Examination of Witnesses (Questions 180-199)|
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
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 protectionand 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
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
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 changeand, 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
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
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
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 distributorsand our paper reflects where the
responsibilities lie in that chainfrom 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
Q194 Jim Cousins: I wonder if I could
get you to turn your minds to the famous Plumber caseand
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
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
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
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 themwhich, 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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