TUESDAY 7 NOVEMBER 2000

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

  120. Are profit levels in the unit trust, pension, insurance industries at an appropriate level at present, do you believe?
  (Sir Howard Davies) I would not wish to offer a view on that question as put. The FSA is unlike the regulators of former nationalised industries. We are not an economic regulator. So we do not set prices and it is not for us to determine what appropriate rates of return or rates of profitability are in the industry. Now that is not to say that we pay no attention to it, because a very high level of profitability in a regulated business might possibly be an indication that there is something going wrong in terms of the disclosure regime, or something going wrong in terms of the advice given to customers or in terms of the competition. We have to ask ourselves if the regulation is affecting competition such that it has an impact on returns. But that is the only way round we would look at it. I would not wish to give a view on appropriate levels of appropriate profitability in the industry. It would be a rather dangerous stance for a financial regulator to take actually.

  121. The FSA has published a consultation paper, number 59, on Market Abuse, where it highlights "misuse of information" as a category of market abuse mentioned in the Financial Services and Markets Act. How does the FSA intend to police this selective disclosure of information?
  (Sir Howard Davies) I might ask Mrs Wisbey to say a little bit about the market abuse regime, but on this specific point of selective disclosure, that is a UK listing authority requirement rather than part of the market abuse regime. What happens there is—and this is as it was under the Stock Exchange—there is a monitoring team in the UK listing authority which looks at unusual price movements. It also liaises closely with the Stock Exchange. If there are unusual price movements, which appear to be related to some piece of information which has emerged either on a bulletin board or from one analyst's briefing or whatever, then that team makes inquiries of the company concerned. At the moment, however, the only powers available to the listing authority have been to issue a censure. Indeed, largely it has been a private censure of companies in the past. That is the only sanction that the listing authority—which, as I said, was previously part of the Stock Exchange's powers—in future it will be possible for us, once the new regime is up and running, to discipline companies and to fine companies for selective disclosure which we feel has distorted the market. In the case of market abuse, very briefly go in to where we are on market abuse, Mrs Wisbey.
  (Mrs Wisbey) We issued a second consultation this past summer, July, and we are in the process within the next week of issuing an addendum to that, to cover basically the safe harbours that will exist in how we deal with the Takeover Panel and also with the recognised exchanges. It also mentions the listing authority, that Howard just referred to, regarding selective briefing. Under the market abuse regime there are three aspects which I think you will be aware of: the misuse of information, giving false impressions, and also the market manipulation issues. They will get covered in the new market abuse regime but we will work closely with our colleagues in the UKLA, the exchanges and the Takeover Panel.

  122. Do you have any difficulty in defining selective disclosure? It ranges from someone chatting in a pub to someone deliberately passing on inside information, does it not?
  (Sir Howard Davies) The rules are quite clear on the point in that it is information which you believe, and you have reason to believe, is market sensitive information. In fact, most of this is actually pretty straightforward. If you have a profit warning coming up, or if you have a merger plan in the pipeline, or your chief executive is about to quit, people know perfectly well that this is market sensitive information. Our concern is not really with the talk in the pub, nor is it with the clever analyst who on the back of a press conference or an analyst conference about the latest profit forecasts asks questions which elicit information or answers of an uncertain kind, and which cause him to write, "This company is in more trouble than we expect." That is part of the normal interaction. People know perfectly well what it is. The real mischief—and we have seen some well publicised examples of this recently—is where the first knowledge that a company is thinking of bidding for another company has appeared just in one newspaper via some analyst or one broker's circular, which seems to have got hold of a profit warning or forecast before other people. These are quite well-defined events, which most companies are very clear about: what is market sensitive information and what is not. Those are the abuses that we are targeting, not the analyst who puts two and two together and gets six, where his colleagues have got five about the company's prospects. That is, I am afraid, part of the market.

  123. The Director-General of the Fund Managers' Association suggested that if you are too rigorous in clamping down on selective disclosure of information, then you will inhibit the information flowing through the market. Do you believe that is a danger?
  (Sir Howard Davies) Obviously if anyone says you were too something or other, that would be damaging. The answer is clearly that we would be if we were too rigorous. But I honestly do not think there is much evidence of that at the moment. As I have said, we are really about making sure that people have a properly disciplined approach to dealing with these important announcements and important pieces of information which are clearly market sensitive. We are concerned that there have been quite a spate of worries in the market and well publicised cases where it appears that information has leaked out in an unstructured way. That is not satisfactory. It is particularly unsatisfactory when over the last couple of years there has been a rapid increase in the number of individual shareholders. It is just not acceptable for information to come out and only for the benefit of the institutional shareholders or major fund managers, where there are so many individuals wanting to trade in the market. What has caused the SEC in the United States to amend their rules—and they produced the week before last a new regulation FD, Regulation Fair Disclosure, which in fact has the same effect as our own rules—but they have clearly felt that there were dangerous things going on in the market, which they needed to be a bit more disciplined about, and we feel rather the same. As I have emphasised, we are not trying to reduce the amount of information available, nor are we trying to clamp down on clever analysts. Indeed, some of us in the organisation think that one of the problems in the markets is that there are too many companies who are not followed effectively by good quality analysts. Nor are we seeking to clamp down on good financial journalism, good speculation. We are seeking to clamp down on the clear cases of people ringing up a friend and saying, "Whoops! We have a bad profit forecast coming out tomorrow," so that people can position themselves around it. That is not acceptable and we will not have it.

  124. Admittedly in a leaked Merrill Lynch report, one of the senior members of the FSA staff was quoted as saying on the iX merger, that the regulatory aspect of the merger would be a "nightmare". The report goes on to add that "any practical level of harmonisation" of UK/German stock would be difficult to achieve. What difficulties are there in harmonising cross-border regulations?
  (Sir Howard Davies) We do not accept they ever said that was a nightmare. The Report does not manage to quote anybody. We have not found anyone. Gay Wisbey might like to comment on regulatory use.
  (Mrs Wisbey) We see a variety of new proposals coming to us because of all the exchanges restructuring themselves over the past couple of years. Each one of them that comes to us is quite unique once it has to deal with cross-border issues. What we do is we immediately call up our supervisory colleagues, wherever it may be, and we discuss some of the issues that could be forthcoming out of such a structure. The structure itself is determined by the exchanges, because they will look at the commercial aspects of this new proposal they have and will, hopefully, work with them in terms of regulatory responsibilities, and then it is evident. This past summer we issued a press release in terms of how we would deal with our German colleagues on the iX issue. We established six working groups on that. We also did the same thing with our Swedish colleagues. We are currently regulating OM London, Jiway, which is a new exchange we recognised last week, that is 60 per cent owned by OM and 40 per cent owned by Morgan Stanley. We work closely with the regulators in cases like this.

  125. How would you describe the problem of regulating the iX merger?
  (Sir Howard Davies) The problem with the iX merger was that it did envisage a kind of forced migration of stocks from one market to another. In other words, the blue-chips in Germany would migrate to London, a regulated exchange; and new technology stocks and telecommunication stocks would migrate from the United Kingdom to NASDAQ Neuer Markt. There is no market in Frankfurt and that creates a particular complication because it is evident from that, that stocks would be traded in two different places, particularly while the migration is going on. It is not realistic to think that Siemens would not trade ever again in Germany if it had been primarily quoted in London. Indeed, on some of the recent exchanges, therefore, it did create particular issues of information exchange between regulators. Clearly if somebody was building a position in Siemens he would want to see where it is being built. It might be built on the regional exchange and not disclosed in London, and we would have to arrange for that. We would also have to align the transparency rules of the respective exchanges. From our point of view, that was not so much of an issue because actually nobody was pressing us to change our transparency rules. The Managers' Fund Association was asking for the transparency rules to be aligned on the United Kingdom level. The changes would have been needed in Germany, that is what was alluded to in that report, where there is not the same transparency regime as in the United Kingdom. From our point of view we were able to cope with this, actually, these migrations of stock, because we were not being pressed to change our transparency rules. They would have needed some changes in Germany in order to make them more closely aligned to the United Kingdom standard, which is more like a United States standard.

  126. Are you happy with the normal arrangements for co-operation with your overseas colleagues in international regulatory matters?
  (Sir Howard Davies) Yes, the normal arrangements are absolutely fine. Clearly when you get into the business of merged exchanges which run across borders you need a different level of co-operation than you had in the past. That is absolutely evident. That is why we had to plan for iX going ahead, although, of course, it did not. As Gay Wisbey said, we had six working groups, which would have been permanent working groups, had they gone ahead, to look at market information, disclosure, transparency, cross membership and listing requirements, to make sure that we could align these to cope with the fact that companies were being listed in one place and traded in another, et cetera. We regarded all of that as feasible. We would not hide the fact that it is quite complicated. It is feasible and our general disposition is to say that as long as our regulatory objectives are maintained and no one is asking us to reduce our level of protection or damage our transparency standards we are prepared to facilitate these mergers. The standards of co-operation between us internationally and the Forum of European Security Committees, FESCO, have lots of working groups. FESCOPOL, the policing arm of it, is to ensure that insider dealers and dodgy dealers are transmitted around. Our director of enforcement chairs that. All of these mechanisms exist. If there are mergers they will have been streamlined.

  127. How much common ground is there with other European Union regulators?
  (Sir Howard Davies) A very high degree. At a conference recently in Paris, the Germans, French, Italians and I all spoke and people commented afterwards that they found it difficult to see any great distinction between what we said. We all took the view that a single European regulator should not be on the agenda, in the present circumstances, and the legal basis for such a thing did not exist. It would not be realistic. We need a better legal basis for the co-operation that currently goes on between regulators. We have made submissions to the Lamfalussy Group, it is different in certain respects, but generally we work in the same direction, of wanting to strengthen the underpinning of regulations in Europe and we expect a preliminary report from the Wise Men on Thursday of this week.

  128. We talked about Europe; what about America? When we were over there two weeks ago we talked to the regulator and we found that they were causing some difficulties about discussions that were going on between the Stock Exchange and NASDAQ. Do you enter those negotiations, even on margins or obliquely, at all in order to facilitate such discussions?
  (Sir Howard Davies) Yes, indeed, we do. Gay, do you know anything about America?
  (Mrs Wisbey) My accent may tell a little bit. We do try to clarify issues when we know a structure. If anything is being proposed between a US entity, such as when LIFFE was putting screens into the US, the CFTC had to grant it a "no action" letter. We had to explain clearly to the CFTC how we regulate and what we do. If they want to go further in some sort of structure, which they are not, and I am not suggesting that, if any exchange were, clearly any dialogue with any regulator would be essential.

  129. You would be a party to the negotiations, as the regulator is seen as a crucial element.
  (Mrs Wisbey) We would be party in terms of making sure that there is a structure that is doable for both regulatory regimes but not party in terms of what the commercial aspects are of the structure.
  (Sir Howard Davies) If a United Kingdom exchange were owned by a foreign exchange, whether it is a Swedish one or an American one, or whatever, we would certainly be involved in ensuring that that structure created certainty on the regulatory system within the United Kingdom.

  130. You would make sure that the American regulatory people could not block any negotiations.
  (Sir Howard Davies) If they had United States regulatory reasons for blocking it then we could not, I think, intervene in it. We would ensure that the United Kingdom regulatory interest was maintained.

  131. Sir Howard, can I take you back to the disclosure plans you have for ordinary consumer projects and/or ordinary saving products, and in particular look at endowment policies of life assurance companies. You are probably aware that many life offices do not really inform fully their policy holders that they have the option of selling their endowment policy on the traded endowment market rather than surrendering them to that particular office. That has raised some concerns because the selling price in the market is estimated to be on average 15 per cent higher than the surrender values. I want to ask you what the FSA is planning to do about this to force life officers to disclose more fully to their policy holders the traded option?
  (Sir Howard Davies) What we have done is ensure that every life company writing to an endowment policy holder with a real projection, which is going on at the moment—six million odd have already received such letters—all of these letters include an FSA fact sheet which explains people's options. I have personal proof that this is happening, since I have received FSA fact sheets myself, from myself. That sets out the options in what attempts to be a fair way. The industry have agreed to send out a description of the options on the specific traded endowment points.
  (Mr Folger) We did discuss this at a previous appearance before this Committee, it was exactly twelve months ago. We have followed, with interest, the continuing growth of the traded endowments market. There is no doubt it does give a very valuable option to consumers, it is some 20 per cent up on the first half of this year compared with the first half of last year. Because we have not been able to change everything at once this is high up in the list of issues we will turn to after N2. We can see that a good case is being made at a relatively low cost to companies, "When people make an enquiry to surrender you should, out of fairness, say that is not the only option. You may find an attractive way forward by taking it to the secondary market". The margins have narrowed somewhat through the force of competition and the Market Makers Association has done a good job through the media making clear this option and the margins that are available to surrender in the secondary market are narrowing.

  132. Can I ask why you believe the regulatory authorities, not just yourself, need to wait for N2? Surely this is an issue which is so clearly in the consumer's interests. Life offices, obviously, would be forced to have better disclosure than they previously have, some sort of regulatory guidance could be issued today?
  (Mr Folger) We need to consult carefully about that, of course. On the other side of the account are those, including some in the industry, who will say that some of the prices paid for these products are themselves excessive. There is some concern that the purchasers of these products, increasingly now institutional rather than individuals, may be paying over the odds. There is more than one side to the question. We would want to come forward with a separate set of proposals for that market, which ensures that there was good disclosure throughout.

  133. Are you saying that you may well wish to consult prior to N2, so that we can move this issue forward?
  (Mr Folger) That is a possibility now that N2 has slipped somewhat since we last discussed this matter.

  134. Is it a possibility or are you going to do it?
  (Mr Folger) We have not finalised our priorities for the coming year, but we shall be setting that out in our plan and budget in the New Year.

  135. Sorry to press you on this, it seems to me, actually, a clear issue. I know you said that some of the industry are saying people may be paying excessive prices, but in many ways that is those institutions' fault if they cannot get the price right. That sort of issue will always be the case, surely, in a free market. Surely you can act more quickly on this.
  (Mr Folger) There is nothing we can do before N2. We had some discussion before about the fact that the powers of the 1986 Act are less than we need to give effect to the improved disclosure. Yes, we could set aside everything else, for example, the work on disclosure generally, which Howard referred to earlier; it is a question of setting priorities.
  (Sir Howard Davies) To underline the point, we have had advice that we could not under the old regime require this to happen.

  136. The FSA has had legal advice or the PIA has had legal advice?
  (Sir Howard Davies) I believe it was the PIA who had that legal advice.

  137. Are you aware that the Association of Policy Market Makers contest that legal advice and believe it is possible under the old Act?
  (Sir Howard Davies) I am aware of that, because they did make that point to the PIA Board, who still hold responsibility for this.

  138. Do you believe, because you obviously share these concerns, it is worth getting further legal advice on this important issue, because if you have the power to act why delay? There are constituents of mine who are getting these letters and who are making poor choices on incorrect information and losing, it is estimated, over £1,000. We are waiting for the Chancellor to stand up tomorrow, hopefully, and give a generous increase in the basic state pension. In the FSA you could issue guidance to sort this out so pensioners in my constituency could get over £1,000 more by being given clearer advice. It is a guidance issue that is very important to us.
  (Mr Folger) Not on the legal advice we currently have on this question.

  139. Could I ask, given the contested legal advice, that you look at this again?
  (Sir Howard Davies) We will look at it again. If I may, we will write to you on this particular point.[2]