be increased;
but the company could have done so over a longer period of time.
I think the position of non-guaranteed policyholders might well
not be so significantly different today at the end point - because
it is important to note that no money has disappeared from the
Equitable by fraud or anything; this is a question of distribution
within the fund as to which policyholders are entitled to whatbut
it would have been necessary to provide at an earlier stage, through
lower bonuses and higher reserves, for the cost of those guarantees.
The rather painful and sudden adjustments that have had to be
made within the Equitable's reserves would have been done over
a longer period of time.
176. It would have implications for marketing?
(Sir Howard Davies) Yes, it would have, certainly.
177. Does that mean that during the transition
period for historical reasons, which I do understand, the regulatory
requirements will not be an adequate guide to financial health
for certain other life assurance companies?
(Sir Howard Davies) No, I think one frequently faces
the position that, in the light of better information and better
understanding of risks and markets, one changes prudential rules.
We are in the course of doing that on a huge scale in relation
to banks at the moment in the Basel committee which has overhauled
banks' capital rules in a fundamental way. Technically you could
say now that there are banks who currently perhaps do not hold
as much capital as the new rules will indicate that they should.
I think it is a little bit harsh to produce a conclusion from
that, that they are wrong at the moment. They are meeting the
current regime, and no doubt when the new one comes in they will
meet that as well.
178. I am not seeking to blame the companies,
but you did say in response to an earlier question from the Chairman
that the regulatory requirements were a poor guide or inadequate
guide to the financial state of life assurance companies under
certain circumstances, and that is why you are changing the rules?
(Sir Howard Davies) Yes, indeed that is true.
179. I think it is a point of fact, is it not,
that there may be companies at present for whom the current regulatory
requirements do not adequately show the position, otherwise you
would not change the rules?
(Sir Howard Davies) Yes, that is most logically true.
It would be possible to give a clearer view of the risks inherent
in their portfolios through different rules, yes, that must be