Questions answered on the day
21 July 2005
Sir Callum McCarthy
We will now move on to the question and answer session.
John Donachie, Fairfield Greenwich (UK) Ltd
Why is the American Securities Exchange Commission (SEC) allowed to regulate UK hedge fund managers? Is the UK not the sole responsibility of the FSA?
Sir Callum McCarthy
I wish life were so simple. I will ask Hector Sants to give you the detailed answer.
Hector Sants, Managing Director, Wholesale and Institutional Markets, FSA
As you rightly observe, there is a difference in approach between the SEC and the FSA. Our approach to authorisation under the Financial Services and Markets Act (FSMA) in particular focuses on the UK location of the firm in question. In the US context, I am afraid the SEC looks at the nationality of the client, therefore under its jurisdiction its rules are able to reach out to those fund managers located here in the UK, who have US clients. I would, however, reassure you that we do seek to have a good dialogue with the SEC and certainly, if they were visiting fund managers here in the UK, we would expect that to occur on a co ordinated basis with the FSA, to ensure there was no unnecessary duplication.
I will just take the opportunity to make the more general point that hedge funds are an important and growing asset class and we are out there at the moment taking opinions on a number of important topics. We certainly welcome input in that area.
David Wigan, Reuters
Following up on the hedge fund point, in respect of the report you published in June with regard to issues such as transparency, I was wondering under what circumstances you envisage further regulation of hedge funds in the UK or offshore funds with UK based managers?
Sir Callum McCarthy
We have set out the issues involved in relation to hedge fund managers in some detail in a discussion paper. It is not an issue about actual hedge funds, who tend to be located offshore for tax reasons, but principally of hedge fund managers. The paper discussed the issues that were raised. We were conscious that, to some extent, it would not be effective to simply set up a regulatory regime for hedge fund managers that was so burdensome that it merely had the effect of driving them off to other less regulated jurisdictions. I think the arguments were clearly established in that paper and I do not think there have been any developments since publication of that paper.
Hector Sants
Echoing Callum’s point, it is not our intention to encourage hedge fund managers to remove themselves from the UK. The purpose of the discussion paper was to open up a dialogue with them to ensure that, if we were to consider any actions, they would be well supported and would be mindful of the point Callum made.
Peter Blackburn
How can the consumer public have any confidence at all in the FSA’s function as a consumer protection body, when it seems to be more concerned with protecting the financial services industry from the consequences of any wrongdoing than in protecting the consumer? In the case of Equitable Life, independent financial advisers were, I understand, warned by the FSA not to alert consumers to the fact that the company was financially unsound.
Ann Abraham, the Parliamentary Ombudsman, has revealed that following the House of Lords judgement, the FSA did not put a health warning on Equitable products, as this might have inhibited the sale of the society to another life assurance company as an ongoing concern and desirable acquisition. As a result of this, thousands more new policyholders were entrapped into buying products from a financially unsound company, many of them into irrevocable, with profits annuity contracts through which they are now being bled to a slow, financial death.
Equitable Life has broken its contract with people holding with profits annuities by illegally changing the terms of the annuities after purchase, something the investor is not allowed to do. Investors were promised by the sales people that their money would be invested in managed, mixed asset funds such as equities, property, fixed interest securities and cash, particularly equities. The society invested the fund, instead, almost entirely in fixed interest securities. The FSA has taken no action.
As far as we know in every case where Equitable Life has been accused in court as selling its policies through misrepresentation, the claims have been upheld, but these cases have been settled out of court under secret gagging orders. This means that only policy holders who have received justice are those who have been rich, literate or knowledgeable enough to pursue their case in court. In essence, small investors who read the advertisements and placed their limited life savings with Equitable have been trampled underfoot and the FSA has done nothing to protect them or to seek compensation for them. I would like to know what the FSA has to say about this.
Sir Callum McCarthy
Thank you, could I just make one general point before I ask Clive Briault to respond? I absolutely refute the implication in the question that the FSA elevates the interests of the providers of financial services over the users and consumers of financial services. That is not the case. We are bound by our statutory duties and seek to interpret them absolutely to the best of our abilities, often in difficult circumstances. I want to make it clear that the starting point of your question is one that the FSA does not accept. Having said that, Clive, do you want to deal with any of the particular points?
Clive Briault, Managing Director, Retail Markets, FSA
I think there a number of questions interrelated in the general set of comments made at the outset. Let me try to answer some of them. Callum has already effectively answered the first one, which is that we absolutely do not accept that we are more concerned with protecting the financial services industry than the consumer. We focus our efforts on the areas that pose the greatest threat to our statutory objectives, including the objective of consumer protection.
Picking up on the various detailed points, first, what we warned financial advisers about was that it was important they should note the costs, as well as any potential benefits, of switching out of Equitable products to other products. Second, it is probably not appropriate for us to comment on the first part of the enquiry by the Parliamentary ombudsman. Her second enquiry is underway and will, among other things, review the findings of the first enquiry. Obviously, we await the outcome of that with interest. It is, however, the case that within the first enquiry, the ombudsman did state the following conclusion, ‘I do not consider that the FSA’s decision not to require Equitable to make a disclosure about its financial position to have been maladministrative.’ In short, the Parliamentary ombudsman rejected that particular aspect of the complaint.
The third point I will make is that the FSA does not prescribe the investment components of a with profits fund, including that providing annuities. That is very much up to the individual firm to decide on its own strategy. It is not uncommon for firms to decide, and indeed a number have done so, that the strategy providing the greatest protection for policyholders is to reduce the risk of investments and to increase the proportion of the fund held in fixed interest securities. It is also important to understand that an annuity fund generally needs to maintain a higher proportion of lower risk, liquid investments, because it is making regular payments out to policyholders.
We have, however, introduced some changes that will benefit policyholders, firstly in terms of the capital adequacy requirements on life companies, and secondly the requirement for all firms to produce a document outlining what we call the Principles and Practices of Financial Management for each with profit fund. That document is available to all policyholders and firms are required to review it regularly and inform their customers of any changes in the principles underlying their investments.
The final point is that if policyholders wish to complain about any aspect of the way in which the firm has dealt with them, including any allegations of mis-selling, they should clearly complain in the first instance to the firm and then, if they are not satisfied, they have the right to send that complaint on to the completely independent Financial Ombudsman Service, which is free of charge to any potential complainant.
Participant 1
You are too slow in protecting the consumer: I am referring to three matters – precipice bonds, endowment mortgages, about which you finally got round to do something, but the damage had already been done, and independent financial advisers. You know perfectly well that IFAs are not fully independent. They often recommend what brings them most benefit. I advise all my friends not to trust them without crosschecking. I have experienced it myself. I would like to have your reply to that, please.
Sir Callum McCarthy
We are concerned with establishing the appropriate degree of consumer protection. We have increased the resources that we are spending on identifying practices, which are likely to lead to abuse. We are increasing the amount of resources devoted to financial promotions to establish which ones are likely to lead to consumer detriment and will continue to do so. We are concerned to establish the independence or otherwise of people giving advice and to ensure that, when advice is given, it takes account of the requirements of the customer and the ‘know your customer’ requirements.
In a whole variety of ways we are aiming to deal with the problems about which you are properly concerned. The only other point I would make is to say that I think most of the abuse, the original problem in terms of endowment mortgages, predates the foundation of the FSA. We have been particularly careful and concerned to try to establish appropriate measures of redress for people who were mis-sold, as opposed to those people who simply made bad investment decisions. I can assure you that we are concerned to ensure that we act promptly and appropriately to stop abuses that lead to consumer detriment.
Clive Briault
One thing I might add to that is to note the way that we have recently tried to respond more quickly to problems before they become widespread. For example, we issued a warning on venture capital trusts at the turn of the year, saying that in our view there was a risk of these being mis-sold and poorly promoted to people for whom they may not be suitable. That was certainly effective as far as we can see in reducing such instances. A second area on which we moved as soon as we took on responsibility for mortgage advice was equity release, where again we did some mystery shopping and some examination in detail of advice given by financial advisers.
In both those cases we found some serious and significant failings and we acted promptly with a press release and a paper to bring those to general attention and by pursuing failings with the firms concerned, including one firm that has been referred to enforcement as a result. I think, therefore, that it is important to note that there are now some areas, where we are trying to be actively involved from the outset, when we see such problems arising and try to nip them in the bud.
Ann Foster
I cannot respond on the issue you have raised about independent financial advisers, because I think it is for them to respond and not me, but I would like to say that one of the priorities for the Panel is to ensure that the FSA is more fleet of foot in warning consumers when there are genuine risks appearing in the marketplace. I think the instances that Clive has given of venture capital trusts and equity release products are the same. I think it is extremely important for the FSA to warn consumers promptly when they see any kind of scam arising and to make sure that they get a single message across to consumers, which is that they should deal with an authorised business, so that they have recourse to redress if things go wrong.
The FSA always claims to be a proportionate regulator. The Panel is not proportionate in that sense of the word and we are quite proud of that. We actually think that individual consumers do matter, even though they may be small in number and the amount of money they may have lost is terribly important to them, even though it may look a small amount on the general scale of things. We are, therefore, absolutely adamant that safety nets should be in place for casualties of failure. It is extremely important.
Sir Adam Ridley, London Investment Banking Association
Could I return to a familiar theme for many of us, which is the burden of consultation on firms and trade associations alike? You have taken very effective steps with your colleagues to reduce the burden, which the FSA imposes on us, but there are still big problems on the international front. There are difficulties when the same theme is under consultation by several different organisations and there are real problems when the timetables become totally unrealistic. You are only one of many important regulators. If one takes European bodies like the Committee of European Banking Supervisors (CEBS), the Committee of European Insurance and Occupational Pensions Scheme Supervisors (CEIOPS) or the Committee of European Securities Regulators (CESR), there is clearly a big voice for major countries in determining the timetable to the extent that the politicians give you any latitude. On the international side, therefore, can you do a bit more to help us there?
Domestically, there are other practical issues that are a bit more within your control. Firstly, trade association staffs and member firms, like officials, go on holidays particularly in the summer. It would be nice if we could be given credit for that fact and not all be tied to our desks, year after year, from mid July to mid September. That is threatening us this year, for example, as CEBS is giving us no fewer than five simultaneous consultations.
In addition to that, the three month minimum, to which, effectively, you have increasingly stuck, looks too little for the bigger consultations. There are some very hefty ones looming, so, where possible, could we ask for a little more time, rather than a little less, even when allowing for holidays?
Sir Callum McCarthy
I will make two introductory comments. One is that, as your question acknowledged, a lot of the timetable decisions about which you are complaining are ones that are outside our control. I would say, however, that the first public comments I made on coming to this job were about the timetables of European initiatives and the need to spread them. Secondly, the FSA was in the vanguard in persuading the Commission that they had to readjust the timetable for the Markets in Financial Instruments Directive, which they have done. I confess that I am now greatly concerned that that additional time may be taken up by additional consideration by the Commission, rather than greater opportunity for the industry and consumers to adjust to the changes that will come. I am, however, very sympathetic to the points you make, provided you understand the extent of our responsibilities and influence.
Hector Sants
We are strong supporters of the importance and desirability of active consultation processes. On the international front, I think you are already aware from last year’s discussion on this point, that we have been very instrumental in ensuring that the International Organisation of Securities Commissions (IOSCO) has now introduced a proper consultation process and that is now going forward. I think that should be effective. As you have indicated, clearly there are some limitations on the EU side, but we do continue to support pressure on the Commission to improve consultation processes. Clive may, in a moment, want to say a word on the CEBS specific point.
On the domestic side we seek to have effective consultation processes and look pragmatically at having the right timeline, which is mindful of issues such as holiday seasons, for those initiatives where we are in control of the process. In addition to that, I would like to emphasise that in terms of style, we are trying to make the formal consultation process part of a wider consultation engagement with the industry. We have sought to set up mechanisms in areas such as the Capital Requirements Directive (CRD), where we have a lot of working groups engaging with the industry. Where we have initiatives specifically within our own control, such as the hedge fund discussion, we have sought to bring forward discussion papers (DPs) to enable a good exchange of views prior to the consultation paper (CP). In a perfect world, therefore, there would be very little in the CP that had not already been widely discussed. That style of constant interaction needs to be borne in mind when looking at the specifics of the consultation period, but we are, nevertheless, sympathetic to everything you have said.
Clive Briault
I would like to add a couple of words about the Committee of European Banking Supervisors. You are absolutely right that there has been an absolute wave of consultation papers from that institution, but that is partly because it is something into which the industry was keen to have an input and about which they wanted to be consulted. It is also partly because the timetable has been somewhat constrained partly because CEBS is itself a fairly young institution, which has only been up and running for 18 months. Secondly, the Capital Requirements Directive itself needed to get to a reasonably firm state, and it is still not of course completely firm, before it is possible to consult on what we call Level 3 areas of work, namely the way in which supervisors across Europe are going to implement the directive, rather than simply what is stated on the face of it.
I would, however, say that the UK voice on CEBS, namely myself, has been active. First, we have encouraged CEBS to set up its own consultative panel, including industry representatives and members of European consumer bodies. Second, very much taking your earlier comments to heart about the summer holiday period, one of the CPs, I think the longest one, which emanated from one of the CEBS committees, which I chair, has a four month consultation period over the summer. The other one from the same group would have had a four month consultation period, except the people to whom it is primarily addressed, namely the external closed assessment institutions asked specifically for the consultation period to be shortened, because they wanted to get on with planning. They, therefore, wanted the supervisors to agree post consultation what the application process was going to look like.
I do just want to assure you that the points which have been made domestically in the UK, we are trying to carry across as far as possible to the European context. Equally, I should say in that context, that some of our colleagues in countries other than the UK are rather less familiar with the consultative process than we are, having issued rather fewer consultation papers than the FSA has had the pleasure of doing over the last five or six years.
Peter Free, P R Free
Ann Foster gave a very good précis of the work done by the Consumer Panel last year and she highlighted the importance of the industry explaining to consumers the concept of risk. I wonder if it is possible for somebody on the panel could explain to me, as a consumer, what your definition of risk is. My own perception is that it depends on whether you are buying or selling. Also, assuming that you can get the concept of what risk is over to me, can you explain how, by getting a number of illustrations from different investment companies, it may assist me in choosing with which investment company to put my money.
In addition, Clive Briault said that, at the beginning of the year, you were highlighting the risks with venture capital trusts. Risk and rewards are important when you give this definition of what risk could be. I feel that it is important that the FSA put certain products outside the remit of compensation for investors. For instance, I think venture capital trusts are an important addition to some people’s portfolios, but they are few and far between. Those people are fairly sophisticated in the investment choices they make and do not deserve to be able to come back and say they have lost money. They have simply made an inappropriate investment choice. I have had made many myself and I do not expect to be compensated. The thing is that, if we always have the compensation culture on products, it restricts the sort of products that are being offered on the High Street. Risk and reward is the essence of how one makes money and it is important that that issue is got over to clients. They cannot have it both ways.
I highlighted the risk with precipice bonds to the FSA. You should have stopped the sale of them to many people. You cannot, however, have it both ways. People have bought those products on the greed scenario of getting a return substantially above the building society. I do not think it is fair that they should then go and say they want their money back.
Sir Callum McCarthy
Could I make it quite clear that the principle on which we operate is not that people who have made bad investment decisions deserve compensation. The principle is that people have been mis sold if the risk has not been explained to them; if the requirements of ‘know your customer’ have not been followed. There may or may not be a case for compensation, but there is certainly not a case for compensation on the basis that people understood the risks and took a decision, which turned out to be bad.
One of the concerns that we have in the FSA is to ensure that people do understand that reward and risk are inextricably related. I think we agree with you on all of those things.
Peter Free, P R Free
I would like to come back to you on that. On the issue of endowments, there are plenty of people out there at the moment, seeking compensation, with no grounds at all, in the sense that perhaps they should not have bought the product in the first place, but they are merely jumping on a bandwagon. There are companies out there at the moment, to whom you only have to write and they pay compensation. You are saying one thing, but in practice an entirely different thing is happening. The public have a perception that it is a compensation culture and I do not think that is right. They cannot have it both ways.
Sir Callum McCarthy
This is a conversation that we should stop, as both sides are in violent agreement.
Peter Free, P R Free
You are in a position to do something about it and you are not. I am not in a position to do anything about it.
Sir Callum McCarthy
Can we go to another question?
I do not think any member of the panel is going to accept the invitation to define risk in general terms.
Clive Briault
I do not mind answering the question. I think what is really important about risk and the way I would define risk in this context, is explaining very clearly to the potential consumer what the product is and what might or might not happen. I think it is less a question of what the technical aspects of risk are and more about asking ourselves the question, either as consumers or providers of a product, is it the case that the consumer really understands the risks involved. Clearly, the nature of the risk will change considerably depending on the nature of the product, but it is important the consumer understands it, even if they are buying something that they might perceive as having no risk. It may not be completely without risk.
If you take, for example, a bank or building society deposit, there is always a risk that the provider of the deposit may fail, in which case the consumer has recourse to the Financial Services Compensation Scheme. The consumer is running a risk in that context. The consumer may also be running a risk in that context if we had a return, and I hope we do not, to the very high inflation scenario that we had in the 1970s, for example, there is a potential risk there about what happens to the real value of the nominal investment in that product. The question is, can the consumer understand and does the product provider help the consumer to understand the nature of the product and what might happen on both the upside and the downside. That, I think, is the absolutely key requirement.
David Kenmir, Managing Director, Regulatory Services
Can I also deal with your point about the compensation culture? We are often accused of acting or trying to act outside our powers, which we do not. Many of the firms to which you are referring, who advertise services to try to get redress for consumers on endowment mortgages, are not regulated. We, therefore, do not, contrary to your suggestion, have jurisdiction over them. We also cannot intervene over individual consumer rights, if they choose to pursue redress that way.
We have however pointed out that the Financial Ombudsman Service is free to consumers. These commercial services often charge up to 40% of any redress consumers may get.
Sir Callum McCarthy
This is a protracted discussion, which I am going to ask the speaker to continue later. It all centres on issues raised about the difference between bad decisions and people not having the risk properly explained to them at the time that they make that decision. That is the centre of the discussion.
John Muldoon, The Porchester Group Ltd
I am a director of a smaller firm and also chair of a large money advice charity. My question is about equity release, lifetime mortgages. I suspect many consumers think these will be the solution to defeating poverty in old age. I was very concerned at a trade road show a few weeks ago to hear the FSA spokesperson acknowledge that the interaction between released assets and benefit entitlement was very complex. He then advised authorised firms to send their clients down to the local Citizens Advice Bureau (CAB) to get advice on benefit entitlement. Can you confirm that it is not the FSA expectation that charities should act as unpaid paraplanners for authorised firms and that the FSA does expect all individuals in authorised firms to be adequately trained and knowledgeable about benefit entitlement?
Clive Briault
The answer is quite simply, yes. I think if a firm is giving advice on equity release products and one of the important aspects on suitability of that product to a particular consumer is the interaction between taking out equity release and any benefit entitlements, then I think it is important that the adviser does indeed take that into account.
Anita Millar, ADM Risk Regulation and Strategy
Earlier this week I attended an open forum in Brussels about the future of European financial services policy. Many of the issues that are being discussed today were also discussed at that forum on the asset management industry and consumer protection, but I keep hearing one theme: the issue of better regulation and, related to that, better supervision. What strikes me is that on the EU side, we hear about the lack of transposition of EU directives and gold plating, for which the UK has had a particular reputation, but on this side the impression is given that EU directives come out of nowhere. Of course, they do not come out of nowhere and the FSA does have a say in the development of that regulation. What I do see, however, is a lack of a common objective set, a shared idea at both the EU and UK levels of what good regulation is.
The FSA does have a set of statutory objectives – financial crime, clean markets and market confidence among them. I do not know to what extent those are shared at the EU level and what those EU objectives are. What work is going to be done to streamline the process, so there is less gold plating in the UK and better regulation at the EU level?
Sir Callum McCarthy
I think that divides into two questions. One is: do we implement whatever comes out of the European process? Second: what can be done to make those European decisions more in line with our thinking? The first point I would make is the decisions on directives are made by governments, not the FSA. You say, quite correctly, that we involve ourselves as fully as we can in trying to influence those, but we are not the decision maker.
There are some wider questions about how we use our influence to help develop good regulations within Europe, where I think there are two particular issues. One is that it is extremely important that when proposals come forward, they should be subject to some form of regulatory impact assessment or cost benefit analysis. This is something that only a minority of national regulators have within Europe, although I am glad to say this is an increasing minority and we are strongly encouraging that among the community of regulators. We are also strongly supporting Commissioner McCreevy, who has expressed his determination to do that in future.
There are also some questions again in terms of how you establish a level of regulation, which is comparable in different member states. Up until now, the various committees of banking, securities and insurance regulators have had their work dominated by the legislative programme that came out of the Financial Service Action Plan, but we now have an opportunity to turn to other questions of implementation and spreading best practice and establishing training between regulators. We will continue to invest quite considerable resources on that.
Hector Sants
I would just like to pick up on your use of the phrase ‘gold plating’. We have made it very clear that we do not seek to gold plate. We do occasionally exercise super equivalence to retain particular rules and regulations, which were already in place in the UK and where we think that is justified on a cost benefit analysis (CBA) basis. An example of that is in the Listing Prospectus Directive, where we retained certain elements such as track record, which was very much in response to industry consultation and support. Where we believe the quality of the marketplace benefits from the retention of those rules we will so do. We would certainly not gold plate without such justification.
Joe Egerton, CLC
We have again heard a plea for principle based regulation and a reduction in detailed regulation. I totally support the FSA’s activities there. It strikes me, however, that that involves a heavy involvement on the part of the industry, which is not always being met, to ensure that everybody understands what acting with integrity and acting fairly means.
A couple of years ago I was asked to manage the appraisal and training programme for a pretty substantial firm connected with general insurance broking. I suggested the progressive introduction of measures to focus on the FSA principles. I suggested as stage one that the appraisal forms should be amended to include the simple question, ‘Has this individual invariably been truthful in dealing with clients, colleagues and other people in the market?’
All these suggestions were rejected and the suggestion about what I thought was a fairly simple question to begin to probe integrity came back with the words, ‘Somebody said, what is truth?’ A number of you will know that the person who asked that question was Pontius Pilate. It does seem to me that the industry does need to make a much more positive effort, because it does seem to me that, on this matter, the FSA is actually doing its best.
Sir Callum McCarthy
Thank you very much, although I am not quite sure what the question is. I would say that one of the issues I tried to illuminate in my opening remarks is how do we actually make a principles based regime more effective and more acceptable to the people it bites on. So far, the response from companies and trade associations to the question, ‘What are the detailed rules we can eliminate and replace with principles?’ has been rather disappointing and we would undoubtedly like to go further in that direction.
Bryan Brown
I am a chartered accountant in practice and I am not in the financial services industry. I am asking my question as a consumer. My question covers three of the points you made in your speech this morning, where you said the FSA takes its responsibilities seriously; it helps retail consumers get a fair deal and I noted the phrase regulatory initiatives. It relates to the unfair terms in the Consumer Contracts Regulations 1999. I am sure all the service providers here today will know about this.
I had a Mini Cash Independent Savings Account (ISA), which was for a fixed period of one year. I closed it 40 days before the end of the one year. I was told they would charge me a penalty equal to 180 days interest. That penalty did not change whether I had closed the account one day after I had opened it or one day before the year was up.
I said this was unfair as covered by the regulations. A pantomime of ‘oh yes it is’ and ‘oh no it is not’ then ensued. They charged me the penalty and I said that if they did not pay it back, I would make a claim through the courts. They did not give the penalty back and I made my claim through the courts. Sadly they gave me my money back. This is the seventh time I have made a claim through the courts under the regulations and each time, boringly, the financial institution caved in and gave me my money back. I have written to the FSA about this and I wonder whether the Unfair Contracts Department of the FSA is actually doing its work properly.
Clive Briault
I can assure you that we are indeed doing our work properly. We published a paper earlier this year on our responsibilities under the terms of the unfair contracts regulation, where we pointed out what it was in the terms of a contract that might make it unfair. This was that either the term was absolutely unfair, because it was an abuse of the relative position of the product provider and the consumer, or unfair in the sense that the terms were not made clear to the consumer at the outset or used in a way during the life of the contract, which again was not clear to the consumer.
We have also taken action in a number of cases, with respect to both insurance firms and some deposit takers to ensure that they do not use contract terms that we judge to be unfair under the regulations. We have published on our website some voluntary undertakings by those firms not to use those terms in an unfair way, so we have been active in this area and we have taken action. I am not aware that we have taken action in the specific case that you raise, but it would probably be unfair for me to comment on that, because I do not have detailed knowledge of it. We are, however, I assure you, active in this area.
Simon Whittaker, Mortgages for Business Ltd
I am the director of a mortgage broker. All of the panel members have put a lot of emphasis on the costs of regulation and how much of it is being forced on the FSA by European Union regulation. I understand that point in so far as it goes, but I would suggest that a lot of it is being caused by the fact that regulation was rushed in and I would also suggest that producing the technically cut down manuals for specialist businesses months after regulation comes in is no use to anybody. We have all had to get used to regulation by going through the whole handbook and the website, which until very recently was totally inadequate.
I am afraid that half of the cost has been caused by, for want of a better word, the incompetence of the FSA and their staff in getting a system that was clear to the people who were going to have to be regulated in place, six months before the date of regulation.
Sir Callum McCarthy
I would simply say that we will note that. You will know the things that we are doing. We have revised the website to make it much more accessible and I think it is generally recognised to be a significant improvement. I would also point out that the timetable against which we operate is not one of our choosing and there are unfortunate aspects of it.
Simon Whittaker
The rules were continuously changing during the period leading up to regulation, as we were preparing for the new regulations. This is unsatisfactory. I seek your assurance that this will not be allowed to happen again.
Sir Callum McCarthy
I give you the assurance that in so far as it is within the FSA’s competence and decision making, you will have as long as we can possibly give. I cannot give you the assurance that you seek, because I am not in a position to do so, because the timetables are often not determined by the FSA and I think we both have to recognise that.
Peter Free, P R Free
I am not trying to be confrontational, although it can come over like that if you want to make a point that digs at the FSA. It is supposed to be positive, so that we can get some benefit from it. The question I put down was, ‘As a policyholder, should I feel disappointment that Standard Life significantly reduced equity holdings in 2004, which I understand was on the direction of the FSA?’ Clive Briault did mention earlier that the FSA do not set down a remit on the investment make up of a with profits fund.
Sir Callum McCarthy
This is a statement that remains true.
Clive Briault
First, it is important to recognise that a firm needs capital to back any guarantees or promises about smoothing that it makes on with profits products. There therefore has to be an appropriate balance between the asset mix and the capital required. You are quite right that to meet our objective of protecting consumers from the risk of a life company who might be unable to meet their liabilities, and to correct a number of inadequacies of the regulatory regime that was inherited on the insurance side, we introduced some new requirements. I believe it is to these that you refer. They are not guidance, but rules, to be fair. They say that firms that operate with profits funds must make a realistic assessment of their liabilities, be they specific guarantees or promises made, and must hold sufficient capital to meet those.
I think that the answer to your question is that it is not up to the FSA to tell a firm what its mix of assets should be, but it is for the FSA to say how much capital a firm should hold, in order to back the particular mix of assets, which it chooses to hold. Firms that found themselves in the position of having a mismatch between the asset mix and the capital they were required to hold had two ways of correcting it. They could either change the asset mix or raise new capital. It is as simple as that in terms of the responses to the new requirements we made.
I think it is also the case that, irrespective of our own rules, a number of firms would anyway have chosen to change their asset mix, in the light of revised expectations about the prospective returns on both equities and bonds and indeed other assets in the future.
Peter Free, P R Free
I hope that not many firms would have taken it upon themselves to reduce asset allocation last year on the basis of where markets were, because obviously it was a golden opportunity to invest in equities.
Clive Briault
I cannot comment on when is a golden opportunity to invest in equities and if I could do that I would probably be in a different job.
Peter Free, P R Free
It certainly was a golden opportunity and the point I am trying to make to you is that when I put my money with Standard Life, I was happy to accept the annual management charge that they imposed, but I did not know I had two investment managers.
Clive Briault
You do not. We are absolutely not an investment manager. I have explained that what we have done is set out the amount of capital that a firm needs to hold, depending on its asset mix and the liabilities it has incurred to its policyholders.
Peter Free, P R Free
If we could be party to the minutes of the meeting where this issue was discussed with Standard Life, was it because they wanted to do that or because you were pressuring them? If they had been able to put forward a case to say, we are in this current climate and we do not think it is appropriate to sell these particular holdings, I think as a policyholder, I think I should have been given the chance to look at that decision, because I am locked in as a policyholder. There are, as you will know, market value adjustments (MVAs) in place. I cannot come out of those funds. I am not being confrontational, but these are the issues the man in the street wishes to be addressed, but you all sit there and do not address them. I want to go back and tell the investment group of which I am the chair, and they are just ordinary policyholders, not wealthy individuals, that I have full confidence that the FSA are working in your best interests.
Sir Callum McCarthy
I am sorry, but I am going to stop this again. The answer was quite clear, that the FSA is not an investment manager and does not instruct any firm to take a particular position in relation to equities.
Nicholas Flower
What influences is the authority bringing to bear upon assurers to ensure that in fairness and good faith suitably modern mortality tables are adopted from time to time, to calculate mortality charges payable in unit linked and other life policies and to ensure that such policy books cannot cross subsidise annuity books or help to finance the acquisition of additional annuity books?
Clive Briault
We do not have any specific rules in place about how often firms should revise mortality tables and reflect that in their charges. Obviously, however, under our principle of Treating Customers Fairly that would at least implicitly require firms to review their charges, where that is a condition of the product. Similarly, I would say here that the industry itself has set up some self regulation in this sense, because one of the Association of British Insurers Raising Standards initiatives refers to this. For those firms that subscribe to that initiative, they are required to run a no more than 20% gap between the charges and the long run actual expectation of costs for this purpose.
In terms of the scale of such charges and the scope for cross subsidisation, I think generally speaking, it would be fair to say that these charges are unlikely to be of a size that was of sufficient magnitude to enable a firm to either subsidise or worsen the terms they offer on new annuity business to a significant extent. It is probably worth saying here that there are good reasons why firms might want to be active in writing both life assurance and annuity business, because the impact of increased life expectancy works in different ways for each of them. There is, therefore, a potential efficiency gain for both the consumers for a firm to be active on both sides of this market.
Alan Macarthur, Compliance-Andover.com Ltd
I am a compliance consultant and I speak with slightly forked tongue here in that I do not want you to reduce the burden of regulation so much that you cause my premature retirement. My question relates to the increasing financial burden being imposed by regulation on the smaller intermediary. This topic has been mentioned by most, if not all of this morning’s speakers.
This year the smaller mortgage intermediary, who also provides life assurance to their clients have been required to pay nearly £900 collectively to the FSA, the compensation scheme and the ombudsman. Previously they would have been required to pay around £200 to the Mortgage Code Compliance Board (MCCB). I will ignore the trifling sum the company will have to pay the likes of me, so that they can understand even a tailored handbook, if only to work out whether or not they will ever be able to persuade the FSA that they are treating customers fairly.
For the smaller intermediary whose legal entity is that of a limited company, its costs will have increased substantially by losing the Companies Act exemption that allows smaller companies not to have their accounts audited. The audit position also affects the smaller IFA firms that operate as limited companies and I am aware that trade body representations are being made to the Treasury on this subject.
Does the FSA have a view on the necessity of the smaller limited company intermediary to have its accounts audited? Will you support any efforts being made to the Treasury to allow smaller companies to have Part Four permission, but to enjoy the exemption permitted to other small companies under the Companies Act or does the FSA believe that having an audit is a useful regulatory tool, applicable to the incorporated portion of the 90% of the FSA’s client base into smaller firms? Do you believe it is a useful regulatory tool, albeit on an uneven playing field, because an audit is not required for the smaller intermediary operating as a partnership or sole trader?
Sir Callum McCarthy
Those are very real issues, which we are debating at the moment.
David Kenmir
On fees it is unequivocally the case that the costs the FSA levies directly on mortgage intermediaries are greater than those levied by the MCCB. There are two reasons for that. Firstly, it is do with the way that MCCB was itself funded in combination by the mortgage providers and mortgage intermediaries. It is also true to say that the MCCB had a very different remit to the FSA. The scope of our regulation is broader, hence the increased cost.
We were aware of the likely increases in fees for mortgage and general insurance intermediaries and because of requests from IFAs, we have this year introduced, in partnership with the Smaller Businesses Practitioner Panel and some of the trade associations, a payment by instalment scheme, which has currently been taken up by over 1,400 mainly small firms. That will help firms spread the cost over the year.
Kari Hale, Director Finance, Strategy and Risk, FSA
In regard to audit requirements, we have been in close contact with the Department for Trade and Industry (DTI) and with the mortgage and general insurance firms and it would be fair to say that we are not seeking to push hard to make sure the exemption cannot be applied to them. We are also looking to explore the issue of whether this is a regulatory tool for all small firms that is warranted on a cost benefit basis. To that end I will be kicking off an internal project in August, where we will be looking into that issue more broadly and with the mindset that there may be some leeway for reducing the costs imposed on firms, but we do need to look carefully at the potential benefits to our regime that might get lost.
Jeffery Roberts
Why are existing pension contributions not safe in the event of a company collapse? Who is to blame and what is to be done?
Sir Callum McCarthy
The implication is that the question is addressed to the FSA. I must say that I think the assumption is wrong. It is not a principal responsibility that we have, as there is a different pension regulator and questions of this nature should be addressed there. Our responsibilities are rather different and this is not a question for the FSA.
Timothy Dowlen, Argent Insurance Brokers
I think everybody in this room looks forward to a pension when they retire. I just wonder how concerned the Board of the FSA is about the management of its own financial affairs. We note that the FSA started seven years ago in 1998. We also note that the FSA has a pension deficit of £79 million. This is compared to a salary roll of £124 million in the last financial period. Can the Board of the FSA comment on whether this situation is due to mismanagement, irresponsibility or just bad luck?
Secondly, given that many of us pay fees to people to regulate us, who are far better remunerated than us, I would like the Board to comment on the concern shown in their report that the current service costs of pensions for the FSA will increase. This is quoted on page 99 as 21.3% last year, rising to 23% this year.
Sir Callum McCarthy
I am tempted to say that I can give you an undertaking on behalf of the Board that this is not irresponsibility and it is not bad luck, it is due to a range of demographic and other changes, which are affecting all pensions across the board.
Kari Hale
Firstly, while the FSA has only been in existence for seven years or so, many of our employees have been working for 20 or 25 years or more and when the FSA was formed their employment rights were TUPE'd into the FSA. The pension liabilities to which you refer have been built up across a number of organisations over a very much longer period.
In regard to managing the deficit, we have a number of very active tools that we are employing to seek to mitigate the potential impact on future years of the costs of our pension liabilities. In particular the defined benefits scheme is not open to new members of staff and has not been pretty much since the FSA was first created. Two thirds of our staff are on a defined contribution rather than a defined benefit basis.
We also take very careful and detailed actuarial advice each year and when we award pay rises to those member of staff who are in our defined benefit scheme; the implications on their pension rights are fully funded in that year. Our internal fiscal disciplines are constructed to ensure that that is the case.
We also look very carefully at the composition of the investment mix within the assets of the fund, which is quite heavily weighted towards equities at this time. On advice and with much deliberation with the trustees, we continue to believe that this is appropriate, given the vastly larger number of future pensioners rather than current pensioners within the fund. We are looking to actively manage, through time, the profile of the assets against the liabilities. Clearly, with a relatively high proportion of equities within the fund, there is going to be a degree of volatility in regards to the asset value at any particular year end. We seek to keep that under careful review and also to be extremely transparent in our disclosure, which, I think, your question reflects.
Sir Callum McCarthy
It is, I think, the only instance, where the FSA actually takes investment management decisions in relation to a pension fund.
Could I say thank you very much to people who have asked questions. We will respond to any of the pre notified questions with which we have not managed to deal and put those up on the website, along with the whole of the proceedings within the next month. Could I also thank the Panel chairs and my colleagues for their contributions.