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Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 160 - 179)



  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 the Governor?

  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 operations difficult.

  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 there?

  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 account.

  Q171  Chairman: But it was not a complete impediment?

  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 recognised—for example the need to discuss funding with credit rating agencies, the probability that that would become public by a different route—so 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 supine?

  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.

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