The Work of the Financial Services Authority
Evidence to the Treasury Select Committee
x
by Stephen Wynn
Executive summary
1. The work of the Financial Services Authority is guided by the Financial Services and Markets Act (2000).
2. There are insoluble problems with this work.
3. There needs to be a new Act.
4. The FSA should be divided into three.
1. Protecting savings
1.1 The first duty of the FSA should be to protect savings, rather than "consumers". Savings of all kinds need protecting whether of individuals or for example, charities. x This is more general than just prudential supervision, such as warnings. The FSA's Annual Report 2007/8 says:
which is a tautology, rather than a definition of "consumer protection". The FSA seems to interpret "consumer protection" to mean:"consumer protection:
securing the appropriate degree of protection for consumers" (page 1)
"Promoting efficient, orderly and fair markets
Helping retail consumers achieve a fair deal x (front page)
1.2 The FSA should protect savings by ensuring they are not locked-in to poorly performing products, with excessive charges and the inability to withdraw cash or move funds elsewhere. Such as the Equitable Life income drawdown plans discussed by Simon Bain in Whatever happened to principles? (2008):
1.3 He describes Equitable Life as "a regulation-free zone". This is discussed elsewhere such as on a discussion board:"Thousands of pensions carrying valuable guaranteed annuity rates were wiped off the books, with customers typically not even informed that they had a guaranteed rate, let alone being offered an informed choice. How did Equitable get away with these flagrant breaches of conduct of business rules, not to mention the overriding principles of integrity and diligence?" x
"Many of the products that they were offered by Equitable Life were, in fact, dangerous.
By this I mean that there was a substantial possibility that the customer [policyholder] would suffer financial damage if he/she invested in such a product. Examples abound within the ELAS product range, starting with the later GAR products (only saved by the arrival of the non-GARS) and extending to the Managed Pension policies which had neither GIR nor any entitlement to guaranteed bonus.
The FSA has wriggled into every possible dimension in order to avoid coming to the conclusion that the product was, in itself, unsuitable for its target market. Can it be that Equitable is far from being unique in offering such products?
Surely, the answer to this question is a resounding 'YES'." x
1.4 I agree. The FSA needs to study the investment performance of products. This depends on the quality of products rather than "suitability". Howard Davies said to your committee in 1998:
"The whole learning experience of the last few years has taught us I think, that suitability is at the core of the problem which investors face, whether this is a suitable product for you." x
The core of the problem that investors face is obtaining a good return on their investments.
2. "The last year"
"The last year has presented great difficulties for the financial services industry, its customers and for the FSA." (Chairman's statement)
2.1 In the last year the FSA has been found guilty of maladministration by the Parliamentary Ombudsman. There are expensive rescues of Northern Rock, Halifax Bank of Scotland and Royal Bank of Scotland:
"The Government will pay £20 billion for a controlling stake of up to 60 per cent in RBS, and £17 billion for a 43.5 per cent share in a new 'superbank' created by the expected takeover of HBOS by Lloyds TSB." x
2.2 These problems have been caused by mortgage-backed securities:
"At the heart of its problem was the aggressive expansion of its lending, financed by borrowing on the money markets, which then froze up." x
2.3 Mortgage-backed securities seem to have had a bad press since their inception. Especially the 298 page best selling book Liar's Poker (1989) by Michael Lewis:
"After the first CMO, the young turks of mortgage research and trading found a seemingly limitless number of ways to slice and dice home mortgages." (page 163)
2.4 In view of this bad press and the reliance of Northern Rock on mortgage-backed securities, why did the FSA consider that Northern Rock was low-risk? It said in evidence to your Committee in 2007:
"in terms of the probability of it getting into difficulty we had it as low-probability" x
3. Vague principles
3.1 Instead of protecting savings the FSA takes actions which are harmful for savings as discussed on my website (www.comparativetables.com/wraps.htm#emp x): wrong projections, x the non-disclosure of dealing charges, permitting charges to be taken out of capital rather than income, lifting caps on fund charges. x
3.2 The Act and the FSA have replaced protecting savings with various vague motherhhood and apple pie principles, such as "market confidence ", "consumer awareness", "the protection of consumers", "treating customers fairly", "helping retail consumers achieve a fair deal". How can we have confidence in the stock market? The Act says: "market confidence" is "3 (1) .. confidence in the financial system", implying "the financial system" is a "market".
The Government says:
"The Government is committed to encouraging more people to save for their retirement." x
3.3 We then find we have to do "deals" with the financial industry, "helped" by a regulator which is financed by the industry. The FSA wants deals to be "fair", providers to be "responsible", markets to be "effective" and consumers to be "capable and confident":
"As well as responsible providers of financial products, an effective market for financial services requires consumers who are capable and confident to take informed decisions." x
"Our concern is to make the market for retail financial products and services operate more effectively by developing capable and confident consumers." x
3.4 But the FSA only wants consumers to be "capable and confident" only up to a point. It does not want them to examine products closely:
"Just like buying other consumer products, you need to shop around. Like buying a car or a washing machine, you don't have to get to grips with the detailed workings under the bonnet or inside the case." x
3.5 The Annual Report 2007/8 says:
"We need to implement these principles more effectively, not to change them." (Chairman's statement)
I disagree. The FSA needs to change its principles.
4. The Financial Ombudsman Service
4.1 At the Annual General Meeting of the FSA in 2007 the FSA was asked, by Chris Harlow a member of the Equitable Members Action Group, about the Lord Neill Review of the FOS. Clive Briault (Managing Director, Retail Markets) responded:"With all due respect, I think that is the body with which it should be discussed because of its operational independence from us." x
4.2 This is not an acceptable response, because the FSA set up the FOS, under the Act (Schedule 17, Part II) and it appoints the directors. There should arguably be a further review of the FOS which is genuinely independent and publishes the responses. The Hunt Review only published about a quarter.
5. The Retail Distribution Review
5.1 The FSA proposes to replace commissions from providers to financial advisers with "payments". Is this anything more than symantics? This is discussed in the Interim Report (2008):
5.2 Why not? This is arguably what should happen. In the following paragraph "manufacturers" changes to "product providers" and "distributors" to "advisers"."3.16 In the DP we discussed how we may require remuneration practices for certain advisers to operate in a way that ‘reduces effectively any conflicts of interest that might otherwise inhibit them acting in the consumer’s best interests. To achieve this, we could go so far as to consider no longer permitting any payments to pass from manufacturers to distributors, but we recognise that this is not practicable at the present time." x
"3.17 So we are not seeking to end the role for product providers in organising payments to advisers from customers’ accounts or investments."
6. Three aspects of the industry
6.1 The FSA is regulating three different aspects of the industry: 1) cash, 2) markets, 3) savings; which need different priorities: 1) liquidity and stability, 2) efficiency, 3) protecting savings.
Cash is the business of banks. Markets are "financial markets and exchanges" such as the London Stock Exchange. Savings are held by life assurance companies, building societies, fund management companies. Banks are concerned with liquidity and financial stability. London as a financial centre and talk of "light touch regulation" relates mainly to markets. Market operators seem to benefit from instability:
"Volatile market conditions contributed to very strong trading across the equity order books of the London Stock Exchange Group during September. £302.8 billion (€383.1 billion) worth of equity trading was carried out during the month, an increase of 24 per cent on September 2007." x
6.2 This is a problem with the industry in general. There is excessive dealing and portfolio turnover. Lipper Fitzrovia publishes a report Portfolio Turnover of UK Funds, x showing that many funds have a remarkably high turnover - well over 100% per annum. x
6.3 The FSA should be split into three. The regulation of banks should be taken away from the FSA and given back to the Bank of England. The regulation of life assurance companies, building societies and fund management companies should also be taken away from the FSA and given to a government department. This leaves the FSA with the regulation of markets.