MR HECTOR SANTS, MR DAN WATERS AND MS LESLEY TITCOMB

15 DECEMBER 2008

  Q100  Chairman: Lord Lipsey's letter of resignation, as you have heard, called for a broader remit with greater resources than the Panel currently enjoys. Having applied the Rizla cigarette paper test, there is not much difference between Mr Phillips and Lord Lipsey. Why did you reject Lord Lipsey? Why is he not there making the case for a broader consumer representation, then both of you can work together?

  Mr Sants: We did not actually reject any proposals from Lord Lipsey. I have to say that neither I nor the Chairman nor the senior executive team received any.

  Q101  Chairman: That is not what Lord Lipsey is saying. Was there any communication between yourselves and Lord Lipsey?

  Mr Sants: I do have meetings with the Chairman of the Panel on a regular basis, and they also know that my door is always open and my telephone will always ring but there was no formal proposal made to us which had the support of the Panel. We do think the Panel is well resourced but of course, we would look carefully at any proposals made.

  Q102  Chairman: So you and Lord Lipsey, if you met, were mute and you smiled at each other and enjoyed the cappuccino and the croissants. Is that it?

  Mr Sants: I was aware that he was considering the resourcing and looking at this issue but, as I say, he made his decision to resign without getting to the point of bringing me a proposal.[1]

  Q103 Chairman: Mr Phillips' comments, as you see, are not much different to Lord Lipsey's. Are you willing to go away after this meeting and have a look at that and see if consumer representation can be enhanced? It seems pretty inadequate consumer representation.

  Mr Sants: Of course. We would always look at any seriously constructed, thoughtful proposal from our panels and from our panel chairs. They are a really important part of the work. I would make the point, of course, it is not just the direct resource committed to them; they do have the ability to leverage the whole of the FSA. So looking at those individual figures that were quoted earlier is rather misleading. To the straight question, absolutely, we take the panels extremely seriously. The consumer panel has a keen role, to represent the consumer interest forcibly, to challenge the FSA, and to provide us with a useful sounding board and advisory forum. To deliver this task, they need to be properly resourced, and we will, of course, listen carefully to any proposals they might have.

  Q104  Chairman: At the moment your Deputy Chairman is a former chief executive of one of the retail banks. Would you advocate the Deputy Chairman being from the consumer side if the Chairman is from the industry or has had industry experience?

  Mr Sants: I hope you will not mind me making the point, as you kindly observed, that our Chairman is in Hong Kong and of course, the composition of the Board is not directly a matter for the executive. It is for the Board and the Chairman, and indeed HMT, so I would rather not comment, in all honesty, on the direct question. I am happy to make a general observation as an executive member of the Board.

  Q105  Chairman: Do you need more consumer representation?

  Mr Sants: Of course, board members are not meant to be representing sectional interests, they are there as individuals but, as an executive, we would welcome greater consumer engagement at the Board level; if it is consistent with delivering effective Board governance.

  Q106  Chairman: Paragraph 6 of your memorandum details your recruitment policy and it contains the following phrases: (1) "We are aiming for the right balance of career regulators and market practitioners"; (2) We are "recruiting external candidates from a range of backgrounds, including retail and investment banking, risk management, quality assurance and consultancy firms" but there is no mention of any attempt to recruit staff who might have a background in consumer organisations.

  Mr Sants: As I think you are aware, those comments are, of course, targeted at the earlier debates we have had in this Committee exhaustively where Committee Members and myself shared a mutual concern that the regulator was not necessarily as well-equipped as it might be to deal with financial stability and prudential issues. So those recruitment characteristics are framed around that particular debate. Of course, we recognise the importance of ensuring we are also properly resourced for our task in conduct regulation and I can completely agree with you; if I use the phrase "market" as reflective of the outside world, then the comment is relevant, we are looking to recruit from areas outside of career regulation. In respect of conduct regulation I would take the same philosophy, that we ought to have the balance of those that bring the consumer viewpoint alongside those who bring the career regulatory perspective as well. As I say, those original phrases are targeted at a different question. I quite agree with the point.

  Q107  Sir Peter Viggers: Thank you for your memorandum. You discuss principles-based regulation. Would you just like to say a word or two about that because you make the point in your memorandum and it might be quite useful for us to hear.

  Mr Sants: We have discussed this in the past. The FSA, right from its genesis, has described itself as a principles-based regulator to seek to distance itself mainly from the concept of a more legalistic approach of the regulator being there just to ensure that rules are complied with, without necessarily giving thought to the consequences of the actions of the firms in question, the individuals in question, the rules in question. That principles-based approach has been in place from the genesis of the FSA but it was revisited, I think, with the benefit of experience in the last couple of years. It has also been right to revisit it with the benefit of the experience of the last 18 months, an extraordinary period in financial markets. What we are saying as a result of those reflections, in particular the reflections of the last 18 months, is that the basic concept of principles-based regulation does look to us the right way forward, is the right regulatory philosophy to have, and indeed, when you look at the issues arising from the last 18 months, they arise not from principles-based regulation falling over but rather from maybe the failure by the regulator to follow through its own principles. I have however sought to nuance our "strap" line, when I have been here in front of the Committee before, and to draw out some of the other phrases that we use to describe our regulatory approach because I do feel some of those other phrases better describe what we mean. The problem with principles is that people then tend to focus entirely on the size of the rule book. I think it is more important to also focus on the outcomes and to really emphasise the point that what we want management of firms to do is to think about the consequences of their actions, whether that be in the conduct or the prudential space, and to decide whether those consequences are aligned with our principles, and that we, as a regulator, should be seeking to make that judgement as well as to whether the consequences of their actions, of the firms' actions, are going to deliver the results that we all want. The emphasis is more on that phrase "outcomes-based regulation" but that in no way suggests that we have moved away from the concepts of trying to do so with as minimal a rule-based framework as possible and emphasising the compliance with our 11 principles.

  Q108  Sir Peter Viggers: Not everyone is happy with this. The Association of Chartered Certified Accountants—I do not know if you have had a chance to see their evidence to us—have been quite critical. They say that ACCA believes that the supervision carried out by the FSA has been regulation rather than principles-based and they go on to say, "We believe that the problem is not one of a lack of regulation but of a failure of the FSA's existing supervisory powers." How do you respond to that?

  Mr Sants: A couple of points. First of all, just to make clear, of course, the policy framework which we regulate to is not entirely within our control. Of course we are a significant driver and influencer of that policy agenda but it may be worth reminding ourselves that the majority of policy nowadays emanates from the European environment and to a lesser extent from the global and international environment, as it should do, but of course, that does mean that not every aspect, not every Directive is necessarily written in the way that we would choose. If you look at the rules and policy here, it may well be that at times that does not comply with a purist approach to principles-based regulation. I think it is worth reminding ourselves of that point. To the second point, how effective are we at delivering in a principles-based way, of course, as I commented before, when we do deliver in a principles-based way, I believe that does give the best result for the system, for the users of the system, and where at times we deviate from that, as there have been occasions in the last 18 months, as we have discussed in this Committee, the results have not necessarily been as good as they should be.

  Q109  Sir Peter Viggers: Meanwhile, the Association of British Insurers comes back at your comments in a different way. The FSA, they say, should also place greater emphasis on prudential regulation rather than on the conduct of business regulation and they go on to say, "Ultimately, the most important outcome for consumers is that their claims are paid and firms can only do this if they have adequate capital." Do you understand their point?

  Mr Sants: I certainly do. It is a crucial topic. I am conscious of time and I do not want to give you too lengthy answers, so I shall try to keep this very short but if you would like us to expand on this topic when we next come back, I will be delighted so to do. The first point is, we have discussed here before that in our retail supervisory area there have been criticisms from industry, as we heard today from Nick Prettejohn, that historically we did not focus enough on prudential issues and were focusing too much on conduct within the supervision of our retail institutions. In terms of that balance point, we would agree with that. So we have rebalanced but what we have also sought to do, of course, is to increase the total amount of capacity in the system through our supervisory enhancement programme and through our recent recruitment programme. We will have something of the order, as you know, of 20% more supervisory capacity and a reorganised supervisory process. We believe overall that that will deliver more capacity for both prudential and conduct, and I think it is absolutely critical to have a balance. We need to be extremely careful that we are not sitting here in a few years' time, looking back and saying, "You were all focused on prudential. What happened to conduct?" It is very important that we deliver a balanced agenda and that is how we have now set up the supervisory process, to make sure it is a balanced agenda, with more capacity, and delivering in a more effective way, which will take us on, I think, to some later points about why we have embedded TCF. A final point I would like to pick up from earlier observations around is the assertion, which is obviously a perfectly theoretically correct assertion, that there is an inherent conflict between prudential and conduct regulation. Of course, there is an inherent potential conflict but first of all I would have to say it is not clear to me why moving that into two separate administrative organisations will necessarily remove that conflict. Whatever happens, the regulatory system in the round has to manage that conflict. Secondly—and I think this is a really important point—I think history is showing us, and the last 18 months are definitely showing us, that prudential and conduct are completely intertwined. As the submission you have there mentioned, at the end of the day, if firms fail, consumers lose out. So the idea that somehow or other prudential is not a consumer issue is missing the point. Furthermore, effective prudential regulation requires conduct issues. We have discussed in this Committee before issues like compensation, competency of management—these are conduct issues which intertwine with prudential in the same way as prudential intertwines with conduct. I would suggest that if you do not have that overall view, you would have a worse regulatory system than you do now have. So I think history is showing at the moment that the integrated approach is the right one but, of course, there is a conflict and that conflict has to be managed.

  Q110  Chairman: On that conflict of interest, there is one issue that we are going to be taking up more because there are different views on it, Mr Sants. It came up at the Northern Rock time.

  Mr Sants: Absolutely.

  Chairman: It is something I think we need more clarity on and, as a Committee, we will be pursuing along those lines to understand it more.

  Q111  Mr Brady: Given Lord Lipsey's description of the term "sales advice" as being devoid of meaning, what should a consumer understand by the term?

  Mr Sants: As a general point, may I just remind everybody that these are preliminary suggestions from the FSA which we now intend to test with consumer research. Obviously, it is critical that whatever terminology we come up with has to be terminology that is understood by the consumer. That is self-evident and we are certainly clear about that goal. I have a lot of sympathy with taking a view that there is a case for arguing in terms of terminology that you have a straightforward division between independent advice and straightforward sales terminology, which indeed is a proposal that has been in our documentation, but there are considerable issues about that and, as ever, when you unpick the problem, it is a more complicated story than it may at first sight seem, not least because we do not want to lose that service which the banking industry delivers, which does have an advisory component. We also have to recognise, that given the way the Directive is framed, they are delivering advice in many cases as the MiFID framework allows them to do. I think there are Directive issues here as well. There is research to be done but we also need to recognise the limitations of what we are able to do within a national context. We also have to recognise the importance of maintaining an important segment of low-cost service to consumers. Dan, I do not know if you want to add a bit more.

  Mr Waters: I think the only thing I would say is that we have had discussion with the European Commission, as you would have expected, on the overall Retail Distribution Review, in which they are very interested and are generally very supportive of what we are trying to achieve. On this particular point, they were very clear that MiFID is the governing legislation in terms of what is advice and what is not. The recommendation being given by an employee of a bank is advice covered by MiFID and the idea that that person could not make clear to a consumer that they were giving advice is unlikely to be an acceptable outcome under MiFID. There is that limitation. The other thing to say is, a consumer needs to know that, if something goes wrong, they do or do not have access to the FOS; they do or do not have access to the protections of our advice regulation.

  Q112  Mr Brady: Under your latest proposed framework that has independent advice and sales advice, do you think it will be clear to the consumer in whose interests a sales adviser is working?

  Mr Sants: We hope so but we are open to further suggestions. We are still working with consumers and industry to refine and develop the terminology we apply. That matter is not closed; that is a suggestion on the table, and we welcome any further contributions to that debate. I do think the point that my colleague has just made is very important about ensuring that consumers continue to have the benefits of the protection offered by the FOS and that framework, and the point that both of us have now made twice, which is that we have to recognise that within the Directive framework banks are offering advice and we cannot change that.

  Q113  Mr Brady: Given that both might be under the same kind of pressures to meet sales targets from above, what is the fundamental difference between somebody selling a car in a car showroom and a bank employee selling a financial product? Why can they both not be called a salesman?

  Mr Waters: The fundamental difference of course is the nature of the market. Consumers behave a lot more competently and confidently in dealing with many retail markets. Financial services is one of the most difficult because of the nature of the products. We have that problem. In terms of the difference we have now put in place, there are rules about the suitability of advice and there are constraints therein. There are also propositions in the RDR which are meant to break the drivers of selling; commission-driven selling as we know it, where the provider is basically competing for distribution by paying commission will be broken by the RDR. There will still be issues in the tied sector about the incentives put upon sales forces and we are very clear about that. The TCF programme is very clear about looking closely at remuneration structures, looking at the training of staff and looking at the monitoring of the quality of the outcomes.

  Mr Sants: Just to give the plain English answer, I think the banks would argue that they are offering advice in the service they proffer. It is not, in the eyes of the FSA, full independent advice, assuming it is not that type of advice which gives full access to all product options, but they would argue that they are offering a degree of advice, and certainly within the MiFID framework they are offering advice, and cars are not sold under the MiFID framework.

  Q114  Mr Brady: When Which? did its mystery shopping survey, they found a number of bank advisers claiming to be offering free advice whilst the cost of that advice is obviously loaded on to the product. Should purchasers of bank products know the true cost of that advice?

  Mr Waters: The answer to that question is yes, and we have agreed and are already beginning work with both the BBA and the ABI on transparency about the cost of advice, and transparency about the cost of the product.

  Q115  Mr Brady: What support are you going to give to firms in managing the transition to the new adviser charging model?

  Mr Waters: That is a very good question and one that we will consult on. It may be that there are intermediate steps that we can take along the way that will smooth the transition. That is something we need to look at in consultation.

  Mr Sants: There was a general point made by Peter Vicary-Smith, and to be straightforward, we completely agree with. It is a question of finding how to navigate through that. There is no disagreement on the points he made.

  Q116  Mr Brady: Have you made progress on dealing with trail commission, a problem that was highlighted in our report on restoring confidence in long-term saving?

  Mr Waters: The basic change that the RDR intends to make is the removal of the reliance of the advisory community on commissions being rolled up and paid up front, so that by 2012 there will be perfect matching between the cost of advice and the money coming from the client. So this business of funding by the provider will be removed. That is quite a fundamental change.

  Q117  Mr Brady: Can I move to a different issue, the whole question of offshore deposits? Obviously, there has been severe detriment suffered this year by a number of consumers who invested offshore, particularly in the subsidiaries of Icelandic banks. Do you think the FSA did enough to make sure that consumers were warned of the dangers of saving offshore?

  Mr Sants: I think you have to ask the question as to what is the extent of the FSA's remit in that, in the sense that in many cases here we are talking about companies that not only are not regulated by the FSA, but they are not even owned by companies which are regulated by the FSA, and of course, they do not fall within the FSCS and the consumer protection regime in the UK. I think these are issues clearly outside our regulatory boundary in the supervisory sense. We certainly have an obligation to make sure that, where those firms are marketing into the United Kingdom and fall within our remit in that respect, the information is clear as to their regulatory status and the status of their consumer protection offering, their consumer protection process. I do believe that that was clear to consumers, but I make the point that these are not firms that are regulated by the FSA and I see no reason why people would believe that firms outside the United Kingdom would be those regulated by the FSA.

  Q118  Mr Brady: Clearly, a lot of people who saved offshore in these banks would have done so under advice from IFAs. Do you think those IFAs themselves were fully aware of the risks of investing offshore?

  Mr Sants: Clearly, if they feel they have been mis-sold to by a UK-regulated entity, they have a case that they should pursue and that would be the right thing for them to do. Again, we are always interested in hearing and keen to hear from consumers who feel that they have been mis-sold to and would take action in those cases.

  Q119  Mr Brady: Do you think, looking ahead, there is a case for more information, more education, both for consumers and for advisers about these risks?

  Mr Sants: I would certainly hope that events have demonstrated the importance of understanding the risks involved in offshore investments. I think that is an important lesson for advisers to learn and I would expect they would have learned that lesson.