TUESDAY 7 NOVEMBER 2000

SIR HOWARD DAVIES, MR PAUL BOYLE,MR MICHAEL FOLGER and MRS GAY WISBEY

  100. Secondly, on fees, they were asking me about fees. Apparently, you have sent out 60 policy papers, which have been greatly appreciated, if we believe the newspapers. One of them was about fees. They still have no idea as to what kind of fees are going to be charged to IFAs by the FSA. Is there some indication you could give of the total amount you hope to get from them? This is because they have been asking. They have had this policy paper which might group people together, big or small people, in a different way. But what they are saying is that they would like to have some idea of what the level of cost is likely to be. Could you even give us some indication of the total amount you expect to get from IFA providers?
  (Mr Boyle) At the moment, I cannot answer that question. There are two main reasons for that. One is that we have not yet set the budget for the period after N2—that is, because some fundamental questions remain to be answered, including the precise scope of the regime, which was the subject of the regulated activities order—and there are a number of other important matters that have not yet been resolved, which prevent us from setting the budget. The second reason is, as you have pointed out, we are consulting on our fees at the moment. The consultation period ended at the end of September and at the end of this month, or possibly early into December, we will be issuing a feedback, having analysed the results of that consultation and making some further proposals. So, unfortunately, we cannot say precisely, at the moment, what the fees will be.

  101. You cannot give any indication of the total amount you hope to get from the industry now?
  (Mr Boyle) The total amount for the industry would be broadly this year's amount, plus some allowance for inflation, salary increases, plus an amount to cover the additional responsibilities that have been placed on the FSA by the new legislation. Those are the matters that we are still quantifying.
  (Sir Howard Davies) Less some savings which will occur at the eventual merger. There are some costs that are incurred at the moment as a result of double running the system to some degree, and also some quite high costs involved in rewriting all the Rule Books, which is quite an expensive process. But we would not expect our overall budget, on a like-for-like basis, to be very much different when the new regime comes into place. But the next fee note that they will get will, I am afraid, still be on the old basis; so the next fee note they get will be the same as the old PIA fee, which we consult on around the turn of the year.

  102. Do you accept that when you are running a business, it is very difficult to do so when you are not clear what you are going to pay, and we are not going to be clear as to whether or not the Ombudsman's fees are going to carry on. The final thing is polarisation. You put out a splendid paper giving some guidance from the London Economics study. They still have not had a decision on what is going to happen. When do you think we will hear what is going to happen on polarisation?
  (Sir Howard Davies) Let me comment on your first point. The Ombudsman scheme funding proposals are highly likely to be carried forward into the new regime, so I think that is fairly—

  103. By you, on your recommendation?
  (Sir Howard Davies) Yes. Our responsibility is for setting the rules of the scheme and the Ombudsman is then responsible for implementing the scheme. As I have explained to you, the crucial thing is the discipline on the Ombudsman for only taking cases which are justified to be taken. That is really the key decision. That is a matter for the Board of the Ombudsman scheme and the Ombudsmen themselves. So all we are responsible for are the overall rules of the scheme. As for the fee level, the fee, as you know, for IFAs is at £1,000 a year. It is not going to vary hugely under the new regime. I would be very surprised if that were regarded as a planning blight on anybody's business, frankly. On your last point on polarisation, as you know, the Office of Fair Trading conducted an investigation into polarisation, which argued that it did have some anti-competitive effects. That report, which is essentially a control mechanism on the regulator, went to the Treasury, and the Treasury asked for our comments on the report. As a result, we commissioned London Economics to look at industry dynamics and the impact on competition. That report was published and we asked for commentary on it. We received that commentary over this summer and my board, at its last two meetings, has considered the OFT's report, the London Economics' report and comments received on the London Economics' report. It has now supplied evidence and argumentation to the Treasury as to what the next step should be. That sits with the Treasury. We expect them to make an announcement on their view because formally speaking the OFT's report is a report to the Chancellor. The Chancellor must decide whether or not to instruct us to amend our rules. We have given advice as to what we think would be appropriate in the circumstances in the light of the OFT report and we expect the Treasury to make an announcement on that, including our advice, quite soon.

  104. May I ask a very quick question on that, following on from the part about polarisation. Just last month you published this rather interesting pamphlet on the costs and benefits of regulation. There is a paragraph in that, on page 46, which says that: "The welfare effects of banning polarisation are complex and banning exclusive dealing can lead to even less efficient forms of exclusion." Do you stand by that?
  (Sir Howard Davies) There were several bits to that paper. Some of it was written by people from the industry. Which bit are you quoting from? It was more of a discussion paper. Some of it was written by other people.

  105. One of the authors was a member of your own staff.
  (Sir Howard Davies) Is that from one of my members of staff or is that from someone in the industry?

  106. One cannot distinguish. There are four authors to the report. One of them is a member of your staff.
  (Sir Howard Davies) Sorry, I thought there were separate bits in there[1]. We do accept that changing any aspect of the polarisation rules could well have complicated effects on industry dynamics and on the way in which consumers are served. Therefore, you need to proceed carefully and with adequate consultation and analysis. Also, at the same time, you need to look at the impacts of changes in the disclosure regime. This is because we think that one of the keys is what consumers understand by the status of the people with whom they are dealing. So I would certainly agree that changes to the regime, the polarisation regime and the status, would have to be considered very carefully alongside changes to the disclosure regime, so that people understood the status of the people with whom they are dealing, in order to offset any potentially damaging consequences from people misunderstanding the character of the advice they were given.

  107. Sir Howard, could I ask a few questions about the Consumer Panel? How effective do you think operations are going as far as you are concerned? Your consultation processes and so on.
  (Sir Howard Davies) The Consumer Panel has played a very important role. We built on the Consumer Panel which the PIA had put in place. I think it has proved to be a very successful part of the new architecture. We do not always agree with the Consumer Panel and if they were in front of you they would make that point to you. But the organisations representing consumers of financial services are not as well resourced or as organised as the industry is. I am afraid that is just a fact of life. That if you consult, you will get a heavy weight of response from the industry, from their trade associations, from individual firms, from law firms paid for by the industry, etcetera; and what you will get back from the consumers' side simply cannot possibly be as well resourced or well researched. Therefore, you do need, in order to rectify that balance, to try to create a forum in which consumer views can come together; and also to provide (relatively modest as it happens) but some funding for the consumer voice to undertake research which is relevant to regulatory issues. The research they have done has been valuable. The views that they have given us have been very valuable. They meet my board from time to time. My board sees the minutes of both the Consumer and Petitioner Panel. We look to them as a very important source of a consolidated view from the consumer sector. Increasingly, they are giving us that. I would say I am very positive about the way the Panel is operating.

  108. What new initiatives has the FSA taken as a result of advice given from the Panel?
  (Sir Howard Davies) There are some new initiatives. The Panel, for example, in relation to polarisation, which is one point which they have looked at quite carefully, were the people who have emphasised to us that we need to carry out research into disclosure. This is because there is quite a lot of evidence that people do not, in fact, understand properly what the status of the people they are dealing with is, as I answered in my response to Mr Cousins. So they have asked us to do some work in that area which we are now doing. In addition, in all of the Rule Books and the regulatory regime surrounding different products, the Consumer Panel are very articulate in explaining to us the importance of rules which do protect the consumer interests. So, for example, on stakeholder pensions, the Consumer Panel have been very vociferous and very effective in representing their views to our board on the design of the decision trees, and on the access consumers should have to decision trees, before they make a decision on stakeholder pensions. They are very much engaged, on a real-time basis really, with debate on the structure of the new regime and the protections we build into it for the consumer interest.

  109. So the fact that the Chairman and some members of the Board of the Panel are leaving after quite a short time in office, does not represent some unhappiness about the way the Panel is working?
  (Sir Howard Davies) No. I am able to reassure you on that point. The current Chair, that is changing in December, the current Chair was the Chair of the PIA Consumer Panel for a period under the old regime. We asked her to stay on until N2. I have to say that this was when we thought N2 was going to be in 1999. She agreed to stay on for an extra year, up to the end of this year, in order to manage the transition from the old regime to the new; and the current Deputy Chair, who has been on the Panel from the start, is now moving up to the Chair. So there is a lot of continuity. We do feel we should rotate the membership, so we have had a few of the people who have stepped down after their first three-year term, and we would expect that to be a normal process. But, no, there is no unhappiness that I am aware of.

  110. You mentioned funding earlier on in your first answer to me. How much is all this costing?
  (Mr Boyle) The total cost of the Consumer Panel's research budget is half a million pounds.

  111. Which in terms of your £170 million is small change, is it not?
  (Sir Howard Davies) Sir Teddy will say that if I say £500,000 is small change, 500 IFAs will wave their fee notes, and say "That is not small change to me". But it is a small part of the budget, yes.

  112. Is it not all a bit of a nonsense, the whole thing? In terms of this idea that somehow you can have surrogate consumers representing somebody called consumers, as against working up a competitive market and allowing competition to serve the consumers, is that not really the way it should be done and should not that be the priority of the FSA?
  (Sir Howard Davies) We do have a strong view in favour of competition, and we do believe that competition is likely to be the best guarantee of a fair deal for consumers, but for a variety of reasons in the past, Parliament has taken the view that some aspects of the market should be regulated. We need to do that in a way which is most effective, which creates as little damage to competition as we can, but nonetheless protecting consumers as far as we can. In order to do that, it is useful for us to have a central point at which the consumer interest in all of this can be articulated as part of the architecture, if you like. The way the architecture has been designed is with a board, which is a balanced board, with some practitioners and some public interest representatives: a Consumer Panel at the apex of the consultation process for consumers; a Practitioner Panel at the apex of the consultation process for the industry. This means that you have a good basis on which to make the fine judgments that you have to make at the end of the day about just how intrusive, how detailed the regime should be. So I would be sorry not to have the Consumer Panel because it does provide an effective counterbalance within the FSA, which helps us make better decisions.

  113. How do you know that the Consumer Panel represents consumers? What are the criteria by which those are selected?
  (Sir Howard Davies) We have set out the type of people whom we think are appropriate. We have put together a Panel, including some members of our board but also some independents, to select them. I do not think it is realistic to believe that you can have a Panel of this kind to act as delegates. As much as anything else, what they are effective at doing is linking up with other organisations—whether it is the Consumers' Association, the Citizens Advice Bureaux, trading standards officers who are, of course, recipients of a lot of consumers' anxieties—and, also, people who can point us towards the kind of research that we need to do in order to buttress our decisions. So I do not think they regard themselves just as tribunes of the people, who have a privileged understanding of what consumers think. They are people who are experienced in seeking consumer views and seeking the ways in which one can detect whether consumers are understanding the kind of information we are putting out. That is their most important role.

  114. So they are more part of the regulators' network rather than genuine but surrogate consumers?
  (Sir Howard Davies) Yes. The point is that they have a privileged role within the system. They are part of the FSA structure, so that they have privileged access to our staff and our research, etcetera. That is the point of having them partly inside the regulator structure rather than purely outside lobbing things to us.

  115. Could we move to stock markets now. In the unit trust industry, according to the FSA rolling models of Kevin James, hidden costs not disclosed to the investors are about £3 billion a year. Why does the FSA disclosure regime not require investors to be made aware of this sort of charge?
  (Sir Howard Davies) It would be fair to say that there is no FSA disclosure regime at the moment. There are several disclosure regimes which we have inherited from the previous regulators. One of the things we have been doing is carrying out some research into whether people understand that disclosure regime; and, also, whether it properly captures the costs of the types of investments that people undertake. That is true in life insurance and other places. We have been exploring different ways and more meaningful ways of explaining what the costs are. The specific issue of unit trusts is that there are two sorts of costs involved in this generically. One is the overall management cost and administration cost of the fund; and then there is also the cost of trading and churning, particularly where you have an active fund. It is true that previous disclosures have tended to focus on the former showing the initial upfront charging payment and administration cost, and not focusing on the transactions cost that you undertake in order to achieve that performance. The industry will say, "If we want to achieve superior performance and exercise our investment skill, then clearly that means there will be trading costs." We accept that. But the purpose of that research paper, which was very much as the one Mr Cousins quoted, we have a series of occasional papers which are not FSA policies but which are floating ideas, producing reports of research that we have done or, in some cases, other people have done, in order to attract reactions. That one suggested that maybe a better approach to disclosure would be a measure which we would call MP1, which captures the full costs of managing the fund. I would not conceal from you that the industry has not been over the moon about that.

  116. That's a surprise!
  (Sir Howard Davies) We are going to consult further on whether this measure is something which consumers would well understand and whether it is justified. I have to say it does not have the status of a FSA disclosure policy at this point.

  117. You are considering changing it?
  (Sir Howard Davies) We are considering it, yes. We shall be producing a consultation paper on our disclosure regime shortly, which will canvass a range of options for changing it.

  118. Will the FSA comparative tables, referred to earlier, have a validity if these sorts of charges are not included in the comparisons?
  (Sir Howard Davies) The issue is: what is it appropriate to disclose in those tables? That is one reason why it is taking some time to get this right. This is because it is fair to say—and the industry make this point and it is a reasonable point—that there is a difference between pure admin. costs which are not easy to measure, and the dealing costs which may well be offset if the fund manager makes good choices by higher returns. Therefore, it is not the same kind of cost exactly as the pure administration cost. If one is going to disclose the two, one has to be very clear about what the nature of these costs and charges are. We have not reached a firm decision on that yet.

  119. That would be put in the decision following consultation?
  (Sir Howard Davies) Yes.