On 4 February 1999 we published our Third Report of Session 1998-99, Financial Services Regulation, as House of Commons Paper No. 73-I. We have now received the following response from the Treasury.

Introduction

The Government welcomes the Committee's report, which is a constructive and valuable contribution to the process of scrutinising the Financial Services and Markets Bill. The conclusions and recommendations will be taken carefully into account in preparing the Bill for introduction, along with the report from the Joint Committee on Financial Services and Markets, expected by 30 April.

Detailed responses

(a)  We welcome the changes to the Financial Services and Markets Bill announced by the Treasury during the course of our inquiry (paragraph 7).

The Government is committed to genuine and open consultation and will make further improvements where justified.

(b)  The draft Bill makes clear that different types of consumers need different levels of protection. Given this provision, we see advantages in the wide definition of "consumer" in the draft Bill (paragraph 15).

The Government is pleased to see that the Committee recognises the need for a wide definition of consumers to take into account the many different types of relationships between different kinds of customers and providers of financial services. We are however considering ways in which Clause 5 of the Bill might be clarified or improved to take account of concerns raised on consultation.

(c)  We expect the Treasury, in making appointments to the Financial Services Authority (FSA) Board, to strike a balance in the expertise and background of its members, and expect them all to be willing to take account of the need to pursue the objective of protecting consumers as much as the other objectives (paragraph 18).

The principle that appointments to the FSA board should be made on the basis of merit with all members working to its common purpose rather than representing individual interest groups is an important part of the Government's proposals. We welcome the Committee's endorsement of that approach. We also attach importance to the Board having available to it appropriate experience and expertise to enable it to carry out its functions effectively.

(d)  We welcome the Government's decision to give statutory recognition to the consumer panel, and believe that, in order that it can be seen to be completely independent, its budget should be independent of the FSA (paragraph 20).

In recognition of the rapidly changing financial services markets, the Government has proposed a structure—for regulation, compensation and dispute resolution—that will have sufficient flexibility to be durable and to respond to the circumstances of the time. That underlying thinking extends to the role of the Consumer Panel. We have every confidence that the FSA will establish and maintain an effective Consumer Panel and provide adequate funding for it, and do not believe that these arrangements will compromise the independence of the Panel. If the Panel were not funded by the FSA, the only viable alternative would be direct funding by the Government. We think it unlikely that providing for the funding of the Panel on a statutory basis would provide any advantage to the consumer compared with the proposed arrangements.

(e)  As we have received many representations about the inadequacy of competition in the field of financial services, we attach particular importance to improving competition. The Government should consider whether this can be done better by adding this as a fifth objective for the FSA, or whether primary responsibility should remain with the Office of Fair Trading (paragraph 23).

(f)  We look to the FSA to strike the right balance between the various methods of regulation, in the light of their assessment of the best way to protect the consumer and encourage competition (paragraph 31).

The Government shares the Committee's view that competition between financial services providers is very important. The way to achieve this is to create an environment in which competition can flourish. This requires, firstly, the removal of any unnecessary regulatory barriers to competition, and secondly, effective mechanisms to enable unjustifiably anti-competitive agreements or behaviour to be detected and dealt with.

In the area of financial services, the first of these elements is of key importance to the FSA. Clause 2(3) of the Bill requires that, in carrying out its functions, the FSA should have regard to the principle that competition between authorised persons should not be impeded or distorted unnecessarily. This is reinforced by the competition scrutiny provisions in the Bill which enable the Office of Fair Trading (OFT) to consider whether any rules, guidance or practices of the FSA (or of recognised investment exchanges, recognised clearing houses or the Competent Authority) are unnecessarily anti-competitive and which give the Treasury powers to deal with these where necessary.

These arrangements are similar to those under the Financial Services Act 1986, which are generally thought to have worked well. In the Government's view, it is not the role of the FSA to make competition judgements. The primary responsibility for this continues to lie with the OFT.

The second element, the detection and suppression of anti-competitive agreements, such as cartels, or anti-competitive behaviour by undertakings, is therefore a matter for the OFT. The OFT's powers to take effective action will be greatly strengthened by the Competition Act 1998. The Government therefore believes that it is right that the OFT should retain this role in respect of the financial services industry, as for all other sections of the economy. Finally, it should be noted that effective measures to improve consumer protection will in many cases be pro-competitive. An example is steps to improve disclosure of product features.

(g)  We emphasise the importance of public awareness both of the types of products available, with their benefits and risks, and of the financial system and the role of regulation. Accurate, comparable information from product providers is an essential part of this (paragraph 34).

The Government agrees that public awareness in the field of financial services is very important since consumers must take ultimate responsibility for their decisions and better awareness is good for competition. That is why the FSA has been charged with promoting understanding of the financial system as part of their wider regulatory responsibility. This is the first time a financial regulator has been given such a role. In the long run, better consumer education should reduce the need for detailed intervention.

As part of the process of helping consumers to make more informed decisions, the Treasury has announced the development of CAT standard ISAs. These are designed to identify a range of straightforward savings products which are simple, clear and fair so that savers should feel confident about choosing them. Though they are not a guarantee of performance, such products are intended to de-mystify the complexity of savings literature and give easier access to people's money, the two main factors which are perceived as being against the consumer interest and a major deterrent to savings. Similarly, the recently announced proposals for a new pensions vehicle call for a benign charging structure and greater simplicity and transparency of investment to aid savers in making their decisions.

(h)  We expect the FSA to continue and refine the practice of the Personal Investment Authority (PIA) of publishing information about persistency rates. The FSA should aim to inform the public as to the nature of the financial products that are available, to encourage the development of more flexible products and to ensure that information is published which will enable consumers to judge whether providers are making disproportionate gains in the early years of, and upon the early surrender of, their financial products (paragraph 35).

The Treasury welcomes the FSA's decision to continue with the publication of persistency information. It is difficult to see how products whose main profitability for the provider is dependent on early surrenders by the contributor are in the consumer interest. Greater consumer education will help raise consumer awareness of products which might be unsuitable for consumers who are unable or unwilling to make sustained long term contributions. And the introduction of other more transparent, flexible low cost products, such as ISAs, without onerous terms for access to savings, will help those consumers who want to save but cannot necessarily afford to do so in a fixed pattern over a longer term.

(i)  We believe that the Government's agenda for extending access to such financial services as savings and pensions will involve the FSA in issues of social and financial inclusion. The FSA will want to develop adequate and sensitive systems for monitoring and regulating, to encourage innovative products suitable to the markets being served and to ensure that providers and consumers will not face unnecessary obstacles in gaining access to these particular markets (paragraph 38).

The Government has among its priorities tackling financial exclusion. The FSA is, of course, primarily a regulator and it is important it should not lose its focus by being burdened with diverse and conflicting duties, all of which could prejudice its ability to regulate effectively. However, the FSA will certainly have a role to play in assisting the Government to deliver on that objective. To the extent that particular financial services are within the scope of the Bill, the FSA should take into account the special needs of poorer groups in our society, and avoid creating burdensome and uneconomic regulatory regimes which might force providers out of relevant markets and stifle competition. In taking such matters into account, however, it is also important that regulatory arrangements are sufficiently robust to reduce the risk of financial failure and mis- selling, given the substantial detriment that that would cause to relevant communities who will be reliant on those savings and investments. We consider that in pursuing its public awareness objective, the FSA will also be able, and indeed may well wish, to focus much of its effort on helping to educate those in communities who have previously not used financial services.

(j)  We remain concerned that mortgages, often the biggest single transaction an individual makes, are proposed to remain outside the scope of financial regulation. We will expect to see clear and detailed justification for any decision by the Treasury to continue the voluntary regime for the regulation of mortgages beyond the review due later this year. Furthermore, we expect the Treasury to include in its justification an assessment of the conduct of those mortgage providers who have not signed up to the existing voluntary code (paragraph 45).

We note the Committee's concern that mortgages may remain outside the scope of financial regulation. The Treasury is already gathering a great deal of information about the performance of the Code from a number of sources including the Council of Mortgage Lenders (CML) itself, and the Banking and Building Societies Ombudsmen. The Treasury also takes a keen interest in the reports of mystery shopping exercises carried out by consumers' representatives which show how the Code is working in practice.

We note that the Committee expects to see clear and detailed justification for any decision to continue with voluntary regulation. The Treasury will review the performance of the Code later this year. In carrying out the review, the Treasury will seek information from many sources in order to get as wide a cross section of information and opinion as necessary in order to take a balanced decision. The Treasury is determined to ensure that consumers are protected, but has not yet formed an opinion as to whether this can best be done by voluntary or statutory regulation.

(k)  We expect the Government to publish its conclusions on the regulation of long-term health plans at an early date (paragraph 46).

The Government will include any relevant comments and conclusions on the regulation of long- term health plans in its formal response to the Royal Commission on long-term care for the elderly.

(l)  We accept in principle the case for the FSA to have direct regulatory powers over professionals who provide financial advice; but the definition of "financial advice" needs to be drawn as narrowly as possible to prevent unnecessary regulation, and measures should be put in place to avoid unnecessary duplication of effort by the FSA and the RPBs (paragraph 50).

The Government welcomes the Committee's endorsement of its policy that people should be able to expect the same standards of protection regardless of where they get financial advice. We also believe it important that the definition of regulated activities should be sufficiently clear to avoid, as far as possible, people having to be authorised unless it is necessary for the protection of consumers. We have been in consultation with the existing Recognised Professional Bodies to understand how unnecessary authorisation arises and are consulting widely on the draft regulations which will define the activities to be regulated under the Bill. Our consultation document, published on 25 February, makes specific proposals to reduce unnecessary authorisation by professionals. The FSA will be able to make appropriate arrangements to ensure that, to the extent that members of the professions are carrying on activities requiring authorisation, unnecessary duplication of effort and costs is avoided. However, in pursuing that aim, it is essential not to lose sight of the need for adequate consumer protection.

(m)  We believe that the balance of advantage lies in having a single regulator, able to combine consumer protection, prudential assurance and policing, rather than separate regulators for these aspects (paragraph 54).

The Government welcomes the Committee's endorsement of the move to a single regulator.

(n)  We welcome the announcement of an annual open meeting to be held by the FSA (paragraph 57).

We are confident that the annual open meeting of the FSA will provide a valuable opportunity for interchange between the FSA, the regulated community and consumers at large. We welcome the Committee's support for the proposal.

(o)  We believe that there are advantages in confirmation hearings for FSA board members. We also recommend that international best practice is followed in the manner of their appointment and their tenure of office (paragraph 60).

We consider that the proposed method of making FSA board appointments already reflects Government best practice. The Treasury has power to appoint and remove all of the FSA's directors, and it generally applies the Nolan Committee's standards in doing so. As regards tenure of office, we think it important that an appropriate balance is struck between independence and accountability of Board members. In our opinion, this balance is best achieved for FSA board members by appropriate use of the Treasury's basic powers of appointment and removal.

(p)  We look forward to examining FSA annual reports and to taking part in debates (paragraph 61).

We welcome the Committee's continuing involvement.

(q)  We welcome the announcement of powers to commission independent value for money audits of the FSA. It is very important that, as the FSA's income is raised from fees from regulated bodies, it is seen to be spending this income wisely (paragraph 62).

The Government agrees that the FSA must be seen to be spending its income wisely. We believe that the power of the Treasury to commission independent value for money audits of the FSA is of significant benefit in ensuring transparency in this context.

(r)  We recommend that minutes of FSA board meetings should be published, with the minimum of deletions for reasons of confidentiality (paragraph 63).

We support the principle that FSA board minutes should be published, subject to necessary deletions for reasons of confidentiality. We recognise the importance of ensuring regulated firms' and individuals' rights to confidentiality.

(s)  We believe that the FSA should undertake the fullest possible consultation. Views should be sought from consumers as well as practitioners, and the FSA should always justify its decisions following consultation, especially where it has not adopted the suggestions received (paragraph 70).

We believe that the draft Bill provides a statutory framework for full consultation. In particular, the Bill requires the FSA to publish for consultation new rules in the way which is best calculated to bring them to the attention of the public. Also, the establishment of statutory consumer and practitioner panels ensures significant representation of these groups.

(t)  Control of the level of fees is an important check on the power and size of the FSA. In addition to consultations with regulated bodies, giving them an opportunity to express any dissatisfaction with the levels of fees, we believe that there should be a wider means of accountability. Fee regulations should be required to be made by statutory instrument, subject to annulment by Parliament (paragraph 73).

The Government agrees that there must be mechanisms in place which ensure the proper control of fees charged by the FSA and believes that the proposals in the draft Bill, together with changes recently announced, achieve that aim. The FSA must regulate proportionately and use its resources in the most efficient and economic way. The draft Bill ensures that there are transparent and open procedures for setting fees and monitoring expenditure. The Bill requires the FSA to publish its draft proposals on fees for full public consultation. These proposals must be accompanied by details of the FSA's expected expenditure. The Bill requires the FSA to take account of any representations made during the consultation period in coming to final decisions on fees. The FSA is also required to produce an annual report to the Treasury on how it has discharged its functions and included in this will be a report from the non-executive directors on their own review of how the FSA has used its resources. In addition, the Treasury will also have the power to commission an independent report, at periodic intervals, into the efficiency and economy of the FSA's operations.

The Government believes that the final decision on fees should, however, rest with the FSA. The Government believes that the optimal level of regulation will be achieved by allowing the regulator, guided by its statutory objectives and subject to the mechanisms set out above, to set the level of fees it charges.

(u)  We welcome the FSA's proposals for an Enforcement Committee, and invite the FSA to consider whether there should be a separate enforcement division within the FSA (paragraph 79).

The Government welcomes FSA's response to representations about its enforcement procedures, whilst recognising that its internal structure is a matter for the Board.

(v)  We welcome the Government's proposals for amendments to the Bill on the FSA's disciplinary powers (paragraph 80).

We have taken note of the various comments received on this area of the Bill, and in particular concerns that the FSA should not be "prosecutor, judge and jury". As the Committee notes, the Government has therefore announced a number of changes to the Bill to clarify the respective roles of the FSA and the Tribunal and to support the basis on which the process would work.

(w)  We expect the Government to respond in detail to the concerns about natural justice and the European Convention on Human Rights. Given the substantial powers given to the FSA, and the complaints from independent financial advisers about the current disciplinary process run by the PIA, it is easy to perceive the disciplinary process as one in which the FSA holds all the cards. For that reason, the initial process, not just the Appeals Tribunal, must be—and be seen to be—fair, accessible, inexpensive and transparent (paragraph 81).

The Government is fully committed to fairness and the need to uphold individual rights in accordance with natural justice and the European Convention on Human Rights (ECHR). For this reason, we proposed that there should be an independent Tribunal. This will be a tribunal of first instance to which all FSA enforcement decisions may be referred. It will be able to consider the full merits of cases referred to it and will ensure compliance with the right to a fair hearing under article 6 of the ECHR.

However, the Government shares the Committee's view that, even though the tribunal will ensure that a person against whom enforcement action is taken will enjoy their full article 6 rights, it is also necessary that the FSA's internal procedures should follow due process. Of course, as with any body exercising statutory functions, the FSA must act reasonably and fairly, but the draft Bill sets out certain basic features to which the FSA's disciplinary procedures must adhere, for example that there should be a period allowed for representations before a final decision is made.

(x)  The draft Bill already contains provisions about the Financial Services and Markets Compensation Scheme and the Financial Services Ombudsman. We believe that the complaints-handling procedure and internal disciplinary procedure of the FSA should be similarly enshrined in law (paragraph 83).

The draft Bill sets out the framework for the FSA's internal disciplinary procedures, such as the opportunity to see the evidence on which a case is based and to make representations and for the arrangements for the investigation of complaints. The latter must include reference to an independent investigator able to conduct a full investigation and publish any parts of their report that they feel ought to be brought to the public's attention. We believe that these provisions ensure the necessary degree of transparency and that to include further procedural detail would undermine the FSA's ability to develop its procedures in a flexible way.

(y)  We stress the importance of ensuring that financial crime is combated effectively; this requires close co-operation between the agencies involved, both in the United Kingdom and internationally. Although the FSA's new civil powers will be useful, we believe that criminal prosecutions should be set in train whenever the evidence is strong enough (paragraph 90).

The Government fully shares the view of the Committee that close co-operation is required between the agencies in the UK, and internationally, to fight financial crime effectively. We are committed to improving co-operation at home and overseas. The Financial Services and Markets Bill will include provisions that will allow the maximum flow of information, consistent with European law, from the Financial Services Authority to the other agencies fighting financial crime both domestically and internationally.

We also support the valuable work of the Financial Fraud Information Network (FFIN) which plays a key role in domestic co-operation by bringing together regulators, law enforcers and prosecutors at the earliest stage of an inquiry. FFIN provides a framework within which information from different elements of an inquiry can be shared and investigation co-ordinated.

The Government is a strong supporter of initiatives to encourage better international co-operation between the agencies involved in combatting financial crime. We support the efforts of the Financial Action Task Force on Money Laundering, whose 40 recommendations are the global standard for anti-money laundering systems, to expand its membership, encourage regional anti- money laundering networks and identify and address non-cooperating jurisdictions. During the UK's Presidency of the G7, we have taken forward work to improve co-operation between overseas financial regulators, law enforcement and prosecuting authorities.

The Government strongly agrees that criminal prosecutions should be taken where the evidence is strong enough and where it is in the public interest to do so. The new civil regime for tackling market abuse is designed to complement the existing criminal regime by filling a gap in the existing protections for financial markets. It is not intended to be a substitute for it.

19 March 1999