Written evidence submitted by Which?
FINANCIAL REGULATION
1. Whilst the major focus has understandably
been on the failure of the tripartite system to deliver effective
prudential regulation, there have also been serious flaws in the
FSA's approach to conduct of business regulation. This has led
to a failure to deliver sustained improvements for consumers and
a number of major problems surrounding issues like Payment Protection
Insurance (PPI), endowment mortgages and bank charges. These failures
cost consumers and the industry billions of pounds and damaged
consumer confidence.
2. Alongside to changes in structure we
need fundamental changes to the approach taken in consumer protection,
macro and micro prudential regulation. In summary, we believe
that the measures we are proposing would lead to a more effective,
efficient and accountable regulator
CONSUMER PROTECTION
AND MARKETS
AUTHORITY
3. The objective for the CPMA should be
to ensure a fair, transparent and competitive market in financial
services, with particular focus on protecting consumers and ensuring
market integrity. It should have a duty to promote effective competition
and when discharging its functions should "have regard"
to factors including the price and value for money of financial
products and services, the need to proactively disclose information
and promoting public understanding of the financial system and
financial inclusion. It should take a stronger approach to enforcement
with higher financial penalties and action against individuals.
It should also regulate products rather than simply examining
the sales process. The Board should contain a number of individuals
with experience and knowledge of consumer issues. Proper accountability
can only come alongside improved transparency. Section 348 of
FSMA should be removed and there should be a presumption in favour
of disclosure of information.
COORDINATION BETWEEN
THE CPMA, PRA AND
FPC
4. Splitting responsibility between three
different regulators does not remove the conflicts which can exist
between different functions, but merely externalises them. We
do not believe that the PRA should be given primacy over the CPMA.
To permit the PRA to prevent the CPMA taking a firm-specific conduct
decision sends a dangerous message to the industry that only firms
which are small enough to fail without causing damage to financial
stability will be forced to bear the full consequences of mistreating
consumers.
PRUDENTIAL REGULATORY
AUTHORITY
5. The current supervisory approach to prudential
regulation is not effective. The significant implicit subsidy
received by the banking sector has eroded market discipline, distorted
competition and encouraged banks to intertwine highly leveraged
investment and wholesale banking activity with essential retail
banking activities and the payments system. Responsibility for
prudence must lie with the banking institution, its management,
shareholders and debt providers and not be delegated to regulators.
Stability is not created by trying to prevent failure, but by
enabling firms to fail in a controlled way. The regulator must
change its approach from attempting to prevent failure in all
circumstances to ensuring that banks can fail, but without significant
harm to their customers, vital banking services or the economy.
MACRO-PRUDENTIAL
REGULATION (FINANCIAL
POLICY COMMITTEE)
6. We support the introduction of the Financial
Policy Committee and note the implications of the use of macro-prudential
tools such as changing Loan-To-Value limits and capital requirements
on consumers. It is important that these issues are tackled prior
to the start of the operation of the FPC.
CONSUMER PROTECTION
AND MARKETS
AUTHORITY
7. Which? believes that structural changes
will not, on their own, address the root causes of poor regulation.
Major changes in approach are needed to ensure financial services
consumers receive adequate protection from the new Consumer Protection
and Markets Authority.
8. The previous approach to regulation failed
to deliver sustained improvements for consumers. It was an approach
that was too reactive and failed to put in place the right incentives
for firms, make competition work for consumers or ensure that
there was a credible deterrent against poor practice. Instead
of tackling the root causes of consumer detriment, the regulator
sought to control the sales process. There was an emphasis on
disclosure of information, rather than ensuring that consumers
could understand and act on this information. This led to a number
of major problems surrounding issues like Payment Protection Insurance
(PPI), endowment mortgages and bank charges. These failures cost
consumers and the industry billions of pounds and damaged consumer
confidence.
9. The ultimate purpose of regulation is
to ensure that markets work in the interests of consumers. The
CPMA should work to ensure that market forces can work more effectively
in the financial services market so that companies which treat
their customers fairly and offer good value for money products
gain business at the expense of firms which do not. Similarly,
it must be made clear to firms, their management and shareholders
that a failure to treat customers fairly will have a significant
detrimental effect on the firm's reputation and bottom line.
10. Over the past year we have seen a number
of welcome changes to the FSA's approach including a move from
a purely reactive to a proactive approach and a greater willingness
to tackle the root causes of consumer detriment. We are keen to
ensure that this new approach is carried across to the new regime
and that the CPMA is given the mandate, powers and tools to deliver
improvements for consumers. In order to achieve this we believe
the following issues must be addressed:
MANDATE AND
OBJECTIVES
11. We believe that the objective for the
CPMA should be to ensure a fair, transparent and competitive market
in financial services, with particular focus on protecting consumers
and ensuring market integrity. We have concerns about the unintended
consequences that could result from the current proposed primary
objective relating to "ensuring confidence"—for
example, it could discourage the regulator from publicising bad
practice or drawing attention to areas where markets are not working
properly for consumers. As a result we believe the Government
should reconsider the objective it has set out.
12. Whatever its primary objective, we believe
the CPMA should have a duty to promote effective competition.[40]
It should be given the necessary powers to regulate the sector
to achieve this, including the ability to apply specific licence
conditions to banks and exercise competition and consumer protection
legislation. Its competition powers would be concurrent with the
competition powers of the OFT and will enable the regulator to
make market investigation references to the competition commission.[41]
13. In order for the CPMA to act as a strong
consumer champion, we support the inclusion of a number of "have
regards" including:
— The price and value for money of financial
products and services: The loss of the Supreme Court case
on unauthorised overdraft charges has exposed significant gaps
in the ability of regulators to tackle unfair charges so we believe
the CPMA should be given the authority and powers to these. We
outlined a possible approach in our submission to the European
Consumer Rights Directive and also raised this issue in our response
to the Treasury Committee's inquiry into Competition and Banking.[42]
— The need to proactively disclose information
which might influence a consumer's decision to engage in a commercial
relationship with a financial services company: there should be
a presumption in favour of disclosure and information should only
be withheld where its release would damage the interests of consumers.
— Promoting public understanding of
the financial system: the regulator should ensure that consumers
have, understand and can use the information they need to make
decisions about financial products and services.
— Promoting financial inclusion:
This should recognise that in the same way as utility services,
access to basic financial services are essential for consumers
to properly participate in society.
14. We support the removal of the need for
the regulator to have regard to the international character of
financial services and markets and the desirability of maintaining
the competitive position of the UK and the desirability of facilitating
innovation. We do not feel these are suitable objectives for a
regulator tasked with consumer protection. The inclusion of "innovation"
presupposes that innovation in financial services is always beneficial
for consumers and markets. In actual fact, innovation of product
design can frequently involve increasing complexity or products
which benefit the industry not consumers. The need for regulators
to have regard to "international competitiveness" creates
a conflict of interest which tends to support the status quo
and be insufficiently challenging to the industry.
SUPERVISION AND
ENFORCEMENT
15. We welcome the intention that the CPMA
will take a strong approach to enforcement to ensure credible
deterrence. In order to achieve this we believe the following
changes are necessary.
Financial penalties will need to be significantly
higher than those imposed by the FSA
16. Examples of fines in Payment Protection
Insurance (PPI) cases have shown the level of fines issued were
minute in comparison to the revenues firms generated from mis-selling—in
the case of the January 2008 fine for HFC Bank Limited it represented
less than 0.4% of sales revenue.[43]
Even after the FSA had decided to significantly increase the level
of penalties it imposed for PPI mis-selling, the fine levied on
Alliance and Leicester represented less than 3% of the revenue
they gained from selling the product.[44]
It is unsurprising that the FSA's regulatory activity in the market
for Payment Protection Insurance has not had the desired outcome
in ensuring that customers are treated fairly. We would suggest
the CPMA looks at the example of other regulators who levy substantially
higher fines for consumer abuses. Under the Competition Act 1998,
the OFT has the power to levy a financial penalty of up to 10%
of global turnover of the business involved. OFWAT and OFGEM have
similar powers. British Airways was fined £121.5 million
for collusion over fuel surcharges.[45]
Argos and Littlewoods were fined a total of £22 million for
fixing the price of toys and games.[46]
OFWAT fined Severn Water £35.8 million for mis-reporting
information and providing sub-standard service.[47]
Shareholders will only be incentivised to put pressure on senior
management to ensure customers are treated fairly when financial
penalties represent a significant proportion of the revenue gained
from selling a product.
Greater action should be taken against the senior
individuals responsible
17. Senior management have to be clear that
breaching regulations will result in serious consequences for
themselves and for their firm's reputation and bottom line. The
CPMA should send a clear signal that it will take action against
individuals, including greater use of orders prohibiting the individuals
from working in the financial services industry.
REMUNERATION SYSTEMS
18. The CPMA should move from a purely reactive
approach to one which seeks to tackle the root causes of consumer
detriment. In our view, remuneration systems linked to sales targets
create a conflict of interest between the consumer and the firm.
They encourage banks to recommend courses of action which result
in the sale of a product, rather than that which is most suitable
for the customer. They also contribute to mis-selling. For example,
advisers at Alliance and Leicester received six times as much
bonus for selling a loan with PPI as they did for selling a loan
without PPI.[48]
The CPMA should prohibit remuneration and commission systems for
both frontline staff and senior management which encourage mis-selling.
EFFECTIVE REDRESS
19. In the past 10 years we have seen substantial
detriment caused to consumers in a number of areas including mortgage
endowments and Payment Protection Insurance. The impact of these
problems on consumers has been compounded by the slow response
of the industry and regulators. Excessively long timescales, poor
complaints handling and inadequate redress have become all too
common. The CPMA should adopt an effective redress system which
improves the incentive for firms to treat customers fairly. Two
approaches which should be adopted are:
Past case reviews
20. The CPMA must show greater willingness
to utilise the s 404 powers to require firms to actively review
past sales of a particular financial product where detriment has
occurred. This would be a similar process to a "product recall".
Collective redress
21. The CPMA should introduce an improved
method of collective redress which would allow a collective claim
to be made on behalf of all those consumers who are adversely
affected. This could have benefits for consumers in improving
access to redress while reducing the administrative cost for firms
and the regulator of dealing with individual cases. We believe
that the Courts should have the power to ensure that claims could
be done on an opt-out basis.
CONDUCT RISK
22. The CPMA should preserve the FSA's Conduct
risk division which is aimed at the identification of emerging
risks before they crystallise and cause major consumer detriment.
We also recommend that the CPMA should make greater use of market
testing and mystery shopping.
23. In addition, there should be a Committee
introduced with members from the CPMA, OFT, FOS to share information
about potential risks and the merits of dealing with the issue
through a complaints-led approach or by regulatory action by the
CPMA. This Committee would gather evidence from consumer and industry
groups and set a timetable for investigation. This proposal would
enhance the current "wider implications" process. At
the same time, we would favour a move towards a more formal process
(along the lines of a supercomplaint process) which allows consumer
bodies to raise potential issues with the CPMA and for the CPMA
to publicly report on action taken.
PRODUCT REGULATION
24. We believe that the CPMA should embrace
the role that product regulation can play in addressing conflicts
of interest, disciplining markets and aligning the interests of
producers with consumers. In many markets, competition provides
an effective force in shaping the products on offer and ensuring
they meet consumers' needs. However, effective competition relies
on consumers being able to make informed choices, based on an
ability to compare competing products with each other. This should
cause firms which offer poor value and poor quality products to
lose business at the expense of their competitors. However, this
is frequently not the case in the financial services sector, where
consumers' ability to make informed choices are hindered by a
combination of their lack of financial capability, product complexity,
incomplete or unclear contracts, the length of time between the
purchase of a product and discovering whether it has worked and
a lack of transparency in the design and marketing of financial
products.
25. Product regulation could be used by
the regulator to address three key issues:
— Ensure minimum standards for key products:
There are certain products, such as current accounts and protection
products, that consumers need access to. We believe the regulator
should ensure that any such products meet minimum standards. We
would draw a parallel with motor insurance where all products
on sale must meet minimum legal requirements, and consumers then
have the option to add on additional "bells and whistles".
— Minimise the toxic aspects of products
and in some cases prohibiting a particular type of product or
specific product (for example single premium PPI): Product regulation
can play a valuable role in limiting the harm that certain products
can cause.
— Ensure the availability of "vanilla"
products: Experience has shown that the financial services industry
alone will not develop simple, good value for money products which
meets consumers' needs. We believe the regulator should pursue
the idea that providers and intermediaries should offer simple,
straightforwardly priced "vanilla" products alongside
their additional product offerings.
GOVERNANCE AND
ACCOUNTABILITY
26. Further steps need to be taken to ensure
that the regulator is subject to greater accountability than is
currently the case with the FSA.
27. We welcome the intention to make the
CPMA subject to audit by the NAO. The regulator should also be
accountable to the Parliamentary Ombudsman. We support the continuation
of the Consumer Panel. The Consumer Panel must be properly funded
and resourced. It is important to recognise the inherent imbalance
in resources between those who lobby on behalf of the industry
and those who lobby on behalf of consumers.
28. In addition to increased oversight by
the Treasury Committee, we believe it would be beneficial if the
regulator made itself more available to scrutiny. This could take
the form of a monthly question time where senior figures and board
members were required to take questions from key stakeholders.
BOARD STRUCTURE
29. In the past, the fact that 10 of the
12 members of the FSA board had been currently or previously employed
by the industry raised the risk that only the prevailing mindset
of the industry gained credence in Board deliberations. There
was a clear preference to codify existing industry practice instead
of asking searching questions about whether markets were working
efficiently and in the interests of customers.
30. It is clear that alternative perspectives
are needed and the Board of the CPMA needs to be more diverse,
with an increase in consumer representation and Board members
with experience and knowledge of consumer issues. It is important
that all Board members are independent of the industry and should
only be allowed to participate in decisions where they are free
from conflicts of interest.
31. We would also like to see greater transparency
around the agendas, forward plan and minutes of board meetings
to provide full information about when the Board is taking key
decisions—though we acknowledge that financial stability
considerations may occasionally limit the amount of information
which can be disclosed in advance. It would also be useful to
hold at least one public board meeting a year—where individual
board members would take questions from stakeholders.
REGULATORY TRANSPARENCY
32. Proper accountability can only come
alongside improved transparency. We believe that regulatory transparency
could have a powerful effect towards incentivising firms to improve
their practices. It also helps the industry as it ensures that,
if scandals do arise, offenders are identified and the entire
industry is not tarred with the same brush.
33. The main roadblock to greater regulatory
transparency is Section 348 of FSMA that prevents the FSA from
disclosing information it receives in the discharge of its regulatory
duties, except in certain defined circumstances. In addition to
the problems involving its interpretation by the FSA, it also
places substantial barriers to organisations making Freedom Of
Information (FOI) requests to the regulator. It allows the regulator
to reject FOI requests without being subject to a public interest
test. Which? has submitted a number of FOI requests to the FSA
asking for the names of mortgage lenders which had performed poorly
in the FSA's thematic work. We believed that consumers had a right
to know which lenders were treating customers unfairly and that
this information should also be shared with the Court judges hearing
repossession requests from these lenders. The FSA rejected our
request and offered a number of excuses including that it would
harm the lenders brand and reputation, would undermine firm's
willingness to engage in a dialogue with the FSA and to provide
the FSA with information and the restrictions imposed on it by
Section 348 of FSMA.[49]
The FSA has also refused to disclose the instructions which it
had given to firms which had been fined for mis-selling PPI, stating
that as the instructions it gave to the firms would invariably
involve information received from the firm, they would also not
be able to disclose it due to Section 348 of FSMA. A culture of
secrecy harms accountability and only benefits those firms breaking
the rules.
34. Section 348 should be removed and the
text of the future legislation should reflect the minimum restrictions
on disclosure required by EU directives. We believe this to only
consist of a requirement for the FSA not to disclose confidential
information it has received from other EU regulators.
35. The actual practice of the CPMA would
be influenced by a clear mandate to disclose information where
it might help the CPMA achieve its objective of a fair, transparent
and competitive market in financial services or where it might
influence a consumer's decision to engage in a commercial relationship
with a financial services firm.
36. In addition to the legislative changes,
we would like to see further transparency in seven key areas.
— Thematic work: We believe the
regulator should disclose the firm-specific results of the thematic
work it undertakes. The current failure to name those firms performing
poorly means that consumers are kept in the dark and firms are
able to get away with not treating their customers fairly without
suffering any practical penalty.
— Misleading financial promotions:
We would like the regulator to take a similar approach to the
Advertising Standards Authority (ASA) and introduce a Financial
Promotions Register which shows where the regulator has received
complaints and where a firm has been required to withdraw or amend
a misleading financial promotion. This would provide a powerful
incentive for firms to improve standards, would help draw the
attention of consumers who may have responded to the misleading
promotion, and could motivate more consumers and consumer groups
to report adverts they find misleading.
— Price data: We would like the
regulator to require firms to provide the relevant price data
on their products, and use this data to publish comparison tables.
This will make it easier for consumers to shop around to get the
best rate and spot when they are getting a bad deal, and for organisations
like Which? to warn them about products to avoid.
— Complaints data: The FSA has moved
to publish complaint numbers for individual firms which receive
more than 500 complaints every six months. However, we believe
that the FSA should go further and publish all of the complaints
statistics it receives from all firms online. As these are already
collected by the regulator electronically, there should be no
additional costs for individual firms.
— Own-Initiative-Variation-of-Permission:
This would ensure that in a situation where the FSA has concerns
about a firm and varies its permission to undertake specific activities.
This could include restrictions such as not allowing the firm
to accept new business, but can also include actions such as requiring
firms to contact customers who have replied to a misleading financial
promotion.
— Warning and enforcement notices:
The FSA should publish details of the firms which it has referred
to enforcement.
— Redress schemes: The FSA should
publish the names of the firms which are subject to the scheme,
list what activity the firms are undertaking, the text of all
letters used in customer contact exercises, the criteria the firms
are using to calculate redress, the response rates to any customer
contact exercise and the amount of redress paid.
THE FINANCIAL
OMBUDSMAN SERVICE
37. The existence of an effective consumer
redress system is vital to ensuring confidence in the financial
system and to facilitate the smooth running of the industry. Which?
as an organisation has redress for consumers as a core principle.
We support alternative dispute resolution systems as a cost-effective
alternative for both consumers and firms. Which? believes that
the FOS is effective at providing a method of dispute resolution
which is fair to both consumers and firms. The FOS ensures a level
playing field between firms and consumers and provides an effective
alternative to the court system. It is important that the reforms
to regulation do not downgrade the role of the FOS.
INTERACTION/COORDINATION
BETWEEN THE
CPMA, PRA AND FPC
38. It was clear from our discussions with
a consumer group from a country that already operates this model
that splitting responsibility between different regulators does
not remove the conflicts which can exist between different functions,
but merely externalises them. There should be coordination arrangements
but we do not believe that the PRA should be given primacy over
the CPMA. If a firm-specific conduct decision would impact financial
stability by leading to a failure of a bank then the PRA has clearly
not been undertaking its remit effectively. In the current environment
we also do not believe that a decision to prevent the CPMA from
taking a firm-specific decision which would lead to the failure
of the firm would or should ultimately lead to the continued existence
of that firm. If a firm has broken the regulations and/or common
law and consumers have suffered financial detriment then it will
not be possible for the PRA to extinguish the legal liability
of the firm. To permit the PRA to overrule the CPMA also sends
a dangerous message to the industry that only firms which are
small enough to fail without causing damage to financial stability
will be forced to bear the full consequences of mistreating consumers.
We believe that the Government should publish some scenarios showing
the circumstances which it believes might lead to the PRA overruling
the CPMA in a firm-specific conduct decision.
39. There will also need to be a coordinated
approach between the CPMA and PRA for breaking up any banks which
pose a systemic risk or harm competition. Under the new regime
there would be two possible reasons for restructuring or breaking
up a bank. For example, the competition authorities may have concerns
about the dominant market share of one individual bank in the
mortgage market. The prudential regulator could have similar concerns
regarding the dominant position of that bank on the basis that
it would make it impossible for the bank to fail without causing
significant damage to the economy.
40. The CPMA will also need to provide input
to the PRA on the preparation of "living wills" to ensure
that these cover how customers will be treated and provide sufficient
protection for customers' interests.
41. The PRA and CPMA will need to work closely
together in making their respective decisions about the granting,
amending or withdrawing permissions for particular activities.
For example, permission to be active in the mortgage market could
include activities which would be of interest to the PRA (mortgage
lending) and the CPMA (advising and arranging mortgage contracts).
42. The supply chain for financial services
is complex and it is possible for a firm designing a product to
have no contact with consumers (by distributing the product through
third parties). We would like clarification about where the regulation
of the product design phase would be located if the firm was not
regulated by the CPMA.
PRUDENTIAL REGULATORY
AUTHORITY
Problems with the current approach to prudential
regulation
43. Which? is concerned with the current
approach to regulation of banks and the legacy of the Government's
intervention during the financial crises. These have significant
effects on the prospects for competition in retail (and likely
SME) banking by creating:
— distortionary subsidies, direct through
state aid bailouts and indirect by reducing funding costs, to
the largest market incumbents thereby strengthening their market
power; and
— no effective regime to enable market
exit by failing banks (whether due to poor management or dissatisfied
customers) while preserving financial stability of the economy
as a whole.
44. These concerns relate to the public
policy for regulation of banks and the role of UKFI in managing
taxpayers' stake in those banks that relied upon state aid to
avoid failure. Further reform should also be taken in the overall
approach to regulating banks: too often regulators are held accountable
for banks' decisions that create instability or put consumers
at risk and those same banks remain in business regardless.
Regulation—implicit subsidy
45. Which? established a Commission into
the Future of Banking early in 2010, and received evidence from
key players amongst banks, regulators and government. Evidence
to the Commission made it clear that the banking industry enjoys
a significant public subsidy, in the form of tax payers' funds
used to protect failing banks from insolvency. Lord Myners noted
that "the banking industry, because it's been underwritten
implicitly against failure, without paying a premium, has enjoyed
a huge subsidy". This was evident in the approach to bank
failure during the crises but also marked a long-standing trend,
when dealing with risks to financial stability, of preserving
the status-quo by state aid or by merger.
46. This subsidy arguably distorts decision
making by banks, fostering riskier behaviour than would otherwise
be acceptable, while enabling those banks to raise funds more
cheaply. For those banks requiring taxpayer support, it has been
necessary to support the whole bank, not just the assets and liabilities
linked to essential banking activities such as the payment transmission
system or securing customers' deposits. Mervyn King noted to the
Future of Banking Commission: "Ultimately the heart of the
problem does come down in my view to the inherent riskiness of
the structure of banking that we've got, and the difficulty of
making credible the threat not to bail out the system, which is
what is underpinning the implicit subsidy and creating cheap funding
for large banks taking risky decisions."
47. It has been argued that the value of
this subsidy, which distorts the cost of capital for banks, has
increased over the course of the financial crisis as the implicit
subsidy became explicit support, and is greater for larger than
smaller banks. For example, Andy Haldane of the Bank of England
estimates that the subsidy for the biggest five banks in the UK
amounted to £50 billion for the period 2007-09, representing
about 90% of the total implicit subsidy available to the banking
industry. In its submission to the Future of Banking Commission
Virgin Money estimated private equity investors demanded a 10-13%
higher cost of capital from new entrants than from the largest
incumbents: effectively double the cost facing the largest banks.
48. This subsidy results in a significant
moral hazard. It fundamentally erodes the ability of small or
new entrant banks to become serious challengers to the large,
established incumbents. As a result market discipline, the key
mechanism of competitive markets, is made ineffectual: good banks
are unable to drive out the bad, while big banks remain big. By
encouraging high and excessive leverage, the implicit subsidy
actually increases the likelihood of taxpayers being forced to
step in and support the banking sector. It also encourages banks
to intertwine highly leveraged investment and wholesale banking
activities with essential retail banking activities and the payments
system.
Is it appropriate for the PRA to adopt a "judgement-based"
approach to financial regulation and supervision?
49. Whilst we accept the criticism of the
previous regulatory approach to prudential regulation, expecting
a move to a more judgement-focused approach with regulators exercising
judgements about the safety and soundness of firms through greater
supervision to lead to greater outcomes poses two particular problems.
Firstly, because the increasing trend to put reliance on the regulator's
supervision of compliance with international capital adequacy
standards, such as those set by the Basel Committee on Banking
Supervision, has created perverse incentives for banks to game
the rules. Secondly, judgement-based supervisory regulation can
all too easily turn into "shadow management" and there
is a limit to how effective this approach can be to regulating
individual firms. Supervisory regulators will always be outnumbered
by market participants who retain an informational advantage.
50. In his evidence to the Future of Banking
Commission, Mervyn King cited the example of Citibank, which still
faced near collapse during the crisis despite high calibre management
and very close supervision by "dozens" of regulators
embedded within the firm. He noted that "I cannot believe
that any regulator in the world could honestly pretend that they
would do better than what happened (at Citibank), and I think
we have to recognise that sometimes things happen which are almost
impossible to anticipate, hard to calibrate in advance in terms
of how much capital you need to put aside, or how much cash you
need to bank, in order to be sure that you won't get into trouble...
Having a system that's robust with respect to that seems to me
of fundamental importance, and as I understand it, that is exactly
what regulators in other industries supplying utilities would
encourage us to do"
51. Which? agrees that the lessons of other
regulated industries have not been applied to financial services.
In other industries, regulators strive to establish the pre-conditions
for effective competition. It has always been recognised that
for effective competition to be possible, the regulator has to
ensure there are specific arrangements in place which allow firms
to fail while ensuring the continuity of essential services. For
example, in the Water Industry when Enron acquired Wessex Water,
OFWAT imposed conditions including requiring the Board to act
as if it was an independent company and prohibited cross-default
operations.[50]
Their primary objective was not to protect Enron's shareholders,
but to ensure that customers would continue to receive an essential
service and that the creditors of Enron corporation should have
no recourse to the assets of the Water company. The result was
that when a combination of fraud and incompetence caused Enron
to collapse, the ring-fencing provisions ensured that Wessex Water
was able to continue to function and essential services were maintained.
52. The prudential regulator must change
its approach from attempting to prevent failure to ensuring banks
can fail, but without significant harm to vital banking services
or the economy. Stability is not created by preventing failure,
but by enabling firms to fail in a controlled way. The PRA would
be the guardian of the "living wills" which banks would
be required to produce.
53. Ensuring that banks face a realistic
prospect of failure would help improve the accuracy of the pricing
of equity and debt to individual banks and help ensure that these
more accurately reflect the risks of a specific bank. Responsibility
for prudence must lie with the banking institution, its management
and debt providers and not be delegated to regulators.
54. The PRA would take pre-emptive steps
to:
(i) protect ordinary depositors and retail customers;
(ii) ensure the continuity of all essential retail
banking services; and
(iii) in the case of any institution that is
too big or otherwise too significant to fail, intervene to restructure
that institution such that its failure would no longer present
a systemic risk.
55. The PRA should have a specific duty
to promote competition. This would help support its focus on not
preserving the status quo or existing institutions, but creating
a market with the realistic prospect of failure. It would also
ensure that the PRA does not impose excessive barriers on new
entrants, by making them carry higher levels of capital or liquidity
than existing banks. It should also have an objective to limit
and remove the extent of the implicit subsidy received by the
banking sector, which distorts competition and disadvantages new
entrants.
56. The PRA should need to "have regard"
to the objectives of the CPMA. It will need to work with the CPMA
to ensure that "living wills" and the arrangements for
the provision of essential banking services offers sufficient
protection for customers' interests. The PRA should take responsibility
for monitoring and setting down standards for remuneration practices
which could work against its objectives for the stable and prudent
operation of the firms it regulates.
57. We support the proposal that the PRA
will not need to "have regard" to the competitiveness
of the UK as a location or the need to promote innovation. This
is for similar reasons to those explained in paragraph 14.
GOVERNANCE AND
ACCOUNTABILITY OF
THE PRA
58. The consumer panel established as part
of the new regulatory function should also monitor, advise and
challenge the PRA through its policy development to ensure that
it takes into account the interests of consumers. The PRAs rule-making
function should be subject to statutory processes which include
consultation with the consumer panel. It is important that the
PRA is not subject to excessive restrictions on its disclosure
of information. Indeed, an approach which involves the active
disclosure of supervisory information to the markets would be
preferable. We welcome the fact that the PRA will be subject to
audit by the National Audit Office.
MACRO-PRUDENTIAL
REGULATION
59. We support the introduction of the FPC
to address systemic risk and to implement macro-prudential regulation.
Consumers and small businesses have been damaged by a move from
"feast to famine" in the availability of credit. The
purpose of systemic risk regulation should be to oversee liquidity
and capital standards at the macro level. It should be concerned
with the inter-dependence of banks and their exposure to common
economy wide shocks that may affect key sectors such as commercial
and domestic property. Its role should be to act counter-cyclically,
to smooth the credit cycle and to "take the punch bowl away"
when credit growth led asset price bubbles grow unsustainably
and threaten to lead to instability. This is not an easy task
and the framework should ensure that the FPC has the credibility
and expertise to challenge the prevailing consensus and to take
appropriate action. We also believe that it would be advantageous
for some of the external members of the FPC to have expertise
and knowledge of consumer issues.
60. However, we express a note of scepticism
about the potential effectiveness of macro-prudential regulation
to prevent a financial crisis, not least because of the risks
of regulators becoming victims of "flawed intellectual models"
and the incentive for banks to find their way round any targets
and rules. Increasing the role of macro-prudential regulation
also raises questions about the fundamental purpose of banks and
bankers. The raison d'etre of a banker should be to restrict
credit to sectors of the economy (such as commercial property)
which become over-valued.
61. Which? do not have the expertise to
evaluate the effectiveness of the different macro-prudential tools
proposed, so we have concentrated on their potential impact on
consumers. This could fall into two different categories.
62. Loan-to-Value limits for residential
mortgages: When these are changed they will inevitably lead
to a number of consumers being stranded with their existing mortgage
provider. For example, if a consumer has just taken out a 95%
LTV mortgage and the FPC decides to limit the maximum LTV to 90%
then that consumer will be unable to move to a different lender
(and unless their mortgage is fully portable, to a different house).
It is also likely that a reduction in the maximum LTV would lead
to house price falls which would further exacerbate the position
of that consumer. Unless mortgage contracts are tightly defined,
banks will be able to exploit these captive customers by increasing
their margins.
63. Other capital requirement changes:
It is likely that banks will use any changes to capital requirements
or risk weights to alter the price paid by existing customers.
For example, many terms and conditions will allow banks to vary
the contract in response to decisions by "regulators".
How any changes to price will be applied and the discretion which
firms may use to apply these changes are likely to be relatively
opaque to consumers (unlike clear contractual terms which could
exist for changes in interest rates to follow a clearly defined
and transparent reference rate such as a product where the interest
rate tracks the Bank of England base rate). We have concerns that
firms may seek to apply these changes unfairly or to exercise
unfair contract terms. There will also be conflicting messages
for consumers if the MPC is lowering the base rate at the same
time as the FPC is increasing capital requirements for particular
types of consumer lending. The exact terms of contracts are likely
to be issues for the CPMA, but how firms may exercise their discretion
may also have systemic impacts if, for example, all banks are
confident that they will be able to react to any changes in capital
requirements by immediately passing on the costs to existing customers
by increasing rates.
Annex 1
SHORTCOMINGS OF COMPETITION REGULATION UNDER
THE FINANCIAL SERVICES AND MARKETS ACT 2000
Competition regulation under FSMA is, at best,
wholly inadequate and, at worst, detrimental to the competitive
landscape in the financial sector. The ambit of the FSA is currently
centred on the maintenance of market confidence, raising public
awareness, the protection of consumers and the reduction of financial
crime. While the FSA also has, among its primary duties set out
in FSMA, the requirement to have regard to "the desirability
of facilitating competition between those who are subject to any
form of regulation by the Authority", FSMA does not give
the FSA concurrent competition powers with the OFT, which would
allow it to either (a) directly apply competition law or (b) refer
markets to the Competition Commission, as is the case for the
regulators of other industries. It is clear that the FSA's approach
is to avoid putting up further barriers against competition, rather
than proactively seeking to improve the degree of effective competition
in the industry. Indeed in some sectors of the market such as
with-profits funds, the FSA actually applies different rules to
existing firms, compared to any recent or potential new entrants.[51]
The inadequate focus on appreciating the benefits which competition
can bring can also lead to codifying existing industry practice
instead of driving improvements for consumers. For example, instead
of improving the ability of customers to switch cash ISAs, the
FSA simply required that the banks provide a "prompt and
efficient service" and referenced existing industry guidance.
Indeed, in its composition, FSMA gives the impression
to market participants in the financial sector that they have
a degree of immunity from UK competition law since agreements
or conduct by a dominant firm, which would usually breach competition
rules, are not subject to enforcement if "encouraged by any
of the Authority's regulating provisions". This provision
of FSMA effectively puts the maintenance of effective competitive
markets in the financial sector subordinate to FSA regulation,
albeit that European competition law can be applied regardless
of this exclusion. Competition law considerations were further
disregarded when, in the course of the financial crises, the public
interest test for merger regulations was widened to include "financial
stability", allowing the Secretary of State to rule in the
case of bank mergers, rather than the OFT or the Competition Commission.
The OFT has some specific responsibilities under
FSMA 2000, necessary to compensate for the lack of competition
objectives in the FSA's mandate. Section 160 of FSMA requires
the OFT to keep the regulating provisions and practices of the
FSA under review, and report any significantly adverse effects
to the Competition Commission: a process known as "competition
scrutiny". There have been no occasions under current legislation
where the OFT has exercised this power. So, while the OFT may
be suited to "repairing" or conducting investigations
into previous competitive markets, it is not up to the proactive
task of regulating vigilantly to make markets in the financial
sector more competitive.
This special treatment of the financial services
industry sends a clear message to both the regulator and industry
that the "normal" rules of competition do not apply.
Annex 2
PAYMENT PROTECTION INSURANCE MIS-SELLING
The mis-selling of Payment Protection Insurance
(PPI) is an example of how a poorly functioning market, and a
failure to intervene at an early stage to fix it, can disadvantage
customers. PPI is designed to cover your debt repayments if you
can't work—for example, you become ill or have an accident,
or you are made redundant. It is sold alongside loans, mortgages,
credit cards and store cards. In the past decade, PPI has been
subject to widespread mis-selling, and this has resulted in millions
of consumers holding expensive insurance they would never be able
to claim on.
PPI offers a clear example of a poorly functioning
competitive market, as the sale of this product involved:
(a) lack of adequate disclosure to customers
about the product they were buying, and the resulting asymmetry
of information between provider and customer;
(b) inappropriate default settings, where it
was left to the customer to opt out of buying the product when
purchasing another financial product;
(c) the existence of inappropriate commission
structures, which focused the rewards for salespeople on selling
PPI, rather than serving the customer well; and
(d) accounting practices which allowed firms
to book an upfront profit from selling single premium PPI policies.
The resolution of the problems in PPI has taken
a long time. Which? first raised concerns about the mis-selling
of PPI in 2002. An initial "supercomplaint" by Citizens
Advice was made in September 2005 to the Office of Fair Trading
(OFT). The OFT followed up this complaint with a market study,
launched in April 2006, which subsequently led to a market investigation
reference, in February 2007, to the Competition Commission (CC).
In 2009, the CC ruled it would be banning the sale of PPI alongside
credit products, stipulating that lenders and credit card providers
would have to wait at least seven days before approaching a customer
about the sale of PPI. Following an unsuccessful appeal by the
banking industry, the CC provisionally confirmed this ruling in
May 2010, and published its final remedies in July 2010, almost
five years after the issue was first raised by Citizens Advice.
In 2005, the FSA conducted a series of mystery
shopping and supervision exercises and in September 2005 called
on firms to take "urgent action" to ensure that their
selling practices for PPI were compliant with regulatory requirements.
However, firms did not respond to the FSA's regulatory action
and continued to mis-sell PPI. The FSA responded by conducting
further rounds of mystery shopping and eventually conducting enforcement
action and levying fines. However, these fines were such a low
proportion of the revenue gained by banks from selling PPI they
failed to have the desired effect. Despite, widespread mis-selling,
no senior management in financial services organisations had enforcement
action taken against them. The only senior management individual
to have enforcement action taken against them for mis-selling
unsecured loan PPI was the chief executive of a furniture retailer
(Land of Leather).[52]
Eventually, at the start of 2009, the FSA eventually secured "agreement"
from the industry to stop selling single premium PPI on personal
loans. The problems for consumers have been compounded by the
failure of firms to deal with complaints fairly. Consumers have
faced unreasonable delays and the Financial Ombudsman is upholding
over 90% of complaints received about some firms. This indicates
that many firms are dismissing valid complaints and hoping that
consumers do not go to the Ombudsman. The FSA is currently consulting
on an approach to require firms to review previously rejected
complaints. The FSA announced in September 2009 that several banking
groups had agreed to undertake a voluntary review. However, almost
a year later, Lloyds TSB disclosed that it had yet to start its
review of past sales.[53]
40 Please see Annex 1 for an explanation of the shortcomings
of Competition Regulation under the Financial Services and Markets
Act 2000. Back
41
For further information please see Chapter 3 of the Future of
Banking Commission report, http://commission.bnbb.org/banking/sites/all/themes/whichfobtheme/pdf/commission_report.pdf Back
42
http://www.which.co.uk/documents/pdf/consumer-rights-directive-allowing-contingent-or-ancillary-charges-to-be-assessed
-for-fairness-bis---which---consultation-response-226521.pdf;
http://www.publications.parliament.uk/pa/cm201011/cmselect/cmtreasy/memo/banking/m20.htm Back
43
http://www.fsa.gov.uk/pubs/final/hfc_bank.pdf Back
44
http://www.fsa.gov.uk/pubs/final/alliance_leicester.pdf Back
45
http://www.oft.gov.uk/news/press/2007/113-07 Back
46
http://www.oft.gov.uk/news/press/2003/pn_18-03 Back
47
http://www.ofwat.gov.uk/regulating/enforcement/prs_pn2108_svtfne020708 Back
48
http://www.fsa.gov.uk/pubs/final/alliance_leicester.pdf Back
49
For further details pleas see Which? Written evidence included
in the Treasury Committee's Fifteenth Report of session 2008-09,
Mortgage arrears and access to mortgage finance, (Ev 63). Back
50
For details of the ring-fencing provisions imposed see OFWAT,
The Proposed Acquisition of Wessex Water Limited by YTL Power
International Berhad, April 2002. Back
51
COBS 20 February 20. Back
52
http://www.fsa.gov.uk/pages/Library/Communication/PR/2008/039.shtml Back
53
http://www.lloydsbankinggroup.com/media/pdfs/investors/2010/2010_LBG_Interim_Results.pdf,
page 122 Back
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