Financial Conduct Authority


House of commons



Treasury Committee


Tuesday 25 October 2011

Angus Eaton, Paul Killik and Philip Warland

Evidence heard in Public Questions 1 - 51



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Oral Evidence

Taken before the Treasury Committee

on Tuesday 25 October 2011

Members present:

Mr Andrew Tyrie (Chair)

Michael Fallon

Mark Garnier

Stewart Hosie

Andrea Leadsom

Mr Andy Love

John Mann

Mr George Mudie

Jesse Norman

Mr David Ruffley

John Thurso


Examination of Witnesses

Witnesses: Angus Eaton, Operational and Regulatory Risk Director, Aviva Plc, Paul Killik, Senior Executive Officer and Partner, Killik & Co, and Philip Warland, Head of Public Policy, Fidelity, gave evidence.

Q1 Chair: Let us begin. Thank you very much for coming in this morning. As you can see, we have already had quite a busy morning on this, clearly. I don’t know how much of what we have just been exchanging you were here for.

Can I begin by asking each of you to comment on the FSA’s consultative document on how the FCA would be organised? I am quoting what they said in June: "The Government expects the FCA to intervene more strongly in retail financial service markets". Do you think that more intervention is what is needed and, if so, what type of intervention? Why don’t I start on the right-hand side as I look and move leftwards?

Philip Warland: Thank you very much, Mr Chairman. We in Fidelity do believe that strong intervention is needed. I think that the litany that the Chairman of the FSA talked about last week at the Mansion House dinner-£15 billion of redress over a period-just suggests that something isn’t working. What they have done up until now is largely looked at how products are sold, how they are advised, and never really got involved in the governance of the product, what the product was aiming to do and was it aimed at the right target market. To the extent that the FCA say, "That is where we think we would go," in principle, we think obviously they could get it seriously wrong and there are issues with openness of markets and competition, but in principle we think that is probably the next step they ought to be thinking about.

Angus Eaton: I think we can understand that intervention is an appropriate step to take now, although we would urge it to be approached in a measured way, in that there is always a danger that the regulator could take an over-protectionist approach without acknowledging the slightly wider public policy issue of ensuring that customers continue to have access to products in the market.

Paul Killik: I differ slightly with Philip on the intervention issue, I must admit. I do feel that the paper was too confrontational. The spirit of the February paper from the Treasury was much less confrontational, and I would like to see the regulator working much more closely with the industry than it is doing today.

Q2 Chair: Can you just explain what you mean by working closely as opposed to intervening?

Paul Killik: I think there is a sense, isn’t there, that indeed, in part of the paper they are referring to the amount of analysis that they are doing of the industry. Analysis doesn’t work at one level unless you are actually working with the industry itself in understanding it, and they have shown a distinct lack of interest in having a dialogue with the industry; at least that has been our experience.

Q3 Chair: This intervention, you are all confident that in practice this will have the desired effect or is likely to have a desired effect. We can all devise theoretical explanations for the need for intervention, but the crucial question is whether it is going to work. I just want to be clear on that.

Philip Warland: I don’t think that you can prove in advance that it is going to work, but, as Angus has said, it seems to us to be a sensible next step. The way we see it working is although they do ask for powers to go out and ban products or withdraw them from the market, and so on and do forth, and-

Chair: We will be coming on to that in a minute.

Philip Warland: Okay. What we think is much more important-and they have already begun to do it a bit in their supervisory practice-is to look at what we would call product governance. If we produce a new product, do we understand the features of it, how it is likely to behave in stressed conditions? Do we take the view as to what part of the market it would be suitable to sell it into, and do we take a view that the advisers who are allowed to handle this product understand the features of the product and where it should end up? If that is the majority of what their "product intervention" is, we think it would be wholly beneficial.

Chair: Anything anybody wants to add before I move on? We are going to come back in some detail to a number of aspects.

Paul Killik: I think product intervention I certainly would agree with. I think there has to be more work done in that area.

Q4 Stewart Hosie: Mr Killik, you said that you were a victim of submission, that there was little detail of how the FCA would be accountable. They will be required to be accountable to us, producing an annual report, holding an annual public meeting and so on. But you have said it wasn’t yet clear who would follow up what was in the annual report or conduct ongoing scrutiny of whether or not the FCA was meeting its objectives or operating in a reasonable or proportionate way. What would you have done? How would you like to see the FCA scrutinised in this regard?

Paul Killik: We have had subsequent conversations on this matter since we submitted our written evidence, but I think we are increasingly of the view that the PRA probably could play a role as a superior regulator here in some senses. At least there would be more of a peer group analysis of the FCA if it was undertaken by PRA.

Q5 Stewart Hosie: That is interesting because obviously the PRA are doing the prudential and the FCA are doing the conduct of business. That twin-peaks approach was designed with a particular reason. Would you then have the FCA as a subsidiary or underneath the PRA in that regard or would it simply be a peer assessment of the way they operate, how they behave?

Paul Killik: I think it makes some sense to do that, yes, because there are going to be probably some turf wars as between what is prudential and what is conduct of business.

Q6 Stewart Hosie: So, am I sensing that we could already begin to have an overlap of regulatory function to replace the underlap and the cracks we had under the old regime?

Paul Killik: I would not necessarily go that far, but I think that there has to be some sense in having a superior regulator, but this is a personal opinion. I am not speaking on behalf of my industry.

Q7 Stewart Hosie: Just one final question then. The Government did say in terms of accountability-and you have said you have had some discussions since-the process for the FCA replicates arrangements for the FSA where appropriate and strengthens them where possible. Do you think, given your experience with the FSA, that this is a good starting point for accountability?

Paul Killik: Do I think it is a starting point?

Stewart Hosie: Yes, is it a good starting point or would you have simply taken a clean sheet of paper and said, "Look, here’s how we think you should behave."?

Paul Killik: I probably would have taken a clean sheet of paper on this. Yes, I do, I feel that this paper, from this consultative document on the FCA, was written by the FSA and therefore I am afraid it carries a lot of the baggage of the FSA with it.

Q8 Stewart Hosie: So the discussions you have had more recently then, have you suggested to them how they might change the way in which they operate or scrutinise and what has the response been?

Paul Killik: I have not been consulted in the matter at all. We put our own submissions in, but there has been no further consultation.

Stewart Hosie: Right, okay.

Q9 Michael Fallon: This Committee has previously recommended that competition should be a central objective. There seem to be mixed views in the industry about that. Would you agree with the Committee on that?

Paul Killik: Are you directing that to me?

Michael Fallon: Any of you.

Angus Eaton: We would certainly support competitiveness. We think the recommendation goes as far as it needs to in these circumstances. Speaking from the insurance markets’ perspective, we consider the markets are competitive and I don’t think we need to go any further.

Paul Killik: Yes, again, but I think there was a slight difference in emphasis between the Treasury paper of February and the FCA paper of June, where a more general discussion on the competition was referred to in the Treasury paper, which I would totally endorse. But it was very heavily consumer-weighted that the competition was only provided it was in the benefit of the consumer in the FCA paper.

Q10 Michael Fallon: How do you see the competition objective? It seems to be a catch-all duty now. How do you see it working in practice?

Philip Warland: If I could just say that we disagree with the view of this Committee. It is been argued over since 1984 when much of this was first legislated for. We think it is better to externalise the conflicts between investor protection and competition and to leave the competition where it is at the moment. I think, as I am sure you will when you get the FSA/FCA in front of you, they will set out some of the difficulties that they will have implementing a competition objective.

Q11 Michael Fallon: So you don’t think the regulator should be bothered with competition?

Philip Warland: I don’t think they should have anything stronger that they have regard to. I certainly don’t think they should be considered a competition authority. They don’t have the skills. I think they find it difficult to recruit the skills, which are very, very particular.

Q12 Michael Fallon: That is not because you think previous regulation has restricted or promoted competition; it is simply because you think they are the wrong people who are doing it?

Philip Warland: Yes. As I say, I think that the conflict is best handled externally-that is between the FSA and the OFT and the competition authorities. I think later on you are going to talk to witnesses who have the ability to make a super-complaint. That seems to me to be quite a good way to move ahead.

Q13 Michael Fallon: Do either of the other two of you think the competition objective should be more explicit?

Paul Killik: I would agree that it should be more explicit, yes. We have to balance commercial interests, but at the end of the day we are competitive businesses and I have seen examples of it recently where the playing field has been made unlevel by the regulator.

Angus Eaton: I would reinforce what I said earlier, in the sense that it is important for a regulator to have regard to competition in the decisions they make in delivering regulation into an industry. For instance, in the Retail Distribution Review some of the actions that have been taken, one could say, have restricted the number of advisers, for instance, in the market. So I think it is appropriate for a regulator to have regard to competition.

Michael Fallon: Thank you.

Q14 Mark Garnier: I shall start with Philip Warland, if I may, Mr Chairman, and then move to your right. In the draft Bill there is a table making it pretty clear how the regulatory system is going to work and how it is accountable to Parliament through the Chancellor. Do you think that that is a reasonable way of doing it? Do you have any comments on it and also what role do you think this Committee should play in the accountability?

Philip Warland: Broadly, we think that the accountability structure is far too weak and then there is the question as to whom it should be accountable to. Adair Turner has gone on the record-I think I am right in saying-that it should not be accountable to the industry, and in most respects that is true. I do think there should be more accountability to us in terms of their costs, and the NAO audits may have a look at that. But it is quite difficult to look at efficiency and costs without also taking a view on are they meeting their objectives correctly, which I tend to agree. I don’t think we should be the arbiters of that. So some mechanism, which allowed a discussion, other than the Practitioner Committee that does not seem to work, between the industry and the regulator-not on a firm-by-firm basis, but on a genuine industry basis-we think would be very helpful and we could point to some places where we think it has gone wrong. We say in our paper that we think that the FCA should make an annual report to yourselves, rather like you have just had the Governor here talking about MPC decisions. I think what the FCA does is not on a quarterly round, but if they had to justify themselves against their objectives to you and you were to hold hearings, we would take considerable comfort from that.

Andrew Eaton: We certainly support this Committee being engaged in the scrutiny of this regulator. From an accountability perspective, we would also add that it is important that the board itself that runs the FCA has been appointed in a transparent way and has a broad representation from the industry and consumers.

Paul Killik: Yes, and I would certainly very much support the broad representation from the industry. One of the weaknesses of the current system is that-as I alluded to earlier on-there is far too little inter-exchange between the regulator and the industry. Indeed, when we are going further away from that with the greater use of call centres and fewer relationship-managed businesses, it just means the regulator gets further and further away from the industry that they are regulating. But coming back to the point of accountability, I would certainly support that the regulator should be accountable to this group, but I also believe that there is some merit in making it accountable to PRA initially.

Q15 Mark Garnier: Fresh in many people’s mind is the regulator’s response to this Committee’s Report on the Retail Distribution Review. Many people have said in the press, and just anecdotally, that this shows a huge amount of contempt for Parliament by the FSA. Do you think that is a fair comment?

Paul Killik: I do, yes.

Mark Garnier: Do you?

Andrew Eaton: As I said, I think it is appropriate that is accountable to this Committee. If that gets hard-coded into the process, then I think they will respond appropriately.

Q16 Mark Garnier: But if they sort of suck their teeth and say, "Yeah, well so what, we will just do whatever we want," how do you think this Committee should be able to come back and make them accountable?

Andrew Eaton: I think the key is transparency. It is important that these issues are raised publicly and the regulator itself is not given the opportunity to operate in quite a closed way.

Q17 Mark Garnier: So there is an argument that they have been transparently contemptuous of the views of this Committee?

Andrew Eaton: That might be an argument, but I still think the transparency is important.

Philip Warland: I agree. I think you have done the world a service in some of the investigations you have had, and I don’t know whether you have done it or not, but you might consider having not only the executives here, but actually some of the independent board members. I don’t know whether you have done that, but that might just raise the ante a bit.

Q18 Mark Garnier: Can I just very briefly return to the costs? We have two large organisations and one, with great respect, small organisation. You all pay fees to the FSA and you also all have to dedicate resources, in terms of maintaining your compliance function and all the rest of it. Paul Killik, speaking as somebody from a smaller firm-your two colleagues-do you think the cost of the regulatory system disadvantages smaller firms and, as you get smaller, it becomes more of a disadvantage or do you think that is an irrelevant argument?

Paul Killik: Yes, I do. I think it would have been very difficult. I set my business up in 1989. I think it would be a very, very difficult job to start that business up today, to be perfectly honest, I really do. We were helped in starting up business by the regulator of the day, the TSA, who were enormously supportive and helped us with the whole formal completion process. You don’t get any of that today from the regulator. So it is a very different world in that sense. As for costs, yes, if you look at the FSA’s bill for this year of £500 million and you put that into context, and I know the figure of £15 billion that has been paid out over 20 years is a big number, but simple maths tells you that is £750 million a year. Well, already, we are spending two-thirds of what we are paying in compensation in running a regulator. Then, of course, you have the regulatory cost to all the individual firms, which is a multiplier of the cost of running the FSA. So the cost to the consumer of regulation, in its present form, is huge and I do not think people really recognise how big it is.

Q19 Mark Garnier: To the other two witnesses. That is an incredibly important point. As two big organisations, presumably you have to push the cost of your regulatory departments and the cost of your membership of the FSA down to the consumer. So effectively what you are saying is the cost of regulation, be it direct fees to the FSA or compensation fees or the cost of compliance actually is detracting from the savings culture of this country, ultimately?

Philip Warland: Certainly in our case-and although we are larger than Paul’s firm we have a similar business model-the problem we have is the FSA has always treated us as an investment bank when we are not. We are an agency business. So our cost of capital has gone up 10 times in the last three years and our total costs of internal compliance have gone up 70%. We think that is wholly unnecessary and we don’t believe they understand our business model. The good news is that early discussions with the proto FCA suggest they do understand that, in a fortuitous way, what they have created with the FCA is a regulator for whom prudential capital is not the key issue, and they are already beginning to think, "How do we have a supervisory practice that deals with agency firms?" where, frankly, if a parent goes down-you can see that from Barings; Barings went down over the weekend. On the Tuesday, the unit trust business was working again. That is our business model and they have never paid attention to that. But yes, those costs that they have inflicted on us will lower the savings rate.

Angus Eaton: I think you are right. The costs are perpetual in the industry, and in fact we would urge stability, if anything, to be honest with you. They manifest themselves in many ways. It is not just regulatory departments. It is clearly big-change initiatives as well. Solvency too costs £100 million per insurance company, for instance. So we would urge that stability. To your question; yes, ultimately, I think the customer will carry it. Hence the reason why we think the regulator should have regard to the ultimate impact on the customer.

Q20 Mark Garnier: Just finally, do you all agree that regulatory stability is key to keeping costs down?

Paul Killik: Absolutely.

Mark Garnier: Okay, thank you for that.

Q21 Chair: Mr Warland, in your submission you said that you were perplexed by the objectives of the Bill, but from what I could tell you were broadly supportive in your opening remarks, or not too critical anyway, and I would be grateful if you could tell me which bits are perplexing you.

Philip Warland: Mainly it is the overlap. If you look at the objectives of the FPC, then the PRA and then the FCA, they all have elements that seem to us to be coterminous. That seems pretty well a recipe for argument and dissent, and so on and so forth. I suppose we would prefer to see something that is much clearer, which is a reference to market integrity, which is one side of the FCA, and a reference to consumer protection that in a sense is the other side of the FCA. Then, as we have set out in the paper, we actually think having regard to international competitiveness is very important too.

Q22 Chair: You have said that you support product regulation. The regulators themselves have said that this will cost more overall. A moment ago I thought I understood you to say you weren’t happy about this rise in regulatory cost. Do you think that the type of product regulation you envisage can be delivered for less or the same that is spent at the moment on regulation?

Philip Warland: I made those remarks, and can try and square the circle by saying that I believe the FCA should and, I think, is thinking of a completely different supervisory approach. At the moment, when they come and visit us they do an ARROW visit, and the ARROW visit was based on, "How the banks go wrong and let’s stop it". The supervisory approach I believe that they should use for a firm like ours should be completely different. It will not start, or it should not start, with prudential capital and complicated policy-adjusted stress tests of how you get there because, as I have described, prudential capital is not where we are most likely to cause detriment to customers. But if a lot of that is stripped away that is what will push back our compliance costs and if there is a little more on product governance. Frankly, we think we have it in there anyway without being told to do it. So we believe there would be a way to protect the public and yet lower the overall cost base.

Chair: Just one other point just for clarity. There was a general nodding of agreement when the suggestion was made-I think by you, Mr Warland-that independent board members might be given a greater role. Maybe not now, but if you have suggestions on how they may be engaged to secure greater accountability to the FCA, this Committee is interested in hearing your views.

Q23 David Ruffley: Mr Killik, the paper that you submitted to us was interesting where you talk about, "Engagement with industry bodies could help a more segmented approach". You also draw our attention to the fact that in the FSA June paper they were actively talking about reducing the number of relationship-managed firms, and you propose to remedy that. An element of self-regulation and a key part of that would be putting together a panel of professionals, retired professionals, who could give knowledge and advice, I am assuming, to the FCA staff. I just wondered what reaction you have had from policymakers, either at the Treasury or the FSA, to that proposal.

Paul Killik: I have not had any. I have not had consultations with them, so I have not had a response.

Q24 David Ruffley: You have not floated it at all?

Paul Killik: I have in papers, but I had no particular response to them.

Q25 David Ruffley: Did you expect a response?

Paul Killik: It would have been nice to have had a response, but in some senses I am not altogether surprised.

Q26 David Ruffley: I just wondered, because it seems an interesting idea. It is a contribution to the debate. Would you have support from the rest of your industry for that?

Paul Killik: Without a shred of a doubt. I think by putting it forward as people at the latter end of their careers, nobody could accuse practitioners of looking after their own interests, but they are coming with a lifetime’s experience. We are currently seeing people being retired out of businesses, at 60, 65 these days, who have probably got another 10 years or at least five years of work within them and they would like to contribute in that way, I am quite sure. It would be beneficial for the whole industry and certainly, I believe, useful for the regulator to have that sort of resource internally.

Q27 David Ruffley: I infer from what you just said in your proposals that you don’t entirely have faith in the likely expertise of staff on the FCA, because in your submission you made clear that in terms of products, the understanding of products, it would be sensible to have some retired practitioners who have been involved in the market for these products and services. You presumably do not believe, or have much faith, that the FCA will be able to recruit such expertise, hence the need for your panel?

Paul Killik: Absolutely. I have been in one small sector of financial services for 40 years, and I can’t claim to be an expert in all aspects of my small segment. It is hugely complex, the whole gamut of the financial services industries. Therefore, to recruit people and believe that you can then train them internally, without any interface with the businesses that they are regulating, strikes me as a bizarre concept. I know how long it takes me to train chaps up before I put them on the telephone to talk to clients. That is a very long process. We are wasting resource when we have people who would happily contribute, I believe, and not using that level of experience.

Q28 David Ruffley: You did not propose this; the June FSA paper proposed that the number of relationship-managed firms be-and I quote-"significantly reduced". To the layman, this seems to be the opposite of what we-

Paul Killik: You are absolutely correct, and since that paper was written by us we have actually been notified that we are now going on to a call centre. As you have rightly observed, we are not a big business, but we are a very particular niche of our industry and I think the FCA are going to be poorer by not having contact with us and understanding where we believe our industry is going.

Q29 David Ruffley: Your views have been given by yourself as an individual. What I am quite keen to understand is, are there other serious concerns of the kind you have identified prevalent in the rest of the industry?

Paul Killik: Yes, there are. I would add that I am a director. I am on the board of APCIMS, which is a trade association for our industry. I have been on that board now for about 15 years, so I am pretty well plugged into the thinking of the industry.

Q30 Mr Ruffley: Of course, APCIMS is a very important trade body. Are they going to make a fuss about this?

Paul Killik: They have made submissions both to the Treasury Select Committee, and also to the Financial Services Group, Peter Lilley’s group, as well as, obviously, having dialogue with the FSA. I am not sure yet whether they are in a dialogue with anyone at the FCA.

Q31 Mr Ruffley: Would you think that the idea of a single supervisor across many different product areas is a bad idea?

Paul Killik: What I think is a bad idea is a one-size-fits-all concept. To take a very high-level view of regulation, from a rather analytical approach to it, without understanding the business models of the various companies underneath it, you end up with the regulator effectively designing the business model for our industry. That is not healthy because we are all being shoehorned into a one-size-fits-all regime.

Q32 Mr Ruffley: On that important point, can I ask Mr Eaton and Mr Warland what their comments would be on that issue?

Angus Eaton: I think from our perspective the-

Mr Ruffley: That is, essentially civil servants putting together a model with perhaps limited experience of the products and the industry that they are designing this regime for?

Angus Eaton: We would certainly support the view that it is essential that the regulator has the capability to do what it is set up to do. I endorse Paul’s comments, in the sense of that is not an easy thing to do. I would say my fear is these recommendations are predicated on the assumption that the industry itself isn’t taking this seriously and not taking consumers seriously. We have invested an enormous amount in product development and have engaged regulators through our product development processes in a positive way. The danger is that if they separately try and analyse the industry in a way that is the broad brush approach, which I think was suggested, that could give rise to issues.

Q33 Mr Ruffley: This could potentially be quite calamitous for your business-not just your business, but for the industry. Would you go that far?

Angus Eaton: I would say the key for us is in understanding the consumer and the regulator needs to have the capability to do that. If we don’t understand the end consumer then I think there are issues.

Mr Ruffley: Mr Warland?

Philip Warland: A number of points. First on experience, in general I agree absolutely. I have been in the asset management industry now for 20 years and I can only think of one person who has ever been in the FSA who actually had business experience of the asset management industry. That is the first thing. The second thing I have to confess is that the FSA does have senior advisers who used to be called, "Grey Panthers". The predecessor in my job here in Fidelity was actually an old Grey Panther in the FSA. So they do have that experience in the FSA. But the biggest thing we suffer from is precisely what Paul has described: they do not understand our business model and they throw a whole series of regulations at us, which are really irrelevant and just add to cost. One big one is they talk about governance. They think governance is the way they govern the FSA, which is committee after committee after committee after committee, and we do not think that is a good way to run a business.

Mr Ruffley: Thank you.

Q34 Chair: I am suddenly curious about a witness who says they don’t understand your business model but you want them to do product regulation.

Philip Warland: I absolutely agree. There is a whole list of things in where the FCA is going where they don’t have the skills. So, they don’t have the skills in the business model, therefore they won’t have the skills in the product, they won’t have the skills in competition. We have discussed it with the proto FCA and they absolutely admit that the thing they are designing-I think it is called the Business Analysis Unit-they don’t have at the moment, and I am not sure they know where they are going to get their people. But as an aspiration we think it is not a bad way to go.

Q35 Chair: But it sounds as if the aspiration is already likely to be a triumph of hope over experience?

Philip Warland: You might think that.

Chair: No, I am only drawing on your own evidence that they don’t understand the business models.

Philip Warland: Absolutely; no, I agree with that. But I should say that I think they are beginning to understand that they do not understand it.

Chair: He who doesn’t know and knows he doesn’t know.

Philip Warland: Yes, slightly listening.

Chair: I forget, or at least I won’t repeat ,the end of that line, because it is a little bit too impolite to the FSA.

Q36 John Thurso: The PRA is seen by some as kind of the big brother in this supposed twin peak; it has the veto, it has the big voice. What is the danger that, instead of it being a true twin peak, it is more of a mountain and a foothill and of the FCA becoming very much the kind of second cousin in the arrangement? Do you see that as a danger? Perhaps we will start with, Mr Killik.

Paul Killik: No, I actually think that would be positive to be perfectly honest.

Q37 John Thurso: You think it will happen or it won’t happen and you think it is a danger or not a danger?

Paul Killik: I don’t see it as a danger. It is difficult to predict whether it will or won’t happen, but I think there is certain merit. Certainly, looking at the accountability of the conduct of business side, I feel that is the area that I am most nervous about. Therefore, having the regulator answerable to a peer group at the PRA I think would make me feel a lot more comfortable.

Q38 John Thurso: That assumes that they would be answerable to them.

Paul Killik: Or accountable.

John Thurso: Or accountable to them. Whereas the system as it is currently designed is that they both have equal accountability, so that the danger would be that they become much more aggressive and difficult, because they are trying to compete with the big brother, or indeed more relaxed because big brother is doing it, but you don’t see those as dangers?

Paul Killik: I don’t.

John Thurso: Does anybody else want to add to that?

Angus Eaton: I am happy to speak on that as an organisation that would be regulated by both regulators. The double regulation issue is one that we are concerned about, in the sense that our experience is while the structure of regulation is important, it is actually its operational effectiveness that is essential. We would urge the recommendation to go further and ensure that both regulators share services where it is appropriate to do so, and indeed interact from a single point, because the danger of two regulators coming in from different angles can only drive some confusion, and indeed costs, coming back to the comments earlier.

Q39 John Thurso: So your concern would be they would each go off and do their own thing and you end up having two sets of compliance, two sets of regulation and a double load of bureaucracy?

Angus Eaton: We can see that as a potential risk, yes.

Q40 John Thurso: What other impact would it have on a firm such as yours, which is going to be dual regulated? Are there any other areas of concern?

Angus Eaton: I think it is the co-ordination, ostensibly, which is the heart of our concern, from experience in trades. We completely respect the fact that conduct regulation is important and needs to have the appropriate airtime, and indeed we see that as a very important component of our business. With two regulators, and indeed other regulators, balancing that is a challenge for us.

Q41 John Thurso: For example, on compliance, do you see this as being double the amount of compliance required by you, because you will have to be doing two sets of compliance, or should it be one set of compliance that satisfies both?

Angus Eaton: Ideally, we would like one set of compliance if that was possible.

John Thurso: There’s a surprise.

Angus Eaton: We should not lose sight of the fact that clearly there is a prudential regulator and a conduct regulator, so by their nature they are different topics. But there are some specifics-for instance, approved individuals with the regulators. There is the danger that the regulators could come in. We would be approving individuals by two different regulators, which, you know-

Q42 John Thurso: You will be regulated for conduct of business only by the FCA and you will be regulated for the prudential side by the PRA. By contrast, Mr Killik’s firm will be regulated for both conduct of business and the prudential by the FCA. So he will only have one person to deal with; you will have two.

Angus Eaton: That is right.

John Thurso: However hard one tries with architecture, we nearly always get it wrong. Is there not a danger that actually you are going to end up-sorry, it is a fact of life, isn’t it?-with two masters or two people to satisfy, while Mr Killik only has one? It is really trying to understand the risks in that and of giving you the opportunity to tell us what we should be looking for, and I will come to Mr Warland next on this.

Angus Eaton: Yes, there is clearly that danger. I think we would just add we do have a fund manager as well who, in theory, could be regulated by one regulator so we have that added complication as well. I would reinforce the point that double regulation could drive costs to consumers, and anything that can be done to drive the efficiency in the process between the regulators is something that we would support.

Q43 John Thurso: Mr Warland, if you would like to address that as well, but also, particularly around the question of the PRA’s veto, because we can have a situation where the FCA might take a decision on product and the PRA would then veto it. To what extent is that going to get us into difficult territory?

Philip Warland: We think there is a danger there, and I think we gave an example in our paper where, had the PRA and the FCA existed when PPI came forward, the FCA might say, "This is very, very bad, that conduct of business," and the PRA might say, "But we really don’t want to take any million, billion pounds out of banks’ capital at the moment," and you can see that sort of tension arising. So I think there will have to be very close co-ordination, as Angus and others have said. We are slightly schizophrenic I have to say, because one of the problems with asset management and securities prudential capital is that, in Europe, and only in Europe anywhere in the world, our capital is actually set by a banking directive. There was a reason for that many years ago when CRD first came in, but that reason has gone away. Again, our early discussion with the proto FCA has made it clear that they understand that if you were to define anew what a capital regime looks like for a firm like ours, which is almost 100% FCA agency business, you would not start with the banking model. We think that is a very hopeful idea and we just hope that the PRA don’t get in the way of it.

Q44 John Thurso: But as you pointed out in your paper, you clearly see that danger that, as with PPI, you can have a situation where the clear consumer interest might be to do something but a prudential authority might take a different view, and is that not an area that really needs to be fleshed out in legislation? For example, in the Crown Estates there is a veto reserved for Ministers that is never used. It is described as a nuclear option, but it never, ever gets used. I mean that is one possibility: you end up with no veto ever being used so it is pointless. Or the other is it is used too often, which completely takes away from the conduct regulation?

Philip Warland: I think you understand these matters in terms of legislation better than I do, but where you are headed I would agree with you.

John Thurso: Thank you.

Q45 Andy Love: Can I come back to the issue of intervention, which we touched upon at the beginning? I am interpreting now, but my interpretation of what you said was that for all the reasons that we know about-mis-selling and other issues in the marketplace-there is the recognition of the need for greater intervention. But of course the FCA envisages having a power to ban products and issue public warning notices. Is that going too far? Perhaps I will start with you, Mr Warland. You were the most sympathetic, if I could say that? Is it going too far?

Philip Warland: Maybe I should say why, I suppose, we are sympathetic is that our product-the one we use the most-which is the mutual fund, is of course totally regulated. So we are not scared about product regulation and that makes us different, probably, from Mr Eaton. We suspect and believe that the FCA would use the power to ban a product only in the most extreme circumstances, and there have been recent cases, Keydata being the most obvious one, or the Lifemark Bond, where, had they seen it coming and had they had the powers, they might either have said, "You can’t do that," which would have been difficult because it was an overseas product, but they could have stopped the advisers selling it. If they had those powers, that would have been both for the good of individuals who bought the stuff and for us who have paid the compensation, or the redress. So, if it is used rarely, then as a reserve power we think that probably could be quite a good idea.

Q46 Andy Love: Mr Eaton, as seductive the argument that PPI could have been stopped in its tracks if they had had these powers, what is the other side of that equation? We understand what it might do and what it might achieve by intervening, but from your perspective what is the downside to that?

Angus Eaton: I think I will start at a macro level, in the sense that there are a number of actors in this industry who have a responsibility to build the confidence back into this industry-one of those actors is the regulator-including ourselves as well. The regulator should exercise its powers in a measured way. I think our fear, for instance, on the warning notice that you cited would be that that could be a tool that was used to publicise potential investigations and not used in a measured way. That itself could undermine the overall reputation of the industry as a whole. So, echoing Philip’s comment, it is all about measured, proportionate approach. But if this is a tool that is used in an unfettered way then we do have a fear that it is going to undermine the confidence in this industry that, of course, is already very delicate.

Q47 Andy Love: Mr Killik, guilty without being able to prove your innocence. Do you think that is a real danger and how can we protect firms against an overweening regulator?

Paul Killik: I come at it in a slightly different way. I think there is a lot of sense coming out of Brussels in the concept of simple and complex products. Again, going back a number of years, I remember the days when a unit trust was a unit trust, which was a long-only fund; it could not short, there was no leverage involved and it was basically what it said on the can. These days we all talk about funds, which can be anything from a hedge fund-a very complicated, structured product-to a very simple old-fashioned-style unit trust. I do think that, rather than banning products, probably it is a matter of ensuring that the person purchasing a product can understand what is in the product. Therefore, I think the concept of having a simple product, which can be bought widely by everybody, but keeping complicated products for those who can demonstrate that they have some knowledge and experience and can understand the risks of the product they are buying, has quite a lot of merit and bears further investigation.

Q48 Andy Love: Early-warning notices, what would be the impact? I am thinking about Mr Warland and Mr Eaton primarily here. What would be the impact on your firm if an early-warning notice was issued, in terms of your investors and your employees?

Philip Warland: The first thing to say is that we hope it would not happen. I went back through the records and I can’t find a reference to the Ombudsmen that has been upheld for quite some time back. We, as Angus says, start with the consumer. In extreme cases, if the regulator sees that there is likely to be further damage if they do not say, "We think there is something going wrong here," again, as a reserve power, one can see the point or one can see that it could be very helpful. But I also agree with Angus that if you get a constant stream of these things, some of which will turn out not to stand up, then what it will do is it will damage confidence, and one idea we have is to perhaps involve the RDC and make the RDC a statutory body and let them make the judgment as to whether this is in the public interest. So, as a reserve power it is difficult to argue against, but how it is used is the issue.

Q49 Andy Love: Taking that up, Mr Eaton, the fact of issuing such a notice would have an impact, particularly on your investors, so how do you presume that we can protect against that happening? What protections need to be in the legislation to ensure that that will only be done in extreme cases, and when it is done it will be done in consultation with the affected parties?

Angus Eaton: Certainly speaking from experience, my experience of a regulator is to work in a constructive and open way with them as we build products, which is what we do now. I think that will mitigate the risk. I would echo Philip’s words. We certainly hope we don’t receive such a notice, but it would mitigate us ever getting to that point because we have built products that ultimately service the consumer and are demonstrated to service the consumer and-to Paul’s point-the consumer understands what they are buying. So, I think that is where one should start. When it comes to a regulator actually deciding to issue such a notice, then I think the regulator should be accountable, perhaps to a tribunal or a higher body, or higher up, before they decide to take that action. I think the concern as well is that because it is connected with publicity and publicising that notice, that in itself is a big step to take for a regulator, which is not the way they exercise it at present.

Q50 Andy Love: Can I come onto a different issue. Mr Killik, you talked in your submission to us about a heavy-handed regulator, and you mentioned in the initial questions from the Chairman the confrontational attitude that you detected. In your paper, you talked about stifling innovation as a result of heavy-handed regulation. Can you expand on that for us?

Paul Killik: This is a combination both of heavy-handed regulation and also the one-size-fits-all concept. We all have to change our business models to fit with the regulator. That, per se, reduces the ability to innovate. You are being occupied with having to change the business model and not with the further development of the business.

Andy Love: Any of the other two want to comment on that?

Philip Warland: I think in our case it is their not understanding the business model and so they get their supervisory practice pretty well wrong.

Q51 Andy Love: Can I ask all three of you a final question. We are seeing here a more interventionist Financial Conduct Authority. We talked about dual regulation and the consequences of dual regulation with the PRA. There has also been quite a lot of comment about the lack of skills and the need for, particularly, the FCA to up-skill its employees, and you mentioned in particular not understanding the business model. Does all that add up, if we are going to have an effective regulator that it is actually going to cost the industry more? We are being told at the moment that it won’t cost the industry more, but in effect all these things, if they are addressed, will actually lead to an increase in costs. What is your view? Mr Warland?

Philip Warland: Certainly that is a potential danger, and if they have to recruit a number of new skills, which I think they do, but if they also alter the way they carry out regulation and make it more appropriate to our business, then we believe actually the costs could drop, so it would be more appropriate. In certain areas it might be more intrusive. That would be pretty difficult these days. But we do think that they can get better investor protection at a lower cost if they are clever.

Andy Love: So you believe in interventionist light-touch regulation?

Philip Warland: No, I don’t think I said that. I think they should intervene and be intrusive where that protects the investor. They do it at the moment where it is totally irrelevant.

Andy Love: Mr Eaton, what is your view?

Angus Eaton: I think there is clearly the risk that you have articulated. I think one area that there ought to be some focus on is the regulator demonstrating, from a cost-benefit perspective, the actions that they are taking and being transparent about that, and then retrospectively assessing the impact of what they have done. I think they are attempting to build some capability that could do that, so it is a case of learning and mitigating that cost because, as we said earlier, ultimately it could be the consumer that carries that cost.

Andy Love: Mr Killik?

Paul Killik: I don’t think I have anything to add to either Philip or Angus, bar one point. It is often referred to as a cost to the industry. It is actually a cost to the consumer. Ultimately, it is only the consumer who can pay and that is often lost sight of.

Andy Love: I thought you would be less worried about the consumer and more worried about your own cost structures, but I take your point.

Chair: Thank you very much for coming before us today. You have given us a lot of interesting evidence. If you have more thoughts as a consequence of the hearing, please come back to us in writing. We certainly have one regulatory optimist at least among us. It is something of a surprise. I would be very grateful in particular if the point that you just made, Mr Eaton, were fleshed out more. You have argued for greater transparency in almost every reply you have given-transparency for costs and benefits. A cost-benefit analysis is manifestly lacking and we need the industry to supply it to us, of which regulatory costs, obviously, is an important part of the equation. Thank you very much for giving evidence today.

Prepared 1st November 2011