SIR CALLUM MCCARTHY AND MR HECTOR SANTS

22 JANUARY 2008

  Q20  Mr Dunne: It is very judgmental though, is it not?

  Mr Sants: It is indeed but, unfortunately, a lot of what we do is very judgmental in order to try to be fair and reasonable to the particular.

  Q21  Mr Dunne: Does it not also raise competition issues in that if you happen to be operating an insurer with an established pool of inherited estate you are in a much, much stronger position because of your rules than a new entrant coming into the market?

  Mr Sants: You are right in saying that those issues are also raised and have to be taken into account on the individual judgment. That is another reason why it is difficult to make hard and fast quantitative generic rules here, you do have to look at the particular. I repeat the basic point that we certainly do not want to see people unreasonably putting through loss-making business at the expense of current policyholders.

  Q22  Mr Dunne: Will you regard it as a success if on the two cases that are outstanding, the two significant ones, you achieve a better result for the distribution towards policyholders compared with shareholders than happened in the AXA case?

  Mr Sants: We have amended our rules since the AXA case so I think it follows logically from that that we thought there were some issues to be taken up and, therefore, we would expect a different result next time around. We should perhaps emphasise that whether or not there is a deal done at all, of course, remains a commercial matter for the firms.

  Q23  Mr Love: This follows up in a sense about the AXA case. I am quoting from Clare Spottiswoode's response to your letter to her. She says: "The FSA response was disappointing and it largely maintained the status quo" and goes on to quote that in the AXA case 70% of the estate went to the shareholders. Is that fair? If there is not any change in your response and we end up with 70% going to Norwich Union or others, is that fair?

  Mr Sants: I do not want to prejudge individual cases, but when she is talking about the status quo she is talking about our current rules. She was asking us to review our current rules, which was the exercise we did do, which resulted in us reaching the conclusion that we should consult again on the mis-selling point, which was the comment I made earlier to the Chairman. You are not talking about the situation prevailing at the time of the AXA distribution. Obviously we have looked again at the set of circumstances and it would be reasonable to assume that the result might be different, but it would be wholly wrong for us to prejudge or in any way indicate a numerical outturn that we are looking for. This is meant to be a negotiation between the policyholders and the firm where we have set up a Policyholder Advocate role to represent the policyholders as part of that negotiation and then we look at the outturn of the negotiation. We are not seeking to predetermine that discussion. The Policyholder Advocate is, quite rightly, vigorously going about her job of negotiating on behalf of the policyholders.

  Q24  Mr Love: Can I just ask one other question. She does say that you could be repeating the same thing if you read the comment, but I will not press that. Finally, you have already mentioned the difference between reattribution and distribution, which if I interpret it correctly is in favour of the shareholders. Taking on board the fact also that they have the power to decide over the timing of when this would happen, in other words they can withhold a distribution to the policyholders, does that not bias the whole system in favour of the shareholder?

  Mr Sants: That takes us back to my earlier comment that I do think it is important to recognise that those funds in the context of the reattribution are not owned by the policyholders. They have a right to those funds but they are not their funds in the most simplistic sense. I do think a lot of the debate in the media fails to acknowledge that point of law. The starting point is that they have a right to those funds and, therefore, if there is a reattribution it is reasonable for them to expect more than zero, which was my answer to the opening question, but they do not own those funds which are being discussed in the context of a reattribution, so their rights are not the same as in the case of something which somebody owns which somebody else is seeking to take away from them.

  Q25  Mr Love: But there is an enormous power in the hands of the company by saying, "We will just withhold this, you will not get a distribution at all unless you get a distribution on our terms".

  Mr Sants: If those funds are not owned outright by the policyholders it is not for them to determine whether they will be offered a distribution or not, that seems reasonable. In terms of the balance of power, I think that has been recognised in the FSA appointing a Policyholder Advocate and putting forward that proposal. We absolutely recognise that policyholders need professional support and representation in that negotiation. Again, I make the point that I think the volume of correspondence in front of you reflects the fact that has been done actively and professionally and we very much support those actions by the Policyholder Advocate which is a role that we proposed and, therefore, we are delighted to see a proper negotiation taking place which hopefully will give a fair result to all parties.

  Q26  Chairman: The public are very much aware of how these monies came about in the smoothing process of with-profit funds. At the end of the day everything was paid out to policyholders at a particular time because monies were held back in order to smooth the process at a later date. We have got to keep in mind the origin of these monies and that is important. I think that is where the public feel there could be unfairness. Finally, given Mr Love's point, do you agree with the principle that shareholders should not obtain a potentially large proportion of inherited estates without suitable payment to policyholders?

  Mr Sants: Yes, absolutely.

  Q27  Chairman: That is fine.

  Mr Sants: There is a contingent liability and if the shareholders want to give it up they need to be properly compensated for that.

  Q28  Mr Fallon: Sir Callum, in the light of the credit crisis and criticism of your banking supervision, what changes have you made to the FSA's structure of senior management?

  Sir Callum McCarthy: We have recently announced the appointment of a new managing director to fill the hole created by Hector's own promotion. We have also established a new set of responsibilities for Thomas Huertas looking particularly at the banking sector and also with a responsibility for dealing with one of the most important pieces of work that the FSA will have over the next year, namely the proposals which the Government, I understand, will bring forward this month and the legislation that it will bring forward later this year designed to change the regime for bank resolution and deposit insurance.

  Q29  Mr Fallon: But Thomas Huertas, as I understand it, is not a managing director. The managing director's appointment you referred to is Sally Dewar, I think. With respect to Sally Dewar, this is yet another internal promotion, is it not, which means that all three managing directors have come from within the FSA bureaucracy. Why have you not appointed somebody more senior with more recent market experience as a managing director?

  Sir Callum McCarthy: Because we looked internally and externally very carefully and very thoroughly and decided that Sally Dewar was the best candidate of the very large number of candidates we looked at. If I may, I will refer the details to Hector because, properly, he was in the lead taking the appointment forward since it is his executive team.

  Q30  Mr Fallon: Yes, but I want to hear from you as Chairman. Do you really think that the structure is right with all three managing directors being internal FSA people?

  Sir Callum McCarthy: If you take the top five people in the FSA, two of us, the two you see before you this morning, have extensive industry experience. Sally Dewar has a mixture of internal and external experience. I think that we have a good balance and have increased the number of people with external experience overall. My answer is yes, I am satisfied.

  Q31  Peter Viggers: I was going to ask a question along similar lines. You have a very broad remit indeed, part of which is, as it were, regulation with some kind of routine element to make sure people are obeying the rules, but you also need people with the very highest quality of market experience. You must have people who are fully capable of understanding market practice. Do you have a strategy for deciding whether you will take people with a regulatory background or with a market background? Do you have an overarching strategy on that?

  Sir Callum McCarthy: I think the overarching strategy is to get a mixture of the two. In any particular case we will look at the specific requirements for that job against the abilities of the various candidates, but as a general practice, though not invariably, we would look both externally and internally.

  Mr Sants: Could I add here that I completely agree that it is vitally important that we have a good understanding of the marketplace and that comes both through our own effective intelligence-gathering capability as an agency and through having people who have in-market experience. We are determined to have the right level of mix of skills and backgrounds to achieve that. I believe that we currently do have that but, of course, it remains an ongoing process and you have to refresh and constantly re-examine. I do not think there is any suggestion, if that is the background to the question, that lack of market understanding or market expertise by the FSA has been an issue in the recent months. I believe the current team is well-equipped to deliver the right level of market expertise. Thomas Huertas, who is providing the banking leadership, is an external appointment with many, many years' experience in commercial banking and credit markets. We have a number of other people in our relevant market area with market experience. I do not believe at all that a lack of understanding of the market is the issue here for the FSA. What is a challenge for the FSA, and arguably a great one, is continuing to ensure we have quality people who can make good judgments, deliver good supervision, train and recruit, and that means we also have to have people managers. I believe that getting good people managers is a bigger challenge than getting individual market specialists, not least of which we can perfectly adequately tap into market specialists directly. It is somewhat of a misunderstanding of the challenge to focus on the market issue relative to the people issues and I happen to believe that Sally Dewar is an outstanding people manager who will stand us in extremely good stead over the next few years.

  Q32  Peter Viggers: There has been a significant turnover in staff, has there not, in the last year? The Financial Times of 16 August referred to about 30% of the existing workforce that has left or will leave this year. Is that figure correct?

  Mr Sants: No.

  Sir Callum McCarthy: The figure is 13.3% annualised which compares with the financial services sector average of 14.5%.

  Q33  Peter Viggers: I am grateful for that. Margaret Cole is quoted in the same article: "Morale is an issue during any change programme. I've invested a lot of effort into the management side of that" and "Ex-FSA employees have reported low morale and a creeping fear among former colleagues that their divisions will be next for staff cuts". Would you like to comment on that? That is from the Financial Times of 16 August.

  Sir Callum McCarthy: Could I just explain that one of the things we did in the enforcement division, for which Margaret Cole is responsible, was to very deliberately upgrade the quality of that division. That involved considerable sifting of staff and considerable change which resulted in a temporary drop in numbers and we are recruiting to produce a more skilled and expert division. That is what explains the numbers point and may also explain Margaret Cole's comments.

  Mr Sants: Also, we would all agree if you go through an element of upgrading that includes some changeover and departures which maybe were not voluntary there will always be a category of people in the outside world who will make negative comments and you need to see it in that context as well. We are talking specifically about enforcement where we have a significant programme of change and we have changed something of the order of a third of the staff at a professional level over the last 12 months and we believe that will bear fruit in terms of a more effective enforcement agenda going forward.

  Q34  Peter Viggers: You have explained careful consideration was given to the senior promotions, but may I say it sounded a little inward. Have you taken external advice from head-hunters and are you satisfied that your salary levels are competitive if you seek to recruit the very highest quality of bankers and financial advisers?

  Sir Callum McCarthy: We do make extensive use of head-hunters. When, for example, seeking a new chief executive we looked very carefully both externally and internally before making the best choice, in our belief. We used head-hunters there and in the choice of the appointment of the new managing director. On the question of competitiveness of salaries, for people of the ability that we seek at the top of the FSA there is absolutely no doubt that any of those people could earn more outside the FSA. The competitive offering that we offer is partly salary but is also the element of public service, the interest of the job, the importance of the job, the range of things involved, and it is not simply money alone.

  Q35  Ms Keeble: I wanted to ask a bit about the Treating Customers Fairly work. The Financial Services Practitioner Panel's biannual survey showed that many firms still fail to understand what principles-based regulation means and how it works, and specifically in the area of Treating Customers Fairly over half felt that the FSA had not been clear enough about what was expected of them. How do you go about making sure that the firms understand and implement these broad-ranging strategies and principles-based regulation into practical systems that will go through the structure of their organisations and ensure that customers are treated fairly?

  Sir Callum McCarthy: Can I give the general answer and then ask Hector to give specifics. In relation to Treating Customers Fairly we have tried to take that concept and break it down into different components of the business cycle: how do you first approach your customer; how you actually promote your financial product; how do you interface with them when the sale is made; how do you operationally deal with them; how do you deal with complaints; how do you deal with post-sales service. We have tried to take the general concept and then break it down into specific areas and identify best practice in each of those areas, or rather good practice in each of those areas. That has been the approach to deal with exactly the point that you raise, how do you translate a general principle into helpful guidance as to what should be done in practice.

  Q36  Ms Keeble: If only 41% of the smaller firms met the March implementation date, that means you have still got the majority not actually having met the basics, which is about having policies, forget about ensuring that they permeate right down through the management lines.

  Sir Callum McCarthy: We have no doubt about the scale of the task involved in implementing Treating Customers Fairly. It is because we are actually measuring, and attempting to measure, the effectiveness and the problems that we meet in actually pushing this through that we publish these figures. I do not in any way take satisfaction from the limited success that we have had to date. We will keep on doing this and we will keep on looking, not only at the processes, because the 41% figure related to process, but at the actual outcomes which is the thing that we are really concerned about.

  Q37  Ms Keeble: What I am concerned about is at present it is the processes that are being looked at. Particularly when you have got rapid change and people doing work on the phone and the Internet, to shift to principles-based regulation and talk about doing processes leaves the customers exceptionally exposed. I am really concerned about whether this is the right way to go at a time when the industry is under such pressure.

  Sir Callum McCarthy: I think the alternative of doing it by specific rules, if I take your, if I may say so, completely correct analysis of the rate of change in this industry, which is to try and draw up specific rules saying, for example, "This is exactly how you should behave on the telephone. This is exactly how you should behave on the Internet" would be markedly less effective than the approach that we have taken.

  Q38  Ms Keeble: If the firms cannot understand it then how can the customers know what is supposed to be happening and how they are supposed to be treated? If you say to the customers, "The principle is you are supposed to be treated fairly", they will understandably say, "What does that mean?" How are you going to get the level of expectation in service delivery in the industry improved?

  Mr Sants: To underline the point that Callum has already made, I do not think it is a realistic alternative to seek to prescribe detailed rules to cover all eventualities of what happens at the interface between a firm and a customer. I do not think it is realistic, nor indeed have I seen any counterproposals or alternative ways which lay out how that can work. It is not a question of us rejecting an alternative which looks credible, there is not realistically any alternative to the way we are going. We absolutely recognise, however, that more work is needed. I should perhaps say that in the same survey of the order of 90% or so of the larger firms do already have processes in place. There is an element here of the issue of smaller firms intrinsically always being challenged with being asked to put in visible processes and, to be fair to the smaller firms, it does not mean that they are not delivering a fair deal to the customers. It may mean that they are not, and certainly that is why we wish to reassure ourselves on that point, but we would be doing a bit of a disservice to small firm industry if we automatically assumed just because they have not got a visible process they are not actually treating their customers fairly. There is a lot of work to be done and we completely concur with that.

  Q39  Ms Keeble: I know we are not supposed to be going into the Northern Rock stuff but one of the issues was around the way in which the regulation works. On a macro-strategic level people said Northern Rock complied and after the event a detailed study obviously showed there were all these flaws. Is there not a real need to ensure that on the detail of what the industry is delivering that it is delivering accurately and not leave it to the macro-principles which are fine but have got to be translated into action on the ground for the customers?

  Mr Sants: I do not want to go back to Northern Rock unless the Committee wants me to.