House of COMMONS






The Work of the FSA 2007-08



Monday 15 December 2008



Evidence heard in Public Questions 1 - 170




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Transcribed by the Official Shorthand Writers to the Houses of Parliament:

W B Gurney & Sons LLP, Hope House, 45 Great Peter Street, London, SW1P 3LT

Telephone Number: 020 7233 1935


Oral Evidence

Taken before the Treasury Committee

on Monday 15 December 2008

Members present

John McFall, in the Chair

Mr Graham Brady

Mr Colin Breed

Mr Stephen Crabb

Sir Peter Viggers


Memoranda submitted by the Smaller Businesses Practitioner Panel, the Financial Services Consumer Panel and Which?


Examination of Witnesses


Witnesses: Mr Adam Phillips, Acting Chairman, Financial Services Consumer Panel, Mr Nick Prettejohn, Chairman, Financial Services Practitioner Panel, Mr Simon Bolam, Chairman, Smaller Businesses Practitioner Panel, and Mr Peter Vicary-Smith, Chief Executive, Which?, gave evidence.

Q1 Chairman: Good afternoon and welcome to this session on the FSA Annual Report. Can you introduce yourselves for the shorthand writer, please, starting with Nick?

Mr Prettejohn: Nick Prettejohn, Chairman of the Financial Services Practitioner Panel.

Mr Bolam: Simon Bolam, Chairman of the Smaller Businesses Practitioner Panel.

Mr Phillips: Adam Phillips, Acting Chairman of the Financial Services Consumer Panel.

Mr Vicary-Smith: Peter Vicary-Smith, Chief Executive of Which?.

Q2 Chairman: You are all welcome, particularly yourself, Mr Phillips. You are just taking up your appointment as Acting Chair - so congratulations. Your predecessor Lord Lipsey's letter of resignation called for a broader remit, with greater resources than the Panel currently enjoys. Do you share that ambition with him?

Mr Phillips: I suppose I should start by saying first of all that I deeply regret the fact that Lord Lipsey decided to resign. His resignation will be a loss to the Panel. Having said that, I think that his letter of resignation created a rather unfortunate impression: first of all that the Panel's remit is rather narrow and, secondly, that the Panel sees it that way. The terms of reference we have, agreed with the FSA, give us a fairly broad remit, which goes well beyond the areas that the FSA regulates in financial services. As far as the Panel is concerned, we had a discussion with Lord Lipsey, when he joined in July, about his wish to set up an inquiry into the effectiveness of the financial regulatory system from the consumer point of view. The Panel agreed at that time that it was the wrong time to be doing something like that. As we have seen subsequently, it was definitely the wrong time to do it, and that was a good decision. We agreed that we would defer a discussion until the end of the year, with the idea that we would do something next year. In fact, the discussion was planned and is still going to be held this Wednesday. I think that we will still take the decision as a Panel that to have such a broad inquiry into the effectiveness of the regulatory system is probably too big an issue for the Panel to take on at the present time.

Q3 Chairman: That is maybe taking us a wee bit further than I want at the moment. Perhaps I could therefore put it to you again if you share his ambitions for the Panel. I gather the answer is no, because you think that you have a broad enough remit and, if a perception has been established, it is a bit unfortunate.

Mr Phillips: I think that is a fair analysis. We think that we already have a broad enough remit; it is the extent to which we use it.

Q4 Chairman: Lord Lipsey did make a speech in the House of Lords and I do not think that it is a perception. I have read his speech on that. How many staff do you have?

Mr Phillips: We have five full-time equivalent staff working for us at the moment in the secretariat. In fact, it is six people but two of them work part-time for the Panel.

Q5 Chairman: How does that break down then?

Mr Phillips: In...?

Q6 Chairman: In the remit; in what they do?

Mr Phillips: Two of them are policy people. One of them is a liaison person who is effectively dealing with outside organisations and also some of our relationships inside the FSA; then we have a part-time manager and a part-time PR person who deals with relationships with the media.

Q7 Chairman: If I am looking at it from a policy point of view, you have two full-time people working with you?

Mr Phillips: Yes.

Q8 Chairman: Do you think two is adequate?

Mr Phillips: When we have asked the FSA for additional resources and we have made a reasonable case, we have got the resource. Looking back at the last year, we have had the secretariat reorganised and it certainly has not been a particularly comfortable experience for the Panel. We have been under-resourced. I would hope that, going forward, we have enough to do the basic work of the Panel. I think that we will need additional resource probably, if we decide on Wednesday that we need to look at the effectiveness of the financial regulatory sector.

Q9 Chairman: Do you think that two people are enough to take on the might of the financial services industry?

Mr Phillips: No, I do not. I think that you need a lot more than two.

Q10 Chairman: So we really need to step this up quite a bit then, do we not, if we want consumer examination of the financial services industry?

Mr Phillips: I think that the Panel would certainly welcome additional resource. There is no doubt about that. The only question I would ask is whether the Panel, on its own, is the best place to look at the effectiveness of the regulation of the financial services industry.

Q11 Chairman: What are you established for then?

Mr Phillips: We are established to represent the consumer interest to the FSA and the FSA regulates part, but not all, of the financial services industry.

Q12 Chairman: When I read my papers every day, there are huge issues coming up for consumers in the financial services industry. I will be asking Mr Sants about the PPI. We raised this issue with him five years ago in 2004-05, and we still have this issue going on. I think that there is a panoply of issues, and it seems to me that that two people to tackle that ---

Mr Phillips: I would say that of course you do have the Panel as well. The work does not rest entirely on the shoulders of the policy people. The way in which the Panel is set up is that it is designed to work with the FSA, as we see it, as a critical friend; and the difficulty that the Panel has is to balance the role of the friend with the critic.

Q13 Chairman: Why do you need to be a friend?

Mr Phillips: The FSA comes to the Panel early on to talk about issues to do with the consumer interest so that it understands better the consumer interest. To that extent, we have to have a reasonable working relationship with the FSA.

Q14 Chairman: If you are a friend, they have got you in their web.

Mr Phillips: That is why we have the discussions about the balance of our relationship with the FSA and the extent to which we are critical.

Q15 Chairman: That seems to me to be a little out of kilter with two policy people. I think there needs to be an examination in your committee to say, "Are we adequately representing the consumer?".

Mr Phillips: I think that is a fair point.

Q16 Chairman: How many members of your Panel have significant experience working in consumer organisations, as opposed to industry experience?

Mr Phillips: I would say that at least a third of them have experience of currently working in consumer organisations. Another third are people who have a broader experience of working in the financial services industry, but only one of whom has worked in the financial services industry directly. The remainder are a couple of journalists and someone who has worked in government.

Q17 Chairman: Would you like to see consumer representation on the board of the FSA itself?

Mr Phillips: Yes, definitely. There is no doubt about it.

Q18 Chairman: We therefore have a bit to go on that yet. Do you think that the FSA is too dominated by the industry on their board?

Mr Phillips: I would agree with that view. I think that it is too dominated by the industry, yes.

Q19 Chairman: You have the chairman of the board who worked in industry and you have the deputy chairman who is a former chief executive of one of the banks in the industry, but there do not seem to be many consumer representations in the really senior positions.

Mr Phillips: I think that one of the issues for the FSA is that it needs people who are experienced in the industry on the board of the FSA. One of the problems the FSA faces is that people who have worked in this industry are not necessarily best equipped to understand the consumer interest, and there is a need to balance that up.

Q20 Chairman: How many times since your appointment to the Panel in March 2004 has the FSA changed its mind as a result of the Panel's influence and lobbying?

Mr Phillips: There are a number of situations where the FSA has been influenced by the Panel; relatively few where you would say that the FSA directly changed its mind. I will give some examples of where we have influenced it and some examples of where we have changed its mind. The recent consultation on the Banking Code has been something that the Panel has been pressing the FSA over for some years. However, in the form in which it has come out, you would not necessarily notice that the Panel had had the influence, because a lot of other people have been campaigning for that too. In a similar way, the work on the Retail Distribution Review: it has been a long-term objective of the Panel to take bias out of the advice relationship. More recently, we felt that the FSA was moving rather slowly to deal with the issue of mortgage repossessions and approached the judges directly, to talk about the requirements of MCOB - the Mortgage Conduct of Business Rules - which are placed on advisers and banks who are seeking repossession. We were able, we think, to speed up the process and, as a result, the protocol was issued by the Ministry of Justice. Another area where the FSA was not doing something a couple of years ago, which we think is very important for a regulator, is in mystery shopping. The FSA now does regular mystery shopping, which highlights the lack of impact that many of its regulations are having on changing industry behaviour.

Q21 Chairman: Have you been pushing the FSA on payment protection insurance?

Mr Phillips: We have been pushing the FSA on payment protection insurance for at least three years.

Q22 Chairman: And nothing has happened?

Mr Phillips: No, and one of the points we made in our written submission was that the FSA, as a regulator, frequently expresses disappointment about what it is observing, but we would like to see a change in behaviour beginning to happen. The answer is no.

Q23 Chairman: After four or five years, we want a change of behaviour?

Mr Phillips: Yes, we do.

Q24 Chairman: If you were to trumpet your successes with the FSA from the rooftops, would it come out as a squeak?

Mr Phillips: I would hope that it would come out bigger than a squeak. I do not think that we have done a particularly good job of making a case for ourselves, but I do think that we have been quite influential with the FSA.

Q25 Chairman: Peter Vicary-Smith, obviously the credit crunch has dealt a severe blow to consumers' trust in the financial services industry. Do you therefore see a need for greater consumer representation on the FSA in order to advise on how that trust can be rebuilt?

Mr Vicary-Smith: Yes, I think there is a need for that, not just in terms of making sure that the Panel is resourced - because we think that the Panel does a good job within the FSA - but also in terms of some ten of the 14 members of the FSA board being either company-employed or previously employed in the industry. We feel it is important that a strategic board has a diversity of views. Otherwise, you will come to any issue with just the perspectives and the history that you have accumulated in your lifetime. Certainly if one looks at the board of other bodies - the Food Standards Agency, OFT and so forth - the boards there are much more diverse. The other dimension of the governance of the FSA that is important is where it is accountable to. The FSA is not accountable to the Parliamentary Ombudsman. The National Audit Office has a very narrow remit. When we have talked to the Treasury about issues, we are told that the FSA is an independent regulator and therefore the Treasury cannot really get involved. In fact, our view is that it is this Committee that has performed most of the regulatory oversight of the FSA. While it has done that well, we do not feel that is necessarily a healthy position to be in for such a vital regulator.

Q26 Chairman: Do you think that there is a conflict of interest at the heart of the FSA, in that it is charged with Treating Customers Fairly and it is charged with prudential regulation?

Mr Phillips: I think that there is undoubtedly a conflict there. One of the key issues for the FSA is how it manages that. One of the areas about which the Panel is concerned is to try and understand whether the consumer interest is being addressed too low down in the system.

Mr Vicary-Smith: I would agree with that. The FSA of course needs to have a whole host of people with experience of the industry but, when it comes to the strategic board, it needs to have a diversity of views and a diversity of perspectives, and we think that is lacking.

Q27 Chairman: And that conflict of interest at the end of the day could be too much for the efficient working of the FSA?

Mr Vicary-Smith: Yes, I think it could be. It asks a lot of individuals. There was a time when James Crosby was on the FSA board and running HBOS. How you would expect someone to build Chinese walls through their heads and that kind of thing? I think that it must be a very difficult position.

Mr Phillips: The only thing I would add to that is that I think there is a potential conflict between the need to maintain a prudential system and to look after the consumer interest. A conflictual relationship is not necessarily the best one to bring the best result.

Q28 Chairman: In June, the FSA reported that only 13% of relationship-managed firms met the March 2008 deadline for having appropriate management information on treating customers fairly. That is a pretty disappointing statistic, is it not?

Mr Phillips: Absolutely. Terrible. It may well be that the management information systems have improved, but we think that if the FSA had carried out its planned survey/assessment at the end of this year, they would have found that the majority of firms were still not treating their customers fairly.

Q29 Chairman: So pretty woeful?

Mr Phillips: Yes.

Q30 Chairman: Nick Prettejohn, your Panel's Annual Report expressed disappointment at the FSA's reluctance to conduct a cost-benefit analysis of Treating Customers Fairly, and the FSA responded that it did not amount to a new regulatory requirement. Have your concerns been addressed?

Mr Prettejohn: We welcome the move to put Treating Customers Fairly as part of the business-as-usual supervision. I think that is the right place for it to be. The ARROW process is the most important process that regulated firms go through with the FSA, and that is the right place for the examination of TCF to be.

Q31 Chairman: The themed visits on Treating Customers Fairly have now been scrapped. Which of you welcomed the FSA's decision not to proceed with that and to merge it into the ARROW visits?

Mr Prettejohn: I think that the ARROW visit is the right place for it to be. Our view is that a disproportionate amount of resource within the FSA and within regulated firms was devoted to Treating Customers Fairly. We think that it is an extremely important programme and the overwhelming majority of regulated firms thoroughly support the principles behind it; we just felt that, in terms of the balance of regulatory emphasis, on the margin, Treating Customers Fairly was getting more resources relative to prudential supervision than was appropriate.

Q32 Chairman: Mr Phillips, I am reminded of the ARROW visits to Northern Rock. I do not think that Treating Customers Fairly would have featured high there, never mind prudential regulation; so it worries me that that has been merged into the ARROW visits. Do you have the same concerns as myself?

Mr Phillips: It was always the case that at some point Treating Customers Fairly would become part of standard supervision. What we have been trying to establish with the FSA is exactly how they will make sure that these supervisory visits to check on TCF are in fact effective. We think that they have to go beyond straightforward looking at the management information systems and a few cursory checks. We think that there has to be a lot more in there than is currently planned.

Q33 Chairman: Would you express concern about it being incorporated into ARROW visits, given that Lord Lipsey's memo expressed an outright disbelief that the TCF failings would be identified?

Mr Phillips: We would have preferred it not to happen so soon. There is no doubt about that.

Q34 Chairman: What about you, Peter?

Mr Vicary-Smith: We were disappointed by it, but I would like to pick up one thing that was said there, if I may. The idea that a disproportionate amount of time is being absorbed on looking at TCF I find extraordinary. This is one of the centrepieces of the new regulatory environment. What we have seen in the original March deadline was that 13% of firms did not even have the management information in place. It was not to say that they were even treating customers fairly; they simply did not have the management information in place. There is a long way to go on TCF. In my view, what gets measured gets done. Therefore, if the FSA needs to absorb it into its regular assessments, I think that two questions arise. One is what happens between now and when the next supervisory visit takes place; because that could be many months, and so there is no tracking with those firms as to whether there is any progress being made. Secondly, in the interests of transparency and accountability, I think that the FSA should publish details of the number of supervisory assessments it is conducting each month on this, and how many companies are meeting the deadline; because I think that they really need to keep on top of this.

Q35 Chairman: To be fair to the FSA, it was the FSA that dragged the industry along on TCF in 2004-05. Do you think that it has lost its nerve a little bit?

Mr Vicary-Smith: It has dragged the industry along and we are supportive of the TCF approach, but the important thing is that they now need to go further and ensure that it is embedded; that it does not just become a wish.

Q36 Chairman: Simon, how will small firms' TCF compliance be assessed and how long will this process take?

Mr Bolam: About 18 months ago, the FSA set up a Small Firms Enhanced Strategy. This is where they target a particular part of the country and invite all the regulated intermediaries, smaller intermediaries, to complete questionnaires; they are invited to go to conferences and seminars; they are assessed. By going through this particular process - and we are now on to about our third large area - quite large numbers of smaller firms are now being assessed. By doing it in large numbers, this obviously helps. The idea is to see 11,500 firms over a period of three years.

Q37 Mr Brady: Mr Vicary-Smith first and then perhaps Mr Phillips, to what extent do you share the concern about the number of consumer credit agreements that are not compliant with the Consumer Credit Act?

Mr Vicary-Smith: I think it is important that, if things are being sold to the consumer, they are compliant. Where we see evidence that things are not compliant, then those firms need to be named and shamed so that consumers know to steer clear of them, and we need to ensure that there is a robust amount of follow-up.

Mr Phillips: I would hope that the introduction of the Payment Services Directive will give the FSA the powers, which it should take, to ensure that consumer credit agreements are fair.

Q38 Mr Brady: It has been put to me that obviously we have had 34 years to get the Act right, but that a very high percentage of credit agreements are not compliant. Would you share that analysis, or have you made any estimate of the extent of non-compliance?

Mr Phillips: We do not have any estimates of that.

Q39 Mr Brady: Would you say, from your experience of looking at credit agreements, that practice is improving, or is it something which is simply being missed?

Mr Phillips: Again, I do not have any information on that, I am afraid.

Q40 Mr Brady: Mr Vicary-Smith...?

Mr Vicary-Smith: No. The only information I would have would be of an anecdotal nature. There what we see is - across the whole area of credit agreements, of advice given and so forth - precious little improvement in the overall standard of the industry. However, that is not specific to credit agreements; it is a general tale of woe about the industry and its progress.

Q41 Mr Brady: Can I suggest that it may be worth a more detailed look at that?

Mr Vicary-Smith: Certainly.

Q42 Mr Crabb: Mr Prettejohn, we hear what you are saying about the Treating Customers Fairly initiative being welcome in principle; but would you say that the burden entailed in complying with TCF for small firms is an unwelcome burden at a time of economic downturn?

Mr Prettejohn: I think that all firms, as you say, thoroughly support the principles of Treating Customers Fairly. I would say that the FSA's definition of the outcomes around Treating Customers Fairly was a very useful contribution to the thinking of the whole industry and has made a big difference to firms, large or small. I will perhaps let Simon comment on the smaller firms, if I may.

Q43 Mr Crabb: Perhaps you would just respond to my question about the burdens involved with complying with TCF. Is that an unwelcome burden at this time for small firms?

Mr Prettejohn: In general, our criticism of the Treating Customers Fairly initiative was that it applied a one-size-fits-all approach to the industry, rather than concentrating on the areas of greatest risk. Whether that is actually for a larger firm or a smaller firm, or a particular issue within a large or a small firm, we feel that all firms were treated equally and the same approach and process was applied to each. Almost by definition, therefore, the burden would seem on some firms, large and small, to have been too high.

Mr Bolam: As far as small firms are concerned, there is a basic concept within them that their very survival is dependent upon treating their customers fairly; that if they did not treat their customers fairly, then their local reputations would soon be damaged and their businesses would contract. The difficulty over the volume of work as far as small businesses are concerned is this. I run a small general insurance-broking business in Edinburgh. This is my TCF policy. It is 16 pages long. This is what a well-run business should have in order to prove compliance. It is the way you have to extract management information to show that you are actually physically treating your customers fairly, even if you think you are. It is the extraction and the documentation of some of that information, or all of that information, that is quite time-consuming - when people in smaller firms are also trying to run the business, be the financial director, be the bank, and all the other responsibilities that you have within a small business. It did seem a bit disproportionate.

Q44 Mr Crabb: Given that the very survival of these firms would be at the forefront of many of their managers' minds at this particular time, do you think that firms should be given more leeway in how they conduct their business?

Mr Bolam: I very strongly support the FSA's more principles-based regulation, which gives that flexibility as you move away from rules - whereby a firm can actually sit down and work out, in a more flexible way, the manner in which they should be running their business. That certainly helps smaller firms run their businesses, as long as their brains are focused sufficiently to understand that they still have to prove that they are complying with the regulator's requirements.

Q45 Mr Crabb: So more leeway in terms of complying with TCF?

Mr Bolam: I would welcome that in terms of smaller businesses, yes.

Q46 Mr Crabb: Mr Vicary-Smith, what evidence are you seeing of any deterioration in firms' commitment to the Treating Customers Fairly agenda at this time?

Mr Vicary-Smith: I think that it is less a question of the deterioration of commitment but rather that, when you measure who is doing it, it is such a small number that it is hard to think of deterioration. I would argue that, if anything, Treating Customers Fairly is even more important for the consumer in harder times, because the financial pressures on firms to cut corners are greater. It is not something that we can select as being only for the good times; it applies all across the board. I would not support the idea of leeway, therefore. I think that there are some important dimensions that the credit crunch raises about TCF, for example on mortgage repossessions, which raise new issues that were not really thought of at the beginning. For example, if the FSA is finding that firms are not treating customers fairly on mortgage repossessions, it will not be good enough if their home has been repossessed and they find out that they should have been given some information before that happened. We therefore need to see a more up-to-date and a more transparent process of regulation through it. It has to work in the bad times as well as in the good times.

Q47 Mr Crabb: Mr Phillips, would you like to comment on the implications of the current economic downturn on TCF?

Mr Phillips: There is a real risk that firms will abandon the efforts that they have been making to treat customers fairly, because they will inevitably be forced to focus on prudential issues, and that things could get worse. We have no evidence of that yet. We have asked the FSA to provide us with evidence of what they observe going forwards, but there is a real risk that things could get worse - yes.

Q48 Mr Crabb: Coming back to Mr Bolam, if I may, the FSA's December deadline requires firms to be able to demonstrate that they are consistently treating their customers fairly. Perhaps you could describe for us what this will entail for a typical small firm?

Mr Bolam: First of all, a small firm should have its policy in place, similar to the example I showed you from my own business. It means that you need to collate information that is seen as relevant, such as how many complaints you have had; how many cancellations you have had; checking files to make sure that the process within the office in terms of giving advice to consumers is good and robust; making sure that your staff, in terms of competence and training, are up to scratch. There are a large number of measures that need to be down in writing so that, if somebody walks through your front door, they can actually see that you have done it. It is that documentation area that takes up a lot of time.

Q49 Mr Crabb: What if firms do not bother about complying with this by December? What will be the consequences for firms of just not doing it at this time?

Mr Bolam: We accept that that may happen. As a Panel, we obviously would be very against it; but the FSA are doing their best, with the resources they have, to try and see 11,500 smaller firms over a period of three years. It would be great if that could be accelerated, but there are cost implications.

Q50 Mr Crabb: Mr Prettejohn, your Annual Report expressed disappointment at the FSA's progress on the issue of consumer responsibility and looked forward to the publication of a discussion paper from the FSA in late 2008. Can you update the Committee on what progress has been made on this issue since then?

Mr Prettejohn: We have seen a draft discussion paper from the FSA at a recent Panel meeting. We think that the notion of consumer responsibility is extremely important. Efficient and effective markets work best when you have empowered and well-informed consumers, and the notion of consumer responsibility actually equips consumers better in their interactions with firms and also, if the worst comes to the worst, if they have complaints or they have to go through a process of law. Having empowered consumers who are conscious of their responsibilities, therefore, seems to us to be a very good defence and protection for the consumer, as well as also making sense for firms.

Q51 Mr Crabb: Mr Vicary-Smith, given the level of financial capability held by the public, what do you believe is the appropriate level of consumer responsibility?

Mr Vicary-Smith: Clearly consumers have a responsibility to act honestly, to declare information openly, to provide information that is asked for by advisers, and to deal in an honest way. What is not rational, I think, is to expect a consumer to be given a lengthy and complex document, drafted by lawyers and teams of investment experts and then to say, "As you have had your document, it is clearly your responsibility". I think that the key thing here is what is going to persuade consumers to engage in this marketplace. What is going to get people to invest, to save, to take out protection, and so forth? That will be when they feel that they are being treated fairly and they are being looked after and looked out for. Telling people "It's your responsibility. You had the document. It's your fault" will not get them to play in this marketplace - and that is what society desperately needs. I would say that pushing too far on a caveat emptor principle beyond "You must deal truthfully" raises real risks that consumers will simply disengage from the industry and will go further back to where we were.

Q52 Mr Crabb: Are you satisfied so far with the progress and the tone that the FSA has adopted on this?

Mr Vicary-Smith: I have not seen things yet with which I am dissatisfied. I am sorry if that sounds rather cautious and negative. This debate has raged on, and I have had conversations with too many in the industry who have wanted to pass so much responsibility onto a consumer that it looked like an abdication of responsibility from the firm, and so I am nervous about this debate and where its implications could lead consumers. Consumers need to be absolutely engaged and we want to make consumers more empowered. We tell people to shop around; we tell them to negotiate; we give them as much advice as we can; but there is a limit to what you can really expect an individual consumer to do, in all the other things they have to do in their lives.

Mr Phillips: I would just like to add to what Mr Vicary-Smith has said. The law is fairly clear that people cannot be required to understand what they read. I think our concern is that the FSA may try to circumscribe that in some way, in order to provide the industry with more certainty about redress claims. I think it would be a great pity if they tried to do that and it would work against, as Peter says, the interests of the consumer and, ultimately, the interests of the industry.

Q53 Chairman: Mr Bolam, this may not be for the record, but you did say that the FSA ensure that you "physically" treat your customers fairly. You would not think of bashing them on the head, would you?

Mr Bolam: No!

Q54 Chairman: Just in case! Eleven and a half thousand firms over a three-year period - is that not a tall order? Are you not afraid of that figure?

Mr Bolam: It seems like a tall order but I have heard nothing from the FSA to indicate that that target will not be met.

Q55 Sir Peter Viggers: Is the FSA deadline for full implementation of the Retail Distribution Review by 2012 realistic and achievable, and what are the problems that they face?

Mr Bolam: We have two IFA representatives on our Panel. They have been working very closely with the FSA in terms of developing the RDR up to this particular moment in time. They are reasonably optimistic that this deadline can be reached. There are obviously certain things that are cropping up, which might cause certain delays, such as IFAs struggling at the moment in terms of getting business, things slowing down. As far as our Panel is concerned, we are absolutely behind the RDR. We feel that, as the thing develops, we should make sure that such things as professional standards are realistic; that we are not, in the process, going to bring another layer of costs on top of what we have already; that the professional standards are achievable. The one thing at the end of the day that we do not want to see is a meaningful contraction of advice to consumers, good-quality advice, in the small towns of the country where the people need that type of advice. Hopefully it will be achievable, but there are certain things there which could slow the process.

Q56 Sir Peter Viggers: Mr Phillips, the Consumer Panel has been concerned, among other things, about complexity. Would you like to expand on that?

Mr Phillips: We have been encouraging the FSA to make sure that it has the details sorted out. We have been pleased by the general direction of movement, although we found that the latest statement issued by the FSA was a bit of a step backwards; but nevertheless they are moving forwards. The particular issue that concerns us is to make absolutely clear to the consumer whether or not they are receiving independent advice and whether the person talking to them is actually working in their interests or in the interests of their employer. We think that the current approach of the FSA to call this "sales advice" is not a very helpful approach. We hope that the research they are doing will lead them to something better. We would like sales to be called "sales".

Q57 Sir Peter Viggers: And from the point of view of the Practitioners Panel, Mr Prettejohn...?

Mr Prettejohn: I think that it will be a difficult transition. It is challenging in terms of its timescale, as Simon described. There is a risk in the short run that there will actually be less advice available to UK consumers through the transitional period, and I think that is a very considerable concern. It is already the case that the regime around advice at the moment means that only the better-off and the best-off can really afford the financial advice that many people need; because, whatever your income and your financial position, life is becoming more complicated and the financial issues are becoming more difficult to disentangle. More people need advice, therefore. Unfortunately, there may well be less, because a number of the advisers who are advising at the moment may choose not to apply for the professional qualifications that will be required and therefore may leave the market. In the short run, therefore, there may be less advice.

Q58 Sir Peter Viggers: Do you perceive that practitioners are being sufficiently alive and alert to the need for change?

Mr Prettejohn: I think that most practitioners, the overwhelming majority of practitioners in fact, would say that they welcomed the change and, in particular, the raising of professional standards.

Q59 Sir Peter Viggers: What about the employment prospects of the IFAs throughout the United Kingdom?

Mr Phillips: We are concerned that there should continue to be an independent sector in advice which is thriving. The issue for us is that the people who are doing it have to be giving good advice and to be well trained.

Q60 Sir Peter Viggers: Lord Lipsey was robust in his view of the expression "sales advice". He said that it was "devoid of meaning". What is your view on that?

Mr Phillips: Absolutely. I concur with that. We have a very similar concern to the practitioners: that advice should still be available to consumers. Our concern is that, if it is advice, it should be clear whether that advice is independent or whether it is biased in some way, and that that should be clearly expressed in the way in which the person describes themselves to the customer.

Q61 Sir Peter Viggers: Do you think that the RDR framework is sufficiently clear on this point?

Mr Phillips: At the moment, no, I do not think it is; but we hope that the FSA will continue to listen to the industry and to the consumers, and to get them to somewhere which is better.

Q62 Sir Peter Viggers: On the very difficult issue of remuneration and bias, commission-based IFAs have pointed out that people do not want to pay a fee upfront. What is your view on this difficult issue?

Mr Phillips: I think that the IFAs are right in this. I think that some people are prepared to pay a fee and that most people would like to see the charge deferred in some way. There are ways of doing that, however, which do not increase the customers' costs and which give them some control over the service that they are getting from their adviser.

Q63 Sir Peter Viggers: On a commission basis?

Mr Phillips: It would not be done as commission; the money has to be recycled in another way. However, the effect would be that, instead of the provider of the product buying the adviser by offering them commission, they would provide funding for the customer to buy the product.

Q64 Sir Peter Viggers: There would be transparency on this basis?

Mr Phillips: There should be transparency.

Q65 Sir Peter Viggers: Would you regard transparency as essential?

Mr Phillips: I think that transparency is essential. I also think that the regulator has to get involved, to make sure that the fees are reasonable. One of the possible outcomes is that fees could rise, because customers, as has already been pointed out, do not shop around a lot in this market.

Q66 Sir Peter Viggers: Mr Vicary-Smith, your memorandum refers to some mystery shopping which found that bank staff are not always clear in describing whether their advice is free. How should the RDR address this issue?

Mr Vicary-Smith: I would first like to say that I think the thrust of the RDR is very good, in the right direction, and we have been very supportive of it. The FSA has done a lot of good work in pushing through the RDR. I think that the adviser remuneration part has perhaps been one of the more useful elements for consumers. Part of the problem is that, in our mystery shopping exercises, people have been told for a long time that the advice is free.  It is not; it never has been; nor should it be; nor will it ever be. In fact, it sounds rather like current account provision to me. However, that is what people have been told: that the advice was free. Therefore, we are now having to tell people that they pay for advice. Well, they always have done. The key thing is that, in paying for advice, people are clear what they are paying, what they are paying for, and that they are able to shop around and compare the prices being charged by different people. I think that the RDR will help in that regard, because this has been a very obfuscated area for too long. Could I say one other thing? It is the point about the level of charging, which I think is an absolutely key one. We see some product providers currently allowing advisers to deduct up to 10% of a consumer's lump sum investment in advice fees. We think that is far too high a level. There does need to be some way that guidance can be given - but that is not an appropriate level of deduction.

Q67 Mr Breed: Mr Vicary-Smith, I was intrigued by the responses about treating customers fairly. Is that what we used to call "integrity"?

Mr Vicary-Smith: Treating customers fairly? Yes. Certainly it does seem bizarre that you have to tell them. I cannot imagine that if you had Terry Leahy here, he would need to be told to treat his customers fairly in that way. I think that it is the dicta of where we are. We are where we are in terms of the industry and how it is regarded by customers.

Q68 Mr Breed: Which, on that basis, is not very good.

Mr Vicary-Smith: The performance of the industry has not been very good, but what is important is that we all ensure that performance improves. I think that the Treating Customers Fairly initiative is one way in which consumers could be helped to have a better level of confidence in the industry with which they have to deal.

Q69 Mr Breed: It seems to me that the extraordinary growth in financial services regulation over the last few years has been matched only by the number of disasters, failures and scandals, which have cost taxpayers and individual purchasers of products millions, if not billions, of pounds. What does that say about regulation in the industry?

Mr Vicary-Smith: One of the things it does say is that the notion that provision of information is a substitute for good advice, for treating people fairly and for good regulation, has been disproved. Too much regulation has focused on firms having to tick a box and say, "We provided this piece of information". You get your statement of key facts on your mortgage and you have to confirm that you have read it - which of course very few people ever do. You just tick the box at the bottom and say that you have. Moving to a Treating Customers Fairly initiative has the potential to reverse that, but only if firms treat it seriously and if the FSA continues to devote the resources necessary to make it work.

Q70 Mr Breed: From what you have already said, I think that you agree with the FSA that this Retail Distribution Review is, as they say, a "golden opportunity" for the industry. You all subscribe to that view, do you, that it is a golden opportunity?

Mr Phillips: Yes.

Mr Prettejohn: Yes.

Mr Bolam: Yes.

Mr Vicary-Smith: Yes.

Q71 Mr Breed: On that basis, Mr Prettejohn, you will be aware of the survey done by Standard Life, which indicated that if these proposals went through, 16% would basically give up and not be prepared to go ahead. A vast majority of those are likely to be in places like Cornwall, which I represent - a lot of rural areas and small places. Therefore, while it may be only 16%, it may be specific to certain areas. How realistic is 16% and how worried are you that we would see an absolute flight out of this by the smaller firms?

Mr Prettejohn: I am extremely worried about the level of advice that will be available to the UK consumer. I think that financial advice is in danger of becoming ghettoized amongst higher net worth individuals, and I think that presents us with a major problem. I think that there are a number of IFAs who will withdraw from the industry rather than go through the process of getting professional qualifications. We all applaud the raising of professional standards. It is a necessary step but does carry with it a risk, through that transitional phase. The answer for many people will be if we can come up with a model, with the FSA, for guided sales, which enables consumers to get some more information. When you call it "advice" you start to get into a difficult area, and hence the problem in coming up with a model. It is really important, however, given the complexity of people's lives and the financial decisions they face, that they can get something more than execution-only sales but do not necessarily have to go through the full advice process that higher net worth people can afford.

Q72 Mr Breed: Mr Bolam, some IFAs believe that this is just a means by which the FSA, which is very friendly with the banks, can basically get rid of all the competition, confine it to the big banks, and reduce the numbers of firms they have to regulate. It will therefore be a nice, cosy arrangement between the FSA and the banks to get rid of these wretched small IFAs that they have to keep looking at, and hand something to the banks. Do you believe that?

Mr Bolam: I can assure you that we are fighting on behalf of the smaller businesses to ensure that there are IFAs in Cornwall and the various other parts of the UK. The outcome of this has to be proportionate. There still has to be a supply of good advice to people. The way in which we seek to achieve this has to have an examination system that, yes, works, but which has to be proportionate in such a way that the people in your constituency do get access to advice. The one thing that we have perhaps omitted to highlight in this process is that there is also work in parallel to this. It is a stream of work that is looking at the prudential requirements of the IFAs and what capital adequacy they should have. That also represents a potential threat to the supply of firms throughout the country.

Q73 Chairman: Mr Prettejohn, you have mentioned people leaving the industry. That is perhaps a bit unfortunate. However, I have chaired quite a number of sessions on confidence in the retail industry and I well remember examples, such as the split capital investment trusts, the precipice bonds, the endowment mortgages - which were pretty scandalous situations. Surely we cannot focus on people leaving the industry? It is restoring the confidence in and the integrity of the industry that is of the utmost importance. There is therefore only one way to go here.

Mr Prettejohn: I think that you are absolutely right. We would support very strongly the implementation of higher professional standards. Implementation of those standards may, in the short run, result in some people who do offer good-quality advice leaving the industry because they do not want to go through the process of getting the qualifications, because they are at the end of their career. However, I would fully accept your argument that we need higher professional standards.

Q74 Chairman: Mr Phillips, your Annual Report labelled the FSA's work on with-profits as "weak". Our Committee went further, in calling for a "reopening of the debate about the overall regulatory system for with-profits funds" in our Inherited Estate report. What progress has the FSA made in the last six months?

Mr Phillips: We were very pleased when this Committee took this up and we were somewhat disappointed by the FSA's response. We continue to be very concerned about the governance of closed and quasi-closed with-profits funds. We would like to see an objective and independent test of the fairness of the principles and practices of financial management that these firms are using and not just, as the FSA put it, better communication with policyholders.

Q75 Chairman: Mr Vicary-Smith, you have also made comments on that.

Mr Vicary-Smith: I would go further than Adam. I think that the FSA's response to the report, which I thought was an excellent report, was woeful. At a time when bonuses are being slashed and swingeing exit costs are being imposed, with-profits policyholders who speak to us are dismayed by the FSA's failure to stand up for their interests. We are very sceptical of the value of the systematic information-gathering exercise the FSA has undertaken. Sarah Wilson, the director responsible, said, "Our starting point in conducting the review is not that significant changes are needed to the regime". I do not think that was the view of this Committee when it produced its report. It certainly is not our view that significant changes are not required to the regime. This is a very clear issue, where we believe policyholders' interests are not being dealt with fairly; in fact, I think that the FSA needs to get a grip on it.

Q76 Chairman: If the FSA is unwilling to conduct a root-and-branch review of with-profits regulation, what are the most important aspects of their work which we should focus on as a Committee?

Mr Vicary-Smith: Within the with-profits area?

Q77 Chairman: Yes.

Mr Vicary-Smith: Stopping companies charging shareholder tax boosts in inherited estate; stopping firms taking further money out of the inherited estate to pay mis-selling claims - which of course is being looked at at the moment; the issue of Norwich Union's phasing of its special bonuses - which I think is an appalling example of a large firm not treating its customers fairly; and also, crucially, ensuring that the with-profits committees stand up for policyholders, rather than simply rubber-stamp the decisions of companies. We have said for a long time that the with-profits committees should not be appointed by the firms concerned but should be appointed by the FSA, because if you appoint a committee from the firm that removes the incentive of that committee to stand up to the firm.

Q78 Sir Peter Viggers: I was going to ask about the "regulatory black holes" that you refer to in your submission, Mr Vicary-Smith. I see in the memorandum that the FSA submitted to us they say, "Historically we have not made comprehensive rules governing the conduct of retail deposit-taking business because they have been covered by the Banking Code Standards Board". Some people may have been rather surprised that the FSA had not been more closely involved in this area before. Do you recommend that the FSA should take control of retail banking regulation?

Mr Vicary-Smith: I would say that regulatory black holes need to be closed. Purely closing regulatory black holes will not remove the risk of detriment to consumers. To my mind, the point is this. If the FSA take over this area, will the outcome for consumers be better or not? I do not mean that to sound evasive, but there are some things within the Banking Code where there is a good degree of protection given to consumers. For example, on issues of online fraud and card usage, there are some good restrictions in there. We would like to ensure that the taking-over of regulation of this area ensures that the positive elements of protection are carried through, and that any rules drawn up are done so in conjunction with consumer groups and others, to ensure that they genuinely serve the consumer interest.

Q79 Sir Peter Viggers: Mr Prettejohn, what benefits does the self-regulatory nature of the Banking Code bring? Do you think that these are outweighed by the obvious disadvantages - their lack of teeth?

Mr Prettejohn: In general, self-regulation can sometimes mean that changes in regulation can move faster and that regulatory changes can have a greater immediate buy-in from the regulated. However, my overall view is that, particularly where there are issues of confidence involved, probably self-regulation has to give way to statutory regulation. We have yet to discuss this in great detail at the Panel, so I must stress that these are probably more personal views. I think that, with the advent of the Payment Services Directive and the number of, if you like, competing regulatory bodies that there are around the banking industry - OFT, the FSA and the Standards Board - some rationalisation of that and a clearer division and assumption of responsibility is probably required to ensure that consumer confidence in the regime as it applies across banking is improved and maintained.

Q80 Sir Peter Viggers: Mr Phillips, has the Consumer Panel addressed this?

Mr Phillips: Yes, and we have been pressing for some considerable time for the FSA to switch on the principles and to take control of banking regulation. We think that that would be more straightforward; it would have a consistent definition of Treating Customers Fairly; and there would be more chance that the introduction of Treating Customers Fairly would be properly supervised within large organisations. I would also like to pick up on a further point, which is the Payment Services Directive. Where the OFT overlaps with the FSA in regulation, we would like to see that much more joined up. We see an opportunity here for the FSA to extend its reach and to provide genuine protection for the consumer and also a more straightforward working environment for the industry.

Q81 Chairman: The FSA deadline for the implementation of the Retail Distribution Review by 2012 - is that realistic and achievable? What are the major roadblocks to that?

Mr Phillips: I think that is more of a question for the industry than it is for the consumers. We would certainly like to see it in place.

Q82 Chairman: Is it achievable, Mr Prettejohn?

Mr Prettejohn: I think that it is achievable, yes.

Mr Bolam: Our Panel believe that it is achievable.

Q83 Chairman: Will firms be able to make a smooth transition from their current business models to the new requirements, and how many firms have started to make that? Has yours, for example, started to make that, Simon?

Mr Bolam: My own firm is general insurance, and so we do not actually get involved in that area. However, I would suspect that most firms will wait until these proposals are set more in stone before they start seriously getting involved.

Q84 Chairman: What is the best way to remove bias and the perception of bias from the remuneration of financial advisers?

Mr Phillips: I think that there are two issues here. The first is the obvious one of commission: where, if the adviser is acting as the agent of the customer rather than the agent of whoever is providing the product, there is a lot more chance that there will be no bias and that there will be a better relationship. Coming back to the point that Mr Prettejohn made earlier about the middle of the market, people in that part of the market are probably unlikely to be able to pay, or be willing to pay, significant amounts of money for advice. There we are looking to the industry to come up with constructive solutions which can deliver unbiased advice. One of the areas that the FSA has explored, but so far with little success, is the area of guided sales - which we think is a real opportunity to provide products that are affordable, hard to mis-sell, and which will be attractive to the middle part of the market.

Q85 Chairman: Mr Vicary-Smith, I remember being at a conference in Gleneagles when the then chairman of the FSA, Callum McCarthy, made a big declaration about the business model and industry being bust, and that they would have to start on it from scratch. Has that road been travelled?

Mr Vicary-Smith: I think there are some indications that, shall we say, the first, early steps have been taken: things like addressing the issue of paying for advice; addressing the issues of professionalism of the industry - or, rather, the professionalism of the advice given. However, there are two really important steps that the FSA can take if this industry is to be brought up to scratch. One is the issue of naming and shaming, where we feel that the FSA has not taken the steps it could take. All our history at Which? is that the glare of publicity and saying who is doing things well and who is doing things badly is an enormous prompt to change. We believe that FiSMA gives more opportunity than the FSA actually takes for that to happen. The second thing is on the level of fines. Where steps are not being taken, then the consequences need to be much more severe. For example, I think that Alliance & Leicester's record fine represented 3% of the revenue gained over that period of mis-selling. At that level there is a danger that fines are seen as a regulatory cost of doing business, and that is not what they should be doing. If we are to see this industry transformed in the way we all have said we want, then the FSA has a role to play both in exposing bad behaviour, accrediting good behaviour and also, where it does need to intervene and fine, to ensure that is at a level that really discourages bad behaviour.

Q86 Chairman: This Committee has been taken away from the consumer and the retail element for the last year or so with understandable problems elsewhere in the economy. Should this be an area we focus on more over the coming months or will the self-regulation and the good relations between industry practitioners and regulators sort it out itself?

Mr Vicary-Smith: I would argue that this would really benefit from more attention because there are two sides to this equation: there is the provision of the product but there is also what happens to the consumer and, in all the sorting out of the problems that exist, we do not want to see the consumer forgotten as everyone focuses on the wholesale side.

Q87 Chairman: Simon, what element of the package of proposals contained in the Retail Distribution Review will be the most significant in driving existing practitioners away from the industry, in your opinion?

Mr Bolam: Too high professional standards.

Q88 Chairman: Too high?

Mr Bolam: If the professional standards are too high, that would drive practitioners away.

Q89 Chairman: Let us get a handle on that. Too high? They should not be at degree level, should they?

Mr Bolam: No.

Q90 Chairman: At what level should they be? First year university level? A-level?

Mr Bolam: At the level 4 for advisers, as is currently recommended

Q91 Chairman: That is first year university-type level?

Mr Bolam: Yes. Again, we are down to what the final model is going to be in terms of firms out there at the end of the day. If the level is too high, or if people find it just too difficult to get there, we have to monitor the position on the contraction of the market.

Q92 Chairman: One of the aims of the Government is to get 50% of people into higher education and to become graduates. Their ambitions are a bit low if we are talking about first year university level for people giving advice which is very sensitive to many people and could involve their life savings and their investments. Should we not be aiming a little bit higher? There is a paucity of ambition here, I would suggest to you.

Mr Prettejohn: I think it is a reasonable place to start but in the long run we should probably be expecting higher standards than that.

Q93 Mr Breed: How many people in the FSA have such qualifications?

Mr Prettejohn: I am afraid I cannot answer that.

Mr Breed: We will ask Mr Sants.

Q94 Chairman: That is a good question, so the advance question to Mr Sants is, what percentage of your workforce is at graduate level? I think we have covered almost everything here. Mr Phillips, if I could just review a couple of things you have said because they have been very important and very helpful to us, we agree that there is a potential profound conflict of interest at the FSA between prudential regulation and treating customers fairly. Presently the FSA is full of people with industry experience, and even at the Strategic Board level the FSA is dominated by industry people, so there is a stronger case, a greater case for consumer representation on that Board.

Mr Phillips: Agreed.

Q95 Chairman: The Consumer Panel, having two policy staff, really need to lift their ambitions on that. Agreed?

Mr Phillips: I accept that point.

Q96 Chairman: On the credit crunch, the firms at present have an incentive to cut corners so it is even more important to have consumer representation and consumer interests safeguarded.

Mr Phillips: Absolutely, but the issue there is that the FSA should be tracking the performance of the industry.

Q97 Chairman: If I can say to you that evidence has been very helpful. I would suggest that there is not a cigarette paper of difference between the views of your predecessor, Lord Lipsey, and your views. Is that unfair?

Mr Phillips: You would have to ask him.

Chairman: He is not in the room as far as parliamentary convention is concerned. However, can I thank you very much for your evidence today. It has been very helpful to us.

Memorandum submitted by Financial Services Authority

Examination of Witnesses

Witnesses: Mr Hector Sants, Chief Executive; Mr Dan Waters, Director, Retail Policy and Conduct Risk; and Ms Lesley Titcomb, Director, Small Firms and Contact Centre, and Retail Intermediaries and Mortgage Sector Leader, Financial Services Authority, gave evidence.

Q98 Chairman: Mr Sants, welcome to the Committee. We do appreciate that Lord Turner is in Hong Kong today in the Financial Stability Forum, and it was with that in mind that I was quite happy to go ahead with our rearranged session on that, but you are due to come back in March and we will have a further range of questions, particularly for Lord Turner, on these issues. Can I start with payment protection insurance. Five years ago we referred this matter to yourselves and the OFT and the Competition Commission and we are still dizzying around. We have a fine on Egg at the moment. What has happened? Can we not get it sorted out?

Mr Sants: I think it is very fair to say that progress by firms in sorting out that key issue has been disappointing. We made that clear. We have a very determined enforcement programme under way. We have significantly increased our fining in that area and if I could pick up on one of the earlier comments, of course, the cost to firms is not just in the fine. Indeed, you would expect the fine not to be the greatest costs that they in fact bear because we are also asking them to provide redress, and our expectation in many cases is that that redress, that compensation to consumers, will be multiples of the fine. So just looking at the fine is not in itself the best way to judge the deterrent effect being delivered. However, we do agree that firms altering their behaviour has been slow and we are determined to see that changed. I believe that message has now got over and we have seen significant changes in firms' behaviour. Dan, you may want to comment on some of the detailed changes.

Mr Waters: Thank you. Yes, we have done a number of rounds of thematic work, as the Chairman is probably unaware. Some improvements have been made but the work done by the Competition Commission makes it pretty clear that there are some fundamental structural problems in this market and, frankly, the tools we have to deploy have not been able to crack the backbone of the problem. We have nonetheless, as Hector has said, fined something like 20 firms a total of about 12 million. We have said that we are escalating current regulatory work with firms. A number of firms have voluntarily agreed to stop selling single premium PPI. So I think it is fair to say the writing is on the wall. We just need to get on with further improvements.

Q99 Chairman: Let me just give you my personal example. I went to my bank and got a short-term loan a couple of years ago. I told them at the time that PPI is not suitable for me but I was a recipient of eight separate letters from the bank over the next three or four weeks impressing on me that I had really made a mistake in the first instance. That, to me, is not far away from harassment. It is a well-respected bank and I do not want to name it and shame it here.

Mr Waters: That kind of behaviour I think was probably not untypical a couple of years ago. We think some things in that respect have improved in terms of the banks and other sellers of PPI not actually forcing or pretending to tell people that it is required. That has improved but other issues have not.

Mr Sants: The general point, Chairman, is well taken. There is no question that effective deterrence requires swift and effective action and a higher level of fines and sanctions than we have historically, if you go back over the full period you are alluding to, deployed but I think our actions in the last 12 months in respect of those 20 firms shows that we are taking a much tougher approach.

Q100 Chairman: Lord Lipsey's letter of resignation, as you have heard, called for a broader remit with greater resources than the Panel currently enjoys. Having applied the Rizla cigarette paper test, there is not much difference between Mr Phillips and Lord Lipsey. Why did you reject Lord Lipsey? Why is he not there making the case for a broader consumer representation, then both of you can work together?

Mr Sants: We did not actually reject any proposals from Lord Lipsey. I have to say that neither I nor the Chairman nor the executive received any.

Q101 Chairman: That is not what Lord Lipsey is saying. Was there any communication between yourselves and Lord Lipsey?

Mr Sants: I do have meetings with the Chairman of the Panel on a regular basis, and they also know that my door is always open and my telephone will always ring but there was no formal proposal made to us which had the support of the Panel. We do think the Panel is well resourced but of course, we would look carefully at any proposals made.

Q102 Chairman: So you and Lord Lipsey, if you met, were mute and you smiled at each other and enjoyed the cappuccino and the croissants. Is that it?

Mr Sants: I was aware that he was considering the resourcing and looking at this issue but, as I say, he made his decision to resign without getting to the point of bringing us a proposal.

Q103 Chairman: Mr Phillips' comments, as you see, are not much different to Lord Lipsey's. Are you willing to go away after this meeting and have a look at that and see if consumer representation can be enhanced? It seems pretty inadequate consumer representation.

Mr Sants: Of course. We would always look at any seriously constructed, thoughtful proposal from our panels and from our panel chairs. They are a really important part of the work. I would make the point, of course, it is not just the direct resource committed to them; they do have the ability to leverage the whole of the FSA. So looking at those individual figures that were quoted earlier is rather misleading. To the straight question, absolutely, we take the panels extremely seriously. They are a key part of the work, both to represent the consumer interest forcibly, to challenge the FSA, and to provide us with a useful sounding board and advisory forum. They do try to combine those two tasks. They need to be properly resourced to deliver them and we will, of course, listen carefully to any proposals they might have.

Q104 Chairman: At the moment your Deputy Chairman is a former chief executive of one of the retail banks. Would you advocate the Deputy Chairman being from the consumer side if the Chairman is from the industry or has had industry experience?

Mr Sants: I hope you will not mind me making the point, as you kindly point out, that our current Chairman is in Hong Kong and of course, the composition of the Board is not directly a matter for the executive. It is for the Board and the Chairman, and indeed HMT, so I would rather not comment, in all honesty, on the direct question. I am happy to make a general observation as an executive member of the Board.

Q105 Chairman: Do you need more consumer representation?

Mr Sants: As a general point, of course, they are not meant to be representing sectional interests. They are there as individuals but, as an executive, we would welcome greater consumer engagement at the Board level if it is consistent with delivering effective Board governance.

Q106 Chairman: Paragraph 6 of your memorandum details your recruitment policy and it contains the following phrases: (1) "We are aiming for the right balance of career regulators and market practitioners"; (2) We are "recruiting external candidates from a range of backgrounds, including retail and investment banking, risk management, quality assurance and consultancy firms" but there is no mention of any attempt to recruit staff who might have a background in consumer organisations.

Mr Sants: As I think you are aware, those comments are, of course, targeted at the earlier debates we have had in this Committee exhaustively where Committee Members and myself shared a mutual concern that the regulator was not necessarily as well-equipped as it might be to deal with financial stability and prudential issues. So those recruitment characteristics are framed around that particular debate. Of course, we recognise the importance of ensuring we are also properly resourced for our task in conduct regulation and I can completely agree with you; if I use the phrase "market" as reflective of the outside world, if you like, or the area which is making the point we are looking to recruit from areas outside of career regulation, in respect of conduct regulation I would take the same philosophy, that we ought to have the balance of those that bring the consumer viewpoint alongside those who bring the career regulatory perspective as well. As I say, those phrases are targeted at a different question. I quite agree with the point.

Q107 Sir Peter Viggers: Thank you for your memorandum. You discuss principles-based regulation. Would you just like to say a word or two about that because you make the point in your memorandum and it might be quite useful for us to hear.

Mr Sants: We have discussed this in the past. The FSA, right from its genesis, has described itself as a principles-based regulator to seek to distance itself mainly from the concept of a more legalistic approach of the regulator being there just to ensure that rules are complied with, without necessarily giving thought to the consequences of the actions of the firms in question, the individuals in question, the rules in question. That principles-based approach has been in place from the genesis of the FSA but it was revisited, I think, with the benefit of experience in the last couple of years. It has also been right to revisit it with the benefit of the experience of the last 18 months, since we moved into this extraordinary period in financial markets. What we are saying as a result of those reflections, in particular the reflections of the last 18 months, is that the basic concept of principles-based regulation does look to us the right way forward, is the right regulatory philosophy to have, and indeed, when you look at the issues arising from the last 18 months, they arise not from principles-based regulation falling over but rather from maybe the failure by the regulator to follow through its own principles. I have sought to nuance, when I have been here in front of the Committee before, and to draw out some of the other phrases that we use to describe our regulatory approach because I do feel some of those other phrases better describe what we mean. The problem with principles is that people then tend to focus entirely on the size of the rule book. I think it is more important to also focus on the outcomes and to really emphasise the point that what we want management of firms to do is to think about the consequences of their actions, whether that be in the conduct or the prudential space, and to decide whether those consequences are aligned with our principles, and that we, as a regulator, should be seeking to make that judgement as well as to whether the consequences of their actions, of the firms' actions, are going to deliver the results that we all want. The emphasis is more on that phrase "outcomes-based regulation" but that in no way suggests that we have moved away from the concepts of trying to do so with as minimal a rule-based framework as possible and emphasising the compliance with our 11 principles.

Q108 Sir Peter Viggers: Not everyone is happy with this. The Association of Chartered Certified Accountants - I do not know if you have had a chance to see their evidence to us - have been quite critical. They say that ACCI believes that the supervision carried out by the FSA has been regulation rather than principles-based and they go on to say, "We believe that the problem is not one of a lack of regulation but of a failure of the FSA's existing supervisory powers." How do you respond to that?

Mr Sants: A couple of points. First of all, just to make clear, of course, the policy framework which we regulate to is not entirely within our control. Of course we are a significant driver and influencer of that policy agenda but it may be worth reminding ourselves that the majority of policy nowadays emanates from the European environment and to a lesser extent from the global and international environment, as it should do, but of course, that does mean that not every aspect, not every Directive is necessarily written in the way that we would choose. If you look at the rules and policy here, it may well be that at times that does not comply with a purist approach to principles-based regulation. I think it is worth reminding ourselves of that point. To the second point, how effective are we at delivering in a principles-based way, of course, as I commented before, when we do deliver in a principles-based way, that does give the best result for the system, for the users of the system, and where at times we deviate from that, as there have been occasions in the last 18 months, as we have discussed in this Committee, the results have not necessarily been as good as they should be.

Q109 Sir Peter Viggers: Meanwhile, the Association of British Insurers comes back at your comments in a different way. The FSA, they say, should also place greater emphasis on prudential regulation rather than on the conduct of business regulation and they go on to say, "Ultimately, the most important outcome for consumers is that their claims are paid and firms can only do this if they have adequate capital." Do you understand their point?

Mr Sants: I certainly do. It is a crucial topic. I am conscious of time and I do not want to give you too lengthy answers, so I shall try to keep this very short but if you would like us to expand on this topic when we next come back, I will be delighted so to do. The first point is, we have discussed here before that in our retail supervisory area there have been criticisms from industry, as we heard today from Nick Prettejohn, that historically we did not focus enough on prudential issues and were focusing too much on conduct within the supervision of our retail institutions. In terms of that balance point, we would agree with that. So we have rebalanced but what we have also sought to do, of course, is to increase the total amount of capacity in the system through our supervisory enhancement programme and through our recent recruitment programme. We will have something of the order, as you know, of 20% more supervisory capacity and a reorganised supervisory process. We believe overall that that will deliver more capacity for both prudential and conduct, and I think it is absolutely critical to have a balance. We need to be extremely careful that we are not sitting here in a few years' time, looking back and saying, "You were all focused on prudential. What happened to conduct?" It is very important that we deliver a balanced agenda and that is how we have now set up the supervisory process, to make sure it is a balanced agenda, with more capacity, and delivering in a more effective way, which will take us on, I think, to some later points about why we have embedded TCF. A final point I would like to pick up from earlier observations around is the assertion, which is obviously a perfectly theoretically correct assertion, that there is an inherent conflict between prudential and conduct regulation. Of course, there is an inherent potential conflict but first of all I would have to say it is not clear to me why moving that into two separate administrative organisations will necessarily remove that conflict. Whatever happens, the regulatory system in the round has to manage that conflict. Secondly - and I think this is a really important point - I think history is showing us, and the last 18 months are definitely showing us, that prudential and conduct are completely intertwined. As the submission you have there mentioned, at the end of the day, if firms fail, consumers lose out. So the idea that somehow or other prudential is not a consumer issue is missing the point. Furthermore, effective prudential regulation requires conduct issues. We have discussed in this Committee before issues like compensation, competency of management - these are conduct issues which intertwine with prudential in the same way as prudential intertwines with conduct. I would suggest that if you do not have that overall view, you would have a worse regulatory system than you do now have. So I think history is showing at the moment that the integrated approach is the right one but, of course, there is a conflict and that conflict has to be managed.

Q110 Chairman: On that conflict of interest, there is one issue that we are going to be taking up more because there are different views on it, Mr Sants. It came up at the Northern Rock time.

Mr Sants: Absolutely.

Chairman: It is something I think we need more clarity on and, as a Committee, we will be pursuing along those lines to understand it more.

Q111 Mr Brady: Given Lord Lipsey's description of the term "sales advice" as being devoid of meaning, what should a consumer understand by the term?

Mr Sants: As a general point, may I just remind everybody that these are preliminary suggestions from the FSA that we now intend to test with consumer research and, obviously, it is critical. Whatever terminology we come up with has to be terminology that is understood by the consumer. That is self-evident and we are certainly clear about that goal. I have a lot of sympathy with taking a view that there is a case for arguing in terms of terminology that you have a straightforward division between independent advice and straightforward sales terminology, which indeed is a proposal that has been in our documentation, but there are considerable issues about that and, as ever, when you unpick the complexity, it is a more complicated story than it may at first sight seem, not least because we do not want to lose that service which the banking industry delivers, which does have an advisory component. We also have to recognise, the way the Directive is framed, that they are delivering advice in many cases as the MiFID framework allows them to do. I think there are Directive issues here as well. There is research to be done but we also need to recognise the limitations of what we are able to do within a national context. We also have to recognise the importance of maintaining an important segment of low-cost service to consumers. Dan, I do not know if you want to add a bit more.

Mr Waters: I think the only thing I would say is that we have had discussion with the European Commission, as you would have expected, on the overall Retail Distribution Review, in which they are very interested and are generally very supportive of what we are trying to achieve. On this particular point, they were very clear that MiFID is the governing legislation in terms of what is advice and what is not. The recommendation being given by an employee of a bank is advice covered by MiFID and the idea that that person could not make clear to a consumer that they were giving advice is unlikely to be an acceptable outcome under MiFID. There is that limitation. The other thing to say is, a consumer needs to know that, if something goes wrong, they do or do not have access to the FOS; they do or do not have access to the protections of our advice regulation.

Q112 Mr Brady: Under your latest proposed framework that has independent advice and sales advice, do you think it will be clear to the consumer in whose interests a sales adviser is working?

Mr Sants: We hope so but we are open to further suggestions. We are still working with consumers and industry to refine and develop the terminology we apply. That matter is not closed; that is a suggestion on the table, and we welcome any further contributions to that debate. I do think the point that my colleague has just made is very important about ensuring that consumers continue to have the benefits of the protection offered by the FOS and that framework, and the point that both of us have now made twice, which is that we have to recognise that within the Directive framework banks are offering advice and we cannot change that.

Q113 Mr Brady: Given that both might be under the same kind of pressures to meet sales targets from above, what is the fundamental difference between somebody selling a car in a car showroom and a bank employee selling a financial product? Why can they both not be called a salesman?

Mr Waters: The fundamental difference of course is the nature of the market. Consumers behave a lot more competently and confidently in dealing with many retail markets. Financial services is one of the most difficult because of the nature of the products. We have that problem. In terms of the difference we have now put in place, there are rules about the suitability of advice and there are constraints therein. There are also propositions in the RDR which are meant to break the drivers of selling; commission-driven selling as we know it, where the provider is basically competing for distribution by paying commission will be broken by the RDR. There will still be issues in the tied sector about the incentives put upon sales forces and we are very clear about that. The TCF programme is very clear about looking closely at remuneration structures, looking at the training of staff and looking at the monitoring of the quality of the outcomes.

Mr Sants: Just to give the plain English answer, I think the banks would argue that they are offering advice in the service they proffer. It is not, in the eyes of the FSA, full independent advice, assuming it is not that type of advice which gives full access to all product options, but they would argue that they are offering a degree of advice, and certainly within the MiFID framework they are offering advice, and cars are not sold under the MiFID framework.

Q114 Mr Brady: When Which? did its mystery shopping survey, they found a number of bank advisers claiming to be offering free advice whilst the cost of that advice is obviously loaded on to the product. Should purchasers of bank products know the true cost of that advice?

Mr Waters: The answer to that question is yes, and we have agreed and are already beginning work with both the BBA and the ABI on transparency about the cost of advice, and transparency about the cost of the product.

Q115 Mr Brady: What support are you going to give to firms in managing the transition to the new adviser charging model?

Mr Waters: That is a very good question and one that we will consult on. It may be that there are intermediate steps that we can take along a way that will smooth the transition. That is something we need to look at in consultation.

Mr Sants: There was a general point made by Peter Vicary-Smith, and to be straightforward, we completely agree with. It is a question of finding how to navigate through that. There is no disagreement on the points he made.

Q116 Mr Brady: Have you made progress on dealing with trail commission, a problem that was highlighted in our report on restoring confidence in long-term saving?

Mr Waters: The basic change that the RDR intends to make is the removal of the reliance of the advisory community on commissions being rolled up and paid up front, so that by 2012 there will be perfect matching between the cost of advice and the money coming from the client. So this business of funding by the provider will be removed. That is quite a fundamental change.

Q117 Mr Brady: Can I move to a different issue, the whole question of offshore deposits? Obviously, there has been severe detriment suffered this year by a number of consumers who invested offshore, particularly in the subsidiaries of Icelandic banks. Do you think the FSA did enough to make sure that consumers were warned of the dangers of saving offshore?

Mr Sants: I think you have to ask the question as to what is the extent of the FSA's remit in that, in the sense that in many cases here we are talking about companies that not only are not regulated by the FSA, but they are not even owned by companies which are regulated by the FSA, and of course, they do not fall within the FSCS and the consumer protection regime in the UK. I think these are issues clearly outside our regulatory boundary in the supervisory sense. We certainly have an obligation to make sure that, where those firms are marketing into the United Kingdom and fall within our remit in that respect, the information is clear as to their regulatory status and the status of their consumer protection offering, their consumer protection process. I do believe that that was clear to consumers, but I make the point that these are not firms that are regulated by the FSA and I see no reason why people would believe that firms outside the United Kingdom would be those regulated by the FSA.

Q118 Mr Brady: Clearly, a lot of people who saved offshore in these banks would have done so under advice from IFAs. Do you think those IFAs themselves were fully aware of the risks of investing offshore?

Mr Sants: Clearly, if they feel they have been mis-sold to by a UK-regulated entity, they have a case that they should pursue and that would be the right thing for them to do. Again, we are always interested in hearing and keen to hear from consumers who feel that they have been mis-sold to and would take action in those cases.

Q119 Mr Brady: Do you think, looking ahead, there is a case for more information, more education, both for consumers and for advisers about these risks?

Mr Sants: I would certainly hope that events have demonstrated the importance of understanding the risks involved in offshore investments. I think that is an important lesson for advisers to learn and I would expect they would have learned that lesson.

Q120 Mr Brady: Would you acknowledge that one of the things that has come out of this problem is the number of people, particularly British expatriates, who felt that the UK's "know your customer" regime meant that they were unable to hold their savings legitimately in UK onshore banks?

Mr Sants: Technically, that has been a decision for the banks themselves but, as you rightly say, this has been an issue which has been highlighted by this set of events and we would reasonably expect the banks to give consideration to those facts.

Q121 Mr Brady: Is it not the case though, would you say, that if a person has been told by their bank that they will not take those deposits in a UK bank account, the bank should have told them that others would?

Mr Sants: It is an interesting question. I think you would have to hesitate to say that it is an obligation on a firm to give advice about other firms' services unless they are setting themselves up so to do. It is entirely the right of a firm to decide it does not want to take on a particular type of business, and unless they have set themselves up as providing general advice, it is not necessarily the case that they have an obligation to refer the business on to a competitor. Dan, I do not know if you have anything to say?

Mr Waters: I have nothing more to say.

Q122 Mr Brady: Will you be undertaking further work in the future to ensure that people working offshore are aware that they are able to hold their savings onshore?

Mr Sants: It is an interesting question, a question maybe for the Committee and maybe for a future discussion as to whether you feel our financial capability objectives extend to UK citizens wherever they are living or whether we are seeking to address those living within our national boundary. It is probably fair to say at the moment our financial capability agenda does not include provision for providing advice services to UK citizens living outside the United Kingdom.

Q123 Mr Brady: I finally have a couple of questions specifically about the situation of KSF Isle of Man. First of all - and I recognise, obviously, that your Chairman is not here with us today and that may place some constraints on your ability to respond to this. You were with him on 3 November when, in response to a question from me, Lord Turner said of the transfer of funds from the Isle of Man to the UK by KSF, "That deposit became a general creditor like other general creditors." Would you accept that that was not an entirely accurate statement given that the Treasury has taken powers by order that give the Treasury specific control over any payment of that money to a related party?

Mr Sants: I think he was making a general comment about the status of a wholesale deposit in an administration, so obviously, from the point of view of the UK entity of Singer & Friedlander, which, just to remind the wider audience - I am sure you are already aware of that - the Isle of Man subsidiary was not a subsidiary of the United Kingdom company. It was a subsidiary of the parent bank in Iceland, so there was no direct connection between those two entities. It is not analogous to the Bradford & Bingley situation, for example. This is clearly an example of a foreign bank with no regulatory connection with the FSA in that sense. That bank had placed a deposit with a UK-regulated entity and the status of that deposit in normal administration would be of a general creditor. That was the answer he was giving. As you say, there may have been subsequent actions away from the general administrative process by the Treasury which would change the status of that deposit but I think he was answering it in the generality, from the point of view of normal administration and with regard to any regulatory obligations we might, or in this case did not have for that deposit.

Q124 Mr Brady: So it clearly did not take account of the specific legislation the Treasury was taking powers under. That is a very helpful response. Finally, you will also be aware there was a degree of controversy relating to the discussions that took place between the FSA and the Isle of Man regulatory authorities prior to the transfer of the 500 million plus to the UK. Have you undertaken any further investigations internally into the nature and content of those discussions?

Mr Sants: Yes, I have looked into the matter, and indeed, had conversations subsequent to the sad events with the Isle of Man regulator, and we are satisfied that the answers we have given in the past are absolutely fair inaccurate, namely that there was the normal engagement between regulators but there was no suggestion that somehow or other we had provided any additional reassurances or made any additional communications with the Isle of Man regulator other than that which you would expect in terms of normal exchange of information between regulators, nor have we received any representations from the Isle of Man regulator since to suggest that they take a different view. So we have had no communication from them suggesting they disagree with that fact set.

Mr Brady: Thank you.

Q125 Mr Breed: Ms Titcomb, perhaps we can direct a few questions to you concerning the interesting concept of treating customers fairly. In June in the executive summary you indicated that a paltry 13% had actually met the deadline of March 2008 but you were pretty confident that by the December deadline 80% - which is still, obviously, not 100% - that would have done it. We are a few days away now, so how many have complied now?

Ms Titcomb: I am afraid I cannot answer that question directly. I am principally concerned with the supervision of the small firms within the FSA and the figures you quote relate to the relationship-managed firms, which are larger.

Q126 Mr Breed: I will ask one of your colleagues then, who may know: how many firms have now met or are about to meet the December deadline?

Mr Sants: We laid out when we published the 13% figure that we expected something in the order of 80% to be able to meet it but, of course, obviously, we have not got to it yet, so that will be a question to ask us as we move through the course of next year. We do have an expectation that considerably more than the 13% figure which we reported earlier in the year will have achieved the target. I will remind you that the target is having a formal and appropriate MI framework to ensure that they have the ability to judge whether they are treating customers fairly. It is not necessarily a test of whether they are treating customers fairly.

Q127 Mr Breed: In general terms, there is a remarkable relationship between late results and bad news. When things are going particularly well, it is remarkable how results are often very timely. On the basis that you do not appear to have got anywhere near 80% perhaps, otherwise you might have indicated to us that that was the case, are you not concerned at this appalling level of meeting this deadline?

Mr Sants: We would agree with you, and one of the reasons why - and why we disagree with some of the earlier comments - we have brought forward - and it is bringing forward; it is not a new departure altogether - the embedding of the TCF propositions within our mainstream supervisory agenda, supervisory process, is to deliver what we believe will be the most effective way of ensuring that we get results in this area. I am a firm believer - and that is reflected in the changes I have made in the FSA - that we are a supervisor. That means that really important things should be done in supervision. They should not be done elsewhere, in some little programme over on the side. They should be handled by our mainstream supervisors, whose job it is to supervise institutions properly on both conduct and prudential issues - back to the earlier point. Treating customers fairly is an absolutely essential part of conduct regulation and we should have TCF in the mainstream of the FSA, not off to one side. That is responding precisely to the point you have made, which is that we think progress is not as good as we would like and we need to turn up the pressure, get better results, and getting better results means putting it into the supervisory process where we are hiring 20% more supervisors.

Q128 Mr Breed: What greater intensity of effort have you made in the supervisory process them, bearing in mind this current situation?

Mr Sants: Precisely the point I have just made. As you know, we are in the middle of a major hiring programme, which, as we reported in our note, we are some 40% of the way through. We are altering our mainstream ARROW framework, which is the review process which firms have really concentrated on to make sure that it effectively picks up this issue. Dan, you might like to give a little bit more detail on how we are doing that. It is a very important point that the Committee rightly should be reassured on.

Q129 Mr Breed: Just before you do that, can you respond to Lord Lipsey's view of the normal ARROW supervisory process, which he describes as "an unambiguous retreat"?

Mr Sants: As far as I know, Lord Lipsey has never enquired as to how we intended to embed TCF in the ARROW process but I am sure Dan will be happy to explain it to you.

Mr Waters: We certainly do not think it is a retreat, ambiguous or not. What is happening is the ARROW framework itself is being changed in a very significant way to require outcomes testing, that is, what is happening in the real world between real consumers and the sales force or the advisers, whatever the interface with a particular firm is, what is happening there, and you are testing that in real terms. Either the firm has its own mystery shopping results or we will go in and look at files, or we may do mystery shopping ourselves in the supervision line to find out.

Q130 Mr Breed: You have cancelled the whole process of visits based upon treating customers fairly.

Mr Waters: We have transferred that work into the actual ongoing supervision of firms.

Q131 Mr Breed: That is the retreat.

Mr Waters: We do not think that is a retreat. We think that is bringing forward from September---

Q132 Mr Breed: You mean specialised visits on TCF now being conducted into just the ARROW programme is not a retreat?

Mr Waters: I do not see why it would be. In fact, it is more important actually to reform the general supervisory framework so it addresses this as part of the day-to-day work. Otherwise, as soon as the project is over, it dissipates. This means it will be built into the fabric of how we supervise, and supervisors need to understand how to do this. My division, which has a conduct risk function, is designed to help train them to do this kind of examination.

Q133 Mr Breed: By what date will all firms have been looked at or checked for their compliance with TCF?

Mr Waters: That will depend on the timings of the ARROW visits, so the higher impact firms are on a rolling---

Q134 Mr Breed: Can you give me a date?

Mr Waters: I do not know that I have a single date. We have a three-year time period for the smaller firms we talked about before.

Mr Sants: Of course, the ARROW framework has full ARROW visits on a three-year framework but there will be additional contact during that period as part of the close and continuous framework. A straight answer is that the longest period it would be would be three years and for small firms Lesley will elaborate. Effectively, that is no change from where we would have been under the previous process, so it is not a retreat. If I may add, that is the longstop answer based around the ARROW framework but I think you are missing the creation here of the Conduct Risk Department, which is a key element in our agenda. We are not just moving the process into the supervisory process, where, as I said before, we will have 20% more supervisors than we had previously. We are not just making sure that it is in the key assessment process which the senior management of the banks pay attention to, but we have also restructured the rest of the retail area of the FSA to concentrate expertise in respect of key conduct projects inside a Conduct Risk Department in Dan's area, to give us real delivery in the consumer issues in the conduct area which matter. The reality is, treating customers fairly is a principle. What actually matters is the events on the ground, the outcomes, and the outcomes are around products and events, just like PPI, which we have been discussing earlier, where the Chairman rightly pointed out the FSA has been fairly slow off the mark, which he is absolutely right about. We need to focus on actual failures and the Conduct Risk Department will provide extra resource to tackle real events which are actually affecting consumers in the here and now. So we have a rebalancing of the process around embedding it in supervision to make sure senior management are engaged and putting extra resource into task groups, which will address real problems as opposed to thematic groups looking at the concepts. I think we are moving into the hard, nitty-gritty of real deterrence by beefing up the conduct risk area. I really do think the fears which have been rightly expressed by the consumer areas will be seen to be misplaced but obviously that is a question you can ask us again as the next year or so unfolds.

Q135 Mr Breed: One last one. We do not want to see TCF going the same way as PPI. Let us put it that way. Your response to the Practitioner Panel contends that the TCF initiative has not resulted in an increase in the regulatory burden. Many of us would find that somewhat difficult to believe. So there is no requirement to carry out any cost benefit analysis. A number of firms, as you know, would completely disagree with you on that. What is your response to them via us?

Mr Sants: I think the point which we have all explored - and Lesley may want to add to it for small firms - but let us be clear; TCF, as our submission to you made clear, encapsulates a regulatory objective which has always been part of the FSA's agenda. It is part of our 11 principles. We have four principles which are particularly focused on consumer issues. The TCF is a shorthand way of describing what we are seeking to do to effectively deliver on those four principles. We were not creating a new policy agenda; we were seeking to effectively deliver on the mandate we had been given. In that sense, that is exactly the point that has been made to the industry. It is not a new policy initiative. Dan, I do not know whether you want to say anything else?

Mr Waters: I do not think I have anything to add to that.

Mr Sants: You might want to add a little more on the small firms' burden, which is an area of principal concern, quite understandably.

Ms Titcomb: The small firms have two concerns, one of which Simon Bolam brought out very well, which was the issue about proportionality of what we are asking small firms to do. I think it is important to understand that we do ask small firms to deal with this issue and to embed the culture of treating customers fairly in a way which is proportionate to the size and nature of their business. What we would require of a sole trader business is very different to that which we would require of a substantial network, and the MI that we would expect them to be collecting, all that kind of thing, would be different as well. At the same time, we have heard from small firms that what they wanted from their supervisory relationship with the FSA was more face-to-face contact with us, more help from us to understand our requirements, and this is what our enhanced strategy for assessing whether small firms are treating their customers fairly is about.

Q136 Mr Breed: And that is not going to cost them anything more?

Ms Titcomb: We have been investing more in it but it has not led to direct fee increases for them.

Q137 Mr Breed: And it will not do?

Ms Titcomb: I cannot say that going forward because I do not know what the fee plans are.

Q138 Mr Breed: So their fears are well founded?

Ms Titcomb: We have to understand that the burden of regulation on firms is not only about the direct costs of FSA. They are also concerned, as Simon amply illustrated, about the time that it takes for them. We have to have regard to that.

Q139 Mr Breed: I hear what you say.

Mr Sants: We have said repeatedly here that we believe the FSA in general - there may be exceptions - should be delivering advice and delivering a proposition which is aligned with good business practice. If there are small firms that feel there is an unreasonable burden being placed on them, Lesley and the team will always listen. That is the purpose of having more face-to-face contact with small firms, which is why we changed the strategy a little over a year ago now, in the autumn of 2007, and launched the revised strategy with many more people on the ground so people can have face-to-face conversations with us. I think that strategy has been well received.

Q140 Mr Crabb: I would like to pick up a couple of points, if I may. You talk about the 20% increase in supervisory staff. That is the 50 extra staff that is referred to in your annual report, is it?

Mr Sants: No. Since then, as you will be broadly aware, following on from the lessons learned exercise we did on the events of the last 18 months or so, and in particular Northern Rock, we have brought forward further enhancements to our supervisory capacity and technical support and have talked in terms of hiring something of the order of 216 or so extra people, of which half would be in supervision. That is the overall supervisory enhancement programme.

Q141 Mr Crabb: So will the result of the change to embedding the TCF compliance supervision within the main ARROW supervisory process lead to a reduction or increase in the number of hours spent on TCF compliance, or will it stay the same?

Mr Sants: It is going to be difficult to do a like-for-like comparison because the nature, going forward, of the initiatives we will take will change in character. I have said this before and it is also reflected in some of that discussion around more principles-based regulation. It does reflect some of the concerns that the Committee has rightly brought up about success in some of these areas historically. We do need to change the balance somewhat in our regulatory style. Our principal focus historically has been on systems and controls, and that is reflective of the discussion that has been had around TCF so far, where we have been looking for management to demonstrate they had the requisite MI, management information, to manage that, take responsibility for treating customers fairly. I think going forward we would like to do more. We have been doing some, as the Consumer Panel kindly reflected, outcomes-based testing, mystery shopping and other related initiatives. I would like to see more of a shift away from systems and controls into outcomes-based testing because, in my view, the best way to ensure that management are doing the job they should be doing is for them to realise that if at the point of delivery it is not giving consumers what they want, we will actually see that and know that, as opposed to making a judgement based on whether or not the management themselves have sufficient MI. So I think a like-for-like comparison between the two activities will be difficult to do. Having said that, broadly speaking, as I said earlier, with that sort of increase, we would expect, conducting regulation in the round, to not see any diminution in our focus on the big issues. I think you will see us focusing more going forward on making sure that we are really addressing the important issues, and maybe not dissipating ourselves quite as widely as we have done in the past. That comes back to the formation of the Conduct Risk Group, which will focus on the big issues like PPI, so we get an earlier and more effective grip on those sort of key issues when they arise.

Q142 Mr Crabb: Ms Titcomb, you were talking previously about the proportionate level of the compliance burden on firms. Mr Bolam previously very helpfully described to us some of the burdens that he has to face, and he showed us the 16-page document that he and firms like his have to produce by the end of December. Do you regard that as the right level, knowing presumably the size of firm that Mr Bolam operates?

Ms Titcomb: I do not think I can really comment on a specific firm's situation here but what I would stress is it is not having a piece of paper that is important here. It is having the culture of treating your customers fairly embedded in your firm. So when we go to, for example, look at a small firm in this context, if they employ people, we look at their recruitment policies, their training competence, how they make their business decisions about which products they are prepared to offer advice on, that type of thing. So we are looking all the time to see the attitude embedded in the firm, particularly in the senior management of the firm, that they treat their customers fairly. That is far more important, to be frank, than the document. The document is one part of the evidence for us but it is by no means everything.

Q143 Mr Crabb: When your staff make these visits, it is the documents they are looking for, is it not? They want to see those bits of paper. They want to see time spent on completing these documents. That is exactly the evidence they are looking for. That is where the burden kicks in, is it not?

Ms Titcomb: Not entirely. For example, when my staff do one of these follow-up visits, if we have concerns with a firm and we think they may not be treating their customers fairly, we go in and review customer files as well, and actually see what the outcome is, what advice has been given to a consumer.

Q144 Mr Crabb: So you will go through the filing system of a small business?

Ms Titcomb: Not all of them, I hasten to add; a sample, but we do go in and look at files. Obviously, we want to try and see the evidence that management can demonstrate to us, and one of the ways they can demonstrate to us is that they have these documents and so on in place but, as I said, very much the requirement is that they are proportionate to the size and nature of the business.

Q145 Mr Crabb: This December many of these firms are basically clinging on for dear life, for survival. The last thing they need is - forgive me - you guys turning up and poring through their filing systems and wanting to see 16-page documents.

Ms Titcomb: When it comes to the small firms, we are not just turning up and doing that. We are taking a very focused approach. We are expecting to visit 11,000 firms over the three-year period starting at the beginning of this year. The process is that first all they are invited to a roadshow, which is free. We strongly advise them to come. They learn about what our requirements are. They have a lot of chance to interact with other firms. We then follow that up with an hour and a half's assessment, either face-to-face or by telephone, when we go through a series of issues with them - and we are talking to the principle of the firm here - to understand their attitude. We then follow up with a number of firms where we find the results of that assessment are not satisfactory, and we follow up with a random sample as well, just to check we are being consistent and so on, where we actually go in and do a visit at the firm's premises. We are trying not to impose too great a burden on them. We think it is proportionate for this important issue, because we want to ensure that they are securing good outcomes for consumers.

Mr Sants: We do have to recognise - and I am sure you do - that we have all been talking about the need to improve the quality of service for consumers, for depositors, for borrowers for savers. We all recognise that there have been significant issues in the past. The Chairman has listed a number of them. We all recognise, and all the previous speakers here have acknowledged that, the need for change in the industry. In bringing in change, that obviously is a burden. Change is a burden. Change requires you to change your practices, but I think there is a collective agreement amongst everyone, from the consumer perspective, the industry perspective and the regulatory perspective, that change is necessary. We do not disagree that change runs the risk of being a burden. We are trying to do it as sensitively as possible. The reason we put extra capacity into the small firms sector, which was welcomed by the Small Firms Panel, was because we do believe face-to-face contact is a much more sympathetic and constructive way to take it forward. Wherever possible, we are trying to coach and help firms. We are not trying to put them out of business; we are trying to help them to adapt to what we believe will be a better structure and a better industry, delivering a better result. Obviously, it is a tension between delivering change, which carries cost, in a time of economic difficulty for the small firms. We have to try and manage that sensitively.

Q146 Mr Crabb: Finally, Mr Sants, your Financial Risk Outlook identified as a priority risk the potential for firms to reduce their commitment to treating customers fairly. Can you back that up with any evidence at this stage about what we are seeing out there?

Mr Sants: I will let Lesley answer on the small firms, which is a key area, I think.

Ms Titcomb: In previous recessions you would have to have observed that one thing firms may do in order to try and improve their income stream is, for example, if they are finding it difficult to advice on mortgages, they will try and go into other forms of business to try and maintain their income stream. They may get into products that they are not very well qualified to advise on, that type of thing. The other thing which is obviously observable in recessions is that fraud can increase. We have identified a number of areas, particularly working with Dan's new Conduct Risked Division, where you can see the potential for enhanced risk in an economic downturn. Diversification into unfamiliar products is one. Another one would be in the area of mortgage arrears and how mortgage lenders treat people who are in arrears. We go through an exercise, as the FRO says, and then focus on that.

Mr Sants: As you say, we are trying to anticipate events here and I think it is important that we try to anticipate events. We agree with you. I think going forward this whole issue of consumer detriment in a difficult time has to rise up the agenda of the regulator and of the authorities in the round. It is more us seeking to anticipate potential issues rather saying we have identified them so far.

Q147 Mr Crabb: So at the moment it is assumptions based on previous experience rather than any hard evidence that you can show the Committee at this stage?

Mr Sants: Primarily, yes, but, as I say, I think you would expect us to try to anticipate issues.

Q148 Chairman: Mr Sants, the criticisms about the with-profits approach of the FSA - you have our comments from our report and Which?, as we heard, as well. What progress has been made in the past six months, if any?

Mr Sants: I think we need to recognise the set of circumstances which we are in. We clearly set out in our submission back to this Committee that we see this as a two-stage process. We are committed to reviewing how that reattribution regime works, the practicalities of the operational processes, and that would pick up, for example, the effectiveness of the with-profits committees and so forth. We will be doing that, and I think it is appropriate to do that when we have some case histories to look at. So we committed ourselves to doing that on the conclusion of, assuming that were to be the case, and it is an ongoing process, the reattribution issue. I think we feel we need to do that at the appropriate time, but we are committed to doing that at the appropriate time. We have also made reference, both when I was here the last time on this topic and on the submission that we made to you, that we do need to keep the general policy regime under review. Good practice for all regulators is to keep their policy regime under review and at the appropriate time we will do that, but I think it is important we are not seen to be constantly moving the goalposts. I think it is also important to recognise, as I have said a number of times here before, maybe not necessarily persuaded everybody who has heard what I have had to say here but I still believe it to be true, namely we need to be very careful if you move the dial in this process where it is entirely in favour of the consumer then I think the product would cease to be a viable product for the industry and we would expect to see considerable repercussions from doing this. Any regime has to be a pragmatic compromise that delivers a viable product or else one should just acknowledge upfront that the regulatory objective is to say the product is not a suitable product, which is not our view. Having said that, we have committed ourselves to the first stage review. We committed ourselves to keeping the second stage review under review for the appropriate time. Then, thirdly, of course, we are in the middle of consulting on the specific issue of mis-selling. I think out of the four that were mentioned on the list which was just discussed, we have specific action points for two and a commitment to review the other two in due course.

Q149 Chairman: Okay. You mentioned the appropriate time but you have promised to report on the information gathering exercise and how management are implementing your rules by the end of 2009. The question I would ask on behalf of quite a number of people who have contacted the Committee is how does kicking this issue into the long grass tie up with your assertion that the with-profits sector remains high on the agenda?

Mr Sants: We are not kicking it into the long grass.

Q150 Chairman: The end of 2009?

Mr Sants: It is just that I think realistically if you want to review how something has worked in practice you need the principal elements, they are not the only elements but the principal elements, to come to conclusion. We do have a reattribution process in train and it is our intention to allow that to complete and then to see the lessons to be learnt from that. We have to be very careful about revisiting frameworks in the middle of processes. I think that might well then prove to be detrimental to the consumers.

Q151 Chairman: Mr Sants, it was this Committee that undertook a very short inquiry into inherited estates which was seemingly, by all accounts, welcomed by people because it moved the agenda forward. It seems that the end of 2009 is a heck of a time to wait for that information gathering exercise. Surely you have got the staff and expertise to do that and if you do not have the staff and expertise then maybe it is a case of saying, "Look, we are inadequately resourced and we had better look at this again".

Mr Sants: It is not a question of staff and expertise, we are perfectly adequately resourced to do that review.

Q152 Chairman: Okay.

Mr Sants: It is a question of doing the right legal thing at the right time.

Q153 Chairman: Can I ask you then why do you get a consumer panel and why do you get Which? and all the representations from people being dissatisfied with yourselves?

Mr Sants: I think because they have some deep-seated views over the effectiveness of the regime. We recognise that they hold deep-seated views, not all of which we would agree with but we absolutely recognise that they hold them. We agree with this Committee that in the light of that, and given those issues we do agree, it is right to look at the operational effectiveness of the regime. I am just pointing out, however, that doing that in the middle of a reattribution process is not realistic or desirable.

Q154 Chairman: Okay. I do not think we are going agree. Your long answers are not helping us. We will come back to that again. The minimum level qualification, you have heard mention in the previous session that we cannot afford qualifications to be too high and I hope you do not accept that view. I just wonder if you would agree with Lord Lipsey, that quiet shrinking violet who does not seem to say anything to you, when he asserts that advisers should be qualified to QCA level 6, the full degree level.

Mr Sants: I think we heard Nick Prettejohn on this point earlier and Dan may want to add on to this in a moment. I do think we need again to be practical, pragmatic and sensible. We are trying to evolve the industry at a pace which it can achieve. The answer is I think our proposals are appropriate for the short-term, we are still consulting on them. I think longer term you would aspire to a higher level than that.

Q155 Chairman: Okay. Dan, John Blackmore, an IFA, has written in and told us, "The proposed solution of CII level 4 for all could hardly be more inappropriate. It is not demanding enough for independent advisers and yet it is unnecessarily complex for sales advisers. IFAs need to be qualified to a far higher standard and sales advisers to a much lower level". Why do you think the one-size-fits-all approach is appropriate"? Surely in this day when, as I mentioned earlier, the Government have got aspirations for 50% of all school leavers to be graduates we should be having that level for IFAs?

Mr Waters: I guess a couple of points, if I may, Chairman. We think it is wrong to establish a new regime that would set a lower standard for people who are giving advice in tied services. They have responsibilities of suitability, they have responsibilities to act in the interest of the client. Admittedly, there is a limited range of products on offer but those duties are clear. We would not want to lower standards or provide a safe haven for people to move into that kind of space. I think it is also true to say at the other end, if you like, that there are many advisers now who have much higher qualifications than level 4, and there will be specialist qualifications for specialist kinds of product services being provided. That is sensible and ought to continue. I think we also have sympathy with the idea that over time level 4 probably is not high enough, but we are talking about a transition.

Q156 Chairman: If that is the case, Dan, would you expect them to be at graduate level? Would that be your aspiration?

Mr Waters: I think in the long-term we are looking at that.

Q157 Chairman: What is the long-term?

Mr Waters: We have not set that out, that is what we need to talk about. Once we get these stakes in the ground and this process moving forward then you look at the longer term. If you want to have a profession that is a profession you need to attract the best of your young people to come into that profession. There is a lot of talk today about people exiting, it is important to know who is going to enter this market as well.

Q158 Chairman: Can I ask you what your qualifications are, Dan?

Mr Waters: I have a JD in law. I am a lawyer by training.

Q159 Chairman: At graduate level?

Mr Waters: Yes.

Q160 Chairman: Why is it good enough for you, but not good enough for IFAs, come on, get your ambitions up.

Mr Waters: I would not wish to commend myself to IFAs on that point.

Q161 Chairman: Okay. What about at your level, Dan?

Mr Waters: As I say, I think we have sympathy to the view that a higher level over time is probably desirable.

Mr Sants: The point is well taken. We are consulting and t is a good point.

Q162 Chairman: The RDR contains many measures to address the supply side issues of retail investment, but there are concerns about the demand side too. Hopefully the RDR will lead to increased trust in the industry, and financial capability may also play a role, but large numbers of young people and low earners will continue to have little interest in taking advice on investing for the future. There was mentioned made earlier and in our report on restoring confidence in long-term savings in 2005 we mentioned that the savings industry is a middle class industry, we are not getting to everyone. What plans does the FSA have, if any, to encourage the industry to better respond to the needs of these groups?

Mr Sants: Of course, we have got our financial capability agenda, if that is where the question is going, which is designed to be and is indeed a partnership with industry as well as with all other relevant stakeholder groups that can assist us in that endeavour. We have a programme there of reaching out to, as you know, 10 million people or so by 2011. We are 5.4 million into that, so just over halfway through, so we are tracking in line with our expectations, and we do obviously think that a successful retail marketplace requires more than that which is within the RDR framework. For example, it does need to include raising financial capability, financial awareness and the capability of consumers to effectively engage with their saving agenda. We recognise it needs to be a twin track strategy and the financial capability agenda seeks to do that and, of course, now we are complementing it with working with Government on the pilot for what was previously called Thorenson Review of Generic Financial Advice/Money Guidance.

Q163 Chairman: The vexed question of bank lending. In recent evidence both the Governor and the Treasury to this Committee highlighted the resumption of bank lending as critical to the economy. The Governor also noted that banks must act collectively in their best interest by lending more rather than individually holding cash because that is what the markets want them to do. Do you agree with that position?

Mr Sants: Broadly speaking, yes. Of course, as a financial regulator we have an obligation also, as you would expect, again referencing previous discussions here about events of the last 18 months, to ensure that they hold the appropriate level of capital which would realistically anticipate any losses that they might expect to incur in the downturn. That has been the purpose of the recent recapitalisation exercise.

Q164 Chairman: But the Governor also told us that he thought, and I quote: "It was of the utmost importance that the tripartite authorities make crystal clear that regulatory minimum requirements have not been raised and if anything in these circumstances might be lowered because banks will need to see their capital used to absorb losses in order to maintain lending". Now do you agree with his statement and have you been making that clear to banks and the markets if you do agree with that?

Mr Sants: Yes, we have made a public announcement on the framework that we used over the weekend of the bank recapitalisation exercise in which we made clear that was not a policy shift for the long term, indeed, the policy shift for the long-term would come with the requisite consultation and cross-benefit analysis and so forth. We certainly have not changed our long-term policy framework and, as I have just said, and as the Governor's comments made clear, the purpose of the recapitalisation was to create excess capital or capital above the regulatory minimum which was there to absorb the expected losses. It obviously follows that as the losses are incurred then the capital of the banks will come down. That was the purpose of them having that capital in the first place.

Q165 Chairman: That is a very important point because I am going on from this meeting to speak in the Queen's Speech economy debate and I am going to quote you saying that you agree with the Governor on the issue of regulatory minimum requirements. Am I going to be fair by quoting you?

Mr Sants: Yes. I might, if I may, just expand a little bit further. The answer is yes but for the purposes of adding to your background information for the benefit of the comments you will be making, I think we do need to understand, of course, that those capital ratios were designed on the basis of a stress test done by the FSA which was a stress test against the business plans which the banks submitted to us, so their expectations of the amount of risk weighted assets they would be deploying over the medium term. Against that we have done stress tests and ensured that they have ensured they have sufficient capital to absorb the expected losses against that set of business plans. Obviously it follows that if they decided they wished to conduct extra activity which involved extra risk weighted assets over and above that which was in the original business plans then you would have to revisit those capital assumptions. So I absolutely agree, you are absolutely correct, with the Governor that those ratios will come down over time, they are designed to absorb losses, the banks expect them to absorb losses and they are not new capital rules. But if the banks change their expected lending patterns then obviously we would have to revisit their expected capital arrangement.

Q166 Chairman: You and the Bank have got a close working relationship on that and both of you would be aware and come to a common view on that issue?

Mr Sants: Absolutely. We share the stress test models with the Bank.

Q167 Chairman: I can go ahead and say it then?

Mr Sants: You can indeed.

Q168 Chairman: That is fine, okay. Now when the Governor was here he made three points, lastly, Mr Sants, on better monitoring, which you will agree with, on the tripartite authorities making crystal clear their intentions, which you have agreed with, and he did say lastly on recapitalisation, "we may not have come to the end of this process". Do you agree with him on that?

Mr Sants: I think that picks up the point I have just made, in fact, namely that if the plans were to change then the capital might have to change, so that point needs to be borne in mind and, of course, we also need to recognise that the real economy situation remains a set of forecasts about the future and the outturns may not always follow the forecasts.

Q169 Chairman: I can take that as a yes as well.

Mr Sants: You can take that as a yes as well.

Q170 Chairman: Good. Can I thank you very much for your attendance today, particularly the rearranged session. Will you give our regards to Lord Turner when he is back and maybe tell him he was not missed because you did very well, but we do look forward to him coming again in February or March. Thank you very much.

Mr Sants: I will pass that on to him. Thank you, Chairman.