LONDON, WEDNESDAY 1 DECEMBER 1999
Howard Davies
Chairman, Financial Services Authority, United Kingdom

I should begin by congratulating ProShare on another year’s sterling effort.

Perhaps the time will come when one needs to congratulate people on another year of Euro effort, but we are not quite there yet. And of course that also presupposes that there will still be a tiny little Euro left to join by the time we make up our minds.

But although ProShare has had another successful year, it has also suffered one great loss, but a loss which is the FSA’s gain. We were delighted that Gill Nott was able to join our Board, having left the Chief Executive position here. Gill’s experience in investor education, and indeed her experience in financial markets generally, is already proving to be a source of great strength to our Board. So I have to thank you for releasing her.

There is little doubt that, during its existence, ProShare has had a big impact on investment patterns in the UK. Twenty years ago the individual shareholder was on the verge of extinction. Like English cricketers today.

But, now, 27% of British adults hold stocks and shares directly. This is quite a respectable figure. In the US it is 43% and in Australia 40%. But then the Australians always beat us these days, at everything. In the EU our percentage is pretty high, though behind Sweden and Denmark who are both above 30%. France, however, is down at 10% and Germany at 7%.

Now of course we all know that it is not simply campaigning by ProShare which has delivered an increase in individual share ownership. Privatisation and demutualisation have been the two biggest stimuli. And we also know that, as yet, the individual shareholding habit is skin deep. Only a third of shareholders have ever bought a share through a broker and many existing shareholders have never sold a share at all, having received them only on privatisation or demutualisation.

I have to say, though, that I do not regard this as necessarily a bad thing – nor the fact that individual shareholders tend to keep their shares, on average, for around seven years.

When I was at business school I was indoctrinated in the efficient markets theory, and fully persuaded of the difficulty of stock selection and beating the market. We had it drummed into us at Stanford that what is known in the jargon as the "naïve, buy-hold strategy" is hard to beat, certainly once you take into account transaction costs and, perhaps, the costs of active fund management.

But individual share ownership is not of course the only, or even perhaps the best indication of whether people are making the best use of their financial resources, or making the best investment decisions. And of course we have to remember that many citizens have very modest resources whose allocation to distribute. Around half the population have liquid assets of less than £750.

There is plenty of evidence that many people are making poor, and in some cases very poor decisions about how to save. We cannot put together a comprehensive picture of the welfare loss involved, but there are many indicators available to us which suggest that it is considerable.

Even if we set aside the pensions mis-selling disaster, which we can only hope is a one-off episode, there are many other signs of poor selling practices, and indeed of very poor buying decisions. We can see from the persistency data published by the PIA over the years that some 30% of regular premium life insurance policies lapse within the first four years, resulting in an almost total loss of premium payments in many cases. Or take the fact that, still today, around a third of mortgages are sold with endowment policies attached, even though the tax treatment of endowment policies makes them quite unattractive for more than a small number of savers.

Or if one looks directly at consumer understanding of financial services and products, we can see that levels of consumer understanding are remarkably low. A survey last year found that one in five of those approaching retirement thought that when they drew their pension it would not be taxable, and a further third did not know whether it would be or not.

The same survey found that fewer than 40% of adults were aware of the link between the return on an endowment policy and the performance of the stock market. Or take the fact that over a million people entitled to free windfalls from the demutualised building societies over the last few years have not taken up the offer.

You have been working hard in the last few years, with modest resources, to make an impact on this problem. The Financial Services Authority is now, also, about to be tasked by Parliament with doing something about it. We have, as one of our four statutory objectives, the task of promoting public understanding of the financial system.

Unfortunately, there has been relatively little debate, whether in Parliament or elsewhere, about this objective. Far too much time, in my view, has been taken up in debating the finer points of our enforcement régime, which amounts to a very small part of the activity we undertake. Of course it is important that we have fair and defensible processes, as indeed I think we do. But from the point of view of the welfare of the majority of people in this country, the public understanding objective, and the consumer protection objectives, are far, far more important. Yet they have been given relatively little prominence so far.

When we began to consult people about how we should deliver against our public understanding aim, we did get a generally positive response, both from the usual suspects, if I might describe you as such, but also from many others in the industry, who could see some long-term attraction in a regulator working on consumer education, as well as on the harder edged aspects of regulation.

And, fortified by this generally positive response to our initial proposals, we have begun to work hard, with relatively modest resources so far.

We have established a busy consumer helpline service. We have developed a range of publications on the consumer website. We are working on the provision of comparative information – the league tables project, as it is generally known. We ran a very positive all-day workshop on Monday to try to take the debate forward.

We have also, and this is perhaps in the long run the most productive work we can do, been pressing for the inclusion of financial literacy as part of the curriculum in schools and colleges. I believe that, for the first time, Ministers are genuinely enthusiastic about this idea, and we were hugely encouraged, as I know ProShare were, by David Blunkett’s recent announcement. Gill Nott has also now been asked by the DfEE to produce guidance on the teaching of personal finance, which will be sent to all schools.

We are also working with the DTI to help develop courses for adults on consumer skills in personal finance. This will be tough, too. Adults are not a captive audience, for the most part, and we know from research carried out by NatWest, or should I say McNatWest, that it’s difficult to get them interested in educating themselves about personal finance. We will need your help in that endeavour. For many people the workplace is the natural place to learn and ProShare’s own research has shown that an employee’s motivation and interest typically increases as a result of participation in employee share schemes. Yet in spite of various different schemes introduced since the 70s the rate of employee share ownership here is still only half what it is in the US.

We can all hope, I am sure, that the government’s recent initiative increases this number significantly. But once encouraged to dip a toe into the market through an employee share scheme, the investor needs to understand the risks as well as the benefits of her choice. And buying shares, even in one’s own employer, needs to be made in the context of a coherent financial planning strategy. In the longer term, employees may well need to think about diversifying their risk, to ensure that their savings do not become overwhelmingly concentrated in their employers shares.

I know that those of you attending tonight, whether prize-winners or not, support the aims of ProShare and have worked hard to communicate effectively to your employees on the subject of employee share ownership. We look forward to working with you and to taking this further in the future.

The big, over-riding question we face at the FSA, however, is how much of our resources to devote to public understanding work, and indeed how to assess the benefit of that effort against other regulatory options we have. We will be saying something about how we propose to set that balance quite soon. And we have developed some new methodology which will help us.

But there is also a question of just how much we should spend, bearing in mind that all our financial resources come from the industry itself. Firms have been generally positive in principle about a consumer education effort on our part so far, but they have been very cautious about the amount of money we should spend.

In my view they have been too cautious. I think there is potentially a win-win strategy here for the regulator, the industry and the consumer, if we can get it right. We know that firms and industry associations have been thinking hard about how to promote investment, in a generic sense. Indeed the Association of Investment Trust Companies has already invested in an extensive campaign.

Some research we carried out suggested that only 28% of financial decision-makers people trusted trade bodies either completely, or a great deal, to provide accurate financial information. This was double the figure for financial product providers, and more than double the number of those who trusted the government, it has to be said. But it compares with 51% who trusted the FSA, or 55% who trusted advice agencies. If you add in those who trusted the FSA ‘a little’ – damning with faint praise, you might think, our total positive score was 78%.

Of course the FSA cannot go around marketing particular financial products. But we can provide the kind of generic advice on decision making which should allow consumers to be more comfortable about the choices they make. So there is potentially some useful work to be done with the industry, particularly when scandals and problems in the past have made people understandably nervous about long term investment options.

I think it is a good moment for us to think imaginatively about the way the industry and the regulator can work together, in the interests of consumers. We are moving into a very new environment, in which many of the products available to consumers are new and little understood.

We now have Individual Savings Accounts. They have not done badly so far, with more than double the amount saved in PEPs and TESSAs in the same quarter last year going into ISAs in the first quarter of this financial year. But much of the money is coming out of existing accounts, and if they are to achieve the government’s objective, then they will need to be far better understood than they are today.

In particular, there is evidence that consumers do not always understand the distinction between mini and maxi-ISAs. It is clear that some have mistakenly bought both, though we will only know for certain the extent of mis-buying when Inland Revenue figures are available next summer.

In the meantime it is up to firms to do everything they can to make sure that consumers know what they are buying. In particular, firms selling mini-ISAs need to make it clear that you can’t then open a maxi in the same tax year, and when selling maxi-ISAs they need to make it clear that if you already have an ISA of any kind you can’t buy one. If firms don’t make this clear, they can expect their customers to complain in numbers, and they will suffer reputational damage as a result. So it is in firms interests to beef up their internal training in this area.

There is also relatively little consumer understanding of the meaning of CAT standards, at this stage, which certainly need more promotion if they are going to become an important part of the scene, particularly for unsophisticated investors.

ISAs are not the only innovation which needs explanation to consumers. Around the corner are stakeholder pensions, whose properties, pros and cons will need a lot of explaining. And then there is the explosion of new offerings via the Internet. In many ways, that is very good news for consumers, since it will improve competition and cheapen delivery mechanisms considerably. But there may be some mis-selling and mis-buying along the way, as people experiment with a cornucopia of new product offerings available to them at the click of a mouse.

How should we best work with the financial services industry, using our new powers, to ensure a happy outcome from all these initiatives? I cannot say that I know the full answer yet. But I am sure that one part of it will be a rebalancing of our regulatory effort, towards work at the "front end", in other words work to improve the buying decision at the outset, rather than mopping up the consequences of mis-selling after the event.

But it will take an imaginative leap on the part of the industry, more imaginative than they have so far shown, for us to make this rebalancing work, in a way which genuinely benefits savers and investors.

We cannot achieve anything like what we want to in this area without full legislative backing, though. Which is why I very much hope that we will be able to see our Bill get Royal Assent by the spring of next year, so that we can really get moving.

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