Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 1-19)


14 DECEMBER 2005

  Q1 Chairman: Good afternoon. Welcome to the first evidence session on European Financial Services Regulation. We are trying to find our way through the fog of information on European financial services. People tell us anecdotally that there are problems with it, but when we ask for evidence we do not get as sharp a focus as we would like, so if you can tell us about the problems that would be wonderful; and even more wonderful would be pointing us in the way forward on this issue so that we can bring more simplicity and clarity to the whole issue in order to benefit government and industry. I will start off with the issue of the desirability of a single market, because all European action is posited on the notion that a European single market in financial services is desirable. As an institution do you consider that it is desirable and are you committed to it, and do you believe that a single market will lead to benefits overall for Britain? We would appreciate a short answer to that.

  Mr Mullen: First of all, there is the matrix that you could use, and as a Committee you may wish to refer to that, certainly I will and my colleagues will; and that is the distinction between wholesale and retail, which is fairly obvious, but also the distinction between prudential regulation and conduct of business. That is an important distinction, not least because, as you may be aware, under its previous administration the FSA had a prudential regulation/conduct of business split, in the way in which they were managed at a high level, and that has now changed to a wholesale/retail split under this current Chairman and Chief Executive. With regard to the Financial Services Action Plan, often lauded as some 42 measures—in fact many of these were enabling directives and there were arguably 26 that had teeth. In addition to that, the Capital Requirements Directive, which is outside of the Financial Services Action Plan, is a major challenge for all industry and particularly for the banking industry. Also, we have International Accounting Standards and the way in which they would be implemented within Europe. I would say that over the last five years, 80% of the UK's law on regulation in financial services has come by way of directive or regulation for us from Brussels. Within that context, and answering your question directly, from a wholesale standpoint and from a prudential regulatory standpoint, the various initiatives that have been made by the European Union and by the Commission with the support of Parliament have been mostly positive. We are of course in the implementing stage of the Capital Requirements Directive, and I would say that with the International Accounting Standards, whilst by no means fully put to bed—we are in a better place than we were heretofore. With regard to retail, we are now moving to the retail agenda. As you know, the Financial Services Action Plan was predominantly a wholesale initiative; and indeed one might say that there was a wholesale bias towards much of what was involved in the Markets in Financial Instruments Directive. However, now we are moving in Europe to a more retail-biased agenda, and in that case there is not a natural consensus in Europe. Being retail, it is also more of a conduct of business bias. This is exemplified by the European Banking Federation, which is a federation of all the National Associations of the 25 EU states. With the Financial Services Action Plan, overwhelmingly the members of the Association represent virtually the whole of the industry in Europe. The Commission and the Parliament would therefore listen intently to the views of the pan-European industry voice because from a wholesale standpoint that is what we were. Now, commercial banks in Europe are only about 45% of the European banks, and therefore there is a difficulty, and one might say an extreme difficulty, in meeting a consensus amongst the co-operative banks, the savings banks and the commercial banks. This means that from a process standpoint it is very difficult to move forward. The structure that is mirrored by the existence of these three entities makes the move towards a pan-European retail market far more problematic.

  Q2  Chairman: I have to exercise my Chairman's privilege and ask you for shorter answers to questions. That was fascinating, but we have an hour to go through everything.

  Mr Coogan: My simple answer is that a single market is desirable, but we do not think it necessarily would be delivered by conduct of business regulations. Commissioner McCreevy last week described opening up an EU mortgage credit market as their flagship, and the key thing we have been seeking to show is that you can make improvements without routinely going to consumer protection rules as your first step. In terms of how this will impact on the UK, we have relatively few internationally active banks that would be looking to go overseas. A number already are overseas. For the vast majority of members that are locally based—building societies being the obvious example—there is nothing that they would be looking to do in terms of operating in other Member States going forward. There are as many threats as there are opportunities, but the single market as a concept is certainly worth pursuing.

  Ms Knight: I agree: the single market is desirable for financial services. Any firm that operates in more than one country knows that there are different rules, different requirements, as well as different law and different tax in those different countries. Does it make sense to remove some of those differences where possible? The answer is "yes" because it then becomes cheaper for those firms to operate, and that means that things like raising the cost of capital by companies becomes cheaper. However most of this relates to wholesale business. The goal that I think we should be aiming for is for firms to operate cross-border. People do not necessarily need to operate cross-border, they will tend to stay within their own country because they understand how the system works in that country—the same language, the protections and how to get hold of information. There are benefits in a single market, but we need to be very careful about what those benefits are and how we approach the changes.

  Mr Sklaroff: Like my colleagues, the ABI believes that the single market is a desirable objective. Clearly, a great deal of progress has been made in the wholesale area. We need to be careful when applying it in the retail market to take account of both market realities and actual consumer needs and wants, which is something that has been a little bit missing in the FSAP in the past. For those reasons we very much welcome the Commission's recent White Paper, which lays stress on, for example, a more consistent approach to implementation and enforcement of the existing legislative framework; and for us there is a big challenge there because there are still many inconsistencies across the market which we would like to see sorted out. Like many other sectors, the big challenge for our industry is the new capital adequacy legislation, which is currently being discussed in Brussels, called Solvency II for the insurance sector. There is a great deal to be done there to streamline the system.

  Ms Nicoll: We are very, very firmly committed to a working single market in Europe. We represent institutional business, managers who manage pension funds, insurance funds and so on. Generally, that single market works well. The other area we represent is that of investment funds, in euro-speak UCITS, units for collective investment and transferable securities. The issue there is that our members are very, very interested. They are given a passport under that directive, and have since 1985. This has created a certain amount of frustration because the UK is the largest asset management centre in Europe, which means that UK houses are very interested in developing cross-border business. They represent a very large portion of that existing business, but as they move into the single market they find a lot of barriers and frustrations to doing business on a cross-border basis. There are benefits for the UK, as an industry, but also the benefits that we very seriously see are those of economies of scale, and the increased competitiveness of the market, which should mean lower costs for investors.

  Q3  Chairman: This question is to the ABI representative. During our recent visit to Brussels we met with Commissioner McCreevy and we also had the opportunity to speak to the European Federation of National Insurance Associations, which indicated very clearly that many insurers were not actually that keen on a single European market, and preferred to hold onto a stronger competitive position in their own national market, rather than accept a weaker competitive position in an albeit larger European market. How excited are UK insurers about commercial opportunities resulting from a single European market?

  Mr Sklaroff: I think the answer is that they are very excited. A large number of our member companies are UK-based member companies that are doing business in a wide variety of other EU markets, and very successful business.

  Q4  Chairman: Why did the European Federation tell us that very clearly?

  Mr Sklaroff: I am guessing here, but they probably may have had two things in mind. One is that the enthusiasm that we have from the UK market perspective is not always shared in other parts of the EU. I think that would be a fair observation, and I suspect that the European Federation sees that in different emphasis than they get from different national associations which are their members. However, perhaps, more importantly, this is related to one of the points that we were all making earlier, which is that when you come to look at the retail markets, that is individual people buying insurance products, the tendency is—I put it no stronger than that—for people to want to buy those products in their own home markets from people that they can identify as familiar and with a redress process behind that which they understand. Therefore, the objective of a single market is not necessarily in the retail markets a large volume of cross-border trade with individuals for retail products; it is more the kind of thing that Sheila was talking about, which is getting the back office consolidated and therefore reducing costs.

  Q5  Chairman: Give me an example of your members who have got on their bike and gone in there and worked in the retail market.

  Mr Sklaroff: We have member companies that are very active in the motor insurance markets in Spain and in Italy. We have member companies that are active in the life insurance markets in Poland and other parts of eastern Europe. We have many members who are active in the French and German markets in both general insurance and savings products.

  Q6  Chairman: Can you send us a list of those?

  Mr Sklaroff: Of course.

  Q7  Chairman: The names of these companies.

  Mr Sklaroff: Absolutely.

  Q8  Chairman: Because this is a very bright, sparkly presentation here and the reality when we take evidence on that.

  Mr Sklaroff: We will send you a note on that.[1]

  Q9 Chairman: I think your former boss, Lady Francis, when she came before our committee in November 2003, said that the UK's industry efficiency compared extremely well with costs in most other countries' insurance industries, including Continental Europe.

  Mr Sklaroff: Yes

  Q10  Chairman: If there is such a competitive position and the costs are much lower, then there should be more of a drive towards retail financial services. Let me tell you at the outset that the evidence that has been given to the Committee is that the areas of enthusiasm are for the wholesale market but the retail market—"just let us keep our position". Is that right? So therefore what Stephen is telling us here is a bit of Christmas glitter!

  Ms Knight: That is absolutely right.

  Mr Sklaroff: No, I think it is more than glitter. Our member companies are active, but the distinction I am making—

  Q11  Chairman: I will take Angela because that is terrific, what you have told us already.

  Ms Knight: The point is entirely right. We look at the single market from a UK perspective. We grumble about some of the changes, especially some of the detail that is coming along, and we are concerned about what is going to happen here. However, the reality is the greatest amount of change will take place in other European countries. That is the first concern they have got- their change is greater. The second is that, broadly speaking we have got more or less the most competitive industry right now as we have got a large open market place, whether it is for, banks, insurers, private client brokers, mortgage lenders or others. We are already being competitive. Elsewhere in other European countries the market is arranged so that there are protections in place within that country for these different types of business. Some of those barriers are going to open up, and they are worried about what is going to happen to their business. Are the Brits going to walk in and take it? So, the third is that they are afraid of loosing business. I recently had to take out a mortgage in France. There are two things that are always difficult in this world; one is getting divorced and the other is taking out a mortgage, and I have done both! I have to say that it was easier to get divorced in the UK than to take out a mortgage in France! I am not surprised that they are getting worried that some of these barriers are coming down.

  Q12  Chairman: There are two stories here: the story for the wholesale market and the story for the retail market. Is that right?

  Mr Mullen: For different reasons.

  Q13  Chairman: Michael, in our visit to Brussels we learnt that German firms have benefited from selling mortgage products into new eastern European countries such as Poland. Are UK mortgage firms interested in lending overseas?

  Mr Coogan: Frustratingly, not. The simple answer has been that the UK market has continued to grow very strongly over the last few years, and although it is more mature than most in Europe they still see the business opportunities here than elsewhere; but we get a regular drip-feed of people coming in, whether it is eastern Europe—and Turkey is another country—and outside of Europe, asking for our assistance. The UK lenders are too focused on doing what they are doing well here. I share Angela's view, which is that those who have gone overseas want to do more of it. They are seeing that there are barriers in the local markets elsewhere. Some of them are driven by the national legislators and some by supervisors and the rules that apply there; and some by the market infrastructure not being as developed as it is in the UK. All of those things mean that when they make comparative decisions about where to invest and where to look for their next business opportunity, they are not looking into Europe as much as they could do.

  Q14  Peter Viggers: My personal experience is that local markets in Europe can be local, parochial and rather old-fashioned, and that there is a big opportunity here for British interests, where we are much more open to the world. Looking at wholesale financial services first, do you think we are close to a European single market, and are benefits beginning to flow?

  Ms Nicoll: The asset management world struggles with the two. We do not actually recognise the distinction between wholesale and retail. The reality of what happens with us is that we have a retail product but it is sold in a wholesale way. Cross-border business tends to be business-to-business. As far as asset management is concerned, it is a pretty open market. Our concerns in that context are the UK approach tends to be that institutional business can look after itself, but that is not necessarily the approach in a lot of other European countries. The danger that we feel is the concern that we will find some of the protections that are much more appropriate to retail investors being applied to institutional business, which could potentially hold back UK business.

  Q15  Peter Viggers: Perhaps we could have a banker's perspective!

  Mr Mullen: London, as we all know, is, if not the largest international banking sector, certainly one of the two largest. Some 22-25% of all international banking by volume is conducted through London, which is amazing considering that we have less than 1% of the total world population. We are a major player globally, and the industry is hugely important to this country and its GDP. Therefore, we have a strong position, in some markets a dominant position, and we are attempting to defend that. There are threats and opportunities coming with the pan-European market in financial services on the wholesale side. Obviously, economies of scale and scope are there and should be welcomed and the opportunities taken. However, from a law and regulation standpoint, the phrase that I use is: "London is `markets optimistic' whereas Continental Europe is `policy optimistic'." The single most competitive element that London has is the fact that it has its own self-regulation in the wholesale markets; and that regulation could come under threat through the more policy-optimistic tendency of Continental Europe. There are advantages, but there are challenges.

  Q16  Peter Viggers: We have been accused of Wimbledon-isation, have we not? We provide the place where people play but we do not have good players!

  Mr Mullen: I am not so sure that "accusation" is the word. I think that we take advantage of the openness of the UK economy, practices and policies. It is to our considerable advantage that we have London as a financial centre and the rest of the world comes to compete in London. It should be seen as a European asset in the world, not so much a UK asset—London as a UK asset.

  Q17  Peter Viggers: To the Association of British Insurers, in your submission you said this: "Europe's retail insurance markets remain largely local for deep-rooted reasons relating to consumer preference, the local nature of risk, and national tax and security systems." I endorse that from my own experience. How feasible is a single European market for retail insurance products?

  Mr Sklaroff: I think the issue is what one means by a single market. If we mean a completely uniform market for retail products, so the same product of the same design at very similar prices, sold to people right across the EU—that is not a realistic objective. What is a realistic objective is a genuinely open and contestable set of local markets; in other words there should be no artificial barriers to companies from any part of the EU coming in to a local market and competing in that local market to sell products that are sensible for the people in that market.

  Q18  Peter Viggers: The idea has been floated of a so-called 26th regime, which is a regime that is European but without being rooted in any particular Member State of the European Union. What is your attitude to that? Scepticism has been expressed about this, so can I ask each of you very briefly to comment on whether you think this is the way ahead or whether it is a cul-de-sac.

  Mr Sklaroff: It is something that is certainly worth exploring. One has to be very careful about what part of the market it would work for, and one has to think through what the consequences would be. If you create a 26th regime, you create something that, by definition, runs in parallel to existing regulatory structures, and there is a whole series of issues about how that works if a consumer has a problem with a product that has been sold under a parallel regime. We do not dismiss it out of hand, but it would be fair to say that we share a little bit of the scepticism about practicality.

  Ms Knight: I think that a 26th regime is looking at things the wrong way round. Instead of having a new regime, it is necessary to consider what are the problems we have got can they be resolved by other means or is it really necessary for a directive or new regime to resolve them. I do not think it is possible to say "yes" to all that and so instigate a 26th regime. Are we getting a better single market at the moment? It is too early to judge because of all the legislation that we have been discussing with respect to the Financial Services Action Plan and so forth the main directives have not yet been implemented, so we are not going to know whether we have got a better market and whether we can solve a lot of the problems both for easy access for wholesale and also for the individual to have a better choice safely, until we have got through the implementation stage. I consider that the 26th regime is one of those matters which should be parked with those who discuss policy, as the practitioners will all say, "no, there are other ways probably of getting there. A 26th regime is a last resort, and certainly we are not there by any manner of means".

  Mr Coogan: From the mortgage perspective we flagged up in our response on the Green Paper that there may be merit in the funding group that the Commission is setting up, looking at how the covered bond legislation is operating across Europe. There have been discussions as a result of the fact that the UK does not have its own legislation. We have been able to enter that market strongly without legislation. In other countries, they may feel that they would like to address that weakness. I suspect that the 26th state approach may not get to the finishing line, but there is still some debate to be had in some areas in the next few months, certainly in funding in the mortgage market.

  Q19  Peter Viggers: The European Commission has promised a better regulation agenda. Have you seen results of this? Do you think that in practice they will be able to avoid legislation where there might be a better alternative available?

  Mr Coogan: Perhaps I could start off, having lived through 18 months of this better regulation agenda, which they called the Forum Group on Mortgage Credit. It is very important before launching into new initiatives that you get the views of all the stakeholders, and that initiative has worked very well from the point of view of bringing the industry, consumer bodies and other interested bodies together over a series of months to talk about a lot of issues. This led to 48 recommendations to the Commission and the Green Paper that it has just received responses on. It was not an easy process because even after 18 months, groups of the organisations could not agree on the way forward, so there were differences of approach particularly in consumer protection areas between the different organisations. That is reflected in the Green Paper. As a way of identifying obstacles and trying to get priorities for the Commission to take forward, and also to flesh out the obstacles that others may be able to take forward through improved market efficiencies, it has a lot of merit. How easy it would be to replicate in other areas, others may wish to judge; but on the retail side we would not wish to be rushed into new initiatives without that level of detail and over a period.

  Ms Nicoll: In the world of asset management, the Commission is, one would hope, presaging a new approach. Recently the Commission produced a Green Paper on Enhancement of the EU Framework for Investment Funds. It was a very good piece of analysis, based very much on wanting to understand how the market operates. We very much welcome that approach. As a result of that, there is now very broad consensus in the industry about what should be done to go forward. The one thing we would say is that whilst we fully support the need for very close analysis, we sense that we may be about to enter a world of analysis paralysis, that sometimes such analysis can be an excuse for not taking action. As an industry we have been discussing a number of these things for two years. You have to remember that timescales in Europe are much longer than timescales in business, and it will be important to do lots of analysis to make sure that action follows.

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