Select Committee on Treasury Minutes of Evidence

Examination of Witness (Quesitons 40-59)


10 OCTOBER 2006

  Q40  Angela Eagle: That is very interesting. I was also interested in your comments on financial promotion, and the fact that breaches of the rules seem to be extremely widespread. I think the overall percentage of non-compliance with the rules is 57%, which is bad enough, but it went up to 79% in general insurance promotions, and 47% in mortgage promotions and 43% in investment promotions. The key issue here is that if some people are breaching the rules and basically paying for dodgy adverts you are rewarding the bad people instead of rewarding good behaviour; because everybody else thinks, "Well, if they're getting away with it, we've got to do the same and its our competition". What do you think can actually be done? Do you think breaches of the rules are being handled well enough or there should be bigger penalties for breaches of the rules?

  Mr Howard: The Panel feels that the solution to this is in making financial promotions an exception to the rest of the FSA's regime, and that here we would like very quick naming and shaming, because I think that is the way that you bring the marketplace into line over this quite strict advertising rules regime. At the moment the FSA has the policy of seeing an advert, maybe in a Sunday newspaper, which is in breach of the rules; on Monday or Tuesday the staff will ring up and negotiate with that individual firm to make sure that advert does not appear again, or negotiate a way in which it can be altered for the next time it is published, and it is left there, which means that the advert has gone out on Sunday, other parts of the industry may have seen it: "Look what they have done;" (because they are all watching how each other is advertising) "maybe we could get away with that", and so the fact that the FSA has decided that something is not clear, fair or is misleading is not communicated to the marketplace.

  Q41  Angela Eagle: It is all in retrospect; it does not actually stop the breaches happening, does it?

  Mr Howard: No, but that is because the FSA, unlike the Advertising Standards Authority, does not feel it is able to provide advice on advertisements before they appear.

  Q42  Angela Eagle: You say that if we could give the FSA a kind of Advertising Standards Authority role that would need a change of the Financial Services Markets Act. Is there some other way that does not require primary legislation in which we can actually get a handle on this?

  Mr Howard: There is, but the Advertising Standards Authority is a voluntary industry code, and perhaps that is the way forward for the FSA: to maintain those rules but to encourage a voluntary code amongst all financial services advertisers which would allow those enforcing that code to immediately publicise adverts which are breaking the rules. So there is a model for that.

  Angela Eagle: That is a very interesting suggestion.

  Q43  Kerry McCarthy: Does the FSA's move away from a rules-based system of regulation to a principles-based system cause you any concern?

  Mr Howard: We support the move to principles-based regulation, but a number of things that have started to crop up worry us. The first is that the industry, being so wedded to the idea of rules, especially compliance officers who seem to hold on to rules like a handrail to save themselves from falling into the arms of the regulator, still wants some sort of rules, and it looks as if they are tending towards creating their own guidance and codes. The worry about that, of course, is that you are setting up here a system of self-regulation if you are not careful. What particularly concerns us about that is that at the moment any rule changes have to be subject to wide public consultation; the FSA ensures that; that is the way it works. If the industry starts creating its own codes and guidance what public consultation will there be about those? So there is a real concern that although the FSA maintains the high principle, basically, of treating customers fairly, the way "fairness" is interpreted by the industry, if left to its own devices, may not be as fair as we might think and the Financial Ombudsman Service might think. Once you have created guidance and codes you have to wonder about their status in the marketplace. Will those codes be something that the Financial Ombudsman will have to take account of, or will he say: "We are not having anything to do with those"? So the status of them is extremely important, I think. One of the other big concerns that we have about the way that this will work is that the FSA itself will have to change the job of its supervisors because at the moment they are enforcing rules, and that is a job which you can do, reasonably well trained to a certain level, to enforce those rules. If you are now going to a principles-based regime those same supervisors (or, maybe, the FSA has to look for different people—it depends what you think about the qualities that are needed) they will have to exercise judgment, and quite sophisticated, judgments in this area. So that is going to be a very different role for those FSA supervisors to undertake. We think there are risks there.

  Q44  Mr Breed: I agree with all that but the smaller firms are going to find it very difficult to challenge because, presumably, what you are saying is the FSA decides what the principles are and the FCS decides what the definitions are. "If you do not like it, hard luck; come and challenge us". That might be all right if you are the Prudential or something, but if you are a tiny company and your ability to challenge the FSA is either going to be costly or difficult, or both, why should there be a system whereby some particular body not only lays down rather general principles but when the specific comes up decides what the interpretation will be?

  Mr Howard: That is the difficulty of moving to principles, is it not? The big advantage of moving to principles is that with rules you have always got gaps between the rules which can be exploited by companies who want to exploit the gaps between the rules. If you have got a principle then there are no gaps, or there should not be, but it is open to someone's judgment. I think that is a very difficult issue. It is clear now the FSA has got to do a lot of thinking down the line to see how this is actually going to work in practice. You have highlighted, I think, one difficulty for small firms. I think the advantage that small firms have is that they are already, one would hope, closer to what the FSA, in my view, is trying to achieve. Small firms know their customers, maybe, much better than large firms do, and if you are moving to a principles-based form of regulation what you are trying to do is encourage large organisations which are anonymous to have a more human face; to be able to look at individual cases and say: "On the basis of your individual case, Mr So-and-so, we think we have treated you unfairly and we are going to recompense you." If a small firm is already much closer to its customers and thinking about its customers and their point of view, one would say that they stand a better chance of getting it right. They have not got all these systems in place, all the rules that have been imposed from head office, which bind them into making decisions which may be unfair in individual cases.

  Q45  Mr Todd: What do you think the FSA should actually do? You said they should think about this issue—I am sure they are doing that.

  Mr Howard: So are we. There are a lot of issues down the line in all of this. The FSA says: "We have got 8,500 pages of rules and we really want to slim those down." The way to do that is to have high level principles and then you can ditch a lot of the rules, but I think it is already acknowledged that you can never get rid of all the rules. So now I think we are starting to think how many rules can you get rid of—can you get rid of half? Can you get rid of three-quarters?—and maintain the confidence in the industry but allow the degree of flexibility for them to make more appropriate decisions on behalf of consumers, decisions that are fair. Leave them the latitude to make decisions with individual consumers which are fair.

  Q46  Mr Todd: Is there a methodology they should follow in deconstructing their rulebook along those lines? What you have basically done is repeat the statement they need to think very carefully about this, with which I think we would all agree.

  Mr Howard: What we are waiting for is to see which rules they are actually going to dump. We have not seen that yet. Which ones are going to be struck out? We are waiting with bated breath to see how they approach this. It is their idea. We will give them the latitude of thinking how they are going to do it, but we reserve the opportunity to—

  Q47  Mr Todd: The impression I have is that it is their idea that you do not entirely endorse.

  Mr Howard: We endorse the idea of reducing the size of that rulebook. We like the idea of moving to principles but we would be very concerned if we just replaced the rulebook with 8,500 pages of guidance and industry codes.

  Q48  Mr Todd: You have suggested that a far broader approach should be taken to measuring the benefits of regulation. How do you think that should be done?

  Mr Howard: I am sorry; could you explain what you mean by that?

  Q49  Mr Todd: The Panel has suggested that the FSA needs to take a far broader approach to measuring the benefits of regulation. How do you think that should be done?

  Mr Howard: Again, I have not got a solution but I would hope those with much greater knowledge and experience might be able to come up with one. The work they have done on benefits at the moment is through an organisation called Oxera which looked at a framework of how the benefits might be quantified. If I can give you an example of how I think it is difficult to quantify the benefits in trying to balance out costs and benefits, it is when you think about market confidence. How do you evaluate a particular change in rules or a particular decision made by the FSA when it comes to the level of market confidence that that decision might engender? There is no doubt that we all feel that confidence in the marketplace is the big missing element at the moment—there is huge lack of confidence on the part of consumers. If you start to undermine the regulatory process you damage that confidence even further. So that has to be a big benefit in the equation and it is very difficult to measure the benefit from individual actions taken by the FSA. I think that is the problem that we are up against.

  Q50  Mr Todd: I think the report you referred to indicated that perhaps too much stress was placed on the economic efficiency argument of regulation and its benefits as opposed to the supposed benefits to the consumer in terms of outcomes—say, addressing financial exclusion or something like that. Do you agree with that view?

  Mr Howard: Yes, there are clearly consumer benefits that you can measure, like the degree of advice available, the quality of that advice; you can measure those sorts of things, but there are a number of aspects as I have indicated there that it is much harder to measure. I think we must try and do that because it is no good just saying: "This costs an awful lot so we will get rid of it"; you have got to see what it is doing on the other side of the equation; you could be undermining the marketplace even more.

  Q51  Mr Todd: Do you feel that the proposed widening of the range of funds that could be marketed direct to retail investors is being addressed appropriately? You have expressed a concern there.

  Mr Howard: Yes, that the FSA could not identify consumers who were more sophisticated and able to deal with more sophisticated products. We thought it was disappointing that they had not been able to grasp that nettle—a little bit like the risk-ratings, I think they felt that it was too troublesome for them but, perhaps, did not deny it would be valuable to do it if it could be done. I still think there must be ways of doing that to discriminate between different sorts of consumers to enable those products to be more specifically targeted. One of the things that the FSA's approach to principles-based regulation says is that in the design of particular products you must have the target market in mind. If you cannot divide up your target market how are providers going to be able to target? So I think the FSA, although it said: "We are not prepared to do this", is still expecting someone else to do it—maybe in the industry—because they have got to clearly identify their target market when they are designing the products and selling them.

  Q52  Mr Todd: So, clearly, it is inappropriate to market hedge funds to unsophisticated consumers. What ideas do you have as to how they can separate out consumers into groups who could possibly handle those sorts of opportunities for themselves?

  Mr Howard: I think their previous history has got quite a bit to do with that. If they have a history and a background of investing in products then they are more likely to have an understanding of what is going on. There is also a role here, I think, for the FSA's task in educating consumers and providing them with more knowledge and background. If the FSA can tackle that and deal with that in a way which becomes effective and spreads knowledge and experience round the marketplace then that is going to help, too.

  Q53  Chairman: Regarding hedge funds, if funds were being distributed to retail investors would you agree with that?

  Mr Howard: That clearly spreads the risk but I am still worried about the nature of those products. When you look at the FSA's research, which says that most people do not recognise that an equity ISA is invested in shares, you do worry, don't you?

  Q54  Mr Newmark: I have been involved with financial services for 20 years and every year that goes by is the same message: the regulations are getting more and more complex and there is an inverse relationship between those that you want to protect and the increasing complexity of the actual warnings or health warnings that go with them. I have been sitting listening to you and I still get no warm fuzzy feeling in my stomach that, at the end of the day, for those that we ultimately want to protect, which are the widows and orphans and the most vulnerable of investors, you have a solution, other than sticking something up which says caveat emptor (most of which they would not understand but "let the buyer beware" which is the simplest message that you can give). Really, what is it you are going about in any form of granularity to simplifying it, as you said at the beginning of your talk, and trying to give these health warnings in very simple terms? Most people switch off as soon as the health warning comes on, whether it is over the 'phone, on the TV or even the microscopic print which you need a microscope to actually read, and they do not actually help the consumers we are trying to protect. I still do not know where you are heading in terms of protecting those people.

  Mr Howard: Shall I give you my solution, for what it is worth (which does not have Panel endorsement, by the way)? This is how I view the marketplace and how we might try and deal with this. First of all, there is no doubt that the most influential interaction is person-to-person, so an adviser to an individual consumer is the most influential arrangement. My suggestion would be that what we need is an easy entry point for all consumers to advice, to a generic advice service. So that they would go along to a generic advice service and get very basic advice about their situation, which may end up with them being told: "Well, what you need is this particular product now. You have got everything else sorted out; you need this particular product; now go out into the marketplace and find an independent financial adviser who is not paid for by commission but paid in some other way, who can give you truly independent advice and get a product suggested by him as the best one for you in your circumstances." So we need a generic advice service and then we need independent financial advisers who are not financed by commission. This is my design. I think the generic advice service will then take out a lot of the work that the independent financial adviser has to do in the first place, and make their model of advice more economic, because the generic advice service will have done a lot of the groundwork, the basis—"Pay off your debts first". That sort of advice will be taken out of the equation.

  Q55  Mr Newmark: A great model, but who pays for it? The people you are trying to protect are those that invest least and have the least money.

  Mr Howard: There are now, fortunately, a number of possibilities coming through. I think Resolution Foundation's latest research shows that there are huge savings to be made if you set up a generic advice service. Also, the new savings bank which will use the unclaimed assets is another possibility for providing finance for a generic advice service. Can I give you one example from the Panel's own experience of the level of advice that can be beneficial? We took a trip to Glasgow and we were struck by the number of cheque-cashing services there were in Glasgow—shops where you go in and cash a cheque. When we enquired further we discovered these cheque-cashing shops charged 15% of the value of the cheque to cash the cheque. A lot of the people going into those cheque-cashing shops were going in there with cheques they had acquired for loans to get them through the next month or the next period. They were not very large sums of money but 15% was being taken out in a cheque-cashing shop. It does not need a terribly sophisticated advice service to point all those people to a bank or to credit unions. The level of advice need not be terribly sophisticated but you can save some of the poorest people an enormous amount of money overall.

  Q56  Chairman: You have given us simple solutions to very complex problems. We are grateful for it all the same.

  Mr Howard: I do not mean to suggest that it is completely easy.

  Q57  Chairman: We have looked at it as a Committee and we are still looking at it in the financial exclusion report. Last question: the FSA is currently undertaking a review of its regulation of the general insurance market. What outcomes would you like to see from this process that would benefit consumers?

  Mr Howard: The general insurance market?

  Q58  Chairman: Yes.

  Mr Howard: One of them would be that they again look at the remuneration model that we have got here. At least in the other areas the commission paid is disclosed but in insurance it is not. I think that would be helpful. The outcome that consumers really need at the end of the day is to be able to rely on and feel confident in the sales process; that they are getting all the information that they need; that they are getting a product that really does suit them and then, at the other end of the chain, that their complaints and their claims are dealt with efficiently and effectively. So those are the outcomes we really want to see being targeted by the FSA.

  Q59 Chairman: Thank you for your evidence this morning, Mr Howard. We are very grateful to you for that.

  Mr Howard: Thank you.

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