Examination of Witnesses (Questions 160
TUESDAY 9 OCTOBER 2007
Q160 Chairman: What is the difference
between your view and the Governor's?
Sir Callum McCarthy: The question
that I was trying to explain, Chairman, is the balance between
the moral hazard arguments, which are clearly important, and equally
the importance of making sure that when there is a liquidity problem
there is a means of dealing with it.
Q161 Chairman: So I can take from
that that you would have dealt with it in a different way from
Sir Callum McCarthy: No, I do
not have the responsibilities that the Governor has; I do not
have the requirement to weigh up the general monetary policy questions
that the Governor has to weigh. I have a different set of responsibilities.
Q162 Chairman: I understand. Did
you ever conduct a war-game type exercise of a similar scenario
to the Northern Rock crisis?
Sir Callum McCarthy: We have conducted
a series of war games but they have been different because the
nature of the problem that we have dealt with in this instance
has been different. What we have looked at in the past has been
institutional-specific problems, whereas this has been a very
different sort of problem. It has been a worldwide drying up of
liquidity, and that gives rise to very different questions.
Q163 Chairman: You conducted war-games
scenarios for avian flu. Is that correct? Did you conduct any
war-game scenarios for a run on a bank?
Sir Callum McCarthy: Yes.
Q164 Chairman: So why did not things
operate smoothly then?
Sir Callum McCarthy: Because the
circumstances that we looked at
Q165 Chairman: Because war-games
are of no use?
Sir Callum McCarthy: No war-games
are useful. I think that the ability of us to work together has
been significantly improved by the fact that we have practised.
It is almost impossible to anticipate in advance the particular
circumstances of any particular crisis.
Q166 Chairman: Why did you not discover
the problems of launching a covert lender of last resort operation
in the war-game simulation?
Sir Callum McCarthy: The positions
that we looked at were rather different from the position that
occurred in relation to Northern Rock.
Q167 Chairman: The Governor said
to this Committee that he stumbled on four pieces of legislation
which frustrated his ability to support Northern Rock in his preferred
covert way. Do you agree with the Governor's interpretation on
those four pieces of legislation?
Sir Callum McCarthy: I agree with
him that each of those four problems are significant problems.
I would add that when we conducted a particular exercise with
the Treasury and the Bank in February we had identified in particular
the problem of having a means of dealing with banking problems
and the need to deal with the question of bank insolvency problems
and also the question of the compensation arrangements.
Q168 Chairman: So the Market Abuse
Directive was an impediment?
Sir Callum McCarthy: We knew.
I do not think it is simply the legal requirements of the Market
Abuse Directive which is an impediment.
Q169 Chairman: I did not say that.
Sir Callum McCarthy: I think there
are also a variety of other practical questions which made covert
Q170 Chairman: Let me focus on the
Market Abuse Directive because the Commission came out with a
statement that was contrary to what the Governor said. Was it
flashing up in red lights to the Tripartite body that the Market
Abuse Directive was an impediment and something had to change
Sir Callum McCarthy: No. I think
that what was clear to the tripartite authorities, and certainly
clear to us, was that there would be obligations of disclosure
on a publicly quoted company which would have to be taken into
Q171 Chairman: But it was not a complete
Sir Callum McCarthy: The obligations
for disclosure are very much specific to the circumstances of
any case. It is impossible to say in all circumstances.
Q172 Chairman: With Northern Rock
was it not an impediment?
Mr Sants: If I might just explain
a little bit further. As Sir Callum has indicated, each individual
judgment has to be situation specific. It was certainly known
to us both during any war-games and, of course, generally during
the course of our normal business that there would be certain
sets of circumstances which would require disclosure. The disclosing
circumstances revolve around, of course, the extent of the support
being offered and the relevance of that support to the long-term
viability of the company and in terms of the knowledge in the
market place at that given point, and so, of course, the nature
of support which came into play would have an impact on its future
profitability and so forth. So there are a set of inter-related
circumstances which determine whether a support operation of that
type needed to be disclosed at that time.
Q173 Chairman: I understand, but
I am trying to get a simple answer to this. When the Governor
came he said "there were four pieces of legislation here
that stopped us in our tracks". The Market Abuse Directive
was mentioned. The reason I am asking this is quite simple, Sir
Callum, because the Governor said that this took place in 2005,
I think. If that was a big problem, (a) was everyone in the tripartite
agreement alive to that and (b) if they were alive, was some legislative
programme implemented to change it so that in your war-games,
when you are doing your simulations, you say, "Look, if a
bank run occurs, then this Market Abuse Directive is a problem
and we really need to get on top of that"?
Sir Callum McCarthy: The point
I was trying to make, Chairman, is that there is a legal position
which, as Hector has explained, is specific to any set of circumstances.
It does not necessarily mean that in every single circumstance
there would have to be an announcement. With the position of Northern
Rock, in the particular circumstances, the Northern Rock Board
took the view that they had to make an announcement and we believed
there was no legal basis for preventing them. If I look quite
apart from the law, there is also a series of practical questions
which I think also have to be recognisedfor example the
need to discuss funding with credit rating agencies, the probability
that that would become public by a different routeso there
are both legal and practical questions which are important.
Q174 Chairman: So there was no legal
impediment in terms of the Market Abuse Directive?
Sir Callum McCarthy: I am not
sure what the legal impediment is to.
Q175 Chairman: In other words, the
Market Abuse Directive was not stopping everything happening in
terms of the Northern Rock situation?
Mr Sants: In those particular
set of circumstances we saw no reason to disagree with the Board's
view that it was necessary for them to make an announcement. Of
course to some degree this is a moot point, because once it had
been leaked the night before they certainly had to make an announcement
in relation to that set of circumstances.
Q176 Chairman: In a sense there is
simplicity to this, that if the Market Abuse Directive was a problem,
it was discussed in 2005 and nothing was done about it, then you
were behind the curtain?
Sir Callum McCarthy: The point
that I am trying to make, Chairman, is that there were disclosure
obligations, which we accept, which have been accepted by the
British Government and the British Parliament. There was also
a series of practical questions and, as Hector has just said,
the important thing (I think it bears out my point about the practical
importance of these constraints), the thing that actually happened
in relation to Northern Rock was the leaking of this information
on the evening of 13 September and the coverage of that in the
news. So, irrespective of whether we had sought to conceal it
or not, it was actually in the public domain.
Mr Sants: I think it would be
clear to us that it was not going to be the case that all support
operations could be covert. It would be clear from the Market
Abuse Directive that there would be sets of circumstances when
that was not going to be possible, and that would be clear from
the point the Market Abuse Directive came into force.
Q177 Chairman: Would you have preferred
a covert lender of last resort operation to save Northern Rock?
Sir Callum McCarthy: I think that
if that had been a practical possibility it would have had some
attractive features. Unfortunately it was not a practical possibility.
Q178 Chairman: Sir John Gieve is
a non-executive member of the FSA Board, due to his position as
Deputy Governor in charge of financial stability. How well did
having this connection work during the crisis?
Sir Callum McCarthy: Perhaps I
could just explain what we have done to strengthen the links between
the Bank and the FSA in relation to financial stability questions.
We have ensured that there is FSA representation or attendance
at the Financial Stability Board at the Bank, which looks at largely
the macro-economic questions associated with financial stability
although the Bank has a very specific set of responsibilities
in relation to payment systems because so many of the important
payment systems pass across the balance sheet of the Bank. They
also have particularly important positions in terms of various
international bodies. They are, for example, leading the work
in Basle on liquidity. In terms of the FSA one of the things that
I arranged was for the Risk Committee of the Board to have John
Gieve on it to ensure that there was a proper interlinking between
the analysis that is made at the Bank and the analysis that is
made at the FSA. If I look at the actual work during the time
of the post 9 August problems, I think that the clarity of information
between FSA and bank was quite clear and I think that the transmission
of information in both directions worked well. From essentially
9 August we set up a daily Tripartite meeting in which we compared
notes and information and identified problems. So I think that
overall those arrangements worked well.
Q179 Chairman: Sir John gave us the
impression that the FSA Board on which he sits was not greatly
engaged. Sir Callum, you sit on the Court of the Bank of England.
Do you believe that the Court non-executives were kept fully informed
and consulted throughout or were the independent members equally
Sir Callum McCarthy: I am sorry,
I would like to make clear that I would not accept in relation
to FSA non-executive directors the adjective supine. I think that
the non-executive directors of the FSA do the task that they are
required to do and that is not a detailed involvement in particular
decisions in relation to the firms in the most part.