Financial Services Bill

– in a Public Bill Committee at on 10 December 2009.

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[Mr. Roger Gale in the Chair]

The Committee deliberated in private.

On resuming—

Q212The Chairman: Good afternoon ladies and gentlemen. I remind hon. Members and witnesses that we are bound by the deadline agreed to on Tuesday, which means that the evidence session must end at 2.30. I hope that I will not have to interrupt anyone in the middle of a speech, but those of you who know me, know me well enough to know that if I have to do so I will.

We are going to take evidence from the City of London Law Society, Clifford Chance and the Investment Management Association. Thank you for joining us gentlemen. Would you like to introduce yourselves? I suggest starting from left to right—that is, my left to right.

David Ereira: My name is David Ereira, I am a partner in Linklaters, and I am here representing the City of London Law Society. I am a member of the financial law committee of the CLLS.

Simon Gleeson: I am Simon Gleeson from Clifford Chance. I am a regulatory specialist in the Clifford Chance regulatory department. I advise, among others, the World Economic Forum and the Institute of International Finance on regulatory issues.

Photo of Roger Gale Roger Gale Conservative, North Thanet

Mr. Gleeson, I think that old age is taking its toll on the Chairman; I am finding it a little difficult to hear you. You may find it easier if you lift your head slightly; it also makes life easier for the Hansard reporters.

Guy Sears: I am Guy Sears, director of wholesale at the Investment Management Association, which is the United Kingdom asset managers’ trade association.

Photo of Roger Gale Roger Gale Conservative, North Thanet

Thank you all very much indeed. Welcome.

Q213Mr. Mark Hoban (Fareham) (Con): I would like to ask all three of you a question about the powers in clauses 14 to 17—the disciplinary powers that have been given to the FSA. Some of the representations that we have received about them suggest that the powers are unnecessary, and it cannot quite be worked out why the FSA needs them. Can you shed any light on why the powers might be appropriate?

Photo of Roger Gale Roger Gale Conservative, North Thanet

Sorry, gentlemen; before we proceed, I think that it might help, given that we have three witnesses, if all Members were to indicate first whom they would like to reply.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

I would like to ask all three, but perhaps we can start with David, then Simon and then Guy.

David Ereira: From my perspective, I do not have a particular response on that issue. My concerns about the Bill relate more to its impact on financial transactions, so I do not think that the FSA’s disciplinary powers per se have a concern on the operation of the banking and financial markets.

Simon Gleeson: There are two aspects that I think require comment, one of which is the idea of punishing a firm by suspending part of its permission. That is an approach that the Japanese authorities have tried in the past, almost universally unsuccessfully. The problems that it creates are that the scope of the impact on the firm subject to it is unknown. If somebody had banned Citibank from engaging in structured finance two years ago, the benefit would have been enormous. The other aspect is that the benefit of the punishment accrues not to the public, but to the competitors of the firm subject to it. If the firm is required to exit a business in which it is already active, there is a significant detriment to the customers of the firm concerned, who will have to look for other service providers. It is very hard to envisage circumstances in which the imposition of this sanction would be useful and valuable.

The second point—because you asked about the three sections—is the issue relating to the imposition of penalties where controlled functions are performed without approval. The issue there is that the definition of controlled functions is loose and widely drafted. That is entirely deliberate, to enable the regulator to ensure that all the appropriate individuals are approved. However, because it is widely drafted, it is very hard for individuals to know with certainty whether they are performing an approved function or not. The textbook example is a main board director of a large international corporate that has a small UK subsidiary. If it is sought to impose a penalty on people for breaching an obligation that is so loosely defined, the danger is that that will potentially require the FSA to reduce the scope of the requirement for authorisation. So there are very serious technical difficulties with both of those.

Guy Sears: You ask whether or not they are needed. Technically, they may well be needed, whether or not there are merits to them. I suggest that there is a deliberate reason why they were left out of the Financial Services and Markets Act 2000 when it was passed, which is that they are of a different constitutional nature than the powers that were given to the FSA. These are exercisable powers, which go either to persons who are not part of the system—in other words, they are part of the wider citizenry—or they are exercisable by way of a punishment, as Simon mentioned, in the nature of the suspension. In the passage of FSMA when it was going through, there was a lot of discussion as to the civil or criminal nature of the proceedings being taken by the FSA under the Act and the appropriate protections that should be put in. Within that, I would suggest that Government and others took the view that, rather than banning a person as now, or not banning them, the suspension, which is a period of time certain  in which you just can’t appear, is in fact by way of a penalty. It is a punishment in its nature. So it is of a different nature than FSMA gave FSA. On the controlled function—

Guy Sears: I wasn’t speaking of the merits though.

Q214Mr. Hoban: No, but just in terms of the nature of whether it is a penalty or a punishment, there are obviously safeguards built into FSMA when the existing powers are exercised.

Guy Sears: There are.

Q215Mr. Hoban: Are those safeguards sufficient, given the nature of the new disciplinary powers that the FSA will be given under the Bill?

Guy Sears: I would suspect they are, because of the use of the financial service markets tribunal. As FSMA went through as a Bill, of course, there were interventions, by various MPs, that made amendments and brought in extra protections within the tribunals process, and also the ability to get representation and legal aid at times. Those protections, of course, are the classic article 6 protections on fair trial matters, which rendered the whole debate about whether it was civil or criminal much less important from that point of view.

On the control function, a person who has never actually had a controlled function and is fulfilling that place is in fact just a member of the citizenry. They have not submitted to the regulatory system, whether by an authorisation or an approval. That is the usual way. Then there is a jurisdictional grip by the regulator to punish—or penalise, or censure, or whatever it may be—a person. Again, I would not suggest that this is a mistake. When FSMA was passed, it was a deliberately different treatment—the fact that somebody had never become part of the system; they were just the citizenry. The one area where FSMA normally deals with the citizenry at large is in market abuse. That extends to all people, whether or not you are actually part of the system. I think that is why there were differences, and I think that others probably accepted as this was being put together that they were constitutionally different. It is a different question to whether or not they are needed.

Q216Mr. Hoban: And are they needed?

Guy Sears: It would seem so to me, if we have a system that seeks in its spirit to ensure that those who carry on important parts and important roles within regulated activities should be subject to proper standards on entry and oversight by the FSA. In a sense, if they do not do that, the FSA has no ability to deal with them—that seems to me a lacuna. That one is quite understandable, albeit different constitutionally.

Q217Mr. Hoban: But what about Simon’s point, though, where you have a large international corporate with a UK subsidiary that is regulated and you may be a board member of the corporate? It just seems a wide power. There is a defence thing in here if you are not aware that you are exercising a control function. Shouldn’t the penalty perhaps be on the authorised person, rather than the individual?

Guy Sears: The proposal in section 63A included in the clause is that, if the person did not know and could not reasonably have known that they were carrying on a control function, they would not be penalised. I agree that it is wide: the extension of the FSA’s control function regime at the moment to persons of significant influence, and lots of firms are having to consider whether their US parents need to be registered in the UK as part of the work that is going on at the moment. As Simon mentioned, it is not just textbook; it is real—people are doing that at the moment. Yes, there are concerns, of course, but I suppose the likelihood that the FSA is actually going to get all the way to imposing a penalty on you if an innocent mistake was promptly rectified is the test in practice.

Q218Mr. Hoban: In terms of suspension, we had a conversation this morning when we took evidence from the British Bankers Association about how this power might be used, and we linked it back to some of the issues in the run-up to the financial crisis, whether Northern Rock lending 125 per cent. loan to value on properties, or people trading instruments that they did not understand—collateralised debt obligations and things like that. Is this power in clause 14 there to prevent people from doing things the FSA feels uncomfortable about them doing? Could it be used as widely as, “Well, I don’t like this, so let’s suspend them”?

Simon Gleeson: I think that there are two answers to that. One is that if that were the intention, it is in the wrong part of the Bill, because it is inserted in the section on disciplinary powers. I think the second is that the FSA already has a power to vary permissions on its own as part of its ordinary supervisory function, so it seems clear that this is intended as a punitive rather than a merely supervisory measure. I do not disagree that the power may be required for supervisory purposes; my question is whether it is at all appropriate as a punishment.

Guy Sears: It is very hard to understand what factual circumstance it would apply it to. I understand that other trade associations have said, “You wouldn’t use this against a high street bank, would you?” It is a matter of practice. It is not going to suspend a high street bank from trading for two months. What would that mean in terms of the realities of the situation? If you felt people were selling a product or had inadequate controls over activities, you would vary the permission and you would not allow them to do that—for instance, selling payment protection insurance policies—so it compared to other things that they were doing. You would vary the permission and stop it. I am genuinely not quite sure who it would apply it to, apart from somebody it wanted to punish in some way and stop having income for a while. The examples that you could think of where it might just work would be smaller firms; I do not think that this will get applied across the board.

Q219Mr. Hoban: So it could be used to penalise your high street IFA, but won’t be used against a high street bank?

Guy Sears: I think that there are several powers that would be used against a high street IFA that would never be used against a high street bank.

Q220Mr. Mark Todd (South Derbyshire) (Lab): I would like to explore the venturing into the control of remuneration that is proposed in the Bill, from two perspectives: first, the difficulty of contract law—the employer and the employee—and the apparent intervention into the delivery of what would appear to be a contract with an employee. Let me develop that one first, and I think particularly our two legal minds will have some answers.

David Ereira: I think that it would be fair to say that that section of the Bill provides for an uncertain outcome. The ability to void a provision in breach of the remuneration regulations would have a very unpredictable consequence. It is not at all clear what gets voided. You could, in fact, end up in a situation in which somebody gets no remuneration but still is under a contractual obligation to perform their services, which is some kind of slavery. But, you are dependent at the moment on what the promulgated regulations are going to say, and as we have no idea what they are going to look like, it is impossible to judge.

Q221Mr. Todd: I am asking for opinion here: would it be perhaps prudent for the Committee to at least seek some draft regulations in this area, so that we properly understand this before we pass it into law?

David Ereira: In my view, that would be extremely helpful, or at least there should be some element of ministerial guidance on what is intended.

Q222Mr. Todd: The other area that I want to touch on is the proportionality of action. The claimed focus of this area is the control of risk in financial institutions, but I think that those who read a newspaper would recognise that that is not the entirety of the public debate on this subject. Is there any risk that the FSA might chose to interpret its powers, if granted in the Bill, in a way that goes beyond the narrow definition of a risk being caused by behaviours incentivised by a contract of some kind?

David Ereira: That is quite a difficult question to answer. I think that the best I can say is that the Bill includes, in effect, a new objective for the FSA, one geared towards economic management and economic strategy. Therefore, on whether the FSA considers that it is within its remit and part of its objective from an economic standpoint to take a perspective that is not necessarily a regulatory perspective, it would be entitled to do so.

Q223Mr. Todd: If I can give you an example, it might help you to think of what I am thinking of. We are currently having some debate about bonuses that might be offered to investment bankers. I do not think it has been argued that their activities have increased the risk to financial stability. Instead, the concern is that either they have taken advantage of stability produced by the taxpayer’s investment, or that it is an unethical thing for them to do. We are in a political environment, and one would imagine that the regulator would hear all those noises when deciding what to do. Is there any area of concern that they might have some freedom to act beyond a rather narrower focus of the purpose of financial stability?

David Ereira: I think that it would be open to the FSA, were it so minded, to interpret its objectives to  include a broader economic objective. If it was felt that controlling remuneration better achieved that economic objective, it could say that is within its authority.

Q224Mr. Todd: I’m just wondering whether Mr. Gleeson has some thoughts in these areas as well, because we ventured close to it when the Banking Act 2009 was going through Parliament and I must admit that I had some anxieties there. This is much more naked.

Simon Gleeson: I find the idea that an agency has a power simply to declare a contract of employment to be void an extremely uncomfortable one, and it is not at all clear to me what the safeguards are for the benefit of that individual. On your second point, the subsequent sentence in the Bill does state that the power can be exercised only for the purpose of ensuring that the remuneration agreement concerned

“is consistent with...the effective management of risks”.

But, as you say, there is nothing here which tells us what that means or how it should be interpreted. This seems to me to be a very significant power, which is given really without safeguards of any form.

Guy Sears: The context is that these are trying to do two things: first, obviously, to be enabling provisions in light of the European legislation; and secondly, to deal with certain consequences and powers within the nation. In terms of the European legislation, the capital requirements directive is progressing. Most of the amendments in that relate to deferral, and treatment of bonus. That will bind all the investment firms in this country and the banks, as I am sure you are well aware.

The undertakings for collective investments in transferable securities managers are being covered by UCITS level II on remuneration, at European level. The alternative investment fund managers directive also has provisions and proposed amendments dealing with remuneration, all based off the financial stability board, or, as the Bill refers to them, the implementation standards. The question, therefore, is slightly more about ensuring that we can appropriately implement what Europe is doing than about worrying what the FSA is going to do. For us, as asset managers, our greater concern is to ensure that the FSA has the flexibility in the UK to implement Europe’s legislation in a proportionate manner. When we read the clauses, it is with a slightly different lens. It is of course difficult to see where they will go—one has to trust that they do not then go super-equivalent on us—but as such, Europe is doing a good job of that at the moment.

Q225Mr. Todd: Those of us who have been around for a while would know that we tend to take what Europe does and then add our own tweaks and spins. I am pleased with your view—I would not say that it was complacent—that we should be focusing on the European dimension and not worry about too much about what is happening here. I am pleased to hear it, but I wonder whether it is entirely sound.

Guy Sears: I did not want to come across as complacent. I appreciate that I was talking for a long time on those points. Our concern in this area is one that arises in several areas, which is the requirement not to have regard to the international dimension. The objectives in making such powers are never conditioned by having regard to what is happening internationally—not just  with the standards, but in terms of the timing and the manner in which they are being applied. Although you have, at the beginning, aspects where they must have regard to international measures on financial stability, there is no corresponding obligation on the FSA in any other measure, whether it be short selling or remuneration. Those are matters where—you are absolutely right—competitiveness risks arise, where we have not got a line in either timing or standard. From that point of view, there would be concerns.

Q226Mr. Colin Breed (South-East Cornwall) (LD): It was interesting to hear what you said. At the end of the day, if we have legally set up companies—banks or financial institutions—with shareholders putting forward risk capital, with a board that has responsibilities for corporate governance, and with risk committees looking after the individual risk aspects of the business, why should an individual be penalised through FSA intervention into their own individual service contracts? Perhaps it would be helpful if Mr. Ereira could answer that question, because he mentioned something rather similar.

David Ereira: Absolutely. The only rationales behind it that you can come up with, it seems, are that either the institution’s own determination of the appropriate remuneration is somehow wrong, and the regulator has some stake in preventing it to avoid creating systemic risk, or—this is the broader point—there is a broader economic argument that the FSA feels is within its remit to apply, as its objective is now overall financial stability, and somehow the paying of large bonuses or whatever it may be is deemed to be putting that at risk.

Q227Mr. Breed:I think that was probably what I was trying to suggest; it is pretty nonsensical.

Mr. Gleeson, can we just briefly have a look at the Financial Services Compensation Scheme, and particularly one aspect of it? In the last couple of years, when compensation schemes were operated, the institutions—the banks and building societies—that failed were relatively small. Therefore, to a certain extent, the amount of money that had to be put into any compensation scheme was relatively small, and perhaps not entirely relevant. We are now moving completely away from that, even with existing ones—Bradford & Bingley, I think. They are now pretty substantial amounts of money that will have to be provided by the industry. Do you find it strange that the industry does not seem to have any role in a creditors’ committee?

Simon Gleeson: The compensation scheme?

Photo of Colin Breed Colin Breed Shadow Treasury Minister

No, I mean that the banks or the financial institutions are going to have to put up a significant amount to this compensation. They do not seem to have any role in what we would normally know as a creditors’ committee, which would at least demonstrate that that insolvency or reorganisation is done in a reasonably cost-effective way. At the moment it seems that the FSA and presumably the Bank of England can do exactly what they like and then charge the bill to the banks.

Simon Gleeson: I agree with that. The intellectual model of what is constructed here is a tax, so the Government will decide what they will do and will then levy a tax on contributors in order to pay for it. I think that is clearly the structure here.

Q228Mr. Breed: Is that fair? Is that treating the customer fairly? [Laughter.]

Can we move on to the Financial Services Authority? It is going to be given intensive and intrusive supervisory powers. We have yet to determine what that will mean. Do you believe that the FSA at the present time has the capacity to undertake such an approach? If it did undertake that approach in such a significant, intrusive and intensive way, is it going to put the credit rating agencies out of business, and indeed anybody else that might have a role in analysing banking performance as such?

Simon Gleeson: To some extent, that goes back to the substance of the question that you asked earlier: where private companies are run as private companies, what business has the regulator to micro-manage them? The answer to that question is that the regulator’s justification is systemic stability, whatever that may be and however that may be defined. I should say that I think it is the case that the FSA has for a long time had all the powers that it needed to do that. The issue was that as a matter of policy it elected not to do that, because it perceived that the market was best left to its own devices in these respects. The fact that the FSA is publicly changing its position on that, I’m afraid, is a matter for the FSA. In reality, if this Bill were abandoned today, it still has in the existing Act all the powers that it needs to intervene to that extent in the business of regulating firms.

Photo of Colin Breed Colin Breed Shadow Treasury Minister

So it has intensive and intrusive powers already. We are just flagging it up in this.

Simon Gleeson: Yes, I think that is right.

Photo of Colin Breed Colin Breed Shadow Treasury Minister

Do you think it has the capacity—the individuals, the money and everything else—to actually carry out such a supervisory approach?

Simon Gleeson: That is an almost impossible question to answer. If you assume that the number of people needed to run the system is roughly equal to the number of people currently running the system, then the answer to that must be no.

Q229Mr. Andrew Love (Edmonton) (Lab/Co-op): Can I go back to the issue of disciplinary powers? I listened very carefully to what you said. There has been quite a lot of criticism over the years, since the Financial Services and Markets Act 2000, about the ability of the FSA to regulate the market, in particular in certain areas. Mr. Gleeson, you mentioned earlier the comparison with Japan. Of course, a comparison is normally made between London and New York, where it appears to a layman like myself that they take a much more robust attitude. Therefore I wonder whether you accept that the powers to discipline, at least in principle, are relevant compared with the powers that are available in New York to ensure that this happens. I would like your view on that.

Simon Gleeson: I think there are three answers to that. When I talk to my colleagues in New York on this subject, they make two points. One of them is that many of the things that we are talking about here are treated in the US system as criminal offences. This creates a large number of problems, of which the most important and something we will probably come on to later is the multiplicity of prosecutors problem. The  more prosecutors you have, the harder it becomes to anticipate public action. Secondly, I do not think that the FSA has ever complained that the reason it has not been more successful is the lack of sanctions. The problems that the FSA says it faces are procedural. This is in many respects why the market abuse regime was created in the first place. The FSA took the view that if you had to overcome a criminal burden, you could never achieve anything, so what was needed was more lower-level punishments, which could be imposed at a lower standard of proof. Whether that is desirable is a different matter, but that is where this is seeking to go. At the end of the day, the primary issue with enforcement is and remains the burden of proof and the way that it can be enforced. No matter what sanctions we give the FSA, the fundamental problem that it faces, which is how does it collect and present evidence, will always be there because safeguards to that extent must necessarily be built into this and every Act.

Q230Mr. Love: You are drawing me down the line of questioning why the United States is indeed much more successful than we are, particularly about market abuse, but I would be testing the Chairman if I were to do that. My understanding of recent statements made by the FSA is that it wishes to proceed more on criminal matters than civil matters. It considers that the penalties available to it are much greater as a result of it recognising the very great difficulties that you have already described of collecting evidence and being able to present it in court.

I wish to ask you, and perhaps Mr. Sears as well, about the appropriate way to improve the situation. I am making the assumption—perhaps I should not—that we all recognise that the FSA has not been successful in such areas, so we would all accept that there needs to be some strengthening of the powers available to it to increase the possibility of success. In fact, if you accept that case and that the powers in the present Bill are not appropriate, what powers should we be thinking about?

Simon Gleeson: To be fair, if we were to ask the FSA, it would say that it was being more successful and that it is getting more penalties imposed now than it was a few years ago. I think that is clearly correct.

Q231Mr. Love: But that is going from nothing to a very low base. I do not want to be too critical; I understand the difficulties of collecting the evidence in a market abuse area, but its record was appalling and it is now just bad.

Simon Gleeson: The difficulties seem to me, and certainly to my colleagues who are more active in the litigation area in this respect, that the primary difficulties that the FSA faces are those of resources and of simply obtaining evidence and are not primarily to do with a lack of appropriate sanctions.

Guy Sears: We have been quite strong on wanting the FSA to be tougher on market abuse. Both the Treasury and the FSA have seen senior committees of the IMA where they have been told unanimously, “Please be tougher on market abuse.” You do not want money for pension schemes and suchlike frittered away by people abusing the market.

The provisions that the United Kingdom has on market abuse include super-equivalent ones. We have been pushing very hard for them to be continued. It was  only at the last minute that they were continued last time. Legislation has just been put through to extend them again because we think that they better express how to deal with market abuse, statutory provisions and the European approach. It is to do with things like information that the market would expect to have released and seen—if you start using that rather than slightly more technical European things.

As for what goes on and how it goes, Simon has a history with it. I obviously was a solicitor to the Securities and Investment Board throughout the litigation until 1993, and then was one of those helping form the market abuse provisions for FSMA. It is about the industry having a concern. You asked what we would have in legislation. Ideas that have been toyed with in the past include things for which firms can ask for clearance from the FSA. They get clearance, but if the FSA then reflects on it and decides that it is an inappropriate thing, a rule is passed; a statement is made and it is not allowed any more. But you do not go back and shoot the person who sought clearance from you. At the moment, you have, “Let’s not tell ’em”, “What if?”, “Or they’ll find out later”. It is very hard at times to approach with perhaps highly complex transactions, which sometimes might be abusive with hindsight, but a lot of the time, as Simon says, it is just the run-of-the-mill small abuses here and there. That needs people to clamp down on it. I think that the FSA is doing much more. One of the reasons is that as a result of the fragmentation of the markets that we have now and the competitive environment, exchange operators no longer have the vision that they had before—they also played a role in the system of controlling market abuse. They only get to see a proportion—perhaps 40 per cent.—of the market now, because of fragmentation. That puts a far greater onus on the FSA and, from our point of view, we have also said that this is one of the matters in which there should be much more consideration of the Committee of European Securities Regulators and European co-ordination looking at it, because of market trading going right across Europe. Not many answers, I’m afraid, Mr. Love, but it is something that quite a lot of people in the industry push for, even if it is not published that much.

Q232Mr. Love: May I ask one final question, which is about culture? There is still a criticism that is made about the City—if I can call it the City for all the institutions—that it does not take market abuse seriously enough. This is one of the signals that this would be sending. In my view, the signal from the Financial Services and Markets Act was ambiguous because it was diluted. Will this measure, even if it does nothing else, at least send a signal to the City institutions and those involved in the City that they have to take these things more seriously?

Guy Sears: I think it is to do with sectors, if I may say so. I think that the equity markets would be pretty nervous if they heard that the FSA was turning up unannounced—they would be very nervous, not because they have done things wrong, but because there is a proper fear/respect of the market abuse provisions. I think there have been other sectors perhaps in which people have not really thought that market abuse is part of that—much more complex transactions that go on. So, I think there are those who came up through the exchanges and the equity markets who have a different  culture—that is great. So, the FSA the other day issued a disciplinary notice concerning pre-soundings in the bond market. That had a very large impact on firms looking at that area—very different to equity. Things like that as well—there is that spreading of culture.

Q233John Howell: May I move us on to some questions about the consumer protection aspects of the Bill? We heard the Minister, in an earlier evidence session, say that the measure, particularly the collective proceedings provisions, would not take us down the route of a US-style litigious culture. We had the bankers this morning saying that it would. Where do you sit on that argument? I start the day with your reaction.

David Ereira: The answer is that it is entirely unclear where the collective proceedings of the Bill will take us. They are not consistent with the approach that has been taken to collective proceedings in other areas, which is my first point. The second point is that the scope and range of actions that can be brought within them seem to be extremely wide. Indeed, they are sufficiently wide to include things that actually predate the commencement of the legislation, under its own terms. It is very unfortunate, but we are dependent upon two sets of regulations being promulgated: a general set of regulations; and new court rules. The existing court rules will not cover what is being proposed; there is nothing about how prospective cases will be vetted, to rule out the frivolous and vexatious, and there is nothing about costs, which is the main issue in controlling the spread of spurious litigation.

I would like to bring to your attention a couple of other points. One is that there is some wording in the clauses that allows the regulations to override limitation periods, which is somewhat surprising, and to change the rules on damages. It seems conceivable, at least within the scope of this enabling legislation, that you could allow for punitive damages—triple damages or whatever it may be. None of this is catered for in the Bill per se, but the enabling power would cover it.

Simon Gleeson: Two points: first, I flag that it is actually incorrect to describe this as a consumer measure. There is nothing that confines these actions to actions brought by consumers. Morgan Stanley and Goldman Sachs could use this to sue the stock exchange, which seems like a bit of a lacuna.

The second point is that, if we look at what has caused the problems in the United States, there are a number of fairly obvious flags. One of them, as David Ereira has said, is the damages system. The major constraint on frivolous litigation in that system is that if you commence litigation and fail, you must pay for what you did. That is inappropriate in a purely consumer-based arrangement, which is part of the reason why we are very concerned about potential misuse of this by people who are not consumers in the ordinary sense of the word.

The second is, of course, the problem of claim farming and those who develop business models that involve commencing class actions for profit. The question as to whether that will be possible under this regime entirely depends on the regulations made under clause 23(4)(a), which effectively enable the court to provide an economic bounty to whoever organised and led the action. If we go down that route, I think it is a significant step towards the US class action system. But I think it is  quite right: there is nothing in the Bill that drives us in that direction. All it does is create the possibility that that may happen depending on what the rules say.

Guy Sears: This is not the same form of collective proceedings as was trailed in the Treasury paper, “Reformed financial markets”. It does not select one or other of the options that that put forward; it puts all of them forward. In that sense, therefore, it actually does not determine some of the big policy questions; it leaves them to others to determine. It asks you to pass legislation so that others can determine those policy questions. In that regard, it is therefore very hard to see how it will turn out. However, large amounts of the money that our firms manage are managed for consumers in the traditional sense of the word. We certainly note that the context of this is that some 900,000 cases have been passed to the ombudsman this decade—let alone all the complaints that are handled before getting to the ombudsman—of which over half are due to only to six issues. I can therefore see why, contextually, people feel that there is an imbalance of power between consumers and regulated firms.

The situation I would suggest that we need to achieve is one in which a perceived imbalance of power is properly corrected where it is seen. The Ministry of Justice and others have had reports on collective proceedings and whether or not we should have them in the United Kingdom. Our concerns on these matters are to do with limitation periods. In other words, will you ever know whether or not you are free from claims? Or, perhaps less selfishly, will you ever know if a firm you wish to buy that is not doing very well is itself free of claims? The need to sometimes rescue or reinvest in firms may be damaged by this at times.

Secondly, will consumers know what to do and where to go? We have a complaints regime that, subject to those broadly put six subjects, worked pretty well. I am not being complacent, but there are always people who can work more on that. There is a complaints regime. There is to be a redress power under section 404, which the Treasury has at the moment and the FSA could then have. The FSA, consumer bodies or individuals could then bring the collective proceedings. I would definitely not seek to say that I know the views of consumers—I see that you have received evidence from Which? and others; it is very important to have regard for that—but will consumers actually understand what they ought to do? And, paradoxically, will some sit back and wait, as ever, for someone else to sort out their problem because of all these proceedings?

Finally, how do we settle with people quickly? Will it actually disincentivise treating matters and trying to sort them out for fear of how collective actions will be put together and brought? I haven’t the faintest, to be honest.

Q234John Howell: Do you think that the regulatory system for consumers in the financial services sector is clear enough in where responsibilities lie, and is it the right structure? The consequential question to that is: given that structure—or perhaps the lack of structure—are these appropriate measures to fit in?

Guy Sears: If I am right about what you are asking me, my answer is that there is no detailed expression of what we would expect the proper standard of consumer responsibility to be in financial services, having regard  to the level of financial education and the nature of products that are sold. Many people in the industry would wholly applaud it if somebody tried to deal with that. Sir Callum McCarthy of course worked on that quite hard when he was chairman of the FSA, trying to bring the panels together to get a statement about consumer responsibility. In any system, if there are balancing powers then they work better. Is it a bit unjoined-up and uncompleted? Yes, it is.

Simon Gleeson: I entirely agree about multiplicity. The thought occurs that there is an existing wider issues process, whereby when multiple complaints are brought to the ombudsman on a similar issue they can be taken together by the FSA as a single issue. In many respects the mechanism that is sketched out here already exists within the regulatory system. The difference is that it is proposed to take that out of the ombudsman system and put it in the courts. I am unable to see the value of that to the consumer.

Photo of John Howell John Howell Conservative, Henley

Mr. Ereira, do you have a view that is different?

David Ereira: No.

Q235John Howell: Mr. Sears, you picked up on the question of education. In relation to the consumer financial education body proposed to be created, what do you think success would look like for that body? What would you like it to achieve?

Guy Sears: That is extremely difficult. That is one reason why debates about where to put money in financial education are so hard. What is success ever going to be?

I would certainly say this. We welcome the fact that it will be separated from the FSA. That will allow those involved to have a clearer voice and at times feel that they set up their own image, their own position, and to be better understood by people rather than having the FSA logo on things, which may be slightly confusing for consumers as to its role. Precisely how you will measure whether or not we have consumer financial education, I do not know. I am involved with the Credit Union, and have been for many years. We have genuinely had people arguing over the fact that its credit cards are better than others because it has higher APRs. It is very difficult. I am not sure that we will get education.

I quite like having examples of how people are affected—a bit like today, after a pre-Budget report. If we had bodies that could produce more examples of people like you—a young couple, single, or whatever you may be—and say that this was the sort of thing they were doing, that would educate people. Beyond that, it is right that there is redress against those who mis-sell. That’s how we have to do it. We will never have equality.

Q236John Howell: Mr. Gleeson, Mr. Ereira, do you have a view on the success of the new body?

Simon Gleeson: Two thoughts on the new body. One is that it is generally agreed that the FSA’s retail distribution review process will substantially reduce the number of private sector IFAs in the country, and will eliminate the availability of private sector independent financial advice for large numbers of the lower-paid. Frankly, if they don’t get the service they are in dire trouble.

How do you measure its success? It would be nice to think that you could measure it by a reduction in complaints to the ombudsman, or something along  those lines. I have done some work in this area, and I am aware that none of those metrics seems to give any useful answer. It is a conclusion that I think the FSA has stated in a lot of the research work into the market that it makes publicly available, but I don’t think it knows either.

Q237Mr. Charles Walker (Broxbourne) (Con): Mr. Gleeson, you suggested that there might be a reduction in the number of FSAs—gosh! I mean IFAs. That is because a new testing regime is coming into place, is it not—a new professional qualification regime?

Simon Gleeson: That is the view of the industry.

Q238Mr. Walker: I note that you sounded concerned that there would be a reduction in the number of independent financial advisers, as many people are. How would you get around the professional standard issue while perhaps retaining the opportunity for people to advise independently from an umbrella organisation?

Simon Gleeson: I am afraid that is almost entirely outside the area where I am comfortable giving evidence.

Photo of Charles Walker Charles Walker Conservative, Broxbourne

Does anyone have a view on that? The issue was raised. We are talking about financial education. You said that if people could not get access to independent advisers they really would be in trouble. The Bill is meant to make things easier for people, but there seems to be a conflict here.

Simon Gleeson: The conflict is not within this Bill. The big policy question is, “Is it better for people to receive bad and biased advice, or to receive no advice at all?” The FSA has a policy on that. It is above my pay grade.

Q239Mr. Love: My understanding is that the new education body is supposed to wrap up the previous work that has been done on generic financial advice. The theory is that you get generic financial advice to tell you whether you need a pension and so on. Then—there is a very grey line here—you are passed over to an independent financial adviser, a company or whoever. You don’t think that will work?

Simon Gleeson: It is asking an awful lot of a public sector body to give that sort of advice. It is also asking an awful lot of individual investors to have the self-awareness to realise that they need to go to a public sector body to get it.

Guy Sears: It may be a weak answer, Mr. Love, but we have already been working with the FSA and talking to it, or to the team that will almost certainly be part of the consumer financial education body. We have put a fair amount of time into these bodies and this work. We think it is worth doing to see whether it can work. You ask whether it will work ultimately; I do not know.

Q240Mr. Love: There is a pilot scheme in the north-west, but I do not know what the emerging evidence from that is. I understand it is a huge ask to be able to deliver this across the board. My understanding was that those involved were modestly confident that things were moving in the right direction.

Guy Sears: We have also been working for some years on the retail distribution review at the most senior level among our firms. They are very committed to working on it and working with the FSA. There are a lot of very good ideas within it. I am not sure this will lead to a  desert within the United Kingdom. If we can up standards, then we will be supportive. As for the products that our firms produce, I do not think that they want them mis-sold. You want them to go to the right people. Everybody has a vested interest in this area.

Q241Mr. Hoban: Could we move on to hedge funds and the rules in the Bill? The FSA introduced a regime for disclosure and short selling around about the peak of the banking crisis. It seemed to have no problem producing a regime at that point. Why are we having new powers in this Bill?

Guy Sears: I am not sure that it had the power to do what it did. That is why this is a very difficult issue. The two backgrounds are that the ability to stop short selling was pinned on the market code, which was itself underpinned by the super-equivalent regime of the United Kingdom in market abuse. In fact, had the Government stripped back the super-equivalent provision, as they first proposed doing the Christmas before that, they would have had no power to bring in the short selling regime. Ironically, I am afraid the lobbying of the IMA meant that we then had a short selling ban, which I am living down.

Q242Mr. Hoban: Before you move on, and in relation to that first point, are you saying that the regime the FSA introduced did or did not have a firm legal basis?

Guy Sears: I think that it is accepted by many people that it did not have a firm legal basis. That does not mean that there wasn’t one. In just the same way, in court, sometimes there will be three days of argument, and then someone will say, “In our judgment, the following is quite clear”. It is very difficult. It was an evidential provision under the market code, underpinned by statute. That is a very different proposition from a direct power to impose and prevent short selling. It was a little easier to get the disclosure obligations, although it was still difficult. Ironically, that is also a reflection of how we implemented the transparency obligations directive, under which 3 per cent. is needed to make a disclosure. That is all implemented on the basis of a long position. There were no powers to make a disclosure on a short position in the same way. Powers are definitely needed to make clear what is and is not allowed, and certainly for the disclosures. It was widely accepted around the City that a better underpinning was needed for what the FSA has done.

Q243Mr. Hoban: So it needed better underpinning. Does the Bill provide that? Are the powers proportionate?

Guy Sears: They could not be much wider, but those are the powers that are given.

Simon Gleeson: On the short selling point, it is probably the case that had the FSA’s short-selling regime been challenged as a matter of administrative law, the challenge would have been successful. It never happened, because the problem had gone away by the time anyone could have mounted a challenge. It is clear that the provisions as currently drafted provide a legal basis for banning short selling. The problem is that they provide a basis for banning selling; The definition of short selling, as set out in the legislation, is any transaction in which someone might benefit if the value subsequently goes down.

Clearly, what is intended is for the regulator, under this umbrella, to craft a slightly more thoughtful definition. Around the world, we have done an enormous amount of comparative survey work on short-selling regimes in different jurisdictions. The hardest thing about a short-selling regime is defining what is meant by short selling. It is not unreasonable that an over-broad definition has been created and left to the FSA to flesh out, but that does create concerns. This definition could be substantially improved if some element of shortness were included in it.

Q244Mr. Hoban: Is there a definition of shortness that we could—

Simon Gleeson: I can certainly provide you with a paper on that, but I would not dare to give one off the top of my head.

Guy Sears: The French have banned naked short selling, according to their publicity. However, what they actually did was impose a requirement for asset managers to identify for the broker that the custodian had the stock in place. They did not actually ban it. The German statement was never supported by any legal power or instrument. Simon might be right to say that people did not want to mount a challenge. I think that there was also a recognition that we were in crisis moments. A lot of people said, “Power or not, the FSA has led”. That was a good thing. It made its statement and set out its case. There was a bit of control and leadership coming into the City at a time when it was pretty febrile. Going forward, people want to see a proper power, not least where they are asked to reveal things—which the Bill fails to do—about their clients, for example, and give protections.

Q245James Duddridge (Rochford and Southend, East) (Con): There has been a massive amount of primary and secondary regulation on the financial services. Given that, and given that this Bill, which is being rushed through in the space of three months, is being introduced, is there a risk of the whole industry becoming regulatory-focused and falling out of touch with either the consumer or the shareholder? Effectively, we could kill our industry by focusing so much on trying to protect it.

David Ereira: The answer is that there is a risk. That risk is not so much the Bill, but rather the approach to the Bill, which is really quite difficult. It is fundamentally a series of pieces of enabling legislation, which will then be followed up by secondary legislation and further regulation. The problem is about change and unpredictability. Responding to that change and unpredictability makes this a difficult environment for people to conduct business in. It increases the risk of uncertainty and of doing business, and that is an unfavourable environment. There is a lot to be said for standing back and asking whether there is some more sensible and stable regime that can be brought in as an overarching review.

Simon Gleeson: The complaint I hear most regularly from senior bankers is that they are now spending so much time dealing with regulatory change that they no longer have time to focus on the running of their institutions, and they expect that to continue for at least two or three years. That is not just as a result of the  activities of this House and this Bill by any means; there is a global tsunami of regulation that is hitting all of these institutions. However, I am not sure that many of them would advocate the idea that that process should simply stop. There is consensus within the industry that regulation needs to change and to improve. Although the risk that you mention exists, I do not think there is much resistance to regulation for the sake of it, even in the outer reaches of the hedge fund industry.

Guy Sears: I don’t think it will cause damage. Regulation does get headlines at times, but the whole issue over wealth creation and such like is a step away from a lot of this. The areas that we are particular mentioning, such as short selling, are to do with the market itself and the environment in which we interact with one another. It is very important that there are clear statements of what is appropriate and that disclosures are made to ensure that there is market confidence. We need to co-ordinate with what Europe is doing on short selling, as it an international issue.

One of the worst things that occurred, in a regulatory sense, during the crisis was that everybody had their own idea on what to ban each week, despite the fact that lots of these instruments were traded across several countries. There is now an opportunity to ensure that we have a clear statement, at least from this area in Europe, as to what we expect to be done and on the disclosures to be made. Frankly, we may have a much more understanding view of short selling than the United States may end up with—they have upticks and much more limited stuff. I do not think that this will restrict us particularly. There are clearly worries that the FSA would get out of step with Europe, but I do not think that is where it is at the moment. This measure is just making sure that the FSA has the powers to get it right.

Q246James Duddridge: Is the direction of travel towards greater regulation going to continue, or are we seeing a tightening followed by a loosening, with perhaps a competitive advantage in a few years from loosening regulation faster than other marketplaces? I will ask Simon first.

Simon Gleeson: Gosh. What is happening at the moment is not simply an addition of more regulation upon more regulation; it is not as simple as the pile getting bigger. I think that the shape of the system is changing: some things are being emphasised, others are being de-emphasised. We will probably not end up with the imposition of massively greater regulatory burdens than currently exist. I hope that if what is done is done properly, the regulation will be more intelligently applied and more effective. What matters is whether regulation is effective or ineffective. We know that some of what is put on the industry in the current couple of years will turn out to be ineffective. We hope that that will be rapidly removed after the event and that the processes that prove to be effective will be developed and imposed. One thing that everybody has learned during this crisis is the overwhelming importance of international co-ordination. In that respect, the risk of competitive de-regulation in the future is probably significantly less than it was perhaps even a few years ago.

Q247James Duddridge: I’d like to follow on from that point. Forgive me, I am not a lawyer, but is there sufficient ability in the Bill to roll back some of the  regulatory changes, as you describe? Would it be easy for Parliament to say, “This was right to do at the time. Parliament decided to do it at the time,” but four years hence, roll back a specific element on a specific month and then a little bit more three months later? Or would it take another Bill or a big piece of secondary legislation put forward by Government?

Simon Gleeson: It takes a big piece of legislation put forward by Government.

Q248James Duddridge: Primary or secondary legislation?

Simon Gleeson: That depends what is being repealed, but, yes, potentially primary. Governments have developed the technique of repealing legislation using secondary legislation, but I believe that it is unpopular.

Q249Mr. Hoban: On the issue of competitiveness, which was raised by Mr. Duddridge, if we look at proposed new section 6B, we see that subsection (3)(b) says

“the desirability of maintaining the competitive position of the United Kingdom in respect of financial services and markets.”

That is in the context of promoting international financial regulation and supervision. How on earth do we manage to do that?

David Ereira: The most appropriate way of doing that is through international co-operation. I can give you a tangible example. In the Bill there is material about recovery and resolution plans and the living will stuff. That is being worked on at an international level. The Bill is completely anticipatory of what may or may not come out of G20 and the international processes. It is not necessarily terribly helpful because until we know what will come out of those processes, we will not know if we have the right framing legislation.

As a small aside to that, the commencement of that particular provision is two months after the Bill gets Royal Assent, so this goes live when we have no time even to think about what the international position is going to be. To be competitive we need a regime that is consistent with what is going on elsewhere. If we are out of step or thought-leading the market, we may end up out of step and less competitive.

Q250Mr. Todd: Going back to consumer protection, the reason collective proceedings are being proposed is presumably concern about the lack of inclusiveness of claims previously—the difficulty of accommodating everyone who might have legitimate claim, the inadequacy of penalties, perhaps, or the cost, alacrity or risk of entertaining a claim when you are facing a very large institution. I think that in the discussion earlier we did not see a huge amount of recognition of some of the reasons why someone might be thinking about introducing this. In the experience of the two lawyers—I am not sure whether Guy is a lawyer—

Guy Sears: I am not a practising solicitor; I used to be a solicitor.

Q251Mr. Todd: For those who are currently practising, is your experience of such proceedings that those sorts of disadvantages are important?

David Ereira: My experience of these proceedings comes in two ways because I have been involved in US-based class litigation out of mis-selling or prospectus issues where the actual case itself has been of little or no  benefit to individual consumers—it has been a great benefit to the law firm that put the artificial class together. Whether it operates at a higher economic level as a—

Q252Mr. Todd: I am thinking more of the experience of the inadequacies of our current system here.

David Ereira: Well, yes. Clearly, there is gap in our system in that the cost of litigation and the difficulty, time and obstacles to bringing successful litigation mean that redress may not be readily available. It means that sometimes it gets forced through the wrong route—through an Office of Fair Trading process, rather than a direct case is a good example.

Simon Gleeson: I think that if this is justified, the thing that must justify it must be shortcomings in the ombudsman process because, as was said earlier, one of the more important things for consumers is that it should be obvious to them where to go for redress. The creation of multiple avenues does not seem to me to be entirely helpful. If the object of the proposal is to address shortfalls in the existing ombudsman system, I have to ask why the policy approach taken is not to address those systems rather than create an entirely new approach.

Q253Mr. Todd: It might be the modesty of the penalties that the ombudsman may be able to impose.

Simon Gleeson: On a purely personal level, I started my professional career doing small crime as a barrister and I do not believe that the courts are the ideal recourse for any consumer.

Q254Mr. Todd: Okay. That’s very helpful. The other area I wanted to question was the information gathering powers of the FSA, particularly the slight oddity at the end, where the FSA is empowered to collect information on behalf of a foreign regulator who may have a concern about financial stability in their own state and wish to collect information from a UK-based entity. That appeared to be a quite loosely worded power. Do you perhaps have concerns? Mr. Ereira first.

David Ereira: I think my main concern is mutuality. We should not be allowing for that unless similar arrangements work the other way and the FSA could obtain similar information.

Q255Mr. Todd: That is not what the clause says.

David Ereira: It’s not what it says at the moment, no.

Q256Mr. Todd: The same with you, Mr. Gleeson? My slight concern is that we constantly use this term “financial stability” as the basis for collecting information. As I’ve said elsewhere, I think we know when we haven’t got financial stability, but I am not sure we know the precise key components of it and they haven’t been defined. So this is a pretty broad brush with which to sweep information in.

Simon Gleeson: I agree with that, but we have a global system and I do not think any national regulator can, on its own, obtain sufficient information from anyone to derive an accurate picture of the global financial system. So I think that in order to achieve that, a power to co-operate among regulators is necessary. However, I  think David Ereira is absolutely right; it is one thing to confer that power, another to regulate its exercise. There is nothing here that regulates that exercise.

Photo of Mark Todd Mark Todd Labour, South Derbyshire

We also know rather little about regulators in any country as it is in the clause at the moment. I don’t know how financial services are regulated in central America and whether their request might be proportionate. It is difficult to speculate on that, but that speculation is invited by the broad sweep of this particular clause.

Q257Mr. Breed: To go on with that point, last week the Treasury Committee was actually trogging around Europe. It would appear that within the college of regulators in the EU, they have agreed some sort of host home country mutuality agreement to be able to go into each other’s. But that is only in the EU. Obviously, this would be much wider.

Just three quick questions: when your banking friends were not saddled down with all this wretched regulation and were being allowed to get on and run their businesses, do you think they did a good job?

Simon Gleeson: Yes, I do actually. What the industry had was a common mistake that was shared among those who ran all the major banks, all the major regulators and, to be fair, all the major Governments as to the extent of risk to which the system was exposed. They were all collectively wrong. However, leaving that aside, if you ask whether they were doing a bad job of running the banks, then it is impossible to answer that question any way other than, no; they were actually doing it quite well apart from the fact that the intellectual structure on which they were basing all of their decisions was fundamentally flawed.

Q258Mr. Breed: The outcome of that was the financial instability that we are now trying to address.

Simon Gleeson: Yes.

Photo of Colin Breed Colin Breed Shadow Treasury Minister

All three of you have mentioned the importance of international co-operation. In looking at what we have got here, can you give us assurances that all these measures will neatly dovetail into all the EU and G20 regulations? If not, is it a good idea for us to go first with this Bill?

David Ereira: The answer is that you couldn’t possibly give that assurance and indeed the example cited about the living will stuff demonstrates that we are jumping the gun slightly on that.

Q259Mr. Breed: Do you think that is a good idea?

David Ereira: No, I do not think it is a good idea. It will probably work out all right, because the wording is sufficiently wide that in all probability we will be able to come up with appropriate regulations that fit within whatever comes out of the international processes. It just seems to me more appropriate to wait and see what comes out of those international processes and then say, “That is what we need”. I think the carts and horses have been put the wrong way round.

Q260Mr. Breed: Mr. Gleeson, is there anything in here that is a hostage to fortune?

Simon Gleeson: No, because there is so relatively little in here apart from a power given to the Treasury to make further orders at a future time.

Q261Mr. Breed: Mr. Sears, do you want to comment on that?

Guy Sears: If I may. If we wait for Europe, particularly, to move, then they will almost certainly do this by way of directives, and we would use the European Communities Act 1972 to implement many of these things. The only hostage to fortune is the usual balance that goes on—as was said by Lord Davidson in his review on regulation—which is that you want to have thought leadership and you want to be first there. On the other hand, just talking about some of these things spooks the horses and causes people to look at other countries, which in fact within two years bring in exactly the same thing. So we have people talking about whether to stay in the United Kingdom. The reality is that most of the places people would think about going to are going to have the same sort of regulations within the time scales.

Q262Mr. Breed: So the balance of risk is that introducing early regulation may frighten away other things, but the risk that we are trying to address may not actually happen, so therefore we may be doing it too early anyway, even in respect of the EU or G20.

Guy Sears: That is the balance, but equally you are not actually bringing it in in respect of Parliament; you are just enabling the FSA to bring it in at some point. So it is a slightly different timing, and the FSA can choose when to do it.

Q263Mr. Breed: Lastly, Mr. Ereira, on a scale of one to 10, how advantageous is the Bill to lawyers?

David Ereira: To lawyers? I regret to inform you that it is excellent news for lawyers.

Photo of Roger Gale Roger Gale Conservative, North Thanet

If Members have no further questions, that brings us to the end of the business for the day. Mr. Ereira, Mr. Gleeson and Mr. Sears, thank you very much for joining us. The Committee and the House are indebted to you.

Ordered, That further consideration be now adjourned.—(Mr. Mudie.)

Adjourned till Tuesday 15 December at half-past Ten o’clock.