Edinburgh
John Tiner
6th November 2003

Thank you Mike for inviting me to the annual dinner of the Scottish Financial Enterprise. In fact, I attended the dinner a number of years ago when Chris Patten, then Governor of Hong Kong, was the guest speaker. Indeed, Mike, I recall I was also seated at your table on that occasion and I enjoyed the evening very much. I am delighted to be back, this time on Table 24, the so called top table, although given what I have been reading by way of the warm up to this dinner in the Scotsman and Scotland on Sunday, I am not sure I shall enjoy it quite so much this time. But the one pre-requisite stipulated in the job advert for the Chief Executive of the FSA, was a leather clad skin and so, on reflection, I think I shall enjoy another fun packed dinner tonight.

During my five and a half weeks in the job, as Chief Executive there have been two themes to my work. Politics and Scotland. Politics because my Chairman and I have enjoyed a quiet little chat with the Treasury Select Committee and then last week I had the pleasure of meeting another group of MP’s to discuss financial services more generally. This was the day that Ian Duncan Smith announced he was calling a vote of confidence on his leadership. Now I know I may have become hard of hearing, but I was amused to find that the buzz going around Westminster that afternoon, was that the Tories were lining up the dream ticket of Howard-Davis! This week the theme has been Scotland. Dinner at your London home, The Caledonian Club, on Tuesday night and a taste of the real thing tonight. I am sure most of you here have frequented the Caledonian Club on many occasions, but I must say a visit to the gentleman’s toilet is a very worthwhile expedition. Please don’t get the wrong idea here. I am referring only to the cartoons that decorate the walls of the little boys’ room which, if your fellow diners are not aware of these, may make your long absence from the table seem rather odd, not to say worrying. My favourite was a JAK cartoon in 1990, the year in which Glasgow was the European city of culture. It demonstrates beautifully, the sophistication of the entire Scottish population. A homeless man is sitting on the ground outside the railway station saying to passers by “Hey Jimmy! can ye spare a fiver for a wee drop of Chateau La Tour 59”.

Now Scotland has always been in the vanguard of forces for good in the world and this was never more so the case, as when god created the earth. God called the first Scotsman before him and told him that he was sorry. And when the Scotsman asked why, god showed him Scotland.

He showed him the beauty of the locks, from the tranquillity of Loch Lomond to the mysterious depths of Lochness. He took him to the Highland mountains and through the Great Glen. And from the rugged islands of the outer Hebrides to the rolling pentland hills. And he took that first Scotsman to Speyside, to Edradour, in fact, and shared with him a certain magical drink.

And after this the first Scotsman was even more confused.

“But I don’t understand why you want to apologise” he said. “You have given the Scots the most perfect home on earth”.

“Ah yes” said god. “But wait until you meet the neighbours”.

Before I start talking about matters economic, financial and regulatory, I could not leave this evening without saying something about the sporting calendar over the next few weeks, starting this weekend. I am not speaking here about Leeds United’s march up the English premiership once Martin O’Neill takes over as manager, but the four matches being played down under this weekend with the oval shaped ball. I can imagine that every Scotsman and Scotswoman will be cheering their hearts out for their Celtic cousins, the Welsh, against the English on Sunday morning. But I can assure you that down South we will be praying for miracles on Saturday morning in a win for our dear northerly neighbours against those nice, charming and good natured Wallaby’s.

Speaking now, more seriously, as one of your neighbours, I think I can confidently say that if envious glances are being stolen across the border these days, it is not simply because of the beauty of the land. The Scottish Financial Services Industry is one of the largest and most successful in Europe. Its importance to the Scottish economy cannot be overstated. The industry contributes roughly 8% of GDP and provides one in ten jobs, either directly or through support activities. An estimate has this figure growing by a quarter in the next three years. Just seven financial services companies accounted for nearly half of the turnover of the top 250 companies in Scotland, in 2002. These are now world recognised companies, whose influence spreads far beyond the borders of your country and beyond the shores of the United Kingdom.

But this isn’t just a story about big business. The industry boasts more than 400 companies embracing an impressive array of brokers, dealers and independent financial advisers, with a strong commitment to serving small companies and private investors. Scotland is also a leader in the development of telephone banking, electronic brokerage and supermarket banking.

Edinburgh is one of the ten largest European centres for banking, life and pensions and investment management, as well as being home to the headquarters of two of the six major banks in the UK. And around 40% of UK corporate structured finance is handled by Scotland’s clearing banks.

Scotland can also boast one of the world’s major fund management centres with over £300 billion of assets under management. It is favoured by many overseas investors for its independence, cost efficiency and specialist expertise. Many of your managers are also known for taking prudential care of their clients interests.

And, speaking of prudence, one cannot ignore the importance of the insurance sector. Scottish based life assurance offices have around £250 billion of funds under management, and the three largest (Standard Life, Scottish Widows and Scottish Equitable) are each in the UK top five insurers by market share.

Putting all this together, one can see that the financial services industry here is a major contributor to the economic well-being of the United Kingdom as a whole. And prospects for Scotland’s financial services industry also look good. Since 1995 the sector has grown an astonishing 57% - nearly five times that of the overall Scottish economy and twice that of the UK financial services industry. And this during one of the major market downturns of all time.

One reason for this is that business skills in the education system in Scotland are second to none, something that the new FSA financial capability steering group will undoubtedly be looking to harness in conjunction with the Scottish Executive, Scottish business, educationalists and voluntary organisations.

I am afraid that whether you like it or not, regulation has become an important factor in the marketplace. This is to some extent inevitable, when you consider the regulator has a statutory obligation to maintain market confidence, to protect consumers, to promote understanding of the financial system, and to fight financial crime. We at the FSA capture these in an overall strategic aim to maintain fair, orderly and clean markets and to help retail consumers achieve a fair deal. But it is nonsense to suggest that the FSA runs any sector, let alone any business. Indeed, to even suggest that shows an abject failure to appreciate what is at the heart of the regulatory system in this country – the role and responsibilities of firms’ senior management. To take this further, I would say we will be looking increasingly to harness the positive forces in the market, by being a principled based regulator and cutting out rules which do not add value. This concerns some senior managers, who on the one hand appreciate the operating flexibility that comes with this approach, but on the other hand are worried by the reduction in the safe harbour provided by detailed, prescriptive rules.

We also have a duty to consider that competition, innovation and international competitiveness are not hampered by inappropriate or disproportionate regulation. With capital, people and technology becoming increasingly mobile and the competitive field of play knowing few boundaries, I well understand the importance the industry attaches to these issues. It is incumbent upon us to consider not only the benefits of any policy proposals we make, but also the cost to the industry, and this is one of the key areas we will be looking at as part of HM Treasury’s two year review of the Financial Services and Markets Act. We will also be reviewing another important aspect, and I know one close to your hearts, that being the relationship between the Financial Services Authority and the Financial Ombudsman Service.

So far, the FSA has issued 205 Consultation Papers. In my speech at the Mansion House on my second day of my new job, I said I planned to halve the number of consultation papers in 2004/5 compared to 2003/4. On the basis that small gestures can have big impacts, I shall be putting on the wall in a prominent place in the FSA office, a chart which will allow everyone to see how we are planning to meet this target and how we are doing. I will be looking at it as I walk to my workstation each day I am in the office. It is clear to me that we need to give the industry, its customers and indeed our own staff, time to get used to the rules and to focus on ensuring compliance with them.

But it is also important to remember that a large number of regulatory initiatives do not come from Canary Wharf or Whitehall but from the international arena, and in particular the European Union. The financial services industry faces, over the period of 2004 – 2008, the task of implementing more than fourteen major EU legislative measures, including International Accounting Standards Regulation and directives such as Distance Marketing, Insurance Mediation, Financial Conglomerates and Investment Services. The way all of these initiatives are implemented is obviously of vital importance. One of the terms I often hear from the industry is “gold plating” and I don’t think they are referring to ornaments on my desk. This is an issue we are alive to and is something we need to avoid, where an overwhelmingly strong case cannot be made for doing more than is required. But I would remind you that we have a legal obligation to implement directives and we need to work together with the industry to make sure this happens.

I could now go on to talk about de-polarisation, Basel 2, life insurance capital, execution only business, training and competence, mortgage regulation and so on. But I fear, no in fact, I am certain, that I would end up speaking to an empty room. But if you would bear with me for a couple of minutes more I do want to close on one issue that has an impact across the industry, from brokers to asset managers and investment banks to boutique research houses. That is the question of bundled brokerage and soft commission. To those train spotters among you, this issue has become known as CP176 and has certainly sparked some controversy.

It is widely recognised that fund managers have potential conflicts of interest. We realise that many people agree with our view, that soft commission and bundled brokerage arrangements lack transparency, particularly with regard to costs, and that fund managers are not properly accountable to their clients. To quote the Chief Executive of the National Association of Pension Funds, my former colleague, Christine Farnish:

“At present many pension funds and other investors are made to pay for unwanted, sometimes unknown services about which they are not consulted. Even if no savings result from any change of practice, the requirement that those who pay for something should know what they are buying, should be one which is welcomed as right and proper in a free market”.

Some people would stop there and challenge our analysis of the strength of the incentives that may influence fund managers’ decisions. They believe that market forces can exert adequate controls, and that transparency and accountability for clients can be delivered through market driven initiatives.

At the other end of the scale, some people fully endorse our concerns and tell us that bundling and soft commissions are malign practices, indicating deep rooted and fundamental conflicts of interest which are not being managed effectively.

In between these irreconcilably contradicting views, there seems to be broad support for dealing with inconsistencies in the current system, especially if the providers of independent investment research are put on a level playing field with providers of bundled research. Some are concerned that paying separately for research might reduce supply to investment managers, though others believe there is already over supply in the research market, which transparent pricing may help to address. Most agree that investment managers should focus on getting the right amount of high quality research, whether from brokers or third parties. This leads me to the question of whether unbundling is feasible or necessary. We didn’t say in CP176 that it would be compulsory. We said we would leave it to market forces to determine. Some fund managers tell us that they cannot successfully pressure brokers to cost out their services. There again, some major brokers tell us that they can separate their spending on trade execution from that on investment research. They point to “step outs”, or “commission sharing” arrangements as evidence that market forces are already moving in this direction.

Such arrangements are not in principle banned by the existing soft commission regime, though some may argue they are a form of softing. If the result is better trading performance and a healthy independent research sector, there could be real benefits for clients. So these arrangements could be seen in the words of the NAPF, as “less pernicious”. It is not yet clear whether there can be a solution to all of the conflicts of interest we are concerned with. Many people have made the point that commission arrangements cannot be divorced from a broader consideration of how transaction costs are managed. Low rates of commission are not the end in themselves, as poor execution or quality may counteract any benefit from the savings. This is an issue we recognised in our work last year on best execution.

It seems to me that a consensus is emerging that softing and bundling do not operate in the best interests of clients. Where costs are opaque and there is an increased risk of conflicts of interest, our approach will be to enhance transparency and accountability, with the aim of facilitating the working of market forces. This, as I have said before and will repeat here again, is the best route to an efficient regulatory system.

We must now carefully assess the responses we have received to our consultation and take a considered view on the international developments – not least on sensible expectations for the timing of change on each side of the Atlantic. Then we can judge what regulatory change is justified, and how it might be phased in. We need workable solutions that do not undermine the competitiveness of UK based fund management. As I told the Treasury Select Committee two weeks ago, we are commissioning some further research of our own on the implications of our proposals for the international competitiveness of the UK market.

I have heard it said that the removal of softing and bundling would be the second big bang, some 16 years after the first. I must confess to being rather bemused by those who, on one hand say it is going to change fundamentally the financial services market in the UK and drive significant volumes of business elsewhere, with on the other hand the concern that we should not be tackling the softing and bundling issue at all, as the costs in proportion to other dealing costs are so insignificant. We will be outlining our intentions on softing and unbundling in the first quarter of the new year. In the meantime, I have no doubt that the debate will rage on.

I realise Mr Chairman that it was suggested in the Scrutineer Column of the Scotsman I should probably close my remarks with a toast to absent friends. But instead I will close on a more positive note by wishing the Scottish Financial Enterprise and its member companies continued success in delivering quality service to your customers, a rewarding career to your people and returns to your shareholders and members.

Thank you.

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