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Financial Services Authority Annual Report 2008-09 - Treasury Contents

Examination of Witnesses (Question Numbers 40-59)


25 NOVEMBER 2009

  Q40  John Thurso: I think you could pick any 20 prospectuses off the shelf from major plcs and you would find a sentiment of that nature expressed about some risk.

  Mr Sants: I disagree with that.

  Q41  John Thurso: There is a massive difference, if I may put to you, between a risk that is flagged in that way and a statement which says, "We have £25 billion of the central bank's money and we would be bust without it". The point is that HBOS were clearly doing the deal of a lifetime but many of the Lloyds shareholders—and, looking back from today, we now know how much worse the situation with HBOS was—might have taken a different view. That is the core issue.

  Lord Turner of Ecchinswell: I do not agree. I think that these words combined with the context. You have to understand that the newspapers of the world were full of commentary of the fact that central bank balance sheets throughout the world were increasing because of support. The Chancellor of the Exchequer was telling Parliament that part of the package agreed in the middle of October was that the Bank of England would do whatever was required in liquidity assistance to make sure that the banks were safe. All of that was not, as it were, hidden. The fact that there was a central bank truly committed to a very high level of liquidity support was absolutely overtly obvious.

  Q42  John Thurso: Are you telling me that Robert Peston, who broke every story going, has voluntarily kept quiet about this or that he did not pick it up?

  Lord Turner of Ecchinswell: I am not quite sure what this is about. I did not understand your comment earlier about being happy to be silent. I did not understand what you meant by that.

  Mr Sants: I do not believe the investment community were not fully aware that the enlarged group which had been created as a result of the Lloyds/HBOS deal would be dependent on central banking liquidity support in the circumstances that were then prevailing at the time. I think these disclosures make that abundantly clear. It was clear to anybody who was an intelligent spectator of the then set of circumstances. I remind you again that, at the end of the day, the obligation of disclosure ultimately sits with the company, with Lloyds. Lloyds were fully aware of the circumstances that HBOS were in and the Bank of England had informed me to that effect, but they had also agreed with the Bank of England that they would not be continuing to avail themselves of the ELA facility in the new merged group and would be using the standard Bank of England facilities. These disclosures make that abundantly clear.

  Q43  Mr Tyrie: Mr Sants, surely you must grasp that giving £25 billion, but with any indication of the scale of the support excluded, must now lead shareholders to feel that material information was not made available to them. To suggest that it was in these documents is going to strike all of them as risible.

  Mr Sants: We have covered our points as to what the wording says. I think that the wording is very plain and understandable English and is not wording that is normally to be found in prospectuses and the level of disclosure is consistent with market practice in relation to the Prospectus Directive.

  Q44  Mr Tyrie: Okay, so it might have covered £125 billion of support. It could have done, could it not?

  Mr Sants: It made it completely clear—

  Q45  Mr Tyrie: Hang on a minute. It could have covered any sum.

  Mr Sants: No. I think what it made clear was that the level of support was the level of support necessary to sustain the institution.

  Q46  Mr Tyrie: I will come back to you, Lord Turner, in a moment. I just want to be clear. This could have covered any sum. The logic of your argument says that the level of support being provided might have been £5 billion, £25 billion, £200 billion. Yes? It either has to be a "yes" or a "no"?

  Mr Sants: It was certainly implying that the level of support was such that, without it, the institution was not currently sustainable and therefore it had to be material to the current sustainability of the institution.

  Q47  Mr Tyrie: So, in these circumstances, in equivalent circumstances in the future, nobody in their right mind is ever going to touch a deal with those words in the prospectus again. You would not touch it, would you? You would not even look at it because now you know that it might mean support of—

  Mr Sants: The judgment is about whether that support will remain in place and the timing and the expectation of the authorities policies in relation to maintaining support. It was well known that many banks were obtaining support from the central bank. The question that investors had to answer was, what was the likely duration and extent of that support in the future.

  Q48  Mr Tyrie: Lord Turner, when you said a moment ago that these people should have been looking at the context, are you really suggesting that, in addition to reading the prospectus, people should be expected to read the newspapers carefully to try and gauge the mood and general atmosphere surrounding the deal?

  Lord Turner of Ecchinswell: It was a very specific general atmosphere where there was continual discussion about the fact that the banking system was dependent on Government and Bank of England support and I do think it is therefore crucial that the words say, "If the Bank of England facility were not available at the end of this period, that would have a material adverse impact" and that, I think, is the answer to, does it matter whether it was £25 billion or £50 billion or whatever. Essentially, the words are saying, "You have to realise that we are dependent on the willingness of the Bank of England to continue to provide the liquidity". The other point to make is, of course, that I do not actually accept that the revelation or the non-revelation that emergency liquidity assistance had any really material impact at the end of the day on whether this was a good deal or not because let us remember that it was repaid. That is the purpose of emergency liquidity assistance; it deals with a particular dislocation in the market which unwound, which to a degree did unwind and the need for the emergency liquidity assistance fell away. I do not think that actually this materially changed the attractiveness.

  Q49  Mr Tyrie: Lord Turner—

  Lord Turner of Ecchinswell: I think there are other things which have been debated about the deal and I am not sure it materially changes it.

  Q50  Mr Tyrie: Lord Turner, I put it to you that, as an institution, you have now made a nonsense for the markets out there of the phrase "material disclosure during a period of financial crisis". You have now put us in a position where nobody looking at that in a prospectus can take the words that, as you put it, there might be a material impact on the solvency of the group as just some risk. It could be a total risk. It could be a risk so huge as to make the purchase of that—

  Lord Turner of Ecchinswell: I think to say that you are dependent to a substantial amount on Bank of England liquidity support and if that support is removed that will have a material adverse impact on the solvency of the group is a pretty strong statement.

  Q51  Mr Tyrie: But £25 billion—

  Lord Turner of Ecchinswell: It is basically saying that, if the Bank of England had chosen not to extend the SLS beyond the 30 January deadline—

  Q52  Mr Tyrie: But £25 billion—

  Lord Turner of Ecchinswell: —it would have been an unsustainable—

  Q53  Mr Tyrie: But £25 billion—

  Lord Turner of Ecchinswell: It has been revealed. It has been revealed, not by the figure but—

  Q54  Chairman: Excuse me!

  Mr Sants: It is a material disclosure and it was—

  Lord Turner of Ecchinswell: That is why it says it is a material adverse impact.

  Chairman: Order, order! Order, order! Peter, one quick question and then we will move on.

  Q55  Sir Peter Viggers: There is a difference between a general warning and a specific provision of facts and I did not hear an answer to Jim Cousins's important question. If support of £25 billion had been made available to the bank, then an amount considerably in excess of that was pledged as security to cover that advance. Where is the specific reference to that to enable a prospective investor to quantify his risk?

  Mr Sants: There is a requirement to ensure that there is an ongoing working capital position which is sustainable for the group and it is back to the earlier point from Andrew as well, if I may. There was a set of discussions between the Lloyds executives, on whom the disclosure requirements rest, with the Bank of England as to the future funding strategy of the enlarged group which included an agreement between the Bank of England and the Lloyds executives that the ELA would be repaid before the combined group was created. Overall, in that context, along with their advisers, they would have to satisfy us through the prospectus disclosure that their working capital requirements were sufficient. I do not have the page immediately to hand but I could supply it to you, but there is a working capital statement in there which you might like to look at. That was dependent to some degree on the Bank of England's judgment and, if the Bank of England were not intending for that ELA to be repaid, they would have had an obligation to inform us that they took that into account in looking at the prospectus, but they had reached a view that the ELA would be repaid before the combined group came forward and that was a discussion they had with the Lloyds executives.

  Q56  Chairman: We will have to move on. We have a huge agenda, so could there be brief questions and brief answers and do not get yourselves excited and I will be delighted. In your speech on 9 November, Hector, you discussed a number of elements of what you called "intensive supervision". Are you not worried that intensive supervision will crowd out private sector vigilance? In other words, you will have the regulatory badging and some people will say, "The FSA is to blame at the end of the day"?

  Mr Sants: Yes. I think that undoubtedly if we put ourselves forward as taking a more intensive approach, which we are. This means we will be in the future and indeed, are now making judgments about whether actions firms are taking will result in adverse consequences. In consequence we are putting ourselves in a position of second guessing to some degree firms' management, and this does raise the question of whether firms will feel that they can rely on us. I think that risk or undoubted consequence of our changed approach is a justifiable one. I think the Committee here in our previous conversations has made it abundantly clear that you did expect us to try and anticipate what might happen and not just react to historic data and that you did want us to make judgments about business models. Once we get into the business of making judgments there is a risk that we will get these wrong, just as there is a risk that management will get it wrong, and there is some small risk that management might see that as a crutch on which they can rely. In reality, I think that that is a very, very small risk which the benefits of the new approach far outweigh.

  Q57  Chairman: To what extent will that greater intensive supervision impact on the potential for economic growth in the financial services and have you assessed what trade-off you would like to see in that?

  Mr Sants: We have to be mindful and continue to be mindful that we need innovation to bring prosperity to the community and we must not undermine the basic principle that boards and their executives are responsible for their own actions, which I think is central to having a successful economic system. Equally, I think that we do need to recognise that there are clearly strong advantages in having a proactive forward-looking regulator. A set of new eyes, a second look at the potential risk has to be beneficial. Secondly, we do know that there are limits to the benefits that complexity and innovation can bring to consumers. Talking about our mortgage review, for example, at the peak of the market, there were some 15,000 different mortgage products on offer. I do not think that was really benefiting the consumers, do we? I think most of us would agree that that does not really sound like a mortgage regime where innovation is bringing benefit. You can well argue there is a point in innovation when complexity kicks in which has adverse effects on consumers. So, I think there are some limits to the benefits of innovation and us helping to draw some limits and begin to enter into that debate of where those limits can be drawn would be helpful.

  Lord Turner of Ecchinswell: I think that Hector has said it pretty much exactly as we believe it. The only thing I would add is that you said, could it be at the expense of economic growth in financial services and I would rather express it as, could it be at the expense of financial services' ability to help the wider economic growth. We do not have a particular interest in the financial services getting bigger. We have a particular interest in financial services performing its functions vis-a"-vis the real economy as effectively as possible and we must make sure that we are not getting in the way of helpful innovation but, at the other end, there can be some other helpful innovations.

  Q58  Chairman: There has been a wide debate on that issue given that you have spoken on this in the past, that there needs to be a sort of civic engagement or whatever you would call it.

  Lord Turner of Ecchinswell: I think we need an open debate about that issue, but we are well aware of the need to get the balance right and going down the line of intense supervision is not our intention to get in the way of helpful innovation in financial services nor get in the way of the primary responsibility for the management of risk which has to reside with the management and boards of directors of companies.

  Q59  Sir Peter Viggers: The IMF has looked at financial services in the United States on the one hand and the UK and Europe on the other and has said in a recent report that it believes that the American banks are about 60% of the way through their particular crises whereas, on this side of the Atlantic, we are about 40% of the way through. What is your approval of the extent to which the banking crisis has worked its way through?

  Lord Turner of Ecchinswell: If I remember rightly from those figures—I may be wrong but I am trying to remember them—the UK actually showed up reasonably well in terms of how far it was through where the specific measure that they were using for how far are you through were the amount of already declared losses and/or the amount of recapitalisation which had already occurred relative to their estimate of what the total losses might be. I cannot immediately remember it, it is from the latest October version of the Global Financial Stability Report[1], but, when I went through and also discussed it recently with people at the IMF, I think when you say America versus Europe, there are three sets of figures, there is America, UK and continental Europe, and we do not score badly in that respect. I would say that overall it may be correct that we have taken and the US has taken very strong action to recapitalise banks up against very strong stress tests which anticipate future bad news in terms of future possible loan losses, which is of course exactly what the Americans did with the recapitalisations coming off the back of the stress tests that they did in February to May of this year. I think that some of the continental European countries have taken a slower process though it may still be an effective process. If you look at the approach of the German authorities to the Landesbank which have significant potential losses in them, they have put in place mechanisms to assure that those losses will be dealt with, but those mechanisms involve dealing with it over time rather than recapitalising in up front. So, that characterisation of the IMF is one which I think I recognise but, within that, we are confident that the approach taken to determine the capital requirements of the UK banks, both in the action last October, the further discussions in January and, crucially, the decisions made a few weeks ago with Lloyds going ahead with the rights issue and RBS going into an APS, have very effectively anticipated a future very bad result, a worse result than is our mean expectation.

  Mr Sants: It is useful to draw your attention to the actual stress test we use which obviously is a locally devised stress test drawing on Bank of England data which underlines the decisions we have made around APS and so forth. We are confident that that scenario, which is in the public domain, looks a very sensible scenario to be anticipating.

1   IMF Global Financial Stability Report-Navigating the Financial Challenges Ahead (October 2009). Back

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