Q 128Sir Peter Viggers: To what extent have your members reached a situation where they are confident that they now know the true value of their assets? To what extent are their balance sheets still contaminated by toxic assets? By way of illustration, I think that the nearest analogue to the present situation is Lloyds of London. Lloyds made a point of identifying and isolating the toxic assets in the so-called spiral and then moving on. Are your members at that stage? Are they doing that?
Angela Knight: No. Lloyds put them into Equitas and floated it off as a different vehicleI recall it as well. We would say that they know exactly where they stand. There are still a number of imponderables, however, which are related to the valuation process of illiquid assets. Illiquid assets are not necessarily bad assets, but assets for which there is no market at the moment. The process for how to value them changed from about 10 October, when the US changed its valuation rules and allowed a valuation that included a reflection of the income stream. That meant that one went from having to try to determine the value of a product using mechanisms that were no longer particularly appropriate, to using mechanisms that were appropriate. That has started to clarify the issues very considerably indeed, but the difficulties are not just the result of exposure to particular types of complex US sub-prime, although that is where they start, and undoubtedly there is that exposure around the world. There has also been a loss of confidence in an asset class generallythat is, housingin many jurisdictions, which has fed through to ordinary assets that one would never even remotely call particularly complex. There are many factors involved. On the specific question, the new valuation rules are significant.
Jonathan Taylor: I would agree with that general description of where we are. In other words, I think that at this point there is something approaching certainty, but I would not want to put it more strongly than that. I would be comfortable with that.
Q 129Ms Sally Keeble (Northampton, North) (Lab): This is a question for Adrian. Given that building societies have not had the same track record of failure, are you concerned that this package of reforms might be applied to you although you are not part of the problem?
Adrian Coles: No, we do not believe that we are part of the problem, although I would not claim that building societies will sail through the recession without any difficulties whatever. We have already had announcements of two building society mergers, which were necessary to ensure that the building society sector maintains its record as a safe haven for investors funds.
We are keen that building societies are perceived to be, and are, as safe as banks that are covered by the legislation, so we took an early view that the legislation should cover building societies in exactly the same way as banks. It would be wrong if some of the mechanisms that could be applied to a bank in difficulty were not available to a building society in difficulty and, as a result, some investors somehow got the perception that a building society investment was less safe than one in a bank.
We are supportive of the additional clauses in the legislation that say that the provisions that apply to the banking sector also apply to the building society sector. We think that we would be in a weaker position if they did not.
Adrian Coles: We have already covered one of the most important ones, and that is the FSCS meeting the costs of a bank or building society in the SRR. Most building societies will never go into the SRR but will still have to meet the costs. Also, single customer information must be kept in the way prescribed by the FSA for FSCS payout. That could impose significant costs on small institutions, but the huge likelihood is that a small institution would be taken over by a larger one rather than go through the FSCS procedures. Therefore, the effort of organising affairs in a way that the FSA wants would be wasted for small and medium-sized building societies.
Q 131Ms Keeble: Are you concerned about the pre-funding arrangements, if they come in? Given the benign track record that building societies have had, do you feel that they would be unduly onerous?
Adrian Coles: As I indicated to Mr. Bone, if we moved to pre-funding, it would mean taking a lump of money out of building societies capital, which is there to protect their depositors, and putting it into the compensation scheme. I do not think that is particularly helpful. If there were a requirement to keep capital
Ms Keeble: But that is a general comment. The point about pre-funding is that, to some extent, the cost has to be related to risk. The risk for the banks could be quite substantial, but you could make a case that the risk for the building societies is slighter, given your track record.
Adrian Coles: Yes, I was going to say that if there were a requirement for pre-funding, and if there were a requirement to keep capital at the current level in building societies, the only place the money could come from is higher mortgage rates or lower saving rates for building society customers.
There is also a strong view among many building societies, which I think the Building Societies Association would now endorse, that there should be some elementwe have not fully worked it outof risk-related premiums. Building societies certainly find it galling that they have to contribute to payments that are being made in respect of institutions that have not been run as prudently as building societies.
Q 132Ms Keeble: On the trigger mechanism, would any variations be required for triggering the SRR for building societies in comparison to banks, given the very different sort of models?
Adrian Coles: Clearly the mechanisms by which the SRR is implemented and by which public authorities might take control of a building society will be very different. You cannot buy shares in a building society, for example, but we have not identified particular differences in the overall approach that we would wish to apply to a building society compared to that which we would apply to a bank.
Q 133Mr. Bone: To return to a point that was made earlier, I found the answers that were given to Sir Peters question about the balance sheets of the banks extremely interesting. In the balance sheets of the banks last year, you had some assets that have turned out to be worth much less than had been thought, so the banks have now written those downas I understand you are sayingand have really got to a valuation. What was the change in the valuation rules? Was it a huge write-down?
Angela Knight: First, the new guidance on how to value an illiquid asset held in the trading book, rather than the banking book, only came in on 10 October, so it has not all been done. What it does is to take a different method for assessing a more certain valuation for an illiquid asset, rather than trying to determine what a market valuation would be when you have no market. If you look at what has happened in the States, you will see that there has been a constant spiral-down of assets for which a market could not be found. Although for various reasons there might have been a fire sale price out there, everyone knew that value was probably not relevant, but you had to use it. It is the volatility that mark to market can bring when a market no longer exists.
The new guidance was formulated first in the US under US generally accepted accounting principles, and then the International Accounting Standards Board moved to bring its guidance more or less into lineI have to say more or less because there are bound to be some legal differences. Both the accounting profession and the industry think that enables the much more certain type of valuation and in due course we will see the outcome of that.
Angela Knight: The level of write-down has been very significant.
Angela Knight: Well, you see that in the public domain daily, as is evidenced through share prices and all sorts of other areas, but where we are with more relevant guidance in place for a current environment will certainly pan out over a period of time. Being able to use the ongoing cash flowfor the various formulae and discounts you will have to ask the auditors for the complex detailsseems a much more sensible way of valuing something that has a value but for which there is no market.
Q 136Sir Peter Viggers: In an early comment by the BBA, you are quoted as saying that your main reservation related to partial transfers of banks, nil-rates and creditors. You made that comment in July. You said that you saw an imperative need for the Government to give further time for consideration of the partial transfer arrangements and that they should be stripped out of primary legislation. Would you like to confirm that that is still your view and elaborate on it?
Angela Knight: If you say where we think the order should be, the first thing is that the regulators regulate and we do not get to the SRR. The second is that, if the SRR is triggered, we would like to see an entire bank movewe hopeinto the hands of a private purchaser. If that has to have stability at some point before the process can take placethe bridge bankthen so be it. Partial transfers come rather a long way down the list. Our preference would be not to have a partial transfer unless there has been a default. If it is the decision of Parliament that a partial transfer must remain as part of the SRR tools before a default is triggered, it is absolutely essential that the creditors rights are not reordered, that the netting is properly taken care of and that the decisions taken at the time cannot be retrospectively changed by clause 65.
Q 137Mr. Hoban: This is a question to you, Mr. Taylor. You said earlier that the provisions of the Bill affect stand-alone investment banks only to the extent to which they are counterparties in transactions where there is netting. Are there any tools in the Bill that you think appropriate to be used if a stand-alone investment bank suffered a financial problem, or are you happy with the existing regime for insolvency and administration?
Jonathan Taylor: I would be happy with the existing regime, but I am not sure whether, in practice, the distinction would work in that way. I am trying to think about it.
Q 138Mr. Hoban: So, in effect, you anticipate that the tools available in the Bill could be used in relation to an investment bank.
Jonathan Taylor: Yes.
Jonathan Taylor: That is right. My point is that, in particular, the netting arrangements are of direct concern to the investment bank. Indeed, as Andrew was saying, there is a link between that and the partial transfer point. That is one of the reasons why the partial transfer point raises serious questions.
The Chairman: If Members have no further questions, may I thank the panel for coming to the Committee today and call the next set of witnesses?
The Chairman: We will next hear evidence from representatives from the Association of British Insurers, the Investment Management Association, Citizens Advice and Which? Welcome to our meeting this afternoon. Could you please introduce yourselves? I will start with Teresa.
Teresa Perchard: My name is Teresa Perchard. I am director of policy at Citizens Advice, which represents citizens advice bureaux in England and Wales.
Guy Sears: My name is Guy Sears. I am the director of wholesale at the Investment Management Association. We represent UK asset managers.
Stephen Haddrill: Stephen Haddrill. I am the director general of the Association of British Insurers.
Doug Taylor: My name is Doug Taylor and I am the personal finance campaign manager for Which?
Q 140Sir Peter Viggers: Mr. Haddrill, the Association of British Insurers said in its submission to the Treasury Committee in July that the case for the special resolution regime was not fully proven. What is your view today?
Stephen Haddrill: Given the events of recent weeks, we feel it is right that a resolution regime of some kind is brought forward and we support the greater part of the Bill. Our anxiety is that there is a big national, governmental and taxpayers interest in a bank that has got into this situation being got back into the market, being eventually funded by the institutional shareholders and the City and being got off the states hands. Therefore we are concerned that the regime should generate confidence that a bank will not be put into special resolution unless it is absolutely necessary. We think that there are some things in the Bill that could, perhaps, be strengthened to provide confidence in that respect. If the bank goes into the regime, to the extent that there is value still left in it that should be fairly distributed among the creditors, including the bondholders of the company, if not the shareholders, so that general confidence about investing in banks is preserved as far as possible.
Q 141Sir Peter Viggers: Have you ideas on what steps could be taken, short of a special resolution regime?
Stephen Haddrill: Ahead of the special resolution regime, as Angela Knight was saying, it is essential that the regulators actually regulate the industry effectively to ensure that the capital is adequate and that the risk of a bank failure is minimised. We would like to see in the Bill a requirement on the FSA to report publicly on why it has not been possible for the regulatory regime to discharge its responsibility in that respect, so that sufficient responsibility is placed on the regulator to keep the bank going, make sure it does not get into that difficulty and avoid going to the SRR. But we accept, now, the case for an SRR in extremis.
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