Financial Services Authority Annual Report 2008-09 - Treasury Contents

Examination of Witnesses (Question Numbers 20-39)


25 NOVEMBER 2009

  Q20  Chairman: There is one final question on this before I pass to my colleagues. I think I know the answer to this, but what would have happened if the emergency support had been disclosed at the time of the takeover prospectus?

  Lord Turner of Ecchinswell: At the time of the takeover prospectus?

  Q21  Chairman: Yes.

  Lord Turner of Ecchinswell: I am not convinced that it would necessarily have had any adverse consequences for the takeover itself because I think that a reasonably well-informed investor at that time was well aware that, in general, central banks throughout the world had been very heavily involved in a full range of the panoply of measures before them and, as I say, the words that are here are very clear. They have things like, "If the Bank of England liquidity facility or other sources of short-term funding are not available, Lloyds Bank, the enlarged group, could face serious liquidity constraints which would have an adverse impact on its solvency". The general warning that there was a significant degree of reliance on the central bank was absolutely clear at that stage and well understood by the market. Having said that, I think it is absolutely sensible that emergency liquidity assistance, when it is provided, is not revealed and that, having not been revealed at the time, one waits until conditions have calmed down before revealing it. I think if you had asked me the question, what would have been the consequence of revealing on 1 October that the bank had crossed the line from normal operations to ELA, I think that it would have made a bad situation even worse. We had pretty much total seize-up in the money markets of the world in any case, but I think that that would have really tipped the thing over the edge.

  Chairman: I was confident that would have been the answer!

  Q22  Mr Fallon: Mr Sants, just to be clear, did you approve the prospectus in advance?

  Mr Sants: The FSA approves the prospectus.

  Q23  Mr Fallon: You did?

  Mr Sants: The FSA obviously approves prospectuses; it is a listing authority function of the FSA.

  Q24  Mr Fallon: But neither prospectus refers to either the amount or scale of the emergency liquidity assistance nor refers specifically to that facility at all.

  Mr Sants: As I said before, the practice in prospectuses is to make sure that the material risks are disclosed and I think that, in the documentation to the Lloyds shareholders, it was made clear that the enlarged group would substantially rely, for the foreseeable future on the continued availability of the Bank of England liquidity facility and so forth. I am sure you can read that on page 33. It was already known to the Lloyds executives at that time following their discussions with the Bank of England that the non-standard facilities would be switched into standard facilities before the enlarged group came into being. Therefore, they were making abundantly clear to their shareholders that the enlarged group would be dependent on liquidity support from the authorities to survive. I think the wording there is unambiguous to that effect. They also knew that ELA would not be the tool being used at the point of the creation of the group. So, that seems to me to be a wholly reasonable disclosure. At the end of the day, I would make the point, however, that the obligation for disclosures rests with the issuers and not with the FSA. Nevertheless, I think that wording is reasonable in light of the information that Lloyds executives had at the time and the conversations they had with the Bank of England.

  Q25  Mr Fallon: Do you think it is reasonable that the amount and scale of the funding should be concealed from the shareholders, that a figure of £25 billion should be concealed from the shareholders? Do you, the FSA, think that is reasonable?

  Mr Sants: It is practice in listing documentation—

  Q26  Mr Fallon: What the prospectus discloses is the access. It does not disclose either the amount or the scale of this funding. Why do you think that is reasonable?

  Mr Sants: That is not the case. It makes completely clear that HBOS is dependent on Bank of England funding and it makes completely clear, particularly in the HBOS documentation which was available before the shareholder vote, that, without that funding, it was likely that the company would be insolvent. The wording to that effect is completely clear.

  Q27  Mr Fallon: Where on page 19 does it refer to £25 billion?

  Mr Sants: I am looking at the HBOS prospectus at page 19 where it says, "The HBOS Group could face serious liquidity constraints which would have a material adverse impact on its solvency in the absence of UK Government taking appropriate action to support the HBOS Group liquidity ... " et cetera, et cetera.

  Q28  Mr Fallon: But there is no reference to the £25 billion.

  Mr Sants: There is no numerical reference to the £25 billion which is actually no more than I think 4% of the gross balance sheet of HBOS, but the risk that the shareholders faced is absolutely abundantly clear. As I say, the obligation at the end of the day does rest on the company and not the FSA, but I think anybody reading this understood fully that HBOS was dependent on central funding.

  Q29  Mr Fallon: So, the risk was large but the amount was trifling.

  Mr Sants: The risk was clearly described, which is the purpose of a prospectus, and I feel that the Lloyds shareholders were fully aware of the funding risk that the enlarged group would face.

  Q30  Jim Cousins: Just following up Mr Fallon's point, do you not think that the prospectus should have made clear that a sum far in excess of £25 billion had been handed over to the Bank of England as collateral? Do you not think that the disappearance of the assets into the control of others was a fact that needed to be disclosed?

  Mr Sants: Those obligations are also covered in the working capital statements and I think that the overall set of risk disclosures—and we can go through each one in detail if you like—make very clear that, without the central authority's liquidity support, HBOS and the enlarged group would not be a viable entity and I think that the HBOS shareholders and the press commentary at the time—

  Q31  Jim Cousins: Excuse me, Mr Sants. Can you draw my attention to where in the Lloyds prospectus was the fact that Lloyds was about to merge with a bank that you have just said was not a viable entity without that liquidity support?

  Mr Sants: I think it is reasonable for the shareholders to be making the judgment on all the public information available at the time, but I draw again your attention to page 33 and page 13.

  Lord Turner of Ecchinswell: If you look at page 13 of the Lloyds TSB proposed placing offer, so this is, I think, the document of 18 November, and in addition to the—

  Q32  Jim Cousins: Lord Turner, you will have the opportunity—and I hope you will—of supplying the Committee with those words which are to be found buried in those documents—

  Lord Turner of Ecchinswell: You did just ask us to point you towards them.

  Mr Sants: You asked us where they were.

  Lord Turner of Ecchinswell: I think you did actually just specifically ask us, could you point us towards them. Are you saying that you do not want us to point you towards them because you did just specifically ask us?

  Q33  Jim Cousins: You have pointed us towards them and we will have the opportunity of reading them later.

  Lord Turner of Ecchinswell: Right, the pointing has been adequate!

  Mr Sants: I do not think they are buried. These prospectuses and documentation are produced specifically for investors to make informed judgments on transactions. That lies at the heart of the European disclosure base prospectus regime. To describe these documents as ones in which information is buried is to completely misrepresent the communication exercise that they are designed to achieve.

  Q34  Jim Cousins: Yes, of course we must bear in mind that we are not here just to consider the interests of very sophisticated people but quite unsophisticated people as well. Mr Sants, in the summer of 2008 you had banned short selling in banks. Why did you not take measures of a similar robustness to protect the interests of the ordinary shareholders?

  Mr Sants: As I think we have made abundantly clear, and the words which we have drawn to your attention are explicit, the risks are properly disclosed in these prospectuses and the role of the FSA is to sign off on prospectuses. The ultimate responsibility for the content of the prospectus lies with the firm and its issuers, but I am answering the question and I think those risks are adequately disclosed, and that is our position and I personally think that it is a perfectly reasonable position. I think it is a sad day if you think that the thousands of stockbrokers out there servicing the retail community and all the many financial journalists are not reading the prospectus.

  Jim Cousins: Clearly, you expect people to rely on those stockbrokers rather than on you. The changes were not the changes to the Market Abuse Directive but the clarification of what the Market Abuse Directive meant in the British context.

  Chairman: Can you give us a brief answer because we do want to move on.

  Q35  Jim Cousins: When did that actually happen because that was the difference between not having a covert operation with Northern Rock and having one for this?

  Lord Turner of Ecchinswell: We issued a consultation paper in July 2008.

  Q36  Jim Cousins: A consultation paper?

  Lord Turner of Ecchinswell: Yes, but we were effectively applying that policy thereafter which we are able to do.

  Q37  Jim Cousins: When was the consultation paper formally concluded and the relevant formal clarifications published?

  Lord Turner of Ecchinswell: The formal rule came into place on 6 December 2008.

  Mr Sants: But we should make it clear that we were already applying that policy because it was a clarification and not a substantive change.

  Q38  Jim Cousins: Let us be clear. The formal clarification of the position about the Market Abuse Directive which the Governor of the Bank of England believed made a covert operation to support Northern Rock to be impossible and a covert operation to support HBOS and RBS to be possible was not formally in force until December 2008 after these covert operations had occurred.

  Lord Turner of Ecchinswell: Yes, but if it is a clarification that our understanding of the law is that there is not a limit on operating covert operations, then it is legal to undertake covert operations before that clarification because the clarification is basically saying, "Yes, we are clear that you are able to operate in a covert fashion".

  Mr Sants: Also, I did not want to go back over the entire Northern Rock debate. Can I say quite clearly that the circumstances pertaining to the Governor's views on Northern Rock were not the same as those pertaining to Lloyds and HBOS. If you wish me to spend another ten minutes going back over that again, which I have done a number of times, I would be happy so to do.

  Chairman: We went over it in our report quite well and we are very familiar with that.

  Q39  John Thurso: The core of this issue is not about the use of covert action. It was something, as we just said, that was called for. The core of this issue is the fact that a major piece of covert action was taking place at a time when a major transaction between two banks was also taking place. The timeline is that, on 17 September, Robert Peston broke a story that Lloyds and HBOS were conducting merger talks. On the 18th they announced it and on 1 October the covert action started. The Governor made it clear in his evidence yesterday that covert action or ELA is a bridge from a particular place to a resolution and he listed them and that was not terribly important, the point is that it is a bridge. You have asked us to accept that, I think your words were, thousands of stockbrokers and a whole community of financial journalists knew about this but were happy to be silent about it. I find that completely incredible. The questions that I put last year to the Chancellor were about this merger and he answered by saying that there was nothing the Government could have done to have made that merger go ahead if the shareholders had not wanted it. He said that it was entirely a commercial decision. When I asked Mr Eric Daniels about it, he said it was something that made good sense. The shareholders had the right to a substantial piece of information which might have changed their point of view. Do you really think it is acceptable for the regulators to have permitted that transaction with this huge piece of information absent?

  Lord Turner of Ecchinswell: It does depend here on how you interpret these words, but I have to say that the statement that it expects the enlarged group to substantially rely for the foreseeable future on the continued availability of Bank of England liquidity facilities and that, in the event that these are not available, the Lloyds Bank Group, the enlarged group, could face serious liquidity constraints which would have a material adverse impact on the solvency of the group are pretty in-your-face words. There are not many disclosures which say, "There is something out there which could have a material adverse consequence for the entire solvency of a firm". Those are pretty strong words.

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