Joint Committee on Financial Services and Markets Minutes of Evidence

Examination of witnesses (Questions 60 - 81)



Lord Eatwell

  60.  I have one extra question on rules. Mr Davies, in your introduction you said that if there was no new Act beyond the spring of next year then you would run into difficulties and yet in your speech to the Chancery Bar Association you said that it is not realistic to think all the codes of practice and rule books have been finally overhauled. So why will it cause difficulties when you will not be ready to do the job anyhow?
  (Mr Davies)  The difficulties to which I refer are (1) practical and (2) potentially legal. When the self-regulatory boards agreed that it was reasonable to delegate their staff to the FSA and have the FSA carry out their functions on their behalf, reporting back to the boards, they did so on the basis of advice that it was reasonable for them to do this on the basis that they were organisations with a limited life and the Government had clearly declared that they would be removed in a finite period, and the boards took the view that, based on that legal advice and their expectation that legislation would be brought forward in a timely way, this was a reasonable exercise of their functions. I think legally it would have been open to the SROs in the past to have had their enforcement work or their supervision work done by somebody else on their behalf. There is no reason why they should employ staff. However, the sort of time horizon at which people were looking was some time in the spring or summer of 2000 as the end point for this process. I think the risk is that if the legislation is not through by then people may argue that the decision made by the SRO boards might have been a different decision if they had known that they were going to stay in existence for a longer period. The second point is a more practical one, which is, of course, that our system at the moment depends very heavily on the goodwill of the members of the SRO boards to continue working, even though they know, of course, that there is no future in the organisations that they run, and I am very conscious that we prevail on a lot of people still to spend a lot of time managing the old system, which must become an activity with diminishing returns. It is true to say that not every jot and tittle of the rule books will be revised in time for the spring of next year but the key point is that those rules which we took over, which we could adopt where we were not going to change them, the old SRO rules can be adopted as FSA rules. That would be our system to manage with a new set of practitioner panels and groups and boards, etc. within that, and that would still allow us some time to achieve the final change of the rule books to the new form, but the legislative responsibility would have come to us. So I think there is a distinction to be drawn between the legislative responsibility and the amendment of the system, where I should say that the pressure on us from the market typically is in favour of lengthening that process because of the year 2000 problem and not wanting to have to change a lot of detailed systems over the next 12 months. So the market on the whole would like the legislation to come through reasonably soon so that there was certainty about the overall environment and we could restock our committees and organise ourselves for the long term and then proceed in a more measured way to revise the rule books, which in any case have to be subject to consultation and cost-benefit analysis before we can change them materially.


  61.  Thank you very much. I would like to move on to the question of scope but might I ask one last question on this. Is there any case for making the Enforcement Committee part of the Bill? We have seen the move to the suggestion that the Consumer Panel and the Practitioner Panel should now become statutory components. What about the Enforcement Committee?
  (Mr Thorpe)  We are looking now again, as I mentioned before, with the industry at how much separation needs to be achieved to satisfy both perceptions and legal requirements and we will be taking that matter up with the Treasury. Certainly one of the issues we will look at is whether greater detail needs to go into the Bill on that point. At this stage it does not show itself as an immediate case.

  Chairman:  On the question of scope, we have two broad areas that it might be sensible to do today. One is the issue of territorial scope and the other is the vexed question of mortgages, which I would like to move on to. Mr Heathcoat-Amory is going to raise the question of territorial scope.

Mr Heathcoat-Amory

  62.  Scotland. I am a little surprised, and perhaps I can put this as a question. Is it the case that regulating Scottish solicitors, in so far as they give financial advice, will now come under the FSA? If so, this is a curious devolution in reverse and I wonder if you consulted with Scottish interests on this and in particular whether you foresee a possible difficulty with the Scottish Parliament, who will be guiding all the legislation governing Scottish solicitors, and whether you could either find yourself reporting to two different bodies or arbitrating in a rather unhealthy English/Scots type of war on this issue?
  (Mr Davies)  I hope not. As I understand it, the Government's intention is that financial regulation remains a power for this Parliament. In the case of solicitors in Scotland, in the case of solicitors in general, if they are regulated to do investment business in the future they will need to be regulated by us. There is perhaps a separate issue that you might not have time to come on to, about how you define investment business, and our general proposition would be to define it in such a way that we only captured in our regulatory regime those people who were genuinely doing investment business as a business and not as business incidental to their legal or accounting professional work. But it is true to say that by making that change solicitors who do carry out investment business as a business will be regulated by their professional body for their legal work and by the FSA for their investment work and that will be the case throughout the United Kingdom. So they will have a dual regulation both north and south of the border.

  63.  So it will come from Scotland down to the FSA in London?
  (Mr Davies)  No.

  64.  At the minute it can be done by the Scottish Law Society?
  (Mr Davies)  Yes, sorry. That aspect, if they are running investment business as a business under the terms that the Bill eventually defined, then it will come to the FSA, yes. We have an Edinburgh office but it will come to us.

Dr Cable

  65.  You made a very powerful plea at the beginning for unitary regulation but the banks have persuaded the Government that one aspect of their business, and specifically one aspect of their loan business, should be taken out and regulated separately under a self-regulating structure. Could you, first of all, tell us where you stand on this issue? Is it such an anomaly and do you feel strongly about it?
  (Mr Davies)  I think it is not quite right to say that it has been taken out because it was not ever in, in that there has not been in the old regime conduct of business regulation of the mortgage-selling process. The conduct of business regulation that there is applies to long-term investment products—personal pensions, life insurance, unit trusts, etc.—and mortgages, which are a liability not an asset, have not been captured by a conduct of business regulation. In awareness of the fact that there was considerable consumer anxiety about mortgage-selling practices, the industry itself decided to set up a self-regulatory regime, which I think it is fair to say has only in the last six to nine months got going in its full form, and that is attempting to improve the standards of mortgage-selling, and the position that the Government have taken is that it will be for ministers to reach a view on whether that code is delivering an improved standard of consumer protection, or if not, whether a more cost-effective means of achieving that would be to put it into the FSA. Ministers have clearly said that they wish to make that decision and that our role will be to provide analysis for them of the costs of putting the regulation into the FSA if that is what they decided. It is clear that in general terms the Bill gives a very rigorous framework to the FSA in terms of deciding on any extension of its scope. It requires us to go through cost-benefit analysis, both our own costs, industry's costs, and also to explain why it is that the examples of consumer detriment that we might find would be corrected by this new regulatory framework. We have not done that analysis in relation to the mortgage market as it is currently operated because it is new, with a new CML code, so we will need to go through a process of looking at how far the CML code has dealt with the kind of problems that there were in the market and whether going beyond that into our regulation would achieve a better outcome at a reasonable cost. It follows from that that I think it would be not just unwise but actually wrong for us to give a view on what the outcome of that process should be now because I think I could then reasonably be accused of having made up my mind beforehand and then produced a cost-benefit analysis to justify the decision I had made. So I am afraid I am not prepared to be tempted by yet another seductive question to decide at this point whether it would be right to extend the FSA regime to mortgages.


  66.  Could I ask a possibly more practical question? If it were to be, and the conclusion was that it were to become part of your business, how would it change the nature of the FSA? What would you have to do? What would it do to your size? Have you any ideas about what it would do to the mortgage industry generally if it were to be brought within your remit?
  (Mr Davies)  I think it is fair to say that, of course, quite a lot of the institutions which deliver mortgages are already regulated by us one way or another, either prudentially and usually also for Conduct of Business and for some of them adding Conduct of Business regulation of mortgages would not make a huge amount of difference either to us or them because we are visiting them anyway and we could look at their mortgage business as well as, for example, their personal pensions business. However, the mortgage market remains quite a diverse market and our estimate is that there are probably 6,000 or so unregulated mortgage providers or intermediaries who would be brought within the net if we were to regulate mortgages. What we cannot be sure of is how many of them would wish to get themselves authorised by the FSA. Some might decide that they did not have the procedures, that they did not have the personnel who were trained to cope with regulatory requirements, so some of them might vanish away. If we did have another 6,000 or so then we would be talking about quite a considerable increase in our activity. As I have mentioned before, we have 4,000 PIA firms and this would be potentially another 6,000 and therefore we would not be talking tens of people but 100 to 200 people if you were going to do a proper job on assessing the effectiveness of that selling process.

Mr Sheerman

  67.  We can see the need for the concentration on whether mortgages should be in or should be out. Mr Davies, looking at the Bill as a whole, is there any other activity that you would have thought—and this legislation has been in progress since July—on mature reflection you would like to see included in the scope of the legislation that has not been put in up to this present moment but which at the moment seems to be a hole in the legislation?
  (Mr Davies)  The Government have announced one extension of prepaid funeral plans which seemed to us to meet the criteria that we have in place in terms of extensions. I am happy to give you a straightforward answer to that, but essentially what we look for is a methodology which says that if we see some new product area or area where people want to come to us and suggest we should regulate it we ask ourselves a whole series of questions, such as how far does it look as if this justifies regulation? Is it something where the costs of being locked into the product are so high that the decision is very important to start with? Is it something which is characterised by many repeat purchases, like Bureaux de Change where you may say that if people pay high commission one day presumably they will go across the street for the next transaction? We ask ourselves a series of questions. If you asked yourself those questions then I think prepaid funeral plans score quite highly. I would say that long-term care insurance probably also scores quite highly. The Royal Commission on Long Term Care recommended that it should be regulated. It is a relatively immature market at the moment, but I suspect that if you ran a complete cost-benefit analysis on that you would find that scoring quite highly. The one other area that I draw attention to is Credit Unions, where the Government put out a consultation paper which suggested two ways of approaching Credit Union regulation, i.e. either just as is, with rather simple regulation which is essentially by registration really rather than supervision, or a more FSA-type framework and we have responded to that consultation by saying that we think there is a case for bringing them into the FSA because we are quite bullish about the prospects for Credit Unions overall in the UK, but we think they are more likely to flourish if they have a proper regulatory regime put around them, although we have some caveats about how that will be paid for, but those are the cases where we can see cases for extension at the present time.

Mrs Blackman

  68.  The FSA will regulate the financial advice that recognised financial bodies give. The House of Commons Treasury Select Committee recommended that the definition of that advice be drawn quite narrowly. Has there been any progress on that? Is it difficult to do?
  (Mr Davies)  I think it probably is not totally straightforward to do, but our point of view on this is quite clear. We would like the legislation to be drawn up in such a way that there was no need for authorisation if a professional firm was retailing advice from an authorised provider of that advice already so that if you were just a conduit for an authorised person then you should be outside. Secondly, where investment business is supplementary to the practice of a profession, and there are for instance some bits of incidental business attached to probate or family law business which arise which could be counted as investment business, we would like them to be excluded because we believe at the moment there is a lot of precautionary authorisation and I think the Treasury are thinking about that at the moment.

  Chairman:  The next question is on the Ombudsman and compensation schemes.

Mr Beard

  69.  The Government has said that they will give the FSA discretion as to whether disputes relating to activities which could be regulated by the FSA under the Bill should be brought within the compulsory jurisdiction. What are the advantages of doing that and will you be required to carry out consultation if you use that discretion?
  (Mr Thorpe)  We are looking at a position with the various Ombudsmen schemes which is only slightly less complicated than that which the FSA has had to deal with in terms of numbers of schemes and their approach to their task. The key point here is that some of the eight schemes that are going at present operate with a compulsory jurisdiction, some operate a voluntary jurisdiction and some expand beyond the scope that the Financial Services Authority will have in terms of investment business. What we are keen to do is ensure that in bringing together a single Ombudsman we do not cut out a complaints handling mechanism that is already up and running and serving consumers well, hence the need to provide legislation which allows the Ombudsman to go beyond our scope in dealing with those complaints. There are two requirements that we understand will apply to any expansion beyond that compulsory FSA scope: firstly, the need to consult and, secondly, a cost-benefit analysis yet again must come into play, but consultation most certainly will have to take place. It will be the industry, after all, that has to bear the cost of its voluntary inclusion.

  70.  The Government has declined to change the requirement that a respondent firm but not a complainant should be bound by the Ombudsman's decision. Is that inherently unfair?
  (Mr Thorpe)  I suppose it depends whether you are the firm or the complainant in this case. If it is unfair, it is the same unfairness that exists in most of the schemes at the moment. I do not think I would make an apology for it. I think it repeats a positive discrimination in favour of those who are likely to be less able to take their cause through other channels through the courts. I believe it is intended that those who are in that position should have the advantage of having all of their rights available to them, the Ombudsman scheme and then, should they choose, the courts.

Lord Montague of Oxford

  71.  I would like us to turn our minds to the public. What do they do if they have got a complaint? Are they going to ring you? Are you going to shove them off to somebody else and is somebody else in turn going to shove them off to somebody else? How is it all going to work? We have heard of the one-stop shop. It does not sound like that to me in terms of consumer complaints. Will you try and see if you could move to that?
  (Mr Thorpe)  I think you have described correctly the system that we are looking at the moment because it is very difficult for most consumers to be able to identify to whom they should take their complaint in the first instance. In many instances there will be several jurisdictions which might overlap. We are with this legislation intending to see a single complaints resolution mechanism, a single ombudsman scheme, as an important precursor to the action of that scheme. We are not seeking to see a change on the primary responsibility that the firm will have for resolving the complaint and our advice to all people who have complaints will be, "You should go to the person who gives rise to that complaint first and seek its resolution." What we are then trying to put in place is a one-stop shop for those who do not obtain satisfaction from the firm or individual that they are dealing with, and yes, it will be a one-stop shop. It will not be us but it will be our ombudsman scheme.

  72.  Very often with a complaint a consumer wants advice. I wonder if there is a role for you with your education objective to see if some of this advice can be given in a slightly more professional way by Citizen's Advice Bureaux? People are comfortable with going to Citizen's Advice Bureaux, partly because they know it does not cost them any money. They are hesitant about going to a lawyer because straightaway they are incurring costs.
  (Mr Thorpe)  I would add on that last point it is not intended that the ombudsman scheme, indeed none of the existing schemes, require you to be legally represented to take advantage of them. In fact, from my own knowledge of the way these schemes operate, they are very keen to try and assist complainants to put their complaints in a useable and progressable form. The use of Citizen's Advice Bureaux is a matter we have looked at and certainly one of the initiatives we have taken is already to start publishing booklets that will be helpful to the consumers and we will look for any channel to distribute those and the Bureaux are very valuable channels for that form of distribution.

  73.  And the training of the personnel within the Bureaux?
  (Mr Thorpe)  We have not gone that far but we will certainly be happy to talk to the Bureaux to discuss that.

Lord Haskel

  74.  As I see it, there will be an ombudsman scheme and a separate compensation scheme. Will one follow automatically from the other or will the consumer have to go to the compensation scheme having had a decision from the ombudsman?
  (Mr Thorpe)  Sadly, sometimes the sequence does not have to be that way because firms make the mistake of going immediately into liquidation, in which case the first port of call for the consumer will be the compensation scheme. We are looking at the pass-over. What we find at the moment is that the majority of complaints are resolved whilst the firm is still in existence, the vast majority. It is very rarely that a case goes to the ombudsman and then suddenly the firm is out of business and falls into another category. Where that does happen there have been problems in the past and we are looking at how we can use the information twice so that we do not put the compensation process through the business of re-establishing the facts.
  (Mr Davies)  But it is worth underlining that for the most part the compensation awarded by the ombudsman is awarded against an existing, continuing firm and there is no way that goes to the compensation scheme to be handled. The compensation scheme only comes in if you have a complaint against a firm which has then gone into liquidation. So that is a tiny proportion of the cases involved. There are some enforcement cases, of course, in the past there have been, but it is not the normal route. You do not need to go to the compensation scheme to get an ombudsman award enforced.

Mr Sheerman

  75.  Could I ask a quick supplementary on that, Chairman. Every time that someone makes a complaint to the ombudsman about an account with a building society, what is the cost of that to the building society regardless of who wins or loses?
  (Mr Davies)  I think we will have to come back to you on that.

  76.  I have heard from the building society organisations that it is substantial and they have a number of people who have threatened to make a complaint in order to get a quick pay-off. Are you aware of that?
  (Mr Davies)  It is a wicked world. I could not rule out that possibility. I should say that at the moment the building societies scheme is a scheme which we have no great insight into. We have not been responsible for managing that scheme. It will gradually be folded into the ombudsman scheme. In general principle the ombudsmen are fairly discriminating in taking up only the cases that they feel are reasonable and it is only in a case they actually agree to take up that the bank or building society would incur significant costs.

  77.  So just an initial reference to the ombudsman does not cost anything? He has actually to take it up to incur a cost for the building society?
  (Mr Davies)  It might cost the building society something because the ombudsman might say, "Here is a complaint" and he might initially refer it to the building society and he might get a letter back which actually removes it completely, where the ombudsman says, "I do not wish to pursue this any further." So it is unlikely that an ombudsman would reject a complaint completely out of hand without getting any kind of answer but quite a number would fall at the fence of just getting one letter back which explains the position; perhaps somebody has misunderstood something.


  78.  Thank you very much. That leaves us with one question. Unfortunately, it is the rather burning issue of market abuse. But maybe we can short-circuit this as far as possible and maybe we are going to have to come back another day. We are going to have some of our evidence sessions on this. Some of us were at a conference last week which you ran where we got a better feel for this issue. But it might be helpful to the Committee if you could explain reasonably briefly what you see to be the state of this particular game at the moment. Where you are in the process of batting backwards and forwards the views and the concerns about this question?
  (Mr Davies)  I think the first point to make is that we do believe that it would be right to have a code. It would be possible to have some offences in the Bill and then for case-law effectively to develop as the regulators took cases and in some other jurisdictions that is what has happened. We believe that it would be better from the point of view of certainty in the marketplace for there to be a code which set out as clearly as possible what the regulators saw as the offences and what they saw as market abuse and what they did not. But we recognised that this was going to be a difficult exercise and, therefore, we set about it rather early in the process. We will not need this code until a year from now at the earliest, we would guess, but we did put out a first version of it last summer and we gave people an extensive period of time for consultation and we have then digested those consultation responses and, as you say, last week held a conference at which we published a feedback statement on the main points that had been made to us about the code. I guess the main points would be around intent. I do not have to tell you we mentioned that. We continue to believe that markets can be damaged even where there is no intent to so do. Indeed, the rest of the law provides for offences of recklessness or negligence. Nonetheless, we believe we do need to clarify the extent to which we take intent into account or take the absence of intent into account, and it is quite clear that we do not propose to prosecute people for accidental offences. We have said that many times in relation to our enforcement procedures. But undoubtedly the market is looking for more clarity from us in that area. The second area is the general question of definitions of what we mean and how the code relates to particular types of market transaction. There is undoubtedly a need for greater clarity there and we are working through a variety of market circumstances with practitioners to try to tease out what we mean. The third area is the interrelationship between the market abuse code and the enforcement processes. I think we have probably handled that this afternoon. I guess the fourth big area is the issue of waivers or no action letters, as they are sometimes called in the US jurisdiction, and the market is asking us in what circumstances we would be prepared to say, "This transaction we will not regard as in conflict with the code," etc. We are currently working on a policy statement which I hope to take to our board next month about the circumstances in which we will be prepared to issue clarificatory guidance and waivers, etc. So where we are going is, we press on to try to revise the code in a way that will meet people's concerns; the enforcement process we are dealing with separately; the waiver process we are dealing with separately, and we hope that in the next few months we can resolve these issues to a reasonable degree. I cannot be sure we will ever end up with a code which everybody thinks is a splendid thing but we are not discouraged from our belief that it is possible to achieve it.

Lord Poole

  79.  May I ask on the question of waivers, leaving aside the consumer market, where I can see that that perhaps might be very difficult, in the professional marketplace when I was running a bank it was incredibly helpful to be able to go along to the Bank of England, talk to one's regulator and say, "I am thinking about doing something along these lines. How would you feel about it? What sort of issues would it raise with you?" The same has applied in other marketplaces that I have operated in and it does lead to things being very speedily resolved and that is often very important in terms of a competitive edge for London. I do not want you obviously to commit yourself to something you have still got under discussion but do you feel at all well disposed towards practitioners of the sort that I am and have been who would like to be able to have conversations rather than 45-page documents?
  (Mr Davies)  Broadly speaking, yes, I would agree with that. The Bank of England has done that in the past and we do it now and I would expect us to carry on doing that and, indeed, there are some benefits from that because while some people who come in are entirely reasonable folk who are seeking the truth, there are some others where you get some interesting information which you do not like the sound of because people come in and talk to you and so we certainly do not want to get into a position where people are afraid to come and discuss things with us. I do not think that that is an issue. The specific request put by some in response to the market abuse document, however, relates to particular transactions and to some kind of legal quasi indemnity. That is not characterised in the kind of relationship that you are talking about in the past and that raises much more difficult issues. You have to be very very clear about the terms of the transaction you are approving because you do not want to approve something and then discover that when it is actually effected the transaction is rather different in crucial ways from the one that was put to you. Of course, you also have to address the question of whether it is right for everybody in the market to pay for that or whether the firms asking for this specific exemption should be asked to pay for it. That in itself raises rather complex issues. No, we are not trying to rule out the kind of informal discussions we have about what our guidance means, what our rules mean, how transactions fit in with them. What we are addressing is a specific point.


  80.  It was quite clear to me at the conference, and this goes back to the conversation we were having earlier, that there is some concern that people may walk into a problem that they had not foreseen. And that you were then going to come after them with some pretty tough penalties. This raises the whole question about whether or not the guidance is clear, whether or not they are going to be caught, in a sense, off-side in this way and if the penalty is going to turn out to be extremely substantial. This is obviously something that you have very much in mind and it is going to be an issue of how far there will be a meeting of minds on this. But I was struck by what I regarded as quite a high degree of nervousness in the market about these powers.
  (Mr Thorpe)  I think we agree with the nervousness. We would hate to see the development of this code evidenced by a series of enforcement cases. That would be evidence of failure in terms of prescribing a code to cope with the alternative bits of the market. I would just reinforce the point that our Chairman was making, that we are in the process of reviewing the comments and it will be a matter of issuing another draft of this code at some point when we feel we have reached a consensus with the Chairman.

  81.  I think that probably is as much as we can usefully do this afternoon, Mr Davies. Thank you very much. I know it has been a very long session. We would like to keep open the possibility, after we have had our deliberations both with the Minister and with others in the world outside, that we might come back to you at a later stage. On the other hand, looking at the timetable, time may very well not allow that. But we have had a very useful session and we are very grateful for the way in which you have answered our questions. Thank you very much.
  (Mr Davies)  Thank you. Of course, we would be happy to return.

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