To be published as HC 1574-ii

House of commons



Treasury Committee

Financial Conduct Authority

Tuesday 1 November 2011

Lord Turner, Hector Sants, Martin Wheatley and Margaret Cole

Evidence heard in Public Questions 52 - 144



This is an uncorrected transcript of evidence taken in public and reported to the House. The transcript has been placed on the internet on the authority of the Committee, and copies have been made available by the Vote Office for the use of Members and others.


Any public use of, or reference to, the contents should make clear that neither witnesses nor Members have had the opportunity to correct the record. The transcript is not yet an approved formal record of these proceedings.


Members who receive this for the purpose of correcting questions addressed by them to witnesses are asked to send corrections to the Committee Assistant.


Prospective witnesses may receive this in preparation for any written or oral evidence they may in due course give to the Committee.

Oral Evidence

Taken before the Treasury Committee

on Tuesday 1 November 2011

Members present:

Mr Andrew Tyrie (Chair)

Michael Fallon

Mark Garnier

Andrea Leadsom

Mr Andy Love

John Mann

Mr George Mudie

Jesse Norman

Mr David Ruffley

John Thurso


Examination of Witnesses

Witnesses: Lord Turner, Chairman, FSA, Hector Sants, Chief Executive, FSA, Martin Wheatley, Managing Director, Conduct Business Unit, FSA, and Margaret Cole, Managing Director, Enforcement, Financial Crime and Markets, FSA, gave evidence.

Q52 Chair: Good morning. Thank you very much for coming before us and helping us with our inquiry into the new institution, the FCA, and a particular welcome to Martin Wheatley, who is coming aboard to look after the FCA. Could I begin with a question to you, Mr Wheatley? I am sure you have read this document very carefully. Do you agree with everything in it?

Martin Wheatley: I think it is fair to say that the document is setting out our early stage thinking as to how we think the FCA will operate, and clearly it is setting that out with some idea of the legislative framework but without absolute certainty of it. It was a document to promote debate, and I think we have had a very good discussion with the industry. It is not a final blueprint.

Q53 Chair: But are you part of that debate or do you have firm views, as expressed in this document?

Martin Wheatley: I have a number of views and I am sure we can discuss them as we go on. I was part of the production of the document-even though I had not taken up post I very much spent my time talking to Hector and Margaret about what should go into the document-but I do stress it is a discussion document to promote a discussion and I am very much having that debate with industry and stakeholders now.

Q54 Chair: I am just trying to clarify whether you are signed up to the proposals in here.

Martin Wheatley: Yes.

Chair: You are, in their entirety?

Martin Wheatley: I am sure you will find some that I can question, but in a broad sense the document is the vision of the FCA but it is something that we are consulting on.

Q55 Chair: Obviously you are consulting, but if I, which I am not going to, were to ask Hector Sants these questions he will tell me, "Of course I support the proposals in the document." I am asking you, new to the job, whether you support them.

Martin Wheatley: And the answer is yes.

Q56 Chair: Mr Sants, we have had a lot of regulatory failure over the last few years, not least PPI. Are you confident that all of those failures were caused by structure-after all, we are changing the structure here-or was some of it caused by people?

Hector Sants: Some of it was caused by the people, both the regulators and the firms and to some degree the consumers. Some of it was caused by the structure, some of that structure being the micro-prudential structure and the powers that go with the micro-prudential regulators, and some of that, of course, in the prudential side-which I know is not the purpose of this inquiry-by the rules that were set in Basel and various international European forums. As we all know, I think we all agree, the causes of the failures over the last decade, both conduct and prudential, come from a variety of different sources, but I am confident that if we took forward the broad agenda, as set out in this document-I do agree with Martin, we were trying here to set out a broad agenda, not the detail of how we carry it forward and we did so with the intention of stimulating discussion and debate, not with the intention of reaching a conclusion-I do believe that if we carried out the broad agenda as set out here, we would significantly reduce the amount of consumer detriment in the future relative to that which we have seen in the past.

Q57 Chair: Are you responsible for any of these failures?

Hector Sants: In respect of the consumer issues that we highlight in the document, broadly no, because these have occurred over the past decade and have been built up, and some of them have crystallised, notably PPI during my tenure as the chief executive. But I think in relation to the principal issues that you are talking about, they all had their origins pre my time as chief executive, and I was not responsible for conduct issues at that time, and they also have their origins in some issues pertaining to the mandate of the FSA, both in respect of FSMA and the way it carried it out. Obviously part of this process now, which I am very much looking forward to, is to try to ensure that the future FCA is better equipped than the FSA was and also that there is a better common understanding between Parliament and the regulator as to exactly what the regulator is trying to do. I think one of the things that I find upsetting-

Chair: That is what we are looking at now.

Hector Sants: -in the last few years is coming quite regularly before parliamentarians and realising that there is a huge gulf between what the regulator is doing and what many parliamentarians think the regulator is doing. That is a profoundly unsatisfactory position to be in.

Q58 Chair: We are going to be trying to close that gap as part of this inquiry. But the answer to my question is partly the mandate, partly the structure and partly the people who were in charge before your time?

Hector Sants: Yes.

Q59 Mr Mudie: Mr Sants, in view of yesterday, we are clearly in a potential pre-crisis period. If a crisis does develop, which body will deal with it? Is it the tripartite system or is it this embryonic system that we are discussing?

Hector Sants: We are still working under the current FSMA-based powers and the previous Finance Bill. Therefore the responsibilities for dealing with current regulatory issues, both conduct and prudential, lie with those authorities that currently have the power, so micro-prudential regulation is the responsibility of the Financial Services Authority. Having said that, we have, as you know, reorganised the FSA over the last 12 months into a prudential and a conduct business unit, therefore we have, as far as we can within the current legislation, anticipated the outline proposal in the current proposed legislation and therefore are working to some degree to the new model, in the sense of having a focused prudential micro-regulator.

The second point I would make is that the degree of co-ordination on micro-prudential matters between the FSA and the Bank of England is at a totally different level than it was in the 2007-08 period. I have regular meetings with the Governor directly myself, in which I brief him on micro-prudential matters, but I should be very clear that my responsibility for micro-prudential regulation is to the board of the FSA and my Chairman.

Q60 Mr Mudie: This is under the heading in the Chairman’s questions, "Learning from the past". One of the things that alarmed us when we went through the last crisis was that the tripartite system rarely met. Is it meeting now?

Hector Sants: Yes, regularly. I am very satisfied, and again Adair may want to come in here, that the degree of co-ordination from top to bottom between HMT, the Bank of England and the FSA is at the required level of intensity. We now have a whole new process that has been put in place over the last few years, which did not exist pre 2007. As you well know, to my knowledge anyway, there were no regular meetings at all between senior FSA officials and Ministers pre the crisis. We now have regular meetings with the Chancellor, with HMT. I have regular meetings with the Bank of England. Of course Andrew Bailey-

Q61 Mr Mudie: When was the last meeting of the tripartite body? The Chancellor in the chair, the Bank of England and yourselves-when was the last time?

Hector Sants: This is not your question, but just to reassure you, the deputies, which are myself, Paul Tucker and the relevant senior official at HMT, normally Tom Scholar, took place yesterday afternoon and the last principals’ meeting was three weeks ago.

Q62 Mr Mudie: Did the Chancellor attend yesterday’s meeting?

Hector Sants: No, that was a deputies’ meeting.

Q63 Mr Mudie: When did the full tripartite-

Hector Sants: As I was saying, three weeks ago.

Mr Mudie: When?

Hector Sants: I would have to check my diary but about three weeks ago; I cannot remember the precise date. If you want me to look at my BlackBerry, I can produce it.

Q64 Mr Mudie: That is interesting. They will be the body that handles most of the crisis. Learning from the past, we were all ill-prepared and a lot of that was due to the banks not being forthcoming about their real financial position. Even when the real crisis erupted and they were in real danger they were still telling the Chancellor that they did not need money. Assure the Committee that you have been all over the banks, that there are no surprises in store, that you know their full exposure rating for Greece, but if it moves on to Ireland and Portugal you have got that covered and that, as we sit, you do not foresee any public money being required?

Hector Sants: We have full transparency from all our major banks as to their positions. That was certainly not the case, as you rightly say, back in 2007-08. I do not wish to sound like I am hedging because I am not. I think the short answer to your question is yes, but nevertheless I should draw to the Committee’s attention a couple of points. First of all, of course, it is possible for fraud-rogue trading-to occur within an institution, which will mean that its position turns out to be different to that which the institution has reported to us. But I believe we have full transparency of those positions. We also have the capability, which we did not have pre 2007, to make our own judgments on the quality of those positions, in the sense that we have hired 200 or so risk specialists. The FSA, as you know, had no risk specialist capability pre 2007; it was not set up to do that. And we now employ multiples of individuals on supervising individual banks compared with that period. So we do have full visibility.

The second part of the question, which is can we assure the Committee that there is no scenario under which UK banks will-

Q65 Mr Mudie: Obviously you cannot answer that question but it was within the context of first Greece and then it moving on to a second wave of Ireland and Portugal.

Hector Sants: Yes. The answer, broadly speaking, is yes.

Mr Mudie: It would only be fair to ask you again.

Hector Sants: Clearly you can construct scenarios of a more cataclysmic nature that go beyond those peripheral European countries where you could envisage there would be circumstances where there might be difficulties.

Q66 Mr Mudie: I have not, so you can assure us with the full transparency, which you have taken advantage of, you do not perceive public money going into anything arising from a Greek default and it moving on to Ireland and Portugal?

Hector Sants: Yes. I do not envisage that happening.

Q67 Mr Mudie: This question only requires a short answer-just a yes, if you wish. You say the banks have been transparent; have you, as an organisation, taken full advantage of that transparency and have the banks at any time refused to give you information or access?

Hector Sants: Yes and no. Yes, we have taken full advantage. No, on prudential matters all the major UK banks have been fully open and transparent with us.

Q68 Mr Mudie: So, bringing in today’s exercise, there are no additional powers, Mr Wheatley, you feel you might need or want to be able to get information? It is forthcoming on request?

Martin Wheatley: Yes, I think that is true.

Q69 Chair: Mr Sants, when the FPC makes a recommendation with which you, sitting on the FPC, disagree, what are you going to do about it when you get back to the FSA prior to the enactment of this legislation?

Hector Sants: I think the process we would adopt is clear. So far that has not happened, may I just say, but nevertheless I understand-

Q70 Chair: But it is in the nature of things that it will one day?

Hector Sants: Yes, it could do. If I disagreed, I would express my view in the committee. As I think you have heard from Bob Jenkins and others, certainly on my experiences so far, it has been a very good quality discussion in the FPC. There seems to be no hesitancy from committee members in speaking up and expressing their views, though I can assure you if I-

Q71 Chair: That is not my question. My question is if the FPC are asking you, you at the moment a separate institution set up under current statute, to do something with which you disagree, what are you going to do then?

Hector Sants: Once the FPC had made its decision then the Executive of the FSA have said as long as they can see no bar to executing that mandate in relation to the powers of the FSA that they will comply with the interim FPC’s request. We have made clear we will comply with all the current requests made and I would comply with future requests as long as there was no issue with complying with that request in regard to our powers. In the event-

Q72 Chair: You mean that you did not have the power to implement it, so they were asking you to do something you are physically incapable of doing?

Hector Sants: Yes. So in the event that there was a problem of that nature we have agreed-again, Adair may wish to come in-that the Executive would take that problem to the FSA board and then the FSA board would consider the issue and, if necessary, revert to the FPC. But assuming that we are able to comply, we will comply.

Q73 Chair: Where is this all set down?

Hector Sants: The procedure within the FSA, so the commitment by the FSA Executive to operate in the way I have described, was agreed by the FSA board, so I made the proposal with paper.

Chair: When was that?

Hector Sants: I am sorry?

Chair: When was that?

Hector Sants: We agreed this set of procedures prior to the first interim FPC meeting, so we were sure how we were going to operate when we went into the meeting, and the Executive-

Q74 Chair: Is that in the public domain?

Hector Sants: I think the actual executive paper isn’t currently but I am sure we could put a summary of it-

Q75 Chair: I think it would be very helpful if this were put in the public domain. It is an issue that I have raised, as you know, both with Lord Turner and you, and also with the Governor, and I think it is extremely important that we have clarity before we have a crisis.

Hector Sants: Will do. I should also say that we have also agreed a set of procedures, which the Governor signed off on, which I agreed with Paul Tucker, as to ensure how we would then subsequently monitor the FSA’s compliance with the FPC’s requests, and how we would report the progress. Obviously some of these issues arrive over time.

Chair: Rather than waste more time on this it seems that you have given quite a bit of thought to it. It is very helpful and I think what the Committee would like to see is the papers supporting all this in full and any relevant minutes about the discussion of it. Thank you.

Q76 John Mann: I want to follow up Mr Mudie’s question, just to clarify with you, Mr Sants, on your answer because you were suggesting that British banks were robust enough to deal with scenarios relating to, in Mr Mudie’s words, Greece and other peripheral economies, which I take to be Portugal and Ireland. Does that extend to Italy?

Hector Sants: I think that is where I was making my rider, that as the Governor indeed has said in a number of press conferences, there are always concerns about what we don’t know about interconnectivity in the financial system, particularly in relation to the interaction between the UK banks and continental Europe. I remind you that we are not the lead supervisor in the continental banks so I am not asserting that I have full visibility of the state of soundness in large continental banks, and therefore we cannot be absolutely certain of the implications of significant disruption to large eurozone economies and the consequence of that on their banks and the subsequent interconnectivity between those banks and the rest of the system, and therefore ultimately the UK banks.

I believe we monitor this very closely. We have done substantial analysis and work on potential scenarios that could arise from further disruption in the wider eurozone, but it would be wrong for me to give absolute certainty to this Committee. What I can assure the Committee of, categorically, is that we are very, very alert to the problem. I believe that we are addressing you with the greatest possible focus and we are doing it through the tripartite structure.

Lord Turner: Could I add one other thing? The direct exposure of the UK banks to Italy is not all that large. Indeed, in terms of the total exposure to the economy it is considerably less than to Ireland, where there is large exposure, not to the sovereign debt but, for instance, real estate loans. Italy, as a direct exposure, is not very large and that was part of the disclosures in the stress tests earlier this year. The bigger issues arise if problems in Italy had consequences for other banks throughout Europe and were part of the wider problem. But to Italy in itself the exposures are not terribly large.

Q77 John Mann: Let me perhaps ask a different question as a follow-up to that. Are you more concerned in your scenario planning with the economic situation in Italy because of the level of debt and the size of the economy than of those peripheral countries? Perhaps more pertinently, should we be more concerned about Italy than about the much publicised problems of Greece?

Hector Sants: Relative to its impact on UK banks and therefore possibly on taxpayers’ money, which I think was the original question, yes but only in the way that Adair has already outlined, in the sense that the interconnectivity in the system between Italian financial institutions and the rest of Europe carries greater risk than the interconnectivity between Greece, Portugal and Ireland and the rest of the system. So in that sense, yes. But as Adair has said, and it is in the EBA data, the direct exposure to Italy is also not particularly significant.

Lord Turner: But I do think you would be absolutely right to focus on the fact that within the present stresses on the eurozone Italy is the most concerning, simply because of the sheer size of its public debt relative to GDP in absolute terms. So I think that is the most important thing in terms of the overall dynamics of the eurozone for us to focus on.

Q78 John Mann: Thank you for that; that is clear. Two questions on the purposes and objectives of the FCA. One of them is protecting and enhancing confidence in financial services and markets. Of course, at the heart of the problems three and four years ago was over-confidence, so how is over-confidence and, in that case, mispriced risk going to be balanced against confidence?

Lord Turner: We have suggested in our letter to you that we are not convinced that the most appropriate statement of the top-line objective of the FCA is enhanced confidence in the system. That seems to us something that more logically fits with the PRA, where the concept of confidence is important, although I take the point that it would be incredibly important then that that does not mean false confidence; it means confidence which is really based on good resilience.

When we switch to the FCA we have suggested that we should more clearly than under the present proposals say at the top what the fundamental focus is, which we think in some way should refer to fair, efficient, transparent markets, and so on. We think at the moment there has not been a clear enough distinction in the top-line heading objectives between the core focus of a prudential regulator, which is to do with the system and confidence in the system, and the core focus of a conduct regulator, which should be about efficiency, fairness, consumer protection.

Q79 John Mann: On the issue of consumer protection, Consumer Protection Objective F is the general principle that consumers should take responsibility for their decisions. Mr Sants, you talked about you having "full visibility" but consumers have opaqueness when it comes to the decisions made by the financial institutions. How can this catch-all, some would say cop-out, of consumers taking responsibility for their own decisions be managed by consumers when they have so little visibility of decisions and processes that lie behind the financial institutions?

Hector Sants: I agree with you. I think the question of what we mean by consumer responsibility has not been adequately teased out and there is not an accepted view as to what we mean by consumer responsibility, and I think it would be very helpful to the FSA going forward if we could get-we will probably never achieve entirely-a much greater consensus on what we mean by that.

Two points, as you say, are apparent from the past, and I might ask Martin to expand on how one might take it forward. The two points that I think are apparent from the past are, I think, there are certain decisions which consumers are being asked to make where it is not reasonable for them to take full responsibility for that decision because it would not be reasonable for them to have a full understanding of the information on which they need to make that decision. An example of one that I have mentioned in the past some time back is that I think it would have been unreasonable to have expected a consumer to have worked out what the risks were inherent in Northern Rock’s business model, which is why there should be an effective FSCS deposit protection scheme, and expecting consumers to know how banks fund themselves is not reasonable.

The other fact, of course, we do know, and that obviously very much lies behind the thinking in the FCA document. That is that historically it has been believed that if you give consumers plenty of information at the point of sale on individual products, it would then be reasonable for them to take full responsibility for the decision, assuming the information had been properly presented to them at the point of sale. Unfortunately, research undoubtedly demonstrates that, for a variety of reasons, consumers do not read that information properly at the point of sale and that is not a very effective way of mitigating risk.

We also know, sadly, that many consumers are not equipped to make those types of judgment, given the degree of education they have had in relation to financial matters and mathematical skills. That is just a matter of record, which is why there is a need to raise significantly the understanding of consumers generally on finance.

We have three elements, which tell us literally that full responsibility is going to be very problematic, and I think Martin has already begun to give thought as to how we tackle this conundrum.

Q80 John Mann: Perhaps I could throw in one final question for Mr Wheatley. With these new arrangements, in your view, is it more or less likely that bankers and other financiers who do wrong will go to prison?

Martin Wheatley: That largely relates to the penalties for particular offences within the system and clearly at the most egregious end they will and should. In the past penalties at the egregious end have been linked to market risk conduct, insider trading of various descriptions. The original point that we started on, which is-

Q81 Chair: Before we move off that, how many are in prison at the minute?

Martin Wheatley: I don’t know the answer to that.

Lord Turner: Perhaps you could ask Margaret, I would suggest.

Margaret Cole: None, because currently there isn’t a criminal offence that is pertinent to the behaviour of bankers. Some may say it should be, but it is not a criminal offence to be incompetent-

Q82 Chair: How many have been found guilty of offences which, under your proposals, would be likely to lead to a prison term?

Margaret Cole: There is nothing in here that changes the criminal law aspects of this. That would be a matter for Parliament. If there were to be a criminal offence relative to behaviour of bankers and the running of banks, that would require new legislation. It is not framed in this current draft legislation.

Q83 Chair: This is certainly a point to come back to and I can imagine what the public are thinking listening to this, but I do not want to interrupt Mr Wheatley’s train of thought on the earlier point.

Martin Wheatley: If we go back to this question about consumer responsibility, individual responsibility, I think the global world of regulation has moved from a belief that providing information to people combined with some conduct rules over the people selling products will lead to good outcomes. That was the broad philosophy that was adopted everywhere and it just has not worked, and so we have seen the detrimental outcomes all over the world; that process did not work. So the heart of the FCA going forward will be the extent to which we can look through products, look through conduct, look through business models of institutions and act at an earlier stage than the detriment occurring-so, rather than going in after large losses, take an earlier judgment as to which products are unsuitable in which circumstances.

Q84 Andrea Leadsom: Lord Turner, under the tripartite arrangement over the last 10 years, how many women were at the top of a bank or a regulator or the Bank of England that presided over this financial crisis?

Lord Turner: Not many, but the institution that scored best on that parameter I have to say would be the FSA.

Q85 Andrea Leadsom: How many women were at the top of the FSA?

Lord Turner: How many women are at the top of the FSA?

Hector Sants: 50% of my executive committee I think over the time of my chief executiveship have been women.

Lord Turner: When I joined the managing directors were Jon Pain and Sally Dewar. You are quite right that overall-

Q86 Andrea Leadsom: In terms of accountability, how many women were directly accountable-as chief executives, as senior executives of regulators, banks and the Bank of England-for presiding over the financial crisis?

Hector Sants: In the case of the FSA, 50% of the Executive.

Andrea Leadsom: Can you give me a number?

Hector Sants: Yes, 4 or 5 out of 8, depending on size.

Lord Turner: In the case of the FSA, 4 or 5 out of 8. In the case of most of the other institutions, absolutely minimal. That is what the factors are.

Q87 Andrea Leadsom: In terms of now, the restructure of the new financial regulatory organisations, of the Bank of England and all of those new bodies, how much effort have you made to ensure that the sex that got it wrong last time are not going to get it wrong this time? Is this jobs for the boys? Did you divvy them up between you?

Lord Turner: We do not appoint either the senior people at the Bank of England or the senior people at any individual bank. We don’t have the right to do that. Nor have we set it as an objective, and it is not part of our statutory objectives to, as it were, influence a gender balance in the belief that decisions-

Andrea Leadsom: Okay, so nothing.

Lord Turner: In relation to our own internal situation, I would say that the FSA is as good as you get in terms of an exemplary approach to the fair treatment of women. We do have a requirement statutorily when we produce a new rule to think about whether that has some diversity impact, but that is quite different from us having an overall aim of trying to change the gender balance in positions of responsibility.

Q88 Andrea Leadsom: So you would agree then that the leadership of the PRA, the FCA, the FPC, the Bank of England, and all of the UK top banks remains men?

Lord Turner: No.

Hector Sants: No. It does not in the case of the FSA.

Lord Turner: In the case of the FSA I would say that we are somewhat of an exception to your general proposition.

Q89 Andrea Leadsom: Which of Martin and Hector Sants is a woman, then?

Hector Sants: I thought you were talking about the senior executives. Unless I have missed a point, there is one lady sitting on this bench. I think you will be familiar with Sally Dewar and other senior members of the FSA community, so no, I am sorry, I don’t agree with you. The FSA, under my leadership, has had a balanced, effective Executive committee, which has reflected properly a gender balance.

Andrea Leadsom: But under your leadership?

Hector Sants: Yes, I am sorry; I am a man.

Andrea Leadsom: Not the leadership of a woman. That is fine, thank you.

Q90 Andrea Leadsom: I just wanted to talk to you a bit about competition. You have rejected the idea of a primary role for the FCA in competition and it has been watered down in spite of the efforts of this Committee and the ICB to require that the FCA has a specific primary objective of competition. Could you explain, Mr Wheatley, how the balance is between competition and regulation? Does more of one lead to less of the other and vice versa?

Martin Wheatley: Can I just clarify the position that we have taken on competition, because I think it is quite important? As the draft Bill currently stands we have a set of three operational objectives, which don’t include competition, and then a duty relating to the objective, which is to have regard to competition in discharging those objectives. What we have said is that that is an uncomfortable position to be in. We would rather have a clearer competition objective so that we would have the ability to step into cartels, price, areas that we felt were unfair-so that we would not only have to take regard of competition once we fear one of our other objectives is not being met. So our view is we want a stronger role in competition than the original draft had suggested.

Q91 Andrea Leadsom: But you have suggested, have you not, in your submission, that you think you should simply refer to the OFT?

Martin Wheatley: No. Our current position is that there is a confused structure, that we would prefer to have a stronger position on competition and a clearer objective on competition.

Q92 Andrea Leadsom: "We do not believe it would be appropriate for the FCA to have responsibility for further specific competition acts of enforcement. The OFT has the relevant technical lead in economic expertise and experience." So in terms of firm, specific competition you do not think that the FCA should have requirements to enforce competition?

Martin Wheatley: Competition is an industry-wide issue, and what we would like to have is the powers to look at industry-wide issues. Within that context there will clearly be firms that we have concerns about, but our view is that we have to start from an industry-wide position and that the original drafting did not give us the ability to do that.

Q93 Andrea Leadsom: Sorry, that is still not clear to me. If you are not going to be responsible for firm-specific competition, so you are not responsible for Lloyds HBOS’s 42% of the UK mortgage market, but you are responsible for the overall competitiveness of the mortgage market, isn’t that contradictory?

Martin Wheatley: I think it is a starting point. It tells you where the starting point is and the starting point-

Q94 Andrea Leadsom: But where is your responsibility? Where would you like your responsibility to be?

Martin Wheatley: We would like a responsibility that had as a clear operational objective responsibility for promoting effective competition in the markets for the benefit of consumers.

Q95 Andrea Leadsom: So if Lloyds HBOS has 42% of the mortgage market you are not going to do anything about that?

Martin Wheatley: We would have to first form a judgment that the mortgage market was either over-concentrated or that that over-concentration was leading to detriment for consumers, and if we concluded that we’d then have to conclude what actions could be taken that would remove that redress. Some of that power would still sit in the Competition Commission to which we would have to make a reference.

Q96 Andrea Leadsom: But could you imagine a scenario where one organisation having 42% of the UK mortgage market could possibly be perfectly fine and perfectly competitive? Am I missing something? It just seems to me that you do not need even an O-level in economics to realise that a 42% market share is completely anti-competitive.

Martin Wheatley: It depends what the rest of the market looks like and so you have to look at the market as a whole.

Andrea Leadsom: So it could be perfectly fine?

Martin Wheatley: Depending on the characteristics and you would have to look at the facts.

Q97 Andrea Leadsom: Will you be considering that 42% market share? And if you decide that it is anti-competitive what will you as the FCA be doing about it?

Martin Wheatley: Partly this relates back to the debate we are having about the powers that we are given. If we have a clear objective-

Q98 Andrea Leadsom: What powers would you like to have? What I am trying to get at is, what competitive powers do you want to have as the FCA in regard to this specific example I am giving you, which to most people would be a clear example of lack of competition?

Martin Wheatley: It is very difficult because it always depends on facts. We would like to move from a situation where we have a set of operational objectives and then a duty that in discharging those objectives we take account of competition. To me that feels uncomfortable and it feels like a constraint. We would like to move to a position where we have a competitive operational objective-effectively promoting competition within our objectives.

If, subject to the parliamentary process, we end up with that, then we come back to your question of looking at the different industry sectors and forming judgments as to whether there are anti-competitive features of those markets. I cannot prejudge whether 42% on its own would represent an anti-competitive position, which would need action.

Hector Sants: The simple answer to your question is yes.

Q99 Andrea Leadsom: Let me ask you in another way, Mr Wheatley. If you do have those powers, so now you do have the powers to look at anti-competitive practices, and if you do conclude that 42% is anti-competitive, what would you then like to be able to do about it?

Martin Wheatley: There were two things we would like to be able to do. If that led to conduct abuses, which were broadly in the space where we have sufficient powers, we would seek redress and we would seek actions to respond to our concerns.

Andrea Leadsom: What sort of actions?

Martin Wheatley: It could be abuse of pricing power, it could be abuse of cross-selling. It could be a product structure that created unfair product terms, it could be promotion of products-there is a suite of actions that we might be able to take-or it might be a reference to the Competition Commission. Again, we would have to judge based on the specific circumstances.

Hector Sants: What we are trying to do is remove the overlap, in simple terms, between us and the OFT, which we tried to use worked examples of in the last paper. That does not mean removing the Competition Commission from the process. What it does mean is removing the overlap and, in our view, potential confused structure that currently exists between us and the OFT. The current drafting of the Bill does not do that, so in relation to the current drafting we would like more powers, not less powers, to ensure we have clarity as to who is responsible for addressing exactly the sort of question you have raised. We are in favour of having more power in the Bill, not less.

Q100 Andrea Leadsom: So more power to force that market share to be reduced?

Hector Sants: Yes.

Chair: Why don’t you send us something with some worked up examples, developing what you have already put in the public domain on how you think this competition structure will operate? I think that will be very helpful to the Committee as part of this inquiry.

Q101 Mr Ruffley: A question for Mr Wheatley. The consumer protection objective specifies that the FCA must have regard to "the differing degrees of experience and expertise that different consumers may have". How on earth, in practice, do you envisage the FCA achieving regulation having regard to those distinctions? It is quite a tricky one, isn’t it?

Martin Wheatley: It is quite a tricky one. That partly derives from the broad legal definition of consumer, which is different from the common man test of a consumer, so the broad legal definition has consumers including everything from retail consumers through to hedge funds, through to major parts of the infrastructure like stock exchanges or clearing houses. In that sense, what we are saying is it is not that within retail consumers we are going to try to judge the responsibility and the duties that we owe to different groups. It is more reflecting that institutional consumers, corporate large wholesale consumers, have the ability to take more responsibility and they have the legal powers to read the 200-page document and understand exactly what it means. That is the sense in which that was in the document.

Q102 Mr Ruffley: Do you think under the new arrangements there will be more protection for the consumer than under the old system?

Martin Wheatley: Yes, I do.

Mr Ruffley: More protection for the consumer?

Martin Wheatley: More protection and because it comes back to this philosophy as to whether you can trust a combination of disclosure and conduct to deliver good outcomes, and what has happened in history is it has not, and therefore we are moving along the value chain to an earlier part of product design to try to ensure that good outcomes are designed into the corporate governance process of the people creating products. It is designed into the features of the product. I think it will lead to more protection for consumers.

Q103 Mr Ruffley: Can you finally give an example of how the new regime with these enhanced protections for the consumer, which you have just described-which will relate to product design among other things-would have prevented one of the failures in the last 10 years from a consumer’s point of view.

Martin Wheatley: A couple of examples and it is easy with the hindsight of history so-

Mr Ruffley: No, but I am inviting you to frame that judgment.

Martin Wheatley: PPI is, as you know, one of the big areas where we have had significant concerns and they have ultimately ended up with a major redress issue with all of the banks selling PPI. With that product we would have been looking at the product production governance within firms, we would have been asking firms to show us how they have demonstrated to themselves, to their risk committees, to their board, that the product met our reasonable standards of care and fairness and we would have analysed the product profitability for firms, and if we saw products that were generating a margin of 70% or 80%, we would have been very intrusive in asking those firms whether that product and those features were properly explained to their clients.

Q104 Mr Ruffley: You do not believe the old system gave the regulator the power to ask those very pertinent questions? You are saying it is only under the new arrangements that those questions could be asked; is that right?

Martin Wheatley: PPI was a particular case in point because the FSA only took responsibility for insurance after some time.

Q105 Mr Ruffley: You said PPI but it was one example. Give me another example.

Martin Wheatley: Another example would be mortgages, where we look at the business model of a firm and look at its profitability-and here it might be the converse of PPI. In PPI we found products that were 80% margin. If we looked at the business model of some of the mortgage products, they are unprofitable under normal circumstances and they only become profitable when people start defaulting on their payments and banks start to impose higher charges based on those defaults. That is another example where we would have gone in and said, "You can’t possibly launch a product that only works if it fails or you only make profits if it fails."

Hector Sants: It might be worth asking Margaret just to expand on the powers because I think in answer to the specific question: could we have done the analysis? Yes. We did not choose to because the FSA had adopted a different philosophy, which we have expanded on before. But where I think the new legislation is different and where we are very focused is, what are our powers of intervention? There we need different powers of intervention and Margaret might want to-

Margaret Cole: Yes. I think this also interlinks neatly with the competition point and where the boundaries are because in relation to PPI there were clearly anti-competitive aspects in the way the product was sold at the point of sale advantage. Yet the whole of the competition area was something that at that time we felt we had to refer across or work with the OFT and the Competition Commission on, and I think with the competition objective we are now proposing that will be much clearer and we can take earlier action. One of the earlier actions we could take would be to ban the sale of that product or ban it with the primary product that it is sold with.

There is a power to intervene earlier to ban a product on a summary basis and then to have a later consultation to make rules within a 12-month period. That is quite an important new power, we think, because that does enable us to intervene at an earlier moment, giving us the opportunity to have a look at the evidence and to justify our action in that 12-month period. That, I think, would have been pertinent in the PPI scenario. But I think giving us a competition mandate would have helped to get there and removing that confusion between the action that we could take and other authorities could take would have helped a lot.

Q106 Michael Fallon: Mr Wheatley, should it be the role of the Financial Conduct Authority to enhance the international competitiveness of UK financial services?

Martin Wheatley: That clearly was part of the FSMA responsibility that sat with the FSA. It creates a set of conflicts and I don’t think it is part of the function of a regulator to have to take regard to that as well as consumer protection and intervention and the various other things. I think that creates too many conflicts.

Q107 Michael Fallon: So it is nothing to do with the domestic regulator whether or not the measures it adopts damage our competitiveness; is that right?

Martin Wheatley: There is a proportionality element, so let’s separate these two things out. We clearly need to be proportionate in our responses. We need to be accountable to the effect of them and to the market, but to have a specific UK competitiveness competition point can only lead to compromises in regulation, and I don’t think it would be a good thing.

Q108 Michael Fallon: All the evidence to this Committee is that it is the other way. Fidelity say it is a signal omission. AXA say they think that the regulatory principles should include the need for a regulator to recognise the international nature of financial services. Killik say it should be reviewed by an independent committee.

Martin Wheatley: As I say, I think proportionality is very important. We should do things that are sensible within the context of the industry that we are regulating, but to add on top of the proportionality requirement a requirement to have regard to the UK’s international competitiveness can only lead you to say there are certain things that you might otherwise consider to be good regulation that you won’t do. That would be a very strange outcome.

Q109 Michael Fallon: But nobody is suggesting they should have an override. All that is being suggested is that you should have regard to it. Do you think the regulatory system that you are inheriting will promote our international competitiveness, or leave it where it is, or damage it?

Martin Wheatley: I think it will promote it because people are attracted to a well-regulated structure. They are attracted to safe, secure, transparent markets that they can have confidence in. So I think all of that enhances the competitiveness of the UK system, but that is quite different from having a specific objective, which will be used to argue against certain things, which otherwise we consider to be sensible interventions.

Q110 Mr Love: Before we leave the issues related to objectives, can I ask you, Lord Turner, where you would rank diversity among the priorities of the regulator?

Lord Turner: I think diversity should probably be at the level of "have regard to" rather than up there in the top-line objectives because I think whereas diversity is a very important objective for society in general, it is not clear that it is the core function of a financial regulator to pursue diversity objectives. That would be my overall point of view.

Q111 Mr Love: Can I just press you a little on what "have regard to" would mean? There have been suggestions that, in some senses, you should measure complexity in the matter, monitor it. Others suggest, and I think you have already moved in this direction, setting up departmental structures that address some of the diverse structures that exist in the marketplace. Which of those or what other things are you suggesting you should have regard to?

Lord Turner: Let me make sure we are clear about what we are talking about. There is, of course, a completely separate thing between the FSA and the FCA’s internal commitment to diversity but leaving that aside, what should be the objective in relation to what happens within the provision of financial services to society in general? Where it has been interpreted so far is that, for instance, we have been supportive of creating regulations, which allow sharia-compliant products and that services a diversity requirement, an openness of access to people who have a different set of religious beliefs or moral values in relation to what a financial product should be. I think it is legitimate that in our activities as regulators we are making sure that there is a regulatory framework which is not to the disadvantage of diversity, but-although it would be for Parliament to debate this, and it could be debated-it has not been seen in the past and I could see some difficulties of us as being given the positive aim of creating a greater degree of diversity. I think it is defined and I think at the moment reasonably defined as being something that we have to take into account; we have to make sure that products are not discriminating, for instance, against different defined groups, but not a positive role, as Mrs Leadsom was suggesting, of pursuing a gender balance agenda. I think that is a reasonable balance, as is intended at the moment within the legislation.

Q112 Mr Love: Mr Wheatley, you are getting your feet under the table. May I ask about a couple of issues that you will have to deal with? The first is the Financial Services Compensation Scheme levy, where some concerns have been expressed, particularly by building societies, in relation to how that levy has fallen upon different diverse structures. There is also an interminable row going on about the definition of "with profits" related to mutual insurers. These will undoubtedly be resolved at some point, but there is a distinct feeling that there is not the recognition within the regulator of the diverse structures that exist out there in the marketplace. How will you seek to address that?

Martin Wheatley: First, there are a number of issues that are existing policy issues that will continue and will be picked up by the FCA in the future, and the comments you make about the levy and the way the levy falls and the "with profits" policy will be part of that. We will be starting the consultation process on the levy in February. We will have various European changes to compensation schemes to take into account and we will try to come to something that recognises the diverse business models that exist in the UK. It is a challenge that is there today. We won’t shirk that challenge. It will be something that we grapple with.

Q113 Mark Garnier: Martin Wheatley, the draft Bill provides that the Treasury will be able to direct the FCA to conduct an inquiry where it considers certain triggers have been met. In practical terms, when do you think the Chancellor should invoke those powers?

Martin Wheatley: As you know, we would have a very difficult process in regard to the RBS report, and a difficult process in terms of trying to invoke those powers against our own legal processes-I am sure Margaret will comment on this-that mean we gather information for certain specific purposes and it cannot be used for other purposes, and that we have investigations on foot. I think we have to move to a situation where there is a very clear set of guidelines as to when those powers are invoked, a very clear hard and fast line, which does not mean to say it is the only case but we have clarity about it that respects the fact that we may have enforcement processes under way and allows us to, as far as possible, complete an investigation and enforcement process before we have to publish, because there is a trade-off between the transparency and publication and our ability to complete the process. But I do think that those powers are useful powers-I think this Committee should be interested in those powers-but we would like to have a more clearly defined structure as to when they are invoked.

Q114 Mark Garnier: In practical terms it is quite a big deal for the Chancellor to come along and say to you that you have got it wrong and that you need to-

Martin Wheatley: That is right. In practice, what we would like to be able to do is to agree with the Treasury a set of almost automatic criteria-I say automatic; it is not so that they cannot be overridden-that say, "Under these circumstances a report will be produced." I think that is a much cleaner system and it gets away from the big hurdle as to getting to a point when a report has to be produced, but subject to our ability to complete our normal processes. Maybe Margaret can comment.

Margaret Cole: It is obviously a primary duty of the regulator to pursue investigations into misconduct or mis-selling or wrongdoing and to bring appropriate disciplinary action, or in some cases we do have the option of bringing criminal action. I think that is a primary duty and it is important that individuals and firms are held to account and also that firms and individuals pay due attention to early redress of consumers who have been harmed.

I have to say there are real legal, practical and fairness implications of trying to run an investigation the purpose of which is external reporting, at the same time as running an enforcement investigation the purpose of which is discipline. I think all of those implications have to be fully considered and it is very much our strong preference that we are unable to complete our primary duty of enforcement ahead of commencing or pursuing separate investigations for reporting purposes.

Q115 Mark Garnier: Hector Sants, in your submission to this inquiry, you say that you believe that this Committee will play a key role in the accountability system. You will be well aware that the virtual indecent haste that you responded to our RDR report was seen by commentators as being the FSA holding this Committee, and indeed Parliament, in contempt. How would you respond to that?

Hector Sants: I am extremely sorry that that impression has arisen, but it is obviously for you to judge. Over the years that I have been in front of this Committee, I have very much been a proponent of accountability to Parliament as a whole and to this Committee, so it absolutely was not our intention to generate that impression, and I am very sorry that that impression was generated. I quite understand that.

Mark Garnier: You do accept that?

Hector Sants: Absolutely. And the reality, just being absolutely open about it, was that I think we felt under media pressure to respond to the report, which was in the media domain. We were concerned that during the summer period-if you recall, it was slightly unfortunate timing for releasing a report, in the sense that the summer was coming up-the press were going to report it as RDR delayed. That is why, while we were considering the issue-and we absolutely did consider the issue, should have considered the issue-we were concerned that the media were going to run stories that basically made it look like the RDR was killed, and that preparations would then be disrupted, and effectively the option of careful consideration of your recommendations would have been removed from us. The press release was somewhat clumsily worded but it was reacting to media pressure. It was one of those things that happen, I am afraid, in the world of instant media, but it does not in any way reflect my personal commitment, the FSA’s commitment, to full accountability to this group.

I think we should put it, if I may, to one side as not what we intended, and in terms of debate going forward we absolutely want to see proper accountability to Parliament and this Committee.

Q116 Mark Garnier: I am very grateful for your apology; good man for doing it. But you do have to address this point. There is a perception that the FSA is not accountable. This has caused quite significant damage to your reputation in terms of the accountability to this Committee and Parliament. I would like to give you the opportunity now to explain how you are going to redress that damage and go forward so that when the FCA is created there will never be a charge laid against you again that you are holding Parliament in contempt.

Hector Sants: I will ask colleagues to come in, in a moment, but since you are looking directly at me, not to duck the question, I will make a couple of observations. But I am keen for Martin and Adair to join in because we have given considerable thought to this and the general point, which I have said here before, is I do feel one of the failings that occurred around the time of the creation of the FSA was that there was not sufficient alignment, as I have said before, between the FSA’s intended philosophy and the understanding of that philosophy by Parliament and the media. That has been some of the cause of the difficulties that we have seen emerge since, so we certainly want to try to avoid that.

I think there are two issues to try to improve that accountability. I think the first point is that absolutely the regulator should be accountable for discharging its statutory duties, obligations, objectives, and should be clear and transparent in reporting on whether it has succeeded in achieving that to Parliament, to this Committee, and there should be a robust challenge to that process. But to get there requires clarity of objectives, which can be reasonably measured.

The first ingredient to improve the situation going forward is to have simpler and clearer objectives that can be more transparently and openly discussed, which is why we don’t like "confidence"-back to the earlier point in relation to the FCA.

The second question, of course, is to make sure that other accountability mechanisms to hold the Executive to account are stronger, and Adair might want to comment on that, which would be a much stronger and more credible board oversight process than the FSA has achieved before. We then come on to a third question, which I think we have not fully bottomed out, and is maybe to some degree at the roots of some of the concerns that you are alluding to, which is, what exactly is the model we want for our regulator? Are we, as we currently are set up and the Bill proposes, operating with a model, which is the one proposed in the Basel framework and so forth, that essentially you have an independent regulator working to a set of objectives for which it is accountable, for which the individual rules are its own responsibility, and those rules are made at a distance from the parliamentary process, or does Parliament want to take responsibility for those individual rules?

At the moment the new legislation is sticking with the former model and that is a model we have been working under, but that has undoubtedly at times introduced tension into the system where some Members of Parliament, quite unreasonably, have had a different view on what is the right rule to make. But of course that was not how we were set up, and I think we have experienced that tension and dissatisfaction; I think that is what you are referring to and I entirely agree with you. I think we need to bottom out which of those two models we are going with and there has to be a recognition of which of the models-I think my Chairman is keen to-

Lord Turner: Could I make a comment on this and also suggest some ways that might make this model work? I personally believe that the model should continue to be the independent regulator within broadly defined objectives; that is the model that we broadly apply across Ofgem, Ofcom and so on. You could change it; one can argue it either way. But I think if that is the model, the nature of the accountability and the transparency of the decision making is very important. One of the things that struck me when I became Chairman of the FSA is that the FSA had been given very significant delegated authority to legislate rules, and I was surprised how little attention there sometimes was to the nature of the debate that was going on within the FSA board about those rules. When we debate the RDR or the MMR-the mortgage market review-the FSA board is, on behalf of society, ending up making rules that have legal force, but the visibility of those debates to the external world is not very great.

What is interesting is that you can draw the analogy with, for instance, the independence of the Bank of England and the Monetary Policy Committee for setting the interest rate. The objective is set by Parliament but it is the MPC that decides the interest rate. But the way in which they do that is very clear to the external world because there is a minute of the MPC, which sets out clearly, so that the world can understand, the arguments that were put forward on either side. It deliberately makes transparent those arguments. Indeed you then invite as an accountability, not merely the Governor, the equivalent of the Chairman, or the executive members of the Bank on the MPC but you invite the non-executives, the independent members, and quiz them to make sure that you believe there was an open debate about it.

We could extend that to the FCA. You could require that FCA board minutes, to a much greater extent than at the moment, where they deal with a direct public policy issue, are published and set out clearly the arguments for and against, in the way that the MPC minutes or the FPC minutes do. You could, as you have not done with the FSA in the past, ask along non-executive members of the board for you to say, "Well, tell me what the debate was about the RDR. Tell me what the debate was about the MMR. Did you receive good enough papers from the Executive to drive that decision?" and so on. So even within what I do think is the better model, which is not Parliament individually writing all of these rules because I think there would be disadvantages to that, but independence within objectives, I think there are particular ideas that could create a better sense of visibility of the nature of those decisions and of a clear sense of accountability. Thinking about what the FCA board should be relative to what we have already set up for the FPC and the MPC might be a fruitful area of thinking.

Mark Garnier: That is incredibly helpful; thank you very much.

Q117 Chair: That is very helpful, Lord Turner. You said that the visibility of your internal debates on MMR, for example, has been very limited. Do you think that there is merit in an approach of scrutiny by exception-that basically you should be able to get on with it and not be interfered with, but now and again there will be issues that are of considerable public interest where you will understand and respond constructively to demands from us for a much higher level of information-you have mentioned MMR-on something where there is a high degree of tension? Then we may ask you for far more by way of documentation, including possibly minutes.

Lord Turner: Yes, I would not exclude that. I think drawing the analogy with the MPC, because the MPC ultimately makes only a small number of decisions-it used to be one, the interest rate; they now have quantitative easing as well-as it were your insight is simply on what were the processes, what were the debates, what was the degree of independence on that one decision.

The FCA, like the FSA, will make many decisions, many of which are of a lower level of importance and quite technical and one would not want to set in process an immensely complicated reporting device to that, but there may be particular ones, like the mortgage market review or the RDR, where we should more explicitly think through whether there is a more intense form of reporting that, while still leaving it for the FCA board to make the ultimate decision, gives a much greater transparency as to what the debates were and indeed enables this Committee to participate in those debates.

Q118 Chair: There are two aspects to it. One is ex post review of how you came to the decisions, where I think the view of this Committee should be that the level of transparency if demanded of you should be very high, subject to anything that you may need to blank out for commercial confidentiality reasons, but probably virtually no other exclusions-security in theory, but that would be extremely rare-and secondly, there would be scrutiny by us while you were formulating those rules, where of necessity you will have to be somewhat more cautious in the exchanges.

Lord Turner: I think even within what there is at the moment one could do more. I do not think, for instance, you have asked us along in the past at the level where we have issued a discussion paper, which is a broadly stakeholder-consultative process, and quizzed us in detail at that point, in the development of the theory. There are documents that are put out into the public domain, but I don’t think there has been a clear enough definition in the past as to what should be the interface of this Committee with that sequence of papers as they are developed.

Q119 Chair: But you are agreeing with me that we need a high level of availability of documentation ex post should we demand it?

Lord Turner: I think that is probably right. I think the crucial documents are probably available in any case because there are consultation papers and discussion papers, but there may be other papers, which-

Q120 Chair: But we are talking about the decision-making process by which you decided over half, for example.

Lord Turner: I would not exclude the possibility that we should write, in the future of the FCA, the minutes-

Chair: I am trying to get past "not exclude the possibility" to support-

Lord Turner: I am quite favourable to the idea that in relation to these major policy issues the minutes should in future be written in a different fashion, more like the fashion of the MPC and the FPC, where it is visible to the external world that one member of the committee said this, another said that, and on balance the conclusion was as follows. Apart from anything else, I think that would get away from the idea that there is one correct answer to these problems. These are trade-offs where whoever is the body is going to make arguments for and against, and that fact should be visible to the rest of society, that a trade-off has been struck.

Q121 Jesse Norman: Each of you has affirmed their belief in the importance of proper accountability, and that is something that has been gravely missing in the past few years as regards the management of major financial institutions, which have in several regards-as we know-been scandalously mismanaged. One thinks of Halifax Bank of Scotland, which fired its head of risk before going bust, and similar concerns at the World Bank. These executives are very highly paid and they bear very large private and public responsibility, so my question for you, Mr Wheatley, is-returning to an earlier question and elaborating it-would you support making certain actions into criminal offences? For example, reckless mismanagement of a financial institution.

Martin Wheatley: I think we have to be very careful about what we consider to be criminal actions. The challenge that we all have is we want good people in those roles, and so we want good people to take on the roles of directors, to take on the role of chief executives.

Q122 Jesse Norman: You are not suggesting that Messrs Goodwin, Stevenson, Crosby, and so on, were successful exemplars of good management in banking?

Martin Wheatley: No, I am suggesting that we need some good people in banking and we may not have been able to achieve that in the past. Clearly, there is a trade-off as to whether the risk and reward of that role is worth the best people going into it. I think we have to have the appropriate level of penalties for the appropriate level of offences. I think that is something we just have to think very carefully about.

Q123 Jesse Norman: But would you, in principle, support the idea of making certain actions into criminal offences in this area?

Martin Wheatley: When you say "in this area", the principle of making certain actions criminal offences, yes. I think we need to be very specific.

Jesse Norman: In the area of management of financial institutions?

Martin Wheatley: Reckless or wilfully misleading, possibly. Genuine business mistakes-people make genuine business mistakes.

Q124 Jesse Norman: No, certainly not for that. For reckless mismanagement, that kind of category.

Martin Wheatley: Again, and maybe I could ask Margaret to comment as she has more experience of this, I think we just have to be quite cautious about where we push the criminal sanctions into.

Margaret Cole: Clearly where there is fraud, that is a clear issue. We also have a criminal offence of misstatements to the market, and that is already there. I think I would be extremely wary of introducing a criminal offence in connection with management or mismanagement of a financial institution. What I think we should do is look at extending the consequences of that through the regulatory structure and perhaps arriving at a solution where it is easier for us to make sure that people who have been involved in mismanagement of financial institutions before are very clearly kept out of practising or working in that industry in the future.

That is not as straightforward as it currently sounds, as we have to reconsider applications when people have left the industry and make fairness judgements based upon an application at the time, so I think we want to be in a world where we can be clearer that people who mismanage institutions will never be able to work in the financial services industry again. So I think there are adjustments we could make here.

Q125 Jesse Norman: Your view is a significant toughening up but not extra criminalisation?

Margaret Cole: That is my view, yes.

Hector Sants: I think realistically, without discussing individuals, which would be wrong-particularly given that we have ongoing investigations in some areas-and Adair may want to comment here as well, when you look back in the round over what has happened by far the greatest category of error is misjudgment. I would see it as a judgment on fundamental competency, but that is different from recklessness. Having clearer powers to ensure that there is a presumption that once incompetency is demonstrated, which means you cannot get back into the industry, is what Margaret is referring to. Clarity of powers for us to use demonstration of incompetence as grounds for barring people from the industry would be a major step forward in itself.

Lord Turner: I did want to add one point. If you try to go down the criminalisation route that any form of criminalisation that is still sticking to-as it would have to-reasonable human rights, presumptions of innocence, clear proof of recklessness, will only very occasionally produce a prosecution, because the burden of proof will be very significant.

Therefore, I think if we simply go down that route we do not address the core of the problem. To me the core of the problem is that people make business misjudgments in balancing risk and return, but that in banks, we want them to make a different balance of risk and return from other sectors of the economy. There are other sectors of the economy where, for instance, launching an aggressive takeover bid in a contested fashion where you can only do limited due diligence might be a reasonable thing for the management of the supermarket or hotel chain to do; taking a risk for its shareholders which may or may not pay off, and if it goes wrong, well, the shareholders suffer but society does not suffer and the shareholders will fire the management. I think the difficulty we have in banking is that when you take some of those risk/return trade-offs, which might be perfectly normal in other sectors of the economy, there is a disaster for the economy as well. Therefore, rather than through the criminalisation of it, we are more likely to make progress here by thinking about whether we should simply face people who are the directors of banks-whether non-exec or executive directors-with a sense of automatic non-criminal sanction, either because we go much further down the line than we have at the moment of requiring deferral of compensation and making clear that that will be lost in some circumstances, or we have much clearer mechanisms to say if a bank, for instance, fails, "You cannot have future employment in the financial services industry unless you positively prove to the regulator that you were the person who was putting up the red flags and trying to warn against the concerns". I think we are more likely to make progress in ways that shift the risk/return balance in a non-criminal sense than criminality itself, but they are very important issues.

Jesse Norman: Well, I am grateful for those two comments. The idea that the FSA might be able to make judgments as to competence is good, and the idea that takeovers in the financial sector have such high externalities that they might be regarded, as it were, as prima facie evidence of mismanagement, if that was an implication of what you were suggesting, is a very interesting point.

Lord Turner: It is not directly what I-

Q126 Jesse Norman: I take your point. I will move on, if I may. The FSA itself operates under a standard of gross negligence from mismanagement having to be proved against it. Do you think that that is too high a burden given, for example, that you are funded by the industry? Should the burden be lower so that you yourselves can be held more accountable by the people you seek to regulate and by the public?

Lord Turner: Well, I think there are two issues. On the FSA as an institution-or the future body as an institution and the individuals when you get to the institution in itself-of course one has to be practical here, given that it has no money and no shareholders. If it was subject to suits against it that resulted in payments to particular groups of people, all that is going to happen is that another group of people in the industry will have a levy placed on them. In those circumstances one simply has to practically work out what the benefit would be.

There is a separate issue of the treatment of individuals. I think it is quite right that in general across the public sector there is an approach to the idea of negligence, where I think the phrase is that it requires bad faith-is that right, Margaret?-on the part of the individual for them to be liable for that. I think it is difficult to go beyond that-it is a general principle that we have applied across the public sector-without removing the fact that you have to empower people with the ability to make decisions. There is a trade-off here with their freedom to make sometimes judgmental decisions; we have talked about the need to get away from box ticking and give the regulators the ability to make more judgments. The more that you make them subject to an individual legal sanction, the more that the automatic response of a cautious individual will be just to stick to the box-ticking approach. I am not convinced that there is an appropriate change in the law in that respect.

Hector Sants: If I may just bring it back to the earlier discussion, I think if we had a more visible and more accountable board-back to our earlier point about independence, as Lord Turner said, appearing in front of Committees such as this and so forth-of course the performance of the individual executives is the responsibility of the board. I think I take the underlying point that you are driving at, "Do you feel the executives are being adequately held to account for their operating processes as well as for their results of their judgements?" A stronger board would be another way of putting an oversight mechanism in place. I think that would be welcome and I cannot emphasise enough my support for the comments about a much stronger and more visible board.

Q127 Chair: I don’t want to cut you off, but I have one important final question. You will recall that at a previous hearing I raised the case of my constituents, the Hintons, who had a business that has essentially had to close, at a cost to them of some £350,000. That problem arose because of faulty information as to the classification of them as directors of a failed and dishonest trading company of representatives. When I met the FSA on this with the Hintons and with Sharon, the account director there, I was told that faulty information given to the FSA had led to faulty classification of the directors on the register. I was told by her that the system was too inflexible and could not be changed. There was no acknowledgement that the FSA had any responsibility to change this information, although it knew it was faulty, and she also refused to commit to any change to the status of those directors in the new register. Now, do you think that that is an appropriate exercise of public accountability for a firm whose value has been reduced by £350,000-that official response and no further support to be given from the senior executives of the FSA?

Hector Sants: No, but I am not convinced that is what she said. I do not want to take up too much of the Committee’s time on this particular issue, I am conscious of that. The Hintons e-mailed me on the subject yesterday, and I read it last night. They made a number of points that seemed to be at variance with my understanding of what had happened in the meeting that took place in the summer. There are a number of unanswered questions, and I think I will be following up and having a further discussion and come back to it.

Chair: Come back to us, yes.

Hector Sants: I am happy to write back to you. Clearly, we have not yet arrived at a position in this unfortunate case where the facts are all agreed between all parties.

Chair: Well, let us come back to it. We won’t deal with it now. Jesse, we won’t deal with it now and we won’t answer this answer.

Jesse Norman: But if the facts were as they have described, can I take it, Mr Sants, that you would be in agreement with the question I put?

Q128 Chair: You do not need to answer that question. We are moving on. I just wanted to get back to something you said, Adair: "The penalty for failure may be a very high hurdle for further employment for the people who were in the bank when it failed." I thought we were trying to create the conditions in which banks could fail.

Lord Turner: No, what I was suggesting, I think, is that we are trying to create conditions in which banks are able to fail. I think we would still accept probably-this relates to the issue of reports as well-that there is a level of failure beyond some size where it is an important event for society, and where we would like them to be very rare indeed. I think if in 15 years’ time there is another failure of the level of RBS or HBOS, I am absolutely sure that society will want some sort of report as to what occurred in those circumstances, and although we want to create the mechanisms where that failure can occur in a much smoother and less disruptive fashion than at the moment, failures of that size should not be considered part of the process.

Chair: So it is a society issue.

Lord Turner: I think we also want to create incentives which make them less likely. I don’t-

Chair: This needs very careful thinking through, what you have said on this.

Q129 Mr Ruffley: Mr Wheatley, could I ask you about the new business and market analysis team that is going to be really rather important in the FCA set-up? What will that team be able to do that other senior managers and directors at the FSA haven’t been doing?

Martin Wheatley: The broad supervisory philosophy that we have had to date has been relatively firm-specific, so we had teams split by industry sector who owned particular groups of firms and either knew a lot about those firms or visited those firms on an occasional basis. Our intelligence comes from information from those firms, and we group up to a level where we understand that if there is problem with the firm, there may be problems across a broader group, there may be problems across a broader product range. The objective of this new group is to act as a matrix check, looking from a different perspective, so not now starting from a firm perspective, but starting from a consumer or broader product perspective that cuts across the specific firm work. It is to give us an additional check that will make sure that we are surfacing problems at an early enough stage.

Q130 Mr Ruffley: Are you going to be recruiting a different kind of supervisor to man this team than the FSA?

Martin Wheatley: Well, I think we will need more business analysts and economists. I think they are the sort of people; we have some at the moment, but I think it is giving more emphasis to that.

Mr Ruffley: We have had evidence to the effect that one needs more practitioners who can be regulators who understand product design and the interstices of problems with financial service products. What is your view about the number of practitioners who should be part of this team? Do you think it should be 30% or 50%, or do you have no basic view at all on the practitioner recruitment level?

Martin Wheatley: No, I think it is very important. I mean, any regulator only gets a sensible balance if you can balance the long-term career supervisors with new blood coming in from the industry.

Mr Ruffley: Sure. So in particular relation to the business and market analysis team, what proportion will be practitioners? What are you aiming for, more or less than 50%?

Martin Wheatley: I think probably more than 50%.

Mr Ruffley: More than 50%?

Martin Wheatley: Yes, but do bear in mind that we have already within the organisation a number of people who we would call practitioners that have come in from the industry fairly recently, so it will be a combination of lawyers, accountants, product designers, people who have come in from the industry already and new recruits to the business.

Hector Sants: Yes. Since 2008, we probably hired something over 2,000 people from the outside world who are not graduates, so the majority of the frontline regulators already have external world experience, but of course that includes experience in law firms, management consultants, accountants as well as in actual regulated firms.

Q131 Mr Ruffley: A final question, Mr Chairman. We have had lots of evidence to the effect that the calibre and expertise of regulators in the new regime needs to be higher, to put it bluntly, than we have currently enjoyed hitherto. In order to attract the brightest and best, what kind of budget will be available to you for salary for top supervisors, in particular in the new business and market analysis team? Are you asking the Chancellor to give you a good spending settlement so you can attract the brightest and best? Is it going to be comparable-the wages you pay, the salaries you pay to the FSA-or is it going to be better or is it going to be worse?

Martin Wheatley: Well, we are going through a budgetary process at the moment, and maybe it is better if my Chairman comments.

Mr Ruffley: Perhaps Lord Turner might want to chip in, yes.

Martin Wheatley: Yes. But we are going through a process which is largely a bottom-up process, which is saying, "What do we think we need?" and then we will have a process of discussion with the board where we talk about what the overall costs of the new structure are likely to be.

Mr Ruffley: Yes. Lord Turner.

Lord Turner: The situation of course is that we are not dependent on a spending settlement from the Chancellor. Again, one of the degrees of autonomy we have is essentially to set our own budget and to have levying powers over the industry. Now, that places therefore the responsibility on the board of the FSA now-the FCA in the future-for striking the balance between the clear desire to have a cost-efficient organisation and the fact that we need to pay appropriate salaries to attract good people. I would say that at the moment our salary structures are reasonable in terms of our ability to attract people of good quality from outside, such as, if I may point out, Martin himself. We would be concerned if we were placed under any tighter controls and told to limit the amount.

You have regulators across the world, in particular in the US, where the salaries are set directly by government or parliament, which have had very major problems in getting people anywhere near as good as the people in the industry that they are regulating. We clearly do not pay salaries at the level of the private sector, we don’t need to, but we need some freedom, and I would say that the freedom that we have had so far is about appropriate, and the board will continue to strike this balance between what is the level of pay required to attract people, while still focusing very strongly on the need for a cost-effective organisation.

Hector Sants: I feel I should say on behalf of my staff that I think the main pinch point in the regulation in terms of retention through pay is not for the more senior people, who may well come into the industry having had a successful career behind them, and they have the additional social value of the wider challenges and tasks that they have, and it is not at our graduate end, where we have worked incredibly hard to have a very good graduate scheme in the last few years, and we had some outstanding products from that. But in the middle, when people are looking to accumulate savings, hopefully, for retirement and in the longer term, if you look at the turnover in our staff, our main area of challenge is people who have been with us for three to five years who have then used that experience to get a higher salary in the private sector, and of course that is where the firms have the most contact. So you are absolutely right, the firms are concerned about the lack of expertise, but it is in that middle section where we need to hold people, and I think the secret to this is pay and terms and conditions. It is not whether you had two years’ experience in the industry before you came in.

Lord Turner: It is also true that while complaining about the quality, they also sometimes nick them.

Chair: Poaching is an enduring problem for all Government agencies.

Q132 John Thurso: I want to ask Mr Wheatley some questions about product intervention, but before I do that, can I chance my arm, Adair, and ask you for a short answer to something you said earlier, which was about the differences between risk and reward, between business and banks. Is it not the case that the levels of return on capital that all the banks are currently targeting are automatically locking in a level of unacceptable risk for the future? In other words, we need to be anticipating lower returns on capital for the future if we are not to repeat the risk.

Lord Turner: Broadly, yes. The logical consequence of the higher equity requirements that we have imposed on banks is that they should accept lower return on equity. Investment in banks should not be a high risk, high return part of the stock market. It should in technical terms be a low beta stock, a lower risk, lower return. The banks have adjusted their expectations to some degree, but I would agree with you that they may not have adjusted it enough.

Q133 John Thurso: Thank you. That is what I thought you said, so thank you very much.

Can I come to the question, Mr Wheatley, about product intervention? The FCA is envisaged to have power to ban products, to issue public warning notices. Now, we have obviously seen the damage that can be done with mis-selling and toxic products, but what are the negative aspects of this approach? What are the things we should be concerned about?

Martin Wheatley: Well, I think the negative aspect-I’m sure the industry will have played this back to you-are the potential negative effects on innovation and choice. Either because we take the view that a certain product is not appropriate or has features that are undesirable, or that the firms themselves self-regulate and do not bring forward products that may fall foul of some of our guidance. So the negative will be that there will be fewer products, and potentially a less broad flavour of products in the market. Now, what we would argue is that the broad flavour of many of the products that have come forward over the last five years has not been good for consumers, in fact, has been very bad for consumers, but the industry has not found a way itself within our existing governance and rules not to sell those products.

Q134 John Thurso: Why not a system of pre-approval of products?

Martin Wheatley: It would probably have the downside I have described, but in even greater numbers. Products typically become more and more complex, and firms want to get their products to the market within a relatively short time frame to take account of the market conditions, interest rate conditions and so on. Pre-approval would place a large burden, so we would need a larger number of staff to do it, and a process between us and the market. I had experience of pre-approval of products in Hong Kong and the effect is that products get brought to you half-baked, because the industry wants to rush the products out. The regulator ends as up as the spellcheck for the industry, because they bring such poorly thought through products in the hope that they will have a place in the window. I think pre-approval is quite a difficult process and has many more negatives.

Q135 John Thurso: You paint a picture of a world where there is an infinite number of extraordinarily good potential products, in a way. Maybe I am just a simple soul, but it seems to me either that I want to borrow money or I want to insure something. I have maybe four or five things I want to achieve, and all the rest is flim-flam. Why can’t we cut to the chase and get this right for the consumer?

Martin Wheatley: Well, it means determining what is the flim-flam, and I agree, there is a certain set of basic needs, long-term needs, housing needs, capital needs and earnings needs. The industry happens to have been quite innovative in producing products that meet those needs through very many different routes, many of which provide very little value.

John Thurso: Yes. I was sitting here through most of the last Parliament hearing about multiple whiz kids with a double first in computer games creating products in basements that brought the financial system to its knees, and here we are saying, "So what. Let’s let them all get on with it again." In so many other areas of product where safety is involved, like aviation or cars or all sorts of things, if you want to do something that is not tried and tested, you have a duty to work it out entirely and then you go and get it licensed by the CAA or whoever it happens to be. I just do not understand the mindset that says you can go and take lots of funny little bits of formulae and create something that nobody knew they wanted, persuade them that they have to have it, then discover it doesn’t do anything and it gets banned afterwards. I mean, why do we go through that tortuous regime? Why can’t we just say, "Look, this doesn’t make any sense to start with, so we will not do it"?

Martin Wheatley: We could, and it would be a very different model, so it is certainly possible to design a pre-approval process and to have some quite strict structures around pre-approval. I can guarantee that this Committee would be inundated with pressure from the industry saying, "No, no, we are destroying the competitiveness of the UK. We are destroying choice. We are destroying valuable opportunities", but it is certainly a choice that could be made.

John Thurso: So our answer back to all the people in the industry who are currently saying to us that this proposed system of product intervention has huge dangers is, "Well, it is better than pre-approval, it could be a lot worse"?

Martin Wheatley: Yes, from their perspective, it could be a lot worse.

Q136 John Thurso: Okay. One of the things that was put to us-perhaps I can put this question to Margaret Cole-is the risk that the power to issue early warnings creates people who are guilty until proven innocent, and the particular one that was put to us was of course the Gartmore case, where at the end of the day, no action was taken against the particular trader, but meanwhile Gartmore have gone basically broke and been bought by somebody else.

Margaret Cole: The Gartmore case is not the greatest example of this, because it is a case where we did not say anything; we did not announce our investigation at all. It was the firm doing that. We are not proposing a world in which we announce investigations. That is a situation where we do not know whether there is anything that we should be holding people or firms accountable for. What we are suggesting is what we see as a rather small move on what I will call the transparency dial, if you like-the balance between fairness to individuals and firms and the public policy considerations around protection of consumers and putting as much information as possible into the public domain. We think that balance can be struck by publishing brief details at the moment when we issue a warning notice. A warning notice is quite some significant way down our process for holding people accountable. It is a moment when we have looked at the case in detail, taken it to an internal committee and reached a conclusion that there is a case to answer. We believe that by publishing brief information at that moment, we are not doing anything more than putting that into alignment with the criminal process or with the civil process or with the process that other regulators employ, like the OFT and Ofgem. They also put out brief information at the equivalent moment to a warning notice. We do not see this as a significant risk.

Hector Sants: Margaret, can you explain that the current proposal, however, does not really work either way?

Margaret Cole: Yes. Well, the proposal at the moment is that we should consult with the party that we are bringing the case against in every case where we might be going to publish a warning notice. We think that effectively undermines the power, because in each case there will be an argument and satellite litigation over whether we can publish the warning notice-arguments being to do with reputation. What we were endeavouring to do was shift the presumption. We were saying that we are going to bring forward the moment when we can put the fact that we are pursuing an enforcement case forward as a general presumption, so the last thing we want to do is get involved in separate satellite litigation halfway through an enforcement process. So we feel the current proposal is not satisfactory.

Q137 John Thurso: This is my last point, and perhaps I will link back to Mr Wheatley for this one. The FCA-this has been touched on already as well-will operate under the general principle that consumers should take responsibility for their decisions, and in your earlier answer, you explained that the legal definition of "consumer" covers everything from the highly sophisticated fund manager right down to the man on the street. Can I ask you to think just about the man on the street, the average consumer? In their written submission to us, Consumer Focus pointed out that, "The documentation for any high street bank personal loan requires degree level education, the standard text describing a PPI product requires PhD level education, and it takes 55 minutes to read a standard consumer credit agreement, let alone understand it". I would add, having recently tried to transfer some M&G fund shares to my son that belonged to him, that trying to do that is a particularly frustrating, lengthy and multi-correspondence experience. But do you not think that we should get to a point where the consumer on the high street should be able to buy something that has a simple tin with a simple set of words on it that says what it does, and he or she can trust that what it says on the tin is what it does?

Martin Wheatley: Yes, I think we should, and I think we do need to get to a situation of having simple, understandable products for most people; although some people will want more complex products. It comes back to the fact that even products that are simple in broad concept, whether it be mortgages or certain types of trading products, can be quite complex in terms of legal structures, and so we rely not just on the individual to ask some sensible questions-we do want individuals to ask sensible questions-but we also rely on the intermediary, the distributor selling that product to make sure that they have understood the circumstances in which they are selling it. They are the qualified professionals, and we expect them to make sure that it is suitable in the circumstances. There are certain responsibilities that consumers have to take, but there are responsibilities that distributors have to take as well, and the banks producing the product. We are very much focused on the production and the distribution of the product as well as the individual’s responsibilities.

John Thurso: The core point is that for most consumers in the high street, looking at the question of caveat emptor, it is about working out the difference between a range of products in which they can trust. Now, they may make the wrong choice for them, but the products will all do what they say on the tin. The point about due diligence, as to whether or not what it says it will do on the tin, cannot be the caveat emptor responsibility of the man in the high street. Am I correct that that is the direction you will go in?

Hector Sants: Yes.

John Thurso: Thank you.

Q138 Chair: It is not only product intervention, is it? There is also price intervention you are considering. I am just looking at box 2-sorry, I am not quite sure what page it is-but in any case, it is close to paragraph 3.15 in the consultative document. You say, "Where competition is impaired, price intervention may be one of the tools necessary to protect consumers. This would involve the FCA making judgements about the value for money of products". How are you going to achieve that, Mr Wheatley?

Martin Wheatley: Again, this links back very much to the objective. If we have a clearer competition objective, falling out of that will be our ability to act in terms of price regulation. We will be able to do that by having discussions with firms about their own processes and whether they are delivering products that are fair to both parties, fair in terms of their own products and fair in terms of the value to consumers. It will be very hard to say that there is an explicit single return that a product should generate, because it will vary according to different products. The truth is that it will be a discussion very often with the senior management of an organisation, for them to assure themselves that they have considered the fairness to the buyer of the product as well as the supplier of the product.

Q139 Chair: Can you think of a large number of products where you might need to do this, and can you think of a large number of products where improving the competition, rather than leaving it impaired, is not the better solution?

Martin Wheatley: Well, that largely comes down to the transparency or otherwise of the product. If it is simple bank accounts where you can compare interest rates and the products that go with that, that is quite different from structured products that are sold by banks, which have a number of quite opaque components, and it is very hard to judge the price you are paying for the product.

Chair: My question though was aren’t we better off operating on the transparency rather than intervening on the price?

Martin Wheatley: I think generally; but there are certain products, and I mentioned structured products, where almost no degree of transparency will give you a proper understanding of what you are paying for the product, and this comes back to Mr Thurso’s comments about how we have moved away from simple products. There are a number of products now that are so complex it is very hard to see what you are paying.

Chair: It might be helpful if you could give us some more information so that we can put some flesh on what exactly it is, what type of structured product it is exactly that we need to have in mind when reading box 2. I think that would be helpful.

Q140 Mr Love: Can I turn to the European dimension? Mr Sants, to what extent is the ability of the FSA to represent UK interests at a European level hindered by the reforms that we are undertaking here at home?

Hector Sants: I think there are two parts to that question. In the short term, some of the turnover in our senior staff has undoubtedly affected our representation on some of the key regulatory committees, because those are elected roles by the European regulatory community and they are elected on a personal basis, so if they leave the organisation the FSA does not automatically have the right to reappoint somebody to those roles. So the process of splitting up the FSA, which has been the cause of some senior people leaving, has been somewhat disruptive to our representation ability. That is a short-term issue.

In the longer term, I am content that the Bill and the supporting documentation does have clarity of responsibility for who is leading the process of representation on the key European regulators; the PRA, as you know, in respect of insurance and banking, and the FCA in respect of securities. There obviously will be the need to co-ordinate between the PRA and the FCA, as indeed at the moment, for example, there is the need on the EIOPA, the insurance one, which I represent on the management board. I have to co-ordinate with the pension regulator, which I think we do pretty well, and there is a need for us already to co-ordinate with the FRC and so forth in respect of ESMA. So co-ordination within the UK regulatory community is nothing new. We will have to make sure we have set up the right processes to do that. We have not created a new problem here, we have always had that problem. By definition, if you have more than one regulator, you have a co-ordination problem in Europe.

Q141 Mr Love: I was trying to get an answer to the question of whether we have a peculiarly bad fit between the UK regulation and European regulation, but let me park that, and perhaps you could give us your view, Lord Turner. But going on, you are trying to address this with a memorandum of understanding now. Getting away from whether or not a memorandum of understanding of common deliverables has applied in recent years, there is quite a lot of comment that we have received that says this is a muddle, and there is real concern that we will not be as effective in representing UK interests as we could be just with a memorandum of understanding. So is it a peculiarly bad fit and is a memorandum of understanding the appropriate way to address it?

Lord Turner: Well, it is clearly the case that against all the advantages that I think we will get from this future separation of the prudential authority from conduct, which I think will enable a better focus on those particular challenges, it will create some complexities in some particular areas, so that as long as it was essentially the FSA, it would clearly be the authority which relates to the European Banking Authority. Whereas in the future, there will be an interest of both the FCA and the PRA in the activities of the European Banking Authority, primarily the PRA though, because the EBA does not do much conduct stuff; it will probably be a bit more complicated in relation to ESMA, where there are both conduct and prudential activities. But I think that simply reflects the fact that whenever you change an organisational structure, you make some things better and you create some new things that you are going to have to manage, so against the advantages of the new set-up, we will have to find a way of managing effectively, for instance, the relationship with ESMA.

I cannot see a better way of doing that than through having a memorandum of understanding, although the thing I would stress, and I think this is what comes out of the talks that we have had, for instance, with the Australians and the Dutch, who are running similar models-this would not surprise you-is that whatever you write down in the memorandum of understanding, what really matters is the degree of interface and working relationships between the individuals involved. I think it will be absolutely essential that the PRA and FCA, even when they have split up, are continually in a relationship where people know each other, talk to each other, and so on.

I think one of the surprising things, frankly, in retrospect, when banking supervision moved out of the Bank of England into the FSA is that although the FSA’s banking supervisors were primarily people who had come from the bank, there was a great deal of, "Well, we are now a separate institution and we are not going to talk to you closely, except to the extent that we formally have to". We have to avoid that in the FCA/PRA relationship. We have to support whatever is in the MOU by the fact that people individually still feel that they are working in a common endeavour in a number of areas. For instance, in the area of authorisations we will have to have sensible co-operation, but particularly in relation to the representation in Europe.

Q142 Mr Love: I want to come to the issue of the people involved and the tasks that they will have to undertake, but let me just stick the memorandum of understanding. As I say, quite a lot of people are worried about muddle. They are also worried about whether that will achieve the objectives that we are trying to set ourselves. To take the example of the CBI suggesting an international co-ordinating committee-some executive body-I understand there will now be costs associated with that. Recognising the difficulties that have existed in the past with memoranda of understanding, you have gone into them in just a little detail, Mr Sants, do you think we need to beef up the co-ordination between all the people who will be involved at a European level?

Hector Sants: At the European level, we would definitely have to do more than just ensure that we have a memorandum of understanding for bilateral processes between the regulators, unequivocally. We have to do that not just because we have to make sure that the regulators are talking-I do not want to repeat Adair’s point-but I can’t emphasise enough when we are thinking about MOU, this is really important. The MOU is not really the important element of co-operation. The important element of co-operation is human relationships. That was where the tripartite failed, and we have to make sure that does not happen in the future.

But back to your European point, we need to remind ourselves of course that the European regulatory process-it somewhat touches on the earlier conversation-is rather fundamentally different from that which we are used to in the UK, in the sense that the substance of the rules are not made in the individual regulators, they are not made in the ESAs, they are made through the political process of the Parliament, the Council of Ministers and the Commission. Therefore the principal authority within the UK that influences those high-level regulatory rules is in fact Government, the Treasury primarily, and the relevant officials from Treasury. So it is vitally important that you have a wholly co-ordinated approach and sufficient resources committed in Government, both in the political sense and in the civil service sense, to working the full spectrum of the decision-making bodies in Europe. Government needs to take the lead in co-ordinating the regulators in order to make sure that we are all speaking with one voice and it is a co-ordinated process, because ultimately, the key regulatory decisions in Europe are political decisions. So I think yes, we do already have structures for co-ordination between Government and the regulators, but I would encourage more formality and far greater commitment of resources to those areas.

Q143 Mr Love: Well, perhaps we could have a paper on that, because I think that is an interesting issue relating to how it all merges with Government, because I think Government has a unique role at the European level.

Let me come back to the issue of people, because not only is there an enormous amount of new regulation coming out at a European level, and an importance that perhaps has not been there in the past, at the same time we have the change in regulatory structure, the ICB report and all the other things happening here. Some of the people representing us in Europe are going to be involved in all of the regulatory changes. Are you stretching the limited number of people too far to be able to address the really important things that might be happening at a European level that are going to be critical for our future?

Lord Turner: Well, the biggest challenge that the FSA has at the moment is that we are going through major structural change, which is always disruptive, while also dealing with not only this major set of new legislation and proposals from Europe, but also of course a financial system that is very fragile and which, as we discussed earlier, could produce future stresses. That is a major challenge, but it is a challenge that I am confident the Executive are thinking about very systematically. What one tries to do is make sure that there are particular people who have particular jobs who you carve out a bit from getting too much involved in the structural reform agenda. You say, "You concentrate on that and just get on with it". It requires systematic management, but this is an organisation of which a lot is being demanded at the moment. In an ideal world, you probably would not have decided to do major structural change amid the biggest financial crisis of the modern capitalist system, but we are where we are, and we will manage through it.

Mr Love: Can I have just one last very quick question?

Chair: A very quick question, and there had better be a quick reply.

Q144 Mr Love: There is a lot of discussion about the importance of financial services to the UK in comparison with other European countries, yet we only get one of 27 votes in all of these structures. The EBA has been based in London. Is there an argument that perhaps others, ESMA, and looking at it particularly, might be based in London to satisfy the importance of this particular sector to our economy?

Lord Turner: It is a very good argument, but it is not one we are going to win.

Chair: Thank you very much for coming before us. We have found that evidence extremely useful. We are heartened by the fact that there is quite a lot of flexibility around this consultative document about which a good number of us have reservations, and I expect we will be returning to these issues before too long. Thank you again.

Prepared 7th November 2011