Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 40-59)



  Q40  Kerry McCarthy: I turn to Europe now, in particular the Commission's Green Paper, The Financial Services Policy. In that you express some concern about the proposed consolidation exercise that has been flagged up in the Green Paper. Could you comment on that?

  Sir Callum McCarthy: This was the proposal that there should be a consolidated rule book. I think that that would be a huge diversion of resources. I think the scale of the task has been deeply underestimated. To do it would take at least a decade, and I do not believe it is the sensible way of approaching the real issue, that of establishing a single market in financial services products in Europe. I am not sure how strongly the Commission is wedded to the idea. I hope that when there is eventually a White Paper that idea will have been withdrawn, because I do not think it has been supported extensively, if at all, in consultation and from the comments they have received on their Green Paper.

  Q41  Kerry McCarthy: Do you still believe that a single European market in financial services products is achievable?

  Sir Callum McCarthy: I think that it is more readily achievable in the wholesale market than in the retail market because the retail market is affected much more by a series of questions of law, of tax and also of cultural differences than the wholesale market.

  Q42  Kerry McCarthy: Achieving a retail single market you think would be achievable without a complete change to things like company law and insolvency law?

  Sir Callum McCarthy: As for the realities about achieving the single retail market, the biggest difference and the biggest obstacle is the difference in the tax treatment. The questions that were raised earlier about the interaction between tax benefits and investment in the retail market are absolutely real questions and they apply Member State by Member State. That is the real underlying problem in terms of creating a single retail market, not the absence of a single rule book across Europe.

  Q43  Kerry McCarthy: Generally speaking, all policy making is subject to fairly rigorous cross-benefit analysis, whereas European policy is not subject to the same treatment. What do you think is the impact of that?

  Sir Callum McCarthy: I think it is deeply harmful. One of the things in the Green Paper that we strongly supported and one of the initiatives that Commissioner McCreevy has taken is to say that he wants not only the Commission initiative but also amendments to it either by finance ministers, the Council of Ministers or the European Parliament, all to be subject to cost-benefit analysis. We very strongly support that because it is a deeply problematic position to find, for example, a directive which is going to have the pervasive effect of the Markets in Financial Instruments Directive (MiFID) that has not been subject to that sort of assessment.

  Q44  Kerry McCarthy: On MiFID, the Chair of your Practitioner Panel has said that the costs of MiFID will far outweigh the benefits to the UK. Do you agree with that?

  Sir Callum McCarthy: I do not know. There are a number of reasons why I do not know. One is that MiFID has not yet been defined. There are still a number of really important questions—defining things like the ability of people to outsource, what is meant by investment advice and some basic questions—which are still unresolved. Until we understand those and what is going to come out of it, it is very difficult to establish the costs and benefits. It is the case that the costs are likely to fall particularly on the UK as the major wholesale market in Europe. Whether the benefits for Europe as a whole outweigh those costs, it is impossible to say because no proper exercise has been done. That is why, in answer to your first question, I think it is deeply unsatisfactory that we should be in that position.

  Q45  Kerry McCarthy: The FSA is carrying out its own cost-benefit analysis.

  Sir Callum McCarthy: We will carry out our own cost-benefit analysis once we have the definition of what it is we are talking about. The reason we cannot do more at the moment is that that has not yet been defined. We hope to do it on the assumption that the relevant committee chaired by the Commission and composed of the finance ministries of the Member States manages to come up with a definition this side of Christmas. We would hope to be able to do a cost-benefit analysis for the UK in the first quarter of next year.

  Q46  Kerry McCarthy: Presumably, if you are not put in a position where you can do a cost-benefit analysis, you would have serous concerns about the directive going ahead?

  Sir Callum McCarthy: We have always said that we regard it as unattractive that something of this importance has been done without a cost-benefit analysis.

  Q47  Jim Cousins: Do you see some contradiction between the provisions in the solvency directives that apply to life insurance funds and the Government's decisions on proposals to tax life insurance funds?

  Mr Tiner: No, I think that the solvency requirements, as they are established (and they are being re-written at the moment, as you may know, in something called Solvency 2) we believe will put solvency of life insurance companies on to a much more risk-based approach as we indeed currently have here. That is all about ensuring that life insurers carry enough capital, enough solvency, to support the liabilities that they write and the risk they run in their assets. Our interest is in making sure that the UK life industry in aggregate, and indeed for individual players, meets all those capital tests. Our understanding from the Inland Revenue's proposals for the additional taxes of life insurance companies would be that that solvency is not threatened by that and in that context is not an issue really for us; it is a question of tax policy with the taxpayers.

  Q48  Jim Cousins: Let me understand what you have just said. Are you suggesting, with the benefit of the information that you have, that any provisions that life insurers are required to make as a result of the solvency directive, any additional provisions they are likely to make, will not be subjected to the Government's proposals to tax life insurance funds?

  Mr Tiner: I am not sure, as I understand the Government's proposals, that there is a direct linkage between hereditary capital requirements and the basis on which the tax is being charged.

  Q49  Jim Cousins: Exactly, and that does open the possibility that life insurers will be required by the Directive to make additional provisions which then become subject to tax.

  Mr Tiner: It would imply that the tax liabilities themselves would be reducing the solvency of the life insurance industry, but I think that the items that would be subject to tax, as I understand the Revenue proposals—and they are immensely complicated—is that it is really the market valuation of assets against historic costs which would generate the potential tax benefits, and if tax charges are generated from that then those provisions would go against their solvency, and clearly we would have a financial stability concern if the magnitude of that was such to threaten the solvency of life insurers. But our current understanding—but I understand that the Revenue are still talking to the industry about this—is that that would not be under threat.

  Q50  Jim Cousins: Could you keep the Committee informed about that?

  Mr Tiner: Certainly.  Chairman: Can I thank you for the paper that you have provided us on the current issues relating to financial services? It has been very helpful to us, and in particular in advance of our meeting with Commissioner McCreadie; we will take up a number of themes that you have intimated here.

  Q51  Ms Keeble: The new basic advice regime for the sale of stakeholder products has been in force now for over six months. What early indications have you received about this and how the new process is functioning?

  Sir Callum McCarthy: I think there are two concerns that need to be separated. One is, is this as a regime being extensively used, to which the answer is no, it is being used by relatively 200 people, and there may be very many reasons for that.* The particular responsibility for the FSA is to try and establish whether the strip-down regime that we established to enable these simplified products to be sold, in a way which still provides appropriate consumer protection, is actually working. So far that looks as if it is working perfectly reasonably, in the sense that there is no evidence that there has been abuse of that strip-down regime, and one of the things that we will want to do, as we have always made clear that we want to do, is if this strip-down regime works for a particular a group of products that were originally defined by the government, most of which we thought were appropriate for the strip-down regime (though not all), we will want to see whether that strip-down regime can be applied more widely, and that is something that we will investigate once we have had more experience in the actual practice.

*Correction from Witness: One is, is the regime being extensively used, to which the answer is no; it is being used by relatively few people,

  Q52  Ms Keeble: Could you just help us with what that assessment is based on? Have you done a study or a survey or is it just feedback that you have had through the industry that it is working properly?

  Sir Callum McCarthy: The initial work was a lot of empirical work to see what would actually provide appropriate consumer protection in terms of degrees of relaxing our normal requirement. At the moment, because this is in the early stages and a limited number of cases, it is basically anecdotal rather than detailed empirical work, which is why we cannot yet decide what we should do; we have to wait until there are more cases and then we will do the same sort of empirical research that we did before. But basically it is to make sure that the question of suitability was properly tackled.

  Q53  Ms Keeble: When do you expect to be doing more detailed follow-up work?

  Sir Callum McCarthy: It will not be until at least a year, simply because we will not have enough instances to test and investigate.

  Q54  Ms Keeble: If you talking about applying that regime to a wider range of products what kind of products would you be looking at?

  Sir Callum McCarthy: Other simpler products. Other products that have lower risk associated with them.

  Q55  Ms Keeble: You would not want to name any of them?

  Sir Callum McCarthy: No, because there are a great variety of them.

  Q56  Ms Keeble: You are currently consulting on the removal of rule RU64, Which? has said that this would make it easier for providers to recommend higher charging for quality products. How do you respond to the Which? criticism and the Which? comments?

  Sir Callum McCarthy: One of the concerns that we have is not to try and control prices but to try and establish an efficient market so that people can make choices, and it is entirely in keeping with that that we try and ensure that the market works effectively but do not try to control particular commissions or charges.

  Mr Tiner: I think that is right. RU64 was a rule that was written by the PIA a long time ago and I think that we are quite keen not to have detailed rules that prescribe pricing but have a system of disclosure. So that is why we are consulting on removing RU64.

  Q57  Ms Keeble: You mentioned previously the empirical evidence about the way in which the new system was working. What type of empirical evidence is that? What appears to you to be happening?

  Sir Callum McCarthy: I say, more than anything else, absence of complaints. If there had been abuses we would have expected to have found out and had some early indication of abuses.

  Q58  Ms Keeble: What kind of abuses would you have thought might occur?

  Sir Callum McCarthy: The normal sort of question of suitability, which was the central question associated with these products: are people being put into products which are unsuitable relative to their financial circumstances?

  Q59  Ms Keeble: So mis-selling basically?

  Sir Callum McCarthy: Yes.

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