Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 100-119)



  Q100  Ms Keeble: Obviously you have a huge job in terms of regulation of the market, management of products, the whole range of things that you are looking at. Do you really think that at the same time the FSA can deal with the whole task of informing the public? And do you think the whole issue about communicating with consumers should be done by either an arm's length organisation from yourselves, or some other organisation?

  Mr Tiner: Actually, no, I do not. I think that first of all we have a statutory responsibility today and we have to fulfil that responsibility. I also think that the FSA brand is an important security for people and they may not know the FSA by name, but they will know, hopefully, that there is a regulator that is taking care of their interests. I think that to try and break that up and to create some other brand for consumers to feel satisfied that when they come into financial services they are getting some protection would be quite damaging.

  Q101  Ms Keeble: If your reliance is on the media providing financial information it is quite notorious that the financial pages are not read by all of the public. The advert that the Chairman showed us was on the sports page and it was presumably put there for good reason, because that is where people look. So if there is a reliance on working through certain outlets, through the IFAs perhaps and through the financial services media, it is not going to reach just the people who must need reliable information.

  Mr Tiner: We do not just put our literature on to the personal financial sections or the business pages of the media. The Mortgage Laid Bare Campaign has been positioned in places where we thought that people would go and look for other reasons. We do a huge amount of regional radio broadcasts for people who listen to the radio during the day, and we try very hard to try to have as big an impact as possible with our consumer communications. Again, putting it to a separate body either within the FSA or outside would seek to confuse the consumers in fact more than inform them.

  Q102  Ms Keeble: If you say that the FSA brand is important, it might be to people who know, but for some people they think it is the Food Standards Agency. It is easy to get confusion there, particularly when food is high in the headlines. You go into virtually anywhere, particularly a supermarket, and there are all kinds of financial products advertised very, very heavily, and in a sense you are trying to provide a health warning to that, which is a difficult job to do. What I have not heard is a really robust strategy for being able to deal with that. There is no criticism of the FSA because I think you are doing an extraordinary job in terms of regulation, but the other side of it is the communications side.

  Mr Tiner: I mentioned the brand, but I think the brand is important in that there is a regulator who is taking care of people's interests, and some people will know the FSA as the Financial Services Authority, and some may be confused about the FSA vis-a"-vis the Food Standards Agency or the Football Supporters Association.

  Q103  Ms Keeble: I had not thought of that!

  Mr Tiner: All are possible, but I think the important thing is that there is somebody taking care of their protection and is important, and we have leaflets. Many of the 16,000 or so leaflets that Callum referred to on equity release are sitting in doctors' waiting rooms. We have the information about opening a basic bank account sitting in post offices—every post office around the country—and so on. So we have tried to make an impact there. I do not claim that we do it perfectly but we try to do as good a job as we possibly can.

  Q104  Ms Keeble: Do you think it diverts you from your other very important job, which is providing regulation and providing the actual security and providing the right regime to maintain a very active financial services industry here?

  Mr Tiner: No, I do not. I think it is part and parcel of trying to create a better market in financial services for retail customers, and I think that there are other countries that separate the prudential responsibilities—the sort of issues you are talking about there—from the market conduct and conduct of business-type responsibilities, and my view is that the model where they are together, where you are able to look at the market as a whole, enables you to provide better quality regulation for the market rather than having it fragmented in that sort of way.

  Sir Callum McCarthy: May I just say that one of the other things that is terribly important is that the industry spends a billion a year or so of sterling on advertising. One of the things that we can do is to bring all our influence to make sure that that advertising is done fairly and properly. One of the things over the past two years that has been put in place has been a much bigger emphasis on our policing of financial promotions. There have been a large number of instances where we have stopped financial promotions that have been inappropriate, and where we do regulate, as distinct from the examples that the chairman gave, where we had no legal powers. We actually managed to stop inappropriate things, made people give redress on occasions and had an influence in that way as well.

  Q105  Kerry McCarthy: You have just set up a scheme to supervise hedge funds. What prompted you to do that now?

  Sir Callum McCarthy: We have always supervised hedge funds in one respect. There are something like 200 hedge fund managers who operate out of London and probably account for between a third and a quarter of the world's hedge funds, and we have always authorised and regulated those hedge fund managers. What we have been concerned to do is to understand this growing asset class better and we have been doing that with a series of exercises, looking at both the prime broker dealers, which are the institutions which I think we can act on most powerfully to have influence over the hedge funds, and about 10% of the hedge fund managers in London, a group of 25 of them, which are particularly big and important, to understand them better and to get better information from them. We have done this because they are of increasing importance in size, because they raise particular issues in terms of some aspects of the financial stability, and they raise issues in terms of consumer protection.

  Q106  Kerry McCarthy: You say they raise issues, but it strikes me that the actual understanding of the financial services industry in general, and the banking world in general, of the extent of their activity and the extent of the risk that they pose is quite limited.

  Sir Callum McCarthy: I think the thing that is limited is an understanding of the strategies that any individual hedge fund manager pursues.

  Q107  Kerry McCarthy: You said that it is very difficult to assess the risk.

  Sir Callum McCarthy: Yes, but I think that that has got better over time. One of the things that we have done in two surveys that we have done of the prime broker dealers is to understand better the degree of leverage associated with the hedge funds, which has significantly improved since the time of LTCM, and by improved I mean has come down and is more logically related to the strategies that they pursue, and to also understand the people who are giving credit to hedge funds, in a financial sense, how much they understand of the strategies being pursued by individual hedge funds and how much understanding they have. Those are the questions that I think have to be pursued and the ones that we are pursuing quite carefully.

  Q108  Kerry McCarthy: You say that you are looking at a group of 25 managers. On what basis did you choose those? Are those the biggest players?

  Sir Callum McCarthy: They are basically the biggest players in the London market.

  Q109  Kerry McCarthy: Is it not the case that it is more likely to be the smaller players, particularly the trader level organisations, which I guess would not pose as much of a risk in terms that they would not have as much capital at their disposal, but in terms of having a slightly less acceptable approach to regulation and supervision.

  Sir Callum McCarthy: There is another question, which is market conduct. We are very concerned to ensure that the very high rewards offered to individual hedge fund managers do not have the effect of encouraging bad market conduct. So we will look across the whole of the market and indeed are revving up and investing heavily in our market abuse surveillance systems.

  Q110  Kerry McCarthy: You did say back in June in a discussion paper that some hedge funds were testing the boundaries of acceptable practices, concerning insider trading and market manipulation. You also went on to say that the incentive structures, light regulatory oversight and weaker control environments increase the likelihood that hedge fund managers will commit fraud. There must have been some evidence which led you to make those comments. Has any important action been taken in recent times?

  Sir Callum McCarthy: We are investigating at least one hedge fund manager in relation to issues about market conduct, yes.

  Q111  Kerry McCarthy: Do you have any picture of how wide these sorts of practices might be?

  Sir Callum McCarthy: No, because they are very difficult to assess. I think an area which is particularly an area of concern for us is in relation to credit risk derivatives and the transfer of information from information about a firm in terms of its debt instruments and transfer of that information into decisions about its equity, and that is an area that we are concerned about.

  Q112  Kerry McCarthy: On the subject of credit derivatives, there has been a problem with delays in confirming trades. What action will be taken to deal with that?

  Sir Callum McCarthy: Early this year we wrote a Dear CEO letter warning people of this because we believed that this was a significant problem. We have been working very closely with the Federal Reserve Bank of New York to ensure that there is, as it were, a pincer movement in the two main hedge fund centres in the world, New York and London, to make sure that people come forward with proposals for how they are going to deal with this. There was a meeting in September; there had been a series of proposals, which are good proposals, from the major broker-dealers about how they intend to deal with it. It is critical that those proposals, as they actually come forward, met this criterion and enabled us to verify what they were doing, because the danger would be that individual hedge funds would use pressure on broker-dealers to say, "Do not bother with us, let us keep on with this practice." We want to ensure that we bring pressure to bear principally on the broker-dealers that they have to spread throughout their customers. That, so far, is working well and the proposals that came forward were reasonable and proper proposals. We, the New York Fed, the SEC are absolutely determined, along with some European regulators, to make this stick.

  Q113  Kerry McCarthy: More generally on credit derivatives, I think you said in your speech to the BBA that you were far from clear that all those who invest in the more complex credit derivative instruments properly understand the risks. What is the FSA planning to do in that area?

  Sir Callum McCarthy: First of all, exhort. I am sorry; I will try to give you a more complete answer. The concern, Treating Customers Fairly, is not just something for the retail market, it also applies to the wholesale market, and there is a responsibility of people in the wholesale market, particularly when dealing with complex instruments, they cannot assume that the purchaser knows about these highly complex matters, and so we are trying to make sure that that is properly understood, and the risks of not doing so are properly understood.

  Q114  Kerry McCarthy: I am slightly concerned that you have used quite a lot of phrases like "exhort" and "put pressure on" and "encourage". That to me is reminiscent of the old-style relationship banking which works very well with the big firms that have got very well established reputations to protect, but I would not have thought it worked so well once you filtered down to the smaller trader level operations. Are you convinced that if you start with the prime broker-dealers that it will eventually filter down?

  Sir Callum McCarthy: If you take the question of the problem of confirmations, the reason we have made clear that we need something verifiable from the prime broker-dealers in terms of progress they are making is that that is the way that we will be able to measure through probably a group of 20 what is actually being done by the much larger population, and it is not, as it were, cosy, clubby regulation, it is a regulation trying to identify where we can bring the maximum leverage and bringing it to bear and policing it very carefully.

  Q115  Kerry McCarthy: And if the discussions that you have been making or the efforts you have been making to get them to comply and to sign up to it and so on, if that is not productive you will consider taking stronger action?

  Sir Callum McCarthy: Absolutely, and I think there is no doubt at all in the minds of the people we have been talking to that not only will we take further action but the New York Fed will take further action, and that is why I described it as a pincer movement.

  Q116  Kerry McCarthy: What is the timetable for assessing the whether the approach you have assumed so far is working?

  Sir Callum McCarthy: It will be in the first quarter of next year that we will see the results.

  Q117  Chairman: I just have a few wind-up questions, if my colleagues do not have anything else, so that we do not miss the issues that we feel should go on the main agenda. I received a letter from Royal London  in October stating that one of the key recommendations of the Treasury Select Committee's report was for the industry to develop a simple system of signalling the inherent risk level of a savings project. The response to this challenge has been disappointing and needlessly slow, and lack of consensus would appear to be the main barrier to further progress, and also dissatisfaction is expressed at the negative approach of the FSA on this. What is your response to this?

  Sir Callum McCarthy: Is this about simple traffic lights, for products, Chairman?

  Q118  Chairman: Yes. You have an early draft of it?

  Sir Callum McCarthy: Yes.

  Q119  Chairman: Some people have seen that early draft thought it was pretty negative and that you are not really interested in it. What is your response?

  Sir Callum McCarthy: My response is that it is absolutely not true that we are not interested. We are very concerned about whether something can really be made to work and we have reservations about the practicality of that. We do, in terms of your Committee's recommendation, think that we can make work what I call a single sheet of paper, two sides approach, which will define the product and the risk, and that would give people a much better approach than a more simple red, amber, green.

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