SIR CALLUM MCCARTHY, MR HECTOR SANTS AND MS MARGARET COLE

6 MAY 2008

  Q1 Chairman: Sir Callum, welcome to you and your colleagues to the session this morning on the FSA and financial stability and transparency. Can you introduce yourselves, please, for the shorthand writer?

Sir Callum McCarthy: I am Callum McCarthy, Chairman of the FSA.

  Mr Sants: I am Hector Sants, Chief Executive of the FSA.

  Ms Cole: Margaret Cole, Director of Enforcement at the FSA.

  Q2  Chairman: Sir Callum, in your memorandum, you note the proposal in the Government's consultation paper is for the decision to activate a new special resolution regime to lie with the FSA. Why do you believe it is integral to the supervisory process for only you to be able to make that decision?

  Sir Callum McCarthy: Because I think it is a decision that is absolutely integral with the normal supervision of banks and I think that the question of doing so is inextricably linked between the two. It is not simply a decision at the time of pulling the trigger. In order for someone to pull the trigger they have to decide over an extended period whether that trigger should be pulled and be in a position to defend that decision, so if you have more than one institution involved in that you would have an extended period during which a bank would be subject to interrogation and a degree of supervision by more than one institution. I think that that would produce ambiguity and a degree of uncertainty. I am not surprised that the major trade associations, both LIBA and the British Bankers' Association, see great advantage in there being unambiguous responsibility.

  Q3  Chairman: But you screwed up the last time, Sir Callum, and the one who is responsible for the fault, that did not find the mistake, could cover it up, so what reassurance could you give this Committee that if you get these powers you are not going to screw up again?

  Sir Callum McCarthy: I was making a difference between a decision in any one case and the argument about whether introducing ambiguity into the system will produce better results.

  Q4  Chairman: But we did have ambiguity in the system with the Tripartite Authority because every one of you came to this Committee and said you did your job.

  Sir Callum McCarthy: I am all in favour of having as much clarity and as little overlap as possible.

  Q5  Chairman: But I am saying, Sir Callum, there was no clarity previously—

  Sir Callum McCarthy: There are some questions, Chairman, which can be asked about that. Sorry, could I just reply to your question which I think is a very fair question. I think there are questions about what happened in the past but I see no advantage in introducing additional ambiguity into the system in order to deal with past failings.

  Q6  Chairman: Okay, Sir Callum, I will put it to you like this then: do you have sympathy with the views of politicians who would be sceptical about giving these powers to the FSA given your track record with Northern Rock?

  Sir Callum McCarthy: No, I think that the question of how we exercised our discretion and our responsibilities in relation to Northern Rock is something which we have examined and we have identified a number of things that we believe it is essential that we put right. We have started a programme to put those right and we are busily doing that.

  Q7  Chairman: You see, Sir Callum, I took the opportunity when the Governor of the Bank of England was here last week, and no doubt your staff have brought to your attention his comments, when you make the point about the trigger, he is very clear and he is saying that they should have someone other than the supervisor with the ability to pull the trigger and that is because of the concerns about regulatory forbearance, "the natural reluctance of a supervisor to announce publicly that the supervision regime has not been successful and the bank needs to go into a special resolution regime." So there is a difference between you and the Governor on that?

  Sir Callum McCarthy: There is a difference between the Governor and myself and indeed between the FSA Board and the Governor. I would point out that there is no evidence at all that we indulged in what was described as "regulatory forbearance" in relation to Northern Rock. The problems in relation to Northern Rock, which we have examined in considerable detail and with a great degree of rather brutal honesty, are different from the questions of regulatory forbearance.

  Mr Sants: If I may make a comment on regulatory forbearance?

  Q8  Chairman: Hold on a second, the Governor made the point as well about the basic argument about the special resolution regime, and in answer to my question he says: "I think you argue, correctly, in my view, that it should not be with the supervisor but with a different body. I think you can argue plausibly that it should be with an independent body, it could be with the Bank." Given that legislation has to come in in front of us, Mr Sants, and politicians have to feel reassured that the FSA is on the job, then I would take a bit of persuasion that it has to lie with yourselves, and I would suggest to you that if it is going to lie with yourselves that it is not done by you sitting back but by convincing people, particularly the body politick in the House of Commons—all MPs, not just the Government—that you are the correct body to have that power.

  Mr Sants: I would absolutely agree with you that we should ensure that we have the confidence of all MPs and indeed of all depositors and savers. I do believe the programme we have set out should generate that confidence. On the point, if I may, of regulatory forbearance I would just like to expand a bit on that. I am afraid I do not really understand that argument. It seems to me that under the new proposed regime, if anything, the incentive for the supervisor is to place the bank early into the special regime, not late, because our objective is to actually protect depositors; that is what we are here for. With regard to your point about ensuring we have the confidence of Parliament; we are here to protect the depositors and under the new proposals, if anything, the incentive for the regulator is to put it early into the regime to ensure that there are no issues for depositors. A disorderly unwinding of a bank would inconvenience depositors, so I do not agree at all that there is some incentive here for us to delay placing a failing bank into the regime. But, as I say, to your first and most important point, I absolutely believe that we can and are ensuring that we are well-placed to do our job effectively. I would echo one point the Governor made, he talked about the importance of not giving an organisation responsibility without authority. I think the issue of having two separate triggers then creates the possibility that we as a supervisor are not able to do our job and I am sure that Parliament would not want to place the FSA in a position where it has responsibility without the necessary authority.

  Q9  Chairman: Given the different views that have been expressed by the Governor last week and yourselves this week, I think it is incumbent on you to go back and discuss with the Governor so that we as a Committee can feel some reassurance that two legs of the Tripartite Authority agree with each other on a particular issue, otherwise there is no confidence in the future. To date, I do not think that you have given us sufficient evidence to give us any confidence that you are the correct body to have these powers, so I think you have a big job to do on that in the next few months.

  Sir Callum McCarthy: Could I make one distinction which may help. We have been answering questions about the use of the trigger. One thing we are in complete agreement with with the Governor is that once a bank goes into the special regime we do not believe it should be the FSA that administers that bank because we believe that it would be an undesirable and incorrect conflict of interest to both regulate an institution and to run it, so on that point there is complete agreement.

  Q10  Chairman: I understand that but there is a big gulf between you yet and I think it is important that you get together and if there is a possibility of a joint submission to this Committee with which you agree, only then I think will we as a body start to have some confidence in those two legs of the Tripartite Authority. In terms of conflicts of interest, if you are given the powers for the special resolution regime you would be in charge both of regulating institutions and shutting them down should they fail (potentially because of your poor regulation), so if you were given these powers, how would you deal with those conflicts of interest? Maybe that is for a later time when you are giving us your submission but if you could give us a flavour today it would help, Sir Callum.

  Sir Callum McCarthy: I think that the regulation of an institution once it has moved into the special resolution regime is not actually a terribly difficult set of issues provided we are not also running that institution, and it is because of that that we have made it clear that we think it would be inappropriate to do both. Once an institution is in the regime we would be concerned to look at the same aspects that we look at normally, ie things which determine whether it is breaching threshold conditions.

  Mr Sants: I come back to my earlier point that our role is to protect the depositors not to protect the shareholders. I think there seems to be a little bit of a misunderstanding here. There is no question that the purpose of setting up the special regime and the Bank regime reform proposals in general, is to better enhance consumer and depositor protection.

  Q11  Chairman: Although I would just make one point there, in a sense you could be protecting the shareholders if through your poor supervision you do not want any of your mistakes uncovered or one does not want one's mistakes uncovered, so there is a potential there, that you want to have a clean record in supervising banks.

  Mr Sants: Any time you take on responsibilities you have to be accountable for discharging those responsibilities effectively.

  Q12  Chairman: I am highlighting the conflict of interest there. Could I go on to one area where we are agreeing and that is market abuse—and we are going to come back to that at a later time—the FSA has successfully prosecuted only two firms and 12 individuals for market abuse since your inception in 1998. Does this mean that the UK has a very clean market or does it demonstrate that the FSA is ineffective in clamping down on market abuse? I am mindful of the comment that Howard Davies made in 1999 when he said: "Perhaps London's markets have been perfectly clean through this period; I beg leave to doubt it."

  Sir Callum McCarthy: I absolutely agree with Howard Davies that there is no evidence to suggest that the London market, the British market, is uniquely clean. Indeed, the evidence that we have produced, and which we are determined to keep on producing, shows that this remains a significant problem. I would say that I think that successive administrations and successive attempts to deal with this have not been very successful in dealing with insider trading and market abuse, and it is because of that that we have determined to increase our resources to attack this, to change the technology that we have available to enable us to identify this more effectively, and why we are seeking from the Government additional legal powers in relation to plea bargaining which we believe are essential if we are to make a step change which, as your question implies, Chairman, we believe is very necessary.

  Q13  Chairman: How does your track record compare with, say, the United States' track record in prosecuting?

  Mr Sants: It is not very easy to make comparisons because, as the Chairman has already indicated, we do not think we are as well-equipped as we would like to be with respect to achieving prosecutions, but certainly on the key point of criminal prosecutions clearly it is the case that the US has a longer track record than we do since at the moment in terms of completed criminal cases our track record is zero. What we have stated is we find the current level of market abuse, at least as best as we can measure it, unacceptable. We need to address it and we can see that the measures we have taken so far have not addressed it, and going forward we intend to be more determined and more effective, and in particular to pursue criminal prosecutions in this area to significantly increase the deterrent effect. As you rightly point out in respect of the US, that has been a difference which we intend to rectify in the future.

  Q14  Chairman: This is one area where we agree because in the Budget debate I made the case for you having this plea bargaining, so I am interested in this, and first of all, in terms of the Government's proposals, do they go far enough for you in terms of achieving that objective?

  Sir Callum McCarthy: I was very grateful for your remarks in the Budget debate, Chairman, thank you very much.

  Q15  Chairman: We can get on sometimes, Callum!

  Sir Callum McCarthy: I am genuinely grateful. The Chancellor's statement when he made clear that he thought it would be a positive step to give us the powers of plea bargaining is an admirable statement. We are in the hands of the Government to give us the legal powers and that has not yet happened.

  Q16  Chairman: You are in the hands of the Government and that is what worries me because I am told that there could be some seizure in terms of getting the legislation here. The Chancellor has given us the rhetoric but it is still to be implemented and I am told it could be getting held up somewhere. Do you know anything about that? The reason I am asking this today is to ensure that we get a move on with this so that everybody is listening.

  Mr Sants: We have no timetable to date so we would obviously very much welcome a timetable being forthcoming.

  Q17  Chairman: So it is disappointing that we have not got a timetable yet?

  Mr Sants: From our perspective, given the importance we attach to this issue, yes.

  Q18  Chairman: I will write to the Chancellor after this meeting today to see if we can get this moved on in terms of legislation.

  Sir Callum McCarthy: I am very grateful again, Chairman.

  Q19  Mr Fallon: Coming back to the supervision of Northern Rock and the report you have done, it appears to be a catalogue of failure. You identify a lack of sufficient supervisory engagement, a lack of adequate oversight, a lack of specific resources directly supervising the firm, and a lack of intensity by the FSA, Sir Callum, at the point you were supervising Northern Rock last summer you employed 2,600 people; how many have been dismissed?

  Sir Callum McCarthy: None has been dismissed. Of the people who were responsible for supervision of Northern Rock at the relevant period, none is now involved in supervision and a number of them have left the FSA.