Joint Committee on Financial Services and Markets Minutes of Evidence

Examination of witnesses (Questions 1 - 19)




  1.  Good afternoon. It appears that we have under-estimated the demand for this event! Welcome to the first public session of this Joint Committee which, as you know, is part of what you described last week as the unusual and scenic route from the Treasury to Buckingham Palace which this Bill is taking. The Committee has decided to look at a range of issues which we set out last week in the press release. The main text is the Treasury's response to the consultation on the draft Bill which is described as a "Progress Report". What we would like to do is investigate how far this meets the concerns of those people who commented on the draft Bill and to the extent that there are outstanding issues we hope to be able to clarify them or try to see if there is common ground in taking them forward. One of the main objectives of this pre-legislative scrutiny stage is to see if we can short-circuit some of the more contentious issues. As you also know, we do not have very much time. We have been asked to report by 30 April which is a very tight remit and contrasts with the process that seems to have overrun most of its timescales so far. After taking evidence from yourself and the Economic Secretary to the Treasury we are proposing to invite a group of witnesses to each session and to take the issues one by one as set out in the press release. We are in new territory and we are going to have to find our way as we go along. We are very grateful to you for coming here today with your team and also for the prompt delivery of the paper you put to us, copies of which are available for people who want them. I would like to begin, Howard, by asking you if you could introduce your team and ask if there are any introductory comments that you would like to make.
  (Mr Davies)  Thank you very much, Chairman. I apologise for the crowd. I know that Queens Park Rangers are not used to large crowds! The team I have brought with me is Mr Michael Foot on my right, who is the Managing Director responsible for financial supervision across the whole of our area of responsibilities. Mr Foot was Executive Director for Banking Supervision in the Bank of England and came out of the Bank to the FSA with me. On my left is Mr Phillip Thorpe who is Managing Director responsible for authorisation, enforcement and consumer affairs and in the previous regime was Chief Executive of IMRO. We are the only three executive members of the FSA Board which in addition has ten non-executives and one ex-officio member. Thank you for giving me the opportunity to make one or two preliminary remarks. I would make six very brief points. First, in spite of my characterisation of this as the scenic route to Buckingham Palace, I should say that we do very much welcome the Joint Committee process. It is clear to us that it is important to build consensus around the new legislative framework for financial regulation. We want to end up with legislation which is generally accepted by both practitioners and consumers as fair and reasonable. To an important extent we do regulate by consent and that consent will be facilitated by a process which allows people to have their say. As far as the timing is concerned we and the self-regulators are working on the basis that the legislation will be through early next year. If there were to be no new Act beyond the spring of next year we could run into difficulties but between now and then the priority must be to produce legislation which is workable and fair and we are working to contribute to that process as far as we can. Second, we have of course, put together in management terms a single regulatory structure already, albeit within the constraints of the different pieces of legislation within which we operate. The main reason for that was that all concerned, particularly the boards of the previous self-regulators, agreed that it was necessary to preserve the integrity of the regulatory system. We also of course have the Bank of England Act to contend with and a body which consisted of the old SIB and the Bank of England Banking Supervisors would not have made much sense. Third, our experience of operating as a single regulator over the last nine months has so far been very positive. The market reaction has been enthusiastic and we have already begun to find many synergies, not just in the obvious areas of cost but also in crisis management where we can take a broader view than before and in handling issues like pensions mis-selling where you need to integrate the views of conduct of business regulators and the prudential regulators of insurance companies. Also it has helped in handling new product introductions like ISAs or stakeholder pensions which will be sold by many different types of institutions. Furthermore, even over the last two years since the Chancellor's announcement market consolidation has reinforced the trend towards regulatory consolidation. Groups like Citigroup or last week Prudential buying M&G cut across the old sectoral boundaries and made it necessary to take a view of them in the round. So we become keener on a single regulator as time goes by. Perhaps we are conditioned to do so but it is nonetheless true. Fourth, I think we are in the vanguard of international regulatory developments but not out on a limb. We have supplied the Committee with a review of the regulatory structures elsewhere and how they are changing. Two general trends are observable. First, banking supervision is increasingly being moved out of central banks. In only three of the G10 countries does the central bank now have sole responsibility for banking supervision. There is also a general trend towards consolidation, sometimes banking and insurance, often banking and securities. Not everybody is going for a single body. There are single bodies mainly in Scandinavia and the Far East so far but the trend towards consolidation is gathering pace. Fifth, my Board welcome the overall shape of the Bill, in other words the statutory objectives with provisos and the flexibility within them to keep regulations up to date. We think the balance of objectives and provisos is about right and manageable in practice. We recognise that a balance must be struck between flexibility and parliamentary accountability but if we want a durable system there will have to be a good deal of flexibility. One answer has been for us to try to illuminate the ways in which we would use this as we go along through consultation papers, etcetera, and we continue to do that. Also we think the powers overall are broadly appropriate. In fact, for the firms we regulate they are no more than a consolidation of the powers the different regulators have now. Lastly, my Board are nonetheless very conscious of the risks of an excessive concentration of power and responsibility in one body and of their own role in holding the staff to account. Perhaps that makes us excessively cautious about proposals for the extension of the scope of regulation, although I have to say I regard caution as a virtue in that context. It has also encouraged us to introduce accountability measures such as a Consumer Panel and Practitioner Forum which Ministers have now adopted as part of the legislative framework. It has also pushed us towards a very open style of consultation but we think that will pay off in terms of improvements in the long run in the quality of decisions. With that preamble we are very happy to take the Committee's points and questions.

  Chairman:  Thank you very much. We are going to begin with the general issue of accountability and Mr Beard is going to put the first question.

Mr Beard

  2.  Mr Davies, the FSA are required to be accountable to the Treasury and through it to Parliament and to consumers and to the financial market industry itself who are your supporters. Do you see any conflict between these various strands of accountability?
  (Mr Davies)  I think we would see the prime accountability route as being through Ministers to Parliament but that we have to take account of the views of the consumers and of financial institutions themselves. It is clear to us that the responsibility we have is to Parliament for the way in which we interpret the statutory objectives and the provisos on them but nonetheless we have to recognise that it will have an impact either on consumers if we do not exercise those powers in an appropriate way or on institutions if we exercise those powers in an unbalanced way. I think it would be wrong to think of there being conflict therefore between these different strands. I can see that there could be tension from time to time but I do not think there is conflict because the prime accountability route is absolutely clear and what we have tried to do in designing the architecture of the system is to establish a Practitioner Forum which will keep us honest, if you like, in terms of those objectives and provisos that relate particularly to the regulated community and a Consumer Panel which will keep an eye on how far we are delivering the objectives that relate to consumers. Clearly the Board will have to reconcile those points of view and I would not be surprised if from time to time they did differ. I do not think that is so much conflict as a way of ensuring we hear all points of view as we deliver against this single prime line of accountability.

Mrs Blackman

  3.  On this point of accountability, one of the major mechanisms of accountability is the annual report which will be driven by the objectives and principles of the FSA. Obviously the devil is in the detail of that report. Will there be any consultation as to the shape of the report and what will be in it and the way that those objectives are measured?
  (Mr Davies)  We are already discussing with the Consumer Panel and the Practitioner Forum as we call it, although I imagine it will be called the Practitioner Panel now it has been made statutory, about how we should measure what we do and the Practitioner Panel in particular are likely to launch quickly some surveys of industry opinion which will provide a sort of benchmark about regulatory sensitivity and regulatory intensity against which they can measure us in the future. We also would expect the Practitioner Panel and the Consumer Panel to have their own sections, if you like, of the annual report and so in that sense we would be consulting them. We had not thought of consulting on the overall shape of our report which is for our Board to determine although of course there are also certain requirements imposed by the Treasury on what we put in that report. We certainly could do so, but we have primarily consulted on prospective things rather than on retrospective things.
  (Mr Thorpe)  There is perhaps a point that influences that. We have said in our terms of reference for the Consumer Panel—and I think this is mirrored with the Practitioner Forum or Panel—that they should anticipate publishing their own reports without interference from the FSA, so there is a check and balance there in terms of their review of us and their unfettered right to say what they feel about our performance on those objectives.

  4.  But they will have an opportunity to comment in the report that goes to the Chancellor as well?
  (Mr Davies)  Yes.

Mr Plaskitt

  5.  It is a follow-on question from that really. You have already indicated that the Government has said that the Consumer Panel will be put on a statutory basis and the model you used is that of the PIA Consumer Panel. Do you think that is the correct model? Secondly, I would like you to say a little bit about how you envisage you are going to act and relate to the Consumer Panel. Can you give us some reassurance that you are not producing an annual report, they are producing annual reports, but that the two are never speaking to each other. I want to know how you are going to react to them.
  (Mr Davies)  First of all, it is true to say that we did build to some extent on the PIA Consumer Panel and we did ask the current chair to chair our Consumer Panel through to the point at which the legislation comes into place and we are pleased she accepted, but in other respects we have changed it quite substantially. The breadth of its remit is significantly wider than before and we have also introduced Nolan procedures to appoint the members of the panel so we advertised publicly and had independent assessment of candidates, etcetera. We have moved it along quite a bit already. What we have set up is a regular relationship between the Panel and our Board whereby the chair of the Panel will attend our Board periodically and so it is not just a question of reports going off separately, there will be practical, face-to-face encounters between the Consumer Panel and our Board. In fact, one of them will take place on Thursday of this week. So we undoubtedly recognise that we need to respond to the Consumer Panel in a clear way. We would expect to produce reasoned response to points they made to us.

  Chairman:  We will have to adjourn at this stage for five minutes or so to allow some of our members to vote.

The Committee suspended from 16.10 to 16.17 for a division in the House of Lords.

  Chairman:  Thank you all very much for returning so promptly. We were dealing with the question of the Consumer Panel. Lord Haskel has a question.

Lord Haskel

  6.  I do feel that this is a matter which is absolutely central to the work that we are doing and the lines of authority and as you explained them the manner in which you are accountable seemed to me to be satisfactory if everything is going well but you are going to be accountable to both a buyer and a seller and when the buyers and the sellers fall out then there is trouble. Do you think that the accountability as you described it to us will be able to withstand the stresses and strains of that situation?
  (Mr Davies)  I think that the previous regulatory system, albeit with its flaws mainly related to the different tiers of responsibility, has nonetheless shown itself to be capable of dealing with that kind of problem. I am reluctant to pray in aid pensions mis-selling as a shining example of anything since it is an unhappy episode, but regulators have in the end been able to get the agreement of the industry to a major programme of compensation as long as their views were soundly based and I think in that we have steered a course between the interests of consumers and the interests of the industry. I think the other point I would also add is that most of the time most businesses are clearly trying to stay comfortably within the regulatory framework and regard most of the regulatory requirements as simply good business. Compliance with the law, good record keeping, good advice to their customers is part of what good business ought to be. I think there is a danger sometimes in seeing this as more confrontational an activity than it typically is. Most of our work is involved in a constant process of debate and negotiation with the industry and with consumer groups to try to set the parameters appropriately and most of it is not in fact highly confrontational.

Lord Poole

  7.  I would like to ask, if I may, a question about your own personal position as Chairman. I assume you have some form of terms of reference. Could you tell us a little of how your own performance is going to be judged and who that will be judged by and whether there are formal criteria laid down?
  (Mr Davies)  The contract that I have is a five year term which began on 1 August 1997 as Chairman of the SIB. My office is, as they say, at the disposal of the Chancellor. The arrangements for assessment of my own performance are at the moment twofold. One is that there is a system of upward appraisal in the Financial Services Authority for all our staff. With the benefit of an external consultant my performance, as perceived by the people who work for me, was assessed at the end of last year and the results reported to the Board. In addition to that there is a remuneration committee of the Board composed of non-executives which is charged with assessing my performance from time to time. They assess also the performance of my two managing directors but in that case with my assistance. We have introduced also, in the case of the managing directors, an arrangement whereby the chair of both the Consumer Panel and the Practitioner Panel will give their views to us on the performance of the Authority as a whole and of the parts of the Authority which they control. But I think that is probably best suited to their performance whereas I think my performance is assessed by my non executive Board members.

  8.  Are there criteria we should know about?
  (Mr Davies)  There are absolute criteria in the sense that we set out for the Board a budget and performance against the budget. We set out objectives in terms of deliverables, at the moment that is heavily based on getting the new regulatory regime up and running. The Board also in addition to the regular financial performance, they monitor staffing, performance, turnover of staff which is quite a good indicator of whether we are managing effectively.

Mr Sheerman

  9.  Mr Davies, I am fascinated by the often quoted failure of the previous Act and I wondered whether when you were making your introductory remarks pertaining to this particular first question where you see the real improvement between the old FSA system and the new? I would like just to draw your attention to a City Editor yesterday who said that "the degree of bullying, intimidation and seedy vindictiveness in the old system was the greatest hidden regulatory scandal". Now, first of all, do you think that is a fair criticism of the old system and do you think the new system will meet that criticism?
  (Mr Davies)  No, I do not think that is in any way a fair characterisation of the old system. I have not heard that point of view advanced by trade associations or by city institutions. I simply do not recognise it as a characterisation of the old system. I think that where we are seeking to make improvements in the old system are twofold. One is undoubtedly that there is some genuine new change in powers in relation to market abuse, which I am sure we will come on to in due course, but more importantly it is in trying to ensure that the regulatory system is able to take a view of the financial services market place which reflects the structure of that market place. The old regulatory system was built on a set of sectoral divisions which are no longer relevant to the way in which business is actually done in that nowadays you can buy life insurance from a traditional life insurance company, from a financial advisor, from a bank, from a unit trust or a company that owns unit trusts or indeed from a supermarket. These old divisions on which the previous regulatory system was built no longer apply. Also the old system had in the investment business area an unsatisfactory two tier split which was put in place for some understandable motives but which generated dysfunctional conflicts but also complicated overlaps and underlaps within the system, whose significance and importance became gradually apparent during the course of the ten years in which the old system operated. Lastly we think also, and this comes back to the remarks I made at the beginning, that if you are interested in the integrity of markets and in looking at risks to market stability overall, then it makes sense also to be able to look at banks, securities houses, insurance companies, fund management overall and to look at the interactions between them in order to get an assessment of the health of the overall financial system. In that, in the old system there was a lot of coming together of regulators, undoubtedly attempts were made to do that but it is much easier within one organisation than it was before.

  Chairman:  Could we move on to the question now of fine income and its definition and what happens to it. That is one issue raised under the heading of accountability in the progress report.

Mr Loughton

  10.  Mr Davies, the press has made good sport about the costs of the new FSA structure and some criticism has come of course by the potential capacity of the FSA to levy fairly hefty fines. Now how are you going to assuage public perception that one may be subsidising the other?
  (Mr Davies)  If I could say just on the overall costs of the system, this year we are going to come in around £10 million below our budget, and our budget for next year is 1.9 per cent up on this year in budgetary terms and we put out a consultation paper on our costs and on our fees. We have had a very small number of responses and all of them have accepted our fees and our budget for next year. So the controversy about our costs in the market place I think can be much overstated, certainly we have found that institutions have been quite understanding of our cost base and appreciated our need to recruit good people and indeed constantly say to us that what worries them is not so much our out of pocket costs but the costs imposed on them if we have poor quality people who do not understand their business well enough. As far as the fine income point is concerned, we have tried to present our budgets and our management accounts in a way which demonstrates that we see fine income not as going to the FSA but as going through the FSA back to the regulated community. The way we present our budget is by publishing what we call a control total which is mainstream regulatory cost and that is for next year £158.5 million, and that includes all of the in-house costs of supervision and the in-house costs of enforcement but it excludes the case-specific costs of enforcement when you hire in law firms, etc.. Then we show the outturn against that control total and that is what we and our Board are managing against. The enforcement costs are somewhat unpredictable depending on the number of cases that arise during the year and the fine income is also wholly unpredictable depending on the number of fines which are levied during the year. So we present that separately: the external enforcement costs and the fine income. Where there is a surplus of fine income over out of pocket enforcement costs there is then a discount applied at the level of the fees but it does not run through our P&L, if you like, it is accounted for quite separately to demonstrate that it goes back in the form of lower fees and is not used retrospectively to justify a higher level of budgeted expenditure than would otherwise be the case. We hope that with this presentation we can make people see where the fine income goes in and where it goes out and that it is not used by us as a back door way of justifying an increase in our budget or an increase in our salaries.

  11.  It sounds like a very good way of a firm shopping the competition in order to reduce their own fees if they go down, which I am sure is good competition. Are you sure it is watertight in terms of appeals going to the independent tribunal from firms trying to take just that tack but in fact the fines are for other reasons?
  (Mr Davies)  Well, we think that operating in this way it would be because there would be no benefit accruing to the FSA from these fines except in so far as we are recouping our enforcement costs but they would be related to the case in question. We do not anticipate that being a problem. I am not aware that it has been a problem in relation to the old system which had the same arrangements for fines.

Lord Montague of Oxford

  12.  I think it is very important, and I am sure you will agree, that the Consumer Panel has a feeling of total independence. Have you given any thought to how you determine the budget for the Consumer Panel and whether those who work for the Consumer Panel can be the employees of the Consumer Panel from that budget rather than your employees?
  (Mr Davies)  Yes, we have given some thought to the budget for the Consumer Panel and we have set, from memory, a budget of £420,000 for the Consumer Panel next year, about half of which will be on consumer research which will be carried out outside the FSA and about half of it is on the staffing support and the costs of the Panel itself and its publications etc.. We do have staff who spend most of their time working for the Consumer Panel but I am slightly reluctant and I can understand the case for a complete separation but also the point of having a Consumer Panel which is inside the FSA is of course that it therefore has a legitimacy within the organisation and its views are conveyed through the organisation and not just in the form of points that are lobbed in from the outside. Therefore we have taken the view that it makes sense for the Consumer Panel to have exposure to quite a number of our staff and for a number of our staff to go and present to them, our regulatory staff, Michael Foot's staff go and present to the Consumer Panel on the way they are doing regulation of sales of personal pensions or whatever. We would not want to see I think the Consumer Panel off completely separated from the FSA, at which point I think it will lose some of its feel.

  13.  Will they be independent?
  (Mr Thorpe)  That is one of those issues we have looked at long and hard and discussed with members of the Consumer Panel. The rather lame answer I suppose is the proof of the pudding being in the eating. We have approached the matter on the basis that the Consumer Panel should put forward a budget proposal and a programme of work, that should be something that the FSA Board—which at present is underwriting this—should see and be content with. The work then taken forward is a matter for the Panel. As I was mentioning before, the Panel should be free to publish its own reports without hindrance from us. We see the independence coming more in its freedom of action within that published and acknowledged budget. Going further away, as my Chairman suggests, decreases our capacity to influence our own staff with the Consumer Panel's thinking. In some senses it would create another public consumer body which we are already aware of and already take note of. For us this is an important informing aspect of our own structure.

  Lord Montague of Oxford :  I find that worrying.

  Chairman:  We will have a chance to speak to others about this in due course.

Mr Plaskitt

  14.  Just a supplementary following on from Lord Montague, you said £420,000 was the budget allocated to the Consumer Panel.
  (Mr Davies)  Yes.

  15.  Your enforcement budget is about £150 million?
  (Mr Davies)  No, the total budget is £158 million, that includes everything. The Consumer Panel is £420,000 but that is not of course all of our consumer related work. Our own work on consumer relations, consumer education, town meetings around the country and all of that, that is separately accounted, that is just specifically what the Consumer Panel itself is.

  16.  That is your consumer work but the Consumer Panel at some stage may want to stand up to you and tell you off about something.
  (Mr Davies)  Yes.

  17.  How do you arrive at that figure? It is about a quarter of a per cent of the total budget you are talking about. How do you arrive at that figure and are you sure it is enough for the Consumer Panel to do a proper job?
  (Mr Davies)  I suspect that in the long run it would not be but I ought to say that at the moment we are operating of course primarily under the old powers and therefore while we have broadened the remit of the Consumer Panel in terms of the issues which it can cover, and we have changed the membership of the Panel, essentially we are operating on the back of the old powers we have through the PIA. We have taken therefore what the PIA spent on the Consumer Panel and increased it a little bit but I think until we have our full statutory responsibilities, and in particular our new statutory objective of promoting consumer understanding of the financial market place, we do not think that we can justify to ourselves, therefore to our fee payers, spending a large amount on the Consumer Panel where they might reasonably say "You do not have statutory authority in some areas for doing that". We believe that we do have in relation to the old PIA areas.

  18.  Will you commit to an early review of the budget?
  (Mr Davies)  Absolutely.

  Chairman:  I think we need to move on. Lord Haskel, you have a question about complaints.

Lord Haskel

  19.  You are required to consult on your arrangements for independent investigation of complaints against you, against the FSA. Can you tell us how your consultation is going and when you expect it to be concluded?
  (Mr Davies)  When we brought the different regulators together into the FSA we overhauled the arrangements for complaints against regulatory staff both in the SROs and in the FSA. I should have to say that in some cases in coming in there were no arrangements at all in the past and we have painted those on, the Bank of England did not have such an arrangement for a complaints commissioner against the Bank of England in the past. The Board have approved an independent complaints commissioner, Mr Jock Worsley, who has terms of reference which have been revised to take account of our new responsibilities and that is operating. I believe there is only one current complaint which he is looking at but that is an operating system. We do recognise however that for the full new regime we will have to amend that because what we have done is patch the old system on to the new. We will be consulting, during the course of this year, we expect to complete that process by the end of this year, that is on our critical path this year.

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