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Financial Services Authority Annual Report 2008-09 - Treasury Contents

Examination of Witnesses (Question Numbers 100-116)


25 NOVEMBER 2009

  Q100  Mr Todd: One of the tools is investment in improving financial capability amongst consumers. When Hector said about commonsense, it is making sure that commonsense can be applied in an informed way to a range of products that a consumer has in front of him. I glanced at Appendix 7 in your Annual Report, which touches on how you have addressed financial capability. If you have a look at that, could you point me to an area where there has been any qualitative research on what the numbers of packages delivered has actually meant? I have to say that I think some of this is rather misleading, by the way, because I am assuming that when it says "742,500 children were reached by the project in England" that is simply a multiplication of the 3,274 schools and the number of pupils that are in them. That sort of rather primitive methodology is what I am hinting at, which is that we do not appear to be looking too hard and just distributing packages and, I have to say, in my experience on that particular one, not terribly effectively, that that says "target exceeded".

  Lord Turner of Ecchinswell: I absolutely agree with you that we need to ask searching questions around this. We have been asked by Parliament to pursue a financial capability agenda. The amounts of money put into it in the past were relatively small. There is now a desire to have a national money guidance approach, which will go to a whole different level of scale and professionalism as we do that. This is a set of questions which the Board has asked the Executive almost as precisely as you are putting forward to us. We seem to be able to measure the inputs now.

  Q101  Mr Todd: So what was their answer?

  Lord Turner of Ecchinswell: The answer is that we are going to have to design better tools, because I do not think at the moment we can answer that. I do not think at the moment we have the ability to say have we not only done the input but do we know that people have greater capability and these are some of the tools which we will have to do, but, again, I would say we are in the sort of ramparts of professionalism. Perhaps Hector can respond.

  Mr Sants: The Chairman is, of course, right, that we can improve our tools, but we have been deploying some tools and I very much agree with you that it is important we do that. Up to now the way I would look at it is as follows. We did do, of course (and I recall discussing this at an earlier Committee) a baseline survey, if you recall, of a wide spectrum of consumers in the community to have a basic understanding of their financial knowledge, and the intention, of course, is to repeat that baseline survey at periodic intervals in order to see what the overall effect of the programme has been on the relevant individuals in the community. On each individual programme, you are right in saying that primarily the earlier targets were in terms of access—the number of people reached—and, of course, in itself that is not telling you too much other than the delivery mechanism is working.

  Q102  Mr Todd: It just means that a piece of paper arrived in their hands.

  Mr Sants: Quite so. What we are seeking to do in terms of then following up the impact of that delivery is qualitative work on talking to those individuals who have been reached with the services to see whether they feel they are better equipped; and in the Report and Accounts we do refer specifically to the work we did there on the marketing guide and making the most of your money, where 69% felt more confident after having read the guide. So the programmes generally are supported by qualitative assessments of consumer response.

  Q103  Mr Todd: I think you have pulled out one of only two examples of that.

  Mr Sants: Quite so, but the critical programme, of course, is the national money guidance service, which is not in the accounts here because we have been working on that during the year, but, just to reassure you, in terms of the set of tools that have been put in place to assess the effectiveness of the money guidance programme, which is obviously the central part of the intended new CFEB agenda, we are doing that type of testing to check that the satisfaction levels are being achieved. We have had some interim work done by an independent evaluator, Professor Kempson. The initial feedback from that is positive, but there is no question that a full evaluation of the success of the money guidance pilot, which needs to be done and will be done and is scheduled to be done, has to include that type of work.

  Q104  Mr Todd: Just to tie this one up, you now do have some serious money to spend.

  Mr Sants: We do.

  Q105  Mr Todd: And, I have to say, from the examples I have seen of it, some of it is misspent on product which is poorly focused and may well arrive somewhere but no-one ever looks at it. What I am looking for is some critical testing of the quality of the material and its functionality in terms of delivering something useful to either an adult or a child.

  Mr Sants: I agree with you, and I think it is absolutely critical, before this ambitious programme the Government has set out for money guidance is taken forward, that that full testing is done, and that full testing has yet to be done on the money guidance pilot.

  Q106  Mr Todd: You very honestly said that the Treating Customers Fairly programme had not delivered the outcome that consumers deserved. A slightly under-stated remark. Why do you think that was?

  Mr Sants: I think it comes back to the comments I made to this Committee before. I think that the regulatory approach, the supervisory approach—

  Q107  Mr Todd: Was this a sort of intellectual failure?

  Mr Sants: I think the regulatory approach, the supervisory approach of the old FSA was intellectually flawed in terms of getting a good result. The focus on the Treating Customers Fairly programme was a focus on making sure management had equipped themselves with the right management information but not on actually testing whether consumers were getting good outcomes, through mystery shopping, investigations, intensive supervisory engagement and strong credible deterrents. I think the historic supervisory approach in the conduct area was flawed.

  Q108  Mr Todd: So how are we going to know whether your new model FSA is delivering if the opposition parties allow you to do that, of course, to work out that outcome?

  Mr Sants: I think on the conduct side you have got two potential ways of testing it. One, of course, is in terms of the amount of effective credible deterrents that we are delivering, and we are certainly intervening more proactively and more decisively in the market place.

  Q109  Mr Todd: Is it not partly the qualitative test which you actually just touched on there, the mystery shopping?

  Mr Sants: Quite so. It is the consumer experience, and we need to outcomes test much more effectively our regulatory approach as well as our educational approach.

  Q110  Mr Todd: I have a last unrelated question on AIFM and the European venture into regulating that sector. We are hearing encouraging noises of a change in approach and adaptations to the representations made. Where has the FSA stood in this process?

  Mr Sants: The FSA certainly thoroughly agreed with the concerns that had been raised by large parts of the community, including the industry and a number of politicians. We certainly believe that the initial drafting of the Directive was faulty in construction, it was far too hasty, it was not adequately consulted on and that there was not a proper cost-benefit analysis done. As you know, we have subsequently done one which shows it, in its original form, to be expensive and we have serious concerns that a number of the measures proposed would be detrimental to the European financial market place and users. A large number, but not all, of our concerns have been addressed, so I would say that the current Directive as being sponsored—

  Q111  Mr Todd: So direction of travel good, but more to do?

  Mr Sants: But more to do. However, I fear that it will be very difficult for more to be done.

  Mr Todd: It would be helpful, but perhaps separately because we are pressed for time, if you dropped us a note on what more ought to be done and your reason for gloom with regard to whether it can be done.[5]

  Q112 Chairman: We do hope to look at the RDR in the New Year, and that would be helpful. I have to say, going back to our report of 2004-05, Restoring confidence in long-term savings, it was the FSA that established Treating Customers Fairly and it has taken industry along, however bumpy that road has been, so I think you deserve congratulations for that issue. Lord Turner, you were quoted at the second Financial Services Authority conference as saying, "It is important for the end destination in terms of banking regulation to be clear." What worries me, and maybe my colleagues, is how are you going to ensure adequate capital liquidity regimes operate now to prevent future crises when international agreements, such as Basel II, occurred, not over months, but decades? How are we going to get there quickly?

  Lord Turner of Ecchinswell: I would say two things. First, there is a challenge to try and make sure that what is effectively Basel III, but a much more extensive redesign than Basel II was, occurs not over decades but, hopefully, over the next 12-15 months. There are very strong commitments which have been made from the Financial Stability Board to the G20 financial ministers and leaders that we will drive through by October next year, but all the major decisions about the redesign of international agreements on the capital and liquidity (and there is an immense amount of work to do in that) either fall into the FSB or to the Basel Committee or other groups, and that is very, very high priority for me personally and for many people in the FSA over the next year to make sure we get there. Having said that, when those agreements are made they will then have to be phased in over a number of years in order to make sure that we are not hitting the banking industry of the world with such high capital liquidity requirements that we are stymieing the recovery from recession, so what we come up with will have to be both a new set of regulations and a transition path. However, it is also the case that we can begin to anticipate some of those things already. For instance, we have already put in place significant changes to the trading book capital regime in particular areas to do with a stressed value at risk approach and a re-securitisation approach which are already agreed will come in from 1 January 2011; so we are already in discussion with the major banks to say, "This is what you will have to meet by then. Are you on a path to build up your capital towards that level?" and that is, for instance, part of the debate which goes on about the aggregate level of bonuses that they pay out. The aggregate level of bonuses they pay out has to be consistent with the build-up to get to that capital level there. There are also things to do with the definition of capital which have already received in-principle support by the governing body of the Basel Committee and, therefore, we are already telling banks that they have to build towards a higher level of capital, and, of course, we already have our own interim capital regime or 6% Core Tier 1 and 4% Stress Core Tier 1, which is already a much more severe regime than that which formally exists under Basel II. What we are trying to do here is simultaneously run the process of designing what the long-term global system is while taking a set of steps which are already requiring a build up of capital. For instance, the Lloyds rights issue and the fact that Lloyds has been able to go ahead with that and not go through to the APS is based on a very rigorous stress-test which requires of it a level of capital significantly above what applied on the formal rules which existed before the crisis. We think we are balancing the challenge of heading towards where we want to be over the long-term, not doing so it fast that it harms the economy, but also making sure that we are steadily building up the robustness of capital and liquidity in the banking system so that it is already in a much better position than it was before the crisis.

  Q113  Chairman: A recent article stated that the FSA's enforcement office "aims to bring roughly five criminal cases a year". If that is the case, how was that figure decided on? The FSA's aim for enforcement is stated as "a credible deterrent without consuming inordinate amounts of manpower". Surely, the aim should be to punish wrongdoing. Why is it not?

  Mr Sants: It is. I think that the quote that you have mentioned was a description of the amount of capacity we currently have. In the context of our normal workload on enforcement in other areas, we currently have enough capacity to handle roughly five, or six, or so complex criminal cases in 12 months, but that capacity is being put in place to deal with expected demand from the supervisors. We are not, to your point, choking off. We do not have cases sitting there that we would like to prosecute that we are not prosecuting because we do not have enough capacity in our integrated enforcement area. I think they were just reflecting roughly what we have there, and that reflects roughly what we currently expect to be our workload over the coming 12 months or so. Obviously, that is a significant increase. I remind you that two or three years ago we were not doing criminal prosecutions of insider dealing at all. To date on our building but, as we have acknowledged, small track record, we have been successful. We expect that number to rise and we have a number of cases in the pipeline.

  Q114  Chairman: You and I have spoken about plea bargaining in the future. You have the Coroners and Justice Bill, which gives you power for immunity to whistleblowers. Have you got all the power that you want or do you still need to push in that area?

  Mr Sants: I think, broadly speaking, we do now have all the powers we need and we are very determined to make sure that they are fully utilised—plea bargaining being a key one. As we have observed here before, when you look around the world, plea bargaining is a vital ingredient of success in insider dealing cases and that power will make a visible difference to our ability to deliver credible deterrence. Insider dealing prosecutions are a very specialised area. We have built up a strong team now and we expect to see a steady stream of cases coming through the court of ever greater complexity. We acknowledge that true deterrence is going to require successful prosecutions of complex cases, with the judges, hopefully, delivering a strong message through the sentencing process, and we would expect that to happen.

  Q115  Chairman: We never usually talk about the finances of the FSA, but looking at your Annual Report it would appear to be an organisation under financial strain. You have just recruited a significant number of people, your remit appears to be widening and you had a deficit last year, I note, of £23 million. Are you concerned about your financial position and will you need to increase your cost to businesses just at a time when financial firms' profits have been hit? I note that you had to borrow £2 million last year. Is that the first time you have had to use your borrowing facilities?

  Mr Sants: There are two separate points there. There is the explanation of why we had a deficit and then there is the question of what are the forward-looking prospects in terms of the cost base and the consequences for fees. In terms of the trailing year, that entry in the accounts attracted a little bit of publicity in the newspapers and so forth, but actually, when you think about it, it is entirely understandable if you look at what happened. What happened was that, in the normal way of the FSA operating, we set a budget at the beginning of the year and we raised fees against that budget and, therefore, we would expect to operate in a matched fashion, assuming there are no issues with collecting the fees and assuming we run to budget. We do run to budget unless we make a conscious decision, caused by circumstances, to overspend, and last year we made a conscious decision, with the Board's support, to invest in the enhanced supervisory agenda, the SEP programme, part way through the year and, therefore, spent more money than we had originally budgeted for, but only after the Board's support and approval. Since we only raise fees once a year, it follows that that has had the effect of creating a small deficit in the year in question, which, of course, we then take into account when we raise fees for the next year. It is a perfectly controlled and managed situation and does not in any way suggest that our finances are not being properly managed. Yes, normally we are in credit as fees come in during the year, but, yes, we did, obviously, borrow to finance that conscious overspending that we had in the year in question. When we go into our next year, however, of course, we take into account our run rate of expenditure and lay out our budget plans. We are going through that process with the Board at the moment. We are presenting our final budget to the Board in the December Board meeting. It would be wrong for me to anticipate that final discussion with the Board, unless the Chairman wants to make any comment, but we have already said publicly that it is inevitable because we have been building up resources last year, which are now in place for a full year going forward, that there will be some further increases in fees, but we would expect that to be at a lower rate than in the past. We are extremely conscious of the economic climate that our firms are working in, we are conscious that the number of firms authorised has modestly declined. But the other feature I would draw to your attention is that we are currently consulting on a new way of calculating our fees which more fairly, in my view, reflects the activity that we as a regulator actually carry out in relation to the firms that are paying our fees. We are going to a far more effective activity-based allocation of fees which, I hope, will be much more transparent, particularly to the smaller firms who, rightly, in the past raised concerns around whether they are paying the right share of the cake. We are consulting on that at the moment—and that will mean, I hope, that a significant number, if not the majority, but certainly a significant number (it depends on our final budget) of firms actually see a decrease next year. Certainly we would not expect any fee increases for the smaller firms. Of course, last year we did freeze the fees for the very small firms and for next year we have this concept of a new £1,000 minimum fee for the FSA.

  Lord Turner of Ecchinswell: Can I add one point? I think the FSA over the last 18 months has been moving towards a much more intensive style of supervision. Quite a lot of that was in hand when I joined as Chairman through the Supervisory Enhancement Programme that Hector had put in place. Over the last year we have taken on a whole series of additional functions. If you look at the intensity of the stress-tests that we are now running on banks and the intensity and the detail we go into, it was simply something that the FSA was not doing before. The remuneration stuff is new; a lot of the interviews of significant influence functions are new; the level of detail that we are getting into in the comparison of the accounting treatments are new; and the liquidity regime has required an extra level of a specialist resource. The Board is very, very aware of the need, as it does, to try and work out what is the correct amount of this extra intensity, and one of the difficulties, of course, is that there is no model of this. Throughout the world the way that supervision is done is very different. I think if you talk to Santander you will find that Banco de Espana has about 70 people permanently on site at Santander. John Mack at Morgan Stanley, the other day, was saying how much he welcomed the 30 or 40 people from the Fed who are now permanently on site at Morgan Stanley. We have not gone to that direction. We have very significantly intensified what we do with a very significant element of specialist support to the firms facing supervisors, but it is something which at the last Board meeting, the Board away-day in fact, we devoted almost two days to very, very carefully debating what is the level of intensity of supervision that makes sense, particularly for the large very important firms, and I think one of the challenges in regulation is what is the balance between a small number of easily enforceable across-the-board rules, like very high capital, which in themselves have disadvantages, versus intense supervision, which also has costs, and it is a debate that we are continually consciously debating.

  Q116  Chairman: Can I thank you very much for your very interesting exchanges this afternoon, and we will continue that debate. We take your points about banking and the wider debate seriously, so thank you very much.

  Lord Turner of Ecchinswell: Thank you.

  Mr Sants: Thank you.

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