Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 180-199)

SIR CALLUM MCCARTHY AND MR JOHN TINER

24 OCTOBER 2006

  Q180  Mr Love: Could I interrupt you there, because I want to investigate this balance between self-regulation and regulation itself. But let me ask you this first: there has been a lot of criticism of the report, that it was rather superficial. You visited five firms in three days in Mumbai and five firms in Bangalore in six days. Do you think that is adequate supervision for this type of report in the light of some of the concerns that have been expressed?

  Mr Tiner: Yes, I do. That is not to sound complacent but our style of regulation is not to send armies of inspectors around to visit companies. That goes to the core of how we regulate. We have, in total, about eight people on HSBC and the Federal Reserve might have 50 people permanently on Citibank. It just shows you a difference in the way in which we regulate. We would expect that it is not us that spends a lot of time on site in Mumbai or elsewhere, Bangalore or wherever, but that the outsourcers, internal auditors, risk-management compliance people would do that and have a responsibility to report to their management.

  Q181  Mr Love: Coming back to this issue, which I think is absolutely at the kernel of this problem about whether it is self-regulation or whether there should be greater regulation from the FSA, there is concern that you are accepting the assurances that are given to you by those companies which seek to outsource, yet there is increasing evidence of difficulties arising, and Dispatches is the latest in a series of exposes about this. Are you sure that there is not a greater role, a more direct role for the FSA, in regulating this sort of activity?

  Sir Callum McCarthy: I think it is really important to understand both our legal powers and our policy. Our legal powers are in relation to regulated firms which are, for example, banks, a securities company, whatever it is, based in the UK, and we absolutely do that. For the reasons that John said, we make it clear to the senior management of those firms that there is no way that they can avoid their responsibilities by outsourcing, whether it is outsourcing somewhere in the UK or elsewhere. As part of that, we will test very hard the ways in which they control, initially set up, police any outsourced activities, so, in addition to the visits that you mentioned to Mumbai and Bangalore, there is all the effort that goes on in the UK looking at the systems that whichever is the bank in the UK has to control its outsourced activity.

  Q182  Mr Love: I understand that. Let me quote briefly from the report. It says: "Most of the third party suppliers firms choose to use in India are BS7799 (British Standard for Information Security) certified." Is there not a terrible air of complacency about that; that you just simply accept this and that is the end of it?

  Sir Callum McCarthy: I would go back to what John said. I hope there is not any complacency about it, because the whole issue of outsourcing raises important issues of control, prudential issues, consumer-protection issues, which are absolutely essential to us. That was a statement which happens to be a true statement.

  Q183  Mr Love: You suggest in the report that offshoring is not inherently more risky than outsourcing but you then go on to say "the main risk identified is the complexity of achieving suitable management oversight and control from a distance." "From a distance" suggests to me that there is a greater inherent risk in offshoring than there is in outsourcing. Would you agree with that?

  Mr Tiner: I think there may be. I would agree. But I think it is a question of degree of risk. The important thing is that the responsibilities of the people that we regulate remain the same. I can see your point, clearly, that inherent risk when something is 4,000 miles away and subject to different types of regulation/different types of management is higher than if it is 20 miles down the road and you can pop down and make regular visits, but, from our point of view, the responsibilities of the board remain the same.

  Q184  Mr Love: It says in the report, in paragraph 70, that "there is no evidence to suggest consumer data is at greater risk in India than in the UK". There has been the Dispatches programme; there was an expose previously about fraud at Citibank. Whether that statement was true at the time the investigation was carried out, I would not seek to comment, but are you still convinced that statement is true today in the light of your recent experience?

  Mr Tiner: We are not going to sit on our hands. When we have got more recent evidence that there may be problems then we will definitely follow it up. I cannot tell you today that that statement that we made when we published that paper remains the case, without further work, but I think what you are asking us to do is quite right. Given the increase in offshoring activity and the inherent risk to which you referred, it is fair that we should be looking again at that area to see whether there are new risks about data protection—and not just about data protection but about criminal activity that might go on within offshoring activities.

  Q185  Mr Love: I think the FSA's primary concern here is consumer confidence, that their data is not being abused in the way that has been suggested. Let me ask you one final question. The Information Commission, as a result of the programme, has said they will be carrying out an investigation to discover the true facts behind all of this. Do you have any involvement with that? Are you in contact with them to ensure that your role is adequately represented in their final report?

  Mr Tiner: I do not know. I need to establish that and write to you. I could not tell you at the minute.[4]

  Q186 Chairman: Andy referred to consumer confidence and you referred to the business model changing, and Peter referred to your speech at Gleneagles, Sir Callum, and I was there listening to it, but at Gleneagles you said that the business model was based on commission incentives which produced "results which are unattractive to reputable providers, unattractive to their customers, and whose benefits to intermediaries are questionable." You also said that it is distinguished by a focus on business volume rather than quality; that persistency of policies is very low, with half of the customers who buy regular premium personal pensions no longer paying them after four years; and at the end of the day the sum picture is one that is incompatible with developing either the reputation of the industry as a whole or a brand reputation for individual companies. There is a persistency to commission in the industry, and, as one who has looked at it for quite a few years, I would see it very hard to change that model. What will be the triggers to change that eventually, in your optimistic opinion?

  Sir Callum McCarthy: One of the things that is recognised in a growing way by the firms themselves is that the business model that they have is unattractive in the ways that I described. I think there is a business imperative for them to change—and, if they do not change, there will be new entrants who will emerge with different business models. That is one thing. In relation to what we can do: we are concerned very much to try, first of all, to identify this problem; second, we are doing a whole series of things in terms of treating customers fairly which are going to make it more difficult for people to use the traditional commission model without recognising the need they have to mitigate the risks that they are running by using that commission model. The other thing which I think is going to be important is the work we are doing on a survey of what is the distribution system. We want to identify a whole series of things, including where there may be regulation that is exacerbating the problem, because if there are places where there is excessive regulation, where it is not justified, we will want to change it.

  Q187  Chairman: At the same conference, Ned Cazalet quoted figures for the industry, where he said that £56 billion has come in over the past five years but £31 billion of that is churning. There are people making quite a tidy sum for themselves in that area, but the consumer is losing out at the end of the day. In order to restore confidence in this industry, it seems crucial that this model is changed. Can it be done just by encouragement from the sidelines?

  Sir Callum McCarthy: I do not think it can be done just by encouragement from the sidelines, no, but I think, first of all, that there is recognition among the firms that the position that you have described is deeply unattractive. There is the fact that we are going to make it more difficult for people simply to administer the commission model in the way that it has been administered in the past, without recognising their responsibilities, and I hope we will be able to bring pressure to bear on an industry which already recognises that the present position is in many ways unattractive, for them as for their customer. I think it is a significantly unattractive position we have got and we are trying to change it.

  Chairman: Okay. The best of luck, Sir Callum, and we will be watching you, hopefully not from the sidelines.

  Q188  Jim Cousins: May I pursue one aspect of the issues raised by my colleague Mr Love. If, in the offshoring process, the administrative functions and processing functions are handed over to the completely free-standing company that is contracted to perform those functions, does your regulatory reach still apply?

  Sir Callum McCarthy: It is because of that that we make it clear to the firm that we regulate that the fact that they have taken a particular function and given it to somebody else does not in any way exclude them from their responsibilities. As part of that, we would want to have the same ability to test the way in which an outsourced company, whether in the UK or offshore, discharges its responsibilities for a regulated company as we would if that activity were taking place within the regulated company.

  Q189  Jim Cousins: I am not here referring simply to geographical location but to a switch of responsibility from the company that is running the operations, that is interacting with the public, and the company that is responsible for the processing operations.

  Sir Callum McCarthy: That, I think, brings us back to the paper that John referred to, which we published at the end of September, about the responsibilities of distributors versus producers. We are trying to ensure that it is not possible for a producer to escape from responsibilities that are properly theirs simply by having, as it were, a cut-off between their activities and the activities of the independent distributor.

  Q190  Jim Cousins: What is your understanding of the legal position about that in terms of the Financial Services and Markets Act?

  Sir Callum McCarthy: It depends on the circumstances, I am afraid is the answer, because it is possible to see some circumstances in which the producer reasonably has no responsibility and it is also possible to think of other circumstances where they clearly do have responsibilities. I am sorry to give you an answer of that nature, but if you look at the document that we published you will see that we teased out a series of circumstances where the responsibilities would be very different and it does depend essentially on the facts of the case.

  Mr Tiner: It is very complicated, because in many cases there are two types of producers and one distributor. It may be that one of the big Wall Street investment banks may find a way of disaggregating a very complex product trading in the wholesale markets, which they would then arrange with a retail producer to package for the retail market, who would then go to distributors—and our paper reflects where the responsibilities lie in that chain—from very straightforward products, where there are clear contractual agreements between producer and distributor which would need to be complied with. It is not straightforward. More broadly, going to the question of outsourcing to companies that are not regulated, the important thing is that that is not a switch of responsibilities. The responsibilities lie squarely with the firm we regulate.

  Q191  Jim Cousins: Turning to a slightly different topic, there has been a great deal of interest in the United States about the exercise of stock options. Is this something you have considered?

  Mr Tiner: Yes, to some extent. The laws are different and the accounting is a little different in each country. You are allowed to issue in-the-money stock options here. It happens. There is a requirement to notify the market within five days if that is done and we have not discovered difficulties with that. Any issue of in-the-money stock options, I think, has to receive shareholder approval here as well. We are interested in this. We are reminding people, through the paper that we call List (which is the way we communicate with the public companies that we authorise through the UK listing authority) about this, but we have not found the same degree of backdating that they seem to have discovered in the US.

  Q192  Jim Cousins: Have you discovered any degree of backdating?

  Mr Tiner: No, we have not.

  Q193  Jim Cousins: Will the transparency directive throw more light on these procedures?

  Mr Tiner: I do not think it will.

  Sir Callum McCarthy: I do not think so, but could we just check on that? I think the answer is no.[5]

  Q194 Jim Cousins: I wonder if I could get you to turn your minds to the famous Plumber case—and I am here not referring to the Polish gentleman that the Governor of the Bank of England welcomes to our shores. Are these expenses, for which you will now be liable, known?

  Sir Callum McCarthy: Not yet.

  Q195  Jim Cousins: Are they likely to be substantial?

  Sir Callum McCarthy: I cannot tell you because we have no idea of what claim Mr Davidson and Mr Tatham will make.

  Q196  Jim Cousins: Your 2005-06 annual report shows a situation of expenditure on enforcement of £33 million roughly, roughly half of which is covered by penalties. Will the outcome of the Plumber force a re-write of those figures?

  Sir Callum McCarthy: They will not cause a re-write of those figures, because I think we will treat them as a cost in the present year, not in relation to past years, but we will recover whatever the costs are eventually agreed by the tribunal in the only way we can recover; that is, by spreading it across the fees that we charge to the firms and individuals we regulate.

  Mr Tiner: I think it is important to point out that the money that we raise from fines does not go to abating our costs. That was very clear at the time the Bill was going through Parliament.

  Q197  Jim Cousins: That is clearly set out.

  Mr Tiner: Is that clear? I thought that was part of the implication. The £33 million of enforcement last year stands on its own, irrespective of the fines we recovered. Obviously, otherwise, we have the wrong sort of incentives ourselves.

  Q198  Jim Cousins: In your annual report you set out some risk-assessment procedures to inform board members of the work of the FSA. Will your own internal procedures before taking enforcement actions be one of those issues that you will bring to board members under those risk assessment arrangements?

  Sir Callum McCarthy: Last year, in the light of the L&G case, we set up a committee of the board to review the whole way in which we approached our enforcement cases and made a whole series of significant changes to them—which, incidentally, in the decision on the costs in the case of Mr Davidson and Mr Tatham, the tribunal recognised would have, in their view, resulted in a different set of decisions being taken by the FSA in relation to those cases. The answer is: yes, the FSA board is integrally involved in the risk assessment of our enforcement process, and has been, and I expect them to continue to be.

  Q199  Jim Cousins: That is an interesting point. You have already indicated that both the Legal & General case and later on the Plumber case are going to lead to changes in the pattern of your enforcement action. How much less enforcement action is there going to be?

  Sir Callum McCarthy: I do not think it will necessarily result in a reduction in our enforcement action, because we will take enforcement on the same basis that we do at the moment.


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