Examination of Witnesses (Questions 100-119)
SIR CALLUM
MCCARTHY
AND MR
JOHN TINER
8 NOVEMBER 2005
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.
| 
