Examination of Witnesses (Questions 880
- 897)
WEDNESDAY 9 JULY 2003
SIR HOWARD
DAVIES AND
MR ANDREW
WHITTAKER, FINANCIAL
SERVICES AUTHORITY
880. That is very helpful. On certain aspects
of this in terms of Parliament I know you have appeared in front
of the Treasury Select Committee quite a bit on this already.
Is that the main way in which you feel yourself accountable to
Parliament?
(Sir Howard Davies) Yes, I think it is. The Treasury
Select Committee have been active in pursuing that responsibility
both formally and informally and we meet members of the Committee
who come in to see us and take interest in particular aspects
and discuss particular interests and areas and, as you say, they
have been active in holding a series of hearings both on the generality
of regulation, hearings on our annual report, and also on specific
issues like Equitable Life and split capital investment trusts,
and that has been the prime focus although there have been a number
of other committees in the Lords, for example, on the European
financial services action plan, on globalisation and regulation
of international financial markets where we have given evidence,
and this Committee and the Overseas Development Committee as well.
There have been a number.
881. And you feel that works quite well?
(Sir Howard Davies) Yes, it does. It is effective.
882. I think you are more under scrutiny
from Parliament than most others so far?
(Sir Howard Davies) I like to think so. We feel that
we have had effective oversight from the Treasury Select Committee.
The reason for my slight pause is I do not always agree with them
but I guess I am not supposed to. Yes, I think it is an effective
process; I think the Committee has been sharp and focused in its
questions and inquiries. Indeed the outcome of its inquiries,
particularly on split capital investment trusts, was I think an
entirely reasonable report to which we have reacted actively.
Lord Jauncey of Tullichettle
883. Sir Howard, your remit covers a very
wide range of financial activities, is that not right?
(Sir Howard Davies) Yes.
884. Before you take a step which involves
a particular class of financial activity, do you consult with
the people concerned? Supposing you are producing a rule which
would affect, let us say, all sellers of life insurance or providers
of life insurance. Would you consult with them in advance before
you produced your rule?
(Sir Howard Davies) Oh, gosh, yes. Indeed, at the
moment we have been criticised for overconsulting, I would say.
In the normal way, if we were going to make a significant rule
change, we would almost certainly begin with a discussion paper
and the discussion paper would explain why this area was one which
we felt was worth reviewing, and we would discuss the pros and
cons of different directions of change and would invite comments
on that, and that would certainly elicit comments from trade associations
and from individuals involved. We then would proceed to a formal
consultation paper and that is the one that has to have clear
proposals in it although it may not just have one, but two or
three, but those would then have to include the cost benefit analysis
and all the formal requirements. That would be at least three
months' consultation. After that process we would produce a feedback
statement which would say, "These have been the main responses
to our consultation; here are the main points that people did
not like about what we were proposing; here is the way we would
change things or not, and if not here is the way we respond to
criticisms that the people produce", and then after that
we must formally consult on the rule change, and we then produce
the documentary changes to the handbook, and that must be consulted
on again for, say, three months.
(Mr Whittaker) We tend to observe the Better Regulation
taskforce three month guideline.
(Sir Howard Davies) We are not statutorily required
to—there is an emergency procedure if we believe it is crucial
to make a change quickly—but that would be the normal process.
885. We have heard evidence to the effect
that you produce a very large number of consultation papers—one
witness said about 19 flying around at the moment and suggested
it was extremely difficult for the smaller firms to cope with
these things. Have you any comment on that? An example we were
given was a document entitled Less is More which ran to
something like 250 pages. It was suggested it might be difficult
for small organisations to have the time or the resources to go
through it.
(Sir Howard Davies) That is a nice story. There is
not a document called Less Is More that is 250 pages long.
There is a document on mortgage regulation which is 250 pages
long and we have said in relation to insurance regulation that
we believe we should cut back on our regulation and that is a
Less is More project but I think they are two slightly
separate things. But I take your general point. At any one time
it is not right to say that there are 19 consultation papers which
all affect small businesses. This is a very large sector and some
of our consultation papers at the moment are related to alternative
trading systems which are electronic platforms for trading bonds
across Europe, and some are consultation papers on general insurance
regulation about high street brokers under the terms of the Insurance
Mediation Directive, and of course it is possible, given your
very large organisation, to add all this up and say, "Gosh,
is this not a large amount of consultation?" We do, however,
recognise that at the moment there is a lot of change and just
in the last few months the industry has begun to say, "Just
a minute, there is a digestion process here", and I think
that has been primarily because of the combination of three things,
really: (1) a speeding up of the financial sector action plan
in the European Community, because ministers in 2000 set a deadline
of 2004 to complete the single market for the wholesale sector
and 2005 for the retail sector, and in the way of that kind of
law-making programme, guess what—it all comes in a rush
at the end because it takes a long time to agree all these things.
So at the moment there is a wave of European Directives under
way which we are required to implement. So that is one track.
The second track has been the outcome of the various government
consultations, particularly on stakeholder pensions, particularly
on the Sandler area, with the idea of new products and charge
caps and all of that, and a great wave of consultation on that,
and thirdly there is the change programme that we yourselves have
under way. What the industry have said to us at the level of the
Practitioner Panel who have sort of winnowed these things down
is, "Please could you, in the area which you can control,
focus on the must-dos rather than the nice-to-dos", even
though some of the nice-to-dos the industry has asked us to do,
because sometimes they have asked us to update the regime. So
we have been pulling back and slowing down; we have lengthy consultation
periods in some areas; we have deferred some changes that we were
planning to make; in areas of money regime we are planning to
change we have not done so yet, we will do so next year, so we
are reacting to that. But I would say that we are not the only
people at fault here and there are these three tracks coming together
in a rather uncomfortable way.
886. Moving to the question of appeals to
your decisions, and I am looking at paragraphs 16 and 17 of your
memorandum, in 16 you refer to the fact that your rules and practices
are subject to independent competition and scrutiny by the Office
of Fair Trading. Is that a matter which they do at their own hand,
or are they scrutinised because you or someone concerned with
the rule has referred the matter to them?
(Sir Howard Davies) I think it can happen in either
way. We would prudently, as you would expect, engage in a dialogue
with the OFT about rule changes and our competition lawyers, of
whom we have a small group, would talk to theirs about what we
are doing, and they are a good open organisation and they will
talk to you. They talk, of course, on the basis of saying, "We
are not pre judging what our final view might be"—that
is perfectly sensible and it is the basis on which we talk to
people too—but nonetheless we would do that on a preparatory
basis. As for a formal review that could come either from themselves,
and indeed they have done that—the polarisation reforms
were kicked off by an OFT review of the old Personal Investment
Authority regime which they carried out on their own initiative
in 1998-99—or people can go to them and complain and invite
them to review an aspect of our rule which they could then do,
or indeed the government could invite them to. I think the government
can only invite, rather than instruct.
887. I think from anything they determine
there is or can be further reference to the Competition Appeals
Tribunal?
(Sir Howard Davies) Yes. They need to go to the Competition
Commission in order to strike down our rule book. In the past,
under the old regime, the competition regime only applied in the
Financial Services Act area, not, for example, to prudential regulation
carried out by the DTI or by the Bank of England. Now it applies
to everything, so that is quite a significant change under the
new legislation. The other change in the new legislation is that
the reference goes to the Competition Commission, and it is the
Competition Commission who are able to instruct us to change a
rule, except there is a possible ministerial override if ministers
take the view that our rule is nonetheless justified in relation
to our statutory objectives, because obviously there is a theoretical
conflict between the competition law and the Financial Services
and Markets Act, so there can in extremis be an appeal to ministers,
although the Competition Commission are required to take account
of our objectives in their determination.
888. Do you actually mean the Competition
Commission or the Competition Appeal Tribunal?
(Mr Whittaker) It is the Competition Commission, and
it is the part of the Competition Commission that used to deal
with monopolies references.
889. Insofar as you deal with complaints
in paragraph 17, you say you have appointed an independent Complaints
Commissioner. If a body or an individual were dissatisfied with
the ruling of the Complaints Commissioner, have they any further
redress or appeal open to them other than Judicial Review?
(Sir Howard Davies) No.
890. So she is final then?
(Sir Howard Davies) I believe so. They have already
then gone typically through the firm, the Financial Services Authority,
and sometimes through the Ombudsman maybe as well if it is an
individual case, and then to the Complaints Commissioner if it
is then about our regulation. I think that is the end of the line.
(Mr Whittaker) I think it is important to draw a distinction
between the role of the Complaints Commissioner and the role of
the Financial Services and Markets Tribunal. If we were dealing
with a disciplinary case where we had taken disciplinary action
and the firm then referred that to the Financial Services and
Markets Tribunal, from that Tribunal there is a right of appeal
through the courts system but the Complaints Commissioner simply
deals with complaints about maladministration, and is the final
authority.
891. Finally, is your Complaints Commissioner
to whom you refer in paragraph 17—and I think we had a memorandum
about this—part of the Complaints Commission which extends
beyond financial services?
(Sir Howard Davies) No, there is no Complaints Commission.
Our Complaints Commissioner is appointed by a group of non executive
members of our board and the executive has no involvement in the
appointment. She then deals with, say, complaints from either
firms or individuals about maladministration in the Financial
Services Authority. So the kind of thing, for example, she is
dealing with is if we have, for example, inadvertently left some
firm off the list of authorised firms so somebody may have found
they were not licensed to do business by an error, that may be
a complaint and we may have inadvertently damaged someone's interest,
or a consumer feels we have not properly regulated a firm and
thereby has lost money because we should have prevented the firm
doing some kind of business or whatever. That is the sort of thing
the Complaints Commissioner deals with. It is not about disciplinary
cases, and there is not a Complaints Commission specific to the
Financial Services Authority.
Lord Morgan
892. I wonder if I could follow up Lord
Acton's question about the way in which you disseminate to helplines
and so on. It seems to me, listening to you, that the ordinary
small investor must feel quite vulnerable in these circumstances
which can have absolutely catastrophic results for him. I have
the report, which is only the overview and summary, of Equitable
Life because we do not want to go over that in detail, I understand,
but I would be interested in knowing whether there was a reference
in the full findings to the relationship between the lack of understanding
which is mentioned by the ordinary consumer about what the FSA
might do and the extent to which they did consult or had available
to them various helplines and so on.
(Sir Howard Davies) I think it would
be right to point out that the review of Equitable Life was about
the Prudential regulation of Equitable Life, and was, of course,
also about the old regime. Indeed, it was restricted to a period
between 1 January 1999 and the point at which the company closed
to new business in December 2000. I think that at that point—and
in all cases even the end of that period was a year before the
Financial Services and Markets Act came into operation—we
were beginning in a very early stage way to plan our approach
to consumer education and it probably was the case that there
was a consumer helpline in operation at that point, even four
years ago, but it was in a very experimental phase. Also, the
point that has been particularly made in the Equitable Life report
concerns the expectations of Prudential regulation and concerns
the question of whether a Prudential regulator can make judgments
about the viability of a firm even if that firm is meeting all
the Prudential requirements. You have helpfully said that you
did not want to get into the detail of the Equitable case, so
let us take it away from the Equitable case. There is an issue
as to what it means to say that a firm is authorised. The way
the regulations work is that it is not judgmental on my part about
whether a firm is meeting the Prudential requirements or not.
There is a set of requirements and you meet them or you do not.
You have an adequate amount of capital, and we determine what
it should be, and then you meet it, and you have an adequate amount
of reserves in the insurance sector and you meet them. We are
not a kind of rating agency, saying, "Here are these authorised
firms and some of them are better than others". We are not
doing that. We are setting a hurdle over which you must jump to
be authorised, and then all authorised firms are in that sense
equal, even though, of course, it is true that some are more equal
than others in terms of their capital standards. The regulator
is not a rating agency, saying, "This is an approved firm
but actually it is a CCC and I would not give business to it if
I were you". We cannot do that; we cannot be a kind of rating
agency. That was the specific point, I think, that people were
saying, "You should have seen that this firm was weak".
That is a different question from whether they were meeting all
the statutory requirements. There are banks out there which are
weaker than other banks but we police a level below which they
feel they cannot go. If they go below that level, yes, we certainly
do something about it, but if they are above that level then we
may cajole and persuade, etc, but they are still authorised firms.
893. Would you agree that a small investor,
who might be somebody elderly, would need a certain amount of
help, irrespective of his or her level of intelligence, to understand
the particular approach?
(Sir Howard Davies) Yes, and, of course, many people
will go through and take advice and there were advisers who were
advising people on the relative strengths and attractions of different
investment opportunities, and there is a whole advisory industry
to deal with this issue. The two questions you have to address
yourself to in this area are: is it possible to have a Prudential
regulatory system which is judgmental in this sense, and I personally
do not believe it is, and I do not think there is a country that
operates one that way; and, secondly, is it reasonable for a Prudential
regulatory system to calibrate its regulatory requirements at
such a high level that you eliminate the risk of failure, to which
my answer again is, no, I do not think you can do that because
at that point you have reduce the economic value of the whole
financial services industry. It would be possible for us to reduce
the risk of failure in a life insurance company to approaching
zero by requiring it to hold all its assets in gilt edged stock
or cash. It would then deliver a small negative annual return
probably, given the costs of the operation. As soon as you allow
companies to engage in taking on a risky portfolio of assets you
admit of some possibility of failure. The Prudential regulator's
reasonable objective, I think, is to minimise the incidence of
failure consistent with, as our legislation says, maintaining
competition, allowing innovation, delivering a cost benefit approach
to regulation. That is the essence of the judgment: have we made
that judgment appropriately? That is, I think, an area where reasonable
men and women may reasonably disagree, but I think that is the
territory and is not the territory of saying that there must be
some absolute guarantee, that being regulated by the FSA must
mean that it will not go bust. That I would strongly resist.
894. Can I ask a final question connected
with this? As you have explained it with total clarity it absolutely
made sense, but I am also, as I say, concerned about the ordinary,
perhaps untutored, investor, who perhaps might remain untutored
even after advice because advice of financial terms varies considerably
in quality in my experience. What do they actually receive? Again,
I do not want to go into the Equitable Life case as such, but
the author of this report mentions not merely what the FSA does
but the philosophy underlying it, which is that market forces
provide the best means of ensuring that an industry meets the
needs of its customers and that therefore the role of the regulator
should be a light touch, that he or she should not intervene with
any great power. Does that come across in what investors are told
also, that their false expectations might be based on the view
that they do not altogether have access to this particular philosophy
as well?
(Sir Howard Davies) I think the Parliamentary Ombudsman
was quoting from Government Ministers in the passage of the legislation,
so that was the instruction to us in terms of the type of regime
that we should be operating. Before we leave this point, it is
important to note that the regime does envisage a safety net and
there is one in the form of the Financial Services Compensation
Scheme, and so there is a safety net for bank deposits where you
get the first £2,000 100 per cent paid if the bank goes down,
plus 90 per cent of the next £35,000, and in the case of
life insurance companies there is a safety net through the compensation
scheme which will give people 90 per cent of guaranteed policy
values in the event that a company becomes insolvent. There is
similarly for the Investor Compensation Scheme (as was) a safety
net there if your advisor firm goes bust or your broker goes bust,
etc. This point has not been ignored. We have a system which is
calibrated to allow risk to be taken which we believe is economically
sensible, but which does provide a safety net, particularly for
small investors, for those who unfortunately happen to be in a
firm where that risk taking has got out of hand.
Lord Elton
895. I have a question on an earlier answer
you gave to Lord Morgan, which gave a picture of you having clearly
measurable standards which you apply before you authorise somebody
in terms of capital reserves etc. How do you actually assess the
fitness of the practitioners themselves to practise their knowledge
of the work that they have to do? Is there now a recognised qualification
in the various fields? How do you do it?
(Sir Howard Davies) The fitness and propriety
test is a combination. If I take you back to my explanation of
authorisation and permissions, it will depend quite significantly
upon the permissions you want and also your level in the firm,
but it will be a combination of both negative testing, ie, have
you got any county court judgments outstanding against you, and
that sort of thing, or any regulatory offences in the past, so
there is that kind of clearance mechanism, and there will in some
cases (though not all) be particular examination requirements.
There is not just one, Lord Elton. There are many. We approve
them. We are not an examination setting body but we approve the
curriculum content of different types of examinations. It is a
competitive market out there and there are different professional
bodies who will produce exams which will meet our requirements
in particular areas, and in some cases there is an experience
requirement. For particular serious senior jobs of overseeing
a whole trading floor, for example, we would expect to see that
person having had some experience of that business before they
get to that role.
896. My concern is more with the small IFAs.
Is there now any recognised qualification that somebody has to
have before they put a plate on their door and say they are authorised
in the sense that they have done the mathematical side of it?
(Sir Howard Davies) There are several that would meet
our requirements. They do have to have a recognised qualification,
yes, but it would not be just one which met our requirements.
We are in the middle of an examination review to look at whether
it would be possible to simplify the examination structure because
it is certainly fair to say that the average consumer is a little
bit puzzled by the letters after people's names which can mean
the same thing but there is a whole set of them. We have had a
positive response to that consultation, to the idea that there
should be a rationalisation, but we expect that rationalisation
to be led by the Financial Sector Skills Council. Our head of
education and training has in fact recently been transferred.
We have seconded him initially to become Chief Executive of the
Financial Sector Skills Council, which is an industry-run body
which will lead this review and, we hope, rationalisation of the
qualifications system. We do not think it is appropriate for the
FSA to set itself up as a kind of national examination board but
we have been promoting rationalisation.
897. Again, looking at the small practitioner,
I was a bit concerned when you answered Lord MacGregor because
you said something which gave me the impression that you really
only tended to pursue breaches where there were very large sums
involved. There was some sort of cost benefit analysis there,
but, of course, for the small investor the misconduct of a very
small firm can be a complete wipe-out. How do you oversee that
field and how do you decide in those circumstances what to pursue?
(Sir Howard Davies) We will always seek to pursue
compensation where we can. The issue I was talking about was whether
we then proceeded to go through the full disciplinary rigour and
also engaged in the fining process or whatever. In quite a number
of our enforcement actions, and this is what I was trying to convey,
we will identify a breach, the firm will say, "Oh dear, oh
dear, we will compensate the investor", and that is what
we will always go for—compensation for the investor. Then
the question will be, do we believe that this was a significantly
serious breach for it to justify the full glory of our disciplinary
process or was this essentially an accidental oversight which
the firm has now corrected and when we look at the systems we
think that they have improved their systems and no useful purpose
would be served by making an example of them in the fining point.
That is a judgment that we make, so we would always pursue compensation
but we would not always necessarily pursue the discipline of fines.
(Mr Whittaker) One particular context in which the
cost benefit analysis does arise in relation to payment of compensation
is that we have administered a pension review which has required
those who have been involved in mis-selling of personal pensions
to take the initiative in working out how much people have lost
as a result of that and to pay them back. Through that process
some £11.5 billion has been repaid to people who have been
mis-sold personal pensions. We have operated a cost benefit process
in deciding whether we should ever do that again and so, particularly
in relation to, for example, mortgage endowments, we have concluded
that the cost benefit analysis would not justify a similar exercise
in that case across the whole industry. If we were to conclude
that it would be justified then we would nevertheless need to
go back to the Treasury and get approval from them in order to
do such an exercise. That is, I think, the only context in which
a cost benefit analysis applies to individual compensation.
Chairman: Thank you very much. Sir Howard, you
have been extremely generous with your time this afternoon. I
am sure there are other questions we would like to have put to
you but we have covered quite a wide range and you have been very
full in your answers, for which we are extremely grateful. It
has been very helpful to us. Thank you very much.
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