House of Commons Treasury Committee

Banking Crisis

Volume I Oral evidence

Ordered by the House of Commons to be printed 3, 11, 18 and 19 November 2008, 13, 14, 27 and 28 January, 3, 4, 10, 11, 25 and 26 February, and 3, 17 and 19 March 2009

HC 144–I [Incorporating HC 1167 i–iv, Session 2007–08] Published on 1 April 2009 by authority of the House of Commons London: The Stationery Office Limited £0.00

The Treasury Committee

The Treasury Committee is appointed by the House of Commons to examine the expenditure, administration, and policy of HM Treasury, HM Revenue & Customs and associated public bodies.

Current membership Rt Hon John McFall MP (Labour, West Dunbartonshire) (Chairman) Nick Ainger MP (Labour, Carmarthen West & South Pembrokeshire) Mr Graham Brady MP (Conservative, Altrincham and Sale West) Mr Colin Breed MP (Liberal Democrat, South East Cornwall) Jim Cousins MP (Labour, Newcastle upon Tyne Central) Mr Michael Fallon MP (Conservative, Sevenoaks) (Chairman, Sub-Committee) Ms Sally Keeble MP (Labour, Northampton North) Mr Andrew Love MP (Labour, Edmonton) John Mann MP, (Labour, Bassetlaw) Mr George Mudie MP (Labour, Leeds East) John Thurso MP (Liberal Democrat, Caithness, Sutherland and Easter Ross) Mr Mark Todd MP (Labour, South Derbyshire) Mr Andrew Tyrie MP (Conservative, Chichester) Sir Peter Viggers MP (Conservative, Gosport)

The following members were also members of the committee during the inquiry: Mr Philip Dunne MP (Conservative, Ludlow), Mr Stephen Crabb MP (Conservative, Preseli Pembrokeshire), Mr Siôn Simon MP, (Labour, Birmingham, Erdington)

Powers The Committee is one of the departmental select committees, the powers of which are set out in House of Commons Standing Orders, principally in SO No. 152. These are available on the Internet via www.parliament.uk.

Publications The Reports and evidence of the Committee are published by The Stationery Office by Order of the House. All publications of the Committee (including press notices) are on the Internet at www.parliament.uk/treascom.

A list of Reports of the Committee in the current Parliament is at the back of this volume.

Committee staff The current staff of the Committee are Dr John Benger (Clerk), Sîan Woodward (Second Clerk and Clerk of the Sub-Committee), Adam Wales, Jon Young, Jay Sheth and Cait Turvey Roe (Committee Specialists), Phil Jones (Senior Committee Assistant), Caroline McElwee (Committee Assistant), Gabrielle Henderson (Committee Support Assistant) and Laura Humble (Media Officer).

Contacts All correspondence should be addressed to the Clerks of the Treasury Committee, House of Commons, 7 Millbank, London SW1P 3JA. The telephone number for general enquiries is 020 7219 5769; the Committee’s email address is [email protected].

Banking Crisis – Oral Evidence 1

Witnesses

Monday 3 November 2008 Page

Rt Hon Mr Alistair Darling, MP, Chancellor of the Exchequer; Mervyn King, Governor of the Bank of England; and Lord Turner of Ecchinswell, Chairman of the Financial Services Authority Ev 1

Tuesday 11 November 2008

Paul Chisnall, Executive Director of Financial Policy & Operations, British Bankers’ Association (BBA); Russell Picot, Member, BBA Financial Reporting Advisory Panel; Stephen Haddrill, Director General, Association of British Insurers; Liz Murrall, Director, Investment Management Association; and Charles Cronin, Head, Chartered Financial Analyst Institute Centre Ev 21

Sir David Tweedie, Chairman, International Accounting Standards Board, Paul Boyle, Chief Executive, Financial Reporting Council, and Michael Izza, Chief Executive, Institute of Chartered Accountants in England and Wales Ev 30

Tuesday 18 November 2008

Richard Pym, Chairman, and Rod Kent, former Chairman, Bradford and Ev 40 Bingley

Gary Hoffman, Chief Executive Officer, Ron Sandler, Non-Executive Ev 53 Chairman, and Ann Godbehere, Chief Financial Officer, Northern Rock

Wednesday 19 November 2008

Peter Hahn, FME Fellow, Corporate Finance and Governance, Sir John Cass Business School, Ronnie Fox, Principal of City law firm Fox, Carol Arrowsmith, Partner, Deloitte & Touche LLP and Mr Charles Cotton, Reward Adviser, Chartered Institute for Personnel and Development (CIPD) Ev 64

Brendan Barber, General Secretary, Trades Union Congress (TUC), Miles Templeman, Director General, Institute of Directors (IOD), Peter Montagnon, Director of Investment Affairs, Association of British Insurers (ABI) and Jonathan Taylor, Director General, London Investment Banking Association (LIBA) Ev 76

2 Banking Crisis – Oral Evidence

Tuesday 13 January 2009

Professor Willem Buiter, Professor of European Political Economy, Professor Charles Goodhart, Professor Emeritus of Banking and Finance, and Dr Jon Danielsson, Financial Markets Group, London School of Economics Ev 86

Will Hutton, Executive Vice-Chair, The Work Foundation, Mr Richard Lambert, Director General, CBI, and Jon Moulton, Managing Partner, Alchemy Partners Ev 96

Wednesday 14 January 2009

Doug Taylor, Personal Finances Campaign Manager, Which?, Peter Tutton, Senior Policy Officer, Citizens Advice, and Andrew Cave, Head of Policy, Federation of Small Businesses Ev 107

Michael Coogan, Director General, Council of Mortgage Lenders, Stephen Sklaroff, Director General, Finance and Leasing Association, and Angela Knight, Chief Executive, British Bankers’ Association Ev 115

Tuesday 27 January 2009

Andrew Baker, Chief Executive, Alternative Investment Management Association, Douglas Shaw, Managing Director and Head of BlackRock’s Proprietary Alpha Strategies Team, BlackRock, Chris Hohn, Founder and Chief Investment Officer, The Children’s Investment Fund, Stephen Zimmerman, Chairman, NewSmith Capital Partners, and Paul Marshall, Chairman, Marshall Wace LLP Ev 127

Peter Chambers, Chief Executive, Legal & General Investment Management, Richard Saunders, Chief Executive, Investment Management Association, Peter Montagnon, Director of Investment Affairs, Association of British Insurers, Alan Grisay, Chief Executive, F&C Investments, Antonio Borges, Chairman, Hedge Fund Standards Board, and David Pitt-Watson, Senior Advisor, Hermes Equity Ownership, Hermes Ev 139

Wednesday 28 January 2009

Robert Hodgkinson, Executive Director of Technical Strategy, Institute of Chartered Accountants in England & Wales, Helen Brand, Chief Executive, Association of Chartered Certified Accountants, Paul Boyle, Chief Executive, Financial Reporting Council, Professor Prem Sikka, Professor of Accounting, University of Essex, and Professor Michael Power, Professor of Accounting, London School of Economics Ev 148

John Hitchins, Partner, PwC, Brendan Nelson, Vice-Chairman, KPMG, and Jonathan Hayward, Chief Executive, Independent Audit Ev 156

Michael Madelain, Executive Vice President, and, Frederic Drevon, Senior Managing Director, Moody’s, Barry Hancock, Managing Director and Head of European Corporate and Government Services, and Ian Bell, Ev 164 Standard & Poor’s, Stephen W Joynt, President and Chief Executive

Banking Crisis – Oral Evidence 3

Officer, and Charles Prescott, Group Managing Director, Financial Institutions, Fitch Ratings

Tuesday 3 February 2009

Ziggy Sieczko, KSFIOM Action Group, Councillor Richard Kemp, Local Government Association, Neil Dickens, Landsbanki Guernsey Depositors Action Group, Chris Cummings, Director General, and Amanda Davidson, Deputy Chair, Association of Independent Financial Advisers (AIFA), and Dr John Low, Chief Executive, Charities Aid Foundation (CAF) Ev 173

Tony Shearer, former Chief Executive of Singer and Friedlander Ev 182

Hon James Anthony (Tony) Brown MHK, Chief Minister, Isle of Man, Mark Shimmin, Chief Financial Officer, Treasury, Isle of Man, John R Aspden, Chief Executive of the Financial Supervision Commission, Isle of Man, Deputy Lyndon Trott, Chief Minister of Guernsey, and Peter Neville, Director General, Guernsey Financial Services Commission Ev 187

Wednesday 4 February 2009

Alex Brummer, Daily Mail, Lionel Barber, Financial Times, Robert Peston, BBC, Simon Jenkins, Guardian, and Jeff Randall, Daily Telegraph and Sky Ev 197

Adrian Coles, Director General, Building Societies Association, Iain Cornish, Chief Executive, Yorkshire Building Society, Neville Richardson, Britannia Building Society, and Graham Beale, Chief Executive, Nationwide Building Society Ev 211

Tuesday 10 February 2009

Sir Tom McKillop, former Chairman, and Sir Fred Goodwin, former Chief Executive RBS Group plc, Lord Stevenson of Coddenham, former Chairman, and Andy Hornby, former Chief Executive, HBOS plc Ev 221

Wednesday 11 February 2009

Eric Daniels, Group Chief Executive, Lloyds Banking Group, John Varley, Group Chief Executive (Board and Executive Committee member), Barclays, Stephen Hester, Group Chief Executive, RBS, António Horta-Osório, Chief Executive, Abbey, and Paul Thurston, UK Managing Director, HSBC Ev 252

Wednesday 25 February 2009

Lord Turner of Ecchinswell, Chairman, and Hector Sants, Chief Executive, Financial Services Authority, and Loretta Minghella, Chief Executive, Financial Services Compensation Scheme Ev 277

4 Banking Crisis – Oral Evidence

Thursday 26 February 2009

Mervyn King, Governor, Paul Tucker, Deputy Governor elect, Financial Stability, Andy Haldane, Executive Director, Financial Stability, Andrew Bailey, Executive Director, Banking and Chief Cashier, Bank of England Ev 305

Tuesday 3 March 2009

Glen Moreno, Acting Chairman, and John Kingman, Chief Executive, UK Financial Investments Ltd Ev 325

Tuesday 17 March 2009

Lord Myners CBE, Financial Services Secretary to the Treasury, Mridul Hegde, Director of Financial Services, Nikhil Rathi, Team leader, Financial Stability Team, HM Treasury Ev 347

Thursday 19 March 2009

Rt Hon Mr Alistair Darling, MP, Chancellor of the Exchequer, Dave Ramsden, Chief Economist, Tom Scholar, Managing Director, International and Finance, and Nikhil Rathi, Team Leader, Financial Stability, HM Treasury Ev 366

Processed: 13-03-2009 15:08:24 Page Layout: COENEW [SO] PPSysB Job: 416782 Unit: PAG1

Treasury Committee: Evidence Ev 1 Oral evidence

Taken before the Treasury Committee

on Monday 3 November 2008

Members present

John McFall, in the Chair

Nick Ainger Ms Sally Keeble Mr Graham Brady Mr Andrew Love Mr Colin Breed John Thurso Jim Cousins Mr Mark Todd Mr Michael Fallon

Witnesses: Rt Hon Mr Alistair Darling, MP, Chancellor of the Exchequer; Mr Mervyn King, Governor of the Bank of England; and Lord Turner of Ecchinswell, a Member of the House of Lords, Chairman of the Financial Services Authority, gave evidence.

Q1 Chairman: Chancellor, welcome to you and your question and he says, “Where has all the money colleagues to this inquiry into the banking crisis. gone? In any deal somebody wins and somebody Could you introduce yourselves formally for the loses but this time everybody seems to be a loser.” shorthand writer, please. Mr Darling: That is a very general question and let Mr Darling: I am the Chancellor and with me I have me deal with it because it perhaps sets the scene for the Governor and the Chairman of the FSA. the discussions we have this afternoon. We face at the moment, along with every other country in the world, an extraordinary set of circumstances where Q2 Chairman: First of all, I would like to welcome the banking system all over the world has been under you along with your colleagues, because this is, I extraordinary strain since the summer of last year. It believe, the first time the tripartite authorities have culminated, as the Governor said in his speech two appeared together to give evidence. We are well or three weeks ago, with a situation where many aware that it is a hugely busy time for you so we are banks across the world had eVectively stopped very grateful that you have taken the time to come lending to each other. Why does that matter? The along. Today’s evidence session is the first in our banking system is absolutely crucial, not just to the inquiry into the banking crisis. Next week, on 11 world economy, to our own economy, but it matters November, we will deal with accounting standards to individuals and it matters to businesses. We all and this will be followed on the 18th by evidence rely on the banking system to operate eVectively. from the nationalised banks. We will be publishing Without it, quite simply, the country would come to details of these evidence sessions shortly. This is also a halt. That is why over the last 15 months or so we a groundbreaking evidence session in another way, have had to take a number of steps that in past years in that for the first time a departmental Select we might have thought to be extraordinary, like the Committee has invited members of the public to nationalisation of Northern Rock at the beginning submit questions ahead of the evidence sessions and of this year. You will recall that even within we are delighted by the public response. You can see Parliament that was deeply controversial at the time. the result, Chancellor: 5,000 e-mails to the Indeed, there are some people who still believe it was Committee with questions to all the principals. Some the wrong thing to do but it was a very controversial of them will be read out today but all of them have thing to do. We were perhaps one of the first been carefully examined and have contributed to the countries to have to face up to a particular problem briefing before us. Many of the e-mails the with what was, I think, our fifth biggest mortgage Committee has received have been about the lender at that time. We had a similar problem with potential losses suVered by the Isle of Man and Bradford & Bingley in September and, of course, Guernsey depositors and Icelandic banks but to since September, since the collapse of Lehman ensure that we give suYcient time to cover all topics, Brothers in the United States, the problem became we will discuss these issues towards the end of the acute across most countries in the world. That is why session. Governor, I am aware that you are currently it was necessary for us at the beginning of October to in purdah; you have the inflation meetings next announce that we were going to embark on a major Wednesday and Thursday and therefore you are programme to help our banks recapitalise, to build unable to answer questions relating to your up their strength, so they will be able to continue to forthcoming interest rate decision or the forecast but lend to each other, to businesses and to people. We you will be glad to know that the Committee will put those measures in place, as I announced in the discuss these with you when you come before us House of Commons on 13 October, and that process again for the November inflation report. Can I start has gradually been worked through. As I have said with you, Chancellor. Ted Whitton has put in a on previous occasions, if you look at the money we Processed: 13-03-2009 15:08:24 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG1

Ev 2 Treasury Committee: Evidence

3 November 2008 Rt Hon Mr Alistair Darling MP, Mr Mervyn King and Lord Turner of Ecchinswell have put into the system, the money that we put into is vital to all our economic prosperity. When the Northern Rock is in the course of being repaid. In banking system fails to do that as a result of a fact, it is being repaid slightly ahead of the schedule complete collapse of confidence in the worldwide we planned. In terms of the money that the Bank of banking system that we saw, not just in the UK but England has been lending through its special around the world, it was necessary to take drastic liquidity scheme, that money is lent to the banking action and that action, based on the experience of system and it is repayable over a three-year period, previous episodes we have seen, was one of so we get that money back as well. In relation to the recapitalisation. I think that was exactly the right recapitalisation of the banks, of course, the thing to do. This was not done in the interests of the Government gets shares in return for that banks; this was done to protect the rest of the recapitalisation in respect of RBS, HBOS and economy from the banks. Lloyds, because the other banks have chosen to raise money on their own account on the private markets, Q5 Chairman: You were talking about moral and therefore the Government gets shares which hazard, Governor, and you told this Committee you eventually, when we get out of the shareholdings, had warned the banks about it. It does seem in that can be sold. So yes, there is an upfront cost. Yes, the sense, your warning about it, nothing was done and Government has had to intervene—and so has every the taxpayer really has been taken for a mug. other government in every large economy in the Mr King: No, the taxpayer has not. The taxpayer is world—but the reason we are doing it is because it is putting money up front, as the Chancellor said. That necessary to maintain the financial system because, does not mean to say that it will not get money down as I say, we all depend on it. That is a very long the road which will more than justify the original answer to the question but it is a perfectly fair sums put up. question that people can ask. I do not know either the Governor or the Chairman of the FSA would Q6 Chairman: I hope that satisfies Mr Peter McKay like to add anything. I am sure they would agree with who put in that question. Chancellor, from the what I have said. questions we have received, it is clear that the Government has some explaining to do for the Q3 Nick Ainger: We have 180 questions, Chancellor. public. Denis Sayers was certainly not alone in We do not want you to be here until 10 o’clock asking “Where are you going to borrow the money tonight. We are going to direct them at one person from to fund the banking bailout and what will be and ask for a short answer. Lord Turner, from the consequences of such a level of government Gavin Elliot, “Is the £37 billion bailout of the banks borrowing?” not an admission that regulation has failed totally?” Mr Darling: The answer to that is that the Lord Turner of Ecchinswell: I think, to be honest, it Government borrows that money from the markets is an admission that at the level of the whole world in the normal way. I will set out the consequences of there was a failure to see enormous risks developing that together with the wider consequences that the in our financial system. I think in retrospect—and Government is having to deal with as the economy hindsight is a very useful thing to have—it is clear slows down and tax receipts slowdown at the time of that the world for many years was on a boom of the Pre-Budget Report and of course again at the credit extension which turned out to be Budget next year. unsustainable. There are major questions that raises also about the capital adequacy regimes which we Q7 Mr Fallon: I will have later questions about and Europe and America and the whole of the world Iceland but an awful lot of people have e-mailed us have applied to banks and whether we need to asking who was really responsible for letting all this change those in future so that they prevent that sort happen. We seemed to have this impression of “see of boom of credit occurring. I think therefore what no blame, hear no blame and take no blame.” I would entirely accept is that there are major Chancellor, if I can begin with you, Sean Walsh questions to be asked about the whole structure of asked us about your responsibility. If you take credit how the world has done financial regulation, in for the boom, why will you not accept some particular in its capital adequacy regimes, its responsibility for the bust? These were British oversight of liquidity, and fundamental things like banks—Northern Rock, Bradford & Bingley, that. Lloyds, the Scottish banks—over-lending to British borrowers and doing so under the control of the Q4 Chairman: Governor, when the problems in the three of you. banking sector were reported on the television news Mr Darling: I think, firstly, all of us have to accept in the past people spoke about “peering into the responsibility for the regulatory regime we have. We abyss”. What would really have happened if the all have to accept responsibility for, in my case, the banks had not been bailed out at the taxpayer’s wider conduct of economic aVairs in this country. I expense? Has the taxpayer not been taken for a will always do that. In relation to the regulatory monkey? system generally, the problem I see is this: that in the Mr King: No, the taxpayer has not; as the past governments have tended to concentrate on the Chancellor said, this is an investment in the banking regulatory system within their own country. As you system which in the end I believe will pay oV.Itwas know, we made major reforms to the regulatory necessary to recapitalise the banking system so that system ten years ago, essentially ending a self- it could continue lending to the real economy, which regulatory system and bringing the regulatory Processed: 13-03-2009 15:08:24 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG1

Treasury Committee: Evidence Ev 3

3 November 2008 Rt Hon Mr Alistair Darling MP, Mr Mervyn King and Lord Turner of Ecchinswell bodies together. What has happened here, as Lord Q9 Nick Ainger: Chancellor, we had a question here Turner has pointed out, the problems that have built from Mr David King asking whether the up over the last few years and became acute by last Government quantified the whole extent of toxic summer, summer of 2007, is that whilst individual assets to which the banks were exposed before regulators focused on what was going on within their oVering the £50 billion bailout package to them. Did own areas of responsibility, and there are clearly you actually go into that sort of detail with the banks lessons to be learned there as well, as the FSA that have been in receipt of the recapitalisation acknowledged earlier this year, where the system is money? deficient is in spotting problems that are building up Mr Darling: What we did is we asked the Financial not in one country but in several countries. In this Services Authority, which is the regulator of these case it happened to be primarily within the United banks, to calculate how much additional capital States but it is a problem, which is why for some would be required in relation to each bank, and years we have been arguing for far greater co- whilst I understand you are passing on e-mails to me, operation between the regulators. That is why we I hope you will allow where it is appropriate us to helped set up the Forum for Financial Stability ten contribute together because it might explain how the years ago. Undoubtedly there are lessons to be FSA did this. Of course it took into account the learned. Nobody can look at the present system and exposure which we were aware that banks had to say that there are not lessons to be learned from it. deal with. Otherwise it would not been possible for There are, and particularly in relation to making us to have reached a calculation as to how much each sure that regulators are focused on what is going on institution was actually able to increase their capital not just in their own country but what problems by. That was absolutely necessary. might be building up elsewhere as well. Lord Turner of Ecchinswell: Could I expand on that? I think it would be useful to explain the role of the Q8 Mr Fallon: But Mr Walsh actually says, FSA in reaching those judgements as to how much “Government should have been well aware of the capital was required. We had reached a point of view multi-national nature of banking transactions.” at the tripartite level all together that a very You and Mr Brown were in overall charge of all this. significant recapitalisation of the banking system Why do you not accept responsibility and say sorry? and of specific banks was required to restore Mr Darling: I have said to you that I accept confidence. We had got to a situation, which was responsibility for everything that I am responsible mentioned earlier, the seizure of the money markets, for but in relation to what has been happening in the when non-bank institutions, whether they be banking system overall, I think there are several corporates or pension funds or insurance levels of responsibility. Yes, in our national companies, were increasingly unwilling to lend to the regulators; undoubtedly we needed to toughen up banking system at anything other than overnight, what was happening internationally. There is and this was becoming extremely critical. Of course, another area which we overlook at our peril and that once non-banks are only willing to lend to banks is the responsibility of boards of banks, who are overnight, banks can only lend to themselves supposed to be the first line of defence in relation to overnight; the inter-bank becomes overnight. This their own institution. Yes, we have to look at what was the whole seizure of the inter-bank market. It governments are responsible for. We also have to was obvious in discussions that something radical ask ourselves how we ensure that in future banks had to be done to restore confidence, and that actually know what they are doing, not just at a confidence has, as you know, three elements to it: senior level but at middle management and so on. Bank of England liquidity support, guarantees to The diYculty we have had over the last few years is certain categories of funding, and recapitalisation. that a situation was allowed to build up where The scale of the recapitalisation we then worked out money flooded into the system, interest rates were by running extreme stress tests—and we deliberately low, people were looking for better returns, and they used fairly extreme stress tests—on the assets of the lighted on the securitised market. Then of course, bank, looking separately at their UK mortgage when that went wrong, when people started to assets, the ordinary mortgages which were on default in America in 2007, the consequences for the balance sheet; at their ordinary corporate lending rest of the world were catastrophic in terms of the assets on balance sheet; and at the assets in their health of the banking system. So yes, of course there treasury and capital markets activities, which might are lessons to be learned on our part, there are include some of the ones which people tend to call lessons to be learned in every single country in the toxic, though there is no precise definition of what world, but crucially, it is important that we make we mean by “toxic”, but it certainly includes several sure that we have a far better surveillance, far better where the present market value of those is very much monitoring of the problems that are building up. We below the original value. There was a process of have been concentrating on America; we do need to developing a set of stress tests which defined what we understand that, as the world becomes smaller, in believed was required in terms of recapitalisation to the sense that we are getting rapid growth in India take them to a level where people could absolutely and China and so on, we need to make sure that we clearly and without doubt have confidence in them. keep a close eye on what is happening right across The net eVect of that is that we have taken them to a the world. level of capital which is well beyond what the classic Chairman: We are coming on to questions about international rules of capital adequacy defined, as boards of directors later, Chancellor. indeed have other countries in similar Processed: 13-03-2009 15:08:24 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG1

Ev 4 Treasury Committee: Evidence

3 November 2008 Rt Hon Mr Alistair Darling MP, Mr Mervyn King and Lord Turner of Ecchinswell recapitalisation programmes, and at some stage— for a fee. In other words, if we guarantee it, we but it needs to be done in an internationally charge a fee, so that the taxpayer would be rewarded coordinated fashion—we are going to have to for that, if you like. In relation to those banks where explain what a long-term capital regime will be, we have used public funds to recapitalise them, we accepting that what we have done at the moment are saying there that additional conditions will was entirely appropriate and required for the specific attach in respect of lending to small and medium- circumstances that we faced. sized companies and also in relation to the mortgage market. There are also restrictions on payment of Q10 Nick Ainger: But so far we have not had a return dividends. Basically, what we are saying there is that to the trust and confidence that existed 12 months we have taken, as you know, preference shares, ago, despite up to £500 billion worth of support to which come with an additional payment, as well as the banking system in this country. Is not the key ordinary shares. The reason we have done that is to problem that banks do not trust each other because make sure that we did not end up in a situation where they still believe that there are undeclared toxic the public recapitalised these banks only to see the assets or liabilities for their fellow high street bank money go out the other side without actually partners and that is why we have not returned to fulfilling the function we wanted. So there are lending? Is not the way forward to actually publish conditions and, as I said when I made my statement or insist that every institution publishes what its in the House on 13 October, those conditions do exposure is? While it may cause a short-term mean that where there are guarantees, there is a fee problem, it is only the long-term solution. for it, and of course, in relation to shareholdings that Lord Turner of Ecchinswell: That is a matter for the we take, when we come to sell them in due course, public accounts of those companies, and they are and of course when we get dividends, and that subject to accounting standards which, on the becomes possible, the public will get a return there whole, require them to use fair value approaches as well. rather than accrual, historic cost approaches in relation to that. I think some people have raised Q12 Nick Ainger: You know from Treasury issues as to whether that process should have gone Questions that there is serious concern from small further but on the whole I think there has been fair businesses, from homeowners, that the very banks openness in terms of the accounting. So I do not which we have bailed out do not appear at the entirely accept that the slow pace at which the money moment to be honouring that commitment for markets are returning to normal can be put down to getting money back and supporting credit a continued uncertainty about that accounting availability at the same level as last year, not treatment. I think it is simply the case that when you pursuing people to repossession and so on. Should have had what was really an extraordinary, extreme you not publish the agreements you have reached collapse of confidence—and the Governor has with these individual institutions so that their described it, I think, as the biggest collapse of customers can actually check whether they are confidence in the money markets which had complying with the agreements? occurred since 1914—it simply takes time for people Mr Darling: There are a couple of things here. I am slowly to return to confidence. I will just reiterate about to write to you,1 Mr McFall, in your capacity one thing, that one of the crucial elements of the as Chairman of this Committee, setting out the confidence here is not the banks in each other; it is details of the holding company that the Government non-bank financial institutions and corporates in the is setting up today to manage the shareholdings in banks. It is when they are willing to start depositing RBS, HBOS and Lloyds TSB, and probably also with the banking system at three months or one year Northern Rock and Bradford & Bingley, or that part rather than at short-term tenors that we will see a which the Government still maintains. That letter return of the money markets to their normal will set out the objectives of this company, which are function. to ensure, as I said in the House at the time, that these companies are managed in a commercial way Q11 Nick Ainger: Chancellor, Mr Neill has raised and at arm’s length from the Government. They will the issue of the guarantees which are in place also of course, being the shareholder in these banks, following the bailout of various banks. He asks what and a substantial shareholder in relation to both guarantees are in place to ensure that the taxpayer RBS and, assuming the merger between Lloyds and receives any profits and/or our money back before Bank of Scotland goes ahead, although a minority being paid out to the shareholders and the boards of shareholder, still a substantial one, make sure that directors? those conditions are put in place. In addition to that, Mr Darling: What we have done in relation to the although the wider body of banks, those who raised eight major banks and building societies is, in return their money on the markets, are not subject to the for them raising their capital—remember, this is detailed agreements which I was referring to, we do quite an important distinction. Most of them are want to ensure that we encourage them to do as doing so through the markets, in other words under much lending to small business as possible and, of their own steam. RBS, HBOS and Lloyds TSB are course, to lend into the mortgage market. You are using the recapitalisation fund, so they are treated probably aware that Lord Mandelson, the Secretary slightly diVerently from the other banks. In return of State for Business and Enterprise, and I met the for that, what the Government is doing is guaranteeing inter-bank lending and it is doing so 1 Ev Processed: 13-03-2009 15:08:24 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG1

Treasury Committee: Evidence Ev 5

3 November 2008 Rt Hon Mr Alistair Darling MP, Mr Mervyn King and Lord Turner of Ecchinswell banks last week and we agreed that we would need up that the deal which was put on the table at the to meet on a regular basis to make sure that we did time of the recapitalisation is not exactly the same as everything possible to make sure that funding is the deal that is on the table now? being made available. What I have said in the House Mr Darling: No, it has not changed at all. of Commons both on 13 October and last week at Treasury Questions is that yes, of course the Q16 Mr Brady: So you think for Barclays, or any of availability of money must be maintained and it the banks that did not access the scheme at the time, must be at competitive rates, but that does not mean they have made that decision on precisely the same that every person who wants a loan will necessarily terms as Lloyds TSB, RBS and the others? get a loan on the terms they want. Pretty much on a Mr Darling: I assume they have. The position is that cross-party basis people did say that what we cannot we said, “You need to recapitalise and there are two do, having done all this, is to then go back into the ways you can do it. One is you can do it through the very irresponsible lending that so many of us have markets in the normal way,” which Barclays have been critical of. It does not mean that automatically chosen to do, “or you can get capital through the Y there will not be any di culties but what I am very bank recapitalisation scheme and the conditions are anxious to do, and we will be putting in place diVerent if you do that.” The banks themselves, and, arrangements, and I agree with you that we should indeed, Barclays’ position has not changed either publish agreements that we have, so that people because on the weekend these discussions took place know exactly what is possible and they will know the you will recall that when I made the announcement terms and conditions on which we do it. on the 13th I indicated that Barclays was proposing to make its own arrangements. Q13 Mr Brady: Chancellor, Eric Daniels, the Chief Executive of Lloyds TSB, has been quoted as saying Q17 Mr Brady: Are you not concerned, Chancellor, that the bank faces “very, very few restrictions” as a that what you have created is a very uneven, consequence of accepting the capital injection from inconsistent situation where diVerent banks are the public. In that context, would you respond, regulated in diVerent ways, have diVerent please, to Joan Neddington’s question, who says competition rules applying to them than others, and that she understands the importance of bailing it is not really a level playing field? banks out but, “as a taxpayer, I object to my taxes Mr Darling: No. This has been reflected in some of funding bonuses. What is the Government going to the e-mails you have been getting. If we had said, do to stop this?” “We are willing to recapitalise you and there are no Mr Darling: In relation to Lloyds TSB, on the strings attached,” I think quite understandably you assumption that they take up the shares that they would have been saying “How come you have have indicated they will from the bank allowed such a situation to arise?” I do not think it reconstruction fund, they will be aVected by the is unreasonable if you take a bank where we might same restrictions as HBOS and RBS, the conditions have over 60% of its shares or in another case over that I was referring to in relation to lending, in 40% of its shares that we should not say there are relation to the payment of bonuses and in relation to restrictions. If you take, for example, the restrictions remuneration of their boards. Anyone who uses the on the bonus payments being made to the board, I bank reconstruction fund is treated the same way do not think it is unreasonable to say, “Look, you and, as I said in reply to Mr Ainger, I will arrange have got into a situation where you need exceptional for those agreements to be published once they are recapitalisation, we are helping you but you have to concluded. accept that there are some restrictions on what you can otherwise do.” Also, in relation to mortgage lending or lending to the small business sector, it is Q14 Mr Brady: So are you saying that bonuses will not unreasonable if you put very substantial sums of not be paid next year? public money into the banks concerned that you do Mr Darling: We do not actually expect many not get something in return for that. bonuses to be paid at all from the banking system next year but what we have said is that there will be Q18 Mr Brady: I want to come back later in relation restrictions whilst those preference shares are there. to the Icelandic banks but finally for the moment, I I am not sure if you are referring to the prospectus am glad you mentioned the e-mailers because the which Lloyds TSB published today but no doubt Chairman has just told me the same thing. Still on you will want to have a look at that. It anticipates the theme of consistency of treatment, Susan and being in a position to try and redeem the preference Jean have e-mailed us wanting to know why it is that shares rather earlier than anticipated and, once they they, as people who are losing out very badly from are redeemed, as part of the agreement we struck, a the situation with Equitable Life, are not being diVerent set of restrictions would then apply. treated in the same way as people who have lost their The Committee suspended from savings potentially through banks or building 4.33 pm to 4.44 pm for a division in the House societies. Mr Darling: As I think I have said on a number of occasions, we will make a statement on how we deal Q15 Mr Brady: Would you accept, Chancellor, that with Equitable Life following the Ombudsman’s in relation to bonuses, in relation to dividends and findings shortly. That is a diVerent problem to the preference shares, there is a sense which has grown problem we are dealing with just now. Equitable Life Processed: 13-03-2009 15:08:24 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG1

Ev 6 Treasury Committee: Evidence

3 November 2008 Rt Hon Mr Alistair Darling MP, Mr Mervyn King and Lord Turner of Ecchinswell is not a bank. It has problems which, as you know, Q21 Chairman: Lord Turner, in retrospect that go back for 15 or 20 years. There was an inquiry by seems a no-brainer, getting out of kilter so much as Lord Penrose six or seven years ago. There then £700 billion. What is going to happen in the future? followed a four-year inquiry by the Ombudsman. I Do you think it will be more in the balance? will be looking at both and, as I said, I will be Lord Turner of Ecchinswell: I think it is exactly the publishing our conclusions shortly. sort of issue that needs to be looked at with far greater attention in future by regulators, by central banks, by governments throughout the world, to do this sort of macro analysis. If I pick up the question Q19 Mr Brady: I am sure you would accept that it earlier of admitting errors where they occurred, I feels the same if you are in the position of having lost think the FSA has admitted two errors. It has your pension savings as if you have lost your life admitted errors in relation to— savings in a bank. Mr Darling: Absolutely. I understand the position of Q22 Chairman: I do not want to go into the past of anyone who has entered into an arrangement and V the FSA. I just want to look into the future. the arrangement turns out to be di erent to what Lord Turner of Ecchinswell: What is going to they thought they were entering into. Like, I suspect, happen? I think there is going to be some sort of every one of us around this table who are Members process of rebalancing because let us be clear that of Parliament, I have many constituents who are part of that money, that imbalance, part was coming aVected by what happened at Equitable Life. As you from wholesale borrowing within the UK, part was know, the situation at Equitable Life, Lord Penrose the flipside of the current account deficit, and some found that the company, as he put it, was of it was eVectively coming from purchases by, for substantially the author of its own misfortunes. The instance, American money market funds of retail Ombudsman has also pointed to a number of mortgage-backed securities from the UK. The failures which she has identified. I need to respond fundamental problem that went wrong there was not to both. I understand perfectly well the point that actually a problem of bad assets. It is probably the Susan and Jean are putting, and I hope that we can case that large numbers of these retail mortgage- respond to Susan and Jean and indeed many backed securities will pay oV on time, as it says on others shortly. the paper. The fundamental reason was that the Mr Brady: I hope so too. underlying investors, American money market funds, were doing maturity transformation; they were investing in long-term assets with short-term liabilities, and they are no longer willing to do that. Q20 Chairman: Chancellor, John has read your Financial Stability Report—that is me—the one you produced in October, which is excellent. I note that Q23 John Thurso: I have an excellent question here in 2002 lending and consumer deposits were in from Leighton Jones, who says “I question whether it is necessary for HBOS and Lloyds TSB to be balance but in 2008 lending exceeded deposits by merged. Each company will have its own injection of over £700 billion. How did we get so much out of government capital and by keeping them as separate kilter? What is the future now in terms of lending entities we will avoid the need for an artificial and deposits? calculation of the value of HBOS shares in terms of Mr King: The banking system borrowed more Lloyds shares, and we will retain the competitive through wholesale funding in order to expand its element in mortgage and banking facilities that lending and it believed that it was profitable to do so, HBOS has always provided.” Governor, could I ask that it could finance the cost of borrowing by you, bearing in mind Mr Jones’s question, what are earning suitably adequate returns on the lending the pressing matters of financial stability that have that it was making. That strategy seemed to be quite meant that Lord Mandelson has overridden the profitable until August 2007, when the risks involved obvious competitive disadvantages in pushing this in borrowing very short term to lend what perhaps through? was thought to be short term because of securitisable Mr King: I do not wish to speak for Lord instruments but turned out to be lending long term Mandelson. It is a question you can put to him. when the securitised mortgage market closed, that turned out to be rather risky. As for the future, the Q24 John Thurso: Presumably you advised him. banks will need to regenerate new sources of Mr King: From our point of view, I think what we funding. The level of savings will be there. Indeed, saw at the time when the merger was engaged was one would expect that in the next year or two the that HBOS was suVering from a very rapidly falling domestic economy will be saving more as a fraction share price and clearly a loss of confidence which of GDP than it has in recent years. I have no doubt was undermining its ability to continue as an that the savings pool is there and one of the aims of individual entity. I think the only alternative to the the guaranteed borrowing programme is to give merger would have been a full-scale nationalisation banks a start in terms of obtaining guaranteed and I think that would have had quite dramatic borrowing to start funding lending to the real repercussions for the UK banking sector. That economy by looking to those sections of the non- merger, I think, was a very important step and it is bank financial economy and the non-financial sector still there as a commercial transaction. It is not for from which it was not obtaining funds before. me; it is for the market and the regulators to decide Processed: 13-03-2009 15:08:24 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG1

Treasury Committee: Evidence Ev 7

3 November 2008 Rt Hon Mr Alistair Darling MP, Mr Mervyn King and Lord Turner of Ecchinswell where it goes from there but our advice which we Mr Darling: I would say two things to you. One is gave at the time was that, in the interests of UK that it is up to the shareholders in Lloyds and HBOS financial stability, the merger was a desirable as to whether or not they want to vote for this outcome. merger. If they do not do so, we will have to proceed on the basis that we have Lloyds TSB on the one hand, HBOS on the other, both will have to go back Q25 John Thurso: Would you have given the same to the FSA and we will have to recalculate the capital advice if you had known that a few weeks later you requirements and proceed accordingly. However, would be taking a share in all the other banks? you should look at what the OFT report says about Mr King: I think it is impossible to say because in the HBOS because it makes it clear that the most likely circumstances where we gave the advice the loss of outcome without the merger would not be a strong, confidence in HBOS was there, and only something independent HBOS continuing to exist and exerting pretty radical would have stopped it. I think that is the same competitive pressures as it was in the past, a hypothetical question that it is very hard to answer. because it recognizes that HBOS has a number of There is no doubt that when we made that problems. Remember, it was very heavily dependent recommendation we were very conscious of the on the wholesale markets, the markets we have been Y di culty facing HBOS, the merger was the right way talking about, markets that have dried up. The idea forward, and now that it is there on the table you that HBOS was a perfectly happy, functioning bank cannot undo it. It is a merger there, it is going to be and there was nothing wrong with it, and then along a commercial transaction, and we will see what came Lloyds TSB and put in a bid for it is not quite happens. right. Look at what the OFT report says. When we looked at it, the authorities, the Bank of England, Q26 John Thurso: What a lot of people are asking is, the FSA and ourselves, it was our view that the the deal for a merger was obviously the right thing financial stability argument was still a strong one. At at a point when HBOS was the only institution in the end of the day, it is up to the shareholders, and trouble. That was the perception. What we have indeed, it is open to anybody else to come along and arrived at is a situation where the whole system was put in a bid for HBOS. The only thing I would have in trouble and needed to be rescued, a wholly to say to you is that so far no other bid has been put diVerent situation, and therefore why is nobody in place, and the problem we had was, if we had not revisiting the merger given it has some pretty nasty intervened, if we had not allowed the Lloyds bid to side-eVects in the reduction of competition? have gone forward, HBOS would have been in an Y Mr King: There is a commercial transaction on the extraordinarily di cult situation. Again, HBOS of table and the two parties have to make up their course has benefited very substantially from the minds about that. recapitalisation coming through the Government’s recapitalisation fund. Why is that? Because, frankly, it needed the money. You should look at the OFT Q27 John Thurso: Let me ask you then, Chancellor, report because it did make the point that if this does this started obviously as something that came out of not go ahead, it does not mean that HBOS is out of Downing Street in terms of a solution to a problem, the woods. Far from it; it still has very substantial and a good one, but there is now a completely problems we need to resolve. diVerent problem, a completely diVerent solution. Why has this now become a commercial decision that does not need any intervention? Q29 John Thurso: Because we are under a time Mr Darling: The initial move in relation to this came constraint, can I ask for a couple of quick answers to from the two companies themselves, as is fairly well a couple of quick questions? One, is it correct what documented and was made public at the time. HBOS was said by a Minister in the House of Lords that the and Lloyds TSB started to talk to each other. Why funding for HBOS was contingent on the deal going was that? Obviously, Lloyds saw an advantage for ahead and if the deal did not go ahead, there would them, but HBOS, you may recall, earlier this be no funding for HBOS? summer had to engage in a rights issue. It was not Mr Darling: No, I am not aware of anyone saying without its problems and HBOS reached the that. It could not possibly be the case because HBOS does need capital, and the amount of capital it needs situation where it needed to find some way to get was fixed on the assumption that the merger would through things and it came to the view that the best go ahead. If that merger does not go ahead, it will thing to do would be to enter into a deal with Lloyds have to go back to the FSA. TSB. The competition authorities would have been engaged at that point because of the combined strength of that bank. I made it clear at the time that Q30 John Thurso: It is available but it has to be I was prepared to say that the competition issue renegotiated. could be trumped by the issue in relation to financial Mr Darling: Of course, and I have said that on a stability. That was a decision that Lord Mandelson number of occasions. took on Friday. He did so under advice from the Bank of England, the FSA and the Treasury. Q31 John Thurso: Second question: over the weekend there was much speculation about a rival Q28 John Thurso: Can you explain to me why it bid and there was a gentleman’s name mentioned. If should remain necessary today? that materialises, will you give it a level playing field? Processed: 13-03-2009 15:08:24 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG1

Ev 8 Treasury Committee: Evidence

3 November 2008 Rt Hon Mr Alistair Darling MP, Mr Mervyn King and Lord Turner of Ecchinswell

Mr Darling: Yes. Legally, there is nothing to stop a lot of case law on this but I think before anyone any third party coming along and putting in a bid. If took any action, they would be well advised to take they want to talk to the Government about it, they proper legal advice. can do so but as of now, or at least, as of when I set oV to come to this Committee meeting, there is no Q35 Chairman: We have had a few questions from other bid on the table. Archie Garden and Luke Goh. Lord Turner, Richard Pym on 25 September stated, “The changes Q32 John Thurso: A question for Lord Turner: if— we have announced today focus the business as a and we must assume it will happen—stability returns strong savings bank, reduce the size of our lending to the banking system and in a couple of years you activities, and increase our capacity in arrears discover you have a problem of competition with collection. We are now strongly capitalised, this giant bank, what will you do about it? undertaking a complex transition with regrettable Lord Turner of Ecchinswell: We are of course not the job losses, but we are planning to put the problems direct competition authority. It is the OFT which is of the past behind us and have a business which is fit responsible for competition. We will all jointly have for purpose going forward.” Was that misleading? to look at that situation at that stage. I think it is not Lord Turner of Ecchinswell: I think the thing you clear that we are heading towards a banking system have to realise about any bank is that there is a so concentrated that there cannot be reasonable distinction between its solvency on an ongoing basis competition. We have quite a few players still, and its liquidity position. You get a situation with a including big building societies like Nationwide, and bank where if there is a loss of confidence in it, that of course Abbey Santander. That is an issue which in itself becomes a self-fulfilling process by which will have to be looked at at the time but it is certainly people are then rational to have loss of confidence in not a direct issue, or certainly not in the sole the bank. That, bluntly, is one of the central points competence of the FSA because it is a competition to realise about a bank, that because it does maturity issue rather than a prudential or conduct of business transformation, because its liabilities are shorter regulation issue. than its assets—

Q33 John Thurso: Turning to a diVerent subject, Q36 Chairman: Lord Turner, there is a simple point Chancellor, if I may, it is regarding compensation here. If you have money in Bradford & Bingley and for the shareholders in Bradford & Bingley. I have a the Chief Executive stands up four days before and constituent’s interest in that one of the ministers of says “We are a strong company. We are going the Church has managed to put his entire life savings forward” and then it is Armageddon four days into Bradford & Bingley shares. There are a lot of later— questions. Archie Garden has asked a question, and Lord Turner of Ecchinswell: I think the pace at which Luke Goh, and a number of others, and what they things were moving in those two weeks after the basically say is the Chief Executive said the bank was Lehman’s bankruptcy is almost impossible to fine on 25 September. Four days later the exaggerate. All of us realised that things did literally Government nationalised it. Given what has now move day by day in terms of the way that the money happened to everybody else, is that not very unfair markets were operating, and I think that is a context on those small shareholders or those shareholders? that was unique for those sort of statements. Mr Darling: Everyone feels very sorry for people, particularly small shareholders in Northern Rock Q37 Chairman: It was not bad supervision? and Bradford & Bingley. The position is that the Lord Turner of Ecchinswell: No, I do not think it shareholders in Bradford & Bingley would be was. I do not believe it was. I have looked at it as best entitled to participate in whatever assets that as possible. I think that was on precisely day six of company has left once its other obligations have my time. In fact, I think it was day five of my time at been paid oV. To be realistic, the prospects are not the FSA. great when you look at the position it is in but the problem with Bradford & Bingley, again, there were Q38 Chairman: You never had time to fashion the two problems. It was very exposed to the buy-to-let FSA in seven days, did you? market. It also had a problem with the self- Lord Turner of Ecchinswell: I do not think so but my certification of mortgages. As with so many other overall impression, I have to say, is that, whereas institutions, we did everything we could to help it but there were errors which the FSA has owned up to it reached a stage in September when the FSA relation to Northern Rock, I think since then in concluded that it no longer met its obligations and relation to its management of what are incredibly it therefore could not be allowed to carry on taking diYcult crisis situations to deal with, it has worked money in. very eVectively both in itself and with the other tripartite partners. Q34 John Thurso: Do they have any recourse to the Chairman: We will come back to that and you can executives one, two, three days before telling them keep us informed on that. everything was absolutely fine and to leave their money in? Q39 Mr Breed: Chancellor, Mr Michael Freedman I Mr Darling: I would be hesitant about giving think speaks for quite a few people when he asks anybody legal advice as to whether they have a “Why is the Government allowing Northern Rock remedy or not there. My recollection is there is quite to aggressively harass mortgage and loan customers Processed: 13-03-2009 15:08:24 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG1

Treasury Committee: Evidence Ev 9

3 November 2008 Rt Hon Mr Alistair Darling MP, Mr Mervyn King and Lord Turner of Ecchinswell with bully-boy tactics to recover debts, threatening Mr King: It was totally reasonable to ask the FSA repossession and personal bankruptcy against for information about the quality of the loan book. customers who make genuine oVers of part It was the only basis we had to go on. repayment? Mr Darling: It should not be because it should be Q44 Mr Breed: That sounds very reasonable. Lord sticking to the same code as all other mortgage Turner, why did the FSA tell the Bank of England lenders and that is, firstly, repossession should be a that Northern Rock had a good loan book when last resort and, secondly, it should explore every quite patently they did not? other option. Lord Turner of Ecchinswell: I think it was the case that Northern Rock did not have the same Q40 Mr Breed: So why are they? concentration on either buy-to-let or some of the Mr Darling: We have talked to Northern Rock impaired credit categories of borrowers that, for about it and are having discussions with a number of instance, Bradford & Bingley had. It had on the people to see how they can improve their whole quite a lot of mortgages which would be procedures. What would be helpful is if you had counted as prime mortgages in the normal specific cases with the consent of the people definition. Of course, you must remember that at concerned so that I can actually find out what has that time not only at Northern Rock but across the happened in that individual case. It is necessary to board the level of arrears was very low in the UK. It find out what exactly the circumstances are in these has gone up since then and we are worried that it will cases and I would be happy to look at them. go up further but as of when they will have made that Northern Rock is bound by exactly the same statement last year, although somebody who was considerations as other people. There is a specific predicting what would have occurred on principle problem with Northern Rock and that is that they might have said it would turn bad, there was not have a number of mortgages where they lent at over evidence in the arrears data at that time to suggest 100% where it is quite clear that there are more major bad debt problems. It is important also to people in that category who are getting into notice what the Governor has just said, I think it was diYculties, but they ought to be behaving in exactly in relation to the thing that was presented to you as the same way as all other mortgage lenders. If that is security for lending, that actually the loan to value not happening, if you let me have the specifics, I will ratios were not particularly high. They were not be happy to look at it. outliers. I do not think it is the case that Northern Rock has turned out to be a big outlier in quality of mortgages whereas that is true of Bradford & Q41 Mr Breed: I suspect, with 5,000 pieces of paper Bingley. there, you might be having a few of those. Mr Darling: What I do need in each case is the Q45 Mr Breed: But at that time you were aware that authority of the individual for me to investigate what they were lending 125% of the valuation on incomes has happened in that particular case. All of us, as of 5, 6 and sometimes 61 times income. That did not Members of Parliament, are familiar with this, that 2 apparently have any sort of trigger for you to think, if you really want to find out what is going on, you and there was no real investigation into the together need to know what happened in that particular case. mortgages which actually concealed much of the potential arrears problem which has now been Q42 Mr Breed: Thank you. Governor, about a year exposed. So the FSA really did not do enough ago, when we were in this sort format, you and investigation in order to give the information and indeed Lord Turner’s predecessor said to the advice for the Bank of England that Northern Rock Committee that “Northern Rock has a good quality had a good quality loan book. loan book.” At that time I rather doubted it, in the Lord Turner of Ecchinswell: I think you have got to sense of the sorts of mortgages they were distinguish between the average and the overall. I undertaking, and trying to suggest to us they were believe that Northern Rock’s accounts show that the below the industry average for defaults has rather average loan to value on new lending in 2007 was proved to be not correct. What sort of real evidence 79%. Now that in and of itself would not did you have to give us the impression that Northern immediately tell you that there was a major problem. Rock had a good quality loan book? I think it is true that there was a tale of very high, and Mr King: We were relying on the reports that we in particular above 100%, loan to value ratios. You received from the regulators. When we looked at the can under certain circumstances justify that if you mortgages that we took as collateral, the mortgages have a very, very clear income based underpin for that we took as collateral did not in fact have creditworthiness. I mean the creditworthiness of a particularly high loan to value ratios, and at that mortgage is always a combination of the asset cover time, as you pointed out, the experience of the and the income cover. I will accept entirely that there performance of the mortgages was certainly no was a minority of the Northern Rock book which worse than that of other mortgage lenders on had some particular features but I think, looking at average. the average figures at that time, whether it was loan to value ratios or whether it was the arrears’ experience then being experienced, you would not Q43 Mr Breed: So you took the word of Lord necessarily have seen Northern Rock as an outlier in Turner’s predecessor? terms of quality of mortgages. Where you would Processed: 13-03-2009 15:08:24 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG1

Ev 10 Treasury Committee: Evidence

3 November 2008 Rt Hon Mr Alistair Darling MP, Mr Mervyn King and Lord Turner of Ecchinswell have seen it as a very strong outlier was in the nature Q50 Chairman: Very quickly. of its funding sources and its reliance on wholesale Mr Darling: It is my job to protect the British markets. That is why at the time the problem was taxpayer and I am very happy to stand up and justify essentially a liquidity problem rather than a solvency that. I could not have a situation where potentially problem. we are exposed to billions of pounds in covering this and there were assets there which I could perfectly legitimately use powers that Parliament has given us Q46 Mr Breed: But it never occurred to anyone that to use. The Act may have provisions in it in relation the fact that someone was doing 125% mortgage to anti-terrorism but they also go far wider than that. deals on 6 times income meant that they might just have a slightly more risky loan book than the average? Q51 Mr Todd: Can we turn back to the FSA’s role. Lord Turner of Ecchinswell: I am sure that did occur. The internal audit report on Northern Rock What people would have to look at was across the demonstrated the poverty of regulation of that whole of the average loan book. As I say, if you particular institution but also generic failings in the looked at the aggregate average figures for Northern banking regulation sector of the FSA. Mr Hoare and Rock, I do not think it was clear that it was an outlier Mr Maloney both asked what is being done to and, therefore, I think in so far as there was a strengthen the FSA’s grip on the regulation of the regulatory failure to focus on key things at that time banking sector? it was much more to do with a failure to focus on the Lord Turner of Ecchinswell: Since the internal audit structure of the funding rather than the particular report was produced, and it was, of course, the FSA characteristics of the loan book. which was most instrumental in pointing out its own faults, and those faults included inadequate resources devoted to some potentially high impact Q47 Mr Breed: Thank you. Chancellor, turning to firms, too rapid turnover of some of the key staV and something quite diVerent, why was it necessary for a failure in some classic protest things to document the Government to use anti-terrorism laws for the and make clear what had occurred and to stick to purpose of freezing the assets of the Icelandic banks? procedures, a very major programme has been put in Were the existing laws relating to insolvency not place. It was put in place earlier this year called the suYcient to cover this situation? Supervisory Enhancement Programme. This entails Mr Darling: No, they were not and actually the an additional 218 people in focused relationship 2 legislation we used, although it does cover terrorism management supervision. By relationship also covers the powers that we have to protect the management we mean supervision of those larger country’s general economic interest. Interestingly, institutions where we have dedicated professional when you look back at what happened when the people to them. That is 218 extra people, which is on legislation went through Parliament, there was an top of about 500, think of it like that. amendment laid in the House of Lords to try and confine these powers to be used in the case of Q52 Mr Todd: Are they in post now? terrorism and that amendment was voted down. I Lord Turner of Ecchinswell: 38% of the positions think it was contemplated at the time that those have so far been filled. We are doing that from a powers might be used more widely. Indeed, in my combination of external recruitment and internal statement, I think on 15 October, when I said that we moves. were using the powers under that Act, I did make it clear that these were general powers which are available to the Government. Can I just say—this is Q53 Mr Todd: You must have a fair number of also important—you need to understand why we poachers seeking to be gamekeepers at the moment? were doing this. We still have a situation now, five Lord Turner of Ecchinswell: I think we could weeks later, where we have stepped in to guarantee probably say that the environment for recruiting is the retail depositors in the Landsbanki subsidiary slightly more favourable than we might have and as of today we still do not have an agreement anticipated last year, that is correct. Yes, we are from the Icelandic government that they will cover recruiting people. We are making sure we improve us for it so we did need to step in to protect the the quality of people on average. We have designed a new induction programme for all new supervisors interested British taxpayers. which will be a nine week course in core supervisory Chairman: We do not want to do that just now. skills and we will also be putting our existing supervisors through that process with a defined Q48 Mr Breed: EVectively that was the ends training and competence scheme. justifying the means. Mr Darling: No, no, no. Q54 Mr Todd: Okay. I think you have said enough to say it is work in progress but certainly you would not— Q49 Chairman: Chancellor, we want to do the Icelandic one at the end. 2 Note by witness: The 218 additional people will be in focused Mr Darling: Mr Breed just said something that I do relationship management supervision and specialist take exception to. support areas. Processed: 13-03-2009 15:08:24 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG1

Treasury Committee: Evidence Ev 11

3 November 2008 Rt Hon Mr Alistair Darling MP, Mr Mervyn King and Lord Turner of Ecchinswell

Lord Turner of Ecchinswell: No, we are not there yet. capital requirements, that will take time I think to Obviously of its nature when you launch a thing like get through any international forum. That is not to that it takes time, but by spring next year we would stop us doing it ourselves. Spain, for example, was a anticipate that we will have completed that country that decided oV its own bat to have what programme. they call dynamic provisioning of capital requirements. Switzerland has taken action oV its Q55 Mr Todd: Thomas Huertas in a speech of a few own bat to raise the capital requirements. The Basel days ago made a number of interesting points about framework is a minimum set of capital requirements, Basel II and the capital adequacy regime. that is how it avoids regulatory arbitrage. It does not Presumably the FSA and the Chancellor, actually stop any country adding to that. the Governor, all three of you, are presumably seeking to pursue amendments to Basel II to reflect Q58 Mr Todd: Nigel Beidas has asked about the the experience we have had in the last few months alphabet soup of tricks that the banking sector got and those are likely to focus on cycle, practicality involved in—SIV, CDOs, all of that—and how that and also the adequacy of capital altogether? was not watched adequately by the FSA. Lord Turner of Ecchinswell: Yes, I think that is Lord Turner of Ecchinswell: Let me draw a absolutely right. I think if you look at Basel II and, distinction between that alphabet soup. There was indeed, Basel I, what is interesting about it in an alphabet soup related to the area of structured retrospect is that both of those took steps to improve credit and derivatives. This is CDOs, ABCP, CDS, the sensitivity of diVerent relative measures of risk to CDO2 et cetera, et cetera. I think what is really quite the relative risk that was being taken between telling in retrospect is to understand that only two diVerent banking activities. I think in retrospect years ago people were saying that the proliferation there was a surprising failure to ask fundamental of all that had made the system more safe than it questions about how large is the capital buVer which was. Indeed, if you read the April 2006 IMF Global banks need and we are bound out of this to end up Financial Stability report, that is exactly the story with larger capital requirements and the issue of that you will get, that this complicated set of whether those capital requirements should be made structured credits and derivatives had made possible counter-cyclical is going to be absolutely clearly on the diversification and the spreading of risk in a way the international agenda. that would reduce the amplitude of the credit cycle.

Q56 Mr Todd: What you presumably do not want is Q59 Mr Todd: I think we all know that was indeed each state inventing its own rules in this area where argued. we will get regulatory arbitrage? Lord Turner of Ecchinswell: It was wrong. Clearly Lord Turner of Ecchinswell: That is exactly what we there should have been more understanding of the do not want. I think what we have to accept is that dangers in that, but it is very easy to say that with a whole series of diVerent nation states have in retrospect. I think the bit which was more clearly an response to the crisis taken specific action, necessary area where regulators and authorities across the action, to increase capital adequacy in order to world should have focused earlier was the other bit restore confidence. We now have a system where we of the alphabet which is the SIVs, the oV balance have just overridden our existing rule book. We need sheet because I think we should have recognised that as rapidly as possible to get to an international things which are oV balance sheet and which agreement about what the future rule book should essentially had done regulatory arbitrage by be but that has to be a more eVective rule book than escaping capital regimes by going oV balance sheet it was in the past. are inherently risky things. I think it is easier to say that was something which ought to have been Q57 Mr Todd: Time line on that because otherwise spotted and things done about their capital we will be inventing our own rules in each state with adequacy earlier. I think on CDOs and CDS, in the consequence— retrospect there was a lot written about it which is Mr King: There are three areas where work needs to just bizarre to read today but sometimes the wisdom be done. One is on the level of capital requirements; of crowds is deeply unwise. secondly, on the regulation of liquidity and the amount of capital that needs to be put aside and, Q60 Mr Todd: Yes. The regulation of foreign banks thirdly, on the so-called counter-cyclical capital licensed to operate here, again we will return to some requirements. On the first, that is a question of of them later in this hearing but the evidence of the judgment, there is no obvious inhibition on making last few weeks has led you to reflect what? that judgment sooner rather than later. The Lord Turner of Ecchinswell: I think there is a major Financial Stability Forum is working on that. The reflection required which I am sure we will come immediate need is not to force banks to have higher back to on the discussion of Iceland about capital requirements at present but to have more passporting arrangements within the European capital, it is the buVer that matters between the two. Union and the EEA. I think there is a real problem On liquidity, we are taking a strong lead we, the UK, of a conflict between a single market approach to are taking a lead in the Basel fora to bring back into passporting and complete reliance on home country the Basel process discussion about regulation of supervisors. I think there are also diYcult issues to liquidity which was never part of the Basel process do with large global integrated finance institutions and should have been. And third on counter-cyclical on the wholesale side, such as Lehman’s, where one Processed: 13-03-2009 15:08:24 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG1

Ev 12 Treasury Committee: Evidence

3 November 2008 Rt Hon Mr Alistair Darling MP, Mr Mervyn King and Lord Turner of Ecchinswell has to recognise that it is very diYcult to take them in. In relation to CDS there is a major issue anything other than a global regulatory approach to about the clearing and counterparty systems that those but that when you go into administration there relate to them. is an entirely national legal approach which cuts across what has been done before. Now, there is probably no way other than to take a global Q65 Ms Keeble: I wanted to ask about the credit approach but that is where we get to the issues of a rating agencies. I really wanted to ask what the greater degree of global co-ordination of regulation proposals are for the future rather than an analysis through colleges of supervisors and processes like of what has happened in the past. We have had a lot that. of submissions from members of the public, including from one Derek Hunter, talking about the fact that the public have put their faith in what they Q61 Mr Todd: Kirk Guest asked about bonuses in thought were Triple A ratings either for banks or the FSA, any in the banking regulatory sector who particular products and then these were not have earned one? founded. This is for the Chancellor first and then for Lord Turner of Ecchinswell: We do have a bonus Lord Turner. What is the intention for better system and I am sure we will pay some bonuses this regulation of the credit rating agencies? It is widely year because I have to say some of them have earned recognised that is much needed. them very well indeed. I think if you simply look at Mr Darling: I agree with you. There are moves both the sheer amount of work, and I think it was pretty from the European Union and, wider than that, good work which was done, relating to the bank internationally to regulate the credit rating agencies. recapitalisation scheme and some of the crisis It is probably fair to say that the whole thing is management, we have had people, as indeed have further down the track in Europe in that there are the Bank and the Treasury, working extraordinarily only 27 countries involved as opposed to potentially long hours and quite competently. Let me be clear, we will not reward bad work but it is part of our some many hundreds, I suppose. The recognition is remuneration process to reward good work and we that they do need to be regulated, they are pretty try to have a system which distinguishes that. important. I just come back to a point I made earlier that I have always believed that a board of a bank should rely on a credit rating agency for an Q62 Mr Todd: Of course, a fair number of FSA staV assessment but it should not substitute the credit left after the Northern Rock fiasco. rating agency’s judgment for its own, and I rather Lord Turner of Ecchinswell: Some did, yes. think that happened on too many occasions. There are other issues like conflict of interest with credit rating agencies, a number of issues that need to be Q63 Chairman: In terms of credit derivatives, a lot looked at. I agree with you that this is an area where is over the counter. Are you quite content with the we need to change the way in which we have done unregulated nature of that or do you think that should be brought into regulation? things. Lord Turner of Ecchinswell: Over the counter do not escape prudential regulation in relation to capital Q66 Ms Keeble: This has been asked for for years, adequacy. There is a separate issue as to whether the certainly since there were the problems with entire level of capital supporting trading in Northern Rock. It is not just about banks relying on derivative instruments was adequate, and I think the ratings, it is also members of the public. I there is an argument it was not. The key issue with certainly recall asking these questions in the wake of over the counter, of course, is that if you do not have Northern Rock. I cannot see that there has really a central clearing house and a central counterparty been any progress and now people have lost money there is a massive accumulation of gross claims of again and the same cries have gone up. When is it the diVerent counterparties among one another going to happen? which can make it very diYcult to see where risk lies and which can create great complexity if you do have Mr Darling: I think there has been a lot more a failure of institution. The FSA has, therefore, been progress in Europe than there has elsewhere. working for some time in particular with the Fed of New York on ideas to put in place a clearing system Q67 Ms Keeble: But we have had the problems here. and a central counterparty system in relation to Mr Darling: I know. Given the nature of what we are credit default swaps in particular, and that is a key dealing with, a solution in one particular country, priority and is on the agenda of the Financial especially when institutions are trading across Stability Forum. several, I do not think will be adequate. You need to have a solution to that certainly at a European-wide Q64 Chairman: The reason I asked that, Lord level, but also much wider than that, internationally. Turner, was you gave the impression in your answer For us to have a solution that is purely directed to to Mark that you are quite content with the the UK would not be enough. The risk is if you did it present system. in one country it would simply result in people going Lord Turner of Ecchinswell: No, no, that was not elsewhere and you really do not want that. There has intended at all. That was absolutely not intended at been a lot of progress made in Europe and I think all. In relation to SIVs, et cetera, we need to bring further progress will be made internationally. Processed: 13-03-2009 15:08:24 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG1

Treasury Committee: Evidence Ev 13

3 November 2008 Rt Hon Mr Alistair Darling MP, Mr Mervyn King and Lord Turner of Ecchinswell

Q68 Ms Keeble: In what? Mr Darling: In Europe. Mr Darling: In relation to the regulation of credit rating agencies. Q74 Ms Keeble: In Europe, okay. The second thing is would you favour seeing an assessment of the Q69 Ms Keeble: Yes, but what? bonus payments and remuneration structure of the Mr Darling: Agreement that it should happen and, banks or institutions included as one of the risk increasingly, agreement as to those areas which factors in an assessment of the creditworthiness or ought to be regulated. I know it can be frustratingly value of the product or bank? slow at times but we do actually need to get other Mr Darling: I am not sure that there is a direct read people to come along with us on this. across between the bonus structure and the creditworthiness of an institution. Q70 Ms Keeble: There must be some sort of timetable by which there can be agreement and Q75 Ms Keeble: It is a risk factor. consensus and by which things can happen. We have Mr Darling: I am not sure that is necessarily the case. seen some voluntary codes but that does not actually What I do think is important, and here Lord Turner improve the situation. When the credit rating may well want to contribute, is one of the things that agencies came here it was glaringly obvious that all the FSA is looking at and one of the things I feel very of the issues that were raised about lack of strongly about is that we should avoid a situation competition, conflict of interest, an over- where institutions have a bonus structure that mechanistic approach were completely justified. almost drives people into taking the very risks that Since then we have seen further disasters and, again, have brought about the problems that we have got people saying, “These had a good rating, we relied in the first place. on them, we trusted them and they lost money”. Mr Darling: I think the credit rating agencies were Q76 Ms Keeble: That is one of the reasons why this just one part of the problem. In relation to Europe, was suggested. at the last meeting we had of the European Finance Mr Darling: I thought you were talking about credit Ministers in September we did make substantial rating agencies still. progress and I am optimistic that we can get something agreed, if not by the end of this year then Q77 Ms Keeble: When they are doing their certainly by the beginning of next. That is, getting a assessments of the risk of a product they should take wider agreement which includes the United States, into account the bonus payments and incentives for example. I hope that can be done as quickly as around that. That is one of the issues that have been possible However, if you left America out of it that suggested. would be rather a glaring hole in things given how Mr Darling: I would prefer to deal with that problem important American institutions are. through the individual regulator. Do you want to add to that? Q71 Ms Keeble: What form will the regulation take, Lord Turner of Ecchinswell: First of all, could I just a voluntary code or European legislation? say something on credit rating agencies. It is very Mr Darling: No. What is proposed in Europe is important for us to understand their role in what has legislation. Personally, I would prefer something gone wrong but also the limits to their role. What stronger than voluntary regulation otherwise I can credit rating agencies did over many years was see you would not make it stick. This is something essentially tried to produce ratings which, if they that we are discussing. were successful, were accurate predictors of the likelihood of a single company or single bank bond defaulting. Actually, over the long-term they had Q72 Ms Keeble: Who is going to take the lead on not a bad record, but not a perfect record, of that that, the Treasury? What is the role of the FSA going prediction. What happened over the last five years to be in it? was that first of all they went way beyond that single Mr Darling: Adair will answer in a moment for the company or single bank credit rating and they began FSA. Certainly in terms of international to credit rate all of these complicated things that we negotiations it is the Treasury and we act pretty were talking about earlier, like CDOs. It turned out closely with the FSA. For example, one of the things that these things were much more tricky to work out we will be discussing at the meeting of the G20 what their default characteristics were, or their value leaders and finance ministers in Washington in a was much more tricky, that they were subject to couple of weeks’ time is the need to make far more much more rapid change in ratings than the single urgent progress on a whole number of things that I company or single bank ratings, and there was also hope will reduce the likelihood of this thing a problem that there were some conflicts of interest happening again. in that and there was a process by which people were, as it were, designing these structures to get a Q73 Ms Keeble: I want to come back on a further particular credit rating agency by understanding area later, so I just want a couple of brief answers on what the model was. this. One is, can we take it that the timetable for the Ms Keeble: Can I just interrupt and say one thing. end of this year, the beginning of next year, will see We had the credit rating agencies here and they some real progress on better regulation of the credit explained all of this. rating agencies? Chairman: We have written a report. Processed: 13-03-2009 15:08:24 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG1

Ev 14 Treasury Committee: Evidence

3 November 2008 Rt Hon Mr Alistair Darling MP, Mr Mervyn King and Lord Turner of Ecchinswell

Q78 Ms Keeble: They explained all of this and Chairman: We are coming now. Peter Sutherland, particularly explained how, in fact, they are Chairman of BP. With that, I will ask you questions commissioned by the people who want the product in ten minutes when we resume at 5.47. assessed. Those are the people who actually commission and pay them. The Committee suspended from Lord Turner of Ecchinswell: Absolutely. 5.37pm until 5.47pm for a division in the House.

Q82 Chairman: Chancellor, I was mentioning the Q79 Ms Keeble: That is where the conflict of non-executive directors and I finished on Peter interest was. Sutherland, but in HBOS we have got Sir Ron Lord Turner of Ecchinswell: There was a conflict of Garrick, former chief exec of Weir’s, a distinguished interest. industrialist on 235,000, a director of Shell, and we have got Anthony Hobson on 221,000, chairman of Q80 Ms Keeble: We have had all of that explained. Northern Foods. These are pretty distinguished Lord Turner of Ecchinswell: There was a conflict of people. What happened? Were they scrutinising the interest and there was also a problem of people chief executives or do the chief executives just run relying on them to tell them something about the amok? liquidity or the value rather than the default. One Lord Turner of Ecchinswell: I think I was going to should never have assumed that a credit rating told say that. As you read out that list, there were many you anything about the market value of the people on that list who clearly had what one would instrument, it was only meant to tell you about the treat as the relevant experience, professional probability of default. I think a lot of what will qualifications, ability to read and think about what happen on credit ratings, or what needs to happen, accounts mean. It is not the case that the boards of will be driven by the market rather than by our major banks—it may have been the case 20 years regulation. People will simply not rely in future on ago—were stuVed with a random bit of the non- credit ratings for things that they cannot be relied on relevant great and the good, they have for quite some for. Sometimes regulation is the way to respond to it time had people who would appear to have the and sometimes it is the market response which drives relevant technical skills often. There is an issue, I it forward. think, about simply the total amount of time that non-execs spend on businesses as complicated as banks and insurance companies. Having been a non- Q81 Ms Keeble: Are you saying that you are executive of a bank, I realised that to do it opposed to regulation? professionally you really do have to put a hell of a lot Lord Turner of Ecchinswell: No, I am not saying I am of time into it. In future I think we are going to have opposed to regulation but I think 80% or 90% of to think about how much time eVectively even very what will now happen to make us correctly use credit competent people can give to really go into the ratings is more likely to come because the market detail. The other thing to say is I do go back to the will just realise it used them in an inappropriate point I made earlier: a lot of very, very clever people fashion and a relatively small amount may come in regulators, in central banks, in banks, in the IMF, from the regulation. That does not mean that the did not see this thing coming. regulation is not important, it just means it is important for us to understand where the big impact is. Q83 Chairman: That is why we have got an inquiry, Chairman: Mention has been made of non-executive because of all these clever people that did not do directors and we have had comments from Harold that. Governor, are you going to stick your nose into Walker and Michael Waugh, and Professor Bob individual institutions now on these issues and Garratt has made comments. I am looking at the maybe be a bit sceptical? Financial Times and Paul Myners, your City Mr King: I would not use that phrase. If I could take minister, has made comments when he says: “The up the question you just put about people and typical bank board resembles a retirement home for spotting it, it is a good question but it is exactly the the great and the good: there are retired titans of question that was asked in 1847, 1866, and you could industry, ousted politicians and the occasion go on. member of the voluntary sector. If such a selection— more likely to be found in Debrett’s Peerage than the Q84 Chairman: So we are never going to change City pages—was ever good enough, it is not now.” If anything? Let us pack up and go home. you look at RBS and HBOS it seems as if that backs Mr King: I am rather doubtful if the need for future it up. For example, RBS has got Bob Scott has its inquiries will ever disappear because banking does independent director, formally group chief executive run these risks that every now and then there is a of CGNU, now of Aviva, Colin Buchan, head of crisis. equities at UBS Warburg, Archie Hunter, Scottish Senior Partner at KPMG on the Institute of Chartered Accountants, Steve Robinson, former Q85 Chairman: You are telling me here, in answer to private secretary to the Chancellor, a very a question, Governor, that non-execs, we kind of distinguished Treasury person. hope for them to do their job, they are just going to Jim Cousins: Chairman, as the Committee’s whip— turn up every few months. Processed: 13-03-2009 15:08:24 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG1

Treasury Committee: Evidence Ev 15

3 November 2008 Rt Hon Mr Alistair Darling MP, Mr Mervyn King and Lord Turner of Ecchinswell

Mr King: I am not saying that at all. Chairman: Governor, I think you are way oV the mark there. Q86 Chairman: What are you saying then? Mr King: What I am saying is that the question you Q96 Nick Ainger: Some banks have not had the have asked is one that was asked in the past and the problem. fact that there is a crisis is in itself not evidence that Mr King: They have benefitted from having a better the individuals in charge of those institutions class of non-executive directors. They have to make necessarily failed. their own choice.

Q87 Chairman: But Governor, this is 2008, we have Q97 Mr Breed: Governor, could we have authorised put £500 million into the banks, we have got 5,000 people who, in other words, have to be properly emails from people who are angry about these and authorised by the Bank of England or the FSA you are telling us, “Look, things are going to go on before they are allowed to become a non-executive as they are without any change”. director? Mr King: I do not say they will go on as they are. Mr King: I have no objection to that whatsoever.

Q88 Chairman: If that is not the case phrase your Q98 Chairman: Lord Turner, give us a precise answer appropriately. answer. Mr King: What I am saying to you, Chairman, is— Lord Turner of Ecchinswell: Can I say, I think it is important to make sure that we have appropriate Q89 Chairman: Phrase your answer appropriately. non-execs but in many cases we have. It is Mr King: What I am saying to you, Chairman, is appropriate to make sure that they have adequate that you and nobody else has any guarantee or any time and visibility of the issue and a lot of banks are solution that will lead you to a position— looking far more closely at that in future. But if I had to identify what will decrease the likelihood that our Q90 Chairman: But, Governor, you do not think equivalents are here in 10 years’ time, it will there ever will be. Give us an idea of the way primarily be precisely the things which the Governor forward. has mentioned. It will be a better system of capital Mr King: We have. adequacy, a counter-cyclical system of capital adequacy, more robust and eVective policies on Q91 Chairman: Tell us, other than, “We will see this liquidity. It is those, I think, which are most likely to again in 20 years’ time”. Give us some comfort. decrease the likelihood of overall systemic problems Mr King: Exactly. Ever since I came to this in 10 years’ time, more likely to do it than operating Committee first back last September I have spelt out through the competence of the executives or the non- for you exactly the direction in which you should go executives of specific institutions. and I am glad to say you have listened. Q99 Jim Cousins: Chancellor, a lot of people have Q92 Chairman: Thank you very much. contacted the Chairman to ask what is the Mr King: Firstly we need to get a resolution Government going to do to support the housing framework for dealing with failing banks. Secondly, market for new home owners and for existing home we need a reform of the deposit insurance system, owners in diYculty. and I am delighted to say that your Committee has Mr Darling: There are two elements to it. In relation followed that advice and has endorsed it. to existing home owners in diYculty, as I said earlier I think in reply to Mr Breed in relation to Northern Q93 Chairman: Governor, my question— Rock it is important that all mortgage lenders, banks Mr King: Can I keep going as to what else we need and building societies, stick to the protocol that to do. most of them signed up to and that is to ensure they explore every possible alternative to eventually Q94 Chairman: Go on. repossession. It is also important to look at diVerent Mr King: Thirdly, regulation of liquidity. Then it instruments, for example, perhaps sale and people comes to the international arena and I have already being able to lease the property they are in. There are explained we will need higher capital requirements, many alternatives which fall short of repossessing a we will need counter-cyclical capital requirements house. I think that is very, very important. In and at the international level we will also need relation to help for mortgages generally, you will be liquidity regulation. aware that I asked Sir James Crosby to report to me on that. I will publish his report and I will let you Q95 Chairman: Governor, I understand that and know my response to it at the time of the Pre- that was in our report. How can we get better, more Budget Report. alert non-exec directors? Mr King: That is a matter for the companies Q100 Jim Cousins: People are wanting to know that themselves. If you want to impose that centrally the banks you have nationalised, partly or wholly, from Government essentially you are saying you are doing what you have told them to do. In the case want nationalised companies. Private companies of Northern Rock you have told them to repay you have themselves to choose the right people for the as fast as they can and they are doing it by shutting job. down their mortgage book. Processed: 13-03-2009 15:08:24 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG1

Ev 16 Treasury Committee: Evidence

3 November 2008 Rt Hon Mr Alistair Darling MP, Mr Mervyn King and Lord Turner of Ecchinswell

Mr Darling: That is a condition. stopping them, the question is whether or not they stack up commercially both for the individual as well Q101 Jim Cousins: They are asking you to accept as for the lender. your responsibilities. Mr Darling: In relation to Northern Rock, as you Q106 Jim Cousins: A lot of people contacted our know, the conditions imposed on it were partly as a Chairman are not very comfortable with what he result of the European Union’s state aid rules. Chancellor is saying but they find Robert Peston even more sinister and frightening. Q102 Jim Cousins: But it is your business plan they Mr Darling: I cannot answer for him. are working to. Mr Darling: It is my business plan, yes, but I have to Q107 Jim Cousins: In fact some of them even seem operate within the law. As you well know, the to think that Robert Peston is the Governor of the European Union under its state aid rules precludes, Bank of England. Now, over Northern Rock, over in crude terms, us running a state owned bank the Lloyds/HBOS deal where Robert Peston was aggressively against other privately owned banks. In four hours ahead of the oYcial market information relation to the banks that we are taking and over the recapitalisation of the banks which shareholdings in, I have already earlier in the Robert Peston announced at 9 o’clock, a lot of hearing referred to the agreements that we will enter people are saying, “This is inside information from into in relation to RBS and Lloyds TSB and HBOS the top”. They are saying, “Who is looking into this? which will bear on both lending to small businesses Who is getting to the bottom of it”? That is one for as well as mortgages as well. you, Lord Turner. Lord Turner of Ecchinswell: Certainly we are very Q103 Jim Cousins: A lot of people who have concerned if there are market rumours and contacted the Chairman feel the Government is information coming out ahead of when it should hiding here behind a lot of rules of its own making. come out. If there is any possibility that there is They are saying what about long-term fixed rates? market abuse deriving from that we will certainly Mr Darling: Sorry, which rules? investigate it.

Q104 Jim Cousins: The rules you have just referred Q108 Jim Cousins: Are you? Are you investigating to. it? Mr Darling: The state aid rules. Lord Turner of Ecchinswell: I think the answer is there is no sign that there is market abuse. Let us be Q105 Jim Cousins: Hiding behind the state aid rules. absolutely clear. There is leakage of information A lot of people are saying, “What about long-term that should not have leaked, the net eVect of which is fixed rate deals? What about help for people to get that Robert Peston has eVectively been broadcasting deposits? What about help for people to switch from that before it is correctly broadcast which should be buying to renting or having a combination of renting in an RNS Stock Exchange statement. But we have and buying” They are saying they want this to no reason to believe that something is going on other happen now before they are put out of their homes. than broadcast, it is an imperfect broadcast, it is not Mr Darling: There are absolutely no rules that the perfect form of broadcast to the market prevent most of the things you referred to. The state simultaneously which we achieve by an RNS but as aid rules, whether you like it or not, are part of the long as he is not and nobody else is tipping oV domestic law of this country and we cannot get out somebody to take a position before he does this of that and we do have to stick to them. That is the imperfect broadcast it is not an issue of market reason that Northern Rock is reducing the size of its abuse. It is certainly an issue for each of the loan book at the present time. You will recall a few individual institutions involved as to who is leaking weeks ago the commercial banks were having a real this, and I wish I knew who it was and I think it is problem seeing money being taken out of them and very serious that these leaks are occurring. But put into Northern Rock so it was necessary for unless it is the case that you believe information is Northern Rock to ensure that it was not draining the being passed to people who are taking positions on system of funds because that would have been it before it is broadcast in whatever the form it is grossly unfair and actually very destabilising for the broadcast then you do not have a case of market banking system as a whole. In relation to helping abuse.3 people who are looking for mortgages, I agree with you that availability of mortgage finance whilst Q109 Jim Cousins: I think there will be concern that maybe not the big problem we have got just now will you say you are concerned about leaks but you are become a problem when the housing market starts to not actually investigating what powers you have recover. As I said to you I asked James Crosby to and, secondly, a lot of people who have contacted report on that and I will have something more to say on that when I get to the Pre-Budget Report. In 3 Note by witness: This refers to disclosure by the journalist. relation to other measures, in relation to people who Improper disclosure of inside information (whether to a might convert from owning to renting, those are all journalist or other party) would be a breach—by the discloser—of the market abuse regime, and could also be a measures that we are looking at. We are looking at criminal oVence under insider dealing legislation. This with the banks at the moment to see whether or not would apply whether or not anyone actually dealt on the we cannot oVer people options but there is no rule basis of the disclosed inside information. Processed: 13-03-2009 15:08:24 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG1

Treasury Committee: Evidence Ev 17

3 November 2008 Rt Hon Mr Alistair Darling MP, Mr Mervyn King and Lord Turner of Ecchinswell our Chairman are concerned that we have now a inappropriate and we have the ability if we want to journalist who because of these previous leaks to reflect inappropriate bonuses in a higher level of him is now leading the markets and that everything capital requirement. We will certainly consider using he says now carries a value and it influences real all that and it is also an issue under discussion among events. Are you not troubled by that? the international regulatory discussions, for instance Lord Turner of Ecchinswell: We certainly are within the financial stability forum. troubled by that but we can only investigate something where there has been an oVence under Q113 Mr Fallon: Iceland. Chancellor, did you have regulation and law and the fact that somebody has a meeting with the head of the Icelandic financial ended up with a status where their opinion is seen as authority in September? leading events or making other people take a point Mr Darling: Amongst others, yes. of view on the basis of that is not in and of itself an V o ence. Other markets have had this at particular Q114 Mr Fallon: That was four weeks before their times, particular investment gurus who are perceived banks failed. as having great insights and whose words swing Mr Darling: If I remember rightly, I think it would markets. Though it might be concerning, it is not in V have been 2 or 3 September. There was a minister for itself any category of o ence against market rules. business who had some responsibility for business We will clearly keep an eye on it, and this is banking and he brought with him the equivalent of something which we have considered whether there the head of the Icelandic FSA, someone from the are any cases to pursue and certainly I will take what Icelandic Central Bank and a couple of other civil you have said and look at it further. I think we have servants. to stick to what is an oVence under market rules. We are not in ourselves a police person of leaks in general, that is not part of our function. Q115 Mr Fallon: So you knew four weeks before the banks failed that there were some serious problems there? Q110 Chairman: Just to sum up, are you active on Mr Darling: It had been a matter of speculation in this case or are you passive, in other words you wait the newspapers for several months that there had for people to come to you? been concerns about Iceland and, by extension, Lord Turner of Ecchinswell: We would certainly there had been a lot of comment about the banks. pursue it if we believed that there were any market Perhaps it would be helpful if I told you the reason abuse implications from it. for the meeting. The authorities, the FSA principally, had been keen to ensure that the Q111 Chairman: You are passive? Icelandic authorities made sure that the subsidiary, Lord Turner of Ecchinswell: We are not passive in the the branch of Landsbanki, was made into a sense that we are continually monitoring abnormal subsidiary so that we could regulate it in this country movements in prices. That is part of the normal and the minister and his colleagues at that time process of looking for market abuse which we do wanted to assure us that they were on the case and through all the classic algorithmic search engines they were looking after matters. which are used to look for the way that markets are moving in odd fashions and which result in market Q116 Mr Fallon: We will come on to Landsbanki. abuse cases. Why did you tell BBC Radio on 8 October: “The Chairman: Right. We are going to spend 15 minutes Icelandic government, believe it or not, have told me on the Icelandic and Guernsey/Isle of Man. Sally, yesterday they have no intention of honouring their you have a question and a very quick answer. obligations here”? Mr Darling: Because on the previous day I had Q112 Ms Keeble: I want to ask about the bonus spoken to the Icelandic Finance Minister and I payments because an awful lot of people have specifically put to him that the legislation that they complained about that in a large number of the had passed over the weekend in Iceland had the emails. Apart from the outrage at the scale of it, the eVect of looking after Icelandic depositors but bonus payments have also been very dysfunctional cutting oV non-Icelandic depositors, including those in creating some of the problems. Have you got any in the United Kingdom. When I said to him, “Is that proposals to regulate them and to try to limit the what you are doing?”, he said that it was and I said, bonus payments and the bonus cultures in the City? “Is that not in breach of the agreement of the Lord Turner of Ecchinswell: We have a responsibility European Economic Area?” and he said he did not to look at not necessarily the level of bonuses but the think so. I have to say to you, Mr Fallon, even if I structure of how bonuses are paid, what they are was wrong on that, which I was not, five weeks later paid for and in what they are paid and how it may they are still not treating non-Icelandic depositors aVect risk taking, that is our responsibility. and creditors in the same way as they are Icelandic Certainly we are looking at, and we have sent a letter ones. That is why I had to step in and guarantee the to the chief executives of all of the banks asking them retail deposits of those people who put money into for information about the way that the structure the Landsbanki branch. As you know, I also took their bonus payments. We will be incorporating action in relation to Kaupthing and Heritable where analysis of that within our normal supervisory we did something diVerent, we transferred them to processes. We have the ability if we want to just tell ING. The reason we did this was because with the people that we consider their bonus structures Icelandic government, for reasons that people might Processed: 13-03-2009 15:08:24 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG1

Ev 18 Treasury Committee: Evidence

3 November 2008 Rt Hon Mr Alistair Darling MP, Mr Mervyn King and Lord Turner of Ecchinswell understand because clearly the country is in very Mr Darling: Yes, because it was part of Bradford & diYcult economic circumstances, I could not have a Bingley, whereas the Icelandic subsidiary of the situation where they simply cut oV British depositors Icelandic branch was a subsidiary of an Icelandic or depositors here in Britain. company, not a British company.

Q117 Mr Fallon: But the result was a run on the Q120 Mr Fallon: I just want to be clear. You are Kaupthing Singer and Friedlander UK bank which washing your hands of the interests of British was not previously in trouble which then in turn depositors— caused the collapse of KSF Isle of Man. Mr Darling: No, I am not. Mr Darling: That is not right. Adair Turner will talk about this. In the week prior to the FSA determining that Kaupthing could no longer meet its threshold Q121 Mr Fallon: --- who happen to be working for conditions, and remember it is the FSA that decides a charity abroad but happened to have all their whether or not an institution can take deposits or savings in an Isle of Man bank. You are saying you not, there had been concern that there was not are not responsible. suYcient money in Kaupthing, that is one of the Mr Darling: My obligation as the Chancellor of the Icelandic banks, and the authorities understood that Exchequer is to people who put their money into this the money would be transferred back to Britain, but particular UK branch. I say, Mr Fallon, that legally, that never happened. I have seen reports suggesting strictly, what we have said to people is, “You have that somehow the problems that aVected Kaupthing got to look for your first 16,000 or so to the Icelandic were all the fault of the authorities here, but that was authorities” because that is what the EEA agreement not the case. I am afraid you have to look behind is, and they are disputing that at the moment, as I this. Iceland, as well documented now, has been understand, and we would have stood in the place having problems for some time. They decided—not between 16,000 and 50,000 under the British us—to introduce legislation at the beginning of Financial Services Compensation Scheme. I have October to eVectively be able to take over their gone further than that. I have said I will look after banks, and I think that was what set in place the the interests of all retail depositors in a branch in chain of events. Remember, it was not in the British London that I think we are responsible for. If you go Government’s interest to provoke any of this to the next stage and say, “Look, you should take because the net eVect of this is we have had to over responsibility for something that is done in the guarantee the Landsbanki depositors, we have had Isle of Man or Guernsey or, indeed, by extension, to transfer the depositors who were in Kaupthing other countries”, that is quite a significant step to and in Heritable, which is another subsidiary, to take. There is a particular Derbyshire point, if you ING, but we have had to make good in the meantime like, and perhaps Lord Turner will deal with that. the Financial Services Compensation Scheme. We have had to expose the British taxpayer to help Q122 Mr Fallon: Just before he does, the Treasury people in this country and I can assure you that I spokesman said on Guernsey, for example: “The would not have done that if there had been any other UK Government will represent the Crown way of doing it. Dependencies in its negotiations with Iceland”. Why are you washing your hands of British depositors in Q118 Mr Fallon: Are you aware that many of the an Isle of Man bank? British depositors in the Kaupthing Isle of Man Mr Darling: Because as part of the agreement we bank were originally depositors, in fact, with the have with Guernsey and the Isle of Man and places Derbyshire Building Society, who are people we negotiate, we are the sovereign state. Mr Fallon, working for British companies and British charities Isle of Man and Guernsey operate a specific regime abroad who are not allowed to have accounts in UK and for tax reasons and others people choose to go banks because they are not resident? Are you not in there, they are regulated by the Isle of Man responsible for their interests too? authorities. I would have to think long and hard Mr Darling: Well, there are two issues here. There is before saying that for the first time the British the specific Derbyshire issue, which I will ask Lord Government would then go and underwrite savings Turner to deal with. In relation to people who put made in another jurisdiction. It is not something that deposits into a jurisdiction which we are not we would lightly do. That said, one of the things that responsible for, which includes the Isle of Man, then we have been pressing on Iceland right from the very I do not think so. The British Government’s start is they really have to go and get help from the obligation must be to depositors who have put their IMF. One of the things that I have said to them is as deposits into UK banks. For this purpose, the Isle of far as we are concerned, we would be happy to enter Man is independent of us; it has got is own regulator. into an agreement with them where we will eVectively loan them the money that we are paying out just now, but you would expect, and you would Q119 Mr Fallon: Just before Lord Turner comes in, be the first to criticise if we did not do this, that we you did include the deposits of the Bradford & must have an agreement with Iceland whereby they Bingley Isle of Man branches in the deal on 29 will pay this money back to us over a period. The September with Abbey Santander, so you rescued Netherlands are willing to do that, we are willing to one lot and washed your hands of the other. do that, but it does have to be part of an agreement Processed: 13-03-2009 15:08:24 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG1

Treasury Committee: Evidence Ev 19

3 November 2008 Rt Hon Mr Alistair Darling MP, Mr Mervyn King and Lord Turner of Ecchinswell with the IMF because Iceland really does need to Q127 Mr Todd: The brand name may well have led have an accommodation with the IMF such is the them to think that the association was with a nature of its problems at the moment. building society and covered by the protective envelope of building society law. Mr Darling: Can I say just a couple of things here. Q123 Chairman: Okay. Those questions were from This is a case where, again, we need to look carefully Julian Williams, Dave Hawton, Klaus Eriksen, at what we need to do. We have said time and time Simon Lam, and many others came. again that people ought to be aware of what it is they Mr Darling: Could we deal with the Derbyshire are investing in, and obviously some of these banks point? that are not registered in this country use names that Chairman: Yes, given it is in Mark’s constituency. perhaps do not immediately alert you to the fact they may not just be yet another British bank. Certainly in relation to the Derbyshire experience, that is Q124 Mr Todd: As a Derbyshire account holder, but clearly something the FSA will want to look at. Most not with this particular product, obviously I have people who put their money into a building society had people contact me about this as well so I would tend not to study all the form and everything else. welcome an explanation of how people who invested The second thing that concerns me is we have a in a Derbyshire oVshore product ended up situation here where, because Iceland is a member of unwittingly, as far as one can tell, as account holders the European Economic Area, the bank was with an Icelandic bank because they were not given passported into our system. It is not a satisfactory an opportunity to say, “Thank you, I’m not going to situation where you have got a branch here which do that”. actually had more deposits than it had back in Lord Turner of Ecchinswell: We have to be clear that Iceland and we were not regulating it. That is not a the Derbyshire chose to sell its business of satisfactory situation. Derbyshire oVshore Isle of Man to Kaupthing and Chairman: We raised that point in June, Chancellor. then ended up in Kaupthing Isle of Man which, it is We are going to come back to this issue. important to realise, was not a subsidiary of Kaupthing Singer & Friedlander, it was a direct Q128 Mr Brady: Time is very short, so one question subsidiary of Kaupthing Iceland. I am sure what the but it may need a response both from Lord Turner Derbyshire would say is, at least in theory, that did and the Chancellor. First of all, I would like to know not disadvantage those people because they were what role the FSA had in advising the Isle of Man being transferred from one Isle of Man registered Financial Supervision Commission to require the bank to another. Clearly, however, they ended up in transfer of £550 million to the UK prior to the a slightly diVerent situation than they were before, freezing of assets in the UK. The other part of that but in legal terms they did not, they would still question is does this not mean as that transfer took have been— place that really there is an obligation on the United Kingdom Government to return that £550 million to the administrators in the Isle of Man so that they can Q125 Mr Todd: The depositors were given no fulfil their obligations to the depositors there? opportunity to move their savings. Lord Turner of Ecchinswell: It is not the case that we Lord Turner of Ecchinswell: They would have had it required them to transfer— at the end of the term of the deposits. Let us remember that the transfer was done on 21 Q129 Mr Brady: I did not say that you required. November 2007, so those who had deposits which Lord Turner of Ecchinswell: Okay, I thought you were maturing over the last year could certainly have did. chosen at the end of that deposit maturity to move their money elsewhere. I would imagine that would Q130 Mr Brady: What contact did the FSA have actually be a very significant proportion of them. I with the FSC in the Isle of Man? accept entirely that they may not have understood Lord Turner of Ecchinswell: Let us be clear, the Isle the implications of what was going on. They should of Man Kaupthing chose to place a deposit with have because I have in front of me here the letter and Kaupthing Singer & Friedlander UK. When we the letter in no way implies that Kaupthing Isle of decided Kaupthing Singer & Friedlander UK, for Man is a UK bank, it in no way implies that it has reasons which we could talk about separately, which a relationship with Kaupthing Singer & Friedlander was regulated by us, did not meet the threshold and it does not in any way imply that it is regulated conditions, that deposit with Kaupthing Singer & by the FSA, which it is not, but I think we can accept Friedlander became a general creditor like other that it is a sorry situation. general creditors and it will get paid out according to the dissolution of Kaupthing Singer & Friedlander. The only relationship we have had with the Isle of Q126 Mr Todd: It certainly is because they invested Man authorities in this is that we have explained to essentially through a British building society and them our general processes of how we regulate may have imagined, wrongly, that they would be banks, including how we would regulate, for protected by building society law. instance, Kaupthing Singer & Friedlander, but we Lord Turner of Ecchinswell: They invested in an did not give them specific assurances to say, “This is oVshore wing, that is the complication. a necessarily safe bank”, because that would not be Processed: 13-03-2009 15:08:24 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG1

Ev 20 Treasury Committee: Evidence

3 November 2008 Rt Hon Mr Alistair Darling MP, Mr Mervyn King and Lord Turner of Ecchinswell a reasonable thing for us to do. It is not for us to end people not being clear as to what the diVerent rights up saying to somebody, “We can give you an and responsibilities are. We come to the situation absolute assurance on this”. We can describe our where you have sitting there all sorts of tax general processes of prudential regulation, but at the advantages accruing from being in the Isle of Man end of the day it is for, in this case, the managers, the and when things go wrong, people then say, “What executive and directors of Kaupthing Isle of Man to about the British compensation scheme?” It is make a decision about where they want to place that important that we take this opportunity, not rushing money and in particular whether they want to put it into it, not a knee-jerk reaction, to have a look at it in a very concentrated fashion, because I think that and, indeed, that is something your own Committee was a feature, that this was a relatively large deposit might want to look at as well. relative to the size of Kaupthing Isle of Man. Chairman: Chancellor, we visited the Isle of Man and Jersey and we are going to be reporting on that. Q131 Mr Brady: Chancellor, do you accept the On that graphic note, I think we will bring it to a halt. Chancellor, a few weeks ago the Committee responsibility on the British Government to return visited Japan to look at their crisis and to see what that £550 million to the Isle of Man savers? lessons were to be learned. One major lesson was Mr Darling: It does not belong to the British that public support is important but it may be Government. diYcult to gain because of the perception that we are just bailing out banks. Secondly, that conditionality Q132 Mr Brady: Clearly, that is my point. applied to public intervention is important in that it Mr Darling: The deposits of Kaupthing were helps to secure mainly public support. That was why transferred to ING and the rest of Kaupthing’s you were here today, to explain that situation. We assets here will belong to the creditors. That has to are very grateful for the explanations you have be dealt with through due process. I would just add given, but we are at the start of this inquiry and we another thing. I think, having looked at what has are going on to international regulation and other happened over the last few months, we really do aspects and we hope near the end to have you back need to have a long hard look at the relationship again because it has been a very worthwhile exercise. between this country and the Isle of Man, a tax We are grateful to all of you for taking time out of haven sitting in the Irish Sea leading to perhaps your very busy schedules. Thank you very much. Processed: 13-03-2009 15:08:41 Page Layout: COENEW [SO] PPSysB Job: 416782 Unit: PAG2

Treasury Committee: Evidence Ev 21

Tuesday 11 November 2008

Members present

John McFall, in the Chair

Mr Graham Brady Mr Andrew Love Jim Cousins John Thurso Mr Michael Fallon Sir Peter Viggers

Witnesses: Mr Paul Chisnall, Executive Director of Financial Policy & Operations, British Bankers’ Association (BBA); Mr Russell Picot, Member, BBA Financial Reporting Advisory Panel; Mr Stephen Haddrill, Director General, Association of British Insurers; Ms Liz Murrall, Director, Investment Management Association; and Mr Charles Cronin, Head, Chartered Financial Analyst Institute Centre, gave evidence.

Q133 Chairman: Good morning and welcome to the Q135 Chairman: Did any of you have any quick Committee’s inquiry into accountancy and the pithy comments on that before I move on to the next banking crisis. Could you introduce yourselves question? please and your organisations. Mr Haddrill: Just to confirm the point that investors Mr Cronin: Charles Cronin, CFA Institute. do wish to see a fair value approach where Ms Murrall: Liz Murrall, Investment Management judgments are made on the market valuation, Association. providing of course that there is a deep and liquid Mr Chisnall: Paul Chisnall, British Bankers’ market there to value it from. Association. Ms Murrall: Yes, I think there are arguments about Mr Picot: Russell Picot, member of the BBA’s the sort of full fair value model and the mixed- Financial Reporting Advisory Panel. attribute model which we currently have. I think the Mr Haddrill: Stephen Haddrill, Association of debate needs to be had, but I think any discussion British Insurers. about this needs to follow due process, and I think we have concerns about some of the moves that have happened recently that are taking it outside that. Q134 Chairman: Can I start then, Charles Cronin. Although some investors like the full value model, I The BBA have sent a letter to Sir David Tweedie, think I would highlight that there are issues with it. saying that they “believe a mixed-measurement For instance, you fair-value your own liabilities model is essential to providing meaningful financial meaning that you fair-value your own debt such reporting”, but, when I value my house, there are that, if your credit rating goes down, so does the four measures I can take: the price I paid; the market value of your debt and you get a credit to the P&L. price it is worth now, if I were forced to sell it; the That seems counter-intuitive to me and I think these price at which I would be happy to sell it at some things need to be addressed and debated. time in the future; and what I think the house is Mr Chisnall: Chairman, I would say that I do not worth in terms of fundamentals, what I have added think the banking industry would agree that the cost on and just how good it is in terms of the number of model is backward-looking. I think it is forward- bedrooms, the condition of it, the postcode, looking and the point is that, unlike fair value, what whatever. Could the same not be said for other it is not doing is looking for a need to place a spot assets, including financial instruments? What is the price, a today price, on instruments that are being most appropriate measurement for financial held over the longer term. I think it is important to instruments? understand that the IASB has just undertaken a very Mr Cronin: Chairman, we are a strong believer in thorough consultation process on fair value. It fair value and I think you would much prefer to see received something like 160 comment letters and or appreciate the value of your house at what it could over half of those comment letters expressed be sold for today rather than at what you perceive it opposition to a move to full fair value, to extending could be sold at tomorrow or at the price it was the scope of fair value. Within those organisations several years ago. One of the disadvantages of that expressed opposition, there was clearly the amortised historical cost accounting is that it is banking industry, there were also the banking backward-looking, it is subject to judgment from supervisors, there were central banks, there were management, whereas, by using fair value audit firms, there were national standard-setters and accounting, you are using market opinion of what there were some user groups and, therefore, I think the market is saying. There are issues about it is important to understand that it is not just the measurement, and we can discuss those later, and banking industry that is saying that extending the there are also issues about asymmetries in the use of scope of fair value would be an inappropriate thing the mixed-attribute model for historical cost and fair to do. value accounting, but, in the main, we would like to Mr Picot: In a way, Chairman, just to add to that, I see broader use of fair value accounting; we think think it is important that the accounting system that investors would prefer that, we know investors properly measures the underlying economics and would prefer that. cashflows and, if you have a trading activity, then Processed: 13-03-2009 15:08:41 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG2

Ev 22 Treasury Committee: Evidence

11 November 2008 Mr Paul Chisnall, Mr Russell Picot, Mr Stephen Haddrill, Ms Liz Murrall and Mr Charles Cronin the use of a market value approach is appropriate, Q138 Chairman: Stephen, the reality in August is not but, where you have got assets and liabilities held for the reality in September is not the reality in October the long term, then it is not actually appropriate to is not the reality this month and is certainly not the then force short-term fluctuations in values through reality at Christmas. Is that the situation? If financial the balance sheets and profit and loss accounts of statements are just reflecting reality, why have they companies. become the scapegoats in this debate? Mr Haddrill: I think that is a strong point, that, to Q136 Chairman: On that point, over the course of some extent, they have become the scapegoats. I the last year several banks have published results think that they are attempting to provide the best and interim statements which show very dramatic possible estimate that you can provide at any one write-downs in the value of their assets. To what time, and I would agree with Charles’ analysis that extent do these reflect reality? he has just set out. I think they are becoming a Mr Picot: What they do represent is a fair value basis scapegoat, to some extent, because people are not of accounting. Where you have got active markets, drawing a distinction between accounting, which is there is going to be a willing buyer/willing seller trying to give the markets the best possible view, and approach, but what we have seen is very illiquid regulation, which then, if it just responds to that markets with very thin transactions and, in some view in a mechanistic way and does not take account cases, complete illiquidity, so what has been of the fact that markets will turn back and so on, happening is that some of the banks have been leads to institutions having to do things which are eVectively forced into ever-decreasing values based damaging and pro-cyclical, and I think we need to on very thin transactions or, in some cases, no distinguish between the story we get out of transactions and then they have used models using accounting, we have to learn from that and take a the credit spreads, and obviously credit spreads have view on that, and then make sure that we do not have expanded very significantly over the last year and pro-cyclical regulation just automatically picking it that has driven down asset prices and that has, in up. turn, to some extent, contributed to the downward pressure where there have been more sellers than Q139 Chairman: Liz, fair value, is that applied to too buyers. many assets or to too few assets? Ms Murrall: I think there are mixed views on the Q137 Chairman: Charles Cronin, is it fair to say that current mixed-attribute model that we have and, as perhaps it does not represent reality that we have I have said, I think the debate needs to be had as to seen the banks coming out of their write-downs, whether or not it should be extended. I think overall drip, drip, and then we open our papers the next we feel that the current regime is just about right, month and the same banks have written down again but, that said, the current standard is quite complex and we do not really know where we are? and there are particular anomalies in it. For Mr Cronin: Chairman, I think the important thing to instance, you have got instruments classified as fair look at and to stand back from is that the underlying value through the profit and loss account that are held for trading and yet available for sale is assets, the assets within the assets in these complex V structured products, a lot of them are suVering. They e ectively your bucket because it is a default are not honouring their obligations, they are not position and they are not the trading assets, so all paying the interest rate and there are write-downs in these things need to be looked at, but I think it is the progress. Everybody knows that these are sub-prime best position we have got at present and I do not assets which have been restructured into a form think we could fault recording instruments for where you have senior-rated assets, medium-rated trading at fair value. and equity assets, but the underlying assets are suVering. Now, you have a situation where you Q140 Chairman: Before I move on to the next have, if I could describe it as, a head of water filling question, would you like to address any of those buckets of assets, which is cashflow water, and the points, Paul? bottom buckets have gone, they have been blown Mr Chisnall: Only that I do not think that the BBA away, and that means that the risk profile of the have said that we would view accounting as a remaining assets has now greatly increased and, determining factor. What we do believe is that there hence, the market is saying that these assets have are elements of the standards that do need review. become more risky and, hence, they are worth less. We support the role that the IASB has been given by Also, the current values are reflecting what the Financial Stability Forum and G7/G8 leaders to happened six months ago and the market is looking look at its existing standards, to look at whether at what is happening in the future, and I think we there are elements that actually do merit review. I would all agree around the table here that the think that the IASB has made a positive start to that. economy is going through some troubled period in It has issued guidance on fair value in illiquid the future and the market is reflecting that there is markets, and I think that the guidance that it trouble in the value of the underlying assets, hence, produced on 31 October is extremely clear, it has the superiority of the fair value model compared to produced amendments to IAS39 to permit the historical approach, which is saying, “Well, these reclassification in appropriate circumstances at fair are the write-downs I’ve got, therefore, these value and on a disclosed basis, and it has also cashflows I know about and this is how I value this announced the establishment of a global advisory product”, and I believe that is wrong. panel to look at other issues identified where existing Processed: 13-03-2009 15:08:41 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG2

Treasury Committee: Evidence Ev 23

11 November 2008 Mr Paul Chisnall, Mr Russell Picot, Mr Stephen Haddrill, Ms Liz Murrall and Mr Charles Cronin standards perhaps do not help current needs will also meet most of the needs of other users circumstances. I think there is a point there that, as that financial statements can satisfy”, which is less an industry, we do believe that it is important that than a ringing endorsement. Is that how you see this the IASB looks at these issues and that we do not potential conflict? have regional groups, including Europe, actually Mr Haddrill: Well, as Liz Murrall has said, I think going away and coming up with their own rules. the financial statements are prepared to inform the shareholders, to inform the investors, and that is Q141 Sir Peter Viggers: Looking at the absolutely right. I think we cannot ignore in this responsibility of those who prepare financial world that other people have a legitimate interest in accounts and those to whom they are responsible, in the issue and I think the IASB must consult the other words, the intended audience of the accounts, preparers, the business community, the creditors Liz Murrall, your submission argued that the and so on when they form their view, but I think the primary audience for accounts should be the primary view has got to be that of the people who shareholder. put up the capital. Ms Murrall: Yes. Q146 Sir Peter Viggers: I think you have all in your Q142 Sir Peter Viggers: Of course it is the diVerent ways expressed concern in your shareholder to whom the auditor is responsible submissions to us of the threats to fair value coming through the directors. either from across the Atlantic or indeed from Ms Murrall: Exactly. Europe. Would you just like to articulate those thoughts? Q143 Sir Peter Viggers: But is there a possible Mr Picot: I think it is very important to recognise conflict of interest between the shareholders, who that markets are very interconnected and that the might wish to see their accounts projected in one banking system at large is best served by a single manner, and other stakeholders, who might wish to language of accounting, and I think that language have other information made available to them? should be the language of the International Ms Murrall: Well, the shareholders, they put up the Accounting Standards Board. I think, as you go capital in the company and they are the bearers of around the world, increasingly we have seen most of the residual risk, so, when everything goes pear- the major economies announce, or indeed move to, shaped, they actually have to pick up the tab. We the use of IFRSs, so countries like China, India, believe that the other stakeholders that may have an Korea, Brazil has announced, Canada, and recently interest in the accounts, such as suppliers, the United States has announced an intention to customers, employees, et cetera, they are protected allow their major corporations to use IFRSs, so I by contractual and other rights that are not shared think it is very important that in Europe we by the shareholders and, thus, by focusing the recognise that a single language of accounting is a accounts on the ordinary shareholders, we believe, very good thing. For multinational businesses, it the interests of others will be addressed as well. obviously means that they have a lower cost of compliance, which is helpful. It also means for Q144 Sir Peter Viggers: Mr Picot, you have been investors that they can look at a set of accounts in gamekeeper-turned-poacher, do you perceive one country and compare it and know that they are problems in account of these and do you think there looking at a like-for-like comparison with another. I is something that needs to be clarified further? think there is concern that there are those in Europe Mr Picot: Where we are at the moment, I think it is who would amend or add words to the international clear that the purpose of accounts is primarily for the accounting standards for adoption in Europe. We shareholders and clearly there are a number of other would be very concerned by that both in terms of the stakeholders, depositors and regulators, indeed the particular instance where they might choose to carve public sector and government and indeed bank out or amend, but also I think it is important that counterparties. My personal view is that I think the Europe needs to understand that, over the next three general quality of financial statements, particularly or four years, there will be a very significant in the banking industry, has improved and I think it influence exerted by countries like China and the has improved quite considerably in terms of United States on the international accounting disclosure, particularly over the last 12 months. That standards world, and Europe needs to understand has put information out into the public domain that and to properly and fully endorse IFRSs, which, I think, has been very helpful right across the otherwise, I think there is a real risk that a European stakeholder community, so I do not see at the voice will start to get severely weakened and that moment particular conflicts which need to be would damage the interests of British and European addressed. companies significantly. Ms Murrall: Fair value is sometimes blamed for this Q145 Sir Peter Viggers: Then to Stephen Haddrill: crisis. We do not believe it is to blame at all. It was your submission drew a distinction between the basically the practice of the financial institutions in purpose of financial statements in the UK law and excessive leverage, risk controls and incentive the focus of the International Accounting Standards structures that encouraged people to take risks. We Board, and I see that the IASB said, “As investors do not believe that changing fair value, suspending are the providers of risk capital to the entity, the it or modifying it in the current crisis would actually provision of financial statements that meet their facilitate to help the situation, and in actual fact we Processed: 13-03-2009 15:08:41 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG2

Ev 24 Treasury Committee: Evidence

11 November 2008 Mr Paul Chisnall, Mr Russell Picot, Mr Stephen Haddrill, Ms Liz Murrall and Mr Charles Cronin think it would exacerbate it because fair value basis, the consequences for reported numbers would provides transparency. It is only when we get the full be very, very severe. What it would make you do is, extent of these losses out into the market can if you had a loan, say, at a historical rate of interest confidence in the markets be restored, trading of 5%, we have seen credit spreads, as priced by the resume and the markets recover. Basically, market, go out by anything up to 500 or 600 basis accounting serves to count the beans and to present points, and what a fair value basis would then them to the markets, and in the current turmoil it is require you to do is to re-measure that loan against vital that the markets have confidence in the a current market rate of 10% and, therefore, you numbers reported. would take a very significant loss in your profit and loss account. If actually what your intention and Q147 Sir Peter Viggers: I maintain that the nearest ability to do is to hold that loan and earn interest parallel to the present situation is the Lloyd’s of over time, that forced downward hit to your P&L London situation in the early 1990s when there was account, I think, would be very misleading. I also do a cycle of reinsurance. That more needs to be done, not believe, and would not support, the comments and the accounting profession can play its part, in which say that amortised cost is just a rear-view identifying and isolating the doubtful, less firm, less mirror method of accounting. If you make a loan of, robust assets, and that this needs to be done to give say, £50,000 to an individual and you charge them confidence to the rest of the market, you would 5%, that £50,000, recorded at cost, absolutely agree? represents the amount of cash that you have Ms Murrall: Yes. expended and what you stand to lose. It also is the basis on which you charge interest, so I think it has a great deal of relevance where you are actually Q148 John Thurso: Can I ask each of you this holding those loans for the long term and it is very question for a reasonably quick answer, if I may: important for the financial system that there is a why is fair value a better method of accounting for mechanism by which long-term assets can be held on financial instruments than amortised cost? an amortised cost basis and not subject to the Mr Haddrill: Simply because it is the best reflection vagaries of the current market because we all know you can get of the value at the time rather than the markets can overshoot, particularly in times of value at the point at which the asset was acquired. crisis. Mr Picot: It is if you are trading, but it is not if your intention is to hold them long-term. Ms Murrall: Historic cost is an arbitrary point in Q150 John Thurso: Part of the problem, it seems to time. If you record assets at historic cost, accounts me, is the particular example you gave of a will not be comparable. straightforward loan where there are two parties, a Mr Cronin: An historical cost is a rear-view mirror borrower and a lender, there is an obvious interest exercise. It is also subject to the management rate and there is a very easy-to-spot principle, and judgment of when you put a write-down in or not, historical cost accounting is probably fairly whereas fair value gives you an instant appraisal of appropriate. The problem comes with very complex what is going on from the collection of the market instruments where actually nobody is quite sure who and an unbiased market. the counterparties are, nobody is entirely certain what the asset is composed of and there is Q149 John Thurso: So it would be fair to say that you considerable doubt as to whether it is going to go are all pretty much in favour of the fair value on earning. concept, but there are perhaps some areas of it that Mr Picot: I think the problem is when you have got need to be improved. On that basis, perhaps I can trading assets, and there is no doubt that some of the assets that are out there are indeed very complex and ask Mr Picot, there are concerns that the interaction Y of fair value with the regulatory capital requirements they are very di cult to value, and they are valued can lead to a vicious cycle where fair value write- on models and, when you get illiquidity, banks are downs require the banks to set aside more capital, having to value some of those products based on thus raising further doubts about the institution. their own judgments because there are not active How concerned are you about this aspect, this pro- markets. It is not like trying to value a portfolio of cyclicality? UK shares or government gilts, for example, where Mr Picot: I think it is an issue. Europe has recently there is a regular, two-way flow and it is very clear moved to a Basel 2 method of measuring capital for what the prevailing market price is, and some would banks, and that is pro-cyclical in that, as the credit say to you that the term ‘fair value’ is quite quality of loans decreases, so the amount of risk- beguilingly misleading here because it is an exit value weighted assets and, therefore, capital increases. approach if there are active markets and, at its most What has not been yet revisited is the definition of extreme, it is a model which may be mainly based on ‘capital’, so you are absolutely right that, as a bank unobservable factors. writes down its trading assets, so its profits will diminish and, therefore, the amount of capital it Q151 John Thurso: Ms Murrall, you make a point generates will diminish and, if that is at the same about the accounts being principally for the time, as it is at the moment, as its risk- weighted shareholders, with which I concur. Is there a conflict assets are rising because of credit quality falling, you between what the FSA is looking to find out about do get that reinforcing, that pro-cyclical eVect. I an institution and what the shareholders want to see have to say, if we were on a full fair value accounting in the accounts in this regard: that the FSA is Processed: 13-03-2009 15:08:41 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG2

Treasury Committee: Evidence Ev 25

11 November 2008 Mr Paul Chisnall, Mr Russell Picot, Mr Stephen Haddrill, Ms Liz Murrall and Mr Charles Cronin actually looking at the underlying capital and the address and actually consider and advise its capital requirements, whereas the shareholder is members on, or is it going to be left to the individual looking for a reasonable value of the business and its members to think about it themselves? ongoing profitability? Should the FSA not actually Mr Chisnall: Well, I think members are looking at be using the accounts, but, rather, using the this themselves and I think that is entirely information they can access within the institutions? appropriate and, as I have said, we have set up an Ms Murrall: What the accounts do is they are there industry working group which will look at some of to count the beans and present the information to the governance around remuneration structures. the market and, once that happens, then the When that group meets and when it looks through information can be used in a variety of ways and some of these issues, I am sure that there will be what, I think, is very important happens because this guidance that will be given which, I think, we will is all part of the pro-cyclicality which has arisen, so need to share publicly. institutions have to write assets down when they are marking them to market in the current climate and this puts pressure on their capital, they then have to Q155 Chairman: Mr Cronin, a little while ago I was sell assets to raise that capital and, hence, you get talking to a major fund, talking about this issue of this downward spiral. This can be addressed quite risk and incentives, and they made the point to me simply by decoupling the financial reporting that incentives should be structured on, say, a seven- requirements of listed institutions to the market and to ten-year company horizon and they should be the prudential requirements or capital requirements subject to clawback. Is there any attraction in that of financial institutions as required by the regulator. proposal? I think the Bank of Spain was cited in the Bank of Mr Cronin: Yes, I think the situation that has England’s Financial Stability Review of October perhaps caused us a lot of trouble is that people, in quite favourably because it eVectively established the creation of these structured products, have regulatory buVers in the upturn. Otherwise, what earned fees and banked them, and obviously you are happens is that, by requiring institutions to be dealing with assets with many, many years to capitalised now, they will be over-capitalised once maturity. There is an aspect here which I would just we have an upturn. like to develop on the prudence standards, which I touched on earlier, about the asymmetry of using fair value versus historical cost in the liabilities and Q152 John Thurso: So you would be in favour of assets of a bank’s balance sheet.1 In our evidence, we counter-cyclical regulation in all of this? included an IMF report which studies the European Ms Murrall: Yes, I would. Bank balance sheets and shows that there is this asymmetry which, in good times, promotes earning Q153 John Thurso: It has been suggested to us in a and, in bad times, is obviously more pro-cyclical number of the submissions we have had that one of which is part of the argument that is being thrown the problems with fair value is that in the good times out against fair value accounting, so I think that one it possibly overstates the asset values, that people thing that the regulatory regime ought to look at is, who are working in the institutions, trading in them, where these asymmetries do occur, that there is some can over a couple of good years make themselves sort of readjustment, recalibration of what capital is extremely wealthy and then leg it before they have to required, if that asymmetry does exist, so that there bear the consequences of what they have done; a isabuVer developed, but I entirely agree with you view which, I have to say, is shared by a great many and I think there ought to be a more measured way members of the public at the moment. How true is of delivering remuneration that matches the risk and that and to what extent should we be concerned the duration of the asset as opposed to just bagging about it? the fees and running. Mr Chisnall: I think it is very clear that remuneration should be linked to risk and the period of that risk and the profile of that risk, and I would Q156 Jim Cousins: Mr Picot, if you water down the think that there are issues that need to be looked at fair value rules, what will be the market by the industry, and certainly, as an organisation, consequences of that? the BBA has established a working party to look at Mr Picot: I am not sure I understand what you mean issues of remuneration, and I think that part of that by ‘water down’. Do you mean to change the current should be whether the remuneration involved in system or to not go— business is actually tied into the period of risk that that business involves, so I would agree with that. Q157 Jim Cousins: Your answers already this morning clearly point to watering down the fair Q154 John Thurso: I think that you would accept value rules, and you have set out your stall very now that one of the things that has happened as a clearly on that, but what do you think the market result of the troubled times we are in is that the consequences of watering down fair value will be? public have become extremely aware of the way in which certain people within the banking sector are 1 Note by witness: The asymmetry of fair value and historical cost accounting inflated profits in good times and hence the remunerated and the seemingly extraordinarily large bonus remuneration of the executives. Therefore there was amounts of money that can be made in short spaces an interest in promoting asymmetry because in good times of time. Is this something that the BBA is going to its pro-cyclicality enhanced bonuses. Processed: 13-03-2009 15:08:41 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG2

Ev 26 Treasury Committee: Evidence

11 November 2008 Mr Paul Chisnall, Mr Russell Picot, Mr Stephen Haddrill, Ms Liz Murrall and Mr Charles Cronin

Mr Picot: My views are that a current mixed- markets, and what we are seeing very clearly at measurement model is appropriate. What I do not present is that market circumstances change. I think support is a move to extend fair value accounting I said at the start— into eVectively a long-term banking book because I think, if you were to take that step, you would see Q160 Jim Cousins: We did have fair value with very, very significant losses being written through Lehman Brothers and we are still waiting for tens of the profit and loss accounts, not just in the United thousands of their deals to be unwound and nobody Kingdom, but right across Europe and right across knows what they are worth. That indicates the America, and you would be looking at tens of credibility problem you have got now, never mind billions of dollars of write-down simply because the watering it down further. current market credit spread is so high in relation to Mr Chisnall: I do not think that we have been asking historical standards, and I think that is a step which to water down rules. I think that we have been would be a very dangerous step for us to take. asking to look at the existing rules, to think about whether there are elements of the existing rules Q158 Jim Cousins: Mr Picot, on September 11, the which, in current market circumstances, mean that Governor of the Bank of England came here, he sat losses are exaggerated. I think that we have asked for roughly where you are sitting now and he made a very specific changes and for those changes to be long statement to us. Four days later Lehman applied in an open and transparent way very much Brothers collapsed in a puV of smoke. What the on a fair value basis, and I think that the important Governor of the Bank of England had said to us did thing here is not to draw inappropriate conclusions. not stand up anymore. Now, if the Governor of the I think that Lehman Brothers probably does provide us with an incredibly important case study in terms Bank of England cannot read the rumbles, how can of understanding what has gone wrong, but I think some poor woman who is relying on a proper it would be wrong to jump to determining what that investment of her divorce settlement to see her means for regulation. I certainly do not think that through the rest of her life, how can she rely on it, you can look at Lehman Brothers and say that the but you want to water down those rules? answer, therefore, has to be that fair value Mr Picot: To be clear, my view is not that I wish to accounting should be applied across the board water down the current system of accounting. What because I think the fair value accounting has been I do not support is to change the current system of part of the problem with Lehman Brothers. accounting to increase the use of fair value where, quite frankly, it does not reflect what management is trying to do, it does not reflect the underlying Q161 Jim Cousins: But, Mr Chisnall, the problem we economics and it does not reflect the actual cashflow have all got, and we have all got it and it is a real which will be earned. I do not think that is an problem, not a theoretical one, is that we have a vast appropriate basis for accounting. At the moment, if secondary market out there in financial instruments you use an amortised cost method of accounting for, and it has already let us down on a number of say, your loans, you are required to disclose the occasions. Nobody knows what is out there, nobody current fair value, so that information is there, it is knows what it is worth, and you come along here there and it is audited in the notes to the financial today and say, “We want more power of judgment. statements, so you can see what that fair value We want more of our little-box-of-tricks models to number is and in a number of cases it is very let you know what it’s all worth”. People do not significantly below what the amortised cost believe you anymore. number is. Mr Chisnall: Well, I do not think that we are asking for a little box of tricks. I think that we are saying that fair value is relevant and appropriate in certain Q159 Jim Cousins: Mr Chisnall, the problem you circumstances and I think that we are saying that it have got is that people just now do not believe you, is not relevant in certain circumstances. In the they do not trust you. They have had the experience context of the Banking Bill, I think that there are— of Lehman Brothers, they have seen the consequences, they have seen this tsunami spread Q162 Jim Cousins: What are audits going to be through the world’s financial system, and you come worth if you take that approach? here today and you say to us, “Well, we want more Mr Chisnall: In the context of the Banking Bill, I subjectivity, we want to be able to model, we want to think that there are lessons to be learned from be able to use our own judgments. Trust us”. How Lehman Brothers in terms of risk mitigation and I can you expect people to accept that? think there are issues within that Bill around netting, Mr Chisnall: I think that the example of Lehman collateral and security and ensuring that you can Brothers is a very interesting one. A large part of limit risk. In terms of audit, if you look at the Lehman Brothers’ balance sheet was at fair value, experience of the US, particularly in the light of and I think it shows that fair value is not some kind Standard 157, part of the problem has been that of magic pill to the answer of all accounting auditors have not found it possible to verify fair problems, but it shows that fair value itself has very values and it has become far too complex and, real diYculties. The problem with fair value and the therefore, the rules, as we currently have them, and problem with fair value, as it is expressed in current I think it is pretty well-catalogued, have caused accounting standards, is that it is on the problems for the audit process in the US, and that is presumption of the existence of deep and liquid one of the reasons that we have seen changes Processed: 13-03-2009 15:08:41 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG2

Treasury Committee: Evidence Ev 27

11 November 2008 Mr Paul Chisnall, Mr Russell Picot, Mr Stephen Haddrill, Ms Liz Murrall and Mr Charles Cronin introduced by the US Financial Accounting Mr Cronin: I just want to make two points. One is Standards Board and the Securities Exchange that there has been this discussion of the loan of 5% Commission as recently as last month. and now the spreads have risen by another 500 basis Mr Picot: I think one clear consequence of using points, and the important thing to put out from that more fair values where there are not active markets is that the risk has increased that you are not going and not tradeable markets is that you would get to get your interest or your principal back. A lot of more management judgments, so in the example I these assets that are lying in these balance sheets are gave earlier of a loan where there is not a traded damaged, and they are damaged as we see them market, it would be management judgment in terms today, so what are they are going to look like of determining the fair value, so it would increase the tomorrow? The whole fair value debate is essentially subjectivity in measurement in the balance sheet. saying, “The market is taking a forward valuation Mr Haddrill: I think you are absolutely right to on these assets”. Now, you may hold them to highlight this point about how do you change a maturity, fantastic, but what are they worth on system and in the moment of crisis because maturity if you do not get your interest or principal obviously that does risk undermining the confidence back, so that is one very key point. The second is of people who may not understand at depth what is that, as far as confidence in the market is concerned, going on. I think what we are seeing here is that we we did an overnight survey of our EU members, it is are in extraordinary times and we did not write the in our evidence, and we used the term ‘suspension of war-book for dealing with extraordinary times fair value’ and that is not on the table, the relaxation, before they appeared, and I think one of the lessons and tempers were extremely high, and 79% of our we have got to learn from this, whether it is in members said that they would be against it. We then relation to regulation or accounting, is that we need asked the question, “If it did happen, would it to plan for the extreme circumstances and that has increase or decrease your confidence in the banking got to include a degree of relaxation in some of the system?” and 85% said no, so this whole process is rules so that people can see it coming and then the actually undermining the confidence that the whole markets will have confidence, and probably we will finance industry needs to start again and rebuild up. never need to get there, but the markets will have Ms Murrall: Our members collectively manage £3 confidence that the plan has been written out and trillion of assets, and we sent a memo round to our things are going according to plan. Board late last week, asking them whether or not they were going to invest in these bank reconstructions that are currently going on in the Q163 Jim Cousins: But, Mr Haddrill, the problem is UK. To date, I have had three responses and I would that the markets do not have confidence. just like to read one out to you: “In our view, Mr Haddrill: Not now. investors are sceptical about investing in banks because they don’t believe the full impact of structured credit losses has been taken in the Q164 Jim Cousins: In your own field, we still have accounting. We feel it is necessary for the banks to AIG and the diYculties of AIG with possibly fully write down toxic assets before any investor spectacular consequences there, but hopefully not. confidence can be built”. Now, how do you deal with this issue of credibility which is now there on the table by saying, “The present system’s too diYcult. We want to go back to Q165 Chairman: That was a point I made earlier. subjectivity. Just trust us”? How can we make progress on this because I was Mr Haddrill: No, I do not think I am saying that. saying that things have changed in August, What I am saying is that we need to plan for these September and October and, given Paul Chisnall’s circumstances rather than change the rules in the point that Lehman’s is predicated on fair value, then middle of them. oV it goes. Is that a fair assessment? He said it was Mr Chisnall: I think it is really important that I have an incredibly important case study of fair value in the opportunity to say this, that there have been Lehman Brothers going on. some organisations that have argued for a Mr Cronin: The fact of the matter is that Lehman’s suspension of fair value, and I want to be absolutely lent money. It was supposed to get interest back, it clear here, that the UK banking industry has not was supposed to have loans valued to a certain level argued for a suspension of fair value. What we have to balance its books and it did not do that. The assets suggested to the IASB, and the Committee have the went septic and it has gone wrong. letter, is that the standards were written in very diVerent market circumstances and, when you look Q166 Chairman: So fair value is— at the current market circumstances, there are rules Mr Cronin: This is not the issue. The quality of the within those standards that actually do merit review. assets was the problem. It was the lending policies, it For example, there are elements of those standards was the whole process that got us where we are and that are pro-cyclical and we are asking that the that is the problem, and it is a distraction to focus on International Accounting Standards Board looks at fair value. some of those rules, determines whether or not some of them should be reviewed and changed, but that the process should be open and transparent and that Q167 Mr Fallon: Coming back to you, Charles the consequence of applying any changes made, as Cronin, you suggest that rather than take fair value appropriate, can be seen in the marketplace. accounting, there should be some more disclosure of Processed: 13-03-2009 15:08:41 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG2

Ev 28 Treasury Committee: Evidence

11 November 2008 Mr Paul Chisnall, Mr Russell Picot, Mr Stephen Haddrill, Ms Liz Murrall and Mr Charles Cronin what you would call “inherent uncertainty in the Q170 Mr Fallon: How damaging do you think it has margin of error”, in other words, disclosure of risk. been to the credibility of the Board? How would you see that working? Mr Cronin: I think the Board put a very brave face Mr Cronin: Well, you are aware that there are three on it, but had to cave in to it as a pragmatic situation. levels of valuing through fair value: there is the direct I think the jury is out in the sense that, if the Board pricing method; there is the similar pricing of had to cave in again, then the game may be up in the products; and there is the model approach. Of the convergence agenda, which would be terrible. assets measured under fair value, I think, probably Ms Murrall: Also, the amendments were made on somewhere between 6 and maybe 8% use level 3 October 13 and they were eVectively to align. There valuation methods, and it is important that the are two sets of main accounting standards, IFRS set models that are actually used are disclosed to by the IASB and US GAAP, and those changes on investors and the critical assumptions that go into the 13th, basically the IASB moved to allow for those models are very, very important. My more flexibility in the fair value reclassification as is organisation has done a lot of work in the credit allowed in US GAAP. The changes that are now rating agencies and there are two reasons why the being put forward and put forward recently by the credit rating values precipitatively fell. One was the EU are a complete mismatch. In one instance, they complete re-examination of the models where they are converging on US GAAP and, in another found the models were at fault and, hence, the actual instance, they are diverging away from it. I think the products themselves were wrong, and the second IASB has not responded to that and I think that is thing is that investors were never given insight to the right because the one thing we do not want is actual underlying assumptions that went into these politicisation of this process. models, and I will give you an example. Say, I stand Mr Picot: If I may, there has been one instance so far here and I say, “House prices are going up by 15% of European pressure which was to do with the first for the next two years and by 7% for the next ten carve-out, which was some three or four years ago. years”, that is an opinion. If am selling you a piece In that instance, IAS39, which was the relevant of paper, you ought to know that I am pricing my accounting standard, was not changed, and I think piece of paper on that opinion. That was denied to quite correctly was not changed. It resulted in words the investors in these assets, more fool them, but that being removed from the standard as an option, but disclosure was necessary. Hence, if you are the UK banks do not follow that option, they follow disclosing your models, you need to disclose your full IFRS, and it is very important that we do not models on your balance sheet, what model you are have that happen a second time. I think the changes using, ideally have consistency of models between which the IASB made in October were welcome. banks, but also the key underlying assumptions need They did even up the playing field vis-a`-vis the US to be known. and they did give some relief from unnecessary write-downs. Now, there clearly is another letter having gone in from the European Commission. I Q168 Mr Fallon: So it was the internal modelling think it is very important to understand that the which has been too optimistic that needs to be overwhelming consensus of stakeholders involved in disclosed? Is that your argument? that European Commission process did not ask, and Mr Cronin: The internal modelling, I will not go into are not asking, for a European solution or a carve- the details of it, but the thing is that their time-series out. What they are asking the IASB to do is to look data that was too short, there was dependency on at the two or three issues which have been subject to correlation between assets which was probably the letter, to go through proper due process and to spurious, and then the assumptions that went into come up with an answer, and I think it is very actually, shall we say, the economic prosperity of important, where you have an independent these assets was perhaps generous. standard-setter, that the due process is respected because, quite frankly, not everyone is always going to agree with what the IASB says, but you have to Q169 Mr Fallon: Could we turn to the issue of how trust their due process and accept what they come you amend accounting standards, and again perhaps out with in the final outcome. I could start with you, Mr Cronin. You suggest in your memorandum that, in essence, the Board has caved in to political pressure after the October Q171 Mr Fallon: Mr Cronin has warned against amendment to IAS39. Have you been concerned further interference. Mr Haddrill, there has been before about political interference in the way that further interference. We have this new letter now of standards are set? 27 October from a Director General in the Mr Cronin: No. This is the first time, as far as I am Commission, telling the IASB to consider three aware, of where we have had a direct threat to the further issues before end-year publication. That is independence of the IASB through pressure from exactly the kind of interference Mr Cronin says will the European Union. There is an organisation called be very damaging, is it not? EFRAG which reviews, for the European Mr Haddrill: Yes, I think it is lamentable, frankly. I Commission, the standards that are produced, and think that, if the European Commission should be they have been involved in the carve-out issues that doing anything at the moment, it should be surfaced a few years ago, but there has never been considering how to bolster the independence of a before such a direct challenge to the authority of the body that is the only global standard-setter we have organisation. in this area. Independence, I feel, has got to be based Processed: 13-03-2009 15:08:41 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG2

Treasury Committee: Evidence Ev 29

11 November 2008 Mr Paul Chisnall, Mr Russell Picot, Mr Stephen Haddrill, Ms Liz Murrall and Mr Charles Cronin upon legitimacy and there are ways, I think, in which Mr Haddrill: When this came up before, it came up the IASB could reinforce its own legitimacy so that from the same source, it came up from pressure from this independence issue could be put to bed. It seems the French financial community. to me that it needs, possibly on the Board, but certainly at trustee level, to be more representative of a wider group of interests, including investors and Q176 Mr Fallon: But why? users and perhaps a business as well. I think there are Mr Haddrill: Why that is, I do not know. At that issues around not so much the way it consults, I time I was in government in the Civil Service and we think it consults very thoroughly, but I do not think felt at that time that the French were worried about it always, however, in that consultation does a what it would expose about the way in which the suYciently good job of indicating what the impact of French banking community was funded. I do not its proposals is, the economic impact, and I think know whether that remains a legitimate concern or that, as we move into a new world, there is a big not, but I think it is a question that perhaps should question to be asked about whether the legal be asked. standing of the Board needs to be reinforced. After all, the Board is coming up against real democratic, Q177 Chairman: How much consultation did IASB political authorities, but it has kind of grown up as provide prior to its announcement after this October a club, a private organisation, and I think that we amendment to IAS39? need to consider whether it is given some Ms Murrall: The trustees met immediately prior to international legal standing that would enable it to that, the week before, and agreed to suspend due be robust and independent and to be questioned process, so, when the IASB made those changes on through some legitimate judicial process really 13 October, it did discuss at its meeting, and I was rather than just people having the option either of there as an observer, whether or not it should have accepting what it says or carving out and throwing a truncated consultation period of eight days, but I away what it says. At the moment, the basis of it think the timing was such and it was under so much tends to polarise debate and I think we have got to pressure from the EU that it agreed to make the move on to something rather diVerent. changes. What they did do is that they ensured that there were a lot of disclosures so that, whereas the results in the actual accounts can be modified by this Q172 Mr Fallon: When you said that the Board is flexibility, the disclosures in the notes would enable coming up against real democratic accountability, someone to look at what the position was before. this is a letter from the Commission, from a senior oYcial in the Commission, and he has not got any democratic accountability, has he? Q178 Chairman: So, if I can follow that down, they Mr Haddrill: Well, he is accountable to his did not have any consultation? Commissioner and his Commissioner has some Ms Murrall: No, no consultation. accountability to the European Parliament, so I am not saying that they are right, and I do not think they are right, to do that, as I made clear— Q179 Chairman: Professor Stella Fearnley has questioned whether convergence to one global standard is the right way forward, arguing that Q173 Mr Fallon: Well, I want to be clear about this. global monopoly stifles new ideas and hinders It is inappropriate, in your view, for the Commission progress. Does anyone agree with that? to be bullying the Board in this process? Is that right? Mr Haddrill: No. Mr Haddrill: I think it is inappropriate for the Mr Picot: No. Commission to be bullying the Board, but I think Mr Chisnall: No. that the Board is likely to be exposed to be bullying Ms Murrall: No. until it has some really solid international legal Mr Cronin: No. standing of its own. Q180 Chairman: None at all? Okay, I have got bad Q174 Mr Fallon: What do you think the news for Professor Fearnley then! How can the Commission’s agenda here is? IASB be sure that the process of convergence ends in Mr Haddrill: Well, the Commission itself is under high-quality standards rather than a rush to the pressure from the French Government, and we have bottom? known for many, many years, going back to the Mr Cronin: I think the process that we have at the point Mr Picot was making about when IAS39 was moment, which is through extensive consultation, first reviewed, that there has been a view within the shows that the standards that we are getting are as Commission and within European circles that good or better. The whole process, as I understand Europe should control accounting within European it, is to actually come up with one single accounting boundaries, and we reject that because we believe standard that is better than the current standards that this is a matter that should be dealt with in a that are in operation. As far as the race to the bottom globalised world on a global basis. is concerned, I think the big issue for me is that, if we do have outside interference, there is a race to the bottom in the sense that the word ‘fudging’ of fair Q175 Mr Fallon: Why is it the French particularly value has been used here and what we have got at the who want fair value accounting fudged? moment is the European Commission via the French Processed: 13-03-2009 15:08:41 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG2

Ev 30 Treasury Committee: Evidence

11 November 2008 Mr Paul Chisnall, Mr Russell Picot, Mr Stephen Haddrill, Ms Liz Murrall and Mr Charles Cronin banking sector essentially altering the rules that are Ms Murrall: No, I think that it is very important that to their own benefit, which is a race to the bottom, the IASB is seen to be independent and has integrity as far as I am concerned. and that the outputs from its processes have integrity. It needs to set the best standards.

Q181 Chairman: A race to the bottom? Q183 Chairman: But, given that there was no Mr Haddrill: Yes. consultation, there will be a question mark over that Mr Picot: I think it is very important that the IASB integrity for the future. is independent and is not subject to political Ms Murrall: I think it was a pragmatic response to a pressure. I think it is good at consulting, I think it is very diYcult situation. an organisation that you can go and talk to. Later on Mr Picot: There needs to be a proper, fast-track this week, on Friday, there is the first of its three process, but with consultation on an accelerated round tables. basis. Q184 Chairman: So they need to do something? Q182 Chairman: I think two for a race to the bottom Mr Picot: Yes. are the extremes here. Anyone else for a race to the Chairman: Okay. Well, can I thank you all very bottom? much. That was a very helpful session for us.

Witnesses: Sir David Tweedie, Chairman, International Accounting Standards Board, Mr Paul Boyle, Chief Executive, Financial Reporting Council, and Mr Michael Izza, Chief Executive, Institute of Chartered Accounts in England and Wales, gave evidence.

Q185 Chairman: Welcome, Sir David and your Commission in America, and the major accounting colleagues. Can you introduce yourself for the firms, and say: “We think we have done it here. Is shorthand writer, please? that right?” However, when we put it through—we Mr Izza: Michael Izza from the Institute of put it through on the Monday and, if I remember Chartered Accountants in England and Wales. rightly, the European Commission voted on the Sir David Tweedie: David Tweedie from the Tuesday or Wednesday—we had no time International Accounting Standards Board. whatsoever for consultation. We explained at that Mr Boyle: Paul Boyle, Financial Reporting Council. meeting: “If we find we have made a mistake, we are going to come back again”. In a way, we have got a Q186 Chairman: Sir David, “spineless” and “caved mistake on the transition. That is what happens in”. Answer. when you do not consult. Sir David Tweedie: Can I come across the table here? I think we experienced something that, I hope, Q187 Chairman: What was the trigger for that? The firstly, we never see again in standards setting, but I credit crisis did not start until October 2008, and fair think there was just a blunt threat to blow the value did not start in that month either. organisation away. That came very, very rapidly. Sir David Tweedie: No, we were rather taken by We heard a speech by the Commissioner saying that surprise, to be quite honest. It came very quickly. he had legislation prepared to have a “carve out” Certainly, US standards and our standards are not from part of our standards. They cannot put words the same in these areas, and the idea is we eventually in at the moment (though I suspect that might be have a common standard in a year or two’s time. thought about); they can only remove words, and This one came very quickly and almost out of what that would mean was they would be able to nowhere, so it took us by surprise. We were not transfer out of things like the trading account into expecting this at all. some other account—held for maturity, or whatever else—without any controls whatsoever. So Q188 Chairman: Other witnesses: how damaged is companies could have taken items out of that, not at the body as a result of the October decision? fair value, as we require, but they could have taken Mr Izza: I think it would be unfortunate if those them out at original transaction price, for example. circumstances were repeated again. We recognise There were no disclosures; you would never know that Sir David had to respond on an exceptional what had happened, and suddenly we would see all basis. When due process is suspended that prevents these losses flowing back in, if they did not think they the consultation process potentially avoiding some had been impaired on a permanent basis. I think of the unintended consequences that may flow. So accounting in Europe would have been totally out of the body has been damaged, but we hope not fatally, control if they had used the option to take the “carve and we hope that we can put that behind us now and out”. Our problem was we originally intended to go forward as we were before towards convergence have at least a week to find out whether, in fact, we and towards improving the IASB. had managed to get our standards equivalent, as far Mr Boyle: I think Sir David has described that he as reclassification is concerned, with the United was, really, between a rock and a hard place, and the States. We did not have a week; we had only a matter decision that they made could, in some respects, be of days. What we did is we contacted the American criticised. However, the alternative that the Board standards sector, the Securities and Exchange would have been faced with, as Sir David has also Processed: 13-03-2009 15:08:41 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG2

Treasury Committee: Evidence Ev 31

11 November 2008 Sir David Tweedie, Mr Paul Boyle and Mr Michael Izza described, would have been even worse. It is really we actually try and create a linkage to the securities important, from our point of view, that accounting regulators in the way that the Americans have it, and standards are set on an independent basis. I think the the trustees have proposed a monitoring group that parallel that we would draw to your attention is that consists of the Chairman of the SEC, the I think there is a widespread political consensus that appropriate EC Commissioner, the Chairman of the interest rate decisions should be made independently Japanese Financial Services Authority, the by the Central Bank and not made by politicians. Of Chairman of the International Securities Regulatory course, it is appropriate that the interest rate Emerging Issues Committee and the Technical decisions are made by an organisation which is Committee—plus the IMF and the World Bank—so properly accountable and properly constituted, and that we do have far more political legitimacy and can be held to account to explain why the decisions people, obviously, can then exert influence. it made are consistent with the political framework that was established. There is an interesting parallel Q191 Chairman: I understand, Sir David, and the there to be thought about, as to whether or not governance of the IASB is not your remit, but I think accounting standards should be treated on the same it is of interest to us. So I think we would be seeking basis, because it is extremely damaging if accounting written evidence from the body and, perhaps, oral V standards are made, in e ect, by politicians for evidence at some stage. political reasons. I say that with the greatest respect Mr Boyle: Thank you, Chairman. If I can just to a committee of politicians, but I think the parallel amplify my comments, it is clearly the case that the with the setting of interest rates is quite an way in which accounting standards operate is a interesting one to be considered. matter of legitimate political concern, just as the way in which interest rates are set is a matter of legitimate Q189 Chairman: Sir David, why should not political concern. My point is that the very politicians have a say in the fact that there should be considerable debates which take place about what public accountability? The point has been made that are the appropriate accounting standards are best the Governor and his colleagues are coming here in settled by the independent board of experts two weeks and he has probably been here half-a- following due process that can then be held to dozen times. There are some mornings, probably, account and explain why it made the decisions it when he is putting his jacket on and coming here made and how those decisions are consistent with when he wishes he was going elsewhere. However, he the objective that it has been set, and that will be a does realise that that is the vibrant, necessary part of proper basis for holding it to account but making its the debate. Why should we not have a more robust decisions, technically, independently. mechanism for your body? Sir David Tweedie: I am delighted to appear before Q192 Mr Brady: Just picking up on some of those you, Mr Chairman. points, I was going to ask, Sir David, where you feel the IASB derives its legitimacy or its moral authority Q190 Chairman: I know; you are very good. from. It is a private organisation, it is funded by the Sir David Tweedie: And the Senate Committees in industry, but I think, from your previous remarks, the United States as well, and I think that is you were suggesting that this is a work in progress; appropriate. The interesting thing about our that perhaps there is no real source of legitimacy at organisation is the way it grew, and there is a the moment but you see it, ultimately, deriving from legitimate flaw in it, at the moment. When we were the various international monitoring bodies. started we were based on the American model which Sir David Tweedie: Yes. The trustees put out a was having an independent standards board with proposal a few months back suggesting this trustees; eminent public figures who would then monitoring group, and they hoped they could have appoint the board and make sure that we did the due that up and running in a few weeks, to be honest. So process appropriately. They do not get involved in we always knew that was a flaw, but there was not a technicalities; we do not get involved in funding, and lot we could do about it until we had a broader so on. The bit that was missing from the United international spread, otherwise we would have been States model was the fact they had the Securities and a regional organisation. That was the problem. Exchange Commission sitting over the trustees, so if something went wrong the Securities and Exchange Q193 Mr Brady: Does that give political legitimacy? Commission would intervene. Of course, they are Does it give democratic accountability? appointed by democratically elected politicians. The Sir David Tweedie: There is going to be a problem we then had was when we started who memorandum of understanding between the would be the SEC? There is not an international trustees and this monitoring group, but, broadly SEC. At the beginning the only people that really speaking, the monitoring group would approve the were taking our standards were the Europeans. Did trustees’ appointment. As a trustee retires and a new that mean that the European Commission would be one is appointed they are recommended by the sitting over our trustees? That would be existing trustees but they can be rejected by this unacceptable to the rest of the world. As countries group. That group obviously has the power to have started to take our standards, and 113 are nominate as well, but their nominations do not have doing so at the moment (we estimate there might be to be accepted by the trustees either, so there will be 150 if we do not get blown away in the interim in a mutual veto. They would check that the trustees few years’ time), what has been proposed now is that made sure that we had observed due process, and so Processed: 13-03-2009 15:08:41 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG2

Ev 32 Treasury Committee: Evidence

11 November 2008 Sir David Tweedie, Mr Paul Boyle and Mr Michael Izza on, and gone through all the procedures that we GDP. In the case of the UK, it is about £700,000. We should go through. Clearly, if there were concerns at the FRC raise that amount through the levy we they would ask the trustees to address them. So that charge to listed companies such that no one would give the entree into our processes. company in the UK pays more than about £2,000 Mr Boyle: It is worth saying that the proposals to towards the IASB which, frankly, is not a level at reform the IASB governance, which the trustees which you can say you are buying any influence. As have put forward, were initiated approximately 12 it is done indirectly, through us at the FRC, there is months ago. Since then, of course, the financial crisis no link between the fact that people pay for it and has become a lot more serious and there are their ability to influence the standards through that discussions to take place later this week at the G20 mechanism; they have to influence through putting meeting about reforming the overall financial their views in as part of the due process. I think that architecture. It might just be worth considering arrangement is gradually being extended around the whether any of the conclusions which the G20 world. The trustees should press for it to be governments come to about wider reforms to the completed. international financial architecture have any relevance to what we constitute as an appropriate Q197 Mr Brady: Are there still areas of concern accountability mechanism for the IASB. We will where that model has not been extended? wait to see what emerges from the discussions. Mr Boyle: We are fortunate in the UK that we had an existing model which could conveniently be Q194 Mr Brady: What is your view on it? adapted to extend to cover IASB funding. DiVerent Mr Boyle: I do not know what the governments of countries have diVerent institutional arrangements, the G20 are going to decide, but I think—and Sir and I think one of the attractions of the IASB’s David and the trustees have recognised this—it is reform of funding is that it allows some flexibility for important for the IASB to have a properly legitimate each country to decide the most appropriate, local status. That is the only way that we can prevent it basis for raising its proportion of GDP-based share being picked oV on an ad hoc basis on ad hoc issues of funding. by people who might have motivations which are not entirely consistent with the organisation’s proper Q198 Mr Brady: Are some of them still raising objective. worryingly disproportionate amounts of money from individual companies? Q195 Mr Brady: Mr Izza, do you agree that is the Mr Boyle: The process is not complete yet. right kind of balance of political involvement, and the right structure? Q199 Mr Brady: Finally, can I just ask how the FRC Mr Izza: Yes, I think it would be sensible. We is funded? support the establishment of a high-level oversight There followed two minutes’ silence of remembrance body for the IASB. We would support the direction Mr Boyle: Currently, one-third is paid by way of a of travel. Specifically on your question, Mr Brady, grant from BERR, although ministers have about where does the IASB get its legitimacy, when announced to Parliament that they are going to the standards have actually been adopted by 113 withdraw that grant, so we are in the process of countries. and there is the potential it will be adopted finding ways of replacing that. One-third comes by 150, I think that is the legitimacy. This actually from the accountancy profession—a charge to the started as a market-driven group, and it has been six professional bodies—and one-third is raised by accepted by national governments. way of a levy on companies which have to prepare accounts. That is, at the moment, limited to Q196 Mr Brady: I understand this is something that, companies on the main market and on AIM and on Sir David, you might not be able to comment on, but Plus Markets. So we have got a balanced funding if I could ask the other witnesses: do you have arrangement such that no one exercises concerns about the funding model of the IASB? disproportionate control. The Government’s one- Mr Boyle: The funding model is also a work in third is being withdrawn, and we have already progress. The original basis on which the IASB was consulted on ways of replacing the one-third funded was, frankly, unsatisfactory. It involved the government funding. Chairman of the Trustees going round to major corporates and asking for donations. Some of the Q200 Mr Brady: What is the likely outcome? donations were individually quite substantial Mr Boyle: The likely outcome is that we will make amounts and this did lead to accusations—fairly or two changes: one is to bring within the scope of our unfairly but led to accusations—that people were, in levy public sector organisations because they will eVect, buying influence. The trustees are part-way now have to produce accounts under IFRS and we through putting in place what I think is an altogether are linked in, as I have described already, to the much more satisfactory funding arrangement, which International Accounting Standards Board, and we is sustainable, adequate and free from undue will also extend the levy to large, private companies, influence. We at the Financial Reporting Council including companies owned by private equity funds, have been one of the leaders in adopting this. The because even privately-held companies still have to way it broadly works now is that each country in the prepare proper audited financial statements. world pays a proportion of the IASB’s costs which Therefore, it is appropriate that they pay for the are broadly proportionate to its share of global system. Processed: 13-03-2009 15:08:41 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG2

Treasury Committee: Evidence Ev 33

11 November 2008 Sir David Tweedie, Mr Paul Boyle and Mr Michael Izza

Mr Izza: If I could also answer your question. There this were to happen again. Have you got any specific are three principles which, I think, are important to assurance that something like this will not happen apply to how the IASB is funded going forward. again? First of all, it does have to be adequately Sir David Tweedie: No. resourced—penny-pinching will not get us to the global set of standards that we all want to see. Secondly, whatever funds are determined have to be Q205 Jim Cousins: You have not got such an sustainable, because if the IASB was faced with assurance? Have you asked for such an assurance? potentially those funding sources running out that Sir David Tweedie: I do not think I would get it if I would distract them from their core purpose and asked. We have not asked but I do not think I would message. When those funds are identified they have get it. That is the power that the Commissioner to be free from interference and influence. I think has—to propose a “carve out”. those three principles are very important. Mr Brady: Just picking up on that, Mr Izza, are you concerned, at the moment, as to whether the third of Q206 Jim Cousins: It does seem to me that if that is those criteria, regarding the exercise of influence, is the case we can only defend the integrity of our a problem? financial system in ways other than simply recasting how the International Accounting Standards Board Q201 Chairman: Can you give us a quick answer? works. Something more would be required in terms Mr Izza: No. of the powers of the Commission and how it proposes to use those powers. Have I drawn a logical Q202 Jim Cousins: Sir David, you have already told conclusion? us that if you had not agreed to the watering down Sir David Tweedie: I would think so. of the accounting standards on foreign financial products something far worse, in your view, in terms of watering down, would have happened. Did you Q207 Mr Fallon: Are you really still an International have a specific threat that that would be the case, in Accounting Standards Board if the Commission can those terms? keep carving out bits it does not like? Sir David Tweedie: We knew what the “carve out” Sir David Tweedie: That is the big question that is was going to be; we knew the words that were going put to us. Others were asked: “Have we been to be removed. The words were the restriction on damaged?” I think the answer is yes we have been by being able to take financial instruments out of the what happened a few weeks ago. I was in the United trading categories, and so on. So it would have given States a fortnight ago and there were questions of: you the ability to start moving these things out “Why did you do this? This is European influence. without any restriction whatsoever. Under the present regulation there is no means by which the Are you a European body?” Other countries that Commission or anyone else can put forward a were completely taken by surprise—because all of proposal to bring in certain disclosures or anything this happened very, very quickly—have to put it like that; it is a case of: “There’s the standard. You through their legislature sometime; the standards lie can take bits out and you can’t put bits in”. That was on the table in parliament for so many days, or the real problem, Jim, that, basically, you would something, and suddenly they were given something have a standard that gave a free-for-all in that area. they had no knowledge was coming. That was a That was our problem. The other aspect of it was major problem for us. It upset a great deal of people. that, quite bluntly, if Europe had yet another “carve So it did damage the whole exercise. out” I think you would have found the United States saying: “This is impossible; we’re not going to have global standards after all”. The whole idea of the US Q208 Mr Fallon: Did you not consider resigning? moving towards IFRS has been based on the fact Sir David Tweedie: Yes. that you have got Europe doing it, Japan’s agreement to 2011, China did it last year and you have got India and Korea coming in, and then Q209 Mr Fallon: Why did you not? suddenly Europe moves out. That would have Sir David Tweedie: We want to make sure we win crippled the whole global process. That was the this project. We are almost on the verge of winning position we were facing. an international project, and that I think is exactly what we have to do. The argument that came about Q203 Jim Cousins: Did you have a specific threat our standards being inconsistent with those of the that that would be the case? United States (which they were) was a legitimate Sir David Tweedie: It was told that the argument up to a point. The standards are not even Commissioner actually made a speech saying he had yet compatible because there are diVerent the legislation already to go, and we knew that impairment rules and so on. You would have to Parliament was ready to take it. bring in pages and pages of American standards into international standards. We did the minimum we Q204 Jim Cousins: The representative of the could do, and that is all we did. We could not survive Institute of Chartered Accountants has already told another one. I think the whole exercise would us that it would be “unfortunate” if something like disappear if we got more “carve outs”. Processed: 13-03-2009 15:08:41 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG2

Ev 34 Treasury Committee: Evidence

11 November 2008 Sir David Tweedie, Mr Paul Boyle and Mr Michael Izza

Q210 Mr Fallon: You have got another one. and what happened? They want reclassification. I do Sir David Tweedie: Not yet. not think that was a better method than we had, frankly. I can understand the argument of a level Q211 Mr Fallon: We have referred already to the playing field, and, to be fair, the Americans have letter from the Director General of 27 October tougher impairment standards if you transfer than telling you to address three other issues before the we have. So it is not quite level but, nonetheless, that publication of year-end results. Why are you being is a classic example of what happens. People will ordered around by the Commission on behalf of look at the weaker standard and say they would the French? prefer that, and they do not want the tougher bits of Sir David Tweedie: We respond to any sort of the weaker standard, like the impairment rules; they request. What we have done with that situation is we would not want those but they will pick the bits that have said that given that the ECOFIN and the suit them. We will just get picked oV against each leaders of the major European countries asked for a other. That is the race to the bottom I think you level playing field, to do something independently of will get. the Americans would create an unlevel playing field. So we have, with them, organised round tables here Q217 Mr Fallon: Absolutely, but you do not see any in London, in America and in Tokyo and we will merit in her argument that, also, if you have one discuss them, and we will go through due process. international standard you do stifle innovation in We cannot do what happened before. If we agree— standards? and we have not said we are going to agree—to Sir David Tweedie: I would cheerfully stifle some of change that will done jointly with the United States the innovation from some of my Board members, and ourselves to make sure that we do keep some but basically I think you find that you get plenty of form of level playing field. We will have due process arguments, and they come from all over. You do not and the Board will not do what happened again. stifle it. One of the aspects that we have done is to insist that we have a very good national standards Q212 Mr Fallon: This is not a request; the Director area; we have got the Accounting Standards Board General says: “We consider that these three issues here, we have got the American standard setter, the should be addressed”, and you have just told the German, French, Australian and New Zealand. Committee that they have power to require that. They are full of ideas and they do a lot of the Sir David Tweedie: No, we agreed to address it preparatory work for us too. So there are plenty of because others have raised the same issues, but that ideas flying around. We have regular meetings with is all we are going to do. We will address them and them. So there are not just 14 people thinking great then we will see what happens. It may be the Board thoughts. will vote for no change. Mr Boyle: If I may, I strongly support this proposition. There is no shortage of people who are Q213 Mr Fallon: If that happens the Commission putting forward suggestions for ways in which can have its way anyway. That is what you are accounting standards can be improved. We have telling us. national standards-setting bodies still in operation Sir David Tweedie: It might. It has not said it will but around the world. A group of about 23 of them meet it might. together on a regular basis, currently chaired by my colleague Ian Mackintosh in the UK Accounting Q214 Mr Fallon: At what point is the Board really Standards Board. So there is no shortage of ideas. going to stand up to the Commission and the However, what you cannot have is a multiplicity of French? diVerent ideas in operation simultaneously. I think Sir David Tweedie: I think you should just watch. there would be no shortage of proposals for new ideas, but you need to have one authoritative body Q215 Mr Fallon: You mean you are now going to to say: “Okay, having heard all the debates this is the do that? way that we think, on balance, is the right way to Sir David Tweedie: If there is a legitimate reason we proceed”. should change we will change. If there is not a legitimate reason we will not. Q218 Mr Love: Sir David, how concerned are you about the pro-cyclicality of the accounting and Q216 Mr Fallon: Okay. I want to come on to this regulatory framework? issue of the alignment between the European and the Sir David Tweedie: That is a major issue. What has American systems. Professor Fearnley has happened up to the past is the regulatory capital submitted evidence to us suggesting that a global requirement is moving in step with the accounting, monopoly of standards may not be desirable (I and clearly that does lead to problems. As banks quote): “as it stifles new ideas and hinders progress. have needed more collateral they are being forced to There should be room for more than one set of sell, and the more banks that sell the market price standards in the world”. Do you have any sympathy drops, and so on. We were discussing with the Basel with that? Committee just last week various proposals to try Sir David Tweedie: None. Basically, you have just and ameliorate this situation. One of the banking had a classic example of what happens when you do supervisor’s proposals has been that we should have a diVerence. There you have American increase the amount of provisions that people make standards allowing reclassification—ours did not— when they lend. We are totally opposed to that on Processed: 13-03-2009 15:08:41 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG2

Treasury Committee: Evidence Ev 35

11 November 2008 Sir David Tweedie, Mr Paul Boyle and Mr Michael Izza the grounds that if you want transparent accounting you are suggesting give investors the confidence to you show losses on loans when you have losses on reinvest in some of these assets? The suggestion has loans, not because sometime you might get one. On been made by others that it would not. the other hand, we understand that their concern is Mr Boyle: To give investors confidence you need to to preserve some form of capital in excess of what present an unbiased version of the truth; to give perhaps might be lost with the loans. There is a way depositors confidence you need to give them some they can do that and we have suggested to them that confidence that, to be honest, “rainy day” money is the way they should do it is just require certain being built up during the good times so that it can be reserves of these banks to be undistributable. spent in the bad times. I was just about to say that prudential regulators already have, and already use, powers to base their calculation of regulatory capital Q219 Mr Love: So it is all the fault of Basel II, then, on diVerent bases than the accounts. They start with or does fair value accounting have some the accounts but then they properly make responsibility? adjustments, and it is up to them, based on their Sir David Tweedie: No, it is the two in combination, regulatory objectives, to decide what the I think, which is the diYculty. You can actually appropriate adjustments are. That can be done break the link and still give the banking supervisors nationally and, also, it can be done internationally what they want and we will not aVect the integrity of by the banking supervisors. the accounting. It can be done. Mr Izza: If I can answer your first question as well, painful though fair value may be, it has got the news Q220 Mr Love: The question that keeps coming to out much faster than other methodologies might have done, leading to speedier actions to deal with my mind, as a non-accountant, is: is it possible to get the situation. It is very important that we do not seek the benefits of fair value in the good times without to shoot the messenger, in these circumstances. suVering the consequences of fair value when times are rough? There seems to be a disconnect there. Is that possible? Q222 Mr Love: Let me ask you a question following Sir David Tweedie: No, I understand what you are up from that: has fair value gone wrong? Does it go saying. It is the connection of the exuberance of the wrong in an asset bubble and the consequences that markets and “Can you damp it down a bit?” That is follow an asset bubble? In other words, does it over- what the supervisors are thinking about doing: value things when it is clear that there has been a increasing the capital requirements in exuberant disconnect with rational decision-making, and when times and then easing them oV by some formulaic the market falls (and it usually falls further than method in the bad times. The beauty about fair value rational decision-making would suggest) it all goes accounting, as the Governor of the Bank of France wrong? said, is that it brought this crisis very, very quickly Mr Izza: What I would say is that there is definitely into the open, and if it had not then I suspect we evidence that fair value may exaggerate pro- might still be having sub-prime lending going on, cyclicality. One of the things that we must be even now, and the disaster would be even worse. mindful of is that this economic crisis is the first crisis Mr Boyle: May I comment on this to, hopefully, help in which we have had to deal with fair value. The way the Committee? I think there ought to be a that we should be looking at how to take this separation of the basis on which accounting operates forward is considering that, and the IASB should be and the way in which the prudential capital consulting on that widely with people to see what requirements are operated. One example of this adjustments, if any, should be made. We should be which, again, would be a parallel is that the doing that on the basis of evidence, not on the basis calculation of profits for tax purposes is diVerent of short-term political response. from the calculation of profits for the accounts, because governments have decided that certain Q223 Mr Love: Is not the problem here, Sir David, expenditure shall not be permitted; that there have that we depend on the market and the market is not to be capital allowances, and so on. Everyone always rational, but the accounting system needs to understands that there is an appropriate rationale as be rational? to why there is a diVerence. The same rationale can Sir David Tweedie: The accounting system reflects be extended to the financial regulators. The purpose the position. Take the housing market: Mr McFall of accounting is to present an unbiased picture of the made the point earlier about how you value your financial health of an organisation. The purpose of house. I am sure we would all like to value it at what prudential regulation is biased. It is properly biased; it was a year or so ago, or hopefully in two or three it is proper that the Financial Services Authority years’ time, but it is not; it is what is there at the should be biased in favour of protecting depositors minute. That is the real reflection of what goes on. I or protecting policy holders. So they have diVerent think we just have to say: “This is it”. The markets objectives and, therefore, they can use diVerent do overshoot; we know they overshoot. What we numbers. In fact, the FSA already have— always have to look at is what are the alternatives? You have heard of historical cost. If you had historical cost for derivatives you would miss $4.5 Q221 Mr Love: Can I interrupt you there because it trillion oV the balance sheets, and that is what some was said in an earlier session that the problem here people have argued. These are gains or losses. with the system is a loss of confidence. Would what Similarly, when you look at the classical example of Processed: 13-03-2009 15:08:41 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG2

Ev 36 Treasury Committee: Evidence

11 November 2008 Sir David Tweedie, Mr Paul Boyle and Mr Michael Izza

Japan, you had a situation which was a microcosm froth oV through increased capital requirements, of what happened at the moment. You had a and how can we use that, as Paul said, to feed back situation where the Japanese banks were allowed to in when actually they are going to need that capital? freeze the loans and not write them down. Everyone You cannot keep it locked there, you are actually knew their problems, people did not lend to these going to have to release it when they need it in the banks, therefore they could not lend on, and other time—otherwise it will not be countercyclical. suddenly you found the Japanese economy is stuck That is the way I think it is going to go. for ten years, and absolutely stagnated. Just this Mr Boyle: If I may, Mr Love, what you need is not summer the Japanese Finance Minister said if it had just transparency but transparency coupled with had fair value and was out and dealt with it would intelligent decision making. have been brutal but it would have been dealt with quickly. I think, Mr Love, that is the way it has to be. Q226 Mr Love: Does one necessarily lead to the I firmly believe transparency is the way to deal with other? accounting: get it out in the open. Mr Boyle: Self-evidently not, and that is why we are in the current diYculties. The solution to this is not Q224 Mr Love: Let me just come on to that, finally, to have opaqueness. So we need transparency plus in relation to transparency. Your institute has intelligent decision making, and intelligent decision suggested and, I think, has led part of the move making includes recognising that when asset prices towards greater transparency. If you look back to are growing very fast that is normally the precursor the good times, if I can put it that way, did it suggest to them falling very fast. Therefore, we should not be any more prudential activity on behalf of the banks counting on those balance sheet values to remain and financial institutions? Did they actually take high forever. It was the fact that asset values were transparency to heart? high; the question is how do you intelligently expect Sir David Tweedie: I think everyone has learnt from what might happen in the future and have some this, the same way as we are going to have a major rainy-day money set aside to deal with that, either on committee look at: are there lessons that we can a personal basis or on a corporate basis? learn from the way we operate fair value? When you look at what exactly has happened with Q227 John Thurso: Sir David, I would like to follow transparency, the dangers of not having up on those questions on fair value but, first, could transparency are dramatic. The pension problem in I follow up very quickly on the answers you gave to the United Kingdom has only really come to light Mr Fallon about the European Commission? It is once we started making sure that companies started clear you need the robust support of the showing these pension deficits. You can argue about Government and Ministers. Are you getting it? the way they are measured, but they are deficits. Sir David Tweedie: Yes, I gather we have a lot of Previously they had not been seen. You have a support from the Treasury and from the Chancellor situation where companies lease major bits of capital and Prime Minister. equipment. I have often said that one of my big ambitions is to fly in an aircraft that is actually on Q228 John Thurso: On fair value, there seems to be, the airline’s balance sheet before I die! They are not from some of the evidence we have had this morning, there because leasing is part of the amount that you adiVerence of view. The investment community is pay for using it, yet you are locked in (if you have an very clearly in support of fair value for all the aircraft) for seven years at a fixed payment. There is reasons that have been put forward: transparency, no way you can get out of it, apart from parking in speed, getting the worst out of the way quickly, etc. the Arizona Desert, but you still have to pay. That is The banking community appears to be somewhat a liability and the other side of the right to the less in favour of that and are more in favour of aircraft. That is not shown in accounting yet. That is modified fair value to allow them to take account of on our programme and we are going to do that too. the vagaries of a market that may not exist. True I firmly believe we have just got to get everything out value, where there is a willing seller and a willing into the open. Accounting is not rocket science; we buyer, is dead simple; the problem we have here is we have just got to do the accounting the way, frankly, have got forced sellers and no buyers—and therefore you would do your own—and companies do not no market and therefore great diYculty. What is do that. your answer to them as to why historical cost accounting for financial instruments is Q225 Mr Love: I understand that and I understand inappropriate? your commitment towards transparency, but there Sir David Tweedie: One of the problems with the are some who are somewhat cynical that the connect present standard, which we inherited and is based on between transparency and prudential operation did the American standards, is the amount of intention not exist during the good times, and people worry that you can build into how you are recording the that it may not be as eVective as we think it is. results. I can buy a government bond; I can say I am Sir David Tweedie: It is going to change; I do not holding it for trading, I mark-to-market and take think there is any doubt about it. That was the gains and losses through the profit and loss account. discussion we were having on the Basel Committee I can say I am holding it to maturity, so I keep it at last week. How do we get something to do exactly the transaction price and do nothing with it until the what you are suggesting: when the markets are end. That is the historical cost model. Or I can say exuberant how do we manage to take a bit of the I’m not sure which of those two I am going to do; I’ll Processed: 13-03-2009 15:08:41 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG2

Treasury Committee: Evidence Ev 37

11 November 2008 Sir David Tweedie, Mr Paul Boyle and Mr Michael Izza hope and I’ll do what they call ‘keep it available for assets, maybe the real estimate of their value is, sale’. So I mark-to-market and then I bring the gain indeed, zero. It is like the market now for “Come on and loss in when I eventually sell it. Those are three Tim Henman” T-shirts; there are no buyers for them diVerent methods for one single piece of paper. That now. There is a serious point here: some of these does not make a lot of sense, and that is part of the products were designed in such a way that if the issue. When you go more on to the loan book, away underlying asset defaulted the resulting value of the from financial instruments, then, again, you have a financial derivative was, indeed, zero. That was the philosophical question. I have discussed this with way they were designed. Therefore the proper several central bankers. One of the arguments they accounting value for that is zero, and people need to put forward was: “If you had forced us to show fair face up to that. That is what fair value is forcing value at the time of the Sovereign loan crisis in Latin people to do. America, and so on, we could have been bankrupt.” Well, yes. The question is: “If, however, you had had to mark those to market as it started to happen, Q230 John Thurso: Is this debate, in a way, a mask to would you have kept lending—which you did do?” the real problem, which is they should not have been There is the moral hazard of all this. If you show created in the first place and, actually, we should not items at 100 you do not have to take any action. If have solid banks, whose job ought to be lending V you actually see them coming down to 95, to 85 and money, getting involved in this stu in the first place, 75, you think: “Am I going to keep lending to this and that what we need to do is create a regulation a guy?” I think the answer is going to be no, you are bit like Glass Stiegel where people who have deposits going to stop much quicker, which is why we have and look after money and are going to be protected not got the sub-prime still being loaned to at the by governments are not allowed to do these things? moment; it has stopped because people are going to Mr Boyle: The question of whether they are not have to do it. That is one of the great issues, I think, allowed is something for the FSA to think about, but and that is going to be a big debate—whether the I must say I have been personally surprised to see loan book should be at fair value. The bankers most some of the write-oVs on complex financial certainly do not want that to happen. The danger is instruments from organisations that I thought were the Latin American crisis. What is better: to warn there to provide mortgage loans into the housing them oV or are they automatically doing it? If they market. It, frankly, came as a surprise that they were are automatically doing it it does not matter so dealing in these sorts of things. They may now much, if they are aware, but nobody wants to invest question whether they had all the necessary skills to in a bank where they are convinced they are showing do that on an appropriate basis. That is something assets at higher values than they are actually worth. for the management of the banks to take up.

Q229 John Thurso: In a way, the classic loan book Q231 John Thurso: Can I move on? Sir David, you does not pose so much of a problem because you were once quoted as having said (I am sure you know have a party on either side and there is clarity, and what is coming): “If you understand IAS 39 you a reasonable judgment can be made by an informed haven’t read it properly.” Why is that? investor as to the quality of that. The problem we Sir David Tweedie: This is the standard we have on have now is we have got instruments which even the financial instruments, and it is probably about 200- Chairmen of the banks selling them do not odd pages long. It is not something that you can understand, as they told us in evidence, and which actually read and then quickly describe; it is may be inherently toxic from the moment they were something you have to dip into to find out the conceived—probably invented by a bunch of guys answer to the particular problem you have. It is with a Masters in computer games. The point is they coupled with a couple of hundred questions—again have almost no value unless there are a lot of people we inherited these. Some of them are blindingly who want to buy them. If nobody wants to buy them obvious in the answers, and the others I recall micro- then they have zero value. Is there any way that one accounting; I could not care less what the answer can deal with that, or is it just going to be a case that was it was just so insignificant. However, that was when the market is bubbling away happily these the style of accounting that was surrounding things will have a value in them but when the market financial instruments in the US and North America. crashes they will have to be written oV in their That is what the problem is. We have to completely entirety? Mr Boyle is dead keen to answer this simplify this standard, and that is what we hope to question. do with the Americans by 2011. So this is very firmly Mr Boyle: There is a sort of misunderstanding that on the list. This advisory committee that we are the banks just lend money to people. That is now setting up with the US is to get eminent people from becoming a kind of minority sport for some of the around the world to say: “This is what happened in banks. If you look at the detail of their balance the crisis. This is what the standards do. Can you sheets, a huge proportion of bank assets is in this give us some high-level views?” We do not trading in financial instruments; in some of the necessarily have to take them, of course, because we banks in excess of 50% of their total assets are these have to make our own minds up, but, clearly if the sorts of instruments. The fair value debate only whole consensus is going in the same direction it really focuses so far on that side of the bank’s would be pretty silly not to pay considerable balance sheet, and if the facts are, as in the example attention to it. So we really want to rewrite the you have quoted, that there are no buyers for these whole thing. Processed: 13-03-2009 15:08:41 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG2

Ev 38 Treasury Committee: Evidence

11 November 2008 Sir David Tweedie, Mr Paul Boyle and Mr Michael Izza

Q232 John Thurso: One of the major problems, I Commission? You consult other bodies; should know, for auditors is: what are management’s there not be a built-in anticipation in your intentions? If you take a non-financial company— organisation which has been missing to date? say, one that owns hotels—if it is owning the hotel Sir David Tweedie: We do consult with the to hold it and trade it, it is an EBITDA multiple, Commission, we see them fairly regularly, but we which is a valuation. If, on the other hand, you just did not have an inkling of this coming until, intend to sell it it gets reclassified with sometimes probably, about a fortnight beforehand. That was impairments and sometimes improvements to the the first we knew. profit and loss. How do we protect auditors from Mr Boyle: I think, Chairman, if I may say so, the what managers decide they are going to do to change problem here is there is a structural issue. The their numbers? Commission would not dream of and has no powers Sir David Tweedie: I think the answer is to remove to instruct the ECB to change interest rates or to intentions from accounting. A gleam in the eye is not instruct the Bank of England to change its rates. The actually a good accounting concept, and that is, reason for that is that a very great deal of thought basically, what I think we have got to get rid of. We was given, at the time that independence of the have to deal with it in the same way. interest-rate-setting power was handed over, to the accountability arrangements. I think, with Q233 John Thurso: Last question: under what hindsight, in the enthusiasm for moving towards circumstances should banks be allowed to use their international accounting standards, there was Y own internal models for asset pricing? probably insu cient given at that time to the Sir David Tweedie: We have rules on that and we governance and accountability arrangements. That issued some guidance at the end of last month. Quite leaves it open for people to interfere. It was the clearly, if there is a market use the market, if they are Commission this time, but the threats could come not allowed to use their models. If there is something from a variety of places—they could come from US that is very similar to what you are trying to value, Congress. So what we need to have is a set of then okay you take the prices that are in the market arrangements for which there is broad political for that and you have to make adjustments to come support and which make it impossible to interfere to your model. The third one is when you have a and to instruct the Board to do this or that. That is situation where the market is very thin, or it is a the only way in which we can prevent this from rather unusual instrument, and then you have to go recurring in the future, and that does require a more back and look at it. What is happening in this thorough debate about these arrangements. present crisis and what they are having to do is look through these instruments and say: “What are the underlying mortgages?”—and there are hundreds of Q236 Chairman: Given this is a banking crisis, the them. “Where are they coming from?” “Are they points you made are of interest to me when you said from California?” “Which particular district in that trading in financial instruments can exceed 50% California?” “How many people are actually owning of a bank’s balance sheet. It would seem to me what those houses?” “Are these buy-to-let things?” “What you are saying is that banks have now organised are the numbers of failures in that area?” That all has themselves into utilities which do the normal issues to be built into the models and the statistics. That is but have casinos attached. How far do you agree diYcult in the subjective, and it has to be constantly with that, and what lessons should banks take from moved. That is why we have just put out proposals this crisis? emphasising the need for clear assumptions to be Mr Boyle: I would not quite have used those words, shown. Plus, what alternative assumptions could but if you look at the areas of significant growth in you have shown, and what would the eVect of that the profitability of banks in the last few years, it has be? I think it is the point you made earlier—some of not been in the traditional lending area; it has been in these things are so complicated it is very, very some of these sexy derivatives and financial dealings, diYcult to manage them, and I suspect the market and, of course, the City of London has been a global for these is going to disappear in the future because leader in some of that innovation. So the upside of nobody is going to buy them, until the next all this has been the attraction of substantial generation forgets all about this and buys them at amounts of business to the City; it is regarded as that time. being a globally significant financial centre and full of innovation and creative people. These are the people who have been making the big money Q234 John Thurso: Thank you. I hope you succeed, bonuses. It is really not for us in the accounting by the way, with getting aeroplanes on the balance community to make decisions about what controls sheet. should be placed around that; our job in the Sir David Tweedie: I think we will. accounting community is to make sure that the financial consequences of that are fairly reported. Q235 Chairman: Sir David, I just want to go back a You can tell from looking at the bank balance sheets bit to the trigger for change for this October what proportion of the assets are derived from that decision. You said that it took you by surprise. If the sort of activity and which are valued on a fair value Commission, the EC, has so much power over your basis. That is a big improvement on what we had body, could that not be seen as an utter failure on previously; it is for others to judge whether that has your part to understand the mind of the gone too far and where the controls should be. Processed: 13-03-2009 15:08:41 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG2

Treasury Committee: Evidence Ev 39

11 November 2008 Sir David Tweedie, Mr Paul Boyle and Mr Michael Izza

Q237 Chairman: Sir David, you smiled there. Is Committee Chairmen really do have to be on top of there a smidgeon of sympathy for that description? their game. So it is incumbent on organisations like What should banks do in the future? mine to support them as best we can. Sir David Tweedie: I think this has been a massive lesson for the entire financial community worldwide. Q239 Chairman: Finally, Sir David, when you What has happened previously, derivatives were appeared before us last time (I think it was after used to perhaps protect for creditors or credit Enron and we were looking at corporate governance guarantees. Now we have got what they call “naked” in UK plc) you did mention, if I remember, receiving derivatives, which are actually bets. That is where a threats from corporations in America regarding lot of the problem has arisen. Certainly, there have discounting of stock options. You saw your way been a lot of those in some of the failures. They are through that battle. What other threats could speculation, pure and simple, and that is what I emanate, and from where? think has to be looked at by the regulators. Sir David Tweedie: I think the one we are in at the minute is probably the most critical to the Q238 Chairman: Last week in our evidence session organisation, because if we have another “carve out” the issue of non-executive directors came up, and it in Europe people are going to feel that Europe has certainly surprised me that some of the non- gone, and suddenly, instead of 100-odd countries executive directors knew their way about the City using our standards, there is 75, and you then find and had a pedigree in financial services, yet missed a that others will start thinking: “If we aren’t going to lot of this. Are there lessons here for non-executive have a unified global system, should we, in fact, directors? simply have equivalence? We will deem the Mr Izza: Chairman, I also saw the evidence that was European style of accounting equivalent to the US given to you last week, and I thought there are real standards equivalent to the Japanese”, and so on. some lessons that we can take from it. Firstly, the That is the big danger. I think in the United States financial institutions are incredibly complex, and I they are incredulous at what has happened. When think it was Lord Turner who said that one of the we are just on the verge of getting the United States things we must look at going forward is how much signed up, this happens, and that has come as a time non-executive directors actually do spend massive shock and disappointment to the United understanding these organisations, because they are States, and also everywhere else. There is a danger not things that you can spend a day every two now that this could be set back for a generation. months on; they are very complex animals. The That is the situation we are in. Michael asked me other thing that bodies like mine also have to do is why I did not resign. It is because I want to win this give our non-executive directors as much support as one, and we are almost there; I would hate to walk we possibly can because, quite frankly, they need it. away at this stage. We may lose, and that might be With that in mind, we have convened a meeting on the time to go. 9 December of all the listed Audit Committee Chairman: You won the stock options one, so let us Chairmen because this year-end is going to be a year- hope that you win this one, Sir David. Can I thank end like they have not experienced before; there are you and your colleagues for attending this morning; just so many issues to deal with, and the Audit it was very helpful. Processed: 13-03-2009 15:08:57 Page Layout: COENEW [SE] PPSysB Job: 416782 Unit: PAG3

Ev 40 Treasury Committee: Evidence

Tuesday 18 November 2008

Members present

John McFall, in the Chair

Nick Ainger Mr Andrew Love Mr Graham Brady Mr George Mudie Jim Cousins Mr Mark Todd

Witnesses: Mr Richard Pym, Chairman, and Mr Rod Kent, former Chairman, Bradford & Bingley, gave evidence.

Q240 Chairman: Good morning and welcome to our 48 hours did not pass without that changing. That is inquiry into the banking crisis. For the shorthand rather dramatic. I can sympathise with people who writer, can you please introduce yourselves? say that may have been misleading. Mr Kent, did Mr Pym: Richard Pym, Chairman. you have sight of the statement that the chief Mr Kent: Roderick Kent, former Chairman. executive was about to make? Mr Kent: Yes, I did. Q241 Chairman: When did you step down, Mr Kent? Mr Kent: Last Friday. Q244 Chairman: You agreed with everything on that? Q242 Chairman: Thank you very much. Mr Pym, on Mr Kent: Yes, I did. Thursday 25 September, you stated that: “We are a strongly capitalised bank now undertaking a Q245 Chairman: Okay. Did you agree with the complex transition with regrettable job losses, but FSA’s verdict that you no longer met your threshold we are planning to put the problems of the past conditions? behind us and have a business which is fit for Mr Pym: The position on the Wednesday was we purpose going forward.” A couple of days later, on had an outflow of funds from the branches and from Saturday 27 September, the FSA found Bradford & online of only £12 million. Previously that week it Bingley no longer able to meet the threshold had been a lot higher because of media speculation, conditions they had placed upon you. Is it fair to so by the Wednesday things had normalised, we describe yourself as the financial services’ Michael were holding our own in UK deposits, but on that Fish in that you suggested good financial weather Thursday, after we made the statement, we lost £26 shortly and everything fine, and then you were million. On the Friday, following further media struck down by a storm and a hurricane taking reporting, we lost around £90 million and by everything away? lunchtime on the Saturday we had an outflow of Mr Pym: Well, that statement was true at the time; around £200 million branches and online, and it was we were a strongly capitalised bank. The summer that which forced the FSA to act. rights issue had created a bank with a Tier 1 capital ratio of 9.9% and that was one of the strongest capitalised banks in the UK, if not in Europe, and Q246 Chairman: If I ask my question again: did you the Chancellor of the Exchequer had certainly agree with the FSA’s verdict that you no longer met guaranteed eVectively UK savers by saying he would your threshold conditions on 27 September? do whatever was necessary, so we were a strong Mr Pym: That is a matter for the FSA, but they had savings bank. During that week we had taken a lot to act because of the outflow. of steps to de-risk the bank. We had sold all of our collateralised loan obligations, all our CDOs, the Q247 Chairman: I am asking you, did you agree debt obligations, we had reduced our headcount by with them? 370 and we had capped our liability to GMAC by £1 Mr Pym: It is very hard for me to say. It was a billion. So we had taken a lot of steps to de-risk the diYcult position and something had to happen. bank. That statement also made clear that we were undertaking a complex transition and that was the warning that this was not going to be an easy period. Q248 Chairman: Did they pull the trigger too We were working against a very diYcult quickly? background. The Lloyds rescue of Halifax on 18 Mr Pym: No. September and the media— Q249 Chairman: So you agreed with them? Q243 Chairman: I will just concentrate on the two Mr Pym: I do not think they pulled the trigger too days. It seems quite alarming that in a period of two quickly. days you made the statement on Thursday and then you had to make another statement on Saturday,1 so Q250 Chairman: So if they did not pull the trigger 1 Note by witness: No statement was issued by the company too quickly, implied in that is that you agreed with on the Saturday. them. Processed: 13-03-2009 15:08:57 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG3

Treasury Committee: Evidence Ev 41

18 November 2008 Mr Richard Pym and Mr Rod Kent

Mr Pym: I accept the implication. Mr Pym: I would not describe the statement as “bright”. The FSA had seen the statement from its Q251 Chairman: Okay, fine. So what had changed first draft the previous week through to earlier that between Thursday 25 September and Saturday 27 week. We were sharing everything very, very closely September that meant the FSA no longer felt that with the Financial Services Authority and with the you met your threshold conditions, other than the Bank of England and were working very, very reasons you have given me so far? closely with them. There was a full exchange of Mr Pym: After the Halifax was rescued by Lloyds on information at all times. 18 September, the whole media attention was on, “Who is next?” As the last mortgage bank standing Q258 Chairman: At what time on the Saturday did that meant all the media focus was on us. After you make that statement?2 At what time on the Lehman’s folded, Washington Mutual, Fanny Mae, Saturday did you no longer meet your threshold Freddie Mac, poor little Bradford & Bingley, the last conditions? mortgage bank standing was always going to be the Mr Pym: I think the telephone conference was centre of media attention and, therefore, there was a around 11.30? loss of customer confidence. Mr Kent: About 11.30.

Q252 Chairman: So why was it Bradford & Bingley Q259 Chairman: 11.30 in the morning? rather than some other small banks? Why did they Mr Pym: Yes. focus on you and why did they focus on you particularly when you had come out with a very Q260 Chairman: What time did you make the robust statement on the Thursday and all it seemed statement on the Thursday? to do was trigger the release of funds? There must Mr Pym: At the opening of business, so the have been something in your business structure that statement was issued at 7am.3 the market and others did not agree with. Mr Pym: The reason why they focused on us was that we were the only one left. Q261 Chairman: Really on the Friday you realised within 24 hours that things were going downhill and you must have had intense negotiations with the Q253 Chairman: So it was nothing to do with your FSA on Friday. business model, nothing to do with the underlying Mr Pym: We were in close contact but, as I have situation, it was just that you, as Chief Executive, indicated, it was the Friday night and the Saturday and yourself, as Chairman, made a very robust morning when it became very intense. statement and said, “Look guys, we’re here to stay” but within 24 hours everything changed enormously? Q262 Chairman: So when was the decision taken on Mr Pym: There is no denying that a mortgage bank the Friday that the FSA no longer felt you could with a large element of self-certified mortgages and meet the threshold conditions? a buy-to-let book is not going to be an attractive Mr Pym: We were informed on the Saturday asset in these financial markets. morning that their executive committee had met and determined that, but when exactly that committee met I cannot say, I am afraid. Q254 Chairman: The market was talking about your relationship with GMAC and your buy-to-let mortgages for quite a long time, so there was a buzz Q263 Chairman: You must have had intense there in the market. Irrespective of what you are negotiations on Friday with the FSA, describe them saying, your business model was up for questioning. to us. Mr Pym: But earlier that week we had capped our Mr Pym: We were in very close contact and during liability. high periods of customer activity the FSA were receiving hourly reports on our cash flows. Q255 Chairman: The business model was up for questioning. Q264 Chairman: So on the Friday night before you Mr Pym: We had stopped all acquisitions from retired to bed was there a feeling that on the GMAC from the first quarter of 2009 onwards, so Saturday things were not going to go so well? we had capped that liability. Mr Pym: We saw Robert Peston’s blog at 4.50 and at that point I think we realised things were not looking too good. Q256 Chairman: Did the FSA have sight of the statement that you made on Thursday 25 September? Q265 Chairman: Why was the decision taken to Mr Pym: Yes. divide Bradford & Bingley between its mortgage side and the rest of the business, rather than trying to keep it going as a single entity as was the case with Q257 Chairman: So they had agreed. If I get Lord Northern Rock? Turner along here he will say that the FSA spoke with you and agreed you had a very, very strong 2 Note by witness: No statement was issued by the company business model and they saw the way forward in as on the Saturday. optimistic and as bright a way as you? 3 Witness correction: The statement was issued at 10.55am. Processed: 13-03-2009 15:08:57 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG3

Ev 42 Treasury Committee: Evidence

18 November 2008 Mr Richard Pym and Mr Rod Kent

Mr Pym: I believe that is the standard contingency Q274 Chairman: Over those two days, when did you plan by the Financial Services Authority as the new know the game was up? This is of real interest to us way to solve banks with outflows. as a Committee, particularly the pulling of the trigger. Q266 Chairman: Yes, but Northern Rock was Mr Kent: I understand that, Chairman. There was treated diVerently. no particular time that we knew the game was up. Mr Kent: First of all, that was not our decision and We were experiencing outflows of funds— we had no part in that. We were asked to provide information to enable people to look at the deposit Q275 Chairman: So you retired to bed on Friday taking business only. That was not our decision at night thinking it was going to be the usual Saturday? all. Mr Kent: It could have been. It could have been, but then there was a rapid acceleration of customer Q267 Chairman: That was the FSA’s decision? activity on Saturday morning and over the Mr Kent: It was entirely the FSA’s decision. weekend— Q276 Chairman: What time was that call on Q268 Chairman: So would it be fair to say that the Saturday morning and it was agreed with the FSA, FSA and the Government reached the conclusion “Look, we want to make the statement at 11.30”?4 that you were bust so the approach by them was Mr Kent: They phoned us. diVerent from Northern Rock? You were down the pan. Q277 Chairman: At what time? Mr Kent: They decided that we did not meet their Mr Kent: At 11.30 and said, “We have something to threshold condition and then they told us that they tell you” and they then informed us that their were intending to do that. committee had reached that conclusion. They then told us that we were able to appeal against it if we Q269 Chairman: So you were bust? wished to, but please could we make it quick and let Mr Kent: That is not correct. At the time when we them know by 12.30. transferred into public ownership we were both solvent and well above our regulatory minimum on Q278 Chairman: But you never appealed? capital, we were still well capitalised. Mr Kent: We obviously talked to our colleagues quickly, we also talked to our lawyers and decided Q270 Chairman: Why did we have that situation that since we had been in constant contact appeal with yourselves rather than Northern Rock? In was not appropriate. other words, why were no other options explored by yourselves and by the authorities? Q279 Chairman: Mr Pym, you will sympathise with Mr Kent: We had been, and I can give you quite a lot shareholders and others who maybe feel that the of history and narrative on that, looking at all sorts statement you made on the Thursday was of options for many months and tried to bring them misleading and they lost money as a result of that? to pass, but at the actual time of transfer to public Mr Pym: I do not think it was misleading, every ownership we were not party to any discussions as to statement there was accurate. the options. Q280 Chairman: You could have a smidgen of Q271 Chairman: The way you are describing it to sympathy with them? me, it seems that you gave up without a fight on Mr Pym: The outcome is very unsatisfactory. On the Friday. that Thursday we took a lot of steps to de-risk the Mr Kent: No, no, on the Saturday. We did not give bank and we were planning for the future, things Y up the fight on Friday. We were informing the FSA turned round later. We always knew it was a di cult about the outflows that we were experiencing, they position. I think it is interesting that on Thursday, became worse on the Saturday, as Mr Pym has just even though we had taken out more than 10% of the said, but actually it was on Saturday morning that workforce, we had de-risked the bank, we had we received the call. We did not know that they were capped our liability to GMAC, the share price edged about to tell us that. down on that day, which I think was an indication of how the market reacted, they did not take it as an optimistic statement, but they took the signals Q272 Chairman: If the call was made on the accurately. Saturday at 11.30, surely Armageddon did not come between eight o’clock on Saturday morning and Q281 Nick Ainger: In response to a question from 11.25? the Chairman you made reference to Robert Mr Kent: It is up to them to make that decision, not Peston’s blog and you were implying something by us. The precise timing of their committee meetings that. What were you implying? we honestly do not know. Mr Pym: I think throughout the banking crisis Robert Peston has been an accurate source of Q273 Chairman: When did you know the game was information. We were aware during Friday up really? Mr Kent: We were increasingly concerned basically 4 Note by witness: No statement was issued by the company on ever since Lehman’s went bust on the 15th. the Saturday. Processed: 13-03-2009 15:08:57 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG3

Treasury Committee: Evidence Ev 43

18 November 2008 Mr Richard Pym and Mr Rod Kent afternoon that we might be featured and at 4.50 the down, the arrears function will be building up blog came out saying there was a chance that we depending on the economy. We have to provide would be rescued subsequently. Also, overnight we transitional services to Abbey and their contract became aware that the Daily Mail and Daily with us expires in the first quarter of 2010. The Telegraph would be featuring big articles on us. One planning of their exit is not finalised yet, but of the things that customers are most sensitive to are depending on when Abbey withdraw from using when business stories move from the back pages to Bradford & Bingley services there will be a reduction the front page, and I am afraid on that Saturday in jobs at that point. morning we ended up on the front page of both the Daily Mail and the Daily Telegraph and at that point customers reacted in the way you would anticipate. Q286 Nick Ainger: Your shareholder framework document sets out priorities for a new incentive Q282 Nick Ainger: Presumably the BBC was structure. How far have you got in completing that? carrying stories as well? Mr Pym: The new incentive plan, as the Framework Mr Pym: The BBC and Sky. Agreement makes clear, will be based on the targets in the business plan and the business plan has not Q283 Nick Ainger: Can we move on to your been agreed and, therefore, neither has the incentive submission. You tell us that there is a need to scheme. So we have the incentive scheme for 2008 restructure and realign Bradford & Bingley by which remains in place, save that obviously there is reducing costs. You tell us in that submission that no payment whatsoever for the profit element of the 370 roles would be lost following your 25 September scheme. Any scheme for 2009 will have to wait until statement. First of all, 370 roles, roles means jobs, the business plan has been agreed. does it? Mr Pym: Yes. Q287 Nick Ainger: What about for this year? Mr Pym: For this year, 2008, as I said the profit Q284 Nick Ainger: How are you going to minimise element will be zero. The current bonus scheme will the impact on the community, which you also state continue to operate but the payments will be much, you want to try and achieve in that statement? much reduced on the previous year. We are Mr Pym: Can I summarise the current headcount expecting aggregate payout of less than 9% of the and then talk about how we go from here. At the end salary bill. of August we had 3,100 people. The transfer to Abbey took out 1,700 people and the closure of new mortgage processing took out 300. The diVerence Q288 Nick Ainger: That scheme runs right the way V between the 300 and the 370 is mortgage sales sta across the whole range of staV? who have now transferred to Abbey. We have 1,100 Mr Pym: Yes. people working for us now, so it is already much reduced, and those people are working essentially in West Yorkshire. We are very mindful of our Q289 Nick Ainger: It is a similar scheme throughout obligations to the community and we are working the whole of the structure, is it? with Yorkshire Forward and Bradford Council. In Mr Pym: No, it is not identical throughout the terms of the subsequent rundown, that will be structure, but that scheme was already in place, phased over quite a long period. We have currently continues in place and payments will be made got a voluntary redundancy programme and we are strictly according to the rules of the scheme with no expecting between 50 and 100 people to leave on discretion whatsoever. Then a new scheme will be voluntary redundancy. The Chancellor gave a launched per the Framework Agreement for next guarantee of no compulsory redundancies before 31 year only once the business plan is agreed. March and that will be complied with precisely and then the job losses will be phased over a period. It is interesting that next year we expect to have, as an Q290 Nick Ainger: The incentive scheme for the example, over 400 people in the arrears function and directors in 2007, total directors’ emoluments were until the arrears do come down we will have a lot of £3,772,000. Bearing in mind what has happened, do people working in the arrears area. From the you think those emoluments were justified? community’s point of view, it is important that any Mr Pym: I am afraid I cannot talk about 2007. job losses are phased over a period rather than in great lumps of people leaving our employment and I think that will be the case. We are working very Q291 Nick Ainger: Perhaps Mr Kent could answer closely with Yorkshire Forward to manage this that. transition. Mr Kent: At the time we were trading quite well and, therefore, the scheme which is overseen by the Q285 Nick Ainger: So by the end of next year how remuneration committee kicked in in the normal many staV do you expect to be employing? way. There was no criticism of it at the time by our Mr Pym: I am afraid I cannot answer that question shareholders or anybody. Yes, I do think it was at the moment because we have not completed our justified. It is worth saying that in respect of 2008, business plan. It might be quite similar to where we other than Mr Pym himself, none of the executive are now because as some of the other areas run directors will be getting any bonus of any sort at all. Processed: 13-03-2009 15:08:57 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG3

Ev 44 Treasury Committee: Evidence

18 November 2008 Mr Richard Pym and Mr Rod Kent

Q292 Nick Ainger: Part of the objectives of the new Mr Pym: We are now undertaking a transition to a arrangement includes protection of consumers. Is much smaller organisation. I have had private that role going to be included in the incentive discussions with each of the executive directors as to scheme? How are you going to reward your staV for when I would expect that transition to have been protecting consumers? completed and their services to be no longer Mr Pym: The part of the Framework Agreement required, but we have to provide a service to Abbey, that concerns protection of customers was we have to rundown the business and we have to essentially achieved by the nationalisation of the manage our arrears better. There is a job to be done, bank and the transfer to Abbey. The remaining and when that job is done the executive directors will objective in the Framework Agreement that we have leave and I will stand down, probably in the summer to comply with is the protection of taxpayers. of next year, without any compensation whatsoever However, the treatment of customers is absolutely as I hand over to, I would propose, subject to crucial. We are very advanced in treating customers agreement with the Treasury, a new managing fairly and that certainly extends very rigorously in director as we set up the business with a much lower the arrears area. We will be determining customer cost base. We are very conscious of the need to measures for next year in our business plan and we remove the higher paid people and manage ourselves will have to work out with our shareholder the into a much lower paid organisation fit for purpose element of that, if any, to which bonuses apply. But going forward, and that means all the executive Bradford & Bingley as an organisation is very good directors will almost certainly be departing next with customers. If I might just give you an year. illustration: on that Saturday morning when we were being overrun by customer activity we only had Q296 Nick Ainger: You referred earlier to the queues in four branches which were quickly business plan, when do you plan to publish that? dissipated. Extra staV came in and people came into Mr Pym: We are required to publish it by the end the call centre volunteering to man the phones. We of March. shut that Saturday lunchtime, one o’clock, with every customer served, no queues by the end of that Q297 Nick Ainger: By the end of March? day, everyone went out with the money that they Mr Pym: Yes. wanted, and I think that is a great source of pride to the organisation in a desperate situation. The Q298 Nick Ainger: Is that not quite a while? Bradford & Bingley team are absolutely committed Mr Pym: We have a six month period to prepare it to giving good customer service, it is absolutely in and submit it to the European Union. The way in the culture of the place. which it will be published is a matter for the Treasury. Q293 Nick Ainger: That is a glowing reference for V Q299 Nick Ainger: Do you plan during that period your sta . Is the fact that four of the non-executive and after the business plan is published to be giving directors have resigned an admission by them that V regular updates on Bradford & Bingley’s positions? perhaps they did not perform as well as their sta Mr Pym: Our position is slightly diVerent from the did? other nationalised bank where a return to the private Mr Kent: No. When we were transferred into public sector is intended at some stage. We are in runoV and ownership all the non-executive directors naturally the reporting requirements of that will be agreed V o ered their resignation. We were asked by the with the Treasury and communicated. That has not Treasury to stay on, all of us, until they had made up been determined yet. We are in a diVerent position their mind as to the structure of the board going being solely in runoV. forward and to oversee in this initial transitional period the beginnings of the new plan. Two of our Q300 Chairman: Further to Nick’s point about the non-executives are staying on and the rest of us, four bonuses, just to get it on the record, you have an of us, are leaving because that period of time is now annual salary of £750,000? over. It was foreseen at the time and we stood by our Mr Pym: Yes. posts as requested. Q301 Chairman: You are entitled to £652,000 bonus Q294 Nick Ainger: Has nobody accepted any sort of initially intended to be divided between shares and responsibility at senior management level for what cash, but you intend to take the £326,000 cash, is happened? that correct? Mr Kent: Let me say straight away absolutely the Mr Pym: That is correct. Half the bonus was in board accepts it is fully accountable for what shares, half the bonus is in cash. Obviously the share happened. Let me also say that we are massively element has fallen away, the cash element remains, disappointed and deeply sorry that this has and I will be standing down without any happened, there is no question about that. compensation whatsoever when the job is done next summer.

Q295 Nick Ainger: Four non-executives have gone Q302 Mr Mudie: The point the Chairman was now but no executive director has resigned. Why is making was it is reported you are on 750,000 plus a that, Mr Pym? guaranteed annual bonus of 350,000, is that so? Processed: 13-03-2009 15:08:57 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG3

Treasury Committee: Evidence Ev 45

18 November 2008 Mr Richard Pym and Mr Rod Kent

Mr Pym: There has been a lot of misreporting. Mr Kent: It would not be a huge amount.

Q303 Mr Mudie: This is your chance to put it right. Q310 Mr Mudie: Would it not? Mr Pym: Thank you for the opportunity. There was Mr Kent: The overall executive director pay as a a guaranteed bonus when I joined and I stood down percentage of the total payroll is quite small. from other activities to take this position on 18 August of this year and the cash element is 139,000 Q311 Mr Mudie: The 2007 bonus appears to be the for this year and 187,000 next year. last year of a three year deal in terms of being Mr Kent: Could I say something. Our previous chief delivered in shares. executive became seriously ill at the end of May 2008 Mr Kent: Yes. and I was appointed by the board to step in and take over. One of the first priorities was to find a new chief executive. This was not an amazingly attractive post, Q312 Mr Mudie: In your directors’ emoluments Mr if I can put it that way, and therefore it was up to us Crawshaw got his salary 640,000, his benefits 8,500, to put together as a board a remuneration package his payment in lieu of pension 192,000 and then there which would attract somebody, and that was what is a short-term cash element paid of 272,000, what we did with Richard Pym and he came in to a was that? diYcult situation, of course. In his defence, that was Mr Kent: That is the short-term cash element for— what was necessary in the marketplace and we took external advice to attract somebody of his calibre to Q313 Mr Mudie: I know it is short-term, that is what come in. I said. Mr Kent: It is a cash bonus. Q304 Mr Mudie: Obviously bonuses are of interest now and it is the way they are shared in terms of Q314 Mr Mudie: So that is the bonus, 272,000? executives and staV. I thought I caught you saying, Mr Kent: Yes, it is indeed. Mr Pym, that the total bonus element of pay was 9% across the company. That goes from the top to the bottom? Q315 Mr Mudie: What is that as a proportion of Mr Pym: Yes. 640,000? You are a banker, you can tell me just like that. Q305 Mr Mudie: We got the Annual Report for 2007 Mr Kent: That is about 40%, is it not? five minutes before we started, but there is reference to the executive’s bonus and hitting a level of Q316 Mr Mudie: Not bad, is it? performance is 50% and above performance the Mr Kent: No, not bad at all. These were highly limit is 150%. How does that tie in with that 9%? paid people. Mr Pym: There are no payments to the executive directors who were in post at the time of the rights Q317 Mr Mudie: My Pym’s bonus is guaranteed. issue in 2008. There are no bonuses. Mr Kent: Yes.

Q306 Mr Mudie: I am not arguing about who was in post or out of post. I am trying to see the equity of a Q318 Mr Mudie: Why is a bonus guaranteed? If it is 9% bonus payment that sounds wonderful guaranteed should it be on his salary? A bonus is throughout the company, and I applaud it, except there for performance. for the executives in the latest Annual Report we Mr Kent: Normally that is the case but when you are having to attract somebody at high speed to a have got their bonus payments were designed to Y deliver 50% and up to 150%. Mr Kent is nodding. di cult job you do need to make exceptions, and Mr Kent: That was for 2007. I do not have in my that is not unusual in the employment market mind— amongst bankers.

Q307 Mr Mudie: What were the annual bonus Q319 Mr Mudie: So you paid shares in 2007, nothing payments in 2007 throughout the company? at all is being paid to the executives? Mr Kent: I would guess roughly twice. I can give you Mr Kent: Nothing at all. the details of that later. Q320 Mr Mudie: But the ordinary staV doing the Q308 Mr Mudie: What does that mean, 18%? work will receive their 9% this year instead of 18%? Mr Kent: I would guess that. I do not have the figure Mr Kent: That is on average. immediately to hand but we can certainly provide it to you later if you wish.5 Q321 Mr Mudie: Is the Government, as the shareholder, having any active discussions with you Q309 Mr Mudie: I just wonder what the eVect of about the make-up of the 2009 bonus? taking 150% out for bonus payments for the Mr Pym: That is inherent in the Framework executives is for the lass on the front till? Agreement, that there will be an incentive programme based on achieving the targets in the 5 Note by witness: The figure is 16%. business plan. Processed: 13-03-2009 15:08:57 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG3

Ev 46 Treasury Committee: Evidence

18 November 2008 Mr Richard Pym and Mr Rod Kent

Q322 Mr Mudie: That is always the case. The comes down; so I do not really think anything you question I am putting to you is, is the Government, could say could allay that—it is the perception that as the shareholder, taking an active part in designing is out there. that bonus scheme? Mr Kent: If you do not think that is useful, I will not. Mr Pym: They will have, yes. Q329 Mr Brady: First of all, to go back to something Q323 Mr Mudie: They are, or have you not started from earlier, I think you said the first you heard of yet? the possibility of rescue was Robert Peston’s blog on Mr Pym: We have not started to design that scheme, the Friday evening. When was the first conversation we have not completed the business plan. Once we you had when the possibility of public ownership have the business plan it will not be diYcult to design was mentioned? the incentive scheme. Mr Pym: I think we were always aware of it in the background, as part of the contingency planning. I Q324 Mr Mudie: You are above it because yours is think we only became truly aware of it at 11.30 on guaranteed, is it not? the Saturday morning. Can I just say that there was Mr Pym: I do not expect to be participating in the a large amount of contingency planning going on new bonus scheme. throughout this period. It was not just focused on Bradford & Bingley; I am sure it applies to all banks, Q325 Chairman: Mr Pym, you were appointed in in that a lot of information was being prepared in August 2008 so you have nothing to do with 2007. case of a serious situation; so we were very conscious One of the issues in our Committee inquiry into the that a lot of information was being passed privately, banking crisis is looking at executive remuneration so that should a distress situation arise, the FSA and from the point of view of incentivising individuals the Bank of England were prepared. It is a credit to but also ensuring the stability of the company. I both organisations that at lunchtime on that think there are numerous examples which have Saturday they were able to produce an information shown that there has been executive remuneration memorandum which they issued to a large number for the short-term, but the medium and long-term of of banks across Europe to enable them to conduct the company has not been secured. That culture has the auction, which ultimately resulted in the sale of promoted excessive risk. Would you say, coming to the deposit business to Abbey. Therefore, I think in Bradford & Bingley, that there is a kernel of truth in our minds we knew that there was a lot of the assertion that excessive risks could have been contingency planning going on. The precise time taken as a result of the bonus culture? that we knew this was a serious option I think was Mr Pym: I do not know what the motivation was on that Saturday morning. because I was not there. This was a business that focused on the buy-to-let market and until early in 2008 arrears on buy-to-let property were below Q330 Mr Brady: Just to pursue this a little further, general residential mortgages, that is shown in the you said you had always been aware that it was in the recent FSA thematic review on buy-to-let lending, contingency planning, going back to the time when but the thematic review does show that in a Northern Rock was taken into public ownership? downturn buy-to-let might suVer more than normal Mr Pym: On the day I arrived, on August 18, I was residential. aware that contingency planning was at a high level. Mr Kent: If I may, I think you should not under- Q326 Chairman: I know that. We have heard all this estimate the step-change that we experienced on our information before. Forgive me, it is not that that I supervision by the FSA immediately after the V am interested in. I am interested in the issue of Northern Rock a air; so in October 2007 we were excessive risk-taking. We are talking here about definitely aware of heightened supervision. At many bonuses which George has elicited of 50 to 150% and times we were reporting on a daily basis to them, then the former chief executive’s 40%. There seems particularly in respect of liquidity, and we were V to be a little bit of slackness there. discussing a whole di erent range of items, mainly to Mr Pym: Can I say that I have not—I just have not do with funding and liquidity funding, rather than thought about what has gone on in the past. My job the normal processes of ARROW which is a risk is to fix the bank going forward. determination, and Basel II, which had been a large Mr Kent: You are asking Mr Pym about what he piece of work for us and all other banks. At the same found. If you like, Chairman, I can describe how we time, in that autumn, we were first contacted by the looked at it in 2007, and the bonus scheme was in Bank of England. I speak at my level as Chairman place. and Chief Executive; and their involvement stepped up quite noticeably. I have to say that both organisations, myself and the Chief Executive at the Q327 Chairman: The thing is, that the company time and now with Richard Pym, had instant access came down; Mr Pym commenced— to the very highest levels of the Bank of England and Mr Kent: I understand that. of the FSA, and we were not afraid to use it. Q328 Chairman: Therefore, when you get bonuses of 50%, 100%, 150%, they do not relate to ordinary Q331 Mr Brady: Was the contingency planning that circumstances. The public are pretty dumbfounded was in place as detailed as looking at the eventual when they read of that, particularly when somebody restructuring that happened? Processed: 13-03-2009 15:08:57 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG3

Treasury Committee: Evidence Ev 47

18 November 2008 Mr Richard Pym and Mr Rod Kent

Mr Kent: The FSA were constantly quizzing us whole book, of £1.2 billion; and that compares to about our contingency planning, and we were capital resources in the bank, shareholders’ funds, of constantly relating how we would do it. That was in £1.7 billion. At the current time it looks as if the a normal commercial environment. capital of the bank exceeds the likely loss on the book. Q332 Mr Brady: When the prospect of public ownership was formally aired, how involved were Q337 Mr Todd: At the moment. you with the restructuring that took place? Was that Mr Pym: Yes, and that is predicting future house proposed to you, or was that your proposition to the prices downwards. authorities? Mr Pym: That was the authorities’ solution to us. Q338 Mr Todd: Yes, you mentioned it was based on some stress testing. You touched earlier on the intent Q333 Mr Todd: Can we move to the task in hand, to raise the number of people handling arrears and which is dealing with the run-oV and the risks that sounds as if it is a practical task you are dealing involved in that—so I suspect this is Mr Pym! The with now. Have you advanced the number? There arrears analysis that—you referred briefly to the was a reference in September to an extra 70 relatively favourable position of buy-to-let positions. mortgages, but what is your picture of the current Mr Pym: Yes, when I arrived at the bank in August loan book and its arrears liabilities? we had just 200 staV in that area. By the end of this Mr Pym: If you look at the national statistics, there year we expect to have 300, and by the middle of next is an uptick in arrears on buy-to-let mortgages, year we could peak at over 400 in that area. which is faster than general residential. That is certainly the case with our book as well. The recent reduction in base rate will make quite a significant Q339 Mr Todd: Presumably, they are all being eVect though on buy-to-let landlords, because their trained on the new code for dealing with arrears? payments will have reduced by between 20% and Mr Pym: Yes, absolutely. 25%. So provided that rents do not fall by that level, the margin that they earn will be improved. Short Q340 Mr Todd: You mentioned your strong term, by one of these strange rules of arithmetic, the customer-relations record. The example you gave arrears actually go up, because you divide your was in terms of savers and depositors. arrears by the monthly payments, so when the Mr Pym: Yes. monthly payments fall the arrears per cent goes up; but, obviously, after a period the customer’s ability to repay improves. It is very diYcult to predict the Q341 Mr Todd: Does the same care go towards those eventual level, the peak of arrears on buy-to-let, who have borrowed from you? because it is a market that has not existed to this Mr Pym: Yes, it does. Certainly, if you get to the extent before. regrettable position of a possession case, there has to be a final sign-oV by an independent member of staV of adherence to regulation protocol and policy Q334 Mr Todd: What is your current data? We have before any possession takes eVect. But in our book, seen what the Council of Mortgage Lenders is with 60% buy-to-let we are not as exposed to the saying; how do you measure against that? owner/occupier repossessions to the same extent as Mr Pym: The total arrears in the business—and the others. On a buy-to-let case we can appoint an LPA business I remind you is 60% buy-to-let, and 20% receiver to take over the rental payments to cover self-certified—the total arrears including our interest obligations. possessions was 2.48% at the end of June, which is above the level of the Council of Mortgage Lenders overall, and at the end of September it was over 3%. Q342 Mr Todd: The rental market place remains relatively buoyant at the moment. Q335 Mr Todd: So you are materially more exposed Mr Pym: Reports vary. There are some reports this than most other mortgage lenders at the moment? morning that there may be a small decline in rental Mr Pym: Yes, we are. The deterioration that was levels. I commented earlier that the payments visible in the second quarter continued into the following the last base rate reduction could fall third quarter. between 20% and 25%, so that should increase customers’ ability to pay. Q336 Mr Todd: You have presumably done some stress testing on trends that are predictable, both in Q343 Mr Todd: The run-oV business owes the FSCS the rental market place, which must be an issue for and the Treasury for loans which enable the transfer buy-to-let and also in the housing market overall, in to the remainder of the bank to the Abbey and for terms of the capital value of the assets themselves. you to continue in activity. How quickly do you What is that telling you? think you will be able to repay the loans? Mr Pym: The last estimate of total loss on the loan Mr Pym: We are very conscious of that obligation, book—and the loan book is around £40 billion— but the speed at which it can be repaid will be was between £600 million and £800 million. The determined by the business plan, and we have not Moody’s estimated stress loss in the latest Moody’s completed that, so I do not think I should speculate rating report was a total loss over the cycle, for the on a repayment profile yet. Processed: 13-03-2009 15:08:57 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG3

Ev 48 Treasury Committee: Evidence

18 November 2008 Mr Richard Pym and Mr Rod Kent

Q344 Mr Todd: Have you started any repayment? Q353 Mr Brady: How often each day would any of Mr Pym: No. you speak to the Treasury? Mr Pym: I guess there is someone talking to the Q345 Mr Todd: Okay. What do you think the main Treasury every day. My meetings are fortnightly, risks are? We have discussed some of them in but with telephone calls in between. discussion of your book; are there any other risks that you think the public should be made aware of? Q354 Mr Brady: Finally, can I ask you: has the Mr Pym: Obviously, when you are managing a £40 Treasury charged back, as the relationship billion mortgage portfolio, which is made up of buy- framework allows, the cost of the implementation of to-let and self-certified, all the risk is in those areas. the transfer order and the other costs from exercising One of the emerging issues for the mortgage market its shareholder function? as a whole is mortgage fraud, and certainly the FSA Mr Pym: I am not aware that they have, but they thematic review does point out that in some areas of certainly will. the buy-to-let market there is high fraud; so this is not just the economic problems of repaying a debt; Q355 Jim Cousins: Just to clear up a point that has this is also a market that has attracted people with been put in play, you are not paying interest to the less than honest motivations, and there are certainly FSCS money, but you are paying interest on the illustrations that I can see of fraudulent valuations, loans from the Government to meet it. What is that which over time will be the subject of legal action rate of interest? and insurance recoveries. There is a fraud element in Mr Pym: Those rates of interest are variable by the our book, which is regrettable, and we are getting on type of facility, whether it is the working capital with it. facility; there is a guarantee fee; there is the Bank of England fee for the special liquidity scheme—so Q346 Mr Todd: Have you made any estimates as to there is a whole mix of rates payable, but which are the scale? designed to replicate, as far as is possible, a Mr Pym: Not yet. We do monitor the fraud cases, commercial rate to avoid any state-aid but I would not want to speculate on the ultimate considerations arising. scale at the moment. Q356 Jim Cousins: So let us be clear about this: there Q347 Mr Todd: You are not paying interest on the is no element of penalty in that; it is intended to money from the FSCS—is that right? replicate a commercial rate. Mr Pym: That is the current plan. Mr Pym: Yes, but there is still some debate on some of those rates to replicate a proper commercial rate Q348 Mr Todd: That is a rather carefully qualified for a bank of our type. answer, is it not? Mr Pym: That is what I understand to be the Q357 Jim Cousins: So the Treasury is putting itself position. ahead of, if you like, the contributors to the FSCS scheme, because it is charging you interest to make Q349 Mr Todd: Okay. You can imagine that those the payment, but it is not charging any interests on who have contributed and continue to contribute to the payments you make. the FSCS do not necessarily see that as a fair Mr Pym: At the moment we are not making any position! interest payments to the FSCS. Mr Pym: I can understand that point of view. Q358 Jim Cousins: What do you think the value is of Q350 Mr Brady: How much influence have the that non-payment of interest to the FSCS? authorities had over the day-to-day running of Mr Pym: I have not calculated the figure, but Bradford & Bingley? obviously the commercial rate on the £14 billion that Mr Pym: Since nationalisation? has been advanced.

Q351 Mr Brady: Yes. Q359 Jim Cousins: So in eVect that is coming out of Mr Pym: We have worked very closely with the the rest of the banking industry. Treasury and the Shareholder Executive, and not Mr Pym: That, as I understand it, is how the scheme just myself but there is a whole team of people who has currently been constructed. are working all the time with the Treasury team to develop this business plan, and contact is very, very Q360 Jim Cousins: Coming back to the buy-to-let frequent, and very, very constructive. We are situation, what is the total amount of the value of the working with some high-quality people. buy-to-let mortgages you have got now? Mr Pym: It would be around £24 billion Q352 Mr Brady: So you are working closely on a approximately. business plan. Would you describe the relationship in operational terms as arm’s length? Q361 Jim Cousins: Am I right in thinking, therefore, Mr Pym: Yes, but it is quite clear what I have to refer that when Bradford & Bingley’s buy-to-let mortgage to them on. We are aware of their areas of sensitivity book was nationalised, we have eVectively got under and where they do want to get involved, and that is public control something like 20% of the buy-to-let clearly laid out in the framework agreement. market in the whole of the United Kingdom? Processed: 13-03-2009 15:08:57 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG3

Treasury Committee: Evidence Ev 49

18 November 2008 Mr Richard Pym and Mr Rod Kent

Mr Pym: Yes, Bradford & Bingley have a market Q367 Jim Cousins: Do you know that? share of 20% of the loans, yes. Mr Kent: I think that is the right answer.

Q362 Jim Cousins: So the Government now is a very Q368 Jim Cousins: Perhaps you would supply us big player, whether it likes it or not, in one of the with some information on that. most vulnerable sectors of the private rented market! Mr Kent: I will certainly do so. Mr Pym: When you say “vulnerable” there are some elements of the book which are not vulnerable at all. Q369 Jim Cousins: Turning now to the issue of There are certainly some, which are the higher loan- GMAC—it is good to know that over here we are to-value loans, which are vulnerable. supporting the problems of the American car industry! How much of GMAC’s mortgage book Q363 Jim Cousins: Bradford & Bingley had a very here did you acquire after the extraordinary deal you attractive set of terms for the end of the fixed rate made with them in December 2006? I had better deals for buy-to-let. Is it the intention that the address that question to Mr Kent. nationalised Bradford & Bingley will honour those Mr Kent: I cannot give you an accurate answer to terms? that. I do not know the answer to that because I am Mr Pym: The standard terms for buy-to-let not sure we had full sight of the extent of their entire mortgages was at the time you reach the end of your book, so I do not know that. incentive period the customer moved to paying base rate plus 1.75%, so with a 3% base rate that means Q370 Jim Cousins: But how much did you acquire? the majority but not all of the buy-to-let customers Mr Kent: How much did we acquire? The basic deal will pay 4.75%. That is certainly an attractive rate. that we set up in December 2006 was to take on for three years—was to take on 350 million of Q364 Jim Cousins: So we have a situation in which mortgages. not only does the Government now have quite a significant stake in the whole future of buy-to-let in Q371 Jim Cousins: That was a minimum. the UK, but it is going to honour the arrangements Mr Kent: That was the minimum, yes—the third that Bradford & Bingley made so that the quarter for that period. refinancing of those deals is being done on a very attractive basis. Q372 Jim Cousins: So what was the total you Mr Pym: The customers have that benefit in their acquired up to the point of— contract and they are entitled to maintain it. It is not Mr Kent: I will have to come back to you on the an issue over which we can vary it or, frankly, would precise number. wish to vary it. It would be unfair to customers to Mr Pym: I think the total acquired was 8 billion—I take away any benefit that is enshrined in their will be told from behind me if that is wrong—6.5, original lending agreement. sorry.

Q365 Jim Cousins: Yes. There is an interesting issue Q373 Jim Cousins: Six and a half billion! there to consider: both the public expenditure and Mr Pym: Yes. housing market consequences of that arrangement. Mr Kent: These were a mixture of buy-to-let and Mr Pym: But at the time those were quite wide self-cert mortgages. From then the preponderance I margins, and there are plenty of residential think was buy-to-let. GMAC itself, just to clear up lenders—that is a normal home mortgage for an something, is 51% now owned by Cerberus, which is owner/occupier—with what are called “go-to” rates a private equity house, which has amongst its of less than 1% above base rate; so this buy-to-let supporters in the consortium Citigroup. GM holds margin is wider. The rate of 4.75% might seem an 49% of it. All of these mortgages—again, to be attractive rate to the customer, but there are plenty absolutely clear—are UK ones. of residential mortgages which would now be less than 4%. Q374 Jim Cousins: I am frankly stunned by this. You have already acquired 6.5 billion of the GMAC Q366 Jim Cousins: It does seem odd, though, does it mortgage book, and presumably, the Government not, that at this particular point in the housing now, through the nationalisation of Bradford & market we have the Government, through Bradford Bingley, is going to honour the further acquisitions & Bingley, oVering an element of public subsidy that were planned up to 2009? compared to other actors in the buy-to-let market in Mr Pym: In that week before we were nationalised, respect of buy-to-let mortgages? we reduced our liability to GMAC by £1 billion. Mr Pym: We are not making any new loans at all— these are loans that have been made, and essentially Q375 Jim Cousins: But there is still some continuing the buy-to-let market in the way we would have acquisition to be made. known it a year ago is closed. Most of the lenders Mr Pym: Yes. who were active have now withdrawn all their products. Q376 Jim Cousins: that is going to be made, is it? Mr Kent: I think the same sort of rate, the standard Mr Pym: Yes, because there is a contract that is variable rate, will be similar with other major buy- enforceable in law, and if we did not honour that to-let lenders. contract, then damages would be payable. Processed: 13-03-2009 15:08:57 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG3

Ev 50 Treasury Committee: Evidence

18 November 2008 Mr Richard Pym and Mr Rod Kent

Q377 Jim Cousins: So by the spring of 2009 the from their analysis, look upon their buy-to-let Government, through Bradford & Bingley, will now mortgage and their property as an investment for be the proud possessor of £7 billion roughly of their retirement. The average age of the buy-to-let GMAC’s mortgage book, and it will also have paid borrower is 45, 44 years old—so they are much older GMAC a considerable amount in fees to make this than the owner/occupier average—and they are also extraordinary acquisition! better oV: their average income is about £80,000. Mr Kent: Of the two types of loans we did, over 90% of them came through mortgage intermediaries, and Q382 Jim Cousins: Did you realise, Mr Kent, that one of the reasons for buying loans from GMAC the mortgage intermediaries were charging very fat was that their network of mortgage intermediaries fees and then putting the fee into the mortgage? was slightly diVerent from our own. Mr Kent: Well, that was completely standard procedure. We did it directly; we took up to 2.5% of Q378 Jim Cousins: Indeed it was. As those of us with fees and added that to the loan balance, and that was constituency experience of those mortgage known both to the customer, ourselves, and the intermediaries that GMAC was using are very well mortgage intermediary; but we capped it at 2.5% and aware of the fact that they were a diVerent sort of we did not go any further than that. mortgage intermediary. Mr Kent: Some of them were good and some of them Q383 Chairman: The self-certified mortgages are were bad, just like within any business. The purchase known as “liar mortgages”, Mr Kent, are they not? from GMAC was similar in its financial eVect, Mr Kent: Some people call them that. I do not think economic eVect on us, as if we had acquired that is justifiable in many of the cases. A self-certified mortgages directly in terms of fees from our mortgage is the appropriate mortgage for somebody mortgage brokers directly. There was not a great who is either self-employed or has separate—several diVerence when we looked at that. To us, it was just diVerent sources of income. An increasing another source of new business coming in. It is true, proportion of people do— with the benefit of hindsight, that the inflexibility that was built in to the GMAC contract did not Q384 Chairman: We have dealt with this, Mr Kent. allow us the flexibility that we would otherwise have We did it with Birmingham Midshires and we have liked as the market deteriorated. had lots of correspondence on it— Mr Kent: I am sure. Q379 Jim Cousins: What due diligence did you do before you did this extraordinary deal, which is Q385 Chairman: We know exactly the situation so going to leave the Government with £7 billion of you are telling us nothing new here. Mr Pym, in some of the worst mortgages? terms of the GMAC B&B deal, is that good for Mr Kent: We had no concept at all that the B&B? Is it mutually beneficial? Government would end up as an owner of Bradford Mr Pym: I think the key weakness in the contract & Bingley when we did that deal in 2006, so this was was that the underwriting criteria were written into a commercial deal in order to secure business in a the contract in December 2006, which meant that highly competitive market. when credit conditions deteriorated there was no ability to change the underwriting criteria for the Q380 Jim Cousins: But, Mr Kent, it is not just that loans, and that is the key weakness. this is going to be diYcult for the taxpayer to shoulder in the many years to come that the Q386 Chairman: If you had been chief executive, do shouldering will have to be done; it is not just that; you think you would have signed a deal such as that? it is the poor people who have these mortgages who Mr Pym: I really could not put myself in the position will become the responsibility of the Government of those people at that time. through this £7 billion. That is what troubles me. What is the arrears rate on that element of your Q387 Chairman: If somebody came carrying these mortgage book? wonderful goods, what were the questions you Mr Kent: The arrears rate is higher, but let me— would have asked? Mr Pym: I think it is the flexibility of the Q381 Jim Cousins: How high? underwriting criteria— Mr Kent: Marginally higher than ours. Again, I can get you the precise numbers if you want on GMAC Q388 Chairman: And there is inflexibility here. buy-to-let—I think is what you are asking. I can get Mr Pym: Which is that as economic circumstances you that and try and get you the precise numbers and change you want to be able to control the loans supply you with them. They are higher than ours. coming on to your loan book, and I think that was We come back to the poor people. These are people the key thing. who wanted to enter into a buy-to-let transaction, but roughly 73% of people who have buy-to-let Q389 Chairman: So there was a short-term element loans are individuals or couples. There is a very good to that: maybe not looking to the long-term and recent report by someone called Julie Rugg and finding how the market changed. David Rhodes which was commissioned by the Mr Pym: I am afraid that when people sign contracts Housing Minister on the private rental sector, which sometimes it is diYcult to envisage economic has just come out. Seventy per cent of these people, circumstances which arise a couple of years ahead, Processed: 13-03-2009 15:08:57 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG3

Treasury Committee: Evidence Ev 51

18 November 2008 Mr Richard Pym and Mr Rod Kent and at that point there was probably no real reason Q395 Mr Love: You mentioned in an earlier why you would do that because you were not comment you made that you are now looking at the expecting the highly adverse situation that we have levels of fraud. I presume this is a major area where now. you think fraud might exist. Have you any indications at this early stage about what the levels of likely fraud in terms of whether or not they were Q390 Chairman: Okay, but you would not put entirely honest about their incomes and how risky yourself in the position of even giving us an idea if those incomes were? you would have signed like that or not? Mr Pym: Most of our analysis on fraud so far is Mr Pym: I think I would be speculating. looking at the buy-to-let market, where there are false valuations. The major area of concern we have Q391 Chairman: Yes, we know, but if you are is false valuation. It is very hard to wind back a self- speculating—we are talking here about speculating certified mortgage to find out if the customer was on sound business principles. telling the truth at the time of their application. At Mr Pym: I think I have been absolutely open that the point you are looking at the value of security you was, as far as I am concerned, the key weakness. are taking a new valuation of the property and you are seeing whether there is a shortfall to the original valuation which raises the suspicion; that is not quite Q392 Chairman: Yes, but you have got the the same case with self-certification of earnings. problem now. Mr Pym: We have got the loans on our book, or the last little bits are about to, and we have to manage Q396 Mr Love: Can I turn to protecting consumers. those customers and get the money back, and that is You mentioned earlier on that it is “in the culture of what we are about. That is our task now. Bradford & Bingley”. In the document that you signed, the shareholder agreement, you had a number of objectives: to protect the taxpayer and to Q393 Mr Love: Mr Pym, I think you mentioned protect consumers. How do you reconcile those two, earlier on that buy-to-let was 60% of the business of and since you indicated earlier on that Bradford & Bingley; self-certification is 20% of overwhelmingly protecting the taxpayer is your Bradford & Bingley. You have come into this main priority, is that not going to have implications business late. Was that an appropriate business for the consumer? strategy for Bradford & Bingley? Mr Pym: What we have got to make sure is that we Mr Pym: Bradford & Bingley’s strategy was as a contact customers—I think you are referring to the specialist mortgage lender, because the strategic point they go into arrears—at a very early stage, and analysis was done that these mortgages were paying not wait until they have got too far behind. We are a higher interest rate, a higher spread over base rate, now putting a lot of eVort into calling customers at and if you adjust the return for risk, that was an the very first sign that they are in trouble, and then attractive market to be in; so the risk-adjusted rate— working with them, and then where appropriate the strategic view was that that was attractive, and working with debt counsellors with them. It is that obviously that has not turned out to be the case. early contact that is essential to reversing the trend, because once people have got behind it is very diYcult for them to dig themselves out of the Q394 Mr Love: If we go back to the time when they problem. It is early contact, and we have now got a were moving into this business strategy—I will not clear nine-step process that we have developed, go into the issue of whether they were correctly which ensures that there is appropriate contact from pricing risk, because that is what all the credit crunch month one, right the way through in nine steps up to is really about—but let us just look at self- month seven. We are building teams to actually certification. As the Chairman has said, there were process that. major concerns about self-certification and whether it was viable. The one major concern about buy-to- let, especially as you have already mentioned in the Q397 Mr Love: Seriously, do you have any circumstances where house prices were likely to fall confidence that this nine-step process will work? The substantially—we have been talking about that fall evidence we hear continuously from organisations for three, four or five years—nobody could predict like the CAB is that for whatever reason—and I do the time that it would happen, but generally is it not think it is entirely the responsibility of the sensible to focus so much, to concentrate so much in mortgage company—people with mortgages who those two sectors of the housing market? get into problems simply do not come forward. Mr Pym: As it has turned out, that strategy has not Mr Pym: Yes, and as an example of that, when we been successful. There is a concept that self-certified call customers and we leave a message, they do not mortgages are exclusively liar loans. As Rod Kent call back. Customers are frequently very reluctant to has expressed, there is a very valid reason why engage with the problem they are in. All we can do people, entirely legitimately, would take a self- is keep trying to contact them. certified mortgage. The lender, though, has to have the compensating controls to pick up where people Q398 Mr Love: You say in your document that you are lying, to make sure there is suYcient evidence will be oVering “a range of treatment strategies” to that they are not lying; and that clearly has not customers. That intrigued us: what is a treatment worked well. strategy and will it hurt? Processed: 13-03-2009 15:08:57 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG3

Ev 52 Treasury Committee: Evidence

18 November 2008 Mr Richard Pym and Mr Rod Kent

Mr Pym: Those are still under development. Let me up?” The remuneration committee look at the just give you an example. If a customer wants to sell market rate for chief executives and finance a property and they have an early repayment directors, sets a figure and works backwards, and the penalty, we will consider waiving the early bonus is designed to be paid regardless. repayment penalty to enable them to sell the Mr Kent: In Mr Pym’s case, until the period until property. That is a treatment strategy. June 2009, it was designed to be paid regardless. You are absolutely right—it was a guaranteed bonus. Q399 Mr Love: I will take your word for that! You also mention in the document that you want to Q402 Mr Mudie: For everyone? increase the focus on collections from larger Mr Kent: No, just for Mr Pym. The bonuses to the portfolio landlords. Is there a particular problem other executive directors in 2007 were not with larger portfolio landlords? The simple guaranteed in any way at all. assumption we would make is that they are less problem than the smaller buy-to-let holder. Have Q403 Mr Mudie: No, but if they hit their targets? you got a particular problem in that area? Mr Kent: If they hit their targets they will get— Mr Pym: Yes, and that was something that emerged in the third quarter. Up until the end of June the Q404 Mr Mudie: The multiplication factor was far large portfolios were performing better than the bigger than the lass on the front desk. small portfolios, and during the third quarter that Mr Kent: That is absolutely true. deteriorated. There is some evidence that some of the larger landlords keep the rents, do not pay us, Q405 Mr Mudie: How do you justify that? Are you and then just wait for us to intervene with a receiver. going to? That is quite close—it is fraud. Therefore, we must Mr Kent: In terms of Mr Pym’s recruitment we had intervene at that point. to find a really—

Q400 Mr Love: One final question: you indicated Q406 Mr Mudie: Leave Mr Pym out of it. Mr Pym earlier on that your capital base is adequate to meet might be extreme and explainable, if you like, but what you consider to be the risk within the company. what about the rest? These bonuses are huge? Well, You said you had done some stress testing in relation you have accepted you pay your ordinary staV in an to that. Are you confident you have stress tested to average 9% but at the top you pay them something what is likely to be the bottom of the market in terms much larger. Now, why? of house prices, because we revise almost on a daily Mr Kent: Yes, absolutely. basis how deep this recession is going to be, how much the market is going to fall. Are you confident Q407 Mr Mudie: They are already getting a huge that when we get to the bottom of that market you salary. will still be in a confident position in terms of your Mr Kent: If you looked throughout the organisation capital adequacy? you would see that bonus as a percentage of salary Mr Pym: I gave you two figures earlier. The first is actually getting greater as you went up the ladder. our own estimate of a range of between £600 million and £800 million, and that is based on a 25% fall in Q408 Mr Mudie: Yes. house prices. I then gave you £1.2 billion, which was Mr Kent: How do I justify that? All I can say is that it the latest Moody’s stress test—so that is in a sense is common practice in the financial services business. independent of us. We are now working on the final The remuneration committee, which is staVed by stress tests for a much larger fall in house prices, non-executives, has to look at the market out there which will be incorporated in the business plan. That because its key objective is to retain and motivate the work is not concluded yet. The figures I have given executives that it has, and attract where necessary. you are the most up to date. Can I guarantee to you There is a market place out there; we could not get that there are no circumstances in which we will round it. We are not large enough, as Bradford & exceed those losses? I am afraid I could not give you Bingley, to make the market; we had to respond to that guarantee. that, so we took external advice from one if not two people to see what the market was and in general Q401 Mr Mudie: Mr Kent, thinking of our terms we were absolutely not hitting the lights out in discussion on bonuses, you are now retired from terms of our executive pay; we were very firmly in the Bradford & Bingley. I do not know where you are middle of the pack. You can therefore criticise the going, but I am puzzled at the morality of the whole of the financial services pay scales—and many bonuses paid. If bonuses are genuine incentives, the have, particularly in the light of what is now lass in the front desk earning maybe £25,000—the happening, but that is the position that we, as an average wage: take your 9% and make it 10% for individual company, found ourselves in. ease: if she gets the bonus target she hits £2,500. If Mr Pym does, he gets £75,000. That is if he took the Q409 Mr Mudie: I hear that it is common practice, same bonus as the girl, but he has given himself, or but is it a fair practice? Can you look the lass on the the remuneration committee has given him five times front desk in the eye in the knowledge that she is that, with a possibility of going to 15 times that. It scraping to keep a home together and the executives does seem slightly obscene, does it not? To be fair to are taking home these huge salaries, on the basis that you, I thought: “Is this not just a question of dressing every other bank pays them? Processed: 13-03-2009 15:08:57 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG3

Treasury Committee: Evidence Ev 53

18 November 2008 Mr Richard Pym and Mr Rod Kent

Mr Kent: I think we pay all of our people properly, problem and I was given the opportunity to come including the lass on the desk. here, and I did my very best at Bradford & Bingley to solve the problem. There is now a problem to get Q410 Chairman: Lastly, Mr Pym, you were all the money back for the taxpayer, and that is what confirmed in your job on 18 August, and I think you I am focused on now. gave an interview to the Times and you retired from Alliance & Leicester only weeks before the credit Q412 Chairman: On this day of 18 November, would crunch, forcing it finally into the hands of Bank you call it fun? Santander. You were quoted in that paper as saying Mr Pym: I have got to tell you I have not had a lot “I missed all the fun”. Can you explain to us what the of fun in the last three months. fun was? Mr Pym: I cannot remember the statement. Q413 Chairman: So you have changed your mind. Okay, that is fine. Actually, Mr Pym, I think from Q411 Chairman: It is direct quotes. listening to the evidence this morning that you have Mr Pym: I am not denying it, but I cannot remember inherited a shambolic organisation with a giant it. I retired from Alliance & Leicester on July 31, and headache, and that it is particularly of interest to the then I think two weeks later the credit crunch really taxpayer that you have got to focus eliciting started, and we had been aware of it in the sub-prime comments that Mr Cousins made. With that in area. Having retired and then seeing all this activity, mind, our Committee will be keeping a close eye on there was an element of the banking business that I it, and wishing you well, but having you along at a missed, to be honest with you. My nature is to be a future date to see how the taxpayers’ interests are problem-solver. I like solving problems, and I would progressing. Thank you very much. have liked to have had the opportunity to solve a Mr Pym: I look forward to it.

Witnesses: Mr Gary HoVman, Chief Executive OYcer, Mr Ron Sandler, Non-Executive Chairman, and Ms Ann Godbehere, Chief Financial OYcer, Northern Rock, gave evidence.

Q414 Chairman: Mr Sandler, welcome to you and the coming years, and in due course return the your colleagues. Would you introduce yourselves company back to private ownership. On the other for the shorthand writer, please? side of the equation, I should point out for Mr Sandler: Certainly. I am Ron Sandler. I am the completeness that the company did make a very Chairman of Northern Rock. On my left is Gary substantial loss in the first six months of the year. HoVman, who is the Chief Executive and took up his That is not unanticipated; we always knew that that appointment on 1 October; and on the far left is Ann would be the case. We expect that the company will Godbehere, who is our Chief Financial OYcer. continue to be significantly loss-making through 2009, and it is only thereafter that we expect the company to return back to break-even and in due Q415 Chairman: We know Mr HoVman; he has been course profitability. In a nutshell those are the here before quite a few times—a diVerent achievements since were last in front of this organisation but the same old face, Mr HoVman. Committee. Welcome back. Mr Sandler, it has been six months since we saw you last: what have been your Q416 Chairman: Good. Mr HoVman, welcome. You achievements during that period? are now in a new post. What will your priorities be Mr Sandler: I think there have been a number—not over the next year? wholly positive, and I will try and give you a Mr HoVman: My priorities will be to execute the balanced perspective. I think the most significant business plans that have been agreed with the achievement is that we have, in no particular order, shareholder and the Government, and to make sure repaid a very considerable proportion of the as we do that that we have the right balance between Government debt, and therefore reduced the what we do for customers, the products and services exposure to the taxpayer. We have completed, we provide for them, how we treat customers in without any disruption, a quite significant financial diYculty in an increasingly diYcult restructuring of the business. We now have environment, repay the Government debt and look something in the order of 4,500 employees versus a forward to returning this company to successful number in excess of 6,000 at the start of the year. The private ownership. organisation is now of a size that makes it much more likely to achieve the objective of returning Q417 Chairman: What risks do you see regarding back to private ownership in due course. Mr achieving your priorities that could put you oV? HoVman’s presence, on my left, is evidence of this: Mr HoVman: I think the main risks are external to we have substantially replaced the management Northern Rock because, as we see every day, the team at Northern Rock. Of the eight senior economic environment is deteriorating rapidly. The executives within the company, six are new to the consequence of house price deflation on Northern business. We have a new management team, which I Rock has meant a substantial increase in arrears think is well equipped to undertake the challenges of over the last few months. I think there is also a risk Processed: 13-03-2009 15:08:57 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG3

Ev 54 Treasury Committee: Evidence

18 November 2008 Mr Gary Hoffman, Mr Ron Sandler and Ms Ann Godbehere that we are knocked oV track generally by all the induction training on the workings of the bank from noise that is around Northern Rock. I understand a risk management perspective, so can you give us an why there is lots of noise around Northern Rock, but idea of what has been happening there? it is up to me, as Chief Executive, to make sure that Ms Godbehere: Certainly. Under the leadership of every single person in Northern Rock knows what the new director of risk, that came on board on 18 their priorities are for customers and the priorities August—he is a very experienced risk director and for the company. I have to say, in my first six weeks he has completely revamped the board papers, first there, I have found them very focused, given what of all, for the risk committee of the board, to be they have been through over the last 14 months. much more transparent, to help steer both the They have had a really proud history but an company and the board to focus on the right pieces incredibly diYcult last 14 months through the of risk. He is still implementing a whole new risk restructuring that the Chairman mentioned. I find structure and a whole new risk governance manual, them resilient, very loyal, and particularly in the which will be first approved by the company, and north-east well connected to the community. There then by the risk committee coming to the board— is a very strong community sense. actually to the risk committee of the board next week. A great deal has been done. I would still say it is work in progress but good progress so far. Q418 Chairman: Have you got a handle on all the Mr HoVman: We would look across diVerent classes assets and liabilities? V of risk, so you mentioned the Treasury risk: clearly Mr Ho man: Yes, I would say so. With my we have taken a view on Treasury risk both in terms colleagues, and Ann as Finance Director, and we of capability and how we have an independent view have also appointed a new risk director and someone of the risk in there—we have done that in terms of also to focus on debt management, so I do think I product design, product manufacture and the way in have a handle on assets and liabilities. which we price risk. We have also done that through our debt management capabilities and also Q419 Chairman: You are still holding quite a operational risk, so we have taken a complete number of CDOs and CLO exposures. How overhaul of the way in which Northern Rock looks confident are you that they are correctly priced and at diVerent classes of risk. that their ratings are correct? V Mr Ho man: As you would imagine, we have had Q422 Mr Brady: Just for the moment I have a short extensive looks—and I have personally looked at the set of questions. One of your conditions, Mr marks to market that we have had in all the Treasury Sandler, for taking on the role with Northern Rock assets that we hold at Northern Rock. We took some was that the bank would be run at arm’s length from substantial write-downs in our first-half results, and the Treasury. Has that turned out to be the case? some in the third quarter as well. Clearly, there is risk Mr Sandler: Yes, it has. in there and continuing risk as we look forward, given what is going on in the financial world, but I am comfortable, and I think Ann is, with the marks Q423 Mr Brady: Have there been any instances of that we have taken so far. unwarranted interference at all? Mr Sandler: Not that I can recall. We maintain a very close dialogue with the Treasury, so the Q420 Chairman: As you know, when Northern Treasury quite rightly exercises a high degree of Rock was before our Committee, the lack of risk oversight over what we do and we seem to scrutiny was evident to us here. Mr Sandler you communicate as fully as possible with our mentioned that some time in July external shareholders, but I cannot recall a single instance consultants would report on the risk structures and where the commercial activities of the company have control mechanisms. Have they reported, and what been interfered with in any way by the Government. are their conclusions? Mr Sandler: They have reported, and the conclusions have—I will let Gary talk in more detail Q424 Mr Brady: So there would be a discussion about the implementation of these conclusions, but about the operational activities, the commercial the principal conclusions have been to create a much activities, but never a point where you would be more independent and much stronger risk function given an indication that what you are doing should within the business, and to embed principles of risk change? management much more deeply in the business than Mr Sandler: Correct. was hitherto the case. I am confident that we now have a well-functioning risk structure with a new director of risk in the business; and the role of risk Q425 Nick Ainger: Mr Sandler, Unite, the trade management is given considerably greater priority union that represents quite a considerable number of V your staV, has given us a submission. One of the within the a airs of Northern Rock than was earlier V the case. issues that they are very concerned about is the e ect of the incentive scheme. They tell us that staV will receive 10% of salary in the first year; however, it has Q421 Chairman: Ann Godbehere, you made that been reported that senior managers are likely to point again when you were before us, that both receive up to 30% bonus this year. This has outraged members, that board members had asked for employees who see the senior managers as Processed: 13-03-2009 15:08:57 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG3

Treasury Committee: Evidence Ev 55

18 November 2008 Mr Gary Hoffman, Mr Ron Sandler and Ms Ann Godbehere responsible for the present position of Northern Q428 Nick Ainger: Can we move on to the purposes Rock, including the redundancy of one-third of their behind the incentive scheme? The bank has come in colleagues. How do you respond to that? for significant criticism around its repossessions Mr Sandler: Certainly we consulted very extensively policy. Is there any link between your repossession with Unite on the scheme, so I am a little surprised policy and the incentive scheme? to hear of this submission. The board took the view Mr Sandler: Categorically not—at least not in the early on that a company-wide incentive scheme for sense that I think is inferred by the question. The Northern Rock was an essential component of incentive scheme, as I have said, is in the early years achieving the very challenging tasks that we had and directed to the payment of the Government debt; or, indeed still have ahead of us. We have worked over put another way, minimising the exposure of the some months to put the scheme in place. It is a taxpayer. The rate at which we do that and our scheme that covers every single employee in the success in achieving that is not in any way connected company. It is quite a simple scheme. It is designed with our repossessions. Just to put some facts behind in the early years around objectives of debt that, approximately 1% of the cash that has been repayment, and in later years the objectives have not generated this year to repay the Government, yet been set and they will be set at the time around amongst other things, has come from repossessions, measures designed to ensure that the company is so it is a minuscule proportion of the cash generation returning properly back on a trajectory to private of the business. It is unquestionably the case that the ownership. We felt and continue to feel it is essential appraisal system within the company in general links that all members of the company are aligned to those performance, which includes elements of customer goals; we feel that that is the best way that the care, into the way employees are evaluated, and that taxpayers’ interests can be properly protected, and filters through the entire appraisal, and ultimately we have introduced that scheme. The scheme for reward system, of the business. I think we do try to senior levels of the company has not yet been include in the incentive scheme an element of finalised, and that requires Government approval, individual behaviour, and therefore we try and take and that approval has not yet been forthcoming, but account of how people are performing. The linkage it will be once we complete the planning exercise we between repossessions and repayment of the have in front of us. The Government has certainly Government debt does not exist. been closely involved in the development of the scheme, and I think it is a scheme that will serve the Q429 Nick Ainger: What about the possible mis- company well. selling of products to consumers? What checks and balances are there in place to prevent the V Q426 Nick Ainger: Are you happy that those senior incentivised sta from going down the road which members of staV that were perhaps culpable in the ended up with Northern Rock’s collapse because of downfall of Northern Rock have been removed failure to properly estimate risk and so on—mis- selling of mortgages? That was the problem. What from their posts? checks and balances are in place to stop that Mr Sandler: I was not around in the period up until happening again? February of this year, so it is not possible for me to Mr Sandler: The simple answer to that question is deliver chapter and verse as to exactly how the aVairs that we are regulated by the FSA, exactly the same of Northern Rock were managed and by whom, and as every other bank in our circumstances is. We have who was responsible for what. I can say, as I said the same requirements to treat customers fairly, as earlier, that the senior management team has been every other regulated entity. The processes by which completely revamped. We have hired a number of we do that, the structures, the procedures, are all extremely talented individuals into the bank, and I regularly overseen by the FSA, as indeed they are by believe the bank is extremely well run. I am not sure the company through our compliance function and that I can go beyond that. risk function, and ultimately by Gary and the management team. Q427 Nick Ainger: So you are satisfied that there are no senior members of staV now who, in the light of Q430 Nick Ainger: So have you put in place diVerent what Unite have said about the reaction of their structures, diVerent checks and balances than members to—first of all the incentive scheme seems existed before, because clearly there was a problem? to be rewarding those senior members far more than You were giving 125% mortgages. People laugh now ordinary members of staV by a factor of three; but when they hear that, but that is what was happening, you are sure that senior management, who may have is it not? What is to stop that happening again? been at fault, which resulted in the collapse of Mr HoVman: There are some diVerent things going Northern Rock, are no longer in post? You are on. As the Chairman said, this is about product telling us that, are you? design, about processes, about training and about Mr Sandler: Not in precisely the terms that you people; and in some ways above all it is about express it because it is a big organisation. There are attitude and culture. I could point to reinforcements many layers of management within the organisation. we have made of existing procedures and some new I believe that the re-vamp of the senior team and the procedures that we have introduced recently, for restructuring of the organisation is such to leave example in product design or in the sales process. Northern Rock now with an organisation that is well Clearly, we are not writing a lot of new business at equipped to do the task ahead of it. the moment, so we need to put that in that context. Processed: 13-03-2009 15:08:57 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG3

Ev 56 Treasury Committee: Evidence

18 November 2008 Mr Gary Hoffman, Mr Ron Sandler and Ms Ann Godbehere

We have used the Treating Customers Fairly to repossession for 15 months plus, and less than 1% framework that the FSA has to embed all those of repossessions of Northern Rock would be under procedures throughout our business. For example, six months. Now, you say that we are above the in product design now the risk management people industry average, and I agree. The reason is not and not just the credit risk people are involved in the because of our policies and procedures and not sign-oV of that product design. The compliance because of our attitude. I have looked at the people will be involved in the sign-oV of that product individual letters. I talk to customers every day at design, whereas previously it would have been much Northern Rock. I look at individual letters to see more down the product line in doing those things. whether the wording looks threatening or whether it To return to your point on the link between looks as though we are trying to help. I have repossession and incentives, to reinforce it— reviewed all those. We want to keep customers in categorically not. That is written down, but it is also their properties wherever possible; but because we about attitude and culture. I talk to people a lot in have the Together Book, even though on our overall Northern Rock and it is a great facility that we have book the loan to value is 60% as at the end of 2007, got in Newcastle and Sunderland to be able to talk to that has been driving more possessions. Together is people regularly. I talk to people a lot about, “You one-third of our book and about 50% of our overall should not do anything that disadvantages arrears and it is three-quarters of our repossessions. customers in the interests of your bonus; please do That is the reason why we will be somewhat above not do that, whatever you are tempted to do.” I the industry average, but nowhere as much as that think they have got that message. statistic suggests. It is somewhat above the industry average. I think at the end of the year we will end up just over 10% of total repossessions, including Q431 Nick Ainger: Let us talk about repossessions voluntary in our numbers—I know some people do then. In the half year to June 2008 you repossessed not do that. That should be put in the context of a 4,201 properties. That was a 68% increase on the company that was growing about 20% market share previous period. The industry average is 0.18% of new business in 2004, 2005 and 2006. I can give repossession; Northern Rock is 0.56%, three times you comfort that I do not think it is our policies and the industry average. Why is that? procedures; I think it is about our book. Mr HoVman: I will talk about what our policy process and attitude is, but I just first of all need to Q434 Nick Ainger: Have you spoken to Shelter correct a number. The 4,201 is the number of about what you are doing? possessed properties we have in our stock as at the Mr HoVman: I have. I have spoken to Shelter and end of September. It is not the number of properties indeed a number of other charities and debt that we repossessed in the first half of this year, so it agencies, because my view, and my style, is to make is a stock number and not a new repossession sure that we are transparent about what we are number. Included in that number of 4,201— doing to see if Shelter or anyone else can give us ideas as to how we improve things. I had a very good Q432 Nick Ainger: But they have been repossessed. session last week with a number of agencies, and I Mr HoVman: They have, but it could be over the last think that their overall conclusion—obviously you 18 months. need to ask them—is that they do not believe we have been aggressive. We have occasionally been inflexible, but we have got some diVerent solutions Q433 Nick Ainger: I see. there. They agree that it will be our book that is Mr HoVman: So it is a stock number not a flow driving it, and Together in particular. number. Let me talk about repossessions. As you can imagine, coming in new as Chief Executive on 1 Q435 Nick Ainger: Do you think as a nationalised October, I heard a lot in the press and lots of bank you should have greater forbearance than comment about “Northern Rock is aggressive on other competitors? repossessions”. I wanted to make sure that either Mr HoVman: I think we need to operate within our that was true or it was not, and so I have taken a competitive framework, which covers all sorts of close interest in the policies and procedures. Above things and we need to operate commercially. all, we want to make sure that customers remain in their home wherever possible, and repossession must Q436 Nick Ainger: It is not going to be to your be a last resort. Having looked at our policies, I advantage to have greater forbearance, is it? You know they are in line with industry standards, so the have been taken over by the taxpayer. The taxpayer Council of Mortgage Lenders guidance and the is increasingly concerned about the level of mortgage code. We have had that reviewed and we repossessions. You have a number, a significant are in line with those standards. We have some proportion, of people on low incomes with diYculty solutions to enable forbearance; we make sure there repaying their mortgages: do you think you should are repayment holidays and that customers can be showing greater forbearance than some of your reduce their payments to enable them to stay in their other competitors? home. Over two-thirds of our repossessions would Mr HoVman: I do not think we should be doing that be where customers are more than nine months in because we are nationalised, because of the arrears. On average we would have talked to framework we operate in, because we are at arm’s customers from them beginning to have a problem length. But do I believe that Northern Rock, because Processed: 13-03-2009 15:08:57 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG3

Treasury Committee: Evidence Ev 57

18 November 2008 Mr Gary Hoffman, Mr Ron Sandler and Ms Ann Godbehere of what it is, because of its great links to the Q438 Mr Love: Mr HoVman, you mentioned earlier community in the north-east but also because of that you had taken a close look since arriving at what the brand stands for and because customers Northern Rock at the repossessions issue. Are you have respected Northern Rock—do I think we surprised at the level of arrears that you found when should be leading the industry on some solutions to you came to Northern Rock? forbearance? Yes, I do. I want us to do that with the Mr HoVman: Given what was happening in the Council of Mortgage Lenders and encouraging my market place and given what had been said by the team to come up with some of those solutions. I do company here in May, and in the half-year results, I not think it is because of the position we find was not surprised by the rising level of arrears. ourselves in but because of what Northern Rock Clearly, the predictions on house prices, even back stands for and its links to the communities. in July, were not as severe as they are now, and that is driving some further arrears. The arrears are now higher than expected when I originally talked about Q437 Nick Ainger: On your Together mortgage, the role, but, no, I am not surprised by the high level clearly people have a huge problem in trying to re- of arrears. Three months plus arrears on the total mortgage elsewhere and take their mortgage to a Northern Rock book is 1.87%, and, as the Chairman competitor, do you think you have a particular duty has said, for Together it is about 3.1%; and on our of care to those Together customers because of their standard book it is 1.2 something per cent, and the diYculties and the fact that they cannot take their industry average would be about 1.33%. mortgage anywhere else? You have indicated that that is an area where you have a major problem in Q439 Mr Love: Could I perhaps say, when you said terms of repossession and debt and arrears. Do you you accepted you were above the industry average think you should be treating them diVerently? on repossessions, that this might be because you are Mr HoVman: I think we have a duty to all customers above the industry average on arrears? in diYculty. You are right to say that we have a Mr HoVman: Yes. bigger proportion of Together customers in diYculty, so it follows we should be making sure that Q440 Mr Love: It is as straightforward as that? they are treated absolutely as fairly as possible. It is Mr HoVman: Yes. worth reminding people what the Together book is. Together has been around for quite a long time— Q441 Mr Love: Let me come to Together, because I back in 1998 is when Together was launched. Of am fascinated by your take on this. You indicated course, it performed very well and was mimicked by earlier on that it is a third of your book? a number of competitors for some time. Everyone Mr HoVman: Yes, it is about— talks about the fact that it was a 125% mortgage. Actually, there were very few 125% loan-to-value Q442 Mr Love: And 50% of your arrears? pieces of business written. Most of them, the Mr HoVman: Yes. mortgage was about 90%, and actually for first-time buyers; so many of the things we would encourage Q443 Mr Love: I cannot remember the figure you— about getting first-time buyers on the first rung of the Mr HoVman: It is 75%. ladder was what Together was all about. In addition, the unsecured element of it, which was maximum of Q444 Mr Love: It is 75% of repossessions. £30,000 and typically 14% or 15% loan-to-value—so Mr HoVman: Yes. you can take the 90% and the 15% together—about 105% not 125%—it was about enabling first-time Q445 Mr Love: We are told, and indeed in the last buyers to get into the market and to live in those few months we have seen, a significant increase in houses. In a rising housing market it has performed unemployment. There are even suggestions from well. Naturally, that loan-to-value in a falling, some quarters that it may go up to 2.5 to 3 million rapidly falling house price market is not performing people. You must have stress tested: what impact very well; and of course I agree that we have a duty will that have on the Together end of your of care to those customers. mortgage book? Mr Sandler: If I could add one point to that, while Mr HoVman: I cannot give you the numbers. I am it is right to focus—and I understand fully why the not going to make a forecast for our numbers next Committee is doing so—on the level of arrears and year. the problems associated with the Together book, at the moment about 3% of Together customers are in Q446 Mr Love: You would accept there will be a three month plus arrears, which is a high statistic significant deterioration? and one that is concerning to us, and rightly so; but Mr HoVman: Yes, I think if house prices fall more there are 97% of Together customers who are not in than people have been expecting, and if there is more arrears—certainly not three months plus arrears. It unemployment than people expected, then there is a is important to remember that the Together product natural knock-on to people in arrears, has enabled many buyers to get on to the property unfortunately, and possibly into repossessions. I ladder; and indeed those buyers are fully able to would say that it is up to the industry, and, as I say, service their debt and are not in any way unhappy I hope Northern Rock will lead the industry, to with the service they have received or the loan they come up with solutions that have more forbearance, have taken out. coming up with what are called, for example, Processed: 13-03-2009 15:08:57 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG3

Ev 58 Treasury Committee: Evidence

18 November 2008 Mr Gary Hoffman, Mr Ron Sandler and Ms Ann Godbehere mortgage rescue products, to allow customers to where there is no respite that you can see on the stay in their homes wherever possible. It is not in a horizon, the Council of Mortgage Lenders says: “Is customer’s interests and not in the company’s it not more sensible for that mortgage-holder to end interests for someone to have their home the mortgage, repossess the property, than to repossessed, so I hope we will be able to come up continue to sustain them in that property?” That is with some solutions that mitigate against the natural a commercial decision from your point of view, but force that you have described, Mr Love. the onward impact of that in other ways is that someone else has to house them, and there are Q447 Mr Love: One of the things that characterises various issues related to that. Are we seeing any Together mortgages are that they have a high loan- change in attitude either from CML or Northern to-value ratio. That means that they will find it Rock that would make them a little more exceedingly diYcult, if not impossible, to re- sympathetic to sustaining people in those mortgage somewhere else; so it is going to become a circumstances in the property? larger part of your mortgage book over time. Would Mr HoVman: You are right to point out that you accept that? sometimes customers will say “it is in my interests as Mr HoVman: I think for mortgages that have been a customer to hand over the keys”—that is a very written very recently, yes, but not true over the unfortunate position for a customer to be in. As I lifetime of the Together book. As I said, it started said, nearly a third of our repossessions this year back in 1998. have been voluntary. They are included in our numbers, by the way, but they have been voluntary. Q448 Mr Love: I accept it started back in 1998, but I would say we must encourage customers to talk to correct me if I am wrong that it started from a very us as soon as possible. Sometimes we end up with a low base. When it really became a major part of voluntary repossession and we have not had a Northern Rock’s business was in the last few years. dialogue or conversation with the customer at all. I Mr HoVman: That is true. do not think that is right. I think we should have a dialogue and try and find a solution. As a last resort it may be in the customer’s interest and it may be in Q449 Mr Love: So you would accept that the vast the company’s interest for a voluntary or an majority of the mortgages lent were Together enforced possession, but every one of those I will products in the last few years— regret. Mr HoVman: Yes.

Q450 Mr Love: Therefore they were high loan-to- Q452 Mr Love: I understand that, but what I am value ratios. The question I put to you is: these really interested in—and I understand the diYculty customers or mortgage holders are going to have to also with getting customers often to speak. People remain with Northern Rock, yet, as you have come to my surgeries and all of our surgeries, and the already indicated—and we have re-forecasting on a first question you ask them is: “Have you spoken to regular basis at the moment about how far house the mortgage company?” Often they will say: “No, prices are going to fall, but whereas six months ago we are scared to do so.” We all know the reasons why 25% looked a very extreme figure, it now looks the that happens. In those circumstances I think what average, and some people are suggesting higher this Committee and Parliament are looking to is house price falls. Unemployment is likely to go up, what positive steps you are taking to address the sadly, even higher than we expected. Is that not significant diYculties that some of your customers going to have a very dramatic impact on your face, in order, where it is appropriate, to try and mortgage book? sustain them in their properties. Mr HoVman: It will definitely have an impact. What Mr HoVman: So far we have made sure that our I am saying is that given what is happening to policies, like repayment holidays and reduced unemployment and given what is happening to payments, are in place. Critically as well, we talk to house prices, it behoves the industry, and Northern all of our people in debt management, helping Rock within that industry, given our prominence, to customers in diYculty, about the attitude they need develop solutions to mitigate that. I cannot give you to have to help customers through this. Of course, what those solutions will be today, but I can say that the number of colleagues I have got working in debt one of the reasons why I met with the charities and management in Northern Rock has significantly the debt agencies was to begin to talk about that. We increased over the last few months—it has more than are having discussions with the Council of Mortgage doubled; so we have an opportunity to make sure we Lenders and I hope we will be able to mitigate some do it correctly. It is about policy, procedures, of it at least. practices, attitude and training; but I also think that in due course it will be about some product that we Q451 Mr Love: I have asked the Council of have not got yet, which are those mortgage rescue Mortgage Lenders this question, and it is critical to products that we need to work with the industry on the whole debate that is ongoing. When you look at and lead the way in Northern Rock to help a customer who has a Together mortgage, the mitigate that. unsecured part may well have run down and they have diYculty meeting their mortgage payments; Q453 Mr Love: I hope you will come back and report their employment may be very risky at the present to us on some of those products because I think this time and it may be a very diYcult period for them— is a sensible way forward in the circumstances. Can Processed: 13-03-2009 15:08:57 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG3

Treasury Committee: Evidence Ev 59

18 November 2008 Mr Gary Hoffman, Mr Ron Sandler and Ms Ann Godbehere

I ask you one last question, which relates to the Mr HoVman: If I take it typically now—and of figure you mentioned earlier of 4,201 that you now course interest rates have moved recently—a typical have in possession, some of which you have held, as mortgage in Northern Rock, a fixed-rate mortgage you indicate, for longer than a year or perhaps 18 would be something like 5.9%. months or two years. The housing market is going down. The mortgage on that property—it is critical Q458 Mr Mudie: What was your standard variable? that it gets sold at the highest price available. Mr HoVman: Our standard variable rate is now Holding on to them, it would seem at this time, is 5.84%. going to prejudice the situation that that person will be in. Why are you holding on to them? Why do you Q459 Mr Mudie: No, not now—at the same time? not get rid of them before the market falls We are looking at the diVerence between the two. completely? V Young kids went in and got this cheap mortgage— Mr Ho man: I would look to get rid of them—your how cheap was it compared to standard variable? words not mine—as quickly as possible at the right Mr HoVman: It would be diYcult for me. I cannot price to protect customers from loss or to make sure go back now in my mind and get that. I can come they get a profit from it sometimes and to protect the back in writing. The important thing is, when company from it; so that is a dynamic that is at work someone comes to the end of their fixed-rate term, across the whole industry and certainly in Northern what do they go on to, because that is about their Rock. You are right to put your finger on it; once a monthly payments and that is the most important property is repossessed, particularly in this market thing. place—once that final decision has been made, albeit that it is last resort, then it is probably best to do it as quickly as possible. Q460 Mr Mudie: That is the big question, is it not? With such a reasonable firm, which stuVed money into their mouths two years ago, to buy this house Q454 Mr Love: My understanding is that most of and furnish it all in one go—now, why, two years these properties are sold at auction. What would later, are they having all this diYculty? hold you up from selling a property? Is there a Mr HoVman: All I can repeat is that the current judgment you are making that you might realise a situation is that someone coming to the end of a greater amount from a sale if you hold on to it in this fixed-rate term— current market? Mr HoVman: It is a diYcult balance. Northern Rock does not put lots of properties into auction; we use Q461 Mr Mudie: That is what I am after. V more traditional estate agents because we think that Mr Ho man: Two years ago they would typically be is better, and so we are making some judgments on a 5.9% fixed, and now, as of a week last Friday, about prices, but I agree with your general point. they would have come on to a standard variable rate of 5.84, which would be cheaper. Q455 Mr Mudie: You refer to 1998 as the start of Together. What was the term of the Together Q462 Mr Mudie: Yes. Why are they having this Y mortgage? di culty, then? It seems strange, does it not? V Mr HoVman: Just like other mortgages, they varied. Mr Ho man: Sometimes it will be, unfortunately, They could be for a one-year or two-year fixed rate because they have become unemployed. or they could be a variable rate, and they would be over many diVerent ultimate terms, say 25 years, so Q463 Mr Mudie: No, but statistically—statistics in many ways they had features of standard cannot lie, but it is very interesting that figures have mortgages. been quoted in terms of repossessions—you are over three times other building societies, and 75% of these Q456 Mr Mudie: Surely they were at a low rate that are Together mortgages. What on earth happens at attracted people, and the 25% on top was an added the end of the two-year term to suddenly cause incentive, so people got a cheaper mortgage on fixed them to— term at a low rate, and this encouragement—“here Mr HoVman: May I answer your question? I need to is some brass to furnish it” et cetera. Is that a fair re-correct—we are not three times higher than the description? industry. I said— Mr HoVman: I think it would be a fair description. It would help particularly first-time buyers get on to Q464 Mr Mudie: I thought that was your figure. the first rung of the ladder because it was a 90% or Mr HoVman: I gave a 3.1% figure for Together and 95% mortgage and there was an unsecured loan on a 1.87% figure for arrears overall for Northern Rock top of it—but typically not 25% loan-to-value, as I against an industry of 1.33% as at a figure a few said—somewhere around 14% or 15% typically. Of months ago. course, in the early years of that product, as house prices were rising, people did very well out of that. Q465 Mr Mudie: This is your written evidence to us. “Represent around 50% of arrears cases and around Q457 Mr Mudie: That sounds very nice, and it is very 75% of all possession cases”. That was written nice until you turn nasty on them. You see, what evidence by yourselves. happens at the end of the term, the two years? What Mr HoVman: Absolutely. In the Together book they would your low rate be during that two years? represent three-quarters, yes. What is happening— Processed: 13-03-2009 15:08:57 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG3

Ev 60 Treasury Committee: Evidence

18 November 2008 Mr Gary Hoffman, Mr Ron Sandler and Ms Ann Godbehere

Q466 Mr Mudie: Tell us then. Mr HoVman: It would be the same. Mr HoVman: Because these are customers that are more stretched than others, because these were Q472 Mr Mudie: Absolutely the same? higher loan-to-value mortgages, as their other bills Mr HoVman: Yes. go up, or as they become unfortunately unemployed, these are the people that are more stretched than Q473 Mr Mudie: In other words, the same as they others. As a consequence, the higher loan-to-value pay on the secured part? products for these types of customers can tip them Mr HoVman: Absolutely. over the edge when the going gets tough. Q474 Mr Mudie: So the Library is wrong. Mr Sandler: Well, if that is what the Library is Q467 Mr Mudie: Politicians in this place have great saying, but the facts are as Gary has described. reference to Library publications downstairs. If I quoted to Graham, he will accept those facts from Q475 Mr Mudie: That would explain instantly why me because they are from the Library. I did a debate people have real problems when they come to the on repossessions. The Library produced a note. end of the rates. Then why do they have problems, They gave an example of a young couple with two because they are— kids; the parents were both at work so they did not Mr HoVman: I think it is about what is going on in have financial problems. They came to the end of the rest of their lives, not just the mortgages as well. this two-year period, and at that time the mortgage went up from the reduced rate, the privileged rate, to Q476 Mr Mudie: Right. The last thing I would say is the standard variable, and they could aVord that; that the advice people point to your attitude in terms but the unsecured went up to 15%. Is that still of—Andy mentioned selling something at auction. happening? This is the business where you repossess; the Mr HoVman: When a customer comes to the end and mortgage is £100,000 and you get £80,000 at auction. they re-mortgage to a competitor of ours but leave They complain that you pursue the people for that the unsecured loan with us—which might be the 20% despite the fact that they have lost their house Y circumstance you are referring to. and they are in all sorts of di culties—you go after that £20,000. Is that a policy? Mr HoVman: First of all, we do not use auctions very Q468 Mr Mudie: To be fair to you, Gary, this is your much, and one of the reasons is because there is a big chance to kill all these rumours! I borrow from you, discount applied at auctions, so that is one of the and, as you have said, and we have not picked it up reasons why we go through more traditional estate but we are asking you about it—the secured part I agents in order to sell our properties. Sometimes that might take a bit longer—to the point earlier on. It should not have any real diYculty with, but what depends on individual customer circumstances about my unsecured part? What rate do I pay on whether we would forbear the rest of the debt or not. that? Sometimes we would and sometimes we would not. Mr HoVman: If you take your mortgage elsewhere and leave your unsecured piece behind— Q477 Mr Mudie: So it could be a policy. It is also dependent on the circumstances. Mr HoVman: Individual customer circumstances. Q469 Mr Mudie: No, just say I stay with you— because who is going to take me? Andy has made the Q478 Mr Mudie: Where does the young couple go? point that— They have bought a £100,000 house and you have Mr Sandler: The unsecured and the secured, in the given them £25,000 or you are insisting it is situation where the borrower remains with the bank, £15,000—okay, but the house has gone down in does not re-mortgage away, they stay the same. value £15,000 so they are in some diYculty—yes? V Mr Ho man: And they would go to our SVR rates. Where do they go if you do not given them a mortgage and you want them to go? Where do they go? You have sold them oV to the TSB, but the TSB Q470 Mr Mudie: So the Library is wrong only take people with 80 loan-to-value. Where do downstairs! they go? Where can they go? Mr HoVman: I suspect what is happening is that the Mr HoVman: If I get the question correctly, if a Library might be quoting interest rates of three customer cannot find a competitive deal with months ago, so it was fair to say that that same someone else, then they will stay with Northern customer that was coming oV a 5.9% rate, two-year Rock. fixed, three months ago, would have gone to a standard variable rate at the time of 7.34%, so Q479 Mr Mudie: Yes, and it is amazing, is it not; it significantly higher. But as interest rates have fallen is a mystery why they do not, and carry on living in then that is reduced. their house at the level they do not, is it not? You do not find it strange that three times as many people you repossess than other building societies? Q471 Mr Mudie: What would the rate be for the Mr HoVman: I think I have said I do not think that unsecured rate? figure is correct. Processed: 13-03-2009 15:08:57 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG3

Treasury Committee: Evidence Ev 61

18 November 2008 Mr Gary Hoffman, Mr Ron Sandler and Ms Ann Godbehere

Q480 Jim Cousins: Mr Sandler, the last time that you the light of changed market circumstances. That is were here you conceded that there was a bit of a an exercise that we are presently undertaking. We contradiction between the Government’s business have been at it now for some months, and I hope that plan for Northern Rock, which was to run down the we are only a matter of weeks away from concluding mortgage book, and the Government’s general on where this is taking us. I am not going to pre- policy towards the housing market, which was to judge the outcome of this process, but we are sustain the flow of mortgages. Would you recognise certainly reviewing the fundamental elements of the today that those contradictions have grown a great business plan to satisfy ourselves and the deal sharper, in which we have some part Government that it is the right one, and if we feel nationalised big banks being told to get their corrections need to be made, of course we will mortgage lending back up to the level of 2007, but in make them. the case of Northern Rock to continue to run down the mortgage book? Q483 Jim Cousins: Mr HoVman told us earlier that Mr Sandler: I clearly cannot comment on what other you were seeking to be one of the leaders in mortgage banks are being told because I am not privy to what rescue products: that would hardly be consistent other banks are being told, but I accept that with the business plan you have now. contradiction, as I did in the past; that on the one Mr Sandler: I am not sure about that. If you come hand there is clearly a desire by the Government to back to my earlier point, which is that our policies keep the housing market and the mortgage market and practices in respect of repossessions has no as buoyant as they can, and at the same time to also bearing on the rate at which we are able to repay the recoup the moneys they have put at risk by virtue of Government debt, only 1% of our cash generated their ownership of Northern Rock. When we went this year comes from repossessions; it is quite into this period of public ownership we did so within possible for us, by virtue of the role we occupy and a clear plan that we formulated, which had been the our prominence, to adopt a set of policies where we intention of returning the bank back to private are, and are seen to be, at the cutting edge of dealing ownership. We used to, and still do, always apply the with customers in diYcult circumstances, whilst at word “temporary” in front of “public ownership” to the same time continuing to progress our reinforce the point that we do not see this as a programme of redemptions, make sure that those permanent arrangement. We recognised then that customers who can aVord to re-mortgage elsewhere the only way Northern Rock was going to be able to can do so and are encouraged to do so, and by virtue return to private ownership as a smaller, more stable of their programme reduce the size of the bank and mortgage bank, and that does mean reducing the its balance sheet to the point that we can in due size of the bank and its balance sheet to accomplish course return back to private ownership. that. In the process it would also create a facility for repaying the taxpayer for the moneys that have been lent to support the bank. Yes, I see the Q484 Jim Cousins: Mr Sandler, you could hardly be contradiction. We have been travelling down a plan a market leader in a new suite of mortgage rescue which we, the board and the Government, agreed products, which for example might involve converting equity debt into shared equity and was the correct plan, and nothing has happened to renting, which is a big step to take and much talked change the path that we have been travelling on. about in terms of mortgage rescue products—you could hardly be a market leader in that area with the present business plan, could you? Q481 Jim Cousins: Let us be clear about this, Mr Sandler: Forgive me, I am not sure I see the because something like £16 billion or £18 billion has contradiction there! The financial impact of what we been run oV Northern Rock’s mortgage book. That are doing is extremely meaningful to the specific has come straight out of a mortgage pool that is pool of borrowers who are in diYculties, but in under considerable pressure. terms of the aggregate process of repaying the Mr Sandler: Yes, it is certainly true that the act of re- Government debt and reducing the size of our mortgaging away from Northern Rock puts demand balance sheet, that is a process that is largely for mortgages elsewhere, and that therefore has to separate from the way we deal with customers who have some impact on the pool of available lending are in diYculties. for fresh mortgages. I accept that. Q485 Jim Cousins: Let us look at other aspects of the present business plan. We heard from Bradford & Q482 Jim Cousins: Is there any indication to you Bingley earlier this morning that they are paying a that the Government is reconsidering the business commercial rate on their loans with the plan for Northern Rock, which requires this very Government. Are you continuing to pay a penalty high rate of redemption? rate? Mr Sandler: We are certainly reviewing the business Mr Sandler: We have not disclosed the details; we plan, as we said we would. We produced the business are not in a position where we can disclose the details plan back in March, and at that time we said we of what we pay for the Government debt; but I think would look at it again in the third quarter in the light to describe it—well, Ann, would you call it a of our experience over the preceding months, and in penalty rate? Processed: 13-03-2009 15:08:57 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG3

Ev 62 Treasury Committee: Evidence

18 November 2008 Mr Gary Hoffman, Mr Ron Sandler and Ms Ann Godbehere

Ms Godbehere: It is a higher rate; it is part of the Q489 Jim Cousins: Mr Sandler, you have told us, state aid process that a company that is a beneficiary very helpfully, that the business plan you got from of state aid has to meet a number of compensatory the Government is currently under review. Do you measures, and in part that is the cost of the debt— not think it would be sensible to accept that and the guarantee—I would say we have the retail Northern Rock is going to remain in the public guarantees. sector for some time to come? Mr Sandler: Yes. There is little likelihood that I can see of being able to return this bank successfully Q486 Jim Cousins: There is some contrast, then, back to private ownership in the near term, given the between what we were told earlier this morning that circumstances that we face. We always said that it Bradford & Bingley are paying a commercial rate was going to be a multi-year process. There can be and you are paying a commercial rate plus, which no doubt that the market conditions that we have brings me straight to this issue of state aid, Mr encountered now make that ever more challenging. Sandler, because we have had an European Commission state inquiry that has now been going on for many months. When do you expect it to be Q490 Chairman: How would you respond to the concluded because it is hanging over Northern Rock desire expressed by the Building Societies’ like the Sword of Damocles? Association that your competition framework Mr Sandler: We are not participating first-hand in should prevent you appearing in the top five, rather that process. It is a dialogue that has taken place, than the top three of savings deals, and that it should and continues to take place, between the perhaps be only against other UK-based providers? Government and Brussels. We may provide the Mr Sandler: I think the competition framework was Government with the information that they use in something that we imposed on ourselves to try and those conversations, but we are not privy to those ensure that we were not taking unfair advantage of conversations, so I cannot comment first hand. I am the Government guarantees that we enjoyed. advised by the Government, and have been for some Inevitably, frameworks such as those involve months, that they would hope that the state aid compromises and trade-oVs and we try and strike procedures or approvals would be obtained before the right balance. I believe we have done so. I do not the end of this year, but that is as much as I can tell think we have distorted competition, as best I can you about that process. judge, in the savings market. I am not on the receiving end of a particular outcry of concern about Q487 Jim Cousins: I had an exchange with the the way the framework is operating. The practical European Commission yesterday in which, frankly, fact of the matter is that we could probably apply at they were talking about the spring of 2009 rather the present time a restriction that we will not appear than by the end of this year. I am, frankly, extremely in the top twenty and the chances are it would still concerned that Northern Rock is now subject to a not have any impact on us, because in recent months special regime of restrictions imposed by the state there has been a flight of savers to security rather aid rules, which it appears that other nationalised than a chase for rates; and therefore the bank has banks are not subject to. Does that concern you? been on the receiving end of some inflows in recent Mr Sandler: Yes, in the sense that the world has months. We have had to take a number of steps to undoubtedly changed in recent months, and whereas mitigate the extent of those inflows. we were in a rather unique situation at the start of this process, we now find that not just in this country Q491 Chairman: That is good, but how easy has it but in many countries in Europe bank rescue been for you to keep within your agreed deposit cap? schemes have been put in place, and they all have Y their own state aid implications. I have not, because Mr Sandler: In October it became quite di cult, but we succeeded. I am not privy to that information, had the chance V to make sense of all of that, but it is clear that there Mr Ho man: The last time I spoke, Chairman, to the are inconsistencies—inevitably. If Northern Rock is Building Societies’ Association’s Chief Executive, he disadvantaged in that process, that has to be a was very happy with the action we were taking to source of concern. make sure we were operating within our competitive framework, because I wanted to make sure that the Building Societies’ Association and the British Q488 Jim Cousins: Do you accept that what follows Bankers’ Association are clear about what actions from these disadvantages has a particular impact on we have taken. the housing market, not just in the north-east but in other parts of Northern England, where Northern Rock was a major mortgage lender? Q492 Chairman: One of the building societies’ Mr Sandler: Certainly our mortgage book is not concerns, maybe, is that through your branches you skewed towards the north-east; it is very much a will focus more in the north-east and therefore use national book. Whatever are the consequences of your competitive advantage for just one area. Are Northern Rock’s lending policies and the way it is they content with your answers to that in the light of having to deal with customers where there is stress your meetings? on their debt, that is quite definitely not a north-east Mr HoVman: I have not discussed that particular problem, and that is unquestionably a national one with them. Clearly, most of our branches are in issue. the north-east, but our internet is nationwide. Processed: 13-03-2009 15:08:57 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG3

Treasury Committee: Evidence Ev 63

18 November 2008 Mr Gary Hoffman, Mr Ron Sandler and Ms Ann Godbehere

Q493 Chairman: Given that you have not given a full Mr HoVman: Look forward to it. answer to that, that is maybe a good time to finish Chairman: Thank you very much for your and say that the next time we meet we will start oV forbearance this morning; it has been very helpful with that question. to us. Processed: 13-03-2009 15:09:12 Page Layout: COENEW [SE] PPSysB Job: 416782 Unit: PAG4

Ev 64 Treasury Committee: Evidence

Wednesday 19 November 2008

Members present

John McFall, in the Chair

Nick Ainger Mr Andrew Love Mr Graham Brady Mr George Mudie Mr Michael Fallon Mr Mark Todd Ms Sally Keeble

Witnesses: Mr Peter Hahn, FME Fellow, Corporate Finance and Governance, Sir John Cass Business School, Mr Ronnie Fox, Principal of City law firm Fox, Ms Carol Arrowsmith, Partner, Deloitte & Touche LLP and Mr Charles Cotton, Reward Adviser, Chartered Institute for Personnel and Development (CIPD), examined.

Q494 Chairman: Welcome to our ingoing inquiry Q497 Chairman: You have the International into the banking crisis. Would you identify yourself Institute of Finance, the Counterparty Risk for the shorthand writer, please. Management Policy Group, the Financial Stability Mr Hahn: I am Peter Hahn. I am from the Cass Forum, the FSA and, indeed, Richard Lambert, Business School. Director-General of the CBI, saying that bonuses Mr Fox: I am Ronnie Fox. I am a City solicitor. are one of the central factors in creating the huge Ms Arrowsmith: Carol Arrowsmith. I am a partner financial problems engulfing the banking sector in Deloitte. worldwide and that is because of a cavalier attitude Mr Cotton: Charles Cotton. I am the reward adviser to risk. If you look at bonuses—I have looked at the at the Chartered Institute of Personnel and annual reports of a number of the major Development. organisations, and, for example, the chief executive of RBS had a salary of £1.2 million but ended up with £4 million; one of the directors of Barclays had Q495 Chairman: You are all welcome. Carol a £250,000 basic salary but ended up with £10.6 Arrowsmith, Joe Stiglitz, the Nobel prize-winning million; and HBOS more than doubled the amount economist, is on the record as saying that the system of money the chief executive had from his basic of compensation in the banking sector almost salary—it seems as if a lot of bonuses are hinged on certainly contributed in an important way to this what they see as seeming success and not their basic crisis. He says that the system encouraged people to salary. Why are you so out of step with everybody gamble. When things turned out well, they walked else? away with huge bonuses, but when things turned out Mr Fox: I think there are quite a lot of people who badly, they did not share in the losses and walked do agree with me but not necessarily those who have away with the large sums. Is Mr Stiglitz’s description been widely reported. I take a contrary view. It of reward in the banking sector one that you seems to me that there are a great many people who recognize? took risks, and substantial risks, who were not in Ms Arrowsmith: I would not want to argue with a receipt of bonuses. They took risks because they Nobel prize winner about many things. I think it is thought it was the right thing to do, not because of fair to say that incentives may well have contributed the way they were remunerated. I think the people in some part to some of the problems. Whether it is who did receive large bonuses, often did so because reasonable to say it is the sole cause I think is they were perceived as having performed very well in unlikely, but there can be no doubt that many what they did. institutions have to go and look at the way they people and review it in the light of new experience. Q498 Chairman: “Risk for success and failure” Peter Hahn. “Prizes for everyone.” Do you recognize that? Q496 Chairman: Ronnie Fox, in your modest and Mr Hahn: Yes, indeed. I have no disagreement with understated way, you have said, “Labour politicians Professor Stiglitz. Certainly most of the reward seem not to understand”—they don’t get it. system was too short-term oriented. But I think you “Business success and the generation of profit need to address the issue on two levels within the involves taking risks”—what are these guys about? organisation: (i) individuals who are at diVerent What is your opinion? levels in trading risks and (ii) the reward structures Mr Fox: I do not agree with the Nobel prize winner, that are provided for the most senior managers I am afraid. I do not think that the remuneration which are determined by boards of directors. systems in the City, and the bonus system in particular, contributed to the banking crisis. I think people take risks in every aspect of business life— Q499 Chairman: Carol Arrowsmith, given your and so did traders—but I do not think the risks professional background, I would like to ask you caused the banking crisis in that sense and I do not some precise questions to get them on the record. think the bonus system is responsible. Can you explain what a typical reward package for Processed: 13-03-2009 15:09:12 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG4

Treasury Committee: Evidence Ev 65

19 November 2008 Mr Peter Hahn, Mr Ronnie Fox, Ms Carol Arrowsmith and Mr Charles Cotton senior and executive management in the banking Ms Arrowsmith: I do not know. sector looks like? Charles may want to come in as well. Q504 Chairman: Does anybody know? Okay, we Ms Arrowsmith: At board level, so the executive will move on. What factors have encouraged the directors, for example the chief executive in the increased use of bonus payments to reward staV in larger banks in the UK would typically have a salary financial institutions? of between £1 million and £1.25 million; they would, Mr Hahn: Frankly, a long time ago bonuses were a on average, have the opportunity to earn a bonus of pretty minimal part of compensation and it was between two and four times that amount; they would decided that financial institutions were boring—we have the right to own shares based on three years’ all remember prudent bankers—and that incentive performance which would be somewhere between compensation encouraged risk-taking which two-and-a-half and five times their basic salary; and benefited shareholders. The structure was incentive they would typically have a pension, the most for shareholders to get more returns, and that has common being a defined benefit based on either driven it for years and years. It is all about career salary or final salary. shareholder returns. Mr Cotton: We did not carry out detailed research in this area. My remit at the CIPD is quite broad Q505 Chairman: Yesterday we had the chief looking at reward, but we do have contacts with HR executive of B&B before us. He took on the job in people in the investment banking community. When August. I think his basic salary is something like I asked them what an equity trader would typically £750,000, but he is entitled to something like get, they said that somebody with a reasonable £650,000 combined stock options and cash. amount of experience, about eight years, would get Obviously, with B&B the shares, you know, are not base pay of about £90,000, a cash bonus worth things you would run for, so he has the cash there, £272,000 (basically three times their salary), and on £360,000. He was getting that cash irrespective of top of that they would get deferred compensation how the bank did. I was told that was a reasonably shares, et cetera, of about £132,000. So we are familiar scene. talking about half a million pounds in all. Mr Fox: These are very large amounts of money. I think people’s perception of what happens, Q500 Chairman: What are the key diVerences in the particularly in the financial services sector, is structure and composition of pay between distorted by the sheer size of the remuneration which investment and retail banks? people receive. I do not agree that bonuses were Ms Arrowsmith: I think there are two very important devised in order to encourage risk-taking. The bonus characteristics. Investment bankers typically have a system is designed to reward good performance. It is much lower basic salary and will have an uncapped a way of marking out people who perform incentive opportunity, so there will not be a exceptionally well against criteria they have been maximum on their bonus, and it will not be given. Sometimes the criteria have turned out with uncommon for the most highly paid people to be the benefit of hindsight to be inappropriate and nowhere close to the main board directors. When sometimes not, but the essential component of a you look at the board of most of the banks, the bonus is that it is supposed to be a fair way of highest paid people will not be those people on the remunerating people who perform exceptionally board, whereas in a retail organisation you are more well against the objectives they have been given. likely to get the kind of classic pay hierarchy, with the most senior people paid more than the less Q506 Chairman: In an article published in Personnel senior people. Today of 24 September you are quoted as saying that salaries in the financial services sector tend to be Q501 Chairman: In terms of bonus payment, the modest. Would you call £1.2 million, £975,000 and percentage shares and cash, what does that work £750.000 modest? out that? Mr Fox: The greatest criticism has been levelled at Ms Arrowsmith: Investment banking is not my those people who are in receipt of between £100,000 specialist subject, but you will generally find that for and £200,000 basic and a bonus opportunity of senior people in investment banking it would not be several times that. unusual for their salary to be no more than about 10% of their annual earnings. Q507 Chairman: But you would not call £1 million modest. Mr Fox: No, I would not call it modest. Q502 Chairman: Stock options? Mr Hahn: With regard to yesterday’s comments Ms Arrowsmith: They will have stock options there are diVerent reasons and diVerent plans for relatively rarely until you get very close to the top of paying senior executives. Today, the new senior the organisation. Most of it is salary bonus, either executive may have a diVerent objective from paid in cash at the time or paid in deferred shares, so someone looking at long-term shareholder value that they get a number of shares which are delivered and risk-taking. They may have a very short-term over time. objective to come up with a strategy and stabilise an institution, and that type of structure and strategy Q503 Chairman: What would the typical reward should be rewarded probably more in cash and more package for a trader in an investment bank look like? certainty than with shares. Processed: 13-03-2009 15:09:12 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG4

Ev 66 Treasury Committee: Evidence

19 November 2008 Mr Peter Hahn, Mr Ronnie Fox, Ms Carol Arrowsmith and Mr Charles Cotton

Q508 Chairman: By the way, I think that Mr Pym, Mr Hahn: One of the challenges that I think you are in taking on B&B, has a gigantic task. I made that dealing with is the fact that a lot of these large point to him at the very end of yesterday’s session. rewards did not correctly take into consideration the But to say that you are going to get your cash bonus amount of risk that people took to earn those irrespective seems a bit— rewards. I think that is probably where we need to Mr Hahn: Yes. focus going forward on the banking system. Chairman: Okay. Q514 Nick Ainger: Carol, how do these packages Q509 Mr Mudie: Carol, I understood you to say that which are in the financial services sector compare, in retail the board is relatively modest in terms of say, with those in the manufacturing sector? bonuses on the investment side, and then it is Ms Arrowsmith: They will typically have more based hierarchical on the retail side. on performance. On average, it is quite common for Ms Arrowsmith: That is an oversimplification. the financial services sector to have it so that half as much of their package is fixed and twice as much of their packaged is variable than for a conventional Q510 Mr Mudie: But the big bonuses are on the FTSE 100 company. So they have more investment side. performance pay. Ms Arrowsmith: Typically. The biggest bonuses are in investment banking. Q515 Nick Ainger: I am not talking about directors, I am only talking about senior managers. Q511 Mr Mudie: I am trying to tie that in. With the Ms Arrowsmith: I am only talking about the main banks now being retail and investment, how does board. I do not have the details of people well within that relate to the board? Does that mean a board an organisation. could be on a very good salary but they are largely dwarfed by the bonuses earned on the investment side of the same bank? Q516 Nick Ainger: Perhaps Mr Cotton can help us Ms Arrowsmith: I think that is true. Many of the on this. How are senior management in investment banking people within those banks will manufacturing rewarded? Do they receive bonuses earn more than the board members. on an annual basis of up to three times their salary? Mr Cotton: No. According to our Annual Reward Management Survey, people in support roles could Q512 Mr Mudie: That seems less clear-cut than what expect to earn up to 10% additionally through a you said, when you say “many of them will earn bonus, for managerial roles between 10% and 20%, . . .”. We saw the Bradford and Bingley, et cetera, and at the really senior level, including director level, and we know the range, but now you are saying it could be 40% to 50%. That is across the whole something slightly diVerent. economy, though obviously in certain roles, such as Ms Arrowsmith: Maybe I am not making myself sales, the split can be 50:50, half your pay is in bonus clear. If you take a retail banking organisation, the and a half is in salary. highest paid people in the organisation are more likely to be board members. In investment banking Q517 Nick Ainger: There is a very significant it is very common for the highest paid people to not V be main board members. di erence in the way that their remuneration is structured compared with the retail and the investment banking system. Can you explain why Q513 Mr Mudie: That is fine when they are that is? separated and they are separate entities, but— Mr Cotton: I would say that in one respect it is the Ms Arrowsmith: When you combine the two, you higher opportunities to earn huge amounts of money will still find a great many people in the investment for individuals for their organisation in the banking part of the business who have the capacity investment banking environment. Also, in the to earn or, indeed, have earned more than the investment banking sector the bonuses are executive directors. discretionary. In many parts of the economy and Mr Fox: Perhaps the reason for that is that the outside you have to perhaps do something. You people who earn the most are seen as having have a formula: “Do x and you get y”, while in the contributed the most to shareholder value and investment sector and banking sector the bonuses profit. Perhaps I can oVer you a story. Some years are discretionary and will depend upon the views of ago I was advising the head of HR in a large the line management in thinking, “Has this person investment bank on the payment of a bonus. He done a good job?” said, “We want to pay this guy a bonus of £7 million”. I said, “What on earth could this guy have Q518 Nick Ainger: But it is still performance related. done to justify a bonus of £7 million?” and he looked Mr Cotton: Yes. at me as though I was slightly touched and said, “Well, the chap made £140 million for the bank.” The moral of the story is that there was a direct Q519 Nick Ainger: Is it not the job of a trader in an relationship in that case, as there is in many cases, investment bank to try to make as much profit as between the bonuses which individuals receive and possible for his employer and the shareholders? Is the profit that they have made for shareholders. that not written into his job description? Processed: 13-03-2009 15:09:12 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG4

Treasury Committee: Evidence Ev 67

19 November 2008 Mr Peter Hahn, Mr Ronnie Fox, Ms Carol Arrowsmith and Mr Charles Cotton

Mr Cotton: One would hope so. reason that banks pay large sums for the right people is because there are relatively few of them. The Q520 Nick Ainger: I still keep coming back to this bonus system gives a direct link between the point: Why does the investment and retail banking achievement and the personal remuneration. The sector have a dramatically diVerent remuneration risk of losing a job is one that is considerable. package from every other sector of the economy? Mr Cotton: That may be a reflection of the labour Q526 Nick Ainger: Mr Fox, losing a job is not market. Up until a few years ago, organisations in unique to the banking system. Everyone, the investment banking sector were competing quite particularly those who are judged on their aggressively with one another to get people into the performance and their pay is judged on their organisation because they could earn the company performance, risks losing their job. I do not think so much money, and so they were prepared to pay and the general public do not think that the risk of higher bonuses. Talking again to my contacts, the you losing your job warrants a bonus three times investment banking sector’s HR people, they said your salary. Would you agree with that? that the turnover on traders is around 25%, so you Mr Fox: I would not agree. The job of a trader in an could expect somebody to stay with the organisation investment bank is not like a normal salaried job. It for four years. The cost of a trader leaving an is diVerent. organisation in the investment banking sector will be £305,000. By contrast, in our own surveys that we Q527 Nick Ainger: It may be diVerent, but the do, looking at employee turnover across the whole rewards are absolutely astronomical when economy, the turnover is about 17% and the cost of compared with hard-working people in replacing somebody is around £7,000. manufacturing. Mr Fox: Do I understand that you do not think the Q521 Nick Ainger: Surely these banks are very large people who work on a trading floor are hard- employers, of hundreds of thousands of people working? across the world in some cases. Mr Cotton: The retail banks. Q528 Nick Ainger: No, I was comparing their remuneration with that of senior management in Q522 Nick Ainger: Yes, the retail banks, but also the manufacturing, who are doing a hard job, with all investment banks. Lehman Brothers employed a the pressure they are now under because of what has considerable number of people. Did they not think happened as a result of the banking crisis, but they of training everyone to do these supposed very, very do not get three times their salary in bonus. important jobs which achieved these high profits? Mr Fox: I agree with that. Mr Cotton: Again, the market was such that the perception was that it was diYcult to get these Q529 Nick Ainger: I am trying to establish what is individuals with their skills. the diVerence, and you say it is the risk of losing their job. Q523 Nick Ainger: We have heard anecdotally that Mr Fox: I said that is part of it. from Oxford and Cambridge, Imperial College, you Mr Hahn: I would look at it in a diVerent way. A name it, mathematicians in particular were queuing trader was able to generate an enormous amount of up to get into the City because of the huge bonuses profit largely by his individual eVorts. To a certain that were being paid. degree, the risks he took were not understood very Mr Cotton: The anecdotal evidence I have is that well, but that is a separate subject. One trader could these people were not wanting to work in the City. generate a massive amount of profit; whereas in a retail organisation thousands and thousands of Q524 Nick Ainger: That is interesting. Mr Fox, you people would be needed to generate the same profit. have referred to the risks that warrant these The profitability that was available attracted more absolutely gob-smacking bonuses. What risk does a and more brilliant people who wanted to take the trader take personally? risk and reward opportunity. Mr Fox: Losing his job. The rate of turnover in the financial services sector is pretty high. They have a Q530 Nick Ainger: I come back to this risk element. short life anyway: there are relatively few people They were not risking their own money. They were over the age of 40 in this sector. They have a short not going down to the bank, withdrawing money life when they have the potential as traders— and then investing it or trading in CDOs. They were not using their own money. I can understand that an Q525 Nick Ainger: Does that have anything to do entrepreneur borrows money, takes a risk, employs with the fact that by the age of 40 they have made so people and makes a substantial profit. Good luck to much money that they can retire and live extremely them. I do not understand, however, this claim that well? traders are taking risks and as a result they Mr Fox: You hear about the successful ones, and personally benefit as a result of that risk-taking. I do many are not successful in it. Even those who are not understand this argument. successful are often not tolerated in an organisation Mr Hahn: I can understand your frustration. I think for very long. The skills which are required to make the industry as a whole is reviewing the risks that it a lot of money trading in investments are quite was taking, because I think the industry is now specific. Exceptional abilities are required. The perceiving that it was paying people (1) for risking Processed: 13-03-2009 15:09:12 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG4

Ev 68 Treasury Committee: Evidence

19 November 2008 Mr Peter Hahn, Mr Ronnie Fox, Ms Carol Arrowsmith and Mr Charles Cotton the firm’s money and (2) for their own performance, Brothers, who received large sums by way of bonus and it did not price the risk on its own money very in the form of Lehman shares, lose very large sums well and the money that was given by shareholders because they were locked into shares of Lehman’s. and the public. Nick Ainger: Thank you, Chairman. Q536 Mr Brady: You say some organisations have done that. It was not the case everywhere. Looking Q531 Mr Brady: Mr Hahn, you said that the origin V of these incentive structures was very much to at the di erences in the structure of remuneration maximise shareholder returns. That probably was packages at these levels—the balance between salary V borne out by the things that you said Mr Fox. and bonus elements and the di erent structures in Would the other witnesses agree with that? terms of long-term reward, claw back and so on— Mr Cotton: Yes. did anybody get it right? Ms Arrowsmith: I do not think you can be unequivocally confident that there is a single right Q532 Mr Brady: That is the origin of it. model. If you look across the organisations that Mr Cotton: Yes. have had serious diYculties and those that have performed rather better, there are common Q533 Mr Brady: They are there to maximise the characteristics around many of the pay structures, so interests of the shareholders. Do they fail? Is the I do not think you can say that all we need to do is fundamental problem of these remuneration find a new incentive pay model and the problem will packages that they do not reflect the need for long- be solved. There are some characteristics—and I term sustainability of the organisations? think the FSA letter makes some good points— Mr Hahn: Fundamentally, at the top of where I think many organisations would be sensible organisations we use the same remuneration to review what they do against those characteristics structure for all industries. Our combined code that and improve many of the things that they do. It is, talks about board structure does not diVerentiate by unfortunately, a global world, so one of the most industries. Companies are allowed to do that. The important things is going to be to have a consistent structure that is accepted is shareholder based, and approach, because otherwise you risk exporting an shareholder based has gotten ever more short term, industry which, however unpopular it is now, is still despite the fact that we have long-term incentives in an important part of the UK world. the structures. One of the things that many investors and shareholders probably followed was that regulators and rating agencies were also looking Q537 Mr Brady: Is there a particular organisation or after their long-term interests in these pay structures, group of organisations that you would say had a and of course they were not, and they really were not better model in terms of protecting the long-term charged to do that, and the incentives were interests of shareholders as well as the short-term becoming ever more short term. maximisation of profit? Ms Arrowsmith: I genuinely think it is very hard to Q534 Mr Brady: Looking forward, do we need to say that there is a single piece. If you look at the look for these remuneration packages to protect the board pay for all the UK institutions, they have a lot long-term interests of shareholders, or do we go of common characteristics. They have a salary and back to expecting the regulators to do that but lean they have a bonus; most of them have a bonus part on them heavily to do so? of which goes into shares; all of them have a long- Mr Hahn: I would think the shareholders would love term piece, and the long-term piece is the largest a combination of short- and long-term incentives. piece, typically, of remuneration, based on three Most of our pension money is on a long-term basis years’ performance; they all base their long term on and they want to see these institutions survive and relative share price performance and earnings; and prosper on a long-term basis, some of them have other things, like economic profit, which is probably a stronger measure because Q535 Mr Brady: Are there any other comments on that has some element of risk-adjusted capital. But, that? without question, you cannot say that there is a Mr Fox: Many of the long-term incentive plans single common characteristic that all of the good which have been around for some years seek to guys had and all of the guys that had trouble did protect the employer from short-term variations. not have. Some of the banks introduced schemes years ago under which there was a claw back from those who had received bonuses if the business did badly. A lot Q538 Mr Brady: How many have claw back and of the detail of the way in which schemes are how many do not? designed is directly relevant to the protection of Ms Arrowsmith: At board level very few people have long-term and medium-term interests. The FSA has claw back. I do not know about below that level. My written to chief executives of listed companies about experience would suggest that it is much less the design of incentive schemes which intended to common now than it used to be. In part, that is balance short-term gain with medium-term gain and because there has been relatively recent long-term gain. We have seen people at Lehman competitive pressure. Processed: 13-03-2009 15:09:12 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG4

Treasury Committee: Evidence Ev 69

19 November 2008 Mr Peter Hahn, Mr Ronnie Fox, Ms Carol Arrowsmith and Mr Charles Cotton

Q539 Mr Brady: Should it be more prevalent? Mr Fox: There are no perfect models. There is no Ms Arrowsmith: I think there are a number of ways perfect financial system. A lot of people in a lot of of managing how you pay responsibly. The first is to fields, whether remunerated by way of a bonus or with paying for the right thing. I think one of the not, fail to assess risk correctly. In my view, it was things that most organisations have to do is to say not the bonus system that caused them to fail to whether their definition of what success looked like assess risks separately, because, as we have heard, was right to start with. The second is to look at what lots of people in rating agencies, in the regulators— safeguards you need to build in. I think time and claw back are two things that organisations need to Q544 Chairman: Can you cut to the chase and tell us consider, yes. what was responsible for that. We have a limited Mr Fox: Last year, Porsche made more money time. You say it was not the bonus system. What is through investments in Volkswagen shares than they it? Just tell us, because we want this on the record. did in making cars. I suspect there are some people Mr Fox: I wish I could answer that. I do not think who would think that is very wrong, that the it was the bonus system. There are world economic business of Porsche ought to be making cars and not factors at play. It is too simple to look at the bonus dealing in shares in another car company. I do think system as being the cause or even a major that some of the discussion around these topics has contributory cause. That is my view. been distorted because of the sheer amounts of money involved, but the responsibilities on those in the banking sector who are charged with looking Q545 Mr Fallon: I should say that I serve on a after very large sums of money and investing those remuneration committee, although not in the sums of money profitably for the benefit of pension banking sector. I want to turn to the FSA’s a letter schemes is very great. Sometimes they get it right, to chief executive oYcers in the banking sector about sometimes they get it wrong. Sometimes they remuneration and ask each of you whether you think perform really well. With the way the world is at the that letter goes far enough or, indeed, goes too far. moment, people should be rewarded for performing Mr Hahn: The FSA letter seems general in nature well, and if they do not they lose out. When you look and we have to think about what the teeth should be. at the long-term interests of the organisation, for a Essentially, I think the regulators already have the number of years I have seen incentive plans which power to look at the structure of pay at the top. are designed to claw back money if the organisation Frankly, if it does not meet their requirements, the does not prosper. I have seen one in a bank where, if FSA should be increasing the capital requirements the bank made losses of more than a certain amount, of that institution. If its pay structure encourages the senior executives, who had large, unvested more risk and recklessness, it should provide more bonuses, just lost their money. capital for risk. That will make the organisation less profitable. It allows a market solution to deal with a Q540 Chairman: Can you name them for us? problem, and boards have the flexibility to decide Mr Fox: I cannot. It is professional— how much risk pay they want to give. Mr Fox: I think it is a very good letter. It says, “The FSA have no wish to become involved in setting Q541 Chairman: It is confidential. Okay. Fine. remuneration levels: that is a matter for boards”— Mr Fox: It is confidential, but it is a well-known and I think that is right. But then they give guidance bank and I might be able to get permission to reveal as to what is good practice and what are sensible that information. things to take into account, and I think that is the right level of guidance. I am slightly worried at the Q542 Mr Brady: We have heard about the way in timing of the letter and whether government which a very competitive recruitment environment statements have prompted the letter to come out in leads to pressure for a bonus-based remuneration October when it did. structure. I think we can all understand how people might respond to that if they think they can make very large sums of money. It seems that these claw- Q546 Mr Fallon: They do draw attention to the year- back arrangements though are equally unpopular. end review that most of these banks presumably will Carol Arrowsmith, you said that there had been be conducting in the next few weeks. It would seem some move away from claw back because of from the letter that they would expect fairly competitive recruitment pressures. If you are going immediate changes. Is that right? to be motivated by the opportunity to earn a very big Mr Fox: What I meant by timing was the fact that it bonus, why should you be worried about claw back followed government concerns about the bonus if you believe you can do that? system having prompted the taking of “excessive” Mr Fox: Because the claw back may operate risks. The FSA are saying that the risk issue is really unfairly. If Mr A does well in one year, Mr B does one that boards should consider and consider very badly in a second year, so the organisation loses a lot carefully when they construct a bonus system. of money, why should Mr A, who was very successful, lose out? That is why a claw back will be Q547 Mr Fallon: I am not quite sure what you are pretty unpopular with Mr A. saying. Are you saying that the Government has prompted the FSA letter? Q543 Mr Brady: Can you get the right model of claw Mr Fox: Concern expressed by the Government may back or not? have prompted the timing of the FSA letter. Processed: 13-03-2009 15:09:12 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG4

Ev 70 Treasury Committee: Evidence

19 November 2008 Mr Peter Hahn, Mr Ronnie Fox, Ms Carol Arrowsmith and Mr Charles Cotton

Ms Arrowsmith: I think the FSA letter is a very Mr Hahn: I do not think the destruction of any sensible letter. I think it is quite diYcult to be more financial institution should be rewarded, but when specific than it has been because the diversity of we think about short selling, short sales of operations within banks means that some of these companies generally keep the share prices closer to areas are things that will need quite significant real values. reform and thought and others will come through that process fairly unscathed. I think the questions Q553 Ms Keeble: Would you not accept that some of particularly about the balance of salary and variable the diYculty people have in this is that people pay and the questions about claw back are things understand profit where something is made and sold that organisations should think about. and so on but with some of what has happened in the Mr Cotton: From a CIPD perspective, we welcome financial services the profit looks like funny money. the attention. We would say, however, that the FSA There is a real diYculty in seeing then why the letter focuses on the technical design aspects of creation of that kind of value should be rewarded remuneration; it does not look at the wider context Mr Hahn: I can understand the diYculties in of where these remuneration systems sit. We would understanding what was going on, but if the say that perhaps you have to look at the people question is how one decides what one can short sell management aspects going on in these and what one cannot short sell, I think that is a very organisations; you cannot really just trust to setting diYcult question and I do not know who should levels and saying, “If you hit this target, you will get decide it. this amount of money.” That is not really a substitute for good performance management. Q554 Ms Keeble: Ronnie Fox, you argue that what justified the bonuses was the special status of those Q548 Mr Fallon: You would have preferred the people in a special industry. It was on that basis that letter to have been more prescriptive. the taxpayer has paid out billions to keep the Mr Cotton: I would have preferred the letter to have financial services going because of their special addressed the people management issues, rather status. Do you not think there is some responsibility than taking it out of context. on the industry to look at what the public perception is of what is going on? In terms of large amounts of money being paid out and these huge bonuses still Q549 Ms Keeble: Peter Hahn, you said that the being paid to individuals who have been responsible justification for bonuses was based on the level of for the crisis, in part—not entirely, but in part—do profits which the traders generated for their you not understand that that creates a real problem companies. Would you accept that that should be of perception for the financial services industry? the case even where the profits are created, for Mr Fox: I think it is very, very sad that so little is example, by short selling? really understood about the way in which the Mr Hahn: Yes, and I think there has been quite a financial services sector works. If you believe in a debate about short selling. I generally think it has free market economy, then short selling is part of a been misunderstood. Our markets overall are based free market economy. Selling things you do not own, on participation of speculators. It is just one of those in the hope that you will be able to buy them cheaper avoidable things that some people bet to go one way when it comes to delivery, is part of the way it works. and some people bet to go the other way and we have Nobody intended the destruction of any financial markets as a result. institution. If there was short selling, that meant that there was somebody buying and they took a view Q550 Ms Keeble: I understand that, but would you too. not accept that for the wider public looking at profits—and everybody understands about profit, Q555 Ms Keeble: We understand that. If the public everybody understands that that is what you are in sees what is happening now, why should they not, business for—where one person’s profit becomes the and us as their representatives, say, “Increase the destruction of somebody else’s business so taxes on the bonuses”? spectacularly, why do you then reward that with a Mr Fox: Why increase the taxes on the bonuses massive bonus? rather than on any other form of remuneration? It is Mr Hahn: Is your question that somebody who has speculated that there is less tax to pay on a bonus succeeded in short selling should not get a bonus? than on ordinary remuneration. That is just not the case.

Q551 Ms Keeble: You are saying that what justifies Q556 Ms Keeble: I am not saying there is less, but in these huge bonuses is the fact the traders generate a sense it is a windfall profit, so why not impose a profits for their companies. windfall tax on it? Mr Hahn: Yes. Mr Fox: I do not see why buying and selling coal or fabrics should attract a diVerent rate of tax from Q552 Ms Keeble: But when you look at the way in buying or selling a financial currency or a derivative. which the profits are generated, if the profits are generated through the destruction of a major Q557 Ms Keeble: We are not talking about buying financial institution, do you think that should be and selling, we are not talking about the salaries; we rewarded? are talking about windfall profits, which so far as the Processed: 13-03-2009 15:09:12 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG4

Treasury Committee: Evidence Ev 71

19 November 2008 Mr Peter Hahn, Mr Ronnie Fox, Ms Carol Arrowsmith and Mr Charles Cotton public can see are unrelated to any particular one has to be practical about how much time amount of eVort or any particular risk-taking with shareholders have to spend on the matters around an the person’s own money. individual company. They own shares in a lot of Mr Fox: I do think that with greater education of the companies. public and greater understanding of the way in which financial markets work, there will be less Q562 Mr Todd: Indeed. It is important to grasp the adverse comment about the large sums earned by importance of the shareholder interest because of some people. course those are normally our pension funds and the collapse in value of these institutions has very Q558 Ms Keeble: Okay. In terms of international substantially damaged the pension funds of many pressure, there has been quite a lot of discussion ordinary people and, therefore, the guardianship by about some sort of international action because of institutional shareholders of this aspect of their role the risk of London losing skilled staV. What do you is something that we should legitimately be think realistically the prospects for that are? concerned about, so, if you have particular Mr Hahn: When one thinks about a major suggestions, any of you for that matter, as to how institution moving today, I would be horribly in fear shareholders might be better informed so that they if I were the prime minister or the finance minister of communicate more eVectively on these matters, that another country if a major bank said he was going to would be helpful. come and locate in my country today, because I Ms Arrowsmith: I certainly think all shareholders would end up having to be the backup network in his recognise their importance, but also I think most central bank in his bail out. From the standpoint of boards do. The boards have a legal obligation to act institutions moving, therefore, I think that is not an in the best interest of the shareholders. There is a issue any more—at least for the time being. The pool of non-executives who oversee any potential diVerence is on the levels, talking about trading and conflicts of interest that the individual executives trading people. If we impose on businesses salary might have, so you have got one line of defence that structures that are uneconomical for those is within the company before it gets to shareholders businesses, it would be very easy for a bank to move and then you have got the shareholders themselves that business to another country, and I think we and their representative bodies, so you have got have to be very careful there. quite a number of layers of governance and communication. I think the UK is actually pretty Q559 Ms Keeble: How about a brain drain in terms well served by its shareholders in the sense that they of individuals moving around? are actually quite a cohesive group. They do talk to Mr Hahn: That is part of it, yes. If we do not let each other and, therefore, there is a greater degree of management determine how they are going to pay concerted action around things that cause particular people for their businesses, we run that risk. concerns around individual companies than there is in many countries. Q560 Mr Todd: The shareholders have a responsibility in this matter, do they not? They must Q563 Mr Todd: And they were mostly caught cold in authorise the reward systems of the board and in this particular matter, so, if they worked in concert, some cases senior executives. Are they empowered they worked in concert in error. suYciently to do that task? Mr Hahn: One of the things that has been exposed, Ms Arrowsmith: The way the board pay works is I think, internationally is the lack of understanding that the non-executives form a remuneration of the modern banking sector and its risks by the committee, they formulate the policy, they, in boards, and it is hard to understand how a board practice, talk to the major shareholders. I think the that does not understand the risks of its organisation legislation that was put in place in 2002 giving is able to reward its executives appropriately if they shareholders an advisory vote has absolutely do not understand the business. stepped up the quality and the frequency of dialogue Mr Todd: I remember vividly a question by our with shareholders. Shareholders having had a long Chairman of a senior board member which area of interest—the first shareholder guidelines revealed— around what executive pay should look like focused Chairman: The Chairman. on share options back in the early 1970s and have Mr Todd: Yes, it was the Chairman actually. been evolved and developed ever since—I think Chairman: The Chairman of an investment bank. there is a very real engagement between the biggest shareholders and particularly the medium-sized and Q564 Mr Todd: Yes, who clearly did not understand larger public companies. some of the instruments in which his bank was trading, which rather bears out the point that you Q561 Mr Todd: Could more be done to inform have just made, so, if we can just turn to the shareholders—as you rightly say, mostly remuneration committee, which is this first line of institutional shareholders, who are the major defence that you referred to, Carol, are they players in this? adequately prepared for what is often rather a Ms Arrowsmith: I think communication with technical task of designing a bonus scheme that shareholders can always be improved. The written aligns with the purposes of the company and reports that go to shareholders are not always the appropriately adjusts to the risks of the transactions easiest things to read and to understand. But I think that they are motivating through that scheme? Processed: 13-03-2009 15:09:12 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG4

Ev 72 Treasury Committee: Evidence

19 November 2008 Mr Peter Hahn, Mr Ronnie Fox, Ms Carol Arrowsmith and Mr Charles Cotton

Ms Arrowsmith: Bearing in mind that the Q570 Mr Todd: Could you explore one of the claw- remuneration committee concentrates on the board back options which is to hold a proportion of bonus rather than the individual roles within it, so much of in escrow for a period of time to examine whether a the concern around investment banking pay is not risk crystallises during that period before paying particularly directed at only pay, are they well- because one of the diYculties, I think, when I was equipped? I think they are a group of people, so there listening to Professor Hahn and he defined profit, is are some good ones and there are some not so good that profit is defined at a particular point in time ones. I think almost anybody involved in the pay based on a variety of assumptions and, when it later area, whether it is in an advisory capacity or whether turns out that those assumptions were not well- it is as a remuneration committee member, has to founded, that profit can prove to be illusory. Now, I take a lesson from this and go back and look at what believe that has been mooted in some places, they do to see whether they feel they are actually actually holding an escrow account for bonuses. doing as much as they ought to have been doing, but Ms Arrowsmith: It forms part of the new UBS I do not think I would say it is something that people compensation arrangements which were published were knowingly negligent of. I think it is an area yesterday, yes. where people do have to go back and say, “What lessons are there to be learned out of this?” Q571 Mr Todd: Is that an innovation unique to them? Q565 Mr Todd: I was glancing at a document that we Ms Arrowsmith: No, I do not think it is. It appears were provided with which was written in 2004, so in some places, but I think it is one of those things long before these events, on the function of where, one has to say, in some parts of some remuneration and nomination committees and the organisations they clearly would have benefited focus, the first task, and the area of risk was “weak from having something that recognised the longer- alignment with strategy”, so a lack of clarity of linking the bonus scheme that you were designing to term risks of the business, whereas it is not the purposes of the business, and some of these necessarily the case for all of the business. I think examples, I think, are crying examples of exactly that is one of the great complexities of the financial that, that the long-term health of the business was services industry, that it is a very diverse industry not seen as a critical driver in designing the bonus and with some of the things that they do you can scheme that people were enjoying. measure quite confidently the profit at the end of the Ms Arrowsmith: I think though that there is a bit of year and with other parts you absolutely cannot. confusion about the people that the remuneration Mr Todd: But many not. committee are responsible for. Q572 Mr Love: Mr Hahn, can I ask you, as someone Q566 Mr Todd: Indeed, you have said they are who, in a sense, stands outside the system and responsible for the executive directors. observed, whether you believe that the executive Ms Arrowsmith: Where the bulk of their pay is remuneration packages are a reflection of the short- typically the long-term element. termism inherent in the City activity? Mr Hahn: Yes, I think that is the case, and I think in many ways our large financial institutions, and again Q567 Mr Todd: But then, to some extent, the it is a similar factor in other countries, ended up messages they pass on through the bonus schemes having very substantially fragmented shareholdings. which they define for executive directors presumably They had so many small shareholders, but without ought to be reflected in the judgments those executive directors make of bonus schemes which any particular material shareholder, and what they they designed for these whiz-kids in the organisation were driving towards was very short-term goals. In who earn far greater sums than they do. fact, whilst we have got all these structures that look Ms Arrowsmith: I think there is certainly a at the long term, it is kind of interesting, and you commonality in pursuing a strategy, but there is not have read a report from 2004 and I went back to a simple cascade down in the mechanisms. 2006 and I found some bank research that was just perfect, and, if I may just read it, and it is about European banks as a whole, it says, “We find little or Q568 Mr Todd: There ought to be that read- no evidence to support the claims that big banks are through, ought there not? Logic would say that. more eYcient or more profitable or have more stable Ms Arrowsmith: Except that the role you expect of a earnings. However, our analysis shows that big board is to have a longer-term time horizon than the banks have capital and funding advantages”, and people below them. that is probably government support. It goes on, “We also observed that the CEOs of big banks Q569 Mr Todd: Yes, but they should not really typically get paid more”, and the numbers are very ignore that long-term horizon when defining a bonus clear, that, despite all the planning, the bigger the scheme for junior persons, should they? It would not bank, the more you got paid, and that is the reality of seem good practice to me. it. What was driving the top bankers probably was Ms Arrowsmith: They do not tend to have such long getting bigger and that was in the short term, and time horizons, and I think it is one of those things you can do that by extending credit, by buying that the FSA has reasonably questioned. another bank, there are various things you can do. Processed: 13-03-2009 15:09:12 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG4

Treasury Committee: Evidence Ev 73

19 November 2008 Mr Peter Hahn, Mr Ronnie Fox, Ms Carol Arrowsmith and Mr Charles Cotton

Q573 Mr Love: We are hearing a lot about the herd Ms Arrowsmith: No, I do not think there is. I think instinct in City activity. To what extent was the herd my job is to be independent and to tell it as I think it instinct amongst big bankers and the people who are is and, if the company does not like it, then I have the paying themselves a great deal, how much was that responsibility to live with the consequences of that a factor, in other words, they looked over at what too, but actually my job is to help the company make somebody was paying in New York and said, “I the right decisions. It is absolutely not to pay people should be doing that”? more just for the sheer hell of it. Mr Hahn: There is a substantial amount of research which shows that, looking at pure comparisons, you Q577 Mr Love: Well, let me press you. A senior can manipulate pure comparisons to get paid more. oYcial at the ABI was stated to say that What I think is a much more fundamental question remuneration consultants’ livelihoods appear to about the structure and the short-termism would depend on pushing an ever-upward spiral in probably be by looking at the one of the banks that executive pay and that many of them admitted that has failed recently. If one of those banks in 2005 they worked for both management and independent decided to be more conservative and hold back in directors. Do you recognise that? Is that a factor? their activity, they more than likely would have had Ms Arrowsmith: It is most definitely not part of the their CEO and board even replaced in 2006 for factor in the way I do my job. failing to take advantage of the opportunities, so the structure was one which was one widely supported Q578 Mr Love: I was not suggesting it was for by players, shareholders and everybody. Deloitte’s, but do you recognise it in the industry? Mr Fox: It is not the case— The ABI seems to recognise it in the industry. Ms Arrowsmith: I would leave the ABI to make their Q574 Mr Love: Ms Arrowsmith, you mentioned own comments about what they said. I think in any earlier the role of competition for the small number industry there are people who are better and worse of people who could do these types of executive at what they do. I think remuneration consultants functions. What role did that play in the advice that need to be very clear about who they work for, and you gave as a consultant to remuneration certainly in my role I work for the company. The committees that may have been considering? In company is the remuneration committee, it is not the other words, were there objective factors or did you self-interest of management, and I might work with say, “Well, objectively they might only be paid this management to get the facts, but I do not work for amount, but perhaps you had better pay them a lot the management and it is a very important more because the competition is fierce out there”? distinction. Ms Arrowsmith: I do not think you should ever say that. I do not think you should ever say, “You Q579 Mr Love: Do you think there is a need for a should pay them more just because they might get code of ethics in this area? poached”. I think you have an obligation to pay Ms Arrowsmith: I am very comfortable with a code people fairly and to do that in an informed way, so of ethics. I have lived by it all my working life, so I to understand to a greater extent what the market cannot see any reason why anybody should have an really does because, generally speaking, when people objection. aspire to be paid more, they can identify the bits of everybody’s package that they would like to add Q580 Mr Love: There has been some suggestion that together to create a package of their own. I think the one way in which to try to ensure that the FSA letter, job of a remuneration consultant is actually to help which I think all of you have agreed is a sensible the remuneration committee to balance some of response in this area, could be implemented, as those objectives to get to a sensible place and that is suggested by the new Chairman of the FSA, is that being broadly competitive. You do not have to we link the remuneration strategy to the amount of match people even pound for pound, but you have capital that the organisation has to hold. In other to be in the right competitive space, so, if you have words, if the FSA thinks that the remuneration very, very good people, and that is a very big strategy leads to risky behaviour, they might ask question to ask in the first place, then you should pay them to hold more capital. How would you respond them properly, but that does not mean you pay them to that, Mr Fox? more than everybody else because that is a recipe for Mr Fox: Is the FSA qualified to make a judgment pay escalation that is just unstoppable. about excessive risk?

Q581 Mr Love: Well, the Chairman seems to think Q575 Mr Love: Would you accept in any sense that so. there was an incestuous relationship between Mr Fox: Well, I am a bit dubious, quite honestly, consultants and the remuneration committees that because I think that the FSA did not show that they they were advising? had a better grip on the risk issues than many other Ms Arrowsmith: I have been accused of many things organisations. in my life, but incest, it is the first time. No, I do not think there is. Q582 Chairman: So who is to take that job, Mr Fox? Tell us. We are looking for answers on this Q576 Mr Love: Well, it may get better! Committee. Processed: 13-03-2009 15:09:12 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG4

Ev 74 Treasury Committee: Evidence

19 November 2008 Mr Peter Hahn, Mr Ronnie Fox, Ms Carol Arrowsmith and Mr Charles Cotton

Mr Fox: Well, ultimately politicians are running the Q587 Mr Mudie: So why, when we question when we country. You asked the question! go over this, do you accuse us of looking for scapegoats? Mr Fox: Well, some of the pronouncements that I Q583 Chairman: So do we all drop into our local have seen suggested that the bonus system is banks in our constituencies and say, “How are you responsible for excessive risk-taking and the collapse doing?” and, if they are not doing so well, they are of financial institutions. Now, I do not think that is V having an o day, we shut them? Come on, give us based on a well-informed analysis. a break! Mr Fox: The Bank of England has had a long- established supervisory role, but I think that the Q588 Mr Mudie: We have heard that, Mr Fox, but events of the past year have demonstrated that you then go on to admit, when asked, that you do many, many people did not understand risks and the not know what caused it. You specifically said that, risks that the financial system was subject to. I do not that you do not know what caused it, so, when we think it is helpful to try and locate a scapegoat. suggest something that you do not like, you say, “Well, that’s not right”, and then we say, “Well, come on. This is an inquiry where we are Q584 Mr Love: Mr Fox, you agreed earlier that the investigating to avoid this sort of thing happening letter from the FSA was sensible and it was again, so tell us”, and then you say, “I don’t know”. suggesting that there had to be a market solution, Then you patronise us by saying, “If you knew more that regulators do not want to tread on this ground, about financial matters, you would not be making and then you tell us that the role is for the these statements”. We do not enjoy it and I do not Government to tread on this ground. Is there a slight think you really mean it, do you? inconsistency there? Could you please clarify? Mr Fox: If anything I have said has been interpreted Mr Fox: I do not think so. I think that the financial as being of a patronising nature, I apologise, it was climate, the economic environment is created by not my intention to do that, but I do recognise— governments. We have seen in one country, in Argentina, that they have nationalised the pension funds, and that has produced a series of distortions Q589 Mr Mudie: But, if you turn round to us and which I hope we will never see here, but they decided say, “If you knew more about financial matters, you that that was the right thing for the economy in wouldn’t be making this statement”, what the hell do Argentina. you think we will think you are doing to us? Mr Fox: I think there is a bona fide intention of finding out more about the way in which the City Q585 Mr Love: Could I ask you, and it is a matter of works and about what has gone wrong. curiosity more than anything else, you mentioned a case of the executive who got a £7 million bonus because he had made a very large sum of money for Q590 Mr Mudie: Well, that is what we are trying the shareholders. If you look at shareholders around to do. the financial services sector at the moment, they have Mr Fox: That is driven by a desire to know more and either faced a dramatic decline in their share values it is one which I would like to help in and, therefore, or indeed in some cases, where they have been I am giving evidence. nationalised, it is suspected that their shares are worthless. Who is going to compensate them? Q591 Mr Mudie: Well, I am just an old Labour Mr Fox: Shareholders are not managers of member of this Committee, just so that you know companies. Shareholders invest and they invest with what you are dealing with! You say that something a view to profit. Now, sometimes they get it right and that has not been raised is something where we sometimes they get it wrong. A third of the shares in accept the world as it is, but I have got a list of the Lehman Brothers were owned by employees of main banks here. Hornby earns £940,000, Daniels Lehman Brothers, current and former employees. £960,000—you did the figures—£640,000 to Steve They took the decision that it was a good investment Crawshaw, he has gone and it has gone up, John to invest in the company that they worked for and Varney £975,000 and Fred Goodwin £1.3 million. many of them got it dramatically wrong. I do not Now, I am just an ordinary old Labour bloke, an old think there is a ready source of compensation for trade union oYcial, but why does someone on £1.3 shareholders. million need to be incentivised to do their job? That is what we ask. Why do they need to be incentivised? Mr Fox: Because that is what the market is saying. Q586 Mr Mudie: You tell us not to look for scapegoats, but there are people who are going to watch this who are in danger of losing their jobs, if Q592 Mr Mudie: So it is the market, we are back to they have not already lost them, and of losing their the market. You told us that you are a free market homes. Do you not think that it is sensible to see man, untrammelled. That is what you said and it is what happened and to examine what happened with on the record. a view to trying to prevent it from happening again? Mr Fox: I think I said that, if you believe in the free Mr Fox: Absolutely. I am entirely in agreement market, then you must allow the market to operate. with that. If you do not, then you— Processed: 13-03-2009 15:09:12 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG4

Treasury Committee: Evidence Ev 75

19 November 2008 Mr Peter Hahn, Mr Ronnie Fox, Ms Carol Arrowsmith and Mr Charles Cotton

Q593 Mr Mudie: Well, I absolutely do not, but you Q598 Mr Mudie: So what you are actually saying to do, do you not? This is what you are saying about me is, “If we were doing it afresh, if we were starting salaries, that it is nothing to do with ability, it is afresh and if there was morality in it and some ethics, actually looking at what someone else or what some then we would not operate in the way we’re other country is paying and saying, “If we don’t pay operating”? Is that it? our chief executive, he’ll go oV to America or he’ll go Mr Fox: I would love the world to operate entirely oV here or there, so we have to pay him”, but I will on a moral and ethical basis, but it is not like that. just come back to the first question that somebody out there must be asking. Why, if you are on £1.3 million annual salary, do you need incentivising? Q599 Mr Mudie: No, but if we did, that is what we Mr Fox: I think many of us believe that some are discussing. We are discussing if the thing that has individuals earn much more than they should do. got us in this mess is caused by this and, if it is caused by this, what changes would we make. Is this not the time, if you were in our shoes as politicians, that you Q594 Mr Mudie: You are looking at us again! would seek to put a bit of morality into it? Mr Fox: No, I actually think that politicians ought Mr Fox: If it were up to me, I would focus on to be paid more, you will be interested to hear, but causation and whether A caused B. People are very many people think that the amounts earned by highly paid in the financial services sector and many popstars or football players are way, way in excess people think they are far too highly paid, but the of what they should be earning. question which I have diYculty with is: did that cause the economic recession and the problems in the financial institutions? I cannot make the link. Q595 Mr Mudie: Stick to the financial ones, the people who got us in this mess. Mr Fox: If you do not believe in the free market, Q600 Mr Mudie: Ronnie, you are running away then nothing that I say in relation to the operation of from it because I think that is an argument and that the free market will convince you, but you may say, is very important and, to be fair to the Chairman, he “Well, why were people willing to pay that much?” is allowing me to press you on the morality of that but they were. They were because they thought that because, yes, that is an issue where I think you are they were getting the best talent and they thought wrong. I think there is a straight connection. They that other people would pay those amounts if they were encouraged, well, you know what happens in did not. the City, something sells, something is bought and everybody is in it, they do not question it, and then suddenly the bubble bursts and we are all looking Q596 Mr Mudie: That is good, so I put a question pretty bad. If you put that to one side, I am just back to you which might percolate down to asking, can you sit at the table and defend the type boardrooms, so let us see where you go with this. of incentive schemes in a firm that pays the lowest- Yesterday, we interviewed a chief executive and we paid 9%, and remember that is 9% of the lot, so, if had the accounts in front of us, and we said to him, you take the 150 or the 50% out, that 9%, being the “What is the average bonus? You pay bonuses from average, is down to probably 6 or 7%. Now, can you you down to the cleaner?” “Yes.” “What is the defend that? average?” and he said, “It is 9%.” “But in your Mr Fox: Do you think that the receptionist who is annual accounts your incentive scheme is from 50 to paid £13,000 a year should be paid more if you can 150% for people who are senior executives.” Now, find half a dozen people who would do the job for the poor lass on the desk, earning £13,000 a year, to £13,000 a year? incentivise her you give her 9% of that, but the fellow earning yesterday £750,000 a year needs a 50 to 150% incentive. Now, tell me, for all that need to be Q601 Mr Mudie: But that is the market. Do you incentivised, why does a cleaner only get 9% and the think you should be asking someone in a firm to go chief executive gets 150%? and run a household on that sort of wage when you Mr Fox: I am going to say something which I hope are sitting down and you have got brass to put back will be understood in the spirit in which I say it. It is and they have all contributed to this great result, but unfortunately not a fair world and the people who she can only have 9%? Do you know what that are well-remunerated and remunerated in a works out at, that 9%? We worked it out yesterday particular way are not necessarily those that you or I and it is £1,250, and the chief executive was going would choose to remunerate in a particular way, and with £75,000 on the 9%. Now, I am all for incentives. Y then the market decided that certain people should As a trade union o cial, I used to get my lads on receive more— incentives, but it was pennies, and this is an example, is it not? Why do we need to incentivise these chief executives, these board members so obscenely when Q597 Mr Mudie: But you are the only one in the they are treating their people so badly? room who thinks that the market is important. Mr Hahn: I would put in a slightly diVerent way of Mr Fox: The diYculty, as I see it, is to link the large how one can influence the behaviour of the amounts of remuneration and the bonus structures organisation. The receptionist cannot really do that, with the collapse of financial institutions. That, I see, but here you have got the CEO and he could sit back is the diYculty and seeking to produce cause and tomorrow and say, “I’m happy to get my 750 every eVect is producing stresses. year and isn’t that nice. You want that mortgage and Processed: 13-03-2009 15:09:12 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG4

Ev 76 Treasury Committee: Evidence

19 November 2008 Mr Peter Hahn, Mr Ronnie Fox, Ms Carol Arrowsmith and Mr Charles Cotton it is a little bit over the requirements and I don’t and the collapse of the junk bond market led to think I’m going to give it to you because why should widespread job cuts and the elimination of bonuses, I? Why should I take any risks?” and that Peter Hahn, then a young banker at now- defunct Kidder Peabody in New York, remembers Q602 Mr Mudie: But should he be earning £1.3 executives, previously on $1m a year, telling him in million? the elevator about how they were going to shop at Mr Hahn: But what you are encouraging in a discount stores. Now, given that Barclays and banking environment, when the economy looks like Goldman Sachs are saying that they are all planning it is a little better, you want the head of the bank to to introduce tough new policies on executive pay, the say, “It’s time to take a little more risk”, and give question is: are these organisations in the vanguard him the incentive to do that. You do not want him to of a new approach to pay in the banking sector, or sit there and just keep going, like we have seen, and I is it simple expediency before a return to business think that is a huge problem, but we are asking these as usual? people to make some really fundamental judgments. Mr Hahn: I think at the moment there is no question, Mr Mudie: Could I not ask you to take a risk? If you it is simple expediency and political actually, but, on were employed with me, I am the shareholder, I am the other hand, it is an extraordinary opportunity to employing you and I am paying you £1.3 million, I think I would be entitled to ask you to take a wee bit recalibrate the system. I think we have seen now that of risk, would I not, and expect you to do that, to go the financial services sector globally depends a lot beyond what any of us do because you are being paid more on governments than we ever really £1.3 million? Why do you need to incentivise understood, so there are probably many roles that somebody on £1.3 million? should be negotiated out of it, but we will see where it goes. Q603 Chairman: Peter, I was going to ask you a final Chairman: On that gem of pure information, I am question because I notice in my Financial Times going to bring the drawbridge down. Thank you today that it says that, in 1990, stock market swings very much for your time.

Witnesses: Mr Brendan Barber, General Secretary, Trades Union Congress (TUC), Mr Miles Templeman, Director General, Institute of Directors (IOD), Mr Peter Montagnon, Director of Investment AVairs, Association of British Insurers (ABI) and Mr Jonathan Taylor, Director General, London Investment Banking Association (LIBA), gave evidence.

Q604 Chairman: Welcome to the second session of Q605 Chairman: Well, at this particular juncture, it our inquiry. Information and opinion can go hand is worth looking at remuneration and incentive in hand, but I am looking for more information in structures. this hour than opinion. Miles Templeman, earlier Mr Templeman: Absolutely, but I think it is a matter this year in your blog, you stated that the City is a of reinforcing and, to some extent, as the FSA is massive driving force behind the dynamism of the already doing, looking at tighter approaches to it UK economy and the Government would do well to rather than, if you like, a wholesale restructuring of avoid anything that would disrupt it. Are you it, and I certainly do not believe it is an area where concerned that the pressure for curbs on pay and the Government itself can get actively involved, but bonuses in the banking sector will end up stifling I do believe that there are some new approaches, yes. wealth-creation and damage the prospects of the UK financial sector? Mr Templeman: Well, I think many of us, me Q606 Chairman: Brendan Barber, the TUC has included, failed to anticipate some of the problems loudly and vociferously spoken about the bonus that were inherent with what was going on in the culture in the City. Is this just the politics of envy? financial world. I retain that view in principle, but Mr Barber: I do not think it is the politics of envy. clearly we are into a very diVerent environment and I certainly think that there is a bigger issue about a now we have learnt that a lot of the operational growing inequality in the country and one aspect of procedures that were going on in the way the that is certainly the issue of pay systems in the City financial community globally was working have led of London, so there is a wider agenda, but, as I think to excessive risk and have led obviously to major has become absolutely clear, the payment and problems. I do not believe the bonus system per se reward systems in our major financial institutions caused those problems. I believe the bonus system in have been a significant factor in the crisis that we all companies is devised to, if you like, reinforce, and have now seen unfold in recent months, and I think reflect, the objectives of those companies. It does not that is the view of the Governor of the Bank of cause them in itself. Obviously, it reinforces England, the Director General of the CBI and a behaviour that the company has decreed it wants to number of eminent economists and it is clearly the achieve, so, therefore, I retain that principle, but view of the leaders of the G20 countries who, in their obviously there are particular problems to address communique´ at the end of the Washington Summit, now. have identified the reward systems in the financial Processed: 13-03-2009 15:09:12 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG4

Treasury Committee: Evidence Ev 77

19 November 2008 Mr Brendan Barber, Mr Miles Templeman, Mr Peter Montagnon and Mr Jonathan Taylor services and banking sector as one of the key issues look at the remuneration structure and say that we on which there need to be new approaches. need to tighten up some aspects of it, and I do not disagree with that necessarily, but I think you have Q607 Chairman: I was very taken by a phrase of to look at the whole financial arrangements and say yours where you said that “plump felines became fat that there need to be regulations, nothing to do with cats some years ago, now they are dangerously remuneration, which could help prevent some of obese”. Do we need to put the executives in the these problems occurring, and there needs to be banking sector on a crash diet, and what would you much better appreciation, which I am sure we will recommend? come back to, in the boardroom and in all of the Mr Barber: Well, I do think that we need to see some people involved in it about how to make sure that the major change. Just to echo a point that came up incentive schemes are aligned with what that towards the end of your previous session, I do think company wants for shareholders in the longer term. this is an important period and that we see some lasting change and we get the new emphasis back on Q610 Nick Ainger: Brendan, you have already genuinely supporting and incentivising and indicated that you are supportive of that. rewarding genuine wealth-creation rather than just Mr Barber: Yes, I do agree with what Richard deal-making, and it would be a tragedy if we see Lambert said, but clearly there are other issues such some cosmetic changes and then, in a year or two’s as the design of these financial instruments that even time, we are expected all to forget about it. This is a hugely important opportunity to get to grips with a the directors of banks who hold massive assets in very important issue. that form did not fully understand. This was an important element in the crisis too, but the reward structure is an important factor in the crisis Q608 Chairman: Jonathan Taylor, in terms of undoubtedly. business as usual, the Centre for Economic and Mr Taylor: I think that there is, as I said, scope for Business Research reported recently that City looking further at the remuneration structures in workers are likely to receive about £3.5 billion in order to ensure that they are aligned more with the bonuses this year and almost £3 billion in 2009, risk which is undertaken. albeit down on 2007 levels. Is this just business as usual? Mr Taylor: No, I do not think it is business as usual, Q611 Nick Ainger: Starting oV with you, Mr Taylor, Chairman, in the sense that I agree, and I think the over the months we have been looking at this issue industry agrees, that the remuneration structures of the lack of transparency in the collateralised debt generally should be looked at further. I think that is obligations, the fact that the risk was never properly consistent with the reports made by various private assessed in many of them and that there was a drive sector groups and, as I think someone in the for short-term profit, but is there not another issue previous session was saying, I think there is a very and that is the culture that exists within particularly good argument for looking at ways in which the investment banking sector and parts, I would remuneration can be aligned more closely with risk. guess, of the retail banking sector of almost a machismo that was driving a culture on the trading Q609 Nick Ainger: Do you all agree with the floors which actually encouraged excessive risk, so it statement by Richard Lambert that remuneration was not just that the shareholders would like to see structures within the banking sector encourage some a positive return so that there is more credit available employees to take spectacular short-term risks, to make the wheels of industry go round much more confident that, if things work out well, they will reap smoothly, but there was also something else going huge rewards and, if they do not, they will not be on? Would you like to comment on that? around to pay the price? Mr Taylor: I am not sure I would put it that way Mr Montagnon: Yes, I do agree with that, and I do round. I think that there is clearly an alignment on also think that the issue fundamentally is dealing the trading floor between results and remuneration, with the risk-taking and the matching of the reward that is the way in which the structures work, but to the risk than the absolute amounts, I think the there may have been at some point excessive risk- absolute amounts would follow on, but the most taking, but I think that is a consequence of the important to get right going forward is to address processes. the structures which lead people to take excessive risk and reward them for taking risks which are not then properly adjusted. Q612 Nick Ainger: Bearing in mind what has Mr Templeman: I would agree with that statement. happened and basically the disappearance of I did not agree with the opening one that Richard investment banks either through administration or had said about it being a prime cause of the problem, mergers or, in terms of Goldman Sachs, becoming in but I do think that the systems that developed did, if eVect a retail bank, taking deposits and so on, do you you like, fail to get that alignment between reward think that those that are still working in the sector and risk, but the critical factor seems to be one of recognise that huge errors were made, that the time and of understanding. In many cases, I believe, culture has to change and that risk now generally those risks were taken without full understanding by needs to be properly assessed before investments are either the individual or indeed the company in total made, or is it still, as the Chairman indicated earlier, and that is the heart of the problem, so, yes, you can business as usual? Has there been a fundamental Processed: 13-03-2009 15:09:12 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG4

Ev 78 Treasury Committee: Evidence

19 November 2008 Mr Brendan Barber, Mr Miles Templeman, Mr Peter Montagnon and Mr Jonathan Taylor change and a recognition that the responsibility for Q615 Mr Fallon: Could we turn to the FSA letter of what has happened actually lies within the banking October on banking remuneration, and I will institutions? perhaps start with you, Mr Barber, because the TUC Mr Taylor: I think there has been a change. I think said that it did not go far enough and then you issued that firms are looking seriously at the structures and a press release. Just before we turn to the letter itself, looking at ways in which they can do things better. you said, “We take the rather old-fashioned view UBS’s measures, which were referred to earlier, are that bankers, like the vast majority of people . . . , clearly one way of looking at that, but I think that should be paid a proper wage and should not require firms are looking at these things seriously, yes. bonuses to get up in the morning”. Are you opposed to all bonuses everywhere? Mr Barber: No, I am not opposed to all bonuses, but Q613 Nick Ainger: Would anybody else like to I think the weight given to bonuses as an element in comment on that? the overall remuneration of people in the financial Mr Montagnon: I would just say one thing in respect world is wildly over-valued and they ought to play a of your remark. I think that the culture really is a much smaller part in the overall package that factor here and the culture can add to the risks if it people receive. is not properly managed, and it does seem to me that it should be the function of the boards of these Q616 Mr Fallon: You do not get a bonus, do you? institutions to make sure that they have in place, and Mr Barber: No, that is not our practice in the TUC! impose, an appropriate culture. That does not mean a culture where no risks are taken because their Q617 Mr Fallon: A large number of your members, business is to make money, but it means a culture for example, in the Civil Service receive bonuses. where reckless risks are not taken and people are not You are not opposed to that, are you? rewarded for taking risks they should not have been Mr Barber: No. By and large, unions do not regard taking and penalised if they fail. bonuses as the most critical element of remuneration Mr Templeman: I certainly agree that there has to packages. The key emphasis is on having a decent have been a change in a way, and I think there is a basic structure of pay appropriate to the job, but of change externally as well which is very important in course there are some areas where bonuses are paid, that I think business and particular financial yes, and those are negotiated. institutions, but all business to an extent, depend on a sense of legitimacy. They have to be seen by Brendan’s members and the public in general to be Q618 Mr Fallon: Now, on the substantive issue, you said that the letter has no teeth, quite correctly, it acting in a responsible way, and I think there is does not have teeth. How would you have given it increasing pressure on all companies and teeth? We had the suggestion in the earlier session particularly, because of recent events, financial that it would be much simpler to give it teeth rather companies, but it is true in all businesses that than all this guidance to simply alter the capital companies going forward are, in a variety of ways, adequacy requirements of the banks concerned if whether talking about sustainability or many other they did not comply. Is that how you would like to aspects of corporate performance, going to have to see it given teeth? have reputations whereby that is an aspect of it. Mr Barber: Well, I think that is certainly a Therefore, I think there is internally a recognition possibility. I know that the FSA letter said that, if that some degree of change, and we can come back the policies are not aligned with sound risk to how much, is also reinforced by an external management, that is unacceptable and immediate perception that is now very important for companies action will be required to change the policies. I think if they are going to be successful in the long term. what we have to see is what lies behind that sentiment as to what can secure compliance in the event that there are not changes that seriously Q614 Nick Ainger: Brendan, are your members address these concerns, so a higher capital reporting a substantial change, a significant change? requirement where the FSA is not satisfied with the Mr Barber: In this area, no, I would not say they are. reward structures is certainly a possible sanction You are asking a question about the culture and I that needs to be considered further. think this is a hugely important dimension to this. This is a world in which people are trading in big, big numbers, they are doing big deals, huge numbers, Q619 Mr Fallon: But there might be others? Do you have your own preferred sanction? millions, hundreds of millions, billions of pounds, Mr Barber: Well, I think that is probably the key and it seems such a tiny sliver of the deal to carve out area where the FSA have to determine the adequacy a few million for the guy doing the trade, but is that of the capital arrangements within an institution, so justified? Is that a reasonable proportion of reward that is the obvious area where potentially one might for that activity? I think that the gap between that see a higher threshold being put in place. culture of the big deal and the real world that the rest of us live in is huge, and we have got a long way to go to bridge it. Q620 Mr Fallon: Mr Templeman, the advisers earlier this afternoon all seemed to regard the letter The Committee suspended from as rather well-balanced. Is that your view? Do you 4.15pm to 4.32pm for a division in the House think the FSA should be in this area? Processed: 13-03-2009 15:09:12 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG4

Treasury Committee: Evidence Ev 79

19 November 2008 Mr Brendan Barber, Mr Miles Templeman, Mr Peter Montagnon and Mr Jonathan Taylor

Mr Templeman: Absolutely. I think guidelines, a manage it better. That would, in my view, support code, the establishment of best practice is exactly the the primary eVort which, I actually agree with the way to approach this issue and, whether you look at others, should be on the part of the regulator looking the FSA one or the IIF one, which is very similar in at this from a risk point of view. If I could just say many respects, this is the right way to approach it. one quick thing about the letter itself, I think there What, I think, you do not want to do, and there are is an omission which is rather important, that it does one or two things in it, particularly about this capital not refer to reward for failure, and I think we need question, is get too specific and I think that is always to be very clear that everybody involved in this needs the danger. There is a desire obviously that you to be very clear that we cannot tolerate reward for make it as hard-edged as you can, but there are so failure. many diVerent circumstances within companies that, therefore, it has to be a set of guidelines, like Q625 Mr Fallon: Does that include claw-back? corporate governance where you set a clear, Mr Montagnon: Claw-back would be quite a useful principled code and some best practices, but you do instrument for preventing that. not attempt to exactly determine how a company should operate. Q626 Mr Fallon: Mr Taylor, is there any downside to the suggested sanction of increasing the capital Q621 Mr Fallon: But we have had code after code for requirement where the regulator is not happy? corporate governance. Why in the end should this Mr Taylor: Well, I think there is clearly a downside not simply be a matter for shareholders? if the capital requirement is excessive, but I think Mr Templeman: Well, I agree with that, but I think that the broad principle and the broad framework you need— which is set out in the FSA letter, which sets high- level objectives which the firms should try to aim at, Q622 Mr Fallon: You do agree with that? is a good one. I think the letter is well-crafted, and Mr Templeman: I think it is a matter where of course I would also make the point that it is the shareholders are absolutely key in this. beginning of an iterative exercise with the firms.

Q623 Mr Fallon: But you said you also agreed with Q627 Ms Keeble: If the banks and financial the FSA. Which is it? institutions do not actually take some action, would Mr Templeman: Well, I think you want both. I think you see tax as being an instrument that could be you want a code of behaviour that is established a` la used, Brendan, specifically on bonuses, not so much corporate governance which, I think, is a good on salaries? model to look at, but there are very specific areas Mr Barber: I think there are certainly major issues where within a company particular shareholders about the way the tax system applies to wealth and should have a very strong role, and I think one of the the enormous rewards that are secured by some things that should come out of all of this is a within the financial institutions and that is a bigger strengthened role for shareholders and more in their issue about fairness in the tax system which, I think, behaviour than actually in the process, so I do not is hugely important. According to Ernst & Young, think the two are in conflict at all; one is general the 54 billionaires living in this country in 2006 paid principles and one is specific companies. tax at a rate of one-tenth of 1%, and that does not seem entirely fair to me, and some of those who Q624 Mr Fallon: Mr Montagnon, why are benefited most from the loopholes available to the shareholders not stronger in this area? wealthy and so on are certainly those in the financial Mr Montagnon: Well, we do not have any legal world. If I may say so, it is an issue that I would hope ability to vote on remuneration other than for at some point this Committee may be able to address executive directors and main board directors of specifically, the tax system. listed companies and in cases where there are diluted share schemes, so we are really rather hamstrung in Q628 Ms Keeble: But, in this regard, we are looking terms of direct intervention. It is also the case that at one particular issue which is high bonuses where quite a lot of these banks actually are foreign and sometimes the linkage or the rationale for them is they may come from the United States where not always transparent. Do you think that, in those shareholder rights are very weak, so we are not circumstances, it might be justified if no other action necessarily able to do very much, but I think we is taken? What do the rest of you think? Do you have could possibly do a little bit more in one important any other views on that? respect, and I agree basically with everything that Mr Templeman: Yes, I do. I think your comment is has been said about the FSA letter. I think that, right in the sense that bonuses have got to be insofar as the remuneration policy across the entire transparent and I do not think there is any way out company is adding to the riskiness of the company, of that. They have got to be transparent and I think that is a matter of interest to shareholders, and I that one of the things that we have to look at, going think that we would like to see some disclosure, not back to Peter’s thing about shareholders only having in the directors’ remuneration report, but in the a view of directors’ salaries, is whether there may be business review of the companies, about how the other remuneration systems within companies that board views, and is managing, those risks so that, if lead individuals to very high levels of return that there is a risk to the entire company, then we can should be brought up in terms of greater engage with the board and encourage them to transparency to the external world. If you earn Processed: 13-03-2009 15:09:12 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG4

Ev 80 Treasury Committee: Evidence

19 November 2008 Mr Brendan Barber, Mr Miles Templeman, Mr Peter Montagnon and Mr Jonathan Taylor above a certain amount, regardless of your position David Beckham. I would like to make one other in the company, your role in that company could be point, if I may, as I think I may have missed an very significant and, therefore, should be a matter of opportunity in responding to Mr Fallon’s question. external transparency, so I think that is the answer It does seem to me that there are other issues beyond to the issue, and then shareholders can vote these strict questions that the FSA is directly accordingly. I absolutely do not think that specific addressing at the moment, in particular, about the taxation on particular types of reward is the answer operation of remuneration committees. I think they because I do not know how you separate them out. draw from a fantastically narrow pool of people as to the directors of our major companies generally Q629 Ms Keeble: Can you see the argument for the and I think there is a danger of them operating like greater transparency being linked much more now a rather cosy club with cross-membership between to the fact that there are very large amounts of public companies, people serving on one company chaired funds which are supporting the industry so that free by so-and-so who, in turn, sits on the remuneration market arguments are not strictly applicable? committee in determining your kind of pay, and I Mr Templeman: Well, it is a diYcult area. In think that reform in that area is an issue that needs principle, I do not really think you can distinguish a attention. What would be wrong with requiring government shareholder from other shareholders, remuneration committees to actually take account, otherwise, I think the companies that have not just of comparisons with the rewards of directors government shareholders will be so distorted and in other companies, but the internal relativities and disadvantaged in the marketplace, so I think the the pay structures right across the company? What answer is that the Government has got to act, in a would be wrong with the workforce being able to be way, like an ordinary shareholder, but I do believe represented within the discussions in the that ordinary shareholders have an important role to remuneration committees of our major companies, play in it. I do not think you can separate out those including the banks? Those seem to me to be issues companies from others. that would be worth attention.

Q630 Ms Keeble: How do you deal with the really Q633 Ms Keeble: Mr Templeman, you said that substantial international problems about the fact there was a need for greater transparency and I just that the industry and in fact the job market is now wondered what key points you would make as to international? How do you deal with the problems of how that is achieved and what it is we should be international regulation? looking for? Mr Templeman: Well, there is not clearly a simple Mr Templeman: Well, again, because the financial answer, but I think the international nature of the community is ultimately something that the marketplace is a very important element because the Government feels it has to bail out, there are certain one thing we do not want to find is that we over- rules that apply to the finance community that do regulate British banks and institutions in the UK not apply to other businesses, and I think that is an and disadvantage them versus the rest of the world, important distinction. I think what that means is otherwise, what the Chairman began with in terms that within the finance community there is an even of our need for the City to be a very competitive greater need for external shareholders to see, have an animal will be disadvantaged, so I think you have to opportunity to comment on and vote on, if have a common statement and understanding of necessary, the detailed levels of the remuneration, principles across the world and all companies and all what those remuneration objectives are based countries have to apply them. against and, as I have said, possibly to go lower into the organisation such that the high earners, who are Q631 Ms Keeble: Brendan, in the previous session not normally under the scrutiny of the remcom, there was some discussion about comparing should be in that view. footballers and whether or not they were entitled to their enormous earnings as well. Now, you organise footballers, do you not? Q634 Ms Keeble: Those people we talked about Mr Barber: We do. previously? Mr Templeman: Brendan and I do not always agree Q632 Ms Keeble: What is the discussion there and on everything, but I would agree with him about the what is the thinking there? Is there actually any role of the remcom. I think it is absolutely key in this, read-across? that remcoms are seen to be more expert, if nothing Mr Barber: I think in these kinds of talent areas that else. I would not agree with him on all aspects about there are labour markets that operate by their own it being a cosy club, but we do believe there is a very kind of rules, and I am not overly preoccupied with strong case in the financial world, and this could be trying to bring David Beckham’s reward system part of external guidance and maybe even FSA back into line with that of the rest of the human race, comment, that there should be members in the non- but it seems to me that the issue you are addressing executive group on a board and indeed in the is how our major financial institutions manage these chairman himself, because in a lot of the companies aVairs. I think there is a relationship to how that failed the chairmen were not experts in the companies more widely manage these aVairs and it financial world, so I think there is a role for expertise is part of a bigger debate about equality, as I say, or a as well as independence that perhaps was not there growing inequality, but I am not too bothered about before. Processed: 13-03-2009 15:09:12 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG4

Treasury Committee: Evidence Ev 81

19 November 2008 Mr Brendan Barber, Mr Miles Templeman, Mr Peter Montagnon and Mr Jonathan Taylor

Q635 Chairman: The Chairman and Chief Executive entire company in the case of banks and, on another, of Northern Rock did not have a financial we are talking about the remuneration of directors qualification and actually we put that in our report, which is decided by the remuneration committee. saying that they should have, but people have come Remuneration committees are committees of the back, saying, “I’m not going to take this board whose function it is to decide the recommendation”, but I suppose you would be quite remuneration of directors, and I think we probably happy with a recommendation such as that? need to separate the tasks out of monitoring the risk Mr Templeman: We would. It is dangerous to be too that is being run by the management in the way it prescriptive about all situations and all companies remunerates all the employees and the way that the and all levels and, therefore, I am nervous about a directors are remunerated, and the report in the blanket rule, but, on the other hand, it should be set business review would actually deal with the up as good practice. remuneration of all the employees. When it comes to Chairman: Exactly. the remuneration committees themselves, I think there are good ones and there are bad ones and, Q636 Mr Todd: We have already touched on the when there are weak ones, there is not a great deal function of shareholders and I have noted that you the shareholders can do because we really have to feel, Mr Montagnon, that a report to shareholders have them working for us, so we would like to see the should expose the risk of the reward systems so that remuneration committee and indeed all directors it should be explicit within the annual reports of the stand for election every year so that we can hold company eVectively, and I think we have also heard them to account for the judgments they take and suggestions for non-board high earners, that their actually we can hold entire boards to account for the reward systems should also be disclosed. Are there judgments that they take of the management risk any other communications that should be made to because I think that would put boards more on shareholders which would allow them to make that their mettle. judgment as to whether these reward systems are V appropriate and e ectively aligned with their Q640 Mr Todd: Are there any other suggestions on interests, which is what they are supposed to be? the reform of remuneration committees so that they Mr Templeman: I can only comment in terms of more appropriately measure the risks involved in the what we have already said about time. I think the particular decisions they take in authorising time element is very critical in terms of that reward remuneration packages for board directors? Is there system. It has to be appropriate to the return and it is anything else that we should be considering there? the same issue, that, when the risk is materialised— No, okay. It has been suggested, Brendan has suggested it, that perhaps there should be a limit on Q637 Mr Todd: I am going to come back to that the number of remcoms that you can sit on or the issue in a second. You have been very silent on this relationship you may have between the company matter, Mr Taylor, as representing a group of people you are a director of and the company in which you who arguably are most directly concerned with this. sit on a remcom. Mr Taylor: On the matter of remuneration Mr Montagnon: If I can perhaps come back to the committees? point I was making about re-election, this would be a big change and I do not think it would be entirely Q638 Mr Todd: No, on the matter of shareholder popular among the director community, but it involvement in deciding the remuneration packages would be a means of people being held to account. and the information given to shareholders. That actually has a certain advantage because it Mr Taylor: I think that certainly remuneration allows them to use sometimes a little bit more committees and the way in which remuneration discretion and judgment in the way they approach committees work can be, in some cases, improved. I these things because we know, as shareholders, that am not sure whether I would agree with all the we have got the safeguard of being able to vote prescriptive points made by colleagues here, but them out. certainly, in some cases, I think they should have the information available. I think they should have the Q641 Mr Todd: I am assuming that you are speaking information available to enable them to do their job V properly. at this moment on behalf of shareholders e ectively? Mr Montagnon: Yes. Q639 Mr Todd: A mild comment! Those are a couple of useful things which, I have to say, would suggest Q642 Mr Todd: Therefore, this is the kind of thing legislative action if you are going to insist on a that your members would look quite carefully at, so company placing something within its annual that is useful and practical. report, for example. That is not just an Mr Templeman: Just to comment on the other point, encouragement from someone that that should I do not think there needs to be greater, if you like, happen, but it is something that is normally change on the required make-up of remcoms, but I enshrined in legislation. do believe that what we have touched on already Mr Montagnon: I think that would be very helpful. about the need for companies to be acting in a way I think it is quite important in this discussion that we that is appropriate to, let us call it, the slightly distinguish between two things. On one level, we are diVerent environment that we are now in will mean talking about remuneration structures across an that companies will want to have representatives on Processed: 13-03-2009 15:09:12 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG4

Ev 82 Treasury Committee: Evidence

19 November 2008 Mr Brendan Barber, Mr Miles Templeman, Mr Peter Montagnon and Mr Jonathan Taylor that remcom who are clearly better able to represent directors. If you were to put representatives from the interests of the shareholders in judging risk and outside the board on to those committees, you are so on, so I think a change will occur because of that. changing the structure and the approach fundamentally— Q643 Mr Todd: The other thing is about resourcing the remcoms so that they actually have the tools Q645 Mr Todd: Which was not the question I asked. available to make some critical judgments. Are there It was the advice resource they had available. areas there that we need to look at, and this is an Mr Montagnon: But I would agree that opportunity, Mr Montagnon, with Ms Arrowsmith remuneration committees should take account of still here, to say your bit about consultants in this the broader situation in the economy and in the area possibly. company when making their decisions and I think Mr Montagnon: Well, the remuneration consultants, that the remuneration consultants should perhaps in our view, collectively, and I am not referring to help them sometimes to do this more than they do. any individuals here, but, collectively as an industry, Mr Templeman: I would agree with the point, but I they have contributed to the general ratchet in do think that the non-executive director, performing executive remuneration because they seem to have business models which require them to earn fees the role in the full manner that he should be, is which require them, therefore, to modify packages perfectly able to do that. That is exactly what they every year which, therefore, requires the packages to should bring to the party. go up. I think that is a structural issue and it is not Mr Taylor: I was going to make a similar point, their fault that they are in that position, but I think Chairman. I said earlier that I did not necessarily it does actually, therefore, call for some mitigation, agree with all the prescriptive remarks and, for the and a code of ethics would be very helpful in this, a avoidance of doubt, that was one that I was not on code of ethics which, for example, would oblige side with. them to make it clear who they were actually working for. If they are advising the remuneration Q646 Mr Mudie: Brendan, I would just like to raise committee and not the management, that is one one matter with you. You have spoken about David thing and, if they are advising the management and Beckham and you conceded that, because he has the remuneration committee, it gets a bit particular skills, it is the market. Now, one of the complicated, and some of them tell me that that is worries is that the people within the bank structure, what they do. It would also allow us to look at, for the people who are trading on the investment side, I example, the integrity with which they approach would suggest that you or I could not do that job, comparisons because that was a factor in this. and there has been evidence earlier that it is a job that has a high and an early finish, a bit like a Q644 Mr Todd: Does a remcom need, in addition to computer programmer, an early finish in life, a bit someone who knows a lot about remuneration like footballers, and that you have to be highly systems, some additional advice, and to some extent skilled to actually achieve it. Now, would you not it backs up what you are saying, in order to put some accept that a high salary is the same for that person of that advice into a rather broader perspective? Is as for Wayne Rooney because of the skill element, there not some obligation to have a broader but the worry really is that the concern should be consultation in deciding on appropriate reward where you have actually not just paid them a good systems? salary to do that job, but you have baited the trap Mr Barber: I was just going to say that I am pleased with, “But you can earn three or four or five times that a proposal that there should be some workforce that if you deliver this amount of money”, because representation has not attracted any direct human nature would suggest that you will not look opposition from any of my colleagues, so I am too closely at something that is making you a lot of taking it that silence is assent on that point! Just in money, such as the type of behaviour we have seen, terms of the consultancy operations and those who so, for these characters, it is more the bonus aVecting advise remuneration committees, it is remarkable behaviour which aVects the firm and aVects the how many of them are given remits which refer to a economy than actually the high salary? benchmark of the upper quartile. If endlessly, year Mr Barber: Yes, as I said earlier, I think the after year after year, you are referred to the upper proportion of the overall reward that is in the form quartile, then that is an endless ratcheting and an of the bonus rather than the base salary is one of the ever-increasing gap with the rest of the workforce. factors that has distorted behaviour so significantly. There was a union general secretary who won a deal that made reference to the upper quartile of male manual earnings and he bought a greyhound and Q647 Mr Mudie: What is your membership like in named it “The Upper Quartile”, so that shows the terms of the finance sector or manufacturing? appreciation that he had for that particular deal, but Mr Templeman: Of the IOD? in this context I think it is rather a destructive factor. Mr Montagnon: Could I just come back to the question because Brendan said that the silence was Q648 Mr Mudie: Yes. assent. I think, for us, remuneration committees are Mr Templeman: It is a broad spread, so we have a lot committees on the board whose job it is to decide the of finance, a lot of manufacturing. We are pretty well remuneration of directors, particularly executive reflecting everyone. Processed: 13-03-2009 15:09:12 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG4

Treasury Committee: Evidence Ev 83

19 November 2008 Mr Brendan Barber, Mr Miles Templeman, Mr Peter Montagnon and Mr Jonathan Taylor

Q649 Mr Mudie: Is there some anger in the more examination of what those risks are and, as manufacturing side, or perhaps do not let me you said, if that were applied, then I think the influence your answer, but we are interested, the potential for high rewards, they are probably not Government is interested, all politicians of all parties going to be as high as they were, we may well have are interested, in how the bankers are reacting to the lived through an exceptional period that may not people who are now feeling the brunt in the real happen again, but I do not think you need more than economy, so what are your members actually saying that, although you need to apply that very carefully. to you? Firstly, are they having a hard time or is it— Mr Taylor: I was going to make a very similar point, Mr Templeman: They are, of course, many are, but Mr Mudie. I think the point is that there is a sort of many are not. The real economy is full of diVerent payment by results element here and the traders are stories even now, but sure, many of our members very incentivised by the results which they get, and would feel, a bit like some of the comments made the key point, as Mr Templeman was saying, is that earlier, that bankers are getting very high rewards, that should not involve the taking of undue risks so is that appropriate, and many of them would from the point of view of the firm, so the firm should either feel angry or not happy about that, so we are have risk controls in place which ensure that its own no diVerent from a lot of other groups. I think we so-called “risk appetite”, to use the jargon, is not have to go back to the comments that, I know, you exceeded. discussed a lot in the previous session. We are dealing with a marketplace, they are people with Q653 Mr Mudie: Brendan, how would you deal with exceptional talent and they do possibly have short this in that Miles does not want the Government to careers, but I think the key to the bonus, the do it and I am pretty sure that, when the dust settles, relationship between salary and bonus, is about the all of this will be forgotten and the world will move nature of the particular job an individual is in. If that on in the same old way— V extra e ort of that person can deliver very big Mr Templeman: That is not what I said. rewards, and it is just like a win bonus for a footballer to get, if they cause their club to win a Q654 Mr Mudie: I am just looking at regulation. dramatically diVerent level by individual eVort, then Everybody says that we need strong regulation, but they will get high rewards and a bonus system is already in the City there are people saying, “Not too appropriate. However, let me just say that I think, to much regulation”. Well, if they say that in the middle answer, if you like, all the other topics we have of this bloody crisis, what the hell are they going to raised, that that bonus system must still be fully say in a year’s time—“Oh no, we don’t need cognisant of all the risks involved in it, look over regulation?” In fact, bankers are lecturing us that we time and, if you like, not be vulnerable to the kind of should be interfering in their behaviour, so what accusation that is being raised against it, but it can would you do, Brendan? be very big. Mr Barber: Well, I am hoping that we are going to see something serious come out of the FSA exercise. Q650 Mr Mudie: Staying on the football analogy, That is about looking to establish potentially criteria Ferguson would say back to you, and indeed other against which the FSA would be able to evaluate not managers would say back to you that, because basic just any directors’ pay arrangements, but the overall salaries have got so big, it is hard to motivate people. remuneration structure within financial institutions Now, here you have got a big salary, so do you need and evaluate whether or not that was incentivising the big bonuses and are they not too dangerous? unwise risk. Mr Templeman: They are only dangerous if they are inappropriate, honestly. If you do not structure Q655 Mr Mudie: But, when the credit crunch broke, them right, they are dangerous and that is what we Hector, over at the FSA, said, “We’re going to have have all learnt. They do not have to be dangerous. to spend more money on top-quality staV. The salaries here aren’t big enough because we’ve got to Q651 Mr Mudie: But what do you mean by get them back from the banks”, so the FSA are “structure them right”? Let us agree with how they implicated and he is looking at his salaries compared are dangerous, that they lead the person on into to what is being paid in the banks. It is a pretty bad behaviour that is injurious to the firm and the larger world, is it not? How do we get some reform? economy. Mr Barber: Well, they have been tasked with this at Mr Templeman: In the longer term. this stage. They have asked for the institutions to respond and they are trying to see if they can think Q652 Mr Mudie: Well, some of them were in the their way through to clear criteria that they could short term here. The later you got into this, the more then assess institutions against. That is, I think, the you were caught with the parcel when the music task and, whether it is the FSA or someone else, I stopped, were you not, so now how do we get think the requirement has to be some much sharper, round that? objective way of assessing the structures against the Mr Templeman: I think by what we said, that those potential risks. I am prepared to give the FSA a go remuneration schemes and those bonus schemes at seeing if they can rise to that challenge, if they can have got to be structured being fully cognisant of the meet that task. risks involved. I do not think it needs more than that, Mr Templeman: One thing I would add, which Peter but that is quite a big step forward in the complex has mentioned and others have, is that what we want world that we are talking about, so there needs a lot to see come out of this, the IOD along with Processed: 13-03-2009 15:09:12 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG4

Ev 84 Treasury Committee: Evidence

19 November 2008 Mr Brendan Barber, Mr Miles Templeman, Mr Peter Montagnon and Mr Jonathan Taylor yourselves, is some improvement in stopping reward I would very much hope that that is an issue that for failure. I think that is what gets everyone most potentially the Committee at some stage might be annoyed. It is not earning a high bonus if your able to turn its attention to. company is doing well and everyone is doing well out of it, though there may be some disagreement about that, but in general that is not the issue. The issue is Q660 Chairman: Would you like to write to us, the that individuals are rewarded too much when they same as Miles has written to us already, on this. fail, and I think that is about the whole contractual Mr Barber: Yes. area that needs to be very carefully considered by remcoms when they are recruiting as well as when Q661 Nick Ainger: One of the things that we have they are going, but also a notion that a lot of the discovered in our inquiries around the credit crunch problems that we are talking about are because an and so on is the fact that all the regulatory investment, which seemed to be successful and was authorities were chasing the game, and, now that we rewarded, actually was a failure, and that is what has are in a position where we are staring a global led to the crisis in a way, so I think it is about getting recession in the face, I just wonder whether your at this and really getting under the skin of making organisation, Mr Taylor, and generally the institute sure as much as is possible, and it is very diYcult, of banking and so on are actually sitting down and that you do not reward failure, and that is what I coming up with schemes, not just about the think we want it to show. remcoms, that is fine, but actually coming up with their own suggestions about how we can prevent this Q656 Mr Mudie: Are you and the TUC, not happening again rather than expecting the FSA to together, but separately, doing anything specific regulate as well which means that they are the other than coming here and giving verbal evidence? policemen and they are basically chasing the burglar Are you preparing documents or working on down the road too late again? anything for your respective organisations that Mr Taylor: My organisation and others like mine would help us in our deliberations? are indeed working on all sorts of ideas in relation to Mr Templeman: I do not think we have got any overall financial regulation and so on, we are specific documentation, but we have certainly been providing information, we are working on that, yes. very involved. For example, last week in Brussels I On things like the sort of financial supervision and was at a seminar discussing these very topics, and issues like that, we are working on that, yes. On the there was a very strong view coming out of Brussels remuneration point, so far that has not been, to be that, if you like, we have got to get our act in order, frank about it, a central point because it is matter of we have got to show some change which is more than commercial confidentiality to firms, but clearly there just back to usual, otherwise, the Commission and is now a policy issue about remuneration which has others will come in against us. been picked up by the G20 and they will be working on that up to 31 March and we will obviously want to be doing what we can to provide input to that Q657 Mr Mudie: What does that mean for you? exercise. Does it mean you have come from Brussels now intent on getting some of your high-quality staV working on a document for our deliberations? Q662 Mr Todd: I just want to test this point about Mr Templeman: We have not done that. We are risk and crystallisation of risk because someone, and mainly saying, “Let’s make sure we get engaged with I cannot remember who, said that sometimes a deal the FSA in terms of them coming out with looks fantastic, you appear to earn a great profit and guidelines”. then, a year down the track, everyone spots what the problem was with it. The UBS model, which briefly came up in the last session, suggests holding in Q658 Mr Mudie: Brendan? escrow at least a proportion so that you work out Mr Barber: We have done work on all of these issues where the skeletons are before you pay the money. Is and we will happily actually put a note together to there something to be commended there? A submit to the Committee. Certainly we are valuable tool? working— Mr Montagnon: I think that is essentially a very useful tool. There is always a problem that, once you Q659 Chairman: You have spoken a lot, in fairness, have paid the money out, it is very diYcult to get it of taxation. back. Actually we, as investors, think that it should Mr Barber: Well, I wanted to come back to the be possible anyhow to write into people’s contracts taxation point in particular. As I was saying earlier, that the money may be recovered if it turns out to I do think there are some major issues here about the have been paid in connection with transactions that way the taxation system applies to some of those have generated large losses. I think you could look accumulating the greatest wealth, which includes at writing that into contracts, but the escrow system, certainly people in the financial community. I think I think, is quite valuable. I would not think it is at this time, when we are all extraordinarily worried actually relevant for every company in every sector, about the potential disasters that might come but, in this particular instance where we want to through in the impending recession, fairness has got make sure that people have not been running to be at the heart of finding our way through and excessive risks, I think it is a useful idea and we that needs to involve fairness in the tax system, and would like to see it spread. Processed: 13-03-2009 15:09:12 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG4

Treasury Committee: Evidence Ev 85

19 November 2008 Mr Brendan Barber, Mr Miles Templeman, Mr Peter Montagnon and Mr Jonathan Taylor

Mr Templeman: Yes, we would too, and I would not Mr Montagnon: Well, the pre-emption principle rule out the notion that some companies might want regime is very important to confidence in the to have claw-back systems. I think it would be markets. I think the shareholders do have a vote on perfectly acceptable— what Barclays is doing and that vote is going to happen next week. I think one of the diYculties that shareholders have is that, whilst they may not Q663 Mr Todd: That is harder to enforce of course. particularly like what is happening, this deal is very Mr Templeman: It is, but the notion where you expensive to existing shareholders and it does not oVered a very high upfront return with the danger or respect pre-emption rights and it gives certain the risk that there is a claw-back would be one instruments at a privileged right to outside investors, company’s way of approaching it, and another but, whilst they do not like what is happening, they company would approach it in terms of a lower also will have to take into account what might going-in bonus, but without the possibility of claw- happen to the bank if the deal did not go through. back, and I think that is why it has to be done at the They have been put by the bank in a rather company level in terms of appropriate risk. diYcult position. Q666 Chairman: But the thing is, Peter, that it is not Q664 Chairman: Again, one sovereign wealth fund I that they were not under the bushes and then they was speaking to recently was talking about having found out that they did this deal. Should there not bonuses over a 79-year period with the ability to be a better way of doing things. claw back in that period of time. Mr Montagnon: Well, I am sure there should, but I Mr Templeman: Many bonuses are over a longer think it comes back to one of the points I made period, as you know. Just to comment on Nick’s earlier, which actually Barclays has acknowledged, question about are we doing other things, yes, we are that their entire board is going to stand for re- and we said at the beginning that one of the key election at the next annual meeting. We think that things is to only see remuneration as a part of this, that, as I have indicated, should happen as a matter some may say a large part and some may say a small of course, and that is a way of holding boards to part, but how we control the financial system, the account if they do this. clearing house for derivatives and so on, there are a Q667 Chairman: But that could be the biggest con lot of things which are being worked on, as you because we know in the political world with a vote know, and we are certainly contributing to that. of no confidence in the Prime Minister, “Forget it, boys, we’ll all get together”, and it is the same with Q665 Chairman: Brendan and Miles have said they Barclays. will produce their own documents and point the way Mr Montagnon: I am not sure that it is quite the forward for us on these issues and that is very same in the commercial world because, curiously enough, I have found that businessmen have thinner important, but, Peter, on the issue of shareholders skins than politicians! and shareholder interest, I note that Barclays with Chairman: So we are looking to you to claw back their rights issue were chasing across the Middle because you will get a vote of thanks from Mr Mudie East instead of wanting to be getting money from the and ourselves! On the issue of claw-back, how do UK taxpayer, which seems to have disadvantaged you favour claw-back for David Beckham if he does shareholders’ pre-emption rights particularly, and not score any goals! With that, of course I am very now they are crawling to the biggest shareholders, grateful for your interest and I am looking forward L&G and others, to sweeten the pill on that. Surely, to these submissions that you are going to make there are things that should be done in that area to because they will be very helpful for us to manage ensure that shareholders have got more muscle, our way through a very complex issue. Thank you because you have commented on that? very much. Processed: 13-03-2009 15:09:27 Page Layout: COENEW [SE] PPSysB Job: 416782 Unit: PAG5

Ev 86 Treasury Committee: Evidence

Tuesday 13 January 2009

Members present

John McFall, in the Chair

Nick Ainger Ms Sally Keeble Mr Graham Brady Mr Andrew Love Jim Cousins Mr Mark Todd Mr Stephen Crabb Sir Peter Viggers Mr Michael Fallon

Witnesses: Professor Willem Buiter, Professor of European Political Economy, Professor Charles Goodhart, Professor Emeritus of Banking and Finance, and Dr Jon Danielsson, Financial Markets Group, London School of Economics, gave evidence.

Q668 Chairman: Good morning and welcome to this a predictive failure, in which I might say that our first evidence session of the Banking Crisis virtually every government and virtually all Inquiry. Dr Danielsson and Professor Goodhart, economists shared. can you introduce yourselves formally for the shorthand writer, please. Q673 Chairman: So massive fallibility then? Dr Danielsson: Jon Danielsson, London School of Professor Goodhart: Yes and we are not able to Economics. forecast the future and the future turned out very Professor Goodhart: Professor Charles Goodhart, diVerent from what people had expected. although I am actually retired now so I am not sure I can properly call myself Professor. Q674 Chairman: Dr Danielsson, maybe you could add to that and take in the question of what is the Q669 Chairman: We take the wise men out of role of the banking sector within the overall financial retirement! You are very welcome to this session and sector and how has that performed? we are interested in the banking crisis inquiry in the Dr Danielsson: The role of the banking sector is to sense of how did we get into this situation and how allocate funds from those who have savings and do we see our way through this and what will the those who have assets to those needing the money. future regulatory environment be like. Maybe I We have cases where we have no real banking sector V could start with a general question: what is the and those countries do su er greatly because there is finance sector for, Professor Goodhart? no way to transmit funds from those who have them Professor Goodhart: It is to seek to allocate savings to those who need them, so the financial system does to their most eYcient and best possible use. I would provide a very useful and needed service in say it is a mechanism of allocating funds in the best allocating funds, and if we did not have this system possible way. we would sorely miss it. This system has a tendency to over-extend itself. We tend to give too much credit and we tend to get into a bubble situation and the Q670 Chairman: Has it succeeded? occasional crisis, but, in my view, that is almost an Professor Goodhart: It has certainly succeeded a lot inevitable part of having the system, and if we did better than trying to do it by oYcial diktat as in the not have this type of banking system we would Communist countries, who failed because their miss it. mechanisms for allocating capital and for ensuring Chairman: I will come back to those questions when that capital was used eYciently completely Professor Buiter comes. Mark Todd? collapsed. Q675 Mr Todd: I notice that Professor Goodhart Q671 Chairman: Let us just look at the past few said that there had been an under-pricing of risk and, years, has it succeeded? Dr Danielsson, you have written of the complexity Professor Goodhart: The extension of credit was of calculating risk in financial products. There are a allowed to go too far too fast and the basis on which lot of highly paid people who do exactly that job. Do credit was extended, particularly in the mortgage you have any advice as to how we can get this right sector, in many countries, in the UK as well as in the or is it a completely vain hope? USA, was ineYciently done. Dr Danielsson: There is one thing that people in the financial system perhaps have not learned from the economists. The economists learned 30 or 40 years Q672 Chairman: Is it not to do largely with the ago that you cannot think about the economy as an underpricing of risk and the lack of due diligence? engineering system whereby you can just create a Professor Goodhart: Certainly the underpricing of whole bunch of equations trying to describe how the risk and with hindsight, in many cases, there was a economy works. That type of thinking was prevalent lack of due diligence, but to a large extent I think it up until the 1970s and that might exist even today was a failure to predict the decline in housing prices somewhere deep in the bowels of some central and the subsequent decline in the economy, so it was banks, but, by and large, we have realised that we Processed: 13-03-2009 15:09:27 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG5

Treasury Committee: Evidence Ev 87

13 January 2009 Professor Willem Buiter, Professor Charles Goodhart and Dr Jon Danielsson need to take into account expectations, and we need under the table and now all of these proposals on to take into account that people are intelligent and liquidity do not focus on modelling, they focus on people react to rules. By contrast, the financial management. system is still treated, when you think about models and risk, as if it were an engineering system and Q680 Mr Todd: In other words, it is back to human treated as if you can take prices in the markets, you beings and understanding what seems like a rational can run them through a model and you can get the approach to access to cash essentially? risk, not realising that people are intelligent and Dr Danielsson: I could not agree more. people react to risk, so, in my view, the financial Professor Goodhart: Going back to the Chairman’s system changed with this observation. If you try to opening position, I think that the lack of concern create a rule that will change the dynamics of the with liquidity that had been shown previously, system. That process complicates the modelling and particularly by regulators, was out of a belief that the therefore if you try to model risk in the financial wholesale markets, where most banks went to get system as if you were trying to model the risk of their marginal funding, were very eYcient and nature you will inevitably fail because people react would work and would be open under all to it. Just to summarise, when you need the risk circumstances as long as the banks had suYcient models the most, they are the least reliable. capital, and it was that belief that wholesale markets will always work eYciently, subject to the banks Q676 Mr Todd: That is a rather glum picture which abiding by the capital requirements, which was suggests that some people have been highly paid for shown not to succeed from August 2007 onwards, relatively little value in this process. Is that fair? and those wholesale markets are still not working properly. The banks’ search for liquidity has Dr Danielsson: It depends a little bit on how you consistently shifted from holding liquid assets to the look at it because I think those institutions who will belief that they could obtain additional funding by survive this crisis the best are the institutions with going to these wholesale markets. It was the failure the best management. To my mind this crisis has of these wholesale markets that brought concern shown that it is management of risk that is about liquidity back to the centre of the stage. important. Q681 Mr Todd: So what should a regulatory system Q677 Mr Todd: A lot of that sounds down to gut for liquidity look like? understanding of human beings. Professor Goodhart: Well, there very nearly was such Dr Danielsson: Absolutely correct. a system introduced in fact in the 1980s. At the same time as the Basel Committee was introducing an accord on capital they were searching for an accord Q678 Mr Todd: And not complicated formulae. on liquidity, but that search ran into diYculties, and Dr Danielsson: I think trying to take what is a very eVectively got dropped in the 1980s, it became too complicated process and put it into a computer diYcult for them to proceed, and the process went model and try to get an outcome is something that on then continuously whereby the banks turned for has, by and large, failed. We need to be careful their additional funding, their liquidity, to the because these models do have a useful purpose wholesale markets and more and more got rid of within the management process, but taking them to their lower yielding but highly liquid public sector the regulatory side I think has been a failure. debt, to the point where the British banks entered the crisis in 2007 holding a really minimal amount of Q679 Mr Todd: One of the gut human instincts highly liquid British government debt. would probably have been that liquidity—access to relative easily accessible assets—would be a critical Q682 Mr Todd: Fine, so you are suggesting in terms part of the security of any system and yet that has of a regulatory environment for the future? been an area which has been relatively neglected in Professor Goodhart: We would need to go back to the control systems we have used. Is that something look at an appropriate regime for liquidity. that we are going to have to devote a great deal more eVort to? That is not specifically to you, Dr Q683 Mr Todd: And Basel II—back to the Danielsson, but do go on. drawing board? Dr Danielsson: There is a tendency in all modelling Professor Goodhart: Basel II has got a lot of good to model what you see and not model what you features. I think it is the best system that I know for should be modelling, in other words, you focus on trying to ensure the capital adequacy and the the observable. Liquidity is one of these things that constraint on risk-taking of the individual system. everybody seems to know what it is but nobody has Where it fell down completely was in looking at the been able to properly define it. We can talk about it systemic risk, the macro prudential, compared to the conceptually but trying to model liquidity in a micro prudential risk. It is not that Basel II is wrong statistical decision-making model has been until or bad; it is just totally and completely insuYcient in now impossible, and therefore, as a consequence, that it did not look appropriately at the systemic even if everybody realised that liquidity was issues. To take a particular and very obvious important, because you could not model it and you example, for an individual institution which is could not put it into a decision-making process, it running into diYculties with insuYcient capital, the was not part of the models, so it sort of got brushed obvious thing for it to do is to cut back its total size Processed: 13-03-2009 15:09:27 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG5

Ev 88 Treasury Committee: Evidence

13 January 2009 Professor Willem Buiter, Professor Charles Goodhart and Dr Jon Danielsson by reducing its loans and refusing to make that funds itself short and liquid (normally) and additional loans, but if everybody does that, as is invests long and illiquid is a bank. My description very obvious now, the system and the economy runs means that there is no such thing as a safe bank, of into extraordinary diYculties, so what is sensible course. The only reason that banks, which are and prudent for the individual bank and individual institutions that have big signs on them “please start institution frequently makes no sense at all for the your run on me”, survive is because they have an system as a whole, and it is systemic issues that Basel implicit or explicit guarantee at the very least of II did not deal with. funding provided from the ultimate source of liquidity, which is the central bank, should the Q684 Mr Todd: Just one last point, if we tighten liquidity of their normal funding suddenly dry up. controls on liquidity, is not one of the inevitable No bank can be safe unless it has a market maker of consequences that we will actually slow the recovery last resort and a lender of last resort standing by. from the current credit crunch because we will have That said, as regards the liquidity issue I think we a more conservative set of instruments which will have to be very careful that we do not end up in a require banks to hold more assets in readily world where banks and other financial institutions convertible forms? are required to always hold the liquidity required to Professor Goodhart: That is actually a generalised cope with the worst contingency. Liquidity is to a problem in the sense that at a time of crisis the large extent a public good. It is a property of assets tendency of the regulators is to tighten up on that can disappear when trust and confidence everything, but the more that you tighten up, disappear. Certain assets are almost always liquid. whether it is on capital, liquidity or anything else, the Government assets tend to have that property, less easy it is for the banks to undertake expansion although if you go to Zimbabwe even public assets, because you are tightening the controls, and I think even public money, is not liquid any more. It means that is of greater concern on the capital side than it that although banks and private institutions could is on the liquidity side because at the moment there provide for their own liquidity by holding large are no real liquidity constraints. The FSA did amounts of treasury bills, I think it would be highly Y introduce a 9% requirement very recently, but apart ine cient to do so because they would not be able to from the FSA’s recent measures the constraints have engage in their socially useful function of borrowing been on the capital side, and the desire has been to short and lending illiquid, rather than lending liquid, raise capital ratios up to 12%, and now everyone is which they would be doing, or investing liquid if they saying, “We did not really mean 12. 12 is fully what invested in treasury securities. Sure, they will need we would like to have but under pressure we would some but banks should not be required to hold more be perfectly happy for you to go down.” Indeed, one inherently liquid assets than is necessary for the of the issues here is that what you want in your ordinary conduct of business during ordinary regulation generally is counter-cyclical so that they market conditions. For the rest the central bank has really tighten and prevent the banks going crazy to be on stand-by. The Bank of England was not, during these asset price booms and bubbles and then and part of the problems that we are seeing is when everything gets diYcult in the bust and because of that. They now are better attuned to the everyone is incredibly cautious anyhow then the job. They should therefore see to it that the public regulations get eased. good of liquidity is to a large extent publicly provided in an emergency rather than force banks to provide it privately always. Q685 Chairman: Professor Buiter, welcome to the Committee. Professor Buiter: My apologies for being late. Q687 Chairman: In this banking crisis inquiry we are looking at how we arrived at this situation, how we Q686 Chairman: We are grateful that you are here get ourselves through the present situation, and and, as you know, this is the first evidence session of what the regulatory environment will look like in the the banking crisis inquiry. I asked your fellow future. On the first point of how did we get into this panellists before you came in: what is a financial situation, could you give us your views? sector for and what is the role of the banking sector Professor Buiter: In many ways it is a classic credit within the financial sector? and asset boom; excessive lending and excessive Professor Buiter: The banking sector intermediates leverage which became more and more risky. That is between savers and investors and it allocates how credit booms and credit busts happen. It took financial portfolios and allows the trading of risk. It some new forms and it was regionally more is an essential part of the transmission mechanism widespread. We had securitisation problems in the for monetary policy and indeed also to an extent for US which of course were not restricted to the fiscal policy, and when it malfunctions the real subprime market, but became an issue there first, but economy suVers grievously, as you see. It depends there were country-specific financial excesses in most how you define banks. I am talking here about countries in the North Atlantic area. British highly leveraged institutions that are very much households had debt equal to 170% of disposable more liquid on the liability side than they are on the income and that had very little to do with US asset side. Deposit-taking and making loans would subprime debt, and there was general regulatory be the classical bank example, but generally I think failure because of the growing belief that self- anything that is highly leveraged and uses a lot of regulation would suYce and that, if intervention was borrowed money compared to its own resources and required, the so-called principles-based light-touch Processed: 13-03-2009 15:09:27 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG5

Treasury Committee: Evidence Ev 89

13 January 2009 Professor Willem Buiter, Professor Charles Goodhart and Dr Jon Danielsson regulation would be suYcient. I think that is and was Professor Goodhart: And in all three cases the real an illusion. Financial markets are very useful but economy had behaved very well in the years up to inherently fragile and dangerous institutions, and that. The 1920s were years of low inflation and the notion that they could be self-regulating was steady growth in the US. The 1980s in Japan was a always ludicrous. Even Mr Greenspan recognises golden era. The period between 1992 and 2007 was that now, somewhat belatedly. There was a general probably the best years of economic developments lowering of regulatory standards. The fact that that the world has ever seen and this had led people finance—and I am talking here about the finance of to believe that risks generally had declined, that we border-crossing financial institutions of which there would not see future problems, so everyone poured may be 60 to 80 institutions that matter globally— into asset markets because risk had gone, and of the fact that the domain of the market and the range course risk had not gone. over which these institutions roam is global and regulation is national means that, whatever you do, Q690 Chairman: It was a great moderation. these firms and financial innovation will be running Professor Buiter: There were also great moderations rings around the regulators. The logic of a global in the 1920s and in Japan as well. market is to have a global regulator. You cannot have that, I recognise that, but that has implications Q691 Mr Crabb: Professor Buiter, you describe the that you will always be in an environment where general regulatory failure: do you think that the regulatory arbitrage will undercut regulatory V international architecture for financial regulation e ectiveness, not just because of innovation within a now needs to change given the current crisis? nation but competition between nations. Lowering Professor Buiter: It needs to but it will be extremely of regulatory standards were used to attract diYcult. In any regulatory regime that one can think financial business. of one will have the US doing its own thing because they are not going to be agreeable to being bound by Q688 Chairman: So from what you are saying it international agreements and certainly not to being seems as if there was a misplaced faith in that market regulated by a foreign entity. I think the best we can mechanism in the past few years? hope for is that we come to a single European Professor Buiter: Yes, in the self-regulating sense. regulator for the European Union for border- crossing institutions. That would take care of 27 dimensions of regulatory arbitrage—not enough, Q689 Chairman: How does the current crisis then but it is a lot easier to reach agreement between a compare to that, say, of Japan in the mid-1990s and single EU regulator for border-crossing financial the Wall Street Crash of 1929? Are there any institutions and the Americans and the Japanese and comparisons? maybe the Chinese and the Indians. At the moment Professor Buiter: In many ways they are very similar. I think there are just too many unco-ordinated, The Japanese boom was of course much bigger than mutually undercutting regulatory regimes. anything we have seen and the bust has been much, much bigger than anything I hope will see. Their Q692 Mr Crabb: Professor Goodhart, would you stock market came down 90%, was it? share that view? Professor Goodhart: Nikkei was at 38,000 at its Professor Goodhart: I do not think a single height; it is now at about 8,400. European regulator is feasible at the moment, even Professor Buiter: So that is a healthy decline! A if it is desirable. As everyone has seen, when a crisis massive asset boom and bubble and a massive bust, comes you need to recapitalise the banks. and in Japan of course that was followed by Recapitalisation is enormously expensive, so you spectacular policy incompetence. There was no need to have a regulator that has access to funds via serious attempt to address the toxic asset issue for a ministry of finance or treasury. There is not a seven years. The recapitalisations that took place federal ministry of finance or treasury who could really were late and inadequate and the banks were provide such funds. Without such European allowed to go on making zombie loans to zombie funding, without a European fiscal competence in institutions rather than trying to clear the debt. I that respect, eVectively the exercise of trying to hope that Japan provides an example at least as ensure that their banking systems remain viable has regards the policy response on how not to do things. unfortunately got to remain within the nation state. They did certain things right. Keeping the zero I fear that under these circumstances with a global interest policy and engaging in quantitative easing is system and national regulators what is actually clearly something that will have to be emulated here, going to be needed is to have rather more power to as is the case already in the United States, but their the national regulator rather than less, so that the reluctance to clear or to ring-fence the toxic assets, national regulator can see the development of asset to recapitalise the banks, and their willingness to let price bubbles and credit bubbles in their own the overhang of bad assets become a tax on new economy and take the appropriate steps to prevent lending to potentially profitable enterprises are all that making their own country’s financial system warnings of what we should avoid, and we have become at risk. done so far. The US in the 1920s was again just a big bubble that burst and a very perverse monetary Q693 Mr Crabb: Do you think that the current crisis policy response where monetary policy actually reveals a failure on the part of the IMF in terms of tightened. sending out warning signals? Processed: 13-03-2009 15:09:27 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG5

Ev 90 Treasury Committee: Evidence

13 January 2009 Professor Willem Buiter, Professor Charles Goodhart and Dr Jon Danielsson

Professor Goodhart: No, they did send out warnings. quite good shape but is squeezed between the This idea that there were no warning signals from banking sector and its inherent fragility, the over- central banks, there were loads of warning signals, leveraged households, and I think also the stretched particularly from the BIS. This stuV about early public finances. The pro-cyclical fiscal behaviour of warning signals is actually pure nonsense. It is not the second part of the Labour administration made that there were not enough early warning signals. the boom larger than it would have been and also Everybody forecast that the situation was getting made it more diYcult of course to respond eVectively dangerous because risk was being underpriced; the with counter-cyclical measures once this becomes problem was not the lack of early warnings. The necessary as it is now. Britain of all the larger problem was the lack of both instruments and countries was probably the most vulnerable; it was willingness to do anything about it. not Iceland but it was not as it should have been.

Q694 Mr Crabb: So how should we improve those Q697 Sir Peter Viggers: Professor Buiter, you made instruments to ensure that sovereign states take heed a passing reference to ring-fencing toxic assets which of the warnings? sparked my thinking that the nearest analogue to the Professor Goodhart: That is very diYcult because in present situation is of Lloyd’s of London in the a boom everyone loves it and the idea that you are 1990s where scrupulous eVorts were made to identify going to have a regulator saying, “I am sorry, we are and isolate toxic assets. Is this something which is not going to have 100% or 125% loan to value ratios; being done suYciently? Is it important and what Northern Rock, you are not allowed to behave that messages are there here? way, you are not allowed to do subprime mortgages Professor Buiter: In the US also it is the one part of based on nothing except the expectation that the Government’s arsenal that has not really been housing prices will go on rising, you are not allowed used yet. The TARP was set up to buy up toxic to do that,” runs counter to the wishes of the lenders, assets. In fact it has not been used for that. The only the borrowers, and virtually every politician at the successful example of toxic asset ring-fencing inside time during the boom, so what you are asking an institution in this case is in the Citigroup deal regulators to do is eVectively to take the punch bowl where $200 billion or $300 billion-worth of dodgy away when the party is going, and that is not a assets is insured now by the Treasury so that if their popular activity. value falls below a certain level they go in, so that is Professor Buiter: The regulators were not terribly a way of providing financial support for that. I think keen, to be honest. During a big asset boom/credit that one wants these assets either oV the books or boom there is universal capture of the regulators and ring-fenced on the books in such a way that they can the political process by the financial sector. You can be dealt with, their true value, or lack of it, is see that because who argues with success? People revealed, that the remaining uncertainty is taken who take home $50 million a year must be doing away and then that the state, if it is the only one who something right. It is very hard to interrupt that can carry that load, can take them on its books and spiral until it is done by brute force through an try to make in the long run as much money out of implosion of the bubble. There is no willingness them as it can. They may have to be held to maturity. among the regulators or among the political classes to interfere with an asset boom or a credit boom. I Q698 Sir Peter Viggers: The question of the future of have never seen that. securitisation, the model of ‘originate-to-distribute’, Professor Goodhart: The subprime market was which has been a very important part of our system regarded as a triumph in 2004-2006. It was providing and of course the boom, to what extent will the access to home ownership for the disadvantaged system self-regulate? To what extent will people who class in America. This was regarded as one of the have had their fingers burnt withdraw from this great triumphs of finance. field? And to what extent will further regulation be Professor Buiter: Finance as social engineering—it needed? was. Professor Buiter: For three years they will withdraw. That is the half-life of memory in the financial Q695 Sir Peter Viggers: The crisis is of course markets. There is nothing wrong with securitisation. worldwide. Was the UK economy in better or worse It is a wonderful invention to make the illiquid liquid shape to cope with the problems a couple of years and the non-tradable tradable. The problem is that ago? when you commoditise relationships, which Professor Buiter: Compared to? eVectively you do, and make them tradable, you tend to destroy the incentive for gathering Q696 Sir Peter Viggers: Compared with other information or at least weaken that incentive, from countries? the original borrower. What information is gathered Professor Buiter: Probably in the worst shape maybe is no longer traded with the instruments when they after the US. It has the largest financial sector get bundled with 7,000 other instruments. Some of relative to size of economy of the major industrial the CDOs apparently if you were to read all the countries. Only much smaller countries have balance documentation that ought to go with it it ran into sheets with 400-450% of GDP for their banking four million pages which even the very well-paid sector. It had this long-standing boom which had lawyer would not have time to deal with. The lesson resulted in this very highly leveraged housing sector. is very simple: we can have securitisation; we will The corporate non-financial sector is actually in have it again; it is an important source of finance, but Processed: 13-03-2009 15:09:27 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG5

Treasury Committee: Evidence Ev 91

13 January 2009 Professor Willem Buiter, Professor Charles Goodhart and Dr Jon Danielsson we need to force the originator to hold onto a sizable round to the banks and building societies and say, chunk of the first-loss or equity tranche of the “You shouldn’t make loans at such high loan-to- securitised commodities. That keeps the incentive value ratios,” for example. for gathering the information and monitoring the Professor Buiter: I do not think that regulators saw relationship intact. what was coming. There were general warnings. Dr Danielsson: Securitisation is something that we Indeed, the risk premium rates had become would sorely miss if we did not have it. It does ridiculously low and things were unsustainable but provide quite a useful function. In addition to what nobody foresaw the complete freezing up of all Willem said, there are a couple of things about wholesale markets that mattered and nobody securitisation that went wrong in the crisis. Most of anticipated that the world’s leading banks would be these instruments are what are called over-the- socialised or living under a government umbrella by counter. They are bilateral agreements between one the end of 2008, so I think the magnitude of what bank and one client. Therefore there is no way to was going wrong was not seen by anybody, at least figure out what exactly is an appropriate market nobody that went on the record. There were price for these instruments and when there is a warnings and they were not heeded. They were not problem there is no way to add up all the exposures heeded basically because people feel that they of the entities. I would think in the future the focus cannot argue with billions. on regulation will be to make all these instruments transparent and liquid and traded on an exchange. If Q700 Jim Cousins: Does that not leave a serious we had taken many of the CDOs and the subprime V issue of the quality of leadership right at the top of assets and CDSs, if all of this stu was traded on an this? Was it wise for political leaders to have an exchange like the London Stock Exchange or some embedded view that the trade cycle had been other exchange, then you would have a couple of abolished? Was it a failure of leadership at the Bank benefits. Number one, you could immediately figure of England that there was this obsession with moral out what exactly is the exposure of an individual hazard? If you are right in saying that people had V institution. Somebody buying the stu could figure indeed identified the problem, then is it not sensible out what is the appropriate market price, and in to look to what the leaders said for an explanation? trouble, especially like the Lehman Brothers, when Professor Buiter: I would agree with that except for they went under they had a few hundred billion the bit about moral hazard. I think there has been far dollars worth of CDSs and the problem is nobody too little attention paid to moral hazard. I think that really knew what was the net exposure of Lehman’s. would be a description of part of the reason we are After they defaulted you could finally sit down and in this mess and even in the resolution of the crisis we do the calculation. They figured out that the net seem to often go out of our way, when there are exposure of Lehman was $6 billion, a lot smaller options available to put out a fire in a number of than anybody suspected. If these instruments had ways, to go for the way that maximises moral hazard been traded on an exchange, that would have been instead of minimising it, so I would not fault the known prior to the default of Lehman’s so they Bank at all for warning about moral hazard; I think might still be alive. In the future we need to keep it is what kills honest finance and so it is very serious. those instruments, they are useful, but they do need Yes, I think the political classes were part of a wider to be traded on an exchange so that they are climate of opinion that believed in the great transparent, we understand the risk, and any buyers moderation. The ‘end of boom and bust’ is just get an appropriate price and can dispose of them if another word for the great moderation. It is the need be. country-specific version of that. Economists in my Chairman: Thank you very much. We are hoping to profession believed it as well. finish for 11 o’clock. The answers are fascinating but Professor Goodhart: And economic leadership in if you could make them a little bit shorter, thank 2005 and 2006 was being congratulated for having you. Jim? achieved the best results that the world had ever seen, and that is in a sense part of the problem. It was Q699 Jim Cousins: I am a little confused by what we a belief that we had overcome the economic and financial problems of the world and it led to hubris, are being told. Professor Goodhart and Professor particularly within the financial sector. If there is no Buiter, are you telling us that those in charge of the risk, just pile on the leverage, add to the balance financial system did not see the problem or that they sheet, buy whatever asset you can, and take home did not warn people eVectively enough about it or the kind of millions that Willem was talking about just that they did not have the guts to stop the party? as a bonus. Professor Goodhart: Basically the last. The BIS and the Bank of England and most other central banks knew that risk was underpriced and they were Q701 Jim Cousins: Dr Danielsson, I believe in one of worried before the event that there would be some your earlier writings you actually used the term kind of severe reversal. They did not know where it ‘hubris’. You have just made a case for ending the was going to come from, they did not know the exact over-the-counter trading system and putting trigger, but they were aware that there were everything through properly regulated exchanges. problems, but I do not think that they were prepared You have made that case now. That case has been on to take the tough actions and they did not really have the table for a number of years. Why did it not the instruments to do so. They were not able to turn happen? Processed: 13-03-2009 15:09:27 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG5

Ev 92 Treasury Committee: Evidence

13 January 2009 Professor Willem Buiter, Professor Charles Goodhart and Dr Jon Danielsson

Dr Danielsson: There are a few reasons why. of derivative markets at the moment which is trying Number one, one thing that happened with risk is to move rapidly towards a central clearing house for that for an individual bank complexity is profitable. instruments such as CDSs. The more complicated you make your products the Y more money you make. This is a di cult problem Q705 Ms Keeble: I wanted to ask a bit more about because the individual making things complicated the instruments and levers that you have referred to, over the counter is not at the top of the bank, it is in in particular, Professor Goodhart, when you gave the middle of the bank. This is the ‘quant guys’, the evidence to the Committee on ten years after the 35-year-old, whatever he is; he creates instruments. MPC you said that you thought there should be His boss has no understanding of what he has is other levers other than just interest rates although doing, the regulator has no understanding of what you were not specific as to whether it should be he is doing. All they know is that he is making money applied by the MPC, the Bank or the FSA. I wonder from some black box. whether you are still of that view that the MPC in particular requires diVerent levers and, if so, what? Q702 Jim Cousins: Yes, but Dr Danielsson, that is Professor Goodhart: No, not the MPC. The MPC is fine, we have heard that a number of times; we a committee which has a remit from the Chancellor believe it. The issue is you have just raised the strong of the Exchequer, and therefore indirectly from policy point about ending over-the-counter trading Parliament, to achieve a specific object which is price and putting it through regulated exchanges. That is stability as measured by a specific inflation target. not a new point. What I am asking you, Dr The interest rate is, under normal circumstance, the Danielsson, is why did that not happen? instrument which the MPC uses for that purpose. Dr Danielsson: The reason is because these complex When you come to look at financial stability, you are products were so profitable that the banks lobbied looking at a field in which there has got to be much very strenuously against making anything over-the- more co-ordination between the central bank, the counter and because the products were so FSA and indeed the Treasury because if anything complicated the banks had all the cards. They could goes wrong ultimately it goes back to the taxpayer, make the case to the regulators in a way that the so you are not looking at the MPC because it is a regulators did not understand what they were being diVerent remit, it is financial stability, and one is told. By making things complicated you look as if looking much more at the financial stability you know the answer to the problem and it is very committees and instruments that might be used by diYcult for anybody to argue against it. Because them. My own preference is for a division between over-the-counter products are ten times more the instruments that look at the condition of the profitable than traded products, the banks like them. individual institution and maybe the individual For the banks complexity is profitable. That is where market, which will be the responsibility of the FSA, the lobbying was the regulator was in a very diYcult and instruments which would be able to have an position to resist. eVect on the system as a whole, which I would like to see wielded by the Bank of England, specifically not Q703 Jim Cousins: Dr Danielsson, you have said by the MPC but by a separate financial stability that the regulator was in a diYcult position. Where committee. is your evidence for a regulator, or anyone in our regulatory system, this great triad of institutions, Q706 Ms Keeble: At present there is obviously rather wanting to end the system of over-the-counter the counter-position in that there are historically low trading and to put it through properly regulated interest rate but much to public anger they are not exchanges but they were frustrated by the money being passed on. What instruments or what men? Where is your evidence for that? pressures or what levers could be used to get those Dr Danielsson: There have been a number of studies low interest rates being passed on? and statements by policymakers that they would like Professor Goodhart: There is an issue about whether to see those instruments being traded. One thing that lending at the moment by the banks is going to be was a great worry prior to this was the fact that the suYciently profitable for them to want to undertake clearing system was seizing up, so a number of it. Remember that there is a margin now between the central banks had made a very strong case in favour oYcial interest rate and the rates that banks can of reducing the number of over-the-counter borrow from each other in the inter-bank market products and making them cleared very quickly. and the wholesale markets and, moreover, when you are thinking of lending there is a much greater Q704 Jim Cousins: Including our own? concern about fear of default, so the default risk is Dr Danielsson: I do not know if the Bank of England much higher, so that the interest rates that the banks has done so but I know a number of central banks will want to charge in order to ensure that their have made that case. This has been discussed very lending is profitable are relatively high compared to widely in policy circles for a number of years. the Bank of England’s oYcial rate at this moment. Professor Goodhart: The Federal Reserve Bank of If you want banks to go on lending, you have got to New York has traditionally taken the lead in trying enable them to charge a rate at which that lending to bring about improvements in these derivative will be reasonably profitable. There is a continuous markets (because they are primarily derivative tension between the desire not to let the banks get markets) and there is a group called the CRMG away with anything and making sure that taxpayers’ which is a group to try and improve the functioning monies are going to be recovered and at the same Processed: 13-03-2009 15:09:27 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG5

Treasury Committee: Evidence Ev 93

13 January 2009 Professor Willem Buiter, Professor Charles Goodhart and Dr Jon Danielsson time to enable the banks to have suYcient accords, make them single product firms that just do profitability in lending to make them want to ratings, no other financial products and services, and expand it. to pay them partly in the securities they are rating and force them to hang on to them. As regards what Q707 Ms Keeble: So is there something further the I would call quantitative and qualitative easing Government could do either to do with the risk or especially, which is the central bank on behalf of the the profitability? Government really taking significant credit risk and Professor Goodhart: There are lots of things that the illiquid assets on its portfolio, part of the solution is to get the spreads between the banks’ funding cost Government can do and some things that the Y Government ought to do. For one thing in order to and the o cial policy rate (which is not the banks’ keep the system suYciently liquid and monetary marginal funding cost) down. That should be a growth suYciently high, the Government ought to continuation of what is already happening—the be under-funding the deficit. The one single thing rapid expansion of the balance sheet of the Bank of that I would like to see from them in a sense to get England. I would not want to put government us out of the present problem would be very simple: securities on it in the way that Charles apparently we sack the Debt Management OYce and just not does, because I think rates on long-dated issue gilts for quite a long time so that the huge government securities are already very low. That is deficit simply comes into the system in the form of not where the problem is. I would have the Bank increases in liquidity and increases in the money aggressively purchase, as an agent for the supply. I am very keen to see that. When the banks government really, and indemnified for the default Y risk associated with these purchases, private are having di culty in lending to the private sector V there needs to be a much greater expansion of bank securities of the kind that have the most pay-o — lending to the public sector. That has not yet really mortgages, mortgage-backed securities, even started. It needs to be done. Another issue which corporate loans, commercial paper, those kinds of goes back to the toxic assets, it is not just the toxic things. assets, the problem is that many of the better mortgage-backed assets, the stuV that was triple A, Q709 Nick Ainger: This is a question initially are now being traded, insofar as they are traded at directed at Professor Goodhart and Dr Danielsson. all, at prices which are far below the expected cash Your colleague sitting next to you has written: flow and expected ultimate repayment, because “Banks that don’t lend to the non-financial people do repay their mortgages as often as they enterprise sector and to households are completely possibly can. Under those circumstances what is and utterly useless, like tits on a bull. If they won’t probably needed is continued guaranteeing not of lend spontaneously, it is the job of the government the worst assets but on the relatively good assets, to make them lend.” Do you agree with that? Should which are now trading at vastly under-valued rates, the Government now be directing banks to lend? and cannot easily be sold. If you could get the triple Professor Goodhart: Banks are profit maximising A stuV which is mortgage-backed being properly entities and they will lend when they can see that traded and at a reasonable price you would find that there is a suYcient return from doing so. The you would unlock and unblock quite of lot of what problem at the moment is that they do not see that is going on in the banking system. there is a suYcient return from such lending. I think this is partly because they are too scared and I think Q708 Ms Keeble: Professor Buiter, I will ask both that government guarantees, because they are so my next questions at once which are about risk, and scared, would actually help. I think that directing perhaps if Dr Danielsson wants to come in on that banks to lend would simply be a retrograde step. If that would be helpful, but in terms of assessment of the Government wants loans to be made at rates risk which you have written and spoken about quite which the banks do not think are viable, then the a lot, from the earlier discussion it seemed to be that Government should make them itself. there was a view that that should be down to due Dr Danielsson: Just to add a little bit to that. I think diligence by investors. To what extent do you think we should keep in mind that the banks today are the credit ratings agencies have been culpable in being prudent under current regulations. Under the what they have done and that they should be further system we have today in a recession, they are regulated? As a second question, when you were supposed to lend less, they are supposed to withdraw talking about Japan, you said almost in passing that from risky activities and preserve their capital. That you thought that quantitative easing was inevitable is exactly what they are doing. On the one hand the here. I wonder if you could just expand on that banks are doing exactly what they are supposed to comment. do. The policy response has been interesting. On the Professor Buiter: The credit ratings agencies of one hand we want them to lend more and on the course and those who used them are culpable. The other hand we want them to lend less. On a slightly credit rating agencies got into a line of business that longer term scale we do need to find a way to adjust they did not understand. They were reasonable at the regulatory mechanism so that in a downturn rating sovereign risk and large corporates but not at banks become a little bit less prudent and in an rating complex structures, but they did it anyway, upturn they become more prudent. That is a longer and in addition they were hopelessly conflicted. Part term issue. I would otherwise agree very much with of the solution is to take away their quasi-oYcial Charles that the banks are profit-maximising and, if regulatory role, take them out of the Basel II anything, experience has taught us that just about Processed: 13-03-2009 15:09:27 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG5

Ev 94 Treasury Committee: Evidence

13 January 2009 Professor Willem Buiter, Professor Charles Goodhart and Dr Jon Danielsson the worst entity for allocating credit in the economy Professor Goodhart: I think under-funding the is the government. We would rather have the banks deficit would be far less damaging to the economy do it as a profit-maximising entity rather than than my colleague’s proposals of requiring the banks government, as a general rule. to achieve some forced minimum amount of lending to the private sector.

Q710 Nick Ainger: The investments that have been Q711 Nick Ainger: I assume you do not agree with made by the Government in banks, some him about the nationalisation of banks either? commentators have said that again there is this Professor Goodhart: I think that “nationalisation” is contradiction that in order to protect the taxpayer an unfortunate word. In the Swedish bank crisis the and possibly to send a reminder to banks that the banks were taken over completely by the 12% interest rate on the preference shares that is government with the intention of reselling them. I actually preventing the banks from lending. Would think that may well have to happen in some other you want to comment on that? countries, not necessarily excluding the UK. Professor Goodhart: Lots of other countries Government temporary ownership of the banks is followed the measures and steps that were taken by not necessarily something to be refused or avoided, the Prime Minister on 8 October, but none of the but the idea that the Government should go on other countries imposed anything like as severe a owning the banks indefinitely would be a very bad penalty rate on their banks as we did. I think that it thing. was too high, it was counterproductive and, as you say, there was an inconsistency between, on the one Q712 Mr Brady: Professor Buiter, you spoke about hand, wanting to ensure that the taxpayer does not the importance of dealing with toxic assets, but how lose, if anything gains, from the funding provided to should we do that? What model should be followed? the banks, and on the other hand a wish that the Professor Buiter: I would create a facility like the one banks expand lending. If you are going to impose or that was created for the Savings and Loans defaulted put funding with banks on terms which are assets. Admittedly that was a lot easier because it disadvantageous to the banks, the banks will do was all property. Create a state agency that buys the V everything they can to get rid of it as quickly as they stu and either sells it later or sits on it until the can, and that usually means not expanding their assets mature. balance sheet. Dr Danielsson: I could not agree more, I have Q713 Mr Brady: Buys it at what price? nothing to add to that. Professor Buiter: At this point, since we have Professor Buiter: There is nothing wrong with recapitalised banks anyway, at any price that the making the banks pay a very high price for banks are willing to part with it rather than carry it government support because, after all, they have at that value on their balance sheet. I would price it failed. You have to discourage the kind of behaviour quite aggressively at more than they can get in the that brought this about and a financial penalty is the market but less than the best estimate of the present value of future cash flow at a reasonable interest best way of doing that. As a consequence banks stop rate. A lot of these things are very diYcult to value lending simply because they want to get rid of the and in that case just give the banks a take it or leave government or those that are not yet subject to this it oVer. They should not be allowed to carry stuV on arrangement want to prevent falling into the their books that is eVectively not valued or valued by clutches of the government. That situation can only management. If that is the situation the banks are in, be remedied either by making the capitalisations by there should be just one entity that, because it is not the government mandatory and not giving banks faced with liquidity constraints, can hang onto discretion as to when to get rid of it, or to things that cannot be valued and watch the cash complement it by forcing lending in the aggregate. I flows come in, or not, over the life of the instrument. would not micro-ration lending but I would assign the banks lending totals that they should use or lose. Q714 Mr Brady: Do the other two witnesses agree So they would still lend to the most profitable that the toxic assets have to be dealt with? Is that activities but what they did not lend under the target fundamental? would be taxed away. I think that is an implication Dr Danielsson: A lot of these toxic assets are low of trying to create the right incentives for future priced not because they are toxic but because there behaviour once this crisis is out of the way. We is no liquidity in the market. Some of them, of would prefer not to have to start from here, but given course, are highly toxic. I saw a calculation which where we are the worst thing you can do is say, said that some of the CDOs are based on a “Okay, do what the Americans did, first talk tough, calculation of 90% of US mortgages defaulting, like they did with AIG, and then allow them to pay which makes no sense. The problem is that there is oV an expensive credit line with a cheap one”. That no liquidity in the market to buy them. If you were basically tells people you can do this again because able to somehow do a “bad bank, good bank” they will be able to get away with it, there will be no model, split the toxic assets up, put them into a bank penalties. You have to impose penalties when you for the government to hold them until maturity, I am can and now is the time that you can prevent damage sure for a lot of these assets the government would to the real economy by forced lending in the not be losing that much money. The problem is with aggregate. valuation as you have correctly identified. If Processed: 13-03-2009 15:09:27 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG5

Treasury Committee: Evidence Ev 95

13 January 2009 Professor Willem Buiter, Professor Charles Goodhart and Dr Jon Danielsson

Charles’ scenario of the government completely against such a small non-terrorist target and the next nationalising the banks happens then that problem time the Government wants to use anti-terrorism is solved because you can just split them up. Trying laws people will point to that mistake and say, to identify the toxic assets prior to this is very “Maybe there is something wrong with what you diYcult because the banks will have an incentive to are doing”. sell the most toxic to the government and there is no proper market mechanism for doing that. Trying to get toxic assets out of the banks prior to Q717 Mr Brady: Because we are short of time I just nationalisation is a very diYcult, if not impossible want to cover one other issue. Given the guarantees task and after Charles’ nationalisation it becomes and the compensation that has been given to trivial. investors in Northern Rock, Bradford & Bingley, Professor Goodhart: I think the better approach is to some of the Icelandic banks and so on, how do we go for guarantees of the better quality mortgage get back to the idea of moral hazard in a sensible backed assets first. You can certainly do an exercise way? Perhaps I am directing this to Professor Buiter. of trying to have a “bad bank, good bank” model, it Is there not a danger that all depositors are going to was done in Switzerland very recently with UBS, but feel that they are always safe? I think guarantees of the better mortgage backed Professor Buiter: I think in the future the incentive assets initially would be an easier and simpler structure for the banking sector will be horrendous. exercise. We are going to be living with the consequences of what we have done for years. Ireland is an extreme example where the entire balance sheet was Q715 Mr Brady: You would do that initially, but guaranteed. Even here, everybody’s deposit you may still have to do the— guarantees have gone up to ridiculous levels, where Professor Buiter: Is this for new issues or existing? the protection of widows and orphans is no longer Professor Goodhart: I think it would be for an issue. Also, of course, from the financial stability existing, yes. point of view you do not need deposit insurance, you need a lender of last resort. They are alternatives and Q716 Mr Brady: Can I move on to something you do not need them both. These guarantees create completely diVerent. Was the Government’s very bad incentives for sensible management and approach to the Icelandic banks the correct one? sensible risk-taking in the future and we just have to Dr Danielsson: I guess I should take that up being try and get out of it as soon as possible. International from that poor little country. The problem with the co-operation is essential. The worst was prevented in Icelandic banks crystallised the question that was the case of the EU the weekend after Ireland did its put earlier about international co-ordination of the “everything is guaranteed as long as it is Irish”, when national regulations. What we have at the moment every European country started raising its deposit is a system where we have international regulations limits, some unlimited. Fortunately, there was and international rules but domestic enforcement. enough dismay at what was done in Ireland, We have not really had any proper cross-border especially here in Britain where Alistair Darling and blow-up of a bank, except that one, and this should Gordon Brown made very strong representations send a warning signal that it is not viable to have a that this was ludicrous and distorted the competitive system where you have global regulations and level playing field, that there was some limitation of national supervision, national enforcement. Within the damage, but that was all it was. We are going to the European Union, if we are going to have the have to get back to international agreements on banking rules as we had them, we do need to have insured amounts otherwise moral hazard will be national supervision. As to that particular case, the king. reason why these banks came to this country was because they could not borrow elsewhere, they could not borrow from other banks. That should have sent Q718 Mr Fallon: Professor Goodhart, coming back warning signals both to the FSA and to its Icelandic to the terms of the bank bailout, apart from the 12% counterparts. As they were increasingly getting rate on the coupon, were there any other terms money from this country and elsewhere, increasingly which you disagreed with? investing it into risky assets, on one level you might Professor Goodhart: I think the restriction on say they were gambling for resurrection, but the dividends was entirely understandable given the FSA should have become increasingly worried shortage of funds. The guarantees were sensible. It about that. However, I suspect it might have been a was really the cost of the money that I think was too way to bring those banks under the UK regulatory high, otherwise it was extremely well-done. The umbrella and it may be that the price for doing so British initiative at that time was correct and it was was too high, I do not know. As to the specific followed round the world, and rightly so. response of the UK authorities to this, I think in Professor Buiter: One trick that was missed was that many ways they did exactly what they had to, they the top management and the boards of all these had to protect their own interests, but there was one failing institutions should have been told to go big mistake there and the mistake was when they because the British banks had failed and they had to decided to take over the assets of the bank by using go to the public trough. The fact that it only anti-terrorism laws. There are three big problems happened to a few people continues the moral with that. First of all, in my mind it undermines the hazard in the future. The fact that the incumbents fight against terrorism to use such a big weapon stayed by and large is strange. Processed: 13-03-2009 15:09:27 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG5

Ev 96 Treasury Committee: Evidence

13 January 2009 Professor Willem Buiter, Professor Charles Goodhart and Dr Jon Danielsson

Professor Goodhart: I have to diVer from my diVerent agendas: the FSA says “stop lending” and colleague on that. After all, the appointment of the the Government says “start lending”; the FSA says top CEO and people on the board is a subject for the “whatever you put in your balance sheet make sure shareholders. One of the concerns that I think a lot it is Treasury securities” and the Government says of us have is that shareholders’ rights were trampled “Whatever you put in your balance sheet, make it is on all over the place. Under crisis conditions I think loans to homeowners and small businesses”. You that is right, but for the Government to step in and cannot do both, so at the moment they are in say, “We are going to get rid of X, Y and Z” when conflict. they were not the owners would have been a step too far. You have to have proper governance and proper Q720 Mr Fallon: Professor Goodhart, finally, the governance is, after all, a matter for Government. I Swedish shareholding you referred to still exists. do not think that Government should take steps to How should a future British Government relinquish remove management when that is the job of the control of the bank ownership it now has? shareholders. I rather agree with Willem that Professor Goodhart: I think in all cases the Swedish management has failed and the shareholders should Government sold oV their shareholdings. Basically have taken steps to get rid of many, if not all, of the what you do is as soon as a crisis is over and CEOs and the chief managers of their banks, but it normalcy has been returned, after a period of time is for them under these circumstances and not for the you auction it oV, you sell the bank back to the Government. private sector.

Q721 Mr Fallon: So that is a straightforward Q719 Mr Fallon: The Government shareholding is privatisation? now to be managed through UKFI. How can UKFI Professor Goodhart: Yes, exactly. We have done protect the taxpayers’ interests but operate at arm’s enough privatisations and the Government should length, yet still want to get involved in issues such as know how to do that sort of thing by now. the level of lending or the remuneration of senior executives? Q722 Chairman: A final question for Professor Professor Goodhart: That is one of the problems. As Buiter. You mentioned that bank senior we have been indicating at several stages, there are management should go and we are now in a halfway really quite deep inconsistencies within the house. Are you of the view that given this halfway Government’s approach to the banking sector. It is house the banks are now back in the driving seat? trying to achieve a whole series of objectives Given that three years is the half-life memory of simultaneously and not all of these can be done at those in the financial services industry, do you think exactly the same time. we will back to business as usual within tickety-boo? Professor Buiter: I agree with that. It would simplify Professor Buiter: Yes. things if the banks had been completely nationalised, which they could have easily been, Q723 Chairman: That is pretty dismal. because in that case the problems that Charles Professor Buiter: That is the way the world has alludes to, that certain things should have been done turned since banks were invented. by the shareholders, would have been solved. Chairman: That begs an awful lot of questions for DiVerent parts of the Government are pursuing our second evidence session. Thank you very much.

Witnesses: Mr Will Hutton, Executive Vice-Chair, The Work Foundation, Mr Richard Lambert, Director General, CBI, and Mr Jon Moulton, Managing Partner, Alchemy Partners, gave evidence.

Q724 Chairman: Good morning and welcome to the Mr Moulton: I think that the previous panel said it second part of our evidence session. Can you fairly accurately: a wall of cheap debts, asset introduce yourselves for the shorthand writer, inflation much accelerated by securitisation, please? complex financial products, and a grotesque failure Mr Moulton: Jon Moulton, Managing Partner of of every regulatory system and governance system in Alchemy Partners, a private equity and distressed the entire set-up. It was really quite spectacular. debt investing firm. That is how we got here. It all collapsed when we Mr Lambert: Richard Lambert, Director General of started running into the well-known wall of debt of the CBI. all kinds that could not be repaid, and that is what Mr Hutton: Will Hutton, I am an Executive Vice- blew it up. Chair of The Work Foundation and author of a number of books on this subject. Q726 Chairman: Richard, what is the financial sector for? Q725 Chairman: Thank you very much, and Mr Lambert: The financial sector is to provide the welcome. With our previous panel I mentioned that credit and payment systems that keep our economy this banking crisis inquiry is looking at how we got going. here, how do we see ourselves through this situation and what will the future regulatory environment be Q727 Chairman: And the banking sector within like. Jon Moulton, how did we get here? that? Processed: 13-03-2009 15:09:27 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG5

Treasury Committee: Evidence Ev 97

13 January 2009 Mr Will Hutton, Mr Richard Lambert and Mr Jon Moulton

Mr Lambert: The banking sector is the key engine and private equity became much more possible of that. because of that emergence of universal banking. One must discuss the incentive structures, the fact that Q728 Chairman: How did the banking sector get in people were able to get alpha pay for beta the situation it is in now? performance, as the Chief Economist of the IMF has Mr Lambert: I would go with Jon’s answer and I said, and the way that performance was computed so would go further back than that and say you would that people could walk away with fabulous gains have to start oV looking at the enormous capital from one year’s performance but what happened in imbalances that have developed in the world over years two and three was largely ignored. That the last 10 or 15 years with huge deficits in the United incentive structure was very, very important. My big States, the UK and other developed economies, critique of the British Financial system as it has enormous surpluses in Asian economies and the emerged over the last generation is it walked away attempts to intermediate that in diVerent ways. One from its ownership responsibilities and became analysis I saw made a good comparison suggesting fixated with and highly focused on transactional that back in the 1970s when there were huge oil relationships. In a way, whether it was the originate surpluses, they were intermediated to developing and distribute model in banking, whether it was the economies like Mexico and Poland; this time round emergence of the derivative markets and the credit the surplus funding was directed to sub-prime default swap market, all of this was about a highly V borrowers in the United States. I think you have to transactional approach to what must be for e ective take the capital balances and imbalances into finance, to add to what Richard said about what the account when you are thinking of the big picture. role of finance is in a capitalist economy. Finance at its best is about building relationships with wealth generators, maturing them, supporting them, Q729 Chairman: Will, the issue of the City of investing in them, seeing them out of tight corners London: has the City of London’s importance to the and supporting them with growth when they need it, UK economy been exaggerated and have politicians, being judicious in how they do that. Our financial regulators and central banks bent their knee to them system always had a bias not to do that and that bias for too long? became accentuated in the last decade. Mr Hutton: You know that is my view. Mr Moulton: The question was how important is the financial system and it is obviously good to have a Q730 Chairman: Oh, is that right? successful financial system. However, it is very Mr Hutton: So it will be no surprise to have me asymmetric, the failure of the financial system confirm it. Yes, that is my view. For example, when wrecks the total economy, and that is why we are Gordon Brown, as Chancellor, set the five famous here. tests for euro membership it was instructed that one Mr Lambert: It is also important to keep it in scale. of them was that it should benefit, at least not According to the Pre-Budget Review, the financial damage, the interests of the City of London and no system in total represents 7.5% of gross value added, other part of the UK economy was singled out. That so it is possible to overstate its contribution to the was very much the mood at the time, that financial economy. services that represented close to 10% of GDP and had grown from 6 or 7% of GDP were at the vanguard of what we were going to sell the world in Q731 Chairman: If it represents 7.5% gross value the 21st century. I always thought that was putting added, that it could wreck the system means there is too many of our eggs in one basket and too many something wrong in the system. sacrifices and distortions were being placed on the Mr Moulton: That is where we are heading now. rest of the economy to make that play. I would just Chairman: There is something disproportionate add a couple of things to what Richard and Jon have there somewhere. both said. I do think this question of global imbalances just did not happen as an accident, that was a direct consequence of the way Asian countries Q732 Jim Cousins: One of the diYculties that we in particular responded to the Asia financial crisis in have all got is that the banking crisis is not over, 1998, a deliberate policy to peg their exchange rates second wave eVects are now developing and one of and acquire foreign exchange reserves at an those, of course, is about hedge funds. Mr Moulton, extraordinary rate, and that is the Japanese story do you agree with the predictions coming out of the and the Chinese story certainly. As much as 40% of United States that the hedge fund sector is eVectively the $10 trillion of liquidity that was generated in that going to collapse? decade came from those two sources alone. Jon Mr Moulton: It is collapsing; it is not a question of a made the point about regulatory failure, and that is prediction. It is contracting very, very rapidly absolutely obvious, but it went beyond that. We indeed. The availability of leverage to actually keep actively fanned the flames and I think the abolition the hedge fund sector going has been very, very of Glass-Steagall in the States in 1998, which was dramatically reduced. The poor performance of made impossible for US regulators to protect many hedge funds has resulted in people pulling because of the line we took in London, made a fusion money out of it and the financial scandal of MadoV of commercial banking and investment banking and so on has helped still more. Yes, the hedge fund possible which very much fanned securitisation, the world will go down by a factor of three or four over kinds of liquidity that was provided to hedge funds, an 18 month period, that sort of magnitude. Processed: 13-03-2009 15:09:27 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG5

Ev 98 Treasury Committee: Evidence

13 January 2009 Mr Will Hutton, Mr Richard Lambert and Mr Jon Moulton

Q733 Jim Cousins: There is obviously a debate to be driving some prices down, but it is not a primary had about what the contribution of the hedge fund issue compared to the scale of what is going on at sector to the problems we have got might have been, the banks. but also some regard has got to be paid as to whether Mr Hutton: I slightly disagree with Richard and Jon the collapse of the hedge fund sector if it continues in this respect: you had the hedge funds at their peak will compound those problems. Do you think that at $2 trillion worth of assets and a lot of that was the collapse of the hedge fund sector and the fact financed by bank borrowing and because of the that many of its investors now find themselves opaqueness we do not know how much of it was trapped inside its funds without any route of escape from UK banks. Occasionally you get a glimpse of will cause yet more problems in the real economy? it. There was a credit line to Bernie MadoV from Mr Moulton: It is causing some level of problems in Royal Bank of Scotland of £300 million which is the real economy. It is not a huge problem. In the clearly going to be written oV and HBOS were context of the banking world, it is one of the involved as well which will have to be written oV and symptoms of the real basic thing that I think is the UK taxpayer will pick that up presumably. Some wrong with the banks. They got too damned of the lending to hedge funds, given the scale of the complicated, nobody could manage them and price fall of the assets that the hedge funds own, has nobody could understand them. Exposures to hedge to be written down and those write-downs come funds when they were lending in exotic ways against straight through and because they are uncertain exotic assets leveraged from one end to t’other was about what proportion of the overall portfolio was clearly part of the reason that the banks collapsed. genuinely toxic or might actually rebound in value— Those exposures were unmanageable and not I was listening to the comments from the earlier understood. That is something that happened right three—in the high uncertainty it constrains your the way across the banking world, not only did they lending. In that respect, I do think the hedge funds contributed to the asset price bubble, they were one get too adventurous, they got too complicated and of the buyers of these securitised assets that Richard became unmanageable. mentioned and that market that is now de facto shut needs to be opened in my view, and I strongly Q734 Jim Cousins: Do our other two witnesses think support Crosby’s recommendations on that. that this is a sector which will continue to cause Whether it be the closure of parts of the securitised problems as it unwinds and which needs greater asset market, whether it be some other potential regulation? write-downs that banks are facing, the distress in the Mr Lambert: My total preoccupation is with the hedge fund sector is plainly part of the story. I am supply of credit to the British economy and to interested to hear what others think, but I think it is British business generally and I do not think hedge outrageous in terms of moral hazard that we, the funds are the first order problem in that respect. I UK taxpayer and British Government, have think the first order problem lies in the regulated emerged as guarantors of UK bank retail deposits, sector rather than in the unregulated sector and that a significant proportion of which were lent to hedge is to do with the way that over the last years a funds and are now being written down. The way the funding gap has opened up in our banking system remuneration structure of the hedge funds was organised was that an annual increase in the assets which is now having to be bridged and that is why under hedge fund management significantly accrued credit is in short supply and is the issue I think we to that hedge fund manager and he or she has now need to be focusing on, at least that is what I am got the money, we have got the loss, and we have got focusing on. a kind of transfixed financial system. I think in terms of the question of moral hazard you were talking Q735 Jim Cousins: You do not feel that what has about earlier, plainly we have to think rather like happened in the hedge fund sector and the Roosevelt did in the 1930s: if we are going to oVer unwinding of this enormous bank of credit guarantees to bank depositors of the type that we are V derivatives inside the bank is contributing to the having to o er, that is the liabilities side of a bank’s liquidity problems we have? balance sheet and the asset side of a bank’s balance Mr Lambert: If you take the Crosby Report on sheet have to be looked at to. If parts of those asset structure are the kind of advances made then frankly house mortgages, what you see there is that over the with virtually no due diligence to hedge funds, who last seven or eight years there has been an enormous then took the positions they took and on the scale growth in mortgage securities in the UK from close they took them, you cannot say that it is not part of to nothing in 2001 to around £250 billion at the end the problem and that going forward it should be part of last year. Hedge fund investors were part of that, of the structure that should be left untouched. they did contribute to that and they have Mr Moulton: UK banks were not major funders of disappeared, and that is part of the problem, but hedge funds. US banks, Goldman’s, some of the big there were many other investors in those assets who Germans, UBS, these were the big funders of hedge have also disappeared. You need to look more funds. The losses in MadoV are mostly not loans to broadly at what is jamming up the wholesale finance MadoV, they are actually loans made to investors markets, not just the hedge fund disappearance. who went into MadoV, so if you were a private client Mr Moulton: There are tens of billions of assets that of RBS they would lend you money to enable you to have been forcibly sold by hedge funds as they shrink go into the MadoV fund. Those are the losses that and that is certainly mopping up some liquidity and have taken place. They were a bit rash. Processed: 13-03-2009 15:09:27 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG5

Treasury Committee: Evidence Ev 99

13 January 2009 Mr Will Hutton, Mr Richard Lambert and Mr Jon Moulton

Q736 Sir Peter Viggers: When this Committee Mr Moulton: They cannot keep up with innovation, looked at the banking model and the originate and it cannot be done. I strongly feel that if one thing distribute concept about 18 months ago, the comes out of this it is that we need trustworthy banks evidence we were given was that a shift back to the otherwise they are going to stay in the national more traditional kind of banking was undesirable ownership, socialised or whatever, pretty well and, indeed, the Governor of the Bank of England forever. We need trustworthy banks and that means thought that “the originate and distribute model has simple banks, banks that can be regulated, can be real value and I would not want to see it disappear”. managed. That does not say we stop innovation in Having had fingers burnt all round, what is the the financial world, but it has to be done in a future of the originate and distribute model and will diVerent place. It is not an accident that this lot all it self-correct or does it need a diVerent kind of happened after Glass-Steagall went away and we regulation? liberalised banking regulation everywhere. We need Mr Moulton: It will come back when people have to have banks which are simple, manageable, forgotten the pain that they have just taken by comprehensible, the so-called “narrow bank”. That following that route. It will not come back before. is the one thing we must do if we want to minimise People will want to be going alongside somebody, as the likelihood of this lot turning up again. It is not was said in the previous panel, to see the bank which easy, it is complicated to even do that, but that is leading the syndication of some assets stay in there concept will survive and would be something the UK for the first loss level. That kind of thing is going to could do on its own because in the current be reassuring and needed over the months and years environment tighter regulation is a competitive ahead. It will be five years forward before people are advantage, not a disadvantage, which it was before. stupid enough to go into the “fire and forget” type of Mr Hutton: I am thinking hard about this and I have financing, which was what it became. not completed where I think we need to get to. Jon Mr Lambert: I do not completely agree with Mr is right, but, that said, how do you get to where he Moulton on this one. wants to get to. I have begun to think that what you Mr Moulton: Very few people do! have to do is set the parameters of what the business Mr Lambert: As I recall, what the Governor was model should be, which is why Glass-Steagall was so suggesting was that the world’s capital needs are intelligent, it was trying to separate, trying to create greater than can be met just oV the balance sheets of these trustworthy narrow banks and leave the exotic the world’s banks and, therefore, capital markets world of investment banking. That would go on but one way or another are going to have to play some everyone understood that was an area of higher risk, part in supplying the capital requirements, for higher return and the contagion eVects to the rest of example, of the developing economies of the world. the national economy through the credit system The lesson we should take from this past experience were limited because you did not involve commercial is that the banks need to have more skin in the game. banks in it. What one needs to do is be very, very That is to say that the future model should be such clear as regulators about what the spheres of in my judgment that would say the banks had a banking activity are and to ride that very, very hard, continuing interest in the risk that they were but within that sphere you cannot expect the originating going forward. regulator to be ahead of the pace of financial Mr Moulton: They have to be part principal, not just innovation. We can try to limit these contagion agent taking a fee and waving goodbye. eVects in future, and we must do. Mr Lambert: Absolutely. Mr Lambert: What I feel is we should not conclude Mr Hutton: I strongly agree with what Jon and from all this that regulation is impossible. We need Richard have said. I think there is a danger in saying, to learn two broad lessons. One is that on the “My God, originate and distribute has got us into regulatory side there needs to be a clearer and better such trouble or securitisation has got us into such communicated focus on capital adequacy and on trouble, let’s go back to boring banking”. I regard liquidity. Clearly the liquidity side of the equation, both originate and distribute and securitisation as as the FSA has recognised after Northern Rock, was interesting and important financial innovations. The underplayed in the regulatory scheme of things. The trouble was, to use Richard’s phrase, the banks did second equally important message that comes out of not have enough skin in the game. I think originate all this is that as well as regulation supervision is very and distribute is quite a good way of diversifying risk important, and that means the supervision exercised and quite a good way of building a balance sheet V by boards of directors, by investors, by others who rapidly, but the point is you need an e ective credit have an interest in the good performance of the default swap market to help you manage the risk and system. you must, as a principal, not walk away from it and Mr Moulton: Supervision and regulation will only the job of domestic and international regulators is to work if it is within the capabilities of the people ensure a regulatory structure in which that takes involved to actually discharge those duties. A large place. bank with 30 or 40 business lines, huge books of derivatives, is not such an animal. Q737 Sir Peter Viggers: Do you think financial Chairman: I know a couple of you have got a lunch regulators can keep up with innovation in financial engagement, so there is an incentive for short fields? What more could they be doing? What more answers! should they be doing? Mr Love: Your lunch is not with us, is it? Processed: 13-03-2009 15:09:27 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG5

Ev 100 Treasury Committee: Evidence

13 January 2009 Mr Will Hutton, Mr Richard Lambert and Mr Jon Moulton

Q738 Ms Keeble: I want to ask a bit about risk out as a result of that, and the fact that credit ratings assessment. What was your view of the due diligence agencies’ judgments became part of the regulatory that was applied by the industry before people structures was clearly a mistake. invested in some of these very complex products? Mr Hutton: That is all true. There was a competitive Mr Moulton: It went from tolerable to notional to dynamic going on in the credit ratings agencies and virtually non-existent as we got near the end of the even the sober and better ones found themselves boom. That was what happened in most areas. In the competed into, what can I say, a more relaxed view leveraged loan market, half the people who were of what the risk was. There was also a general view taking pieces of the loan did not even bother to go to which was held by regulators and market actors look at the due diligence materials. That is fact. themselves that these sophisticated instruments did do the job of reducing risk. The system was careering Q739 Ms Keeble: Was that a culpable level of failure along, it was creating jobs, it was creating wealth and of due diligence? Was it that people did not do it anyone who wanted to constrain it would have been when they knew they should or that they were not portrayed as an instrument of the Nanny State. competent to be able to unravel these bundles? 2005, 2006 and 2007 were very extraordinary years. Mr Moulton: A mixture of both. The trouble was if you wanted to get a leveraged loan you had to take Q746 Ms Keeble: Do you think that the credit what was on oVer, so you grabbed what there was ratings agencies are capable of reforming themselves without checking it. It is the one woman on a desert or do you think there is a requirement for island sort of problem. regulation? Mr Hutton: I think there is no question they have to Q740 Ms Keeble: One woman. be regulated. I have always thought in the financial Mr Moulton: In the case of some of these assets the markets there are one or two fulcrum points, and I products are simply incapable of being analysed by think this is true of actuaries in the insurance the vast majority of people out there. Northern industry and credit ratings agencies in the capital Rock’s last capital issue, an oV balance sheet vehicle markets, where there might be a need for a kind of is on the website, 11 layers of debt, three currencies, public interest player because what is taking place is interest rate swaps, currency swaps, 415 pages of so fundamental that you need that as part of the prospectus, nobody understood it. infrastructure of eVective markets.

Q741 Ms Keeble: Should there have been some Q747 Ms Keeble: In terms of the legacy of the whistle-blowing about the lack of due diligence banking crisis that we have got, all three of you have given that there is supposed to be a requirement that pointed to the fact that we will end up with a it should be undertaken? diVerent industry which could have a diVerent ethic, Mr Moulton: There was a lack of whistle-blowing. It as it were. Would you like to say how that might look was all part of the desire to keep the boom going. and could you say some of the specific measures that might get us there? There has been approximate talk of need for greater transparency and so on, Q742 Ms Keeble: Who should have been blowing particularly in some of the products, but could you the whistle? say some specific measures that you think would Mr Moulton: Probably the most obvious target correct some of the diYculties that we have had? would, I am afraid, be the FSA. Mr Hutton: My goodness! I am working on a small paper on this and I would be happy to supply the Q743 Ms Keeble: It seemed that in the absence of due Committee with that. diligence people were relying on credit ratings agencies and I wonder if you, Jon, or others would Q748 Ms Keeble: That would be helpful. like to comment on the reliance on those, whether Mr Hutton: It is building on the sort of things we that was misplaced and a misuse of the ratings have all said. There has to be an EU-US agreement agencies, and whether the reform, therefore, should on reintroducing Glass-Steagall, a modern version be through greater regulation or proper use of of that. I am sure that is part of the story. I think the ratings agencies? whole system of credit insurance and credit default Mr Lambert: Clearly credit ratings agencies were swap is a good financial innovation but I am part of the process of turning, whatever you call it, strongly of the view that there should be better stone into gold or whatever the right cliche´ is— infrastructure to handle counterparty risk, a central alchemy. clearing house which these derivatives are traded through so you can be certain that the counterparty Q744 Ms Keeble: That is a bit unfortunate! is creditworthy him or herself and there is a standard Mr Lambert: Sorry, yes! Pure gold. contract. A lot of them are weird and wonderful and are not standard. There are a lot of things that can Q745 Ms Keeble: I thought you might be getting be done. Another thing, and this is the hardest thing back at him over the one woman on a desert island. because it is true, is that you cannot insulate what is Mr Lambert: For example, Commissioner happening in the credit capital markets from the McCreevy has had some important points to make equity markets. Richard has made this point and so about the conflicts of interest over trading and the has Paul Myners, that institutional shareholders appropriate regulatory response to what has turned were not exercising proper scrutiny about what Processed: 13-03-2009 15:09:27 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG5

Treasury Committee: Evidence Ev 101

13 January 2009 Mr Will Hutton, Mr Richard Lambert and Mr Jon Moulton banks were doing and they were not looking at that would free up lending on a scale that would be remuneration structures. I think you have a valuable. I think that is something we should be longstanding problem in the UK capital market considering. about a highly transactional approach to equity. Ownership of a company is a very, very profound Q752 Mr Love: Mr Hutton, you were staring at the obligation as well as conferring rights to dividends sky, if I may say so, at that point. and rights to sell. Mr Hutton: This is pro-cyclical, and there is no Mr Lambert: Transparency, improved supervision doubt about it, but the idea that we are going to get and a countercyclical approach to capital adequacy. international agreement on where we are in the cycle Mr Moulton: Transparency for me does not cut it. and by what degree banks should actually increase Nobody in this room can read the accounts of an or decrease their capital is, I think, close to utopian. HSBC or a Barclays and claim that they understand There was a way this was done which was very them. There is nobody in the room who could do eVective, we just managed the liabilities of banks and that. it used to be done by a system of special deposits and reserve asset requirements. It was very eVective, Q749 Chairman: You showed us AIG’s book in May beautifully operational, it could be done in a very and you were rather perspicacious, and that is why timely way, did not need international agreement, you are back here again! but we deregulated it away because the banks argued Mr Moulton: I do not think transparency cuts it. My it was burdensome because it meant there were model of the future is that we want our banks that periods in the economic cycle when they had to lodge do the money transfers and hold our deposits, the with the Bank of England potential interest bearing central part of our financial system, to have simple assets that they could work hard, they could sweat, capital structures, to hold assets that are capable of at either no interest rate or a penal rate of interest being understood, which means much shorter sets of and forewent profits. I wrote a lot about this in the accounts, some chance that the boards would 1990s. The argument was we must promote banking understand them, and let them operate like that. For sector eYciency by abolishing reserve asset ratios the capital structure, Basel II has proved to be quite and regulate the banking system through interest fatally flawed. Let us remember that Northern Rock rates because the object of the UK is to promote was allowed to reduce its capital on the back of Basel banking eYciency and the financial services II. We need to come up with some simple rule which industry. I understand why people talk about is, “You will have 15%, 12% in capital, you will have capital, it would be a better way of doing it, if 10% in liquid assets”, and then people will trust them possible, but practically I do not think it is possible because the models will be transparent, they will be to do it. The tried and tested way that G7 states used capable of being understood. right up until the 1980s and 1990s should be returned to as part of this going back to simple banking. Q750 Mr Love: Can I relate my question to your answer and Mr Lambert’s answer, and that is about Q753 Mr Love: You clearly will have some diYculty the concern, and I wonder whether you share it, that with what Mr Hutton said, but do you have any there is a pro-cyclicality within the system at the sympathy for the Spanish system where you build up moment. How concerned are you about that? what they call loss capital in the good times in order Mr Moulton: Very. The pro-cyclicality is really to protect you against the bad times? varied in Basel II in terms of bank capital structures. Mr Moulton: I think it is actually a better system. I It looks back, sees what the risk was historically and am just picking up one small point. Market to projects it into the future. The better things are, the market is a point only because assets are hard to less capital you need; the worse things are, the more value, hard to understand. If you exclude those capital you need. That is exactly the opposite of assets as far as you can from a bank, that problem what we want. It might be a lot less accurate, a lot vanishes. less sophisticated, but an arbitrary fixed level of capital would be more reassuring and more Q754 Mr Love: I will not get into that because we appropriate. had a very interesting discussion in the last session. I think the whole issue of valuation of those assets and Q751 Mr Love: There are some who suggest fair protecting the public interest in terms of ensuring the value accounting lies at the heart of the problem here money you put in from the public sector is not lost and who would want to tinker with that. Do you when the whole thing unravels is particularly agree with that? important. While I have some sympathy for the toxic Mr Lambert: I think that Jon is right, it is the pro- asset problem, the Americans have not been able to cyclicality of the current regime that is important. solve it and I am not sure we will be able to solve it One suggestion I would make for consideration is either. I want to go on to the role of the media in all that the people who drew up Basel II could not have of this. Mr Lambert, I have to say in your speech to been doing it with the assumption that at some point the Reform Media Group you sounded a bit like a most of the banks in the developed world would politician, if I may say so, when you were laying out have their governments standing behind them. It some of the diYculties that there are with the way the seems to me that we find ourselves now in a unique media has handled this. You said during that speech, position such that if you could get global agreement “publish and be damned”, which certainly a lot in for a time that the Basel II protocols could be relaxed the media would agree with. Should that apply when Processed: 13-03-2009 15:09:27 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG5

Ev 102 Treasury Committee: Evidence

13 January 2009 Mr Will Hutton, Mr Richard Lambert and Mr Jon Moulton it may well bring into focus the whole future of a up in the business pages, or outside the business bank, a financial institution? When is there a pages, and their colleagues were not that responsibility not to publish and be damned? sympathetic. I think they behaved pretty well, and Mr Lambert: When there is a degree of uncertainty could have better behaved better in one or two places about the accuracy of the story, I think that is where maybe, but actually we want more quality it ends. What I was trying to say there was over the journalism, not less. last 30 years the media has become a player in this world because of everything we know about in terms Q757 Mr Fallon: Returning to Government support of 24 hour news and online publication and for the banking sector, there has been a mix of everything else. It would be impractical to try and policies now—banking recapitalisation, the Special put controls on media reporting in a world of blogs Liquidity Scheme and the credit guarantee scheme— and online publication. I also think it would be is that policy mix right? improper to have a world in which informed insiders Mr Lambert: I think it was certainly right in had information that was not generally available. I October; whether it is complete is another question. do think that publish and be damned is important. The banking system was close to the edge of a steep My suggestion in that speech was perhaps the media precipice and that combination of decisions pulled it might spend more time among itself thinking about back. We are still in a world where the wholesale the way some stories are presented, whether it is markets are frozen. There is a particular reason to be speculative stories about “Bank A is in trouble, so concerned about the larger companies. Obviously now we should be looking at Banks B, C and D”, SMEs are in one category and the banks are lending and, secondly, unsourced quotes saying hostile to the SMEs. We should be thinking about the things about banks on the view that banks are refinancing needs of larger companies who need a V di erent. Unlike a motorcar company, if people lose syndicate to take them through and are now finding confidence in a bank that has serious systemic that noticeably harder than it was. My strong sense consequences. My suggestion was that the media is that it is going to be appropriate for the public should be talking among itself more than it is doing sector, the taxpayer, to take on some more credit risk about this issue. one way or another in the coming weeks and months. Q755 Mr Love: Mr Hutton, let me press you as a noted commentator on these issues. That judgment Q758 Mr Fallon: The work underway seems to that Mr Lambert is talking about, that very fine include extending the loan guarantee scheme, judgment about whether the evidence that you are considering buying back the troubled assets or basing your story on is strong enough to warrant quantitative easing. Which of those three, Jon being published in a time of financial crisis, how do Moulton, do you think will help unblock these you make that judgment? Are we asking too much of frozen markets? our commentators and journalists to be able to make Mr Moulton: I do not think you can pick one, I think that judgment? the Government is doomed to do all of them to some Mr Hutton: Gosh! measure. I am not necessarily enthusiastic about the likely outcome of state controlled banks giving state Q756 Chairman: We are going on to another session guaranteed loans to companies resulting in very on this so we do not want you as an expert witness optimal allocation of resources in the economy, but on this, just give us your passing comment. those things are going to have to happen because the Mr Hutton: Okay, I will give you a 30 second view. severity of the crisis is extreme. Broadly the media do a pretty good job. In the fortnight up to 11–12 October there was a run in the Q759 Mr Fallon: But of the three, which would wholesale money markets and I knew, and almost you favour? everybody in financial journalism knew, that both Mr Moulton: Quantitative easing will ultimately be HBOS and Royal Bank of Scotland could only get the biggest part of that; it has to be. overnight money and increasingly were having to Mr Hutton: There are a number of things to be said. turn to the Bank of England. You could argue, If you are talking about the structure of the package whether it was Robert Peston or the city editors of that was put to the bailout on the 11th and 12th, it the quality broadsheets, they were pretty was a balance and it was right. I think the 12% responsible. They could have said, “Get your money dividends were too high and loading the insurance out”, because if the interbank market seized up, why premium on interbank guarantees, that kind of are you as a retail depositor being patsy. There were weighted average of credit default swaps in the run- a couple of occasions when I thought some of the up to the crisis, made certain that insurance stuV that was said about Bradford & Bingley was premiums were extremely high, which I think was a pretty tricky. In the main, I would suggest to the mistake and I notice the Government has rectified Committee if we had had some better journalism, if that. What happened on deposit guarantees had to the financial journalists had been able to make a take place. My concern now is to echo what Richard better pitch to news editors about the seriousness of said and I urge the Committee to look at what is what was going on in 2006–07, it might have alerted happening in the States. There has been a very the national discourse more than it possibly did. I substantial easing in the US interbank wholesale think most financial journalists would say they were money markets in the last two or three weeks and really anxious to get stuV on the front page or high there Libor rates have come right oV the peak and Processed: 13-03-2009 15:09:27 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG5

Treasury Committee: Evidence Ev 103

13 January 2009 Mr Will Hutton, Mr Richard Lambert and Mr Jon Moulton are beginning to look normal. That has been about under our feet, the old views do not matter. It is the Federal Reserve buying Fanny Mae and Freddie really odd. Now we move it into a state-owned bank Mac guaranteed asset backed securities in the we are bound to have political pressure for where the residential market and securitisation market, and lending will go and that will be ineYcient. Some of it also beyond that where the federal government has will go to deserving homes, some will go to the stepped in. I think we are going to have to do wrong places. If we then have state guaranteed loans something similar. I am very concerned that we are from state-owned banks, I am not quite sure what we still talking about a 20 billion loan guarantee scheme are achieving really, we are socialising the losses for working capital when actually what we have got across the entirety of the economy. These things I do to do is try to restore our interbank market to the not necessarily follow all the way through and I do depth and breadth that it existed pre the crisis. not think anybody else does, but I am uncomfortable because these are enormous changes Q760 Mr Fallon: Jon Moulton, is there not some and nobody has thought them through. danger of quantitative easing here, unlike the United Mr Lambert: I think we are not in that place. We are States, in that our currency is so much weaker and not in a place where we have a nationalised banking more exposed? system. We have every reason to try and avoid it for Mr Moulton: They are not being careful at all about the reasons that Jon implies. I would also say quantitative easing, much more normally known as strongly that what took place in October was such as printing money, which is essentially what we will be to give our banks now a strong capital base. The doing. Obviously it will lead to a reduction in intention, and it was stress-tested by the FSA, was to confidence in the currency and ultimately it will lead give the banks a cushion from which they could go to inflation, and possibly quite severe inflation. The through a rough time and they are in that position so problem at the moment is that we are choking to it is wrong to assume that the banks need more death and really you have got to deal with the capital. current problem rather regardless of the consequences that will follow. The consequences will Q762 Chairman: In a sense it is not nationalising the be severe. The increase in public borrowing and the banks, it is nationalising the credit lines. I had a increase in printing of money have severe Christmas breakfast in my constituency last Friday consequences to follow. with 80 businesses and they were all howling. Mr Lambert: Again, I do not see things in quite such Businesses which have been established 30 or 40 stark terms, I have to say. For me, the important years with their banks have their arrangement fees thing is credit guarantees and it is important to keep which have gone through the roof and they have got clear in one’s mind the diVerence between what one overdrafts which maybe they are not getting now might call expenditure, which is a fiscal loosening which was a formality just a while ago. It is a real and the automatic stabilisers, and what you might crisis situation. How do we get that down? call investment, which is owning shares in Northern Mr Lambert: That is about credit guarantees, I am Rock and the Royal Bank of Scotland. I think one absolutely clear about that. would be seeing credit guarantees under the Mr Hutton: There always was enormous short- investment heading rather than the expenditure termism in the British banking system remember. heading and they should be the first step we should Your opening question was one of my critiques of take and then see how things go. the banking system back in the mid-1990s, that it Mr Hutton: There is quite an interesting scheme that always was a banking system which was prepared to the Americans have got going with Citigroup where oVer you an umbrella when the sun was shining and there is $306 billion worth of loans, some of them to not when it was raining. There are very high margins business, some of them to households, and what has on debt, very short-term debt, and the arrangement happened is there is a guarantee of 10% of the loss in fee structure is embedded in all of that. Picking up a catastrophic event and some American economists what Jon was saying about simple banks in the have developed some quite interesting models for future, I would like to see much more medium and how you might oVer a guarantee and pick up the long-term lending. One of the ways that one can catastrophic element as a government if there was a migrate from the asset structures we have now in very, very severe recession, but compensated by a British banking to the asset structures that I think bigger upside in the recovery. There are some very, would be preferable and better for the real economy very interesting schemes emerging in the United would be to use the credit guarantee system that States about how to do credit guarantees in the way Richard is proposing as a bridge from one banking that Richard has been describing. system to another. It could be a very creative moment for British finance. Q761 Chairman: Jon, I think you said it is unpalatable and you do not like the idea of Q763 Mr Todd: We are having to throw away a lot government lending or nationalising. Is that because of intellectual architecture in this process and Jon there are competing and conflicting interests at the hinted at that. We would normally want to consider moment? moral hazard, giving inappropriate messages both Mr Moulton: I think it is really bizarre. We have to those who had made mistakes in the past and been talking about capital and banks, and if the messages to those who may be in these ventures in Government owns the banks who needs any capital? the future, the protection of the public interest and We are really in a world where the floor is moving the requirement to achieve reasonable security for Processed: 13-03-2009 15:09:27 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG5

Ev 104 Treasury Committee: Evidence

13 January 2009 Mr Will Hutton, Mr Richard Lambert and Mr Jon Moulton what the public sector does, limiting the role of the Q767 Mr Todd: Representing some of them! state, which Jon has set out. My interpretation of Mr Lambert: —that this is a global crisis. It is your answer, Jon, is that architecture has to be important for Will to understand that the banking discarded because reviving the economy and system in Germany, which he has so admired for so protecting its future is quite clearly the most obvious long, is down the plughole as well. It is important to requirement and that we must put these things into put this in a context that says this is not a matter just the past at least for the present. Is that right? for constituents, it is a matter for the whole Mr Moulton: With extreme pain, yes. developed world. You cannot point to a banking system anywhere in the developed world, some of which are very diVerent from ours, which has Q764 Mr Todd: I thought it was. The support for the escaped this shock and that is something that we banks, and I think Will mentioned this, the reference should hang on to. to the interest rate on the coupon rate, appeared to Mr Hutton: There are degrees of failure. You are place perhaps too high a priority on the perception right, but there are degrees and the epicentre of the of the protection of the public interest. Is that the crisis is New York and London and it radiates out. view of all of you, that perhaps that mechanism Mr Lambert: That is because they are the biggest designed in a hurry may need further reflection? international capital markets, it would be surprising Mr Moulton: It should be converted into ordinary if it was not the case. share ownership without a requirement for a Mr Moulton: It would certainly help the politics to coupon, much larger ownership, it gives more upside see all bankers as victims. to the public in the long-term and takes the pressure Mr Todd: That is what I am hinting at. oV the banks in the short-term. Mr Lambert: The current structure gives a disincentive for banks to lend as aggressively as we Q768 Nick Ainger: Some of the points I wanted to would like them to do. raise have been touched on already, but thinking Mr Hutton: I said it when I first looked at it, I said back to the Japanese crisis, and we went over there it and wrote it, and completely agree with Richard last year to see what lessons they have learned and so and Jon. I do not understand where that 12% came on, a few minutes ago all three of you agreed that from and I cannot think what they were thinking of one of the ways to try and get the credit markets when they imposed it on the banks. You have got to working again would be for credit guarantees to be think of a kind of Marshall Plan. brought in. What if they do not work? This has been the problem and certainly this was the problem in Japan. Initially they tried certain things, Q765 Mr Todd: They were surely influenced by the recapitalisation and so on, but it was not suYcient moral architecture that I just referred to, which is try and they just seemed to be stumbling from one thing to get reasonable protection of the public investment to another and nobody got a grip of, “This is where that was put in place and secure its early repayment, we are now, that is where we have to be and we have if possible, and the desire to make a moral message. to do this, and if that does not work we do that, that A lot of my constituents would happily lynch and that”. If the credit guarantees do not work, what bankers from lampposts. would you suggest? Mr Moulton: Very popular entertainment! Mr Hutton: First of all, I think they will work. You get to a point where you try credit guarantees but my own instinct, by the way, is to leapfrog the credit Q766 Mr Todd: It is a thought! Giving apparently guarantee system and go straight to where the relatively free bailouts to banks and oVering them V Americans are. What is happening essentially is the ways of taking large amounts of dodgy assets o Fed is buying tradable credit guaranteed assets, that their books is about as popular to the ordinary is what is happening in the States, and that is where V person on the street as o ering them cyanide. How we would have to go to and rather than muck about do we get this message across that these sorts of I would go straight there. I would go straight there painful measures, which are very counterintuitive to now, in January 2009. What I fear is going to happen many people, are nevertheless necessary? is we are going to have a limited credit guarantee Mr Hutton: I said we need a Marshall Plan for the scheme rolled out tomorrow, working capital for banks and Nuremburg Trials for bankers. You enterprises of up to £15 million turnover, good and cannot be certain of what has taken place, but the obviously one welcomes it but in terms of the lack of activism about trying to bring some of these magnitude of what we are confronting it falls far people to book has made it harder to get the policy short. The quicker you get to that solution, and my mix right because we actually have to have understanding is that is very hotly debated in the functioning credit institutions in this country and Bank of England and you will have to ask the Bank functioning wholesale money markets. That is why what their position is, the better. The Bank is we are in this discussion now. That is what we have reluctant to go as far as the Federal Reserve at the to sell the British public and tell the British public moment. but, equally, some of the people who are involved in Mr Lambert: I think the authorities here and in the actually creating the crisis should be in the dock, if United States have learned a very great deal from not literally at least metaphorically. what happened in Japan, which was mainly Mr Lambert: If I may just say something there. I monetary policy failed and the Bank of Japan made think it is important to understand— some serious policy errors during that decade, the Processed: 13-03-2009 15:09:27 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG5

Treasury Committee: Evidence Ev 105

13 January 2009 Mr Will Hutton, Mr Richard Lambert and Mr Jon Moulton

fiscal policy failed and the banking system was not Mr Moulton: You can see the popularity of it. cleaned up quickly enough. We have learned lessons Mr Lambert: It is absolutely top of my pile! My from that. What we have not discussed at all this impression was that the very large majority of morning but I think is relevant when we are thinking companies who came into the category set out by Sir what is going to happen to the economy over the David Walker have complied and the ones who have next 12 months is the massive monetary easing that not are much smaller and were not required to. has taken place in this country in the last few Maybe the net should be made wider. I have talked months, both through the Bank of England and to colleagues who have read the document and my what has happened to sterling. If you throw in a understanding is it is a good start but there is more massive monetary stimulus and a fiscal stimulus and to go. take an appropriately bold measure on guaranteeing risk, making sure that it is not done on a free basis, Q773 Chairman: The way you describe it, Jon, it is a that people have to pay for that extra risk, then I bit of a con, is it not? think we should be feeling much more cheerful as the Mr Moulton: It does not do much. It really does not year progresses. do much for anybody. People struggle to come up Mr Hutton: I agree with that. with what they actually want reporting. Somebody Mr Moulton: I think the main thing is to avoid lots has to read it and respond to it for it to be worth of panic packet actions. 20 billion is not a very large producing and there is very little readership. number against the scale of the problems we are talking about. Guarantees are not investments, they Q774 Chairman: So what a pig in a poke. are partial losses usually, but they are still going to Mr Lambert: No, that cannot be right. be required to be done. Personally, I would be happier if the scheme was a lot larger, although it Q775 Chairman: Jon has got that point of view. V o ends many of my basic principles. We are in a bad Mr Moulton: I am allowed that view! hole and we have to get out of the bad hole. Q776 Chairman: Let him speak, for God’s sake. Q769 Chairman: Jon Moulton, given that you are in Now that Jon says it is a pig in a poke, over to private equity, I had a letter yesterday detailing you, Richard! Rake’s progress on the future regarding private Mr Lambert: If you compare where we are now with equity. Are you disappointed that the Guidelines where we were 15/18 months ago in our general Monitoring Group’s report suggests half of the understanding of what his business is we have come private equity firms in the UK are complying with a heck of a long way. the code of conduct rules set out by David Walker? Mr Moulton: You are in a very substantial minority, Q777 Chairman: Professor Buiter said to us that the one of the very few people to have read any of the half-life memory of those in the financial markets is information that has been produced. three years and the banks are now in control again, given the money that they have, so people are going Q770 Chairman: Is that not a feature of the markets? to be below the radar for a few years and then it is Mr Moulton: No. At my own firm we do not comply back to business as usual. with the guidelines, we answer any question Mr Lambert: This is a once in a century event and it anybody ever asks us, and we say so freely. We get is a pile-up which will take years to untangle and the asked about two questions a year. I do not think it half-life is a lot longer than the Professor was matters a rat’s. What has happened in this downturn suggesting, I think. is that private equity has lost control of a lot of companies, eVectively to the debt market. Actually Q778 Chairman: Then it will be back to business as private equity is a much smaller owner of companies usual, Jon? in the real world now than it was a year ago so, Mr Moulton: Longer half-life and if we want to again, we are becoming just a secondary issue avoid the thing coming back again we need to take compared to the scale of everything else that is out action which is quite radical about the structure of there. the banking industry.

Q779 Chairman: Then back to business as usual, Q771 Chairman: So Sir Mike could be better sailing Will? or playing golf? Mr Hutton: Both things are true curiously. I think a Mr Moulton: I think he would enjoy both a great lot of British financiers are lying low waiting for the deal more. storm to pass and looking forward to 2010–11 when this monetary easing that is taking place, which is Q772 Chairman: That is aVecting you, Richard, absolutely stunning, will start to see some kind of because you have got a lot of private equity firms revival and they are hoping to avoid too much signed up with the CBI. David Walker said that impairment as a result of what is taking place of their private equity firms that did not comply with the freedom of action in the future. In that sense Willem code should be named and shamed. Mike Rake went Buiter is right to say that we are talking three years back on that. Was he right to go back on it? but the combination of issues from shareholders Mr Lambert: I am afraid I am one of those who has anxious to protect their investments in future, not read every single word of this document here. inquiries like your own and this Committee, and Processed: 13-03-2009 15:09:27 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG5

Ev 106 Treasury Committee: Evidence

13 January 2009 Mr Will Hutton, Mr Richard Lambert and Mr Jon Moulton action by the Government, this is a moment in time Mr Hutton: I strongly agree with Jon, do not allow in which we can really improve the dysfunctionality anyone from the financial community to tell you that of British finance, which has been longstanding in any more regulation is going to stifle innovation and my view, that was at the heart of my book, The State somehow damage the City of London. What a lot of We Are In, 12 years ago. That dysfunctionality is one bankers say privately is they badly, badly need some of the reasons why we are in the hole we are in and regulation to restore trustworthiness and their it should be addressed in some of the ways I have credibility and the standing of the City. Whether you talked about this morning. will get them to say in public what they say in private is another matter. I strongly agree with Richard that we are in a hole that we need to get out of. I also urge Q780 Chairman: As far as our Committee is you to think through what you think a competitive concerned we have a number of sessions to go. What British financial system that serves the interests of should we keep our eye on? What should we not be real business in this country would look like. This is beguiled by? a once in a one hundred year chance to change the Mr Moulton: People telling you that we will kill motion of British finance. As Winston Churchill innovation in the banking system which has, of said, in Britain finance is too proud, industry too humble, but there is an opportunity to reverse that course, proved to be a disease. We should avoid equation and really get wealth generation going being told it is too complicated to do it; it is perfectly outside just the narrow confines of the Square Mile. capable of being done and it needs doing. It in the interests of all political parties and all Mr Lambert: I think, I am afraid, you need to be businesses to do that. focusing on the short-term needs and thinking about Chairman: That was tremendous evidence, very the longer term problems afterwards. The short- helpful to us. There were some unpalatable term needs are to do with a funding gap of some scale comments, but I hope your digestive systems are in the banking system internationally and nationally okay for the nice lunch you are going to! Thank you and how best to address that. very much. Processed: 13-03-2009 15:09:43 Page Layout: COENEW [SO] PPSysB Job: 416782 Unit: PAG6

Treasury Committee: Evidence Ev 107

Wednesday 14 January 2009

Members present

John McFall, in the Chair

Nick Ainger John Mann Mr Graham Brady John Thurso Mr Michael Fallon Mr Mark Todd Ms Sally Keeble Sir Peter Viggers Mr Andrew Love

Witnesses: Mr Doug Taylor, Personal Finances Campaign Manager, Which?, Mr Peter Tutton, Senior Policy OYcer, Citizens Advice, and Mr Andrew Cave, Head of Policy, Federation of Small Businesses, gave evidence.

Q781 Chairman: Welcome to this, the second session Mr Tutton: It is very diYcult. Our main concern is of our Banking Crisis Inquiry, and we are looking obviously with borrowers and people with arrears particularly into the consumer issues. Can you problems—we do not see very many savers at the introduce yourselves for the shorthand·writer, moment at Citizens’ Advice, we tend to see people please, starting with Andrew? who have no money. Our concern about Mr Cave: Andrew Cave; I am the Head of Policy at Government action there is really about ensuring the Federation of Small Businesses. that people are helped as much as possible if they get Mr Tutton: I am Peter Tutton; I am a social policy into diYculty. That may be about ensuring rate cuts oYcer at Citizens Advice. but it may be about doing other things as well. We Mr Taylor: I am Doug Taylor; I am the Personal see the package of help for borrowers from the Finance Campaign Manager at Which? Government; we will need to see how that works, we will need to see how the forbearance parts of that work, and maybe the Government’s role there can Q782 Chairman: Good afternoon; thank you for also be ensuring that lenders do what they can to coming. Doug, maybe a question to you first. Falling help by forbearance when borrowers are in interest rates, we are told, do not benefit savers and diYculty. That is our main priority. there has been a big issue of that over the past few weeks. What will be the impact in those sections that Q784 Chairman: Doug, in terms of mortgage arrears are heavily reliant on their savings income do you you are quoted as saying that the FSA “is fiddling think? while Rome burns” and should be naming and Mr Taylor: It is clear that the banks have wanted to shaming companies that are not treating customers have their cake and eat it recently by passing on the who have mortgage arrears fairly. How widespread base rate cuts to savers but not necessarily passing is that phenomenon? the benefits of that to borrowers. We found in Mr Taylor: That particular quote was taken on the November that 92% of banks had passed on their cut basis of the FSA’s paper that it issued on consumer and instant access accounts had fallen 2% in the last responsibility and it was about where we thought year and notice accounts had dropped 3%. Perhaps they should be putting most of their energy, so it was to illustrate what the impact can be, there is now a around things in the market that might be a cash ISA with 0.1% interest which means that diYculty. somebody saving up to £3,000 in that account would have interest paid in the year of £3, which would not be subject to tax but is nevertheless a relatively small Q785 Chairman: It was not based on any practical amount, so the impact can be great. I suspect the evidence? impact is greatest on those people who are most Mr Taylor: The FSA themselves when they have reliant on savings for their pension, so people who looked at the market have found in their thematic have fairly substantial amounts of money is where work on mortgages significant problems in the past that eVect will be significant and they will probably about the information that companies had held on be forced into a situation of eating into their capital. the way that mortgages had been sold, and they found particular problems about issues around I think the reality is that for borrowers, who tend to those mortgages which had gone into the securitised have a larger amount, the impact can be areas, so particularly sub-prime and buy-to-let. substantially greater, and by not passing on some of There is some evidence in that area that the FSA the benefits to borrowers we have seen some needs to be extremely vigilant about the situation particular diYculties for people on standard and ensure that the best practice which the best variable rates. lenders are following is more universally adopted throughout the market. Q783 Chairman: What can the Government do, Peter, to have a better balance between the diVerent Q786 Chairman: I wonder how many of them come interests of savers and borrowers? Is there anything through your door at the end of the day; Peter, if you the Government can do? can give us a view on that and maybe add to that the Processed: 13-03-2009 15:09:43 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG6

Ev 108 Treasury Committee: Evidence

14 January 2009 Mr Doug Taylor, Mr Peter Tutton and Mr Andrew Cave fact that many of the problems in the US market Mr Tutton: We have not seen evidence of that nature came from its fractured methods of selling but if we did we would be extremely concerned about mortgages. To what extent do you think that the it, people being put in that position after the event, current mortgage crisis in the UK reflects a failure an actual change by lenders that is very detrimental. on the part of mortgage advisers rather than banks? We would be very concerned but we are not seeing Mr Tutton: In part is the answer to that. We have evidence of that at the moment; but we will keep a two diVerent things with mortgages. Since the credit sharp lookout for it. crunch or where it started to accelerate quite markedly we started to see growing numbers of Q788 Nick Ainger: In terms of those people who do people getting into diYculties from 2005 onwards find themselves in a situation where, because of the and in many of those cases what we were seeing is fall in the value of property, when they are coming people would come in and they were being given, in to the end of a fixed term loan they are faced with far some cases, loans that were unaVordable from the higher rates because they are in excess of the 90% start—in particularly the right to buy sector people loan-to-value ratio, what do you think can be done were finding diYculty with the first payment—and to actually help these people who are faced with that more generally lots of evidence of people who type of situation through no fault of their own? looked like they could aVord it on paper but the Mr Tutton: It is a diYcult one. Our main concern reality was that very quickly they were getting into with this and where we are seeing it at its worst is in diYculty, disproportionately from sub-prime the sub-prime sector where there are people who lenders as well. That is an intermediated market as cannot remortgage because that market just does well, so what we found when we talked to borrowers not exist at the moment so they are just stranded was that they were listening to the advice and what there. Helping them is going to be diYcult; they were being told by financial advisers—people obviously, again, it goes back to what I said before were saying yes you can aVord this, they were taking in that we really need these lenders to show that. In terms of regulation we probably have not forbearance. If people are struggling to make the seen quite the same as in the States, what the FSA payments we would expect lenders to think what has set up has had some eVect, I guess, but it has not other ways are there around that, can they defer been wholly successful. We have certainly seen some payments until maybe the market picks up. There cases of irresponsible lending, cases where are specific things, if people have lost their jobs, like borrowers have not had their vulnerability to debt the standard interest rate payment—we have recently seen the Government has made reforms to properly pointed out to them, where advisers seem ISME which are very welcome but that will not interested in selling loans rather than really checking necessarily help, we might find people who are aVordability, where lenders in some cases have not stranded on rates very much higher above the really looked hard at what was going on with standard interest rate so the Government might advisers. That certainly had a part in the build-up of want to think about moving that to help people. problems that we saw increase—in 2005/06 we were There are a few practical things, but it is a very seeing a 10% increase a year in arrears problems; diYcult problem. when the credit crunch started to hit in around the autumn of 2007 what happened was that we saw an immediate increase in arrears which was about all Q789 Nick Ainger: Do you not think the actual these vulnerabilities, people who were really mortgage lender has also got a share in this as well? struggling, it did not take much to put them over the There are two parties to this and they both share edge. I think a bit of that was a failure of regulation. risk, and to penalise someone because the value of all houses has fallen, do you not think that that actually Chairman: Thank you very much. Nick. is unfair and they should actually be renewing or providing a new mortgage at the same rates and they bear the same sort of risk as the mortgage-holder? Q787 Nick Ainger: I was contacted in December by Mr Tutton: It all sounds fair enough to me. There is a family from Cambridge who had received a letter a problem, as I say, particularly with what we saw from Abbey, their mortgage provider, saying that with the sub-prime market and where you have they had done a quarterly review of the value of their discounted periods. They then end and people get property and as properties in the area had fallen stranded; it is a recipe for disaster. I agree with you quite substantially their 90% loan-to-value ratio was that that is something that needs to be looked at if now exceeded and that they required the mortgage- the market comes back, particularly with more V holder to basically pay the di erence within three vulnerable borrowers. We have seen a lot of people months to bring them back within the 90% where their payments jump up and they cannot go threshold. I contacted Abbey and they said that they anywhere else, so it is bound to go wrong. I kind of had no intention of invoking this clause, but I then agree with you as to how that gets worked out. questioned them as to why they had sent the letter in Mr Taylor: This is going to become an increasing the first place. Is this common practice? Have you problem if house prices fall by another 15% because heard of any similar cases and do you not think that you will end up with 1.5 million households in this given the circumstances the industry faces at the particular situation because the standard variable moment if there are existing clauses they should all rate, which is where they will move to, is so much be revoked rather than an assurance being given that higher. They will find that not only will they be they will not invoke them? paying more money but you are potentially into this Processed: 13-03-2009 15:09:43 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG6

Treasury Committee: Evidence Ev 109

14 January 2009 Mr Doug Taylor, Mr Peter Tutton and Mr Andrew Cave issue about increasing repossessions. It is a very Q794 Ms Keeble: I wanted to ask a bit about credit significant issue and at least part of the solution must cards and store cards which obviously are be in the way that those lenders handle customers responsible for quite a lot of consumer debt and so who are in financial diYculties. on. Doug, you advise people against taking out loans on store cards; could you just say why? Mr Taylor: The APR on store cards is invariably Q790 Nick Ainger: You mentioned repossessions: higher than the APR on credit cards and credit cards Shelter in its submission to us has suggested that the often have other potential benefits to them such as law on mortgages needs to be reformed to protect section 75 of the Consumer Credit Act, so by and borrowers and they are objecting to the ability of large the deal that a consumer will get on a credit lenders to force a sale based on only two months of card is better than the deal they will get on a store arrears. They are also objecting to the application of card. If somebody wants to use a store card in order foreclosure which means that all the sale proceeds, to access a special discount that is one thing, but to regardless of the size of the original debt, revert to use the store card as a means of borrowing money is the lender. Do you agree that those are two issues not a sensible course of action. particularly that need to be reformed? Mr Tutton: Yes. There was a recent case where this Q795 Ms Keeble: Certainly during the boom in retail happened which caused a lot of panic. On the good spending we saw an enormous amount of credit side the FSA and CML have both given statements being provided through store cards. Do you see any saying this is an unfair practice if lenders are doing sign that any of the providers have actually brought this. We would agree with Shelter, we think the law their practice into line, because we still hear of some needs to be looked at again to make it absolutely quite extraordinary promotional deals on local clear that borrowers are always getting the radio and so on, and what kind of interest rates do protection of the courts. The Ministry of Justice are you see them now charging? conducting a review into mortgage law and we think Mr Taylor: The average APR I believe on store cards that is one of the things they need to look at. is about 24%.

Q796 Ms Keeble: Average. Q791 Nick Ainger: Are there any other issues on Mr Taylor: Yes. We have no evidence of this but I which you think the law on mortgages should be imagine that staV are incentivised in the sale of store reformed? cards. I can only speak anecdotally from my Mr Tutton: We are just thinking through this at the Christmas shopping where I was oVered several moment and maybe it is one thing we could get back times a store card. to you on. We can look at things like what are the powers of the courts when people come before them; Q797 Ms Keeble: I probably had the same the court takes a snapshot: can you pay at that time. experience as well. Those powers have been more or less the same for 20 Mr Taylor: That would be my response to that. or 30 years; is there a case now for courts to have more flexible power to give borrowers more time? Q798 Ms Keeble: Are there any companies that you We have seen, for instance, the government two-year think are good or any that you think really need to deferral but not necessarily all lenders will play ball improve their practice because some, I have to say, with that, so if there are lenders that will not do the look like financial services with bits of furniture courts need more powers? That would be one thing attached. that we would look at, the powers of courts to help Mr Taylor: We have just taken a very straight and people; making sure that people have the protection simple approach to this and that is a credit card is of the court and that lenders cannot sidestep that better than a store card, so we have not looked at the would also be important. market company by company and tried to identify Nick Ainger: On the package which the Chancellor best buys so to speak, we have taken a very simple announced in the Pre-Budget Report, part of that and straightforward approach on this one. package was that there should be no enforcement action until at least three months had elapsed while Q799 Ms Keeble: There have obviously been the the borrower was in arrears. Is it enforceable? reports about Amex and their 46%; what is behind that? Mr Taylor: It seems an enormous amount of interest Q792 Chairman: Could you give us a quick answer to charge on that particular product and clearly they because I want to move on? go for a niche market. I do not know what their Mr Tutton: Yes, the pre-action protocol should thinking was on that but it does not seem a very make that enforceable. sensible proposition for anybody to take that particular card.

Q793 Nick Ainger: It is enforceable in your view? Q800 Ms Keeble: Just on store cards—and Peter has Mr Tutton: The pre-action protocol has come in; if probably got some experience on this as well—do that is an industry standard and it is not being agreed you think that the pressures imposed on people as a to, CML guidance is if they say that is not agreed to result of buying with store cards are properly then the courts should be throwing those cases out. recognised? Should the regulation be more Processed: 13-03-2009 15:09:43 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG6

Ev 110 Treasury Committee: Evidence

14 January 2009 Mr Doug Taylor, Mr Peter Tutton and Mr Andrew Cave integrated with financial services and do you think Q803 Ms Keeble: What evidence do you have? this is something that needs to be looked at in terms Mr Tutton: We constantly get evidence about people of when companies collapse—for example MFI had with store cards who do not know necessarily what about 30,000 customers with various amounts of they are taking out, people who think they are taking purchases and bills and so on outstanding. What do a loyalty card or something and then are shocked you think we should be looking at there? when they get a bill—they do not really understand Mr Tutton: There are a number of diVerent issues what is going on; they do not understand the with store cards and we are clearly keen that people agreement. Our clients tend to have low levels of are not left in any diYculty by the collapse of firms— financial capability, often on low incomes and quite we were very concerned about Farepak for vulnerable, and do not necessarily understand where instance—so that people lose money. More they are coming out, so there is a need for more generally on store cards, they are regulated products training, a need for sales staV, a need for people to and we would be keen to see how well store cards understand better the tools for borrowers to are sold. understand. It also brings us into the whole area of financial capability and how do we get consumers to better understand the products that they are getting. Q801 Ms Keeble: Is there any monitoring currently Ms Keeble: Thank you. or not? Mr Tutton: This is always of course the thing with Q804 John Thurso: Andrew Cave, can I perhaps regulation; they are regulated under the Consumer address this question to you: your December 2008 Credit Act and the Consumer Credit Directive will poll of small businesses set out pretty graphically the also probably pick them up, but in terms of sales kind of diYculty that SMEs are having with regard practice what actual oversight is there? I guess the to both access to finance and to the increasing cost other point on APRs is of course that two or three of that. Has there been any improvement since then, years ago it went all the way through the are you seeing anything coming through, or is it Competition Commission who made an order on continuing to deteriorate? store cards, so this is a matter that has already been Mr Cave: We do not have any polling data to the subject of an extensive investigation. If there are compare with the polling that we did in December so still problems there maybe there is also a point on, I would not like to say that we can prove that it is as I understand it, the Competition Commission has deteriorating or it is the same, but the figures that one shot at doing things and I do not know how came out from the BBA yesterday do demonstrate to good its ability is to come back and look at things us that overdrafts have reduced by £100 million in again if market conditions change and there is still a October and November and small businesses are problem, or if the remedies have not been successful having to dip into their savings to the tune of £900 in completely rooting out the problems. So there is million. These figures again are for October and another question there about once something has November but the anecdotal evidence that we been through, can they come back again and deal receive from members on a day to day basis suggests with a problem further on. that the problems are continuing, and if you look at the survey data from December the most startling result from that was that in answer to the question if Q802 Ms Keeble: Have you been surprised by the this situation continues what will be the situation, continued promotion of store cards and do you 41% said that they would consider curbing hiring think that that is building up some more pressures and 39% said that they would consider closing their on people in terms of them taking out loans or taking businesses, so it is quite a distressing time out there out excess credit which they simply cannot aVord for our members. given the financial pressures building here? Mr Tutton: It is a tricky one. We are obviously Q805 John Thurso: The Government made some always concerned about the way that credit is announcements in the PBR and, perhaps more marketed and we think the way that credit is importantly, made quite a lot of announcements marketed of course needs to be responsible, that yesterday and eventually brought them to borrowers need to have the risk properly pointed out Parliament today. Have you had an opportunity to to them and we are concerned that if anyone takes look at that and what impact do you think those out credit they should be helped as much as possible announcements will make? to understand the consequences, how vulnerable Mr Cave: Of the announcements today the key one V they are, so that people understand can I a ord this, is obviously the £1.3 billion finance scheme for small what is the interest rate, what is it going to cost me? businesses, which we welcome. We proposed a very The problem is that at the point of sale in the shop similar scheme last October and it is important to do you get that time to think about it? On the one point out that since last October when it was first hand that the things are being promoted is not in proposed to now over 6,000 businesses have closed itself a problem if that promotion is responsible and their doors, so we would have liked to have seen this borrowers are properly helped to decide what they come on tap much sooner. However, it is better late are getting into. Our worry is that these are very than never and we believe that it will make a real quick sales of credit agreements, how well are the diVerence. When you actually look at the criteria as staV trained, how well are the borrowers informed; long as the banks actually follow through with this, that is the worry. and this is the key question now— Processed: 13-03-2009 15:09:43 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG6

Treasury Committee: Evidence Ev 111

14 January 2009 Mr Doug Taylor, Mr Peter Tutton and Mr Andrew Cave

Q806 John Thurso: Do you have a concern on that? business owners are scared to go and talk to their Mr Cave: Yes, we do. bank mangers at the moment and really they should be going and talking to them more than before, but Q807 John Thurso: Can you identify it? equally bank managers are scared of making a bad Mr Cave: The issue of confidence is a really big decision or the risk of making a bad decision and, problem for our members and the phone calls that hopefully, the announcement today will bring back we are having already today oV the back of this a bit more confidence to that relationship. morning’s announcement is “What is the point in John Thurso: Thank you. this because it is still going to be delivered through the banks?” I do not share that view 100% because Q810 Chairman: I had a business breakfast in my the fact that it is guaranteed 75% by the Government constituency on Friday morning and there were should start to give confidence back to banks and about 80 businesses there. There was quite a bit of more importantly branch managers at the grass anecdotal evidence and if I could distil it, it would be roots level to think yes, this is okay, we can take this that businesses were saying that behind the scenes risk. There has been a lot of talk about whether £1 there are changes to their arrangements—for billion is enough; in our view this is a stimulus, this example, arrangement fees that cost them a lot, is a measure that needs to stimulate confidence both overdraft facilities being withdrawn or the charges on the side of business but also in banks as well and increased, and in fact I had quite a big business this demonstrate to banks that they can lend to small morning that said to me that they were approaching businesses during a downturn, viable small their bank to change their covenants but the bank businesses, and hopefully that will free up other now want a fee to discuss the change in their lending. covenants. Does that strike a chord with you? Mr Cave: Very much so. This is something that we Q808 John Thurso: The problem with the Small first picked up on last October but we are getting Firms Loan Guarantee Scheme in many parts of the case studies of examples of that happening now. For country has not been that the scheme is not there but example, one member in Wales had been banking that the banks simply did not want to implement it. with this bank for 30 years and millions of pounds This scheme is very much based on the same levels of had been going in and out of her bank, she had a very criteria; is not the danger therefore that it will suVer viable business, no problems whatsoever on the the same problem? horizon. The bank decided that they were going to Mr Cave: The criteria have been broadened out, also change her loan into an overdraft and they were the fee associated with it is 1.5%, with the SFLG it going to charge her an arrangement fee, and that was higher, but coming back to your last point and arrangement fee when you added it up added up to this one as well, our concern about the delivery is £100,000. I could keep going; there are a lot of whether banks will be promoting it, whether they examples there. will use it as a facility, so as an organisation we are now moving into the next phase of our campaign to Q811 Chairman: That is good; maybe if you could make our members aware of this. We have a bank share that type of evidence with us it would be good. watch programme that we launched last year and we Mr Cave: Yes, we will do. will be watching very closely the behaviour of the Chairman: Thanks very much. John Mann. banks across the country at grassroots level to pick out this behavioural inconsistency where they say at Q812 John Mann: Thank you, Chairman. In national level they are going to make use of this November 2006 the Competition Commission fund, but they do not at grassroots level, so we will decried the lack of competition in the home credit be picking up on that. market; is lack of competition when we are dealing with the poor and the sub-prime market the Q809 John Thurso: My next question was going to problem? be are there regional diVerences in the impact of Mr Tutton: It is a diYcult one really. It is partly what the banks are doing being felt by SMEs; is that about lack of choices for credit, it is partly about data you have or is it data you are going to collect people on low income having to use credit for basic over the coming year? essentials which perhaps should come from Mr Cave: We will be collecting that over the coming somebody else, so people are going to a home credit year. We already have anecdotal evidence and case provider maybe because they cannot get access to studies that demonstrate that there are huge something like the Social Fund. There are a number behavioural inconsistencies. I do not know whether of diVerent problems and there are other problems it is by region but, for example, we had a small across the sub-prime market which broaden out business come to us recently who had been told by more to things like sub-prime mortgages and so on, their bank manager that the European Investment and problems about practices as well. So it is partly Bank money could not be oVered at a preferential about competition and I think the issue of rate. That is simply not the case. We took that to the competition that we see in some problem areas is senior managers in the bank concerned and they said that it is not really about the market structure, it is “We will look into that.” There are a huge number about the practices of firms and what firms do. They of these cases that crop up and we obviously need to may be allowed to do that within the market iron those out, but a lot of it comes from the fact that structure but, as you say, regulators can stop them there is fear on both sides of the fence. Small doing it. Processed: 13-03-2009 15:09:43 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG6

Ev 112 Treasury Committee: Evidence

14 January 2009 Mr Doug Taylor, Mr Peter Tutton and Mr Andrew Cave

Q813 John Mann: If you have a poor credit rating coming to us with specifics, not on more competition then you are going to pay more despite the fact that for this market of the poor but how there can be you are poorer. sensible lending and how that can be encouraged, be Mr Tutton: Yes. it through regulation or be it through other means. Mr Taylor: We do try and intervene in the work of Q814 John Mann: Doubtless you would say that is bodies such as the OFT which is currently looking at wrong. the issue of responsible lending and we will seek to Mr Tutton: Yes. assist those regulatory bodies in order to make sure that the most eVective system is in place. Q815 John Mann: What should be done about it precisely? Mr Tutton: Again, it is a very diYcult thing. We Q818 John Mann: But your submission is could say that instead of home credit, lending to encouraging more and more competition, more and some of the poorest people, are there alternatives more diVerent companies, more and more people like the Social Fund, so that where people are being who will knock on the door of my constituents. Is forced to use credit at high rates of interest for that the solution, or is not the solution in fact more essential items, should that happen—it could be for eVective regulation so that there is less competition, household items where in the past that would have there are less doorstep lenders who are better been something that may have been helped through controlled, better understood and would that not the benefits system. We are obviously supportive of allow some of my constituents to in fact make a more the Government’s moves for financial inclusion, to informed consumer decision? try and encourage things like credit unions and Mr Taylor: That may or may not be the case, we alternative lenders that are cheaper; that is have simply taken a view on how we could best— something else that can be done. With home credit it isadiYcult one; the Competition Commission found that it was expensive and there was some Q819 John Mann: You are the biggest consumer excess profit but not as much excess profit as some organisation in Europe; are you a consumer people would have said because of the cost of organisation for the informed middle class, collection, so if you can get the cost of collection electronically astute consumer—which are some of down it might help. my constituents of course, and all this Committee— or should you not actually be facing up—and the Q816 John Mann: You have a whole section of the CAB as well at the sharp end of this—to actually community there and I could give you countless coming to us with more formidable proposals about examples where someone knocks on the door or what should be done that would protect the position rings them up or writes to them and tries to get them of the most vulnerable consumer who in fact is to, say, buy their council house at a discounted rate, costing all other consumers because of what is fills in what the savings will be, then goes in and going on? V under a di erent name but the same individual then Mr Tutton: On looking at some things like sub- sells them a secure loan because there is plenty of prime mortgages we have argued long and hard. We equity because they have a discount on the initial did a big report in December 2007 where we argued council house sale. Then they have also got perhaps very strongly, but the problem that we were seeing in a credit card or a couple of unsecured loans and they the market was about bad practices, bad selling then get targeted and targeted and end up paying practices, and the regulators out there need to do more and more and more. You are saying competition is part of the answer; the Consumers’ more about it. We consistently argued that the OFT Association says it more strongly, you say it need to be more on the case with regulating lending throughout your submission: competition, practices, so yes we would agree. We have argued for competition, have you not become rather part of the years that there need to be tougher rules about problem? irresponsible lending and controls on the way that Mr Taylor: In looking for a market solution to lenders go to consumers; it is something we have issues, clearly in the banking sector they are profit argued again and again and again, so I agree that to maximisers and that is their objective. It may well be an extent competition is important but there are that if society wants to create a diVerent way of certain issues which are classed as competition dealing with diYculties then that social policy issues—for example, PPI went to the Competition objective has got to be met through government Commission but it is actually a fair trading issue, not intervention. a competition issue. That is about remedies and it is about the way regulators work, it is not about us. We Q817 John Mann: Are we not in a bit of a diVerent have argued for a long time that you need to make situation now because other consumers are having that point to the regulators. to pay for those consumers in the sub-prime market Mr Taylor: We will come back when we have a who are not actually paying back. We are in a solution to any problem which we have researched diVerent economic situation; that is now better and believe is robust; we would not want to come up recognised than it was in November 2006. Should with something that was half-cocked and therefore you not be changing your tack, you are the biggest what we come up with is what we think is robust. consumer organisation in Europe, should you not be Chairman: Crisply put. Andy. Processed: 13-03-2009 15:09:43 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG6

Treasury Committee: Evidence Ev 113

14 January 2009 Mr Doug Taylor, Mr Peter Tutton and Mr Andrew Cave

Q820 Mr Love: In the written evidence that Which? why we have argued in terms of UKFI that there submitted to the Committee you draw out the should be somebody with specific responsibility for conflicts of interest that are faced by those banks and defending the consumer interest. financial institutions over the significant injection of public money; on the one hand you say that they Q823 Mr Love: You also talk about accepting that remain commercial enterprises but that because of there would be an adjustment in the cost and the amount of public money they have received they availability of credit. The Prime Minister earlier should have a specific duty to the wider public today confirmed that they are indeed monitoring the interest. Does that wider public interest mean that availability of credit because there is a whole debate they ought not to be commercially driven? that we are having in this Committee about that, but Mr Taylor: The Government has made clear that in terms of the cost of credit does the Consumers’ they are institutions that have a commercial remit. If V Association and the CAB accept that in these we take them in two di erent tranches, if we take diYcult economic circumstances there will indeed Northern Rock for example which is fully have to be a recognition that there will be a cost nationalised, then there has been an incentivisation V V element to the way in which the banks operate at the of the sta to get o the books a high level of present time? mortgages, and I think it has gone down by £13 Mr Taylor: Both over the short term and the long billion. The consequences of that are that they have term there is going to be a need for a new equilibrium the highest record of repossessions, so they can be a on the price of credit, and the issue of course is what commercial organisation without necessarily is the consequence on consumers, particularly in the running rampant against the interests of their short term, and if credit becomes suddenly hugely borrowers. If we look at some of the more recently more expensive for consumers that can pose a partially nationalised banks and the Lloyds/HBOS particular problem. I think we have seen, deal, we do think there are some public interest particularly with credit cards, where risk-based issues here and we would certainly like to see them pricing has resulted in some very substantial increase to be exemplifiers of good practice on issues such as in interest rates, which I know BERR have tackled, treating customers fairly and how they deal with where we believe there may be some issues around mortgage arrears. I do not think there is necessarily unfair contracts. I think this is an issue that has got an inconsistency with being a commercial to be handled sensibly, fairly and reasonably but organisation and operating best practice. over a period of time I suspect we will find a diVerent credit market in place. Q821 Mr Love: You talk about excellent practice or best practice in your written submission but you do Q824 Mr Love: Can I just ask the CAB is it fair for not go into it in detail; where does that excellent us—and I put myself in this as well as perhaps the practice lie in terms of—let us take Lloyds TSB as a CAB—to say that banks should pass on all the specific example. Where are they making mistakes, benefits of reducing interest rates both to borrowers or without personalising it to one specific bank and, if they are going to do that, with savers as well? where are the banks making the mistakes, in your Is that in the circumstances a reasonable demand of research, in terms of not acting in the public interest? them in the current economic climate? Mr Taylor: It would certainly be in terms of passing Mr Tutton: I kind of agree that where you are on the benefits of base rate cuts, it can also be coming from there is a recognition that credit costs looking at the interests of savers and borrowers for consumers are going to rise and, to a certain which I referred to earlier in this session. extent, we would argue that in the past perhaps credit costs in some respects have been too low, Q822 Mr Love: Let me just stop you there because credit has been too available, people have over- you also say in your written submission that you borrowed and that has been one of the problems we accept that they have a role to rebuild their balance have seen in the past. I guess balancing that is our sheet, to repay the taxpayer investment, to increase concern, particularly with mortgages, that with their contributions to the financial compensation those people who are particularly vulnerable we scheme, all of which everyone accepts. If that is the have seen a 33% increase in arrears enquiries on case can they deal with savers and borrowers in the mortgages. We will probably see something like way that they have dealt with them in the past or 50,000 to 60,000 people with serious mortgage does there have to be some recognition of the arrears this year. These are people hanging on by particular situation that they face in this diYcult their fingernails; they need all the help that they can economic climate? get. So our answer is I agree with what you are Mr Taylor: It is an enormously diYcult conundrum saying in the bigger picture that the credit prices are and we were very clear to put all of that in the going to change and consumers are going to bear it. submission so that we do not to appear not to have The other side of that coin of course is where there taken that into consideration. Clearly the extent to are headline credit prices. For many of the people we which they rebuild their balance sheet is a matter see what they pay for their credit is not just the that can be considered in terms of how they are able interest rate, it is all the other charges—default to also support, through their liquidity, issues of all charges, if you get into trouble—around it as well. borrowers, so there is a balance to be struck and So we have to bring that into the picture too; if what we are keen to ensure is that they operate that headline rates change perhaps now is also the time to balance fairly and in the consumer interest, which is clear the stables out of all the other default charges Processed: 13-03-2009 15:09:43 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG6

Ev 114 Treasury Committee: Evidence

14 January 2009 Mr Doug Taylor, Mr Peter Tutton and Mr Andrew Cave and all the other things that cause problems for mortgage market recently has been relatively consumers, that has to come into it as well. So on the competitive, when looking at the deals that are one hand, yes, we can see that rates might go up for available now compared with 12 months ago consumers in the longer term as Doug says; availability is much less. I think it is an issue and we however, I think lenders have to balance that against raised during the HBOS/Lloyds consideration that the need to protect mortgage borrowers because it the OFT needs to keep under consideration the issue will cost lenders a lot more in the long run and in the of that particular merger and we would hope that medium term if people start losing their houses in was the case. even greater numbers. Thirdly, we have to look at the price of credit as a whole which includes all the various default charges, service charges, admin Q827 Mr Todd: You also say that the barriers to charges that are added on top as well, and make sure entry into this market are likely to be rising that they are fair and consistent. dramatically and that without the arrival of new players like the Icelandics—whom we now look Q825 Mr Love: My final question, I have said that back at with horror, but nevertheless provided some there is a lot of very bad practice going on there, you novel products in the marketplace which some have are there to expose that and we, hopefully, will be regretted taking up, the Irish banks and so on—this able to help you to do that, but let me ask you a very is going to become a very moribund marketplace simple question. Someone who is on an 80-90% with really routine oVerings with very little loan-to-value ratio, when it is likely that house prices competitive edge in it. I could broaden this to the will continue to decline—by what amount we do not business sector where I imagine that that anxiety is know but let us call it 15% plus—in the future is it shared as well. not right for banks and lending organisations to be Mr Cave: It is shared, more so because the survey we cautious in those circumstances and will there not did of our members in late 2007 revealed that 45% of necessarily, as part of that caution, be an increase them who try to switch banks find it exceptionally in cost? diYcult to do that. You cannot have competition Mr Tutton: Yes, but subject to protecting the most unless you have the ability for people to move from vulnerable. one bank account to the next.

Q826 Mr Todd: We have seen probably the most Q828 Mr Todd: These are good customers. dramatic change in competition in this sector over the last 12 months that there has been in my lifetime, Mr Cave: Good customers, yes. We have seen and that is taking the core banking services of recently a reduction by half I think in the amount of current accounts, mortgages, loans and savings with time a bank is required to process the information the departure of a number of players altogether, so and details for switching, but I think more attention we have the Irish and Icelandic fringe banks needs to be given to that. disappearing from the market altogether, the merger that has been facilitated by the Government, the Q829 Mr Todd: Would it be worthwhile having a arrival of the state as an owner of a large chunk of further study in this area to perhaps sharpen our the banking sector as well and the changes in the knowledge of some of this, because this is all business models of companies like Northern Rock V which has virtually withdrawn from some activities anecdotal stu which we can share but it is not altogether. In your evidence you highlighted some of obvious what the data is on the actual competition those areas of concern but not all of them; the that is taking place because, as we have said, the banking sector has never been a particularly human evidence suggests that it is very hard to make attractive sector in competitive terms anyway so this choices and exercise them? is going to make it a great deal worse, is it not? Mr Taylor: The OFT work on personal accounts in Mr Taylor: The potential for that is absolutely clear. the retail market is a good starting point and indeed The Cruickshank review in 2000 found that the there is continuing work around transparency current account market was not competitive, the within that area, but I am sure that would be very OFT Review in 2007 found that the market was not welcome. working well and there is further work being done currently by the OFT, so certainly in terms of the current account market there are serious issues. We Q830 Mr Todd: The decision that was taken to now have a super-bank and a reduction in the facilitate the merger, that raised anxieties but I think V availability as you say. In mortgages there is a you accept that as a one-o perhaps it was the only genuine problem: the OFT again highlighted some way forward. of the competition issues in terms of mortgages as far Mr Taylor: It was a pragmatic issue. We could not as the HBOS/Lloyds merger was concerned; we judge the impact on financial stability if that was not found that 60% of people change their mortgages in waved through so to speak; we were just keen that research we have done and as the market contracts the secretary of state ensured that this was kept and availability disappears that is going to be more under future consideration and we would like to diYcult. All the signs are that there could well be have seen some specific powers for the OFT in that diYculties in what is not a particularly competitive area, but we will certainly be looking to the OFT to market; although it would be fair to say that the keep an eye on it. Processed: 13-03-2009 15:09:43 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG6

Treasury Committee: Evidence Ev 115

14 January 2009 Mr Doug Taylor, Mr Peter Tutton and Mr Andrew Cave

Chairman: Can I thank you very much for your that you have made. If you can pass that on to us, evidence, it is very helpful to us. We are at the early Mr Cave, that would be really helpful. Thank you stage of the inquiry and we will build on comments very much.

Witnesses: Mr Michael Coogan, Director General, Council of Mortgage Lenders, Mr Stephen SklaroV, Director General, Finance and Leasing Association, and Ms Angela Knight, Chief Executive, British Bankers’ Association, gave evidence.

Q831 Chairman: Welcome to the second part of our Q833 Chairman: You are talking about hedge funds, session today. Could I ask you to introduce private equity, money market operations. yourselves for the shorthand writer, starting with Ms Knight: Pension funds, some of the finance arms Michael? of major corporates, all who have provided lending, Mr Coogan: Michael Coogan, Director General of either directly or indirectly. That has gone as well the Council of Mortgage Lenders. and so what in eVect the business community has Ms Knight: Angela Knight, Chief Executive of the been experiencing—many of them may not have a British Bankers’ Association. direct relationship but may well have had an indirect Mr SklaroV: Stephen SklaroV, Director General of relationship with those lenders—is a gap in their the Finance and Leasing Association. financing at a time when they are having to pay quicker and they are being paid slower. Under those circumstances the best thing for an SME to do is get back to their major bank quickly, sort out their Q832 Chairman: Thank you very much. Angela, no business plan for a nasty turndown and then get the surprise, the first question to you: we have had financial arrangements in place. Some of that has anecdotal evidence from the Federation of Small not taken place: I do not think the industry has Businesses and others about the problems that small necessarily been quick enough oV the mark, but businesses are having with loans and whatever else there have now been a lot of changes made by the and the general lack of availability of loans. It was banks to get to their customers quicker. mentioned about overdraft facilities being withdrawn, arrangement fees going up, changing covenants and the costs associated with that. Why is Q834 Chairman: Just to get an idea of that, how there a perception that there is not the lending out much do you think the cake has shrunk in terms of there and why is there the view that the banks could lending available, given that some participants have do more to help businesses and consumers? now departed the market? Are you talking about Ms Knight: We all have to recognise first of all, 40% shrinkage? Chairman, that it is a very diYcult economic Ms Knight: There are two ways of looking at it; I can environment. As you know when you are running a give you both of them and presumably the truth will small business a number of things happen to you be somewhere in between. If you look at the Bank of more so than larger companies; for example, you England’s financial stability report which they suddenly find that you are getting paid slower whilst published at the end of last year you will see two on the other hand you have to pay for your raw things in that report. Firstly that the savings ratio fell materials quicker and often in cash. Those of us who oV a cliV in 2005, but, secondly, that the demand for have ever run a small business—and I ran a small finance carried on. The gap is £300 billion or heavy engineering company in the late Seventies thereabouts; the wholesale market was filling that through to the late Eighties in the north of England, gap, non-banking lenders and non-UK lenders were and part of that was through a very nasty filling that gap, and securitisation was filling that recession—know that it is very uncomfortable gap. These options are not there. Do I think that the indeed, so I have to say that I am not surprised that gap is as big as that? No, because of course we are small businesses are concerned. As far as availability now in a very significant downturn so I am sure it has of finance from the major banks is concerned, as you shrunk. If you look at the Financial Times today you all know from the statistics that we produce as the get another bite of the cherry. The Financial Times BBA, indeed statistics that are also borne out by today has published a pie chart, with which we others—lending to small and medium-sized would broadly agree, that shows what the major enterprises not only has been maintained but has banks are lending to industry. Their gap is 11% so increased. However, what has been very noticeable clearly on the one hand there is a chunk of money is that a number of other lenders have left the that is no longer available, on the other hand there market. The Icelandic banks is one of the obvious are also many lenders who are not there. In a ones, and another two groups are firstly non-UK recession, after the initial start, the demand for banks who have previously lent into the UK—not working capital tends to diminish and also there will surprisingly, they have got the same problems in be businesses which are not sustainable through this their own country so they have taken their lending current downturn. So where the gap actually lies is back there—and, secondly, there has been quite a lot something the economists need to work out. What of lending from the non-banking industry which we do believe is that the announcements that were again has gone away. made today by BERR are going to be very useful Processed: 13-03-2009 15:09:43 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG6

Ev 116 Treasury Committee: Evidence

14 January 2009 Mr Michael Coogan, Mr Stephen Sklaroff and Ms Angela Knight and I think that that is something which will help Ms Knight: I think we have got quite a muddle out both the small business but also a larger chunk of their, frankly. I have brought the committee a little corporate Britain as well. equation which I will leave with you.

Q835 Chairman: The LIBOR rate, I think, has Q839 Chairman: Quadratic? reduced by 3.5% since October. Ms Knight: I am delighted to say, no. I said to my Ms Knight: Yes. capital people, Chairman, “Can we make this as simple as possible?”, and when they did I then cut the rest out; so it is understandable, I can assure you of Q836 Chairman: Why have these savings not been that. Let me try, as simply as possible. We went, over passed on to borrowers in full? night, from a situation where as a banking industry Ms Knight: Broadly speaking, the LIBOR drops we held 8% total capital as a regulatory requirement, have been passed on. I use the expression “broadly”. of which 2% was core tier one—which is the There is another side to this though, and that is expensive one. If you like a situation where we had called the saver. If you are a bank, you have both to hold 8% tier one capital, of which 6% was core tier borrowers and you have savers and, actually, the 1—a big jump. The FSA and, indeed, the tripartite more that you can bring in, in the way of deposits, authorities made a very valid point. They said, by the more, of course, you can lend out. In a situation increasing that tier 1 capital, that provides more in which you have got very low interest rates and in capital to absorb losses as the country goes into a which you are passing those interest rates on—and recession and also helps sustain lending—a very there has been a very dramatic fall in interest rates valid point—and, indeed, similar actions were taken over this last year: it is, some 4% in 12 months— in other countries. However, as far as the market is then, clearly as a bank you have got a very rapidly concerned, of which, perhaps, I would particularly changing situation as far as an organisation is cite two categories; one is the analysts and the other concerned and you still do need to attract savers. It is the rating agencies. Their view is that, 8% tier 1 has is a balance, and there are many more savers than become the new minimum. If we have rating there are borrowers. At the moment those who are agencies saying, “That is what you have got to do or, actually raising most concerns, and who can be if you do not, we may revise your rate”, then we have surprised, are the savers; often prudent people who got a significantly greater problem. are now facing a much lower return on their money because of the low interest rates. You cannot please Q840 Chairman: I think we have got a long way to everybody all of the time. get to that. Ms Knight: Absolutely. It is that educative plea, for Q837 Chairman: The committee has received a lot of which we believe the authorities have an ongoing representations and submissions for this inquiry and role: whether they are this country or in other we have had evidence presented to us that banks countries, whether they are central banks or have been passing on low rates to savers but not to regulators. That is where the debate has to take lenders. In other words, we have had low savings place; otherwise we cannot use the capital for the rates but often high borrowing rates. Are the banks purposes for which it was intended. just pocketing a few bob for themselves here? Ms Knight: No, is the answer to your question. I Q841 Mr Fallon: Angela Knight, coming back to the understand the point that you are making, but I lending gap, if it is between 330 billion or 11% of come back to you again, Chairman, and say that, total lending, presumably a scheme then of 10 or 20 broadly, you find that the rate reductions have been billion that was announced today, however passed on. If you have got a fixed interest mortgage welcome, does not go anywhere near covering it? though, for example, then you will not necessarily Ms Knight: The demand has dropped as well. One of receive anything like the same benefit as if you have the things that is quite noticeable is the demand for got a mortgage which is a tracker. So there are credit has dropped. You can see that in all sorts of diVerences, and people made diVerent choices at the ways. For example, the demand for people to start, but at moment as well one of the very borrow for mortgages is one; that is not there at the noticeable things that is happening in the housing moment. The high street is reporting figures which market and elsewhere is a reduction in value. That, show that people are not purchasing, and certainly of course, is aVecting the assets that banks hold, it is our own figures show that they are paying back aVecting the risk weighting of those assets; the risk, loans. So the demand for credit is going down as therefore, starts to go up, so the amount of capital well, and that is why I say to you I am not sure where that banks have to hold against that risk also the gap is. What I do know is that this is, at the very increases; and in an environment in which we have least, a good start. had to increase the total tier one capital that we hold, we have, in eVect, got a double whammy. Q842 Mr Fallon: The gap must be much, much wider than 20 billion, must it not? Q838 Chairman: I understand. I do not want to get Ms Knight: The gap is certainly going to be wider into this area, but in terms of your relationship with than that, but, equally, at the same time, you have the FSA and their understanding of what “minimal got businesses that are taking other actions to their capital” means and investor’s understanding of what business model for the purposes of addressing the that means, are you happy with that arrangement? recession. Self-evidently, you do not expect to be Processed: 13-03-2009 15:09:43 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG6

Treasury Committee: Evidence Ev 117

14 January 2009 Mr Michael Coogan, Mr Stephen Sklaroff and Ms Angela Knight able to sell the same number of goods or services in year, and an ongoing financial underpin regulatory a recession that you did when you were on the rise cost that was not there before, which is going to and, if you look back to see what has happened in impact on their ability to lend. other recessions we have had, you find that once one has gone through that first period, there tends to be Q847 Mr Fallon: If the other building societies quite a significant reduction in, for example, the should not have been expected to chip in, who else demand for working capital. should? Mr Coogan: The eVect of going down the route Q843 Mr Fallon: I understand that. which the compensation scheme would expect to do Ms Knight: One other aspect is this whole business is bail-out from other people in the same business, of credit insurance. I think we have got to come back but a consequence of it is to knock-on on the to that. amounts of money available from some lenders for net lending. Q844 Mr Fallon: I want to be clear about the lending gap. How can we judge here in Parliament whether Q848 Mr Fallon: And you want that reviewed? the right figure is ten billion, 20 billion or 50 billion Mr Coogan: I think it is important if we think when you are not clear what the lending gap is? activity in the market is not simply relevant to the Ms Knight: I think that we will certainly be able to borrowers but is relevant to the builders, the estate assist in that a little further, but, equally, some of it agent, intermediaries, the economy as a whole. depends upon what the Bank of England decides to do as it is addressing its money market at the Q849 Mr Fallon: So the taxpayer should take a moment. There are more ways to get to the end than bigger share. Is that what you are saying? one, and, indeed, the BBA believes that there are a Mr Coogan: I am afraid, you either reduce the price, number of issues that collectively need to be the interest that the deposit takers are taking, or addressed of which this is only one part. your look at the taxpayer, looking at that issue as a whole, rather than individual groups of institutions, Y Q845 Mr Fallon: Mr Coogan, you put out a but it is a di cult issue however you cut it. The statement last night, before you appeared here question underpinning all of this is should we be today, saying the Government should review the trying to underpin the existing borrowers or should cumulative eVect of its recapitalisation process on we be encouraging no activity? V the willingness and capacity of large lenders to Mr Sklaro : Chairman, could I briefly intervene on provide mortgage funding. You said, “The way in the general question of lending to business? Angela which Bradford and Bingley and the others have alluded earlier to the issue of non-bank lenders, and been bailed out has aVected the capacity of other there is a particular point which I want just to make deposit takers, particularly building societies, to to the committee about this. While we too welcome provide new lenders.” That suggests that the bail-out the announcements that were made by the is actually hurting the retail mortgage market rather Government this morning, nonetheless, a major part than helping it. of lending (defined widely) to business in this Mr Coogan: I think the bail-out was necessary. country, is carried out by asset finance companies, a Because we have had the bail-out, we have a more very large number of whom, a majority in terms of stable environment in which to move forward. We our membership, are not banks and, therefore, do have had the further announcement on small not have access to any of the facilities which have so business today, but there clearly is a case, and it has far been brought into existence by the Government been made by a number of banks, that the cost of the and by the Bank; and one of the conversations which bail-out needs to be reviewed. There are, according we are having intensively with the Government at to press speculation, further announcements in the moment is to see whether we cannot get access to terms of further interventions, and we would see, as those schemes, such as the Special Liquidity Scheme, part of that process, there is scope to look again at such as the Credit Guarantee Scheme, in order that the terms that were placed last October on this hugely important sector for investment in individual banks. businesses of all sizes, but particularly SMEs, can be supported. Q846 Mr Fallon: But how do the terms aVect other deposit takers? Q850 Chairman: If you got access to it, would it have a to be a bigger cake? Mr Coogan: If we move on to the second question, V which is the compensation scheme, the eVect of Mr Sklaro : We believe there is unmet demand out asking deposit takers to bail-out Bradford and there, and a good example actually is in the motor Bingley and the Icelandic banks has already had a market, which has been the subject of much debate significant eVect in terms of the interest payments in recent weeks. We think we could, almost that would be expected to be made by the deposit immediately, begin lending to more people in that takers and then the capital, if there are losses on the market if we were able to obtain funds in the market books in Bradford and Bingley. So what you are at a better rate than we currently can. looking at is a draw on last year’s profits, which has undermined the outturn which will be announced by Q851 Chairman: So you are going down the road of a number of deposit takers, building societies, this having a bigger cake? Processed: 13-03-2009 15:09:43 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG6

Ev 118 Treasury Committee: Evidence

14 January 2009 Mr Michael Coogan, Mr Stephen Sklaroff and Ms Angela Knight

Mr SklaroV: Yes. element here which will ensure a continuing provision of existing finance and some more finance Q852 Sir Peter Viggers: In each of your cases, your at sensible rates for the borrowers. clients would prefer to make large loans with good Mr Coogan: I think in the mortgage market there security and repayment without hassle? has been a shrinkage in capacity, and there has been V Ms Knight: Yes. the Northern Rock e ect last year where they have been looking to shrink their own business, and that has led to re-mortgaging at a substantial scale in Q853 Sir Peter Viggers: On that basis, you could, in 2008, and those remortgages have been at lower commercial terms, aVord to demand fairly low loan-to-values. There has been competition to get interest rates, modest interest rates, whereas a small those customers at lower loan-to-values and the 40 loan of no security and diYculty with recovery billion net lending has typically been at lower LTVs means, in commercial terms, a higher interest rate. than you would see in a normal market pre the credit How do you square this circle? Who should bear that crunch. So customers in that healthy position of high extra cost? The Government is urging you to lend. equity in their position and a credit history Are you prepared to bear the extra cost of the less demonstrating their ability to pay, there is still commercial loans yourselves, are you prepared to competition for those customers; for those accept coercion from government or do you think customers who need a deposit as a first-time buyer, government should pay? there are very few products available where you do Ms Knight: I think, if one unpicks both your not need a very significant deposit compared to the question and the announcement today, we come to past; so that pricing for risk is now low. a view of what this may look like. I think I would probably call it, a “sharing out”, which may, I hope, be helpful. On the first point you are absolutely Q855 Sir Peter Viggers: Stephen, do you have any correct that, if your loan is secured and you have got comment? a good business there, then it will impact beneficially Mr SklaroV: I do not think I have got any particular the rate that you are charged. If the security has further comments on that. Our concern across all the dropped in value though and the same amount of markets that we represent is that we do have money is required by the business, then you are into something like a level playing field in terms of access a rather more risky scenario, and that risk then to funds in the market, and at the moment we do not, reflects back into the capital. I will not go through for the reasons I was talking about earlier. So that in the process, but a bank inevitably will have to charge the consumer lending market, including the second more because it is costing them more to lend. There charge mortgage market which we represent, we is a few things that can help. One is that you do not have a similar split of companies between people need any further intervention, the business and the who are banks and people who are not banks, and bank look at the business plan and bring things into the point we are making at the moment is that, if you balance. There is a lot of eVort now being put in this want an eVect in the economy in terms of improving area, there are specialist people that banks are lending, you have got to address those firms which putting into regional oYces and so forth, and do not at the moment have access to the schemes that seminars and other help programmes are taking the Government has brought forward. place around the country. But the other part of it is Mr Coogan: That applies in the mortgage market as possibly one of the things that is going to be well, especially if lenders are excluded—smaller important that comes out of the small business part lenders who do not qualify for the bank schemes. of today’s announcement. That, in eVect, says that in a situation where, for example, a business still Q856 Sir Peter Viggers: There are two criticisms that wants to borrow X but their security is now worth can be made of government intervention and the less than X, then that additional amount of money interface between government and the private that they require can be covered by the small loans sector. One is there is a lot of form-filling and guarantee scheme. I have forgotten; it is not called bureaucracy, and the second thing is that when that. What is it now called? Can anybody government does intervene it tends to distort the remember.? market and distort commercial pressures. Do you have experience of either of those? Q854 John Thurso: Enterprise Finance Guarantee. Ms Knight: I think both concerns are correct ones to Ms Knight: Thank you. That is one way which is of make. As far the first one, can we simplify both the significant help. 1.5%, I think is going to be the form-filling process and the speed in which some of charge, so, again, it is in a sensible area. The larger these issues are looked at? Certainly from the part of the announcement of today’s package, which banking perspective, there is still some work to be will be perhaps more appropriate for the medium- done, but that is what we are seeking to do. We hope sized enterprises, is one which the banks pay for, and to be able to turn round business inquiries quickly, that is about parcelling up a portfolio of loans in a because the inquiries for the guarantees will come way that will have a partial guarantee from via ourselves. I will be able to answer the question as government, so releasing more money for lending. to how possible that is and how convoluted the None of this is clearly going to say to every business form-filling is in a little while—today is only the first in the country that the fact that there is a recession day of the announcement—but your point is a valid will make no diVerence to you, it does make a one; let us hope we can get there. As far as distortion diVerence. But I do think there is a shared cost of the market is concerned, I think the answer to that Processed: 13-03-2009 15:09:43 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG6

Treasury Committee: Evidence Ev 119

14 January 2009 Mr Michael Coogan, Mr Stephen Sklaroff and Ms Angela Knight question is that we need to take great care that we do with which rates can increase. So I think there is a not have permanent distortion of the market. I do sensible pattern there and those principles are now not think anybody sees these interventions as very much available. As far as store cards are designed to keep, for example—sticking with the concerned, store cards is not something which comes business for a moment—businesses that are not within my province. viable afloat, because if you are keeping artificially afloat a non-viable business, all you are doing is Q858 Ms Keeble: I accept that. Do you think there is weakening the strong and that is not going to suYcient transparency, given the tendency to change provide any long-term benefit. So there is that rates, and do you think there is enough information balance, and it is something that is going to have to provided about the fixed fees, the annual fees, in be very carefully watched. In terms of the broader relation to the actual cost of credit, particularly now, questions of distortion, is general intervention and when interest rates are going down and people the various actions that government has taken so far should be able to get cheaper rates? for the purposes of stabilising the financial system Ms Knight: This is something that this committee distorting? As you have heard from my two and, indeed, your Chairman has been quite keen on colleagues here, they feel that there is not necessarily over a number of years, trying to make sure that equal access and, indeed, I am sure that that is there are simple boxes in which people can something that is going to be hotly debated. The understand what their credit card is costing, what financial system stability is dependent upon the happens if they pay oV at a minimum rate and what financial system working, and if the financial system happens if they pay oV at a faster rate. It is not the works the banking system works. We do not just easiest area that warrants simple explanation, have a problem here in the UK, we have a problem unfortunately. I do not believe that we have right around most countries which have financial necessarily got it all right, but I do not also believe centres of any substance in the world. So there is no that it is all wrong either. Clarity of explanation is perfect solution, actually. But I think this is a essential, the summary boxes are essential, but also situation in which actions get taken first and then some of the commitments that have recently been one starts to look at making those actions better, agreed, not only about making the information as fairer and more equitable as time progresses. One of readily available and understandable as possible, the noticeable things in the mortgage world has but also commitments about rate changes, I think been, as has been said, coalescence down on to the are important as well. We are not entirely sure, by major banks and perhaps only two or three building the way, what is going to happen in the generality societies, not just for the provision of new with credit cards. Use of credit cards are popular but mortgages, but for the huge amount of it is not increasing at a rate faster than normal; it has remortgaging going on. As people with mortgages, not shot up. As to whether actual credit card use is from some of the building society sector, the now going to flatten out and diminish, we are not Northern Rock and some of the specialist lenders, entirely sure. Again, I suspect that is going to be as come up for renewal at the end of whatever their much related to what is happening in the high street term is, they are seeing rates which they consider to as anything. But turning back to that set of be far too high and so they are coming back to the principles, we believe, is actually a very important major providers. That is something that is, I step, it is certainly something that the banks are very Y suppose, inevitable in a di cult time, but certainly much committed to and is also something by which over a period of time one wants to have a broader the industry can be judged externally as well. market and that ensures good competition. Q859 Ms Keeble: I wanted to ask Stephen about Q857 Ms Keeble: I want to ask a bit about credit store cards. They have perhaps had less attention cards and store cards. Angela Knight, we have than credit cards. How significant do you think they obviously seen the reports in the paper of Amex are in the market? Can you put some numbers on it charging up to 46% on one of its cards. What is the as well, please? general pattern of interest rates on credit cards and Mr SklaroV: Yes, the numbers are down on store what is your perception about what is happening cards. The size of the store card market has actually to those? dropped by about half over the last five years. Ms Knight: The credit card situation is one in which the actual way a credit card looks at the rates that it Q860 Ms Keeble: From what to what? charges is dependent upon its portfolio. Like you, I Mr SklaroV: I am just checking to see if I have the saw the list in the paper. I have been told that it was a numbers. If I do not, I will write to you. The latest bit of an apples and pears comparison because some per cent, yes, I have here. The total market in the cards have fixed charges and other cards do not, but, most recent figures we have, which is the year to the as with other areas, in credit cards there is a lot of end of November last year, is 2.8 and a bit billion, choice for individuals and, indeed, there have been and that is down 1% on the previous year. To pick some statements made by the credit card industry, up a point that Angela was making, in the FLA we which in this instance was led by APACS, for the represent both credit card and store card companies. purposes of presenting a set of principles which the The two commitments that the industry made very industry is signed up to, for transparency, that gets recently at the Credit Card Summit which the into the whole area of rates, notice that should be Government held, which Angela was talking about, given if rates are going to increase and the frequency are very, very important, particularly in terms of this Processed: 13-03-2009 15:09:43 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG6

Ev 120 Treasury Committee: Evidence

14 January 2009 Mr Michael Coogan, Mr Stephen Sklaroff and Ms Angela Knight issue of risk repricing, where the interest rate is keen to ensure that customers are not becoming over changed. What we have all now committed to is that indebted and, therefore, these rather low credit when someone has taken out a card—whether it is a limits are put in place. credit card or a store card (it applies equally)— within the first year of having taken out that card, Q864 John Thurso: Angela Knight, can I follow up there will be no increase in the interest rate and, after on the answer that you gave to one of the that, not more frequently than every six months. Chairman’s opening questions regarding funding Furthermore, customers will be given, not only for SMEs in particular? plenty of advanced warning if there is going to be a Ms Knight: Yes. change, but also the opportunity to terminate the arrangement if they would like to make alternative V Q865 John Thurso: We had evidence in the earlier arrangements and pay it o . session from the FSB regarding their December survey, showing the diYculties they are having. This Q861 Ms Keeble: Credit cards are one thing, but joins a pretty growing body of evidence which store cards are sold very easily over the shop suggests that sound companies, and certainly all the counter. I was going to ask you about training and ones that I have dealt with in my own constituency, monitoring, and so on. If people find other sources follow this pattern—they are sound companies, they of credit dry up, this is obviously, sometimes, an have a long banking relationship with their extremely easy source of credit, and we heard from particular bank (one of the five or six main banks)— Y the previous witnesses its interest rates are often they are finding it di cult to get, in some cases, round about 20-24% or so. What is your perception facilities renewed, in nearly all cases they are looking of the impact on people’s personal indebtedness of at quite large jumps in the margin—two to four, four the ability to get store cards, is their position going to six, things like that—and they are also paying to change and how about the training? double the fees. Does that picture correspond to Mr SklaroV: To start with the training point, our what the banking industry thinks is going on? industry, the finance industry, which sits behind the Ms Knight: I think the banking industry would say store cards, is very keen to work with, for example, to you that that is the case in some instances, but it the high street stores to ensure that training for shop is by no means the case in all instances. Let me try staV who are selling store cards is as good as it could and perhaps put a little bit of meat on those bones. possibly be, and there is always more progress to be What can quite often happen is that a business has made in that area. We work very closely with them— come to the point at which it needs to renew its facilities. It asks its bank to do so. From the perspective of the business it is the same people, it is Q862 Ms Keeble: Saying that it is as good as it can the same business, they are asking for the same possibly be is a sweeping term. facility and they are producing the same product; so Mr SklaroV: I am saying we would like to make it as their assumption is that there is no reason why their good as it can possibly be. I would not for a moment facilities should not just roll-over. From the suggest it already is. perspective of the bank, the economy has turned down significantly, the value on which those facilities has been secured has reduced, the situation Q863 Ms Keeble: What is happening about checking as far as money is concerned is much less liberal than somebody when they sell you something over the it was two, three, four years ago and, as far as that counter, when they say, “Do you want a store card”? business’s customers are concerned, banks need to Mr SklaroV: What it means is that the customer look to see how good those customers are as well. So, should have a good understanding of what it is they if you like, its the same situation, but there are two are being oVered. Earlier on this afternoon we heard perspectives, and that is one of the reasons why the that sometimes customers may not understand business community and the banks need to get closer exactly what it is they are being oVered, but if I can together. It is one of the reasons why a number of just go on to the other part of your question, it is our members are now setting up seminars, 100, 150 important to understand that the borrowing limits or so around the country, it is why they have brought on store cards are very, very much lower than they specialists in and they are doing better training as are for credit cards, quite deliberately, and the well within the banks: because, as you can see, there average outstanding balance on a store card now— are two perspectives. Both in some ways are correct, it has been dropping—is about £130, and it is a but actually it is the broader economic environment diVerent sort of product from a credit card. I which is going to impact the price of finance as well completely understand your question, because it is as the fact that we have moved from a time in which the other side of the same thing. A store card is there was a lot of credit, very liberal and very finely designed, apart from anything else, to be used by a priced, to a tougher scenario generally. wider range of customers in the store than would perhaps be going to get a credit card. Therefore, the Q866 John Thurso: I take that point. I think there is criteria are diVerent and the interest rate is diVerent, a third person you need to put into that discussion, you are absolutely correct, but also the credit limit is which is the Government, which I do not think has very much lower. Very often these cards are not used yet worked out that you cannot ask for free very frequently during an average year—perhaps availability of credit at 2007 levels and an only four or five times—and the providers are very improvement in your balance sheet and get both at Processed: 13-03-2009 15:09:43 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG6

Treasury Committee: Evidence Ev 121

14 January 2009 Mr Michael Coogan, Mr Stephen Sklaroff and Ms Angela Knight the same amount of money, as it were. One specific capital markets; and do you think there is merit in case I raised was regarding HBOS, where there was actually dealing with this by the bad bank scenario, a significant increase. The asset collateral was over where that is taken out of the system so you can put 250%, even on a reduced margin. There were three the confidence back in lending, so that banks deliver times interest cover, so these are not high numbers, the solution rather than BERR? but you are seeing quite it a bit, and it coincided with Chairman: That begs a long answer. Keep it short. HBOS having put out a press statement saying they would maintain facilities for their customers. I wrote Q867 John Thurso: Just, yes, will do. to Lord Stephenson to ask him to join these two Ms Knight: I will try on that. For toxic debt, I things together, and he saw fit to give it to the presume you mean exposure to structured products, customer care department, who, today, responded these are very diYcult to value if at all— at a relatively low level to tell me it was just hard cheese and they needed to make more money. That Q868 John Thurso: Exactly; diYculty of valuation. corresponds precisely with what the director Ms Knight: —if they have got some US subprime in regionally in Inverness of HBOS and RBS have said them, but may be still paying some sort of income. are the instructions from their head oYces, which Actually this has been very diYcult for the industry may be precisely what they should be doing. I am not around the world under the mark to market rules, actually quibbling with that. What I am saying is although there have been some rule changes. So, that we need some honesty injected into all of this so clearly, there is a problem here, though I think you that we can deal with it honestly. Would you agree also have to recognise that there is not necessarily a with that? big toxic debt problem in the UK. What there is is a Ms Knight: Yes, I do think there needs to be a large amount of assets whose value has dropped but considerable degree, or rather a greater degree, of which are perfectly good assets, such as those honesty generally than there has been to date, a bank relating to housing. Inevitably, if your risk and your cannot face in all directions at the same time, you assets are going up and if you have got assets which cannot lend at the same price as when there was a lot are hard to value, it absorbs more capital and it of credit availability, you cannot have an increase in constrains lending. There is nothing further to say your capital requirements and at the same time be on that point. On the second point, do we need some able to service everybody at a very fine rate and at a sort of toxic park here in the UK? That is something time of recession when, of course, the whole of the that has been heavily discussed within the press, as way that business looks is very diVerent. So there is you know, and it has been heavily discussed by a need to have a true and honest discussion and a analysts. I am not entirely sure that the case is made true and honest debate, and with the British people, for that all. I think what the case is made for is a because at the moment half the time they do not broader liquidity scheme operated by the Bank of know what to believe, and, of course, you turn on the England. I think there are other broader monetary television in the morning and hear what happens and scenarios elsewhere, I also think this issue will you take fright. Recessions are not nice things. This depend upon what Europe decides to do as well. is the third recession of my working life, There is an example in the US which has not yet unfortunately, and it is a very long time since the last worked. one. One of the noticeable things as well (and I believe that this does impact this whole area) is this. Q869 Chairman: Angela, just before you pass on, If, for example, you came out of university in 1992 will there be further write downs with the banks? aged 22, 23, this is the first time that you have seen a Just give us a simple answer, yes or no? recession. You are about 40. It has never been nasty Ms Knight: I am sorry? for you but nor are you are having to deal with a situation that is pretty tough. A 40-year old is Q870 Chairman: Will there be further write downs probably in charge of a lot of things, businesses and with the banks. Will they come out with further right across the piece, so I think there is something write downs? here that is not particularly helpful. As far as the Ms Knight: Whatever the banks are holding on a banks are concerned, they say and they have said, commercial basis is for them, Chairman, it is not for many of them, in recent statements that they are me. I do not have insight into— giving lending commitments to businesses, realistic commitments against proper business plans, but Q871 Chairman: As a representative of the BBA, they also do recognise that they need to get closer to you do not have a clue? their customers to their customers. I would hope Ms Knight: No, I did not say that, Chairman, so, that the sort of example that you cite is one that will please, do not put words into my mouth. What I said fade in terms of numbers, though with the millions is I am not privy to the private commercial issues of of businesses there are around millions of people in each and every bank. Nor should I be. We are in a the banking industry, I cannot promise they will be reporting season, we need to wait for that, and the perfect every time, but a better overall relationship is last thing that anybody needs is more speculation. required. There is enough speculation from others. John Thurso: To what extent does the fact that there is still a lot of what has been called toxic debt Q872 Nick Ainger: Mr Coogan, we had a submission sloshing around the system undermine confidence from Which? which indicated that they expect that if generally, particularly in inter-bank lending in the house prices fall by a further 15% in 2009 there could Processed: 13-03-2009 15:09:43 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG6

Ev 122 Treasury Committee: Evidence

14 January 2009 Mr Michael Coogan, Mr Stephen Sklaroff and Ms Angela Knight be 1.5 million mortgage holders that have got a loan- but the threat still hangs over them and, presumably, to-value ratio of over 90%. A significant number of other people. Do you not think that you as an those will be coming to an end of a fixed-term deal organisation should be asking your members not to and will find it enormously diYcult or enormously actually carry out that sort of policy? expensive to remortgage. What can be done to help Mr Coogan: I think in this environment it is diYcult those people? to see customers being able to make those sorts of Mr Coogan: The first thing we have talked about is payments. It is a commercial decision of the lender trying to open up those funding liquidity schemes whether to write in those terms or at all to customers that are made available in the coming months to a to draw their attention to the eVect of house pricing wider range of firms that may be able to oVer rules. Yesterday at a CML event we had a speaker refinancing. I think the straightforward answer the from the FSA reminding members of the Unfair Government has come up with is to try and Terms Contracts legislation and the importance, not encourage lenders to reduce their rates so that, when only to have fair terms, but to apply them fairly. people go on to a standard variable rate, there is not Whether that term is fair or not, I cannot comment, the payment shock that would have been the case 18 but the issue is a live one within the industry as a months ago. That strategy has worked because whole. The publicity surrounding that particular people coming out of fixed rates now are more likely case is widely available to the rest of the industry. to be able to address the SVR issue than they would have been. Q876 Nick Ainger: So you do not think it is going to be a policy which is going to continue and it is not Q873 Nick Ainger: There are those, though, who are going to spread to others of your members? not coming to the end of their deal but are being Mr Coogan: For individual organisations, they are informed by their mortgage lender that, as their ratio going to have to take commercial decisions. We have has gone over 90%, which was the deal that they already seen in the area of trackers, where there were struck when they took out the mortgage, they are floors which have not been applied in one or two now being asked to actually make an additional cases, that individual companies are addressing the contribution to actually bring their loan-to-value current recessionary circumstances and trying to ratio down to at or below 90%. Is that common respond to their customers’ needs. throughout the industry? Mr Coogan: I have seen speculation to suggest that Q877 Nick Ainger: But do you not think that least one lender has written to its customers in that members of your organisation also have to bear situation, but I believe the situation is that they are some of the risk when house prices are falling? It warning customers about the lack of available does not just fall back on the borrower, but the drawdown facilities. I am not aware of any lender lender should also share some of that risk and, which has asked for money back, and clearly that therefore, they should not be following that sort of would be an issue which the consumer press would policy? look at very quickly so that the regulators would Mr Coogan: They do share the risk, because if the look at whether there is a fair term being applied loss ever has to be crystallised into repossession and fairly by the individual lender for those customers. sale, they are not getting their money back in the vast majority of repossessions, of which we reported an Q874 Nick Ainger: I have got here a letter from expectation of 45,000. So in the vast majority of Abbey, and I will quote from it: “If when we receive those cases they did make losses when they the updated value of your property the amount that crystallised the debt. So they are at risk, they know you have already borrowed means that your that is the case; that is why they are keeping people mortgage balance exceeds 90% of the new value, in their homes as far as they can; that is why they are then we will give you three months to bring the being realistic about what customer aVordability is. balance back down to 90%.” Do you approve of that sort of policy? Q878 Nick Ainger: Let us move on to those that are Mr Coogan: Individual commercial decisions will facing repossession then. Shelter has called for have to be taken on their individual terms. Clearly, improvements in the law regarding mortgages, and for customers in a situation where they have got particularly those that are in arrears. They are stretched finances, the lender will have to look at objecting to the fact that under the current what is realistic for those customers. I think what legislation lenders can force a sale based on only two customers will need to do is respond to letters they months in arrears. Do you think that should be receive to find out if they are being treated fairly changed? under their terms. Mr Coogan: I think the approach of the legislation in 2009 is being reviewed by the Government as part Q875 Nick Ainger: This was a mortgage taken out in of a wider ranging response to the recession. They 2007, not long ago. These people have never ever have already, with our support and the courts’ missed a payment, and yet they are being threatened support, introduced a protocol. We have already that if they do not pay a significant sum then action seen, through the lending panel and the industry as could be taken; they will be in breach of the terms of a whole, support for a moratorium of three months, their mortgage. Abbey, following pressure, have a number of individual lenders have said six months said that they have no intention of invoking that before they pursue arrears through starting court clause in the mortgage agreement, which is welcome, proceedings. So the risk that Shelter highlights may Processed: 13-03-2009 15:09:43 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG6

Treasury Committee: Evidence Ev 123

14 January 2009 Mr Michael Coogan, Mr Stephen Sklaroff and Ms Angela Knight be a legislative one is not a real one in practical Q882 Mr Love: I want to look at some of these issues terms. What the legislation should or should not do but in relation to those banks that are in receipt of is one of the things the Government is currently significant public funding. Do they have any form of reviewing, and we are active in that role. What I duty to the public interest? Should they be, more should say is, if you go too far to make customers’ than everyone else in the market place, recognising position in their homes too secure, unable to be and accommodating the consumer interest? Perhaps repossessed, that impacts security that already Ms Knight would like to start and I will then come exists, impacts the future pricing of mortgages. to Mr Coogan and ask him as well. Ms Knight: I think the answer to your question is that those banks for whom there is a significant Q879 Nick Ainger: What about the foreclosure taxpayers’ involvement have all given some clear where a lender can actually claim all the proceeds of commitments, to concentrate on lending as far as the a sale, whereas in fact there may well be a balance UK is concerned. I think one of the aspects of this is that should be returned to the home owner? that it is surely also about using the taxpayers’ Mr Coogan: If there is a balance, it should be money wisely. They have clearly a requirement to returned to the home owner. lend in an appropriate manner, with sensible lending policies, and they have also undertaken, as I said, to Q880 Nick Ainger: One final point. Perhaps this is make finance available to small businesses and to for Angela Knight. Some banks are imposing a individuals in particular. Those banks are, after all, charge for every letter or call regarding arrears. Is collectively very strong, both in the SME market, that not a disincentive for people, as you have said, and making finance available to them, and they are very strong in the mortgage market as well to assist urgently to come forward if they are facing by providing remortgages and new mortgages. I am problems? When we are looking at trying to help sure that wanting them to use the taxpayer people stay in their homes, address their financial involvement, if you like, in a wise way is one of the problems, actually substantial charges per letter is most appropriate actions that they can take. not a good way of encouraging people to come forward? Ms Knight: I had a discussion with a number of our Q883 Mr Love: I want to come back to you, but let members, before coming to this Select Committee, me turn to the CML. You talked earlier on about on some of the broader issues, of which that is one. Northern Rock and re-mortgaging taking place at a I asked how they see getting close to their customers pretty regular rate. We were told earlier on that at a time in which many of them may well find currently Northern Rock are incentivising staV to themselves in anything from a more diYcult take lenders oV their books. My understanding is situation to very diYcult financial problems, All of that their standard variable rate, which you spoke them have come back to me with the same sorts of about earlier on, is significantly higher than that of statements and that is that they are putting in place, other mortgage lenders. Is that the type of practice or have already put in place, arrangements whereby that you would say is in the consumer interest? they can monitor closely and can get to the customer Mr Coogan: I think there are a number of diVerent quickly to assist them, if they are looking at getting consumers in this issue. There are the consumers in into more diYculties and how they can prevent that Northern Rock, encouraged to remortgage, who and, in other instances, how to get them out of are, there are consumers in Northern Rock who do diYculties. I am afraid I do not recognise the specific not have the capacity because of their loan-to-value question you ask—I will take it away—it certainly and whether they are being treated fairly and then V was not something that was raised with me that there is the e ect in the market as a whole, the charges of that sort of nature were going to be levied. consumers who are not able to borrow from other It is all about getting people through a diYcult time. institutions because there is not the funding available for house purchase. So there are diVerent consumer interests at play. I think the reasons that a Q881 Nick Ainger: Should it not be in the Code of business take a decision was set out in their business Conduct? plan, agreed with government and agreed with the Mr Coogan: I was going briefly to say that we issued European Commission, and if that plan can be the industry best practice in addition to the court revised in a way that would make more flexibility for protocol, and you do not charge every contact, you all concerned, I think there would be benefits overall. are encouraging people to come in, and we have Ms Knight: They were required, as part of that issued consumer information on what they should agreement, to unwind their mortgage book. expect to receive and what they should expect to do to try and make sure that they have a dialogue early, Q884 Mr Love: I understand that. The Government that they are not over charged, that they are charged also asked the industry to maintain the flow of credit appropriately. to the market place. Whilst I recognise that they Chairman: I think these are messages to take away need to pay back the money that has been given out both to yourself and yourself, particularly the Abbey of public funds, is there a proper balance, in your one. It is maybe a good case study for the rest of the view, between the challenges that they face? industry as well, so if you can take it away and tell Mr Coogan: I think the original plan predated the them that the Select Committee want to look at that, worst part of the credit crunch after Lehmans and, I that would be good. think, needs to be revisited accordingly. In terms of Processed: 13-03-2009 15:09:43 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG6

Ev 124 Treasury Committee: Evidence

14 January 2009 Mr Michael Coogan, Mr Stephen Sklaroff and Ms Angela Knight how much they could do whether on savings or maintain that lifestyle, they are not going to be mortgages, there was a general underlying concern happy for the small number of SVR customers to be that they should not be allowed to compete against benefited, and you are still looking as a government other players in the market unfavourably because of to have net lending nearer 2007 levels than our their nationalised status. So, again, we need to look forecast of a negative net lending figure in 2009. at this in the light of 2009 circumstances, and they Ms Knight: To add to that point, if you look at some are diVerent to the early part of 2008. of the money fact tables, best-buy tables for mortgages, for example, you find that the major Q885 Mr Love: We heard earlier on that whilst, on banks, including ones that you comment upon—I do balance—and you can only take an average—most not mean the Northern Rock, but I mean the big of the reduction in interest rates had been passed on banks who have got a government shareholding— to a reduction in savings rates, that is not the case in are featuring very strongly; that is they are still there terms of those who hold mortgages, where, certainly making mortgages available when others are not. with the last reduction, mortgage holders are still having to pay. Most of what they would have Q887 Mr Todd: The market for financial services in received as a reduction should have been passed on. the UK remains highly competitive. I think you We are also seeing arrangement fees, additional heard the last few exchanges of the last session, charges. There is a whole panoply of things that are which did not get much assent to that view. Can you occurring at the moment in all of these organisations square that opinion? which the CABs would characterise as not best Ms Knight: I think that what we have got, obviously, practice, and this includes the organisations in a market that is coalescing at a very fast rate, and I receipt of public funds. Do you think that the do not just mean the banking industry but I mean industry is responding adequately to the concerns the broad financial services market— that are being expressed about the way things are moving currently? Ms Knight: First of all, the banks have each in their Q888 Mr Todd: And building societies as well. separate ways made statements in this area both in Ms Knight: It is now much narrower for practical terms of rates, for personal customers and for small purposes than it was a year ago. That does not mean businesses. But your point is actually a valid one, that it is an uncompetitive market. It is a diYcult and that is how can a bank continue to pass on rate market, but there is still a lot of choice in the market, reductions, oVer reasonable rates to savers, run a and I would sincerely, not only hope, but expect, business and also ensure that you hold the amount that as the recession bottoms out and starts to turn of capital that are required by external authorities up we will get a greater degree of competition than and the capital that is required by the market? That we have at the moment. But I do not think that you means, if you are going to do all those things, there can expect, on the one hand, that when there is one are times when you cannot pass on rate reductions, bank stabilising another bank to have exactly the there will be times when you would like to oVer same competition as you had before that event took better savings rates but your hands are tied and so place. You cannot have some building societies not there are times when you have to use money for being able to lend in the market and have the same capital purposes when you would rather use it for sort of competition for mortgages before that took lending. That comes back to an earlier point that was place. We nevertheless do, I am glad to say, remain made that it is actually much better to have an having a significant amount of choice and, certainly honest, open, more rounded discussion about these speaking for the banking industry. There are things, although they are complicated, and I quite diVerent banks specialising in certain sectors, some agree that, rather than just targeting one particular in SMEs and, of course, some in mortgages and area and pretending that we can do everything at the others in other directions. same time when we cannot. Mr Coogan: Can I also add that the number of customers on a standard variable rate where there is Q889 Mr Todd: I think there is probably quite a lot a choice to be made is only around 10% overall and of competition for someone like me, but there is a for some of the institutions much less than 10%. large number of people who really have very little choice. I think you heard the witness from the Q886 Mr Love: It has been suggested to us in some of Federation of Small Businesses saying the kind of the submissions that those in receipt of public funds information they are getting of the diYculties of should be leading the way and reducing standard getting genuine choice in basic banking services for variable rates. Where I understand it is only 10% of a small business, and even one that is relatively the market place, that would be a clear signal that secure and should be a reasonable risk. We are there was a recognition amongst the banking talking about competition in a very refined market fraternity of the pain that is being suVered out there place of relatively well-to-do people with solid asset whilst not prejudicing their need to have a bases and reasonably reliable employment, commercial return at this particular point. although, I have to say, that does not actually apply Mr Coogan: There is tug of war, where the banks to me. and building societies are the rope and the Ms Knight: I am delighted to learn of the comfort of Government are pulling in every direction. Savers your position! As a general comment, there is always on fixed interests and returns are going to be keen to more choice for somebody who is in a more Processed: 13-03-2009 15:09:43 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG6

Treasury Committee: Evidence Ev 125

14 January 2009 Mr Michael Coogan, Mr Stephen Sklaroff and Ms Angela Knight comfortable financial position than there is for Ms Knight: Firstly, as far as competition rules are people who are not in such a comfortable financial concerned, we would not normally expect to have position. invoked the public interest clause in competition for the purposes of allowing one financial institution to Q890 Mr Todd: If you look at the fundamentals of stabilise the other and, thereby, take a larger than the market place, you are seeing a lot of normal share of the market. That is one aspect of consolidation, you are seeing probably at least a competition. In terms of other aspects of medium-term presence of the state in the market competition (and you are citing doorstep lenders place, which tends to be an impediment to and concerns there), as far as the banking industry competition as well, you see the withdrawal of a lot from our perspective, as you know, we are strong of the fringe players and barriers to entry in them supporters of, for example, credit unions and other coming back going up rapidly. This is going to be a of those types of— market place which, in spite of what you have said, was never applauded for its competitive nature Q895 John Mann: That is not the question. becoming even less competitive into the future. Ms Knight: Then I am not understanding your What are we going to do about it? question; I am sorry. Ms Knight: There is nothing that we can do as an industry to suddenly magic more people into the Q896 John Mann: Twelve months ago there were market place. What certainly can happen is that loads of people going round my constituency and there is greater attention paid to competition of elsewhere with APRs, doorstep lending of 26, 30, 40, products and diversity of products. Indeed, if one 50%. Is that a good thing? That is competition. goes back to some of the points that were made Ms Knight: That is one of the issues that is regulated earlier about codes and principles and so forth, these by the oYce of Fair Trading, not by ourselves. are not just pie in the sky or fine words on pieces of paper, these are genuine attempts to ensure that Q897 John Mann: Could we not do with losing some there are goods and services available from the of the market? financial services industry to the very wide range of Ms Knight: I do not know what will happen in this individuals and businesses in the UK. Not downturn. everybody will be perfect with their finances and not everybody will find that they see their way through Q898 John Mann: Would it be a good thing if we lost the recession with their finances in good order, and some of the market? that is the same for businesses, but using the various Ms Knight: I, too, share some of your concerns other tools of disposal of the authorities and, indeed, about some of the high-price lending stories that I of the industry itself, we can certainly make sure that have read. I, too, would prefer that individuals got there is a broad brush provision given the their finance at the more competitive rates for constraints that we keep on coming back to of others. I also recognise that we should not put all liquidity, of capital, of availability of credit. doorstep lenders in the same pot. As to what has V Mr Sklaro : Can I add the comment, perhaps one happened in your constituency, I cannot comment. obvious point from what I was saying earlier, that one very good way of injecting some more Q899 John Mann: The mantra of competition seems competition back into the lending market is to allow to have masked quite a lot of incompetence. A case the non bank lenders access to some of these that came in front of me this weekend of a series of schemes. 95% mortgage, three unsecured loans, one secured Mr Todd: Good point. loan, totalling 150% debt-to-asset ratio and increasing daily. The taxpayer is going to have to Q891 John Mann: A return to normal competition pay for that, and that is incompetence, is it not? rules. Is that rules from 12 months ago? Would not my constituents be better oV with a Ms Knight: I presume you— choice of 100 or 200 mortgages rather than 12,000, if that kind of financial incompetence by lenders was Q892 John Mann: It is in your submission. restricted and we had a healthier market where Ms Knight: It depends what you are referring to. Do competition was defined by real choice rather more I think we are coming back to— choice? Mr Coogan: Coming in here, in terms of the mortgage market, obviously, with the experience of Q893 John Mann: You said you would expect to see the United States in the backdrop, was it a good idea a return to normal competition rules in time. Do you or a bad idea to have invented a subprime market in mean 12 months ago? the UK? After this recession, when there are people Ms Knight: Yes. There is— who have lost their jobs and had poor credit histories, how do we rehabilitate them and bring Q894 John Mann: Twelve months ago. So if we look them back into the mainstream at lower interest at competition then from 12 months ago, would it be rates than the mainstream banks? The subprime better competition, if we take door step lenders, if market in the late 1990s helped to achieve rather than having one of them lending at 172% rehabilitation for customers. That also lea to APR, we had, say, 20 lending at 50% APR? Would entrants into the market pricing subprime loans at that be better competition? below the price of risk, and that was part of the Processed: 13-03-2009 15:09:43 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG6

Ev 126 Treasury Committee: Evidence

14 January 2009 Mr Michael Coogan, Mr Stephen Sklaroff and Ms Angela Knight precursor to the events of 2007. So what we need is only about $600 million to date has been accounted competition which is properly priced, a rational for. Would you agree with those figures as ball park price for risk. One of the questions I was asked figures from David Tweedie? earlier: what we need is a broad range of product Ms Knight: They are both broad estimates, yes, and providers of various types, not just banks or building I have no reason to either say they are right or societies, or specialist lenders, preferably or, wrong, but, I would have thought, they come from preferably large and small, not just large, and what an eminent body, so they could be right. I think that we need are products that meet the needs for one of the areas that we all do not know about is how customers at diVerent stages of their life. Whether much of that is not in the banking system at all, that is 200 or 2,000 or 12,000, what you need is to because, of course, there is a significant proportion have access to a choice. Clearly, some your of assets that have been bought by countries, for constituents are making borrowing decisions when example, where the requirements are not to disclose V they cannot enter the mainstream market. There are and by entities who have got them in di erent parts also responsibilities on consumers. of their book and so do not have to declare on a mark to market value. The last thing is that with a lot of these assets, many are still providing an Q900 John Mann: Therefore, a return to 12 months income stream. What there is not is a market to is not necessarily what we would want to see in terms purchase them. That can come back. The big of the market that is there. We would be better oV if question is that they are very complicated, all be it we shrunk certain parts of the market to allow others that in many instances they were triple-A rated by to grow and, in particular, the subprime market? the rating agencies. That market may come back, we Mr Coogan: I would say that the mortgage market is do not know what the default rate will be, but they dysfunctional and our challenge is to reopen the are still paying a sensible income stream. market to more lenders to make it the competitive market that was at one point the envy of the world Q902 Chairman: Stephen, do you agree with those but is not at the moment. ball park figures? Mr SklaroV: Again, I have no particular reason to disagree with them. As Angela says, they come from Q901 Chairman: One last question. When David a very good source. Tweedie was here, he mentioned an IMF figure of Chairman: Okay. Can I thank you for your evidence; 1.4 trillion dollars, the estimate for bad loans, but it has been very helpful. Processed: 25-03-2009 21:21:27 Page Layout: COENEW [SO] PPSysB Job: 416782 Unit: PAG7

Treasury Committee: Evidence Ev 127

Tuesday 27 January 2009

Members present

John McFall, in the Chair

Nick Ainger Mr Andrew Love Mr Graham Brady John Mann Mr Colin Breed Mr George Mudie Jim Cousins John Thurso Mr Michael Fallon Sir Peter Viggers Ms Sally Keeble

Witnesses: Mr Andrew Baker, CEO, Alternative Investment Management Association, Mr Douglas Shaw, Managing Director and head of BlackRock’s Proprietary Alpha Strategies Team, BlackRock, Mr Chris Hohn, Founder and Chief Investment OYcer, The Children’s Investment Fund, Mr Stephen Zimmerman, Chairman, NewSmith Capital Partners, and Mr Paul Marshall, Chairman, Marshall Wace LLP, gave evidence.

Q903 Chairman: Welcome to our hedge fund Mr Shaw: UK regulation has been very much more investors’ inquiry. This is part of our banking successful in preventing fraud than other forms of inquiry. Please introduce yourselves for the record. regulation. Mr Baker: I am Andrew Baker, chief executive of the Alternative Investment Management Association Q907 Chairman: How damaging do you think those which is the global trade body for the hedge fund episodes are for the hedge fund industry? industry. Mr Shaw: Extremely damaging. Issues of fraud have Mr Marshall: I am Paul Marshall, chairman of damaged the reputations of some funds of hedge Marshall Wace. I am also a founder trustee of the funds companies and come as a great shock both in Hedge Funds Standards Board. their longevity and the apparent, although as yet Mr Shaw: I am Douglas Shaw, managing director of unknown, scale of the supposed fraud that Mr BlackRock where I help manage the single strategy MadoV appears to have perpetrated. hedge fund business. Mr Hohn: I am Chris Hohn, managing partner of the Children’s Investment Fund. Q908 Chairman: Mr Hohn, do you agree there are Mr Zimmerman: I am Stephen Zimmerman, chief two ways in which you can be thought of as a systemic risk: when a hedge fund failure causes a executive of NewSmith Asset Management. We look bank to fail or lots of hedge funds fail together after a combination of long only and single strategy causing significant damage to the market and assets hedge funds. are then sold oV, depressing asset prices? Mr Hohn: In the past there has been one example of Q904 Chairman: Welcome to this inquiry. Mr Shaw, that in the case of long-term capital where a hedge to start with you, do you think that the UK fund was allowed to become too big and leveraged. regulatory system for hedge funds as currently That caused problems in the markets many years designed will prevent a MadoV or Nadel-type ago. Today I do not see that as a particular issue. I do failure, or is it only a matter of time before we see a not think that hedge funds in general have excessive leverage, so I do not see that issue as having a high similar case here? probability. Mr Shaw: I think UK fund managers, of which hedge fund managers are a part, are generally quite happy with the regulatory regime under which they Q909 Chairman: Mr Zimmerman, in paragraphs 7 operate. UK-based hedge fund managers are and 8 of its memorandum the Hedge Fund regulated in exactly the same way as other fund Standards Board say there are two ways in which management companies. I point out that the degree hedge funds could potentially inflict harm on banks: of fraud in fund management is extremely low and a hedge fund failure destabilising a bank and a run very rare. on hedge funds. Do you think that is the case? There are two ways in which you can be thought of as a systemic risk: a hedge fund failure causing a bank to Q905 Chairman: To cut to the chase, you do not fail, as I mentioned to Mr Hohn, or lots of hedge think there will be a MadoV and Nadel-type case funds failing together, causing significant damage to here? the market? Mr Shaw: I do not think one can ever use the word Mr Zimmerman: I think that is very unlikely. As Mr “never”. Hohn has already said, the evidence suggests that there has been only one failure in the hedge fund world. I think that given the reporting regulations Q906 Chairman: Do you think regulation will that exist here and various disclosures that take prevent that? place, that is extremely unlikely. Processed: 25-03-2009 21:21:27 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG7

Ev 128 Treasury Committee: Evidence

27 January 2009 Mr Andrew Baker, Mr Douglas Shaw, Mr Chris Hohn, Mr Stephen Zimmerman and Mr Paul Marshall

Q910 Chairman: Mr Marshall, do you think the Mr Hohn: I think that in some circumstances that recent crisis has increased the risk of either of these can occur but it can occur through general panic and events occurring? long investors also panic. After Lehman Brothers Mr Marshall: I very much agree with the statement there was a general panic of all investors, I think. you have quoted. I think the recent crisis has led to a sharp de-leverage of the hedge fund industry, triggered primarily by Lehman Brothers. The Q917 Mr Fallon: For example, he suggested that Lehman Brothers event created risks for the hedge highly leveraged funds could be induced to fund industry, but I think that broadly that is now undertake forced sales in times of systemic stress and behind us. that simply added to problems in the market. Mr Hohn: High leverage can be an issue, but it is not Q911 Chairman: Douglas Shaw, do you think that the case that all hedge funds have high leverage; when hedge funds reach a certain size they should be many have low leverage or high levels of net cash. directly regulated by the FSA? Mr Shaw: I think there is a case for that, and you may already see that happening. As I understand it, Q918 Mr Fallon: Mr Shaw, is there not a case for the FSA is in much more frequent contact with the better regulation of those hedge funds that are 40 largest UK-based hedge fund managers and are systemic and significant? managing them on a relationship basis. We have had Mr Shaw: Yes, and I think that is already some tumultuous times over the past year, but hedge happening, but the FSA’s own data published fund managers probably worried more about their recently showed that the degree of hedge fund credit risks on banks than maybe banks did about leverage as employed by the 20 largest hedge funds their risks on hedge funds. in their domain appears to have been falling significantly ever since October 2005. Therefore, the Q912 Chairman: Mr Baker, how many hedge funds evidence such as it is suggests that hedge funds were are there in the UK? probably reducing risks oV the table as they Mr Baker: According to FSA figures, the number of foresaw troubles ahead. management firms operating here is in the region of 400 to 450 and of those some firms operate single funds and some multiple funds. No one knows for Q919 Mr Fallon: Mr Marshall, does the regulator sure the exact number but it is thought that there are have suYcient data about the assets and liabilities in excess of 1,000 managed by UK-based managers. you hold to regulate you properly? Mr Marshall: Before I answer that question perhaps Q913 Chairman: But you have only 33 members on I may add to what my colleague said about leverage. the Hedge Fund Standards Board. The leverage in the hedge fund industry fell in 2008 Mr Baker: I do not represent the Hedge Fund from 1.7 to 1.4 times. That is the aggregate for the Standards Board but the trade body AIMA. industry. If that is compared with 40 or 50 times for the banking industry that gives you a measure of the Q914 Chairman: But the Hedge Fund Standards diVerence in the problem. That does not mean there Board has only 33 members. cannot be an individual hedge fund which has very Mr Baker: It has been in existence for less than 12 high leverage as we saw in 1998 with LTCM where it months and currently it has 34 signatories. I believe was 33 times. There can be isolated funds with that one more signed up yesterday, so it is quite early significant leverage. We would welcome the work days. The managers had only to prove that they had that is being done to look at whether special types of signed up by 31 December, so there is a significant leverage limits can exist for those types of funds. Do pipeline of people who are about to sign up. I think that the regulator gets enough data on hedge funds? At the moment I understand that they receive Q915 Chairman: Are there any here who are not from the prime brokers formally every six months— members of the Hedge Fund Standards Board? obviously, they can receive it on a daily basis— Mr Zimmerman: We are not members of the board. aggregated data for the top clients of all the prime We are looking at whether we should join. Because brokers. In the US nothing of that kind exists. You of the nature of our business we are already members could move to a more formal process of aggregating of another association. We think that voluntary data through the prime broker to provide that industry initiatives are a very important and information to the regulator and then co-ordinate valuable way to promote self-improvement. At the that on a global level. minute we are looking at the merits of joining.

Q916 Mr Fallon: Mr Hohn, Sir Andrew Crockett, Q920 Mr Fallon: Would you do that for the whole former chairman of the Financial Stability Forum, population of hedge funds or just for the has given evidence to us that in disturbed conditions systemically vulnerable ones? hedge funds add to market volatility and the “herd” Mr Marshall: The beauty of doing it through the phenomenon can accentuate market movements prime broker rather than asking individual hedge and destabilise market dynamics. How do you fund managers to provide the data is that you get a plead? much more eVective aggregation. Processed: 25-03-2009 21:21:27 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG7

Treasury Committee: Evidence Ev 129

27 January 2009 Mr Andrew Baker, Mr Douglas Shaw, Mr Chris Hohn, Mr Stephen Zimmerman and Mr Paul Marshall

Q921 Mr Fallon: Do you support that, Mr Baker? Q925 Sir Peter Viggers: What is the diVerence Mr Baker: I agree entirely with what Paul Marshall between covered short selling and naked short has said but I add one other point. The FSA has selling in terms of market eYciency, looking at it access to any data it wishes to ask for. Part of the entirely from the point of view of market eYciency issue is that we are dealing with a global market, and profitability? global players and capital flows within the global Mr Shaw: I do not think that a well-managed hedge market. It is very important that whatever fund management company would engage in naked information is put in place in one country is short selling. I do not believe that the practice is comparable with the information gathered in other prevalent. Naked short selling occurs where a short countries. We probably all know that America and sale is made in the market without any realistic hope the UK account for the vast majority of hedge fund of delivery. It is not thought that that is a common assets, so if there can be agreement between the US practice. If it was the amount of settlement failure in and UK authorities about what information of UK financials or UK stocks as a whole would be systemic importance needs to be gathered and how very high. I am not aware of any data from, say, best to gather it the hedge fund community is ready CREST, to suggest that the quantity of unsettled and willing to provide whatever is asked for. bargains is high or that it represents any kind of systemic risk.

Q926 Sir Peter Viggers: I have been told by a banker Q922 Mr Fallon: You appear to be telling us whom I know and trust that there was substantial collectively that you are not the problem but if you naked short selling of Northern Rock before it went were you are now slightly less of a problem? down. Can you comment on that? Mr Baker: The industry is not as large as it was, so Mr Shaw: I have not seen any evidence of that. by definition it has de-leveraged and the assets it Perhaps that is a question for CREST which would manages have come down. To embellish a point have data on unsettled bargains like that. made earlier, a lot of issues that crop up in capital markets are put into a generalised bucket called the Q927 Sir Peter Viggers: Was the FSA right in hedge fund problem. I would be so bold as to say banning short selling for a period in September? that if all hedge funds ceased to exist tomorrow these Mr Shaw: In one word, no. issues would not go away because hedge funds are Mr Zimmerman: No. If you look at bank shares and not the only entities that operate in the capital what happened during that period of time and markets, use these techniques and are monitored by subsequently when they fell markedly the evidence the regulators. It is crucial that more data is captured has not made that out. so we can work out which firms are operating in Mr Marshall: You may have had submitted to you which markets. evidence commissioned from an independent research source by the London Stock Exchange which shows that the eVect of the short sale ban— Q923 Chairman: You mentioned the availability of this is only up to 6 January—has been to reduce information, but worldwide assets under the liquidity significantly in the concerned stocks, management of hedge funds are estimated to be over increase transaction costs by 150% and create a $225 billion and they are held by 1,100 hedge funds. marginal increase in volatility in those stocks. If you Can I ask Mr Marshall what his assets under look at what happened to the share prices in the management are? period, Barclays fell by 75%, Lloyds by 66% and Mr Marshall: It is ƒ5 billion. RBS by 84%. You will see that there was a clear Mr Shaw: BlackRock deals with a wide variety of impairment of the facilitation by the market and also assets—mutual funds, pension funds et cetera—and no observable impact in reducing the decline in the as a whole manages $1.31 trillion, of which only $8 shares. billion are hedge funds. Therefore, arguably my company manages more money than the entire Q928 Sir Peter Viggers: How are the reporting hedge fund industry. requirements on financial stocks which continue V Mr Hohn: We manage $9.5 billion. until June a ecting you? Mr Zimmerman: In our case it is £2 billion, of which Mr Shaw: We have to employ somebody and one third is in hedge funds. develop resources to make sure we meet our reporting requirement. That was a task we did not have before and so there is an operational burden that did not previously exist. At the margin I would Q924 Sir Peter Viggers: Perhaps I may ask the four have thought it would hinder short selling because a practitioners to answer in a word how important short seller must ponder whether he wants his name short selling is to their activities. and position to enter the public domain. Maybe he Mr Marshall: Integral. does or does not, but now it is something he must Mr Shaw: It is important for our hedge fund think about whereas before he did not. activities. Mr Hohn: Limited but helpful. Q929 Sir Peter Viggers: Are your activities being Mr Zimmerman: Important. unduly restricted? Processed: 25-03-2009 21:21:27 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG7

Ev 130 Treasury Committee: Evidence

27 January 2009 Mr Andrew Baker, Mr Douglas Shaw, Mr Chris Hohn, Mr Stephen Zimmerman and Mr Paul Marshall

Mr Shaw: They were restricted in the period of time Q932 Nick Ainger: The public who two years ago when the ban existed. had considerable confidence in the British, arguably the world, banking system felt that their savings were safe. That is certainly not the case now. Among Q930 Sir Peter Viggers: Mr Baker, your association the people they blame are bankers but also hedge submitted to us a memorandum, for which we are funds. Do you think stories like this where an grateful. It says: “A disclosure regime related to individual hedge fund on the back of short selling short positions and restrictions on naked short makes £270 million profit on the problems of a bank selling is the way forward.” Would you like to like RBS will restore confidence upon which at the expand on that? end of the day the whole system is dependent? Mr Baker: We believe very strongly that it would be Mr Marshall: It is very important to put these stories helpful to have a common approach around the in their context. This headline is somebody’s attempt world to the whole subject of short selling. It would to estimate what Paulson made on the short position include a number of elements, the two principal ones over the six-month period in which he was reputed being some kind of restriction on naked short selling to have held it. They do not allow for any long and a disclosure regime. The FSA will be publishing position that he had against it. For all we know, a fuller consultation paper. What we have seen so far Paulson is more of a dedicated short seller. is strictly in response to the temporary selling ban. That paper will be published in the early part of Q933 Nick Ainger: But the important thing is that February. An integral part of that report will be to here is a story which will be repeated across the look at the merits of a disclosure regime and, in tabloids. Is that type of story, which is likely to be particular, how this issue is handled in other parts of repeated with other hedge funds revealing that they the world. We as an association recognise that there have made very substantial profits from the failures is significant public interest in this issue and to go of British banks, going to help to restore confidence back to a time when short selling had no disclosure in the system? regime attached to it is probably not the way Mr Marshall: No, it is not, but I think it is a very forward, which is why we have embraced the idea of partial reporting of what is actually going on. The disclosure in aggregate to the marketplace. What I word “hedge” means that we both hedge the risk and mean by “in aggregate” is that the total short interest try to preserve capital. The primary responsibility of of shares in any particular company would be a hedge fund manager is to his investors and, publicly available information but individual therefore, to try to maintain a stable performance of positions held, say, by the managers on the panel the funds through volatile times. Certainly, in the would be disclosed to the regulator but would not case of Marshall Wace that is how we use hedging. themselves be in the public domain. We feel that it Typically, there will be shorts and longs in the same does not serve the market’s interests to know the sector. You can extract from that one piece of identities of the short sellers. information which says that for one particular stock over a particular period of time someone has made x profit, but that is a very partial view of what is Q931 Nick Ainger: This morning the FT is carrying going on. If we look at the aggregate position last the story that Paulson & Co, one of the world’s year, the industry lost—we are not proud of it—18%. biggest hedge funds, made more than £270 million The industry is not sitting there making vast fortunes shorting RBS shares over the past four months. All at the expense of the British public. Somebody said four hedge fund managers in response to Sir Peter to me yesterday that to blame hedge funds was like have accepted that shorting is a significant part of blaming passengers for a bus crash. The hedge funds their income and turnover. I ask each of you whether are themselves suVering from the financial your funds have been shorting British banks. environment. Occasionally, some of them make Mr Marshall: Not in the recent period, but we were profits and that is taken out of context and is, I think, short and long with British banks during 2008. misleading. Mr Shaw: In 2008 we bought British banks and were short in British banks. Mr Hohn: In our case it was relatively minor last Q934 Nick Ainger: Perhaps the other fund managers would like to comment. Do you not appreciate that year. there is a real issue of confidence? You have said you Mr Zimmerman: We have done both. Yesterday I do not believe that this is a fair reflection of what has was just looking at some statistics which are quite been happening, but the fact remains that shorting illuminating. I think that at the end of 2006 and bank stocks is a highly contentious issue particularly beginning of 2007 the Royal Bank of Scotland was for the shareholders of those stocks and people who priced at around £6 and it is now 16p or whatever it see what has happened to Barclays in the past is. It was the sixth largest company in the country, or 1 fortnight, for example the huge volatility and so on. 3.4% of the index. Barclays was over £72 and is now They now believe that that is down to short selling, 90p or so and it was the seventh largest company at the lifting of the ban and so on. 1 22%. You can see the huge destruction of wealth that Mr Shaw: The headlines and stories are to some has taken place in these companies over this time. I extent beyond our control. We very much welcome hasten to add that I do not believe that is down to the the opportunity to appear before you today, to be short selling of their shares. transparent with you and provide evidence to the Processed: 25-03-2009 21:21:27 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG7

Treasury Committee: Evidence Ev 131

27 January 2009 Mr Andrew Baker, Mr Douglas Shaw, Mr Chris Hohn, Mr Stephen Zimmerman and Mr Paul Marshall

Committee in oral and written form. We share the that we are very keen to put right. Part of the issue, concerns of the wider population as a whole, but in as I am sure you appreciate, is that the industry does investigating the banking crisis you will find many not do just one thing. features which contributed to it. Some hedge funds as we read today in the FT have made profits from the decline in bank share prices. They had a Q937 Chairman: Private equity came along and legitimate purpose to serve in trying to meet the afterwards set up a code. Sir Mike Rake is now objectives set by their clients, but I do not think it is chairing that and is writing to the Committee to say right to say that they made money out of the that progress is being made. Sir Andrew Large is misfortune or concern of others. They felt that share chairman of the Hedge Fund Standards Board, but prices in banks were too high; they had an if the board has only 33 members it is not making expectation that those share prices would fall, but much of a dent. There is a view that what the the fact that prices did indeed fall does not mean they industry is doing is snubbing the public and making made the share price fall. shedloads of money out of taxpayers at a time when Mr Baker: Mr Ainger, I think you put your finger on every single penny they have put into institutions it by your use of the word “confidence”. What should be preserved. There is a PR problem here. Barclays did yesterday is a very good illustration of What measures do you have to deal with it? what happens when banks make statements to the Mr Baker: One of the things we are very keen to do marketplace about the nature of their balance is to have discussion with international regulators to sheets. That is what gives confidence. There is make sure that there is a common approach to transparency and the published balance sheets are a short selling. true and fair reflection of the assets held. The share price rose by up to 75% at one point, so anybody Q938 Chairman: There is still a PR problem and you sitting with a short position over that period—this is have a big hole to deal with. Mr Baker, you said that something that does not get into the newspapers— short positions should be declared to the regulator would have been ferociously squeezed and lost a but not to the market. If you were long you would great deal of money. Therefore, “confidence” is have to declare that to the market, so why is there a exactly the right word. If there is transparency in the discrepancy? If disclosures are beneficial for banks bank’s balance sheets confidence will return and why do we not go further on this? Mr Marshall, do share prices will recover. you think that is a good point? Mr Zimmerman: If I may turn the question round Mr Marshall: Yes, I do. slightly, go back to the dot.com boom many years ago. We had a number of companies whose share prices rose incredibly sharply to ridiculous levels. Q939 Chairman: Why do we need to drag it out of Because there was such a small free float in those you? companies no shorting took place. Unfortunately, Mr Marshall: Our primary recommendation is for investors lost money in those companies because aggregate disclosure. Obviously, the reason hedge there was no proper price discovery. I totally accept fund managers resist specific short disclosure is your point and endorse what Mr Shaw said; these because it can work against their positions, but there are worries and it does not help confidence, but I is a good case for a symmetric disclosure of longs think we have to go back to the root causes of why and shorts. At the moment the policy is that at 0.25% these companies have performed so poorly. you have to disclose a short position and at 3% you disclose a long position. I think the primary reason Q935 Chairman: Do you accept that as an industry for disclosure of short positions is one of financial you have a PR problem? stability. That is really an aggregate rather than fund Mr Marshall: Yes. manager issue and that is why we are more in favour of a policy of aggregate disclosure. Q936 Chairman: You remind me of the time when representatives of private equity came before us. Q940 John Thurso: Mr Marshall, I want to talk Everything seemed to be okay and it was the fault of about regulation. In an answer just now you said everybody else. You suVer from the present that the point of a hedge fund was to hedge risk and economic environment like everybody else, but do therefore to conserve wealth on the basis, I assume, you not accept that with stories like this where £270 of absolute return. As the Chairman has just said, million has been made in the past four months and the public view of the hedge fund industry is that the taxpayer has put billions of pounds into the they are an opaque bunch of spivs who gamble with banking industry the hedge fund industry is seen as public money. To what extent should regulation be gambling against the taxpayer? What PR message brought in to rectify that? do you give to assure taxpayers that that is not the Mr Marshall: We do have a problem with our public case and that the billions they have put in has not image and I think the best way to address it is to been eroded by hedge fund speculators taking away engage in this debate, and we are very grateful to be the wealth of the banks? here to have that opportunity. One of the things I am Mr Baker: We fully accept that there is a legitimate keen to get across is that the UK has a very good public interest in this issue and that our industry regulatory regime for hedge funds and it is diVerent undoubtedly has an image problem, and it is one from the regime in the United States. Processed: 25-03-2009 21:21:27 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG7

Ev 132 Treasury Committee: Evidence

27 January 2009 Mr Andrew Baker, Mr Douglas Shaw, Mr Chris Hohn, Mr Stephen Zimmerman and Mr Paul Marshall

Q941 John Thurso: Is it good because it is light touch Mr Shaw: For example, in Luxembourg. for you? Mr Marshall: No. It is good because it treats hedge fund managers in the same way as all other Q945 John Thurso: This seems to me to be slightly a matter of angels on a pin. What is the diVerence managers. When you want to set up a hedge fund between regulating the activity of a manager and management company in the United Kingdom you regulating what is happening to the money must go through a lengthy authorisation process somewhere overseas? during which your business and investment plans are Mr Marshall: I think there is a case—I know that the considered, you are screened to ensure that you are Financial Stability Forum is considering it—for a fit and proper person and so on. In the United looking at how oVshore funds are regulated and States less than 50% of hedge fund managers are whether they should be subject to a greater burden registered with the SEC. When you are registered of regulatory supervision. with the SEC the amount of overview is very limited. Mr Baker: All of the decision-making is done by the To come back to the very first question, that is why managers who are based onshore. Every decision a MadoV-type situation is very unlikely here. We they make which results in a trade or the purchase have a competitive advantage in terms of our and sale of an asset is controlled and regulated by regulatory regime and in relation to financial the FSA. stability. Mr Shaw: Yesterday I met with an insurance company. There is a market for insuring yourself Q946 John Thurso: To what extent is it important to against the fraud of a fund manager, not necessarily regulate the assets and the products in which the a hedge fund manager. Of the 67 instances shown of managers are dealing as opposed to the activities of known and reportable hedge fund fraud over the the manager? past decade every single case arose in America. That Mr Baker: Regulation tends to break down into two insurer could not show me one instance of hedge components. There are aspects of regulations which fund fraud in the UK or Europe. Therefore, it is not deal with systemic risk—stock markets being as if the FSA is necessarily light touch; it is more that destabilised—and aspects that deal with investor it is principles-based which means that, frankly, protection to stop mis-selling and the wrong people there are fewer rules. There are 11 principles rather buying the wrong products. The vast majority of than a whole set of complex and prescriptive rules. what we have been talking about today is in the That adds a little bit of uncertainty to our day-to- sphere of financial stability for the reason that hedge day jobs as to precisely how the rules are to be funds tend to have very high levels of minimum interpreted, but to have a duty of care to put our investment. That is intended as a deliberate deterrent clients first and have prudent businesses is a very to retail investors. That statement has been made in good starting point. the Hedge Funds Standards Board because investor protection issues are not the primary purpose of that document. The primary purpose is to raise the Q942 John Thurso: Am I right in understanding that standards of investment practice by managers and basically what you are saying is that there is no ensure that systemic issues do not arise. diVerence in the regulation of fund managers? Whether you fall into what is called “hedge” as opposed to classic fund management, all investment Q947 John Thurso: When we conducted our inquiry fund managers are regulated in the same way in into the Northern Rock collapse we took evidence this country? from a number of very senior chairmen of banks. Mr Marshall: Yes. One matter that emerged from it was that they did Mr Zimmerman: Yes. not wholly understand the instruments of debt they had allowed their staV to play with. If I remember rightly, it was the chairman of Goldman Sachs who Q943 John Thurso: Why then in the submission of said that due diligence was, frankly, not up to the Hedge Fund Standards Board to the inquiry do scratch. Is that an issue in the hedge fund industry? Is you say that by contrast hedge funds rely on your due diligence up to the mark on these complex sophisticated investors who do not need the products? protection of regulators? Mr Baker: I suggest that you invite comments from Mr Marshall: I think that is a reference to the fact the other practitioners, but to the extent that it is an that a significant number of the funds managed by issue it is a very small part of any problem. By and hedge fund managers are oVshore primarily for tax large, hedge funds did not deal in these highly exotic reasons. instruments. The risk management techniques of hedge fund managers by and large have come through this process in fairly good shape. The whole Q944 John Thurso: So, the manager sitting in his issue of asset-backed securities and very complex oYce in the square mile is regulated but the money structures such as CDOs was largely avoided by the he manages oVshore is not? hedge fund community because of their sheer Mr Marshall: The oVshore funds are more likely to complexity. It was banks packaging and selling to be regulated. other banks which seemed to be the biggest issue. Processed: 25-03-2009 21:21:27 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG7

Treasury Committee: Evidence Ev 133

27 January 2009 Mr Andrew Baker, Mr Douglas Shaw, Mr Chris Hohn, Mr Stephen Zimmerman and Mr Paul Marshall

John Thurso: If that is a general view I do not need Q952 Mr Mudie: Why did you sign up? to pursue it. Mr Shaw: Because I felt that regardless of the standards our internal procedures and policies were very robust and the marginal degree of work by Q948 Mr Mudie: I want to go back to one of the BlackRock in order to achieve the lofty demands matters raised by the Chairman, namely the was well worth it. standards board and the failure to get your industry to adhere to it. The background to it was the G8 in Q953 Mr Mudie: For a member of the public, an 2007. It was so outraged by the behaviour of the investor, even the FSA, who looks at the 34 hedge fund industry that it threatened legislation. I organisations that have agreed to sign up to these believe the German Minister of Finance called you standards the other 966 may be questionable. “locusts”. Your industry set up a working group and Mr Zimmerman: They may have signed up to you now have a code of practice. That was 12 another standard that is more rigorous. In our case months ago. As you told the Chairman, out of over we have a hybrid business which is a combination of 1,000 potential members you have attracted only 34. looking after pension funds and looking after hedge From where I sit that is a dangerous snub to the funds. Because the bulk of our business is looking public and the authorities by your industry. Tell us after pension funds—I do not want to get too what is happening. technical here—but, we signed up for something Mr Marshall: In the next session you will have called the audit and assurance faculty which is part before you the chairman of the Hedge Fund of the Institute of Chartered Accountants and we Standards Board, so he will be able to give the best think that the measures which they adopt are as answer. rigorous as the Hedge Fund Standards Board.

Q954 Mr Mudie: Does it cost money to sign up to Q949 Mr Mudie: You are a person who has joined? this standards board? Mr Marshall: Yes. Mr Zimmerman: Yes.

Q955 Mr Mudie: How much would it cost you? Q950 Mr Mudie: But you were on the working group Mr Zimmerman: I cannot immediately answer that. or were represented on it. Of the 34, 14 were the organisations who drew it up. Therefore, you have Q956 Mr Mudie: If you have higher standards attracted 20 fresh members in a year. If I were a trade Y because of your hybrid activities surely you can union o cial on recruitment I would be sacked. aVord to sign up to this so you have the stamp of Mr Marshall: It is small consolation but the 34 approval in both industries. Are you hard up or represent over 50% of the assets of the industry, so in something? terms of your concern about financial stability it Mr Zimmerman: It is not a question of financial goes quite a long way towards addressing that concern but what is best for our business. At the time particular issue. Another way to interpret it is that we decided to sign up for this particular control. As the reason why the uptake has been so slow—the I said in my earlier submission—you make a fair campaign for uptake started in the middle of last point—we are looking at whether we should also year—is that they are quite challenging standards. sign up for the HFSB. People have to go through a significant due diligence process internally—as the devisers of the standards Q957 Mr Mudie: Mr Baker, do you not think there and participants in it even we had to do it—before is a real danger that the authorities will feel you are they are comfortable that they can sign up. That may challenging them to bring forward their own well be the case for NewSmith. regulation? Mr Baker: As a point of clarification, the figure that I quoted earlier for managers was somewhere Q951 Mr Mudie: I am not sure the insurance trade between 400 and 450, so the number is not 1,000. It body ABI thought they were very high standards. As is managers who sign up to the standards, not their to the important aspect of disclosure it made individual funds. recommendations which were turned down flat. A key part of the unhappiness with hedge funds is that Q958 Mr Mudie: This is the trouble with hedge they are not that high. As in the case of private funds: we cannot get an exact figure for anything. V equity, they are the bare minimum to stave o Mr Baker: It is partly to do with the definition of government regulation. exactly what a hedge fund does. A lot of the Mr Shaw: We stand up to the hedge fund standards. standards have been employed by managers for It is not right for everyone, but I think you should quite a long period of time. There is a high degree of consider that in 2008 when people would have been overlap between the large body of work that AIMA doing their work to sign up to the hedge fund has been publishing for a number of years—we call standards the business issues and challenges that the them our sound practices—and the hedge fund market posed to hedge funds were intense. We were standards. A lot of managers believe that they are worrying about where our clients’ money was and already meeting the standards and therefore they are our risk on banks. seriously considering whether or not to sign up. One Processed: 25-03-2009 21:21:27 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG7

Ev 134 Treasury Committee: Evidence

27 January 2009 Mr Andrew Baker, Mr Douglas Shaw, Mr Chris Hohn, Mr Stephen Zimmerman and Mr Paul Marshall thing we are very keen to do in our discussion with Q965 John Mann: I was touched by hearing the international regulators alongside the discussion problems that you are suVering but pleased that all about potential disclosure templates, disclosures of you have mentioned transparency. I am sure you and actions on short selling is to come up with a set will want to send us a note giving more details about of sensible measures which a supervisor can your oVshore finances but also perhaps you would undertake when they come in to visit a manager. include in that details of how much you have earned Rather than lifting up these standards and dropping in the past three years so we can see the depth of the them into statutory regulation, or formalising them suVering. The submission of the Hedge Fund within the regulatory code book, they could Standards Board says that there is no need for the nevertheless become a very valuable checklist for the protection of regulators and the market will weed regulator to go through when they perform a out the mediocre. Let us take an example of one of supervisory visit. the mediocre: Merrill Lynch. Why have you not been weeded out, Mr Shaw, because you were at Merrill Q959 Mr Mudie: Sir Andrew who chaired the Lynch, or even you, Mr Zimmerman, because you working party must wonder why he put in all that were there as well? time. As the Chairman says, your PR is pretty bad, Mr Shaw: It is a market for labour and services and is it not? You are threatened with G8 regulation and if we serve the investors in our funds well we will quite commendably you say you will try to protect have a business. Like any other business if we do not self-regulation by having a code of standards. You do that we will be weeded out. We do not ask for work on that code for two years and you have 34 protection, government money or taxpayers’ signed oV. Do you not feel that the authorities will money; we are not asking for special privileges. Our say that these lads are just not serious? job is to serve our clients, help meet the objectives Mr Baker: I think it is very valuable that a lot of this they set us and do that to the best of our ability. stuV is now accepted practice and there is, therefore, There is no special magic in that regard. a template for discussion. A lot of the regulators are referring to these standards as part of the debate. If all of it was to be lifted up and put into statutory Q966 John Mann: If we look at the funds that get regulation I do not think the industry would object. into problems the mediocre seem to re-emerge. These are felt to be very commonsense standards. Mr Shaw: Funds do not go bust. They may lose money precipitously or unexpectedly; they may occasionally disappoint their customers, but they do Q960 Mr Mudie: Mr Hohn, why have you not not go bust. signed up? Mr Hohn: Our application is pending. We believe that we are largely compliant. Q967 John Mann: Where are the mediocre who have been weeded out? Q961 Mr Mudie: If you were an investment bank Mr Shaw: As to the number of hedge funds as would the requirement to disclose to the authorities reported by various hedge fund databases, the peak be higher or lower than it is now? was about 10,000 globally probably in the summer. Mr Hohn: I think that disclosures on positions are That number may be 7,000 and potentially on its the same as any investment bank. way to 6,000. Assets in the industry used to be reported at over $2 trillion and are now $1.3 trillion. Q962 Mr Mudie: Let me put it to you specifically. When we ask whether the hedge fund industry is Q968 John Mann: But the managers re-emerge regulated of course it is, but when you look at it elsewhere with diVerent hedge funds. closer the regulation is of the managers. Are you Mr Shaw: Only if their clients think they will give telling this Committee on the record that regulation them a good service. of a total hedge fund is the same as the regulation of a manager? In other words, there are parts of the hedge fund industry that are not regulated and you Q969 John Mann: Mr Hohn, three years ago Rolf simply regulate the manager. There are activities or Breuer of the German Stock Exchange stated that corners that are not gone into because you are the activities of hedge funds were challenging simply regulating the manager. I would welcome a stability and ripping the heart out of the economy. straightforward answer. Was he not right? Mr Hohn: Things like short selling disclosures are Mr Hohn: I do not think so. One of the problems in not captured. the system is poor governance by the boards of companies. In the case of the banks, for example, the Q963 Mr Mudie: No. boards lacked oversight of management. In the case Mr Hohn: The answer is yes. I was just giving an of Deutsche Bo¨rse we were exerting ownership rights example. as owners of the shares and naturally boards are resistant to that. Q964 Mr Mudie: What are you saying “yes” to? Mr Hohn: Yes, there are things that are not captured Q970 John Mann: But you exacerbate instability by by disclosure. definition? Processed: 25-03-2009 21:21:27 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG7

Treasury Committee: Evidence Ev 135

27 January 2009 Mr Andrew Baker, Mr Douglas Shaw, Mr Chris Hohn, Mr Stephen Zimmerman and Mr Paul Marshall

Mr Hohn: I do not believe that is true. It is important national ownership, were hedge funds. Therefore, that shareholders of companies are allowed to hedge funds are extremely diverse; they do not act in exercise their ownership rights. I think it is a very uniform ways and have diVering opinions about bad thing if there is no oversight of boards by where value is. shareholders as owners. Q976 John Mann: Would you like to reassess your Q971 John Mann: Mr Hohn, in July when statement about the “fantastic buying commenting on what he described as massive opportunities”, or have you secured them because dislocation in the financial system Mr Marshall said they will come within three weeks, three months or a that “it will create fantastic buying opportunities”, year but not longer? so you do exacerbate such problems, do you not? Mr Marshall: My time is running out. I guess that That is your raison d’etre? that statement is an example of bad PR if you take Mr Hohn: I do not agree with that. You cannot just it out of context. put everybody in the same bucket. Q977 John Mann: Would you like to apologise for it? Q972 John Mann: So, was Mr Marshall wrong in Mr Marshall: The people to whom I made those saying that the massive dislocation in the financial remarks were an audience of investors. system would create fantastic buying opportunities? Mr Hohn: It has also hurt a lot of hedge funds. As Q978 John Mann: But lots of people are losing their Mr Marshall said, the average fund is down by 18% jobs. Small businesses cannot get loans. Would you and many by much more than that. There are two like to apologise for that? sides to it. A lot of funds have been killed by it. Mr Marshall: I think people will welcome the fact that we are looking to invest in businesses. Q973 John Mann: When I go to the bookies there are always those who also lose regardless of how much Q979 John Mann: Mr Baker, you said on 10 March they hedge my bets. There will always be losers, but 2008 that a serious threat to the UK economy as a there are “fantastic buying opportunities”. Let me whole was taxation of non-doms. On which side of give you another example: the steel industry. Let us the looking glass were you when you said that? Is not assume that the management decides to play the oVshoring now part of the problem rather than the long game; in other words, to sacrifice short-term solution? profits for their shareholders by keeping on Mr Baker: My reply is that our industry is a huge employees and retraining them so they are well success. Financial services are a very important part positioned to benefit from the projected outturn in of the UK economy and the hedge fund industry two or three years’ time. For hedge funds generally within financial services is a great success story. Part on the basis of that logic they would be a prime of that success is built on the fact that it can thrive target, would they not? only if it attracts the very best talent around the Mr Zimmerman: I think that we are omitting the fact world. A lot of that talent is international. If a that there are many other investment vehicles regime is introduced—at the time I was talking around, long-only funds and mutual funds, that about prior the introduction of the non-dom levy— sell shares. there is a fear that given our industry is disproportionately dependent upon foreign Q974 John Mann: But Mr Hohn was accused of that professionals working in this country it would drive in relation to Deutsche Bo¨rse. The same logic—I do that industry away. We were not seeking special not suggest that it is his fund—of picking on a firm treatment; it was merely to say that we should keep that is playing for the medium term, some would in place a highly successful industry that depends on argue rationally in this case, that is, by sacrificing open borders and a level playing field when it comes shareholder dividends and keeping on labour to to the tax structure. benefit the outturn, would be a prime target for you to latch onto, would it not? Q980 Mr Brady: Mr Shaw, you said earlier that Mr Hohn: But we have never invested against hedge funds provided a way of reducing risk for intelligent long-term investments. We would investors. How do you explain the paradox that support that. there seems to have been a loss of confidence in hedge funds and such big redemptions at a time of Q975 John Mann: But a fundamental problem is that very high risk in other places for investors? when things are on the up in the global economy it Mr Shaw: Hedge funds have enormous investment will balance out in some way or other, but when flexibility with which to measure and manage risk, things are on the down the rational decision-making but they have been beset by a number of challenges: can be undermined by the whole mindset that is the credit issue, who their counterparties are and behind your industry? what risks they are taking upon those. They were Mr Shaw: Sometimes when things are on the down, successful in taking risk oV the table and reducing as you say, it is the hedge funds that are buying. We leverage overall in this banking crisis; they were should not forget that in the banking industry some reducing their short positions in UK banks going of the largest shareholders who were buying into into this financial crisis and the ban. The industry Northern Rock, which unfortunately went into has been beset by a number of challenges as have Processed: 25-03-2009 21:21:27 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG7

Ev 136 Treasury Committee: Evidence

27 January 2009 Mr Andrew Baker, Mr Douglas Shaw, Mr Chris Hohn, Mr Stephen Zimmerman and Mr Paul Marshall investors in the industry who in many instances have fund management business and started in this area required liquidity. Sometimes hedge funds regardless only in 2003/4. One thing I found was that the level of whether they have made or lost money are easier of questioning and due diligence was very high. to get out of than other investments they have made. Mr Shaw: Regulation is a two-sided coin. There is a There has been something of a trend of hedge fund crisis in the UK banking sector, but it is very highly investors selling hedge funds because they need regulated. London-based hedge fund managers are liquid assets for other purposes. highly regulated. The funds we manage, especially those oVshore, are very lightly regulated, but it is the Q981 Mr Brady: You have just been severely beaten highly regulated entities that are the cause of the by my colleague. I want to give you the opportunity issue, not the lightly regulated ones. to come out fighting. Would you make the case that this is a time when given the risk in the markets Q985 Mr Brady: To move to a rather diVerent point, people ought to be looking at hedge funds? it has been suggested that a lot of hedge funds now Mr Shaw: Hedge funds are very much counter- hold quite large amounts of cash because they have cyclical but they are very nimble; they can move their no other place to put it. To what extent do you think assets around rapidly and have more investment hedge funds could fill the gap that is being left at the flexibility. As we sit here today I am sure that some moment by the banks that refuse to lend? people are carefully reviewing the position in UK Mr Baker: You have to look at the amount of banks. You saw a spectacular increase in Barclays’ lending that may be required. By and large, hedge shares yesterday following the release of a statement funds do not engage in the sort of lending that we at the expense of many short investors in that stock. have been reading about as a requirement to kick- Maybe people will now reappraise UK banking start the economy. Hedge funds are a source of risk stocks as a marvellous opportunity. capital. If all the hedge funds were liquidated today one would have about $1 trillion available for investment. With their global remits that would be Q982 Mr Brady: But at the moment you are all spread across a very wide range of markets. saying that redemptions are advancing? Therefore, looking to hedge funds to solve the Mr Marshall: Yes. If I may add to that, possibly we particular issues in the UK economy is probably a are reaching a point where hedge funds will begin to stretch too far. enter the main stream. If you look at the investors in Mr Shaw: There is an increasing amount of interest hedge funds, up to 70% of them are now institutional by investors in bonds which are securitised loans. investors—pension funds, insurance companies and Therefore, there is some interest in the high yields so on. We have also seen the UCITS 3 framework currently available in the marketplace. which eVectively allows funds to use leverage and manage according to value at risk. You now have a Q986 Mr Brady: How much of the success of hedge fund framework which will allow certain hedge funds and their managers in the past has been based funds—the less complex ones—to be sold to the on leverage? How important is leverage to what retail market. I think that in future hedge funds will you do? increasingly become part of mainstream fund Mr Marshall: That is a very good question. I am not management in people’s understanding. aware of a study which seeks to break down the diVerent components of returns on hedge funds. Q983 Mr Brady: If the position of pension funds Undoubtedly, some part of the return was based on amongst your investors increases in scale does it not leverage and some on what we call alpha, ie the skill argue strongly for a far higher level of regulation, component. Because it is a Darwinian industry the which I suppose takes us back to Mr Zimmerman’s 40% or 50% of the funds that will disappear will be earlier point about the other regulatory structures those whose returns are heavily dependent on that are available for funds operating in the pension leverage and it is owed to investors that they should industry? Should you all be going to that regulatory get their returns primarily from alpha, that is, skill- model instead of the new one set up just a year ago? based investing. Mr Marshall: As fund managers we are regulated Mr Baker: Leverage has come down progressively. like any other in the UK. I believe that the pension fund investment in hedge funds will come primarily Q987 Chairman: Mr Marshall, did you say that through onshore vehicles and managed accounts hedge funds would go into the retail market? rather than oVshore vehicles. I do not believe that Mr Marshall: Not exactly. Hedge fund-like that will change the regulatory debate. strategies are now being made possible through the UCITS 3 framework to a limited degree; in other Q984 Mr Brady: Is that a common position? Mr words, you can use a limited amount of leverage Zimmerman, you made the point that you were through things like 130/30 funds and if you are already very heavily involved in pension funds and subject to volatility you can have a volatility therefore had a higher regulatory standard. framework where you can operate with leverage. Mr Zimmerman: Yes. One must not underestimate the amount of due diligence that is done by pension Q988 Chairman: The reason I ask that is that there funds and other counterparties on hedge funds is a high degree of disclosure in that market and it generally. It is very high. I grew up in the traditional treats customers fairly. That is a big, big step. Processed: 25-03-2009 21:21:27 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG7

Treasury Committee: Evidence Ev 137

27 January 2009 Mr Andrew Baker, Mr Douglas Shaw, Mr Chris Hohn, Mr Stephen Zimmerman and Mr Paul Marshall

Mr Marshall: Personally, I am very much in favour their customers fairly, but it cannot influence what of it because in the world it is uniquely a framework happens to the funds in an oVshore jurisdiction in where leverage limits are imposed. terms of direct investor protection.

Q989 Chairman: So, you are in favour of a massive Q995 Jim Cousins: Mr Baker, you see where this has step change in disclosure if that takes place? got us? Almost all the funds are oVshored and 30% Mr Marshall: Yes. to 40% of them are gated and their investors must rely upon the investor protection systems in oVshore Q990 Jim Cousins: We have heard that there are jurisdictions. Is that something with which you are 1,000 UK funds, not managers? comfortable? Mr Baker: That would be my guess. Mr Baker: The directors of any fund will realise that gating is a measure of last resort. The purpose of Q991 Jim Cousins: How many of those funds do you imposing a gate is not to hold onto the assets or think are closed in the sense that investors are being cause discomfort. The only reason for imposing a told they cannot get their money out? gate is that it has become very diYcult to treat Mr Baker: The imposition of gates? leaving investors fairly with the interests of those investors who choose to remain within a fund. Today Q992 Jim Cousins: Yes. we have concentrated on a lot of strategies that are Mr Baker: There is no precise information. I have accused of being short term and speculative, but a seen estimates that up to 30% or 40% of funds have large chunk of hedge funds invest long term in highly had to impose gates, but let us not forget that a gate illiquid assets. If there is a sudden flock of is very clearly disclosed in any fund’s redemptions no financial institution can withstand a documentation. A gate cannot be imposed if there is significant run on its investor base. not permission to do so within the fund’s byelaws. It is the directors of the fund, not the manager, who make the decision about whether or not a gate needs Q996 Jim Cousins: As we are discovering. to be applied. Mr Baker: Last week Lord Turner used the phrase “contractual maturity transformation”. Hedge Q993 Jim Cousins: I understand that, but I think we funds do not have contractual maturity both agree it is of some significance that gates, as you transformation; they are governed by their byelaws put it, may exist on 30% to 40% of funds. Reference and the gates are a very specific liquidity has already been made to the locations of funds management mechanism, but no manager would oVshore for tax purposes. How many of the 1,000 wish the directors of a fund to impose a gate because funds do you think are oVshore for tax purposes? potentially it threatens its business. Holding onto Mr Baker: I suspect that 100% of the funds are investors’ money is an absolute last resort; no one oVshore. When we talk about “tax purposes” again wants to do it. A number of people on this panel who we come back to my point about this being a global have the facility to impose those gates have chosen industry. Most funds attract investors from a variety not to even though it has led to severe redemptions of diVerent countries. The funds need to be in a form from their businesses. which creates tax neutrality for all investors going into that fund. If there are elements of double Q997 Jim Cousins: I should like to think about the taxation investors will not touch it. The reason that UK funds are by and large onshore is to prevent non- implications of all of that. Perhaps I may ask the UK investors being exposed to the UK tax regime. four practitioners the following question. Time does Mr Shaw: The funds are generally oVshore but the not allow us to go through this verbally. As far as assets of the funds, the bank accounts themselves, your hedge fund operations are concerned—I typically will be within the European Union or narrow it down to that—could you supply the America. Committee with some information about how the pay structures work? I am not asking what the pay levels are but how it is structured. What are the Q994 Jim Cousins: If the funds are oVshore what reward systems that trigger whatever pay people end implications does that have for investor protection? up with? If you could write to the Committee about We have already discovered a gaping hole in our that it would be more helpful given the time we system. People who have oVshored investments find have.1 Mr Hohn, you have been engaged in an that they are not protected as investors. Is that an eVort to use hedge funds to improve corporate issue for hedge fund investors? governance as you saw it. That is right, is it not? Mr Baker: An investor who wants to invoke his rights in terms of investor protection is obliged to do Mr Hohn: As part of their investments. it through the jurisdiction in which the fund is centred, so a large chunk of the hedge funds Q998 Jim Cousins: I am not trying to be horrible managed in this country is based in the Cayman here, but you even in your own eyes you failed, did Islands. The Cayman Islands has a legal and you not? regulatory structure very similar to this country’s. The FSA applies some degree of oversight because it 1 Treasury Committee, Banking Crisis, Written Evidence, wants managers to behave responsibility and to treat HC 144–II, Ev 499 Processed: 25-03-2009 21:21:27 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG7

Ev 138 Treasury Committee: Evidence

27 January 2009 Mr Andrew Baker, Mr Douglas Shaw, Mr Chris Hohn, Mr Stephen Zimmerman and Mr Paul Marshall

Mr Hohn: In what way? Mr Baker: We believe we employ about 40,000 people in this country. It is very hard to get hold of the tax figures but it is a significant employer. Apart Q999 Jim Cousins: In improving corporate from the benefits to marketplaces, it is a counter- governance. You have admitted failure in some of cyclical source of capital and the buyer of illiquid your statements. You feel rather frustrated that you assets at the margin and therefore there is eYcient were not able to use your hedge fund operations to price discovery. It supplies liquidity when other improve corporate governance? buyers are not available. Those are very esoteric but Mr Hohn: In some cases yes and in some cases no. technical issues that operate within markets. The benefit is fundamentally to investors.

Q1000 Jim Cousins: Would ABN AMRO be one of Q1004 Chairman: Are there any big stories about those cases? what you do as practitioners that you want to give Mr Hohn: Yes. I think ABN AMRO had a corporate us? governance problem. We thought that the wild Mr Marshall: We are part of the savings industry acquisition spree was value destructive. What which is a very significant industry worldwide but happened was that we put a motion on their AGM which generally around the world has not done a requesting the potential sale of the company and in a great job. We will do well or badly depending on democratic process, not driven by hedge funds, over whether we deliver stable and dependable returns to 70% of the shareholders in that giant company voted savers. That is ultimately our purpose. for that. They sensed that the board had failed the shareholders. In that example the shareholders did Q1005 Chairman: Thank you, Mr Marshall; you very well. have been very open. To sum up what I feel has come out this morning: first, in answer to Mr Mudie’s question you have less disclosure than the banks; Q1001 Jim Cousins: Mr Hohn ABN AMRO has second, large hedge funds are possibly destabilising landed up with the British taxpayer. Pray for us. banks by short selling, as I think emerged from Mr Mr Baker: Would it help to mention that last year Fallon’s questions; third, I think you all agreed there the OECD wrote a report which looked at the was a need to ban naked short selling; fourth, you impact of hedge funds and private equity on felt that there was a weak industry body and there is corporate governance? I am very happy to send you quite a long way to go there; and, fifth, as to a copy of that. disclosure, which was raised earlier and Ms Keeble has just picked up, you are waiting for the FSA to ask you for information. The question should be: Q1002 Ms Keeble: You have talked about regulation why have you not thought of what you can tell them and rules concerning the establishment of funds and and engage more closely in that disclosure? Lastly, the general principles and disclosure regimes. What you have a poor public image and you have a long you have not said—it came up frequently with the way to go. Is that a fair assessment, Mr Marshall? bank regulation—is how active the relationship with Mr Marshall: I did not agree with all of the the FSA is and how often it contacts you, the nature summary. You said that we were a weak industry of the scrutiny and the follow-up. Can you say how body. The industry body is AIMA. I think you were on a day-to-day basis the relationship with the FSA referring to the standards boards. as regulator works? Mr Baker: Perhaps I may describe just the general Q1006 Chairman: Yes, the Hedge Fund Standards structure and the experience will be diVerent for Board. each firm. Mr Marshall: The standards board has a slow uptake of its standards.

Q1003 Chairman: We went into the question of the Q1007 Chairman: Is it right that it is just like the FSA earlier. If you would write further to us on that private equity industry until it gets a rocket up it? it would be helpful.2 Have you shown what Mr Marshall: Frankly, I welcome this meeting economic value you add, except to your investors? because no doubt it will help to accelerate the Apart from making money for people what do you process of signing up to the standards. do? Chairman: You agree with that summation. Thank you very much. It has been very helpful to us and will 2 HC (2008–09) 144–II, Ev 499 feed in very well to our banking crisis inquiry. Processed: 25-03-2009 21:21:27 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG7

Treasury Committee: Evidence Ev 139

Witnesses: Mr Peter Chambers, CEO, Legal & General Investment Management, Mr Richard Saunders,Chief Executive, Investment Management Association, Mr Peter Montagnon, Director of Investment AVairs, Association of British Insurers, Mr Alan Grisay, Chief Executive, F&C Investments, Mr Antonio Borges, Chairman, Hedge Fund Standards Board, and Mr David Pitt-Watson, Senior Adviser, Hermes Equity Ownership, Hermes, gave evidence.

Q1008 Chairman: Welcome to the second part of of Mr Montagnon’s committee is telling the today’s session. Please introduce yourselves for the Financial Times that we did not do this, that it is a record. problem and we should be looking for solutions. Mr Chambers: I am Peter Chambers, chief executive of Legal & General Investment Management. We Q1011 Chairman: Mr Borges, you nodded when I are 100% owned by Legal & General Plc, the asked the question. insurance firm. Mr Borges: Chairman, you are absolutely right. We Mr Grisay: I am Alan Grisay, chief executive oYcer have learned a great deal in the past few months. of F&C Asset Management which is a company Corporate governance in financial institutions has listed on the London Stock Exchange. singularly failed. The responsibility of boards was Mr Saunders: My name is Dick Saunders, chief not properly carried out in many ways; risk was not executive of the Investment Management properly controlled. If anything we need more, not Association. less, investor activism. Mr Montagnon: I am Peter Montagnon, director of investment aVairs, Association of British Insurers. Mr Borges: I am Antonio Borges, chairman of the Q1012 Chairman: Mr Montagnon, with apologies to Hedge Fund Standards Board. you, but this is not personalised—you are a good Mr Pitt-Watson: I am David Pitt-Watson, a senior friend to me and this Committee—what about adviser to Hermes Pension Fund Management shareholder activism? Come on, let us get going. which is a fund manager and pension fund. Mr Montagnon: I think it is absolutely clear—we have said it—that we have not been as eVective as we might have been. This is not because there was no Q1009 Chairman: Mr Pitt-Watson, do you have any activity; there was a lot, some behind the scenes, but sympathy for shareholders who have lost out or feel it was not as eVective as it might have been. We need that their rights have been trampled on as a result of to look at that and make ourselves more eVective the part-nationalisation of a number of the UK and we intend to do that, but we also need to put this retail banks? in context. Just because we were not as eVective as Mr Pitt-Watson: I feel sorry for the ultimate we might have been does not mean that we caused shareholders in the damage that has been done the crisis or could have prevented it, but it is right generally in the recession because they are that we are players here and we have to improve pensioners and ordinary people like you and me. our game. However, we are where we are with the nationalisation and the question that the shareholders and their agents need to ask themselves Q1013 Mr Fallon: Mr Borges, to return to the issue is whether they were partly responsible for where we of the extent to which large hedge funds may pose a have reached. I note that yesterday the chair of the systemic risk, in your submission you say that ABI Investment Committee wrote in the Financial currently the standards board is looking into Times that there was a gap, that fund managers were behavioural standards. Therefore, there is a not carrying out their duties as good owners in problem, is there not? making sure the banks were behaving in an Mr Borges: No. We are reducing risk in the process appropriate fashion. I think there is a gap. This is of creating standards that will make this industry despite the fact that this Committee and others in the more reassuring so investors can have more past have sought voluntary codes of agreement to confidence in it. Therefore, we are trying to look at make sure that that governance would be carried every type of behaviour that will lead to this goal. We out. Therefore, I have great sympathy for the people do not want to react after crises happen but take whose pensions have been lost; I have a bit less preventive action if possible. Most of those measures sympathy for the people who are in my industry who are designed precisely to engage with regulators, to should have done more to protect the interests of create a scale of action that will evolve as problems those whose money they managed. become more serious and, therefore, to adjust to the severity of the circumstances. Q1010 Chairman: The question to be asked is: where were Mr Montagnon and his crew? Were they posted Q1014 Mr Fallon: But you say that a run on hedge missing in terms of ensuring there was good funds can cause large-scale forced selling in the shareholder value? For example, two years ago the markets and concerns arise if there are perverse Royal Bank of Scotland’s price per share was 589p; incentives to redeem early or in excess of what people yesterday it closed at 15p. What is the state of want to redeem, forcing hedge funds to be more shareholder activism in this country? liquid than they should have been. Mr Pitt-Watson: I have lots of praise for Mr Mr Borges: Precisely. One of the issues we are now Montagnon and what he does at the ABI, but we are researching and on which we are in intense still scratching the surface. In relation to the sorts of discussions with the FSA is precisely the best regimes problems at the banks shareholders were not for redemptions. We do not want a run of hedge blowing the whistle. I welcome the fact that the chair funds; we want to protect every investor in hedge Processed: 25-03-2009 21:21:27 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG7

Ev 140 Treasury Committee: Evidence

27 January 2009 Mr Peter Chambers, Mr Richard Saunders, Mr Peter Montagnon, Mr Alan Grisay, Mr Antonio Borges and Mr David Pitt-Watson funds. We do not want investors who redeem early to Mr Borges: I do not think so. We have already be privileged. Therefore, we are trying to put in place contacted about 120 fund managers. I point out that standards that will deal with this threat. of the 400 fund managers based in London there is a core that represents the vast majority of the industry. Q1015 Mr Fallon: But if you want to improve A very significant number of fund managers are behavioural standards those standards must have fairly recent; others will disappear rather quickly. been wanting in the past and presumably there has This is an industry that evolves quite fast, which is been some malign activity in the markets? one of its great attributes. If people do not perform Mr Borges: No. It is true that what has happened well they disappear quite rapidly. New funds and over the past few months has taken many of us by managers emerge with the idea that they can be surprise. Three or four months ago nobody would better and innovate. In that sense it is an industry have expected MadoV to have happened. That also that meets investors’ demands and survives forces us to make our standards even tougher in the according to their success and performance. We have sense that we do not want crises like these ever to focused on the core, that is, the more stable funds happen again if we can prevent them. In the same that have been in operation for a while and represent way, when the redemption regimes were put in place the long term, whilst we also try to attract as far as nobody expected the kind of massive redemption possible the smaller funds. Of the core, I argue that that has been taking place. Because that creates a until now only five have told us they are not threat to the model on which the industry operates interested. Some of them have told us they are not we want to discuss how to deal with it. interested because they think our standards are not tough enough for them, whatever that may mean. Everybody else has said they are interested but they Q1016 Nick Ainger: Mr Borges, a senior consultant want more time. This is a lengthy process that to your organisation, Thomas Deinet, said in consumes resources to be in compliance and this is September that signatories were rolling in and the not really the right moment to make big investments. total number of hedge funds committed to the standards would be announced in September prior to the first HFSB conference on 15 October. In the Q1018 Nick Ainger: But if in a period where previous evidence session we heard that the number everyone is focusing on standards and regulatory of hedge funds to sign up now totals 34 out of over compliance you cannot persuade the hedge fund 1,000. Would you describe that as a success? What is industry as a whole to commit to what is in eVect your definition of “rolling in”? self-regulation do you not accept that you have Mr Borges: First, let me clarify that Thomas Deinet completely failed in your concept of self-regulation is executive director of the Hedge Fund Standards and standards within the industry? Board, so he is very much in charge of this process. Mr Borges: I make two points. First, I do not think Both he and I were nominated in July. In the period we have any problems in persuading people that this up until July the standards were defined through a is important. Only a very small number of fund broad process of consultation which took a great managers have said they are not interested; deal of time with a deep study of the legal everybody else is, and I assume they will join shortly. implications of the whole exercise, and it was in July I do not underestimate the time and eVort required that we began to unfold the eVort to get signatories. to join because the standards are quite onerous and Our goal was to get about 10 funds per month. That complying with them is a serious responsibility. process started very well; funds started to join Second, this is not self-regulation but building on according to what was expected, and I would call FSA principles. We have received a great deal of that an early success. The process slowed down quite support from the FSA which believes they are an a bit after the crisis became extremely serious, extremely helpful way to deal with the problems of because at this point many fund managers are telling the industry precisely because we are rooted in FSA us they are quite interested in it but they need to take principles; we extend FSA regulation in a way that time; it is a serious process that involves resources. makes verification by investors easier, which is our At the moment they are so concerned with survival whole point. that they have to postpone everything else. But we have been getting between five and 10 every month Q1019 Nick Ainger: Let us move on to the standards. which is what we wanted when the process started. The HFSB operates on a comply or explain basis. How do you respond to those who say that Q1017 Nick Ainger: But 14 of those 34 were already essentially it is toothless? It appears that some of the on the working group, so presumably all of those hedge funds have told you that already and that is were virtually automatically signed up. Since your the reason they have not joined up. If it is deemed to involvement we have had 20 sign up. Is it not an be toothless firms are basically able to carry on as indication that the industry does not want to before. At what point do you start to take any participate in the standards board? Bearing in mind action? the bigger picture and it is now acknowledged by all Mr Borges: First, I think it has been made clear by parts of the financial services sector that we need the previous session that one of the great advantages better and, in certain areas, more regulation, the of London as a financial centre is the quality of its hedge fund industry appears to be flying in the face regulation. I would argue that one of the important of the move towards greater regulation? components of that is the comply or explain Processed: 25-03-2009 21:21:27 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG7

Treasury Committee: Evidence Ev 141

27 January 2009 Mr Peter Chambers, Mr Richard Saunders, Mr Peter Montagnon, Mr Alan Grisay, Mr Antonio Borges and Mr David Pitt-Watson principle which is admired by many investors who this would not have been possible; it would not have think this is exactly the way to go. That is a happened. distinctive feature of our approach and one that we very much hope to maintain. It is not toothless at all Q1022 Ms Keeble: You said that you approached because the whole point of our approach is that 120 hedge funds of which 34 agreed to join and the investors are in charge. Our role is to make that rest for diVerent reasons did not. Have you kept a channel more eVective and give more power to record of the firms and their responses and their investors to control what is happening in the hedge approach towards you and regulation? fund industry. That is the whole purpose of the Mr Borges: Yes, because we are in constant contact standards. In that sense we believe this is far more with them. The only ones we are not talking to are eVective and powerful than other forms of the four or five who have said they are not interested. regulation which perhaps are very prescriptive but Every other one we talk to virtually every week to do not operate. The current crisis shows that the verify how much progress they are making and how regulation of the banking sector, however soon they will be able to join. prescriptive it may be, has failed and it is appropriate to consider whether comply or explain and investor Q1023 Ms Keeble: Are you prepared to disclose that due diligence is a more powerful mechanism to to the Committee so we know the attitude of the achieve the results we want. diVerent hedge funds? Mr Borges: I am certainly prepared to disclose the response we are getting from the hedge fund managers. Q1020 Nick Ainger: Of the 34 hedge funds that have now accepted the standards how do you monitor Q1024 Ms Keeble: The 120? those and what sanctions are there if firms are found Mr Borges: Not one by one; that would be a little not to be complying? diYcult. I would have to verify my records. I do not Mr Borges: The whole point of our approach is that always talk to them myself, but really there is they are monitored by the investors. The standards nothing to hide. are supposed to provide investors with a guide by which they will be able to verify whether or not the Q1025 Ms Keeble: Can we have the information so standards are being applied. This is not an industry we know the diVerent hedge funds that have been that operates on the basis of small investors. These approached and their attitude? large investors—pension funds, insurance Mr Borges: Very good. companies and so forth—have a great deal of expertise which they can exercise in their due diligence process to find out whether or not these Q1026 Ms Keeble: Is that information routinely standards are being met. The point of our eVort is to shared also with the FSA? provide hedge fund managers with a set of standards Mr Borges: The FSA has not asked this question. It which they announce to the world they will meet and follows our progress steadily. I remind the that facilitates the investor due diligence process and Committee that the FSA has explicitly supported raises the whole industry to a diVerent level. our approach on several occasions including some very formal speeches by the chief executive.

Q1027 Ms Keeble: In terms of your best practice standards, you said that it was down to the investors Q1021 Nick Ainger: The due diligence which has to monitor it, but do you not yourselves do some been shown by major institutions, for example those monitoring of how far they are complying with your caught up in the MadoV scandal, was not very good. standards? What gives you confidence that these standards will Mr Borges: No, we cannot do that; we are not in the be able to prevent a MadoV repeat? For example, process of enforcing standards. We are a very tiny everyone expected that major banks would have had organisation whose main responsibility is to keep the the resources, both financial and personnel, to carry standards up to date and induce managers to sign out due diligence. Clearly, they did not and MadoV up. is a very good example of that. Mr Borges: MadoV is probably the best example of why we need something like our standards. If our Q1028 Ms Keeble: Does the FSA do any monitoring standards existed in the US the MadoV fraud could of your standards and how far the hedge funds not have happened, or it would have been extremely comply with them? diYcult to carry out. MadoV operated with Mr Borges: FSA has indicated that for fund complete integration of the whole activity from managers that adopt the standards they will custody to brokerage to management to evaluation certainly verify the extent to which they are being and administration. It was all under the control of followed. It will be an important part of their one person and that made possible the kind of supervision process. fabrication of statements and mis-information that went on and prevented due diligence from Q1029 Ms Keeble: Are the 34 that have signed up discovering any kinds of results. With our standards being actively monitored by the FSA? Processed: 25-03-2009 21:21:27 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG7

Ev 142 Treasury Committee: Evidence

27 January 2009 Mr Peter Chambers, Mr Richard Saunders, Mr Peter Montagnon, Mr Alan Grisay, Mr Antonio Borges and Mr David Pitt-Watson

Mr Borges: They are actively monitored by the FSA Mr Borges: I am not sure I can give you a precise in any case.3 answer because it is constantly changing depending on the agenda. Currently, we have two main Q1030 Ms Keeble: On your standards? objectives: one is to promote more convergence Mr Borges: Exactly. With those standards the FSA because that will help the global industry; the other now has an additional instrument to verify at what very important one is to promote the London level they operate. If you allow me to quote the chief approach to regulation, which is not even met in the executive of the FSA, “FSA will take compliance United States—the regulation of hedge fund with these standards into account when making managers in the United States is way below our supervisory judgments.” standards, which is why MadoV happened—and persuade the Europeans that that approach is far Q1031 Ms Keeble: You have said in your better for the whole of Europe than anything else memorandum to us that you stand ready to co- they may come up with. operate and identify areas where refinement and adaptation of current regulation may be needed. Q1036 Ms Keeble: Both you and the hedge fund Can you identify those areas for the Committee? managers who were here previously talk about Mr Borges: A very obvious one is fund responsibility to the investor. Do you not accept that administration where we recommend independent with the amount of money being moved around very third-party administration. We may make that quickly there is a major responsibility to the public standard a little tougher in the context of the MadoV because of the impact on the economy and that is scandal. That is a very obvious example which is on what justifies our concerns about tighter regulation? the table right now. We may also recommend some Mr Borges: I think we all operate on the behavioural changes when it comes to redemptions assumption—certainly the hedge funds tend to do as discussed earlier. These standards are very much so—that the goal is to benefit the broad economy. alive and we shall be adapting them to our How do we benefit the broad economy? We do so by experience. having proper financial markets that operate with maximum stability but also maximum eYciency. Q1032 Ms Keeble: So, it is just in those two, Beyond that, I think the discussion becomes: how do administration and redemption, where you would we achieve that goal? Is it through more intense or recommend specific regulation? prescriptive regulation or through the comply or Mr Borges: We are recommending that our explain and private sector initiative process? This is standards become more specific or concrete. where the debate may arise. I argue that so far we However, our standards cannot be changed every have shown that our approach is probably superior. day; there is a lengthy consultation process before we put anything in place. We do not change them every week; maybe we will be doing it once a year. Q1037 John Mann: Mr Saunders, in your submission you make reference to investors not Q1033 Ms Keeble: Maybe? bothering because they are over-reliant on credit Mr Borges: Depending on what we experience in the rating agencies. Is that because they are lazy or thick markets and if new problems teach us new lessons. and cannot understand the complexity of what they are buying, or is it a lack of transparency? Q1034 Ms Keeble: You have also said that you are Mr Saunders: In some parts of the market there is an prepared to contribute to the discussions around over-reliance on credit ratings. I think in particular global convergence. Obviously, international of the sorts of mandates that pension funds give to regulation around the financial services industry is managers which constrain them as to what they can particularly important. Can you say what your invest in, say investment grade securities as contribution to the discussion would be and what designated by a credit rating agency. That is one kind of regulation or tightening you might reason why we were party to some guidance recommend? published before Christmas, along with the Mr Borges: There are two levels. First, we contribute European Securities Forum and the European Fund a great deal to European regulation. I am one of the and Asset Management Association. That gave best members of the Committee of European Securities practice guidance to fund managers. One of the Regulators. There is a market participants panel of matters to which we drew specific attention was that which I am a member and to which I try to if one was given a mandate by a client to invest only contribute to the best of my ability. in securities of a certain credit rating one should draw the client’s attention to the risks inherent in Q1035 Ms Keeble: It is very clear that there are lots that. Most major fixed income managers such as my of discussions, meetings and thought, but I want to two colleagues here have major inhouse research know what are the specific contributions and departments and would not rely on credit rating recommendations. agencies at all but on their own due diligence and judgment. 3 Witness correction: The FSA monitors only UK based hedge fund managers. Managers from abroad, for example Germany, or Spain, fall under the regulation/supervision of Q1038 John Mann: Would it help if some of these their respective local regulators. funds were brought onshore rather than oVshore? Processed: 25-03-2009 21:21:27 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG7

Treasury Committee: Evidence Ev 143

27 January 2009 Mr Peter Chambers, Mr Richard Saunders, Mr Peter Montagnon, Mr Alan Grisay, Mr Antonio Borges and Mr David Pitt-Watson

Mr Chambers: Most of the funds we manage are that episode where something like 150,000 trades onshore, so from my perspective I do not think it simply failed to go through when Lehman collapsed. makes much diVerence. Credit rating has three We felt that the FSA could have put more resource components. First, as Mr Saunders points out the and attention into the problems faced by investors. mandates given to investment managers are generally determined by credit rating, so it is a standard thing; it is independent and it will be Q1043 John Mann: Is it a problem of their judgment investment grade or better or worse. It is the same or resources, skills or lack of power? for placing money with banks. There is deemed to be Mr Saunders: I think it is a bit of both. an independent judgment that grade A1 or better is a suitable place to deposit money. It is an independent thing set by clients. Second, the credit rating agencies Q1044 John Mann: Not enough resources? themselves got themselves horribly conflicted in two Mr Saunders: There are not enough resources. types of business. At the same time as they were rating banks and counterparties they also started to rate diVerent parts of paper particularly in Q1045 John Mann: They could do with more collateralised debt obligations (CDOs). Some of resources? those tranches were in short and it with the test of Mr Saunders: And more of the correct resources. I time it seems that that did not fare very well. Part of do not think they fully grasped immediately the the problem that exacerbated the bank issues early import of the situation. on in the process was the failure of some of these Mr Pitt-Watson: When one thinks about regulation, types of operations. There was a clear failing in we need to recognise what we have seen is a systemic credit ratings in that distinct sense. Third, do we rely crisis (ie one which aVected the whole system), but on credit rating in terms of the only judgment to regulators who tend to be in their own wormhole make when investing in a particular credit? No, we (that is, a single part of the system). For example, do not; we do our own work, but clearly it is a piece there were big knock-on eVects from the way we of information that is in the public domain and has were preparing international accounting standards some worth. and it’s eVect on the way we calculated the solvency of banks. If I was to criticise the FSA it would not be Q1039 John Mann: Would you be more concerned if for their resources or skills but they needed to look you were looking at an oVshore rather than out of their wormhole (bank solvency) and recognise onshore fund? that the numbers generated by new international Mr Chambers: I do not believe it makes an awful lot accounting standards were hugely pro-cyclical and if of diVerence. It depends on the oVshoring. For anything went wrong suddenly in bonds markets, example, if there is a UK gilt fund that is managed there would be insolvent banks. We need to have onshore as opposed to oVshore there is no diVerence someone who is overseeing the whole chain of in the way the manager will manage; it is just a regulation because right now it does not fit together. diVerent regulatory background.

Q1040 John Mann: Mr Saunders, are the regulators Q1046 John Mann: The Hedge Fund Standards over-reliant on stories in the media to determine who Board has said that hedge funds rely on they should be examining? sophisticated investors who do not need the Mr Saunders: I cannot speak for the regulators. protection of regulators. These investors impose very high standards of performance on the industry Q1041 John Mann: What is your opinion? and weed out the mediocre. Do you feel that the Mr Saunders: I do not think so. The media play an mediocre are being weeded out? Is that an accurate important role in putting information before the statement? whole market. On the question whether the media Mr Saunders: I think it is an accurate statement. Let should show self-restraint during periods of market us take the example of MadoV. The vast majority of instability or whatever, I do not think there is a case the investment management industry steered well for special rules. One would have concern where clear of MadoV. market abuse is involved and somebody is using the media to try to move the market in a particular direction, but the FSA has very strong powers to Q1047 John Mann: But everyone is saying that deal with market abuse and as far as I am aware MadoV is a total exception and it could not those are suYcient to handle that situation. happen here. Mr Saunders: It is possible for a UK investor to Q1042 John Mann: In your opinion is the FSA invest in a US hedge fund, so it is a real issue. The under-resourced, under-skilled or insuYciently option of investing in MadoV was open to all hedge empowered in terms of doing what you would want fund managers in the UK. it to be doing? Mr Saunders: We can take the Lehman collapse as an example. We would have liked the regulator to do Q1048 John Mann: Can you give other examples of more to step in to protect the interests of investors in the mediocre that have been weeded out? Processed: 25-03-2009 21:21:27 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG7

Ev 144 Treasury Committee: Evidence

27 January 2009 Mr Peter Chambers, Mr Richard Saunders, Mr Peter Montagnon, Mr Alan Grisay, Mr Antonio Borges and Mr David Pitt-Watson

Mr Saunders: I cannot by name. Q1054 Mr Mudie: You cannot have it both ways. You bring forward standards and say, quite rightly, Q1049 John Mann: Can anyone? that they have been subject to consultation and have Mr Borges: I can. Even in the best years, for example been accepted and you will adhere to them. Thirty- the early part of 2007 or 2006, dozens of hedge fund four members of the industry accept them. You managers closed down simply because their cannot look an investor in the eye and say that the investors were abandoning them. This is the nature rest accept them because they have refused to sign of the industry. up, or they have yet to sign up. The worrying thing that transfixes the Committee is the lack of transparency and the fact that you put money into Q1050 Chairman: In the MadoV scandal Santander something, are treated so oVhandedly and you do lost £2 billion; HSBC lost £668 million and RBS lost not know what on earth is happening. There is really £400 million, a total of £1.2 billion. Where was the no process and no standards that are accepted due diligence of the banks, Mr Pitt-Watson? throughout the industry. Clearly, we have a problem. Mr Pitt-Watson: As Mr Borges has said, I do not think it would be easy to pull oV the MadoV scandal Mr Borges: I do not think so. You have to take into in the UK. It is extremely surprising that people who account that this is now developing. If in one year’s put in these sums of money did not note that there time we still have 34 there will be good reason to was no separate custodian holding on to the assets worry. My conviction is that you do not need 100% that MadoV held, that MadoV was audited by a firm acceptance. These standards will become the norm of three auditors who appear to have a close and the litmus test is when every investor asks every connection with him and that it involved £50 billion. fund manager to conform with the standards. This must surely have raised questions. Q1055 Mr Mudie: You cannot say that; that is of no Q1051 Chairman: The point is that whilst it is said comfort. Darwin said that we evolved, and look how MadoV cannot happen in this country here we have long it took. Pension funds and individuals are banks who are losing money and it is the UK losing money; we just cannot wait for the industry to taxpayer who must pick up the bill for it. evolve. You and your colleagues have quite rightly Mr Pitt-Watson: Indeed. put some standards on the table. For some of us they may not be enough but at least it draws a line. You Q1052 Mr Mudie: You have said it could not have two fingers up from the rest of the people in the happen. Mr Borges, when it did happen you were industry. Where in the hell does that leave us? It quoted as saying that the scandal highlighted just leaves us as politicians with a problem but investors how important it was to have an independent are also left with a problem. You have spelt out the process in relation to administration of the fund and problems in the industry and the industry has shown its valuation. It also highlighted the need for robust in turn that it is not willing to do anything about it. governance practices and oversight and independent That leaves investors not knowing who they can and boards that challenged management procedures and cannot trust. behaviour. Those are your words, are they not? Mr Borges: What will make the process accelerate a Mr Borges: Yes. great deal is when investors demand the standards on the part of managers to be in place. I think the Q1053 Mr Mudie: You follow it by saying: “Hedge hedge fund industry has also evolved in a Darwinian fund standards are designed to address exactly these sense and our standards are designed to accelerate issues.” If the hedge fund standards are designed to that process rapidly. Our standards are designed to deal with these issues what sort of commentary is be imposed by investors, and as soon as investors that on the state of the hedge fund industry before make them a requirement you will see a sea change. your hedge fund standards are accepted throughout We are in that process right now. the industry? Are you saying to us that all these things are happening and, if so, how can you say to the Chairman that MadoV cannot happen here? Q1056 Mr Mudie: I am unconvinced. Mr Mr Borges: The hedge fund standards are designed Montagnon, your response to the hedge fund to become the norm and in that sense to make sure standards consultation document was very that every fund manager if possible adopts them and worrying; it was that there were a number of areas in every investor knows when making his decisions the report which could have been given more explicit whether a manager has or has not committed to consideration or greater emphasis. These are to do those standards. Clearly, the standards are what they with the quality of disclosure as to the investment are because in Britain some of these best practices objectives of funds, better reporting of the actual have been put in place over the years and we now risks being run through leverage rather than have a much better tradition particularly on the issue generalised discussion of the risks that leverage of separation of functions and responsibilities and poses and so on. My first and only look at the quote third-party involvement. This has evolved in Britain was late last night, but there was a reference in it to over the years precisely because there are principles- the eVect that they had not accepted your based regulations, comply or explain and respect for consultation return which suggests that that is less investors. than satisfactory. Processed: 25-03-2009 21:21:27 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG7

Treasury Committee: Evidence Ev 145

27 January 2009 Mr Peter Chambers, Mr Richard Saunders, Mr Peter Montagnon, Mr Alan Grisay, Mr Antonio Borges and Mr David Pitt-Watson

Mr Montagnon: First, we applaud the hedge funds the other—of all the banks to ask about capital, for putting these standards on the table. We believe because it was clear following the problems faced by that it is a move in the right direction and we want Northern Rock that risk profiles were quite high and to support them in that because it is very helpful we could be comfortable with that only if there was when an industry produces standards. It is true that suYcient capital in place. All of them to an when our members considered them it was felt that individual said there was no need to raise other some of the elements to do with disclosure and capital. Indeed, one of the major banks was very transparency were not where they would like them to adamant. We asked them under what circumstances be, and we very much hope to be able to work with they would need more capital and the response was the Hedge Fund Standards Board to bring that up to that there were no circumstances under which they speed. At the moment because in part we are not in would need it. That was six weeks before the rights that position I do not see investors being quite ready issue. We then saw a number of banks straight after to do the monitoring role that the board would like the rights issues, because, quite frankly, all of them them to do. When we are in that position I think the had given an indication that they did not need this standards could be extremely useful, but I do not capital. In a number of cases, particularly the Royal think that invalidates the eVort so far; I just think we Bank of Scotland, we suggested that the heads of the have a bit further to go and we are happy to go on companies were no longer tenable and the chairmen that journey with them. and chief executives should both depart, though not at the same time because that would not be Q1057 Mr Mudie: That is a very civilised and quiet constructive. We gave that message to the chairman. answer. What you are saying is that your worries We did not give him his own message; we spoke to about disclosure and leverage have not been dealt the senior independent director. We also spoke to the with but, ever the optimist, you believe that you will chairman and the independent director twice on that evolve and deal with them some time in future. It is subject. We were told that that message would get pretty worrying from an investor’s point of view that back to the board and we demanded action on it. We your organisation raised these important points and were then told that there would be action and we they were not accepted in the final document. would be pleased by an announcement at the end of Mr Montagnon: I would prefer to be quiet, civilised August. At the end of August they announced three and optimistic because I believe that in discussion we new non-executive directors but said nothing about can get it to move further in the direction we want. the chairman and chief executive. We engaged again Mr Mudie: You may be optimistic but that does not and the only way in which the chairman and chief help an investor to take a decision when entering this executive stood down at all was by the government opaque world. requiring it as part of the capital-raising episode. The question is: did we engage enough? I would like to think we did. Why were we not listened to? I am Q1058 Sir Peter Viggers: I should like to ask about not sure I can answer that question. Should we do the involvement of shareholders. Let us begin with more, and how can we do more eVectively? I am not Mr Chambers. I suppose I should declare an interest sure I know the answer to that but I shall be very in that Legal & General manages the investments of happy to have a debate. a pension fund of which I am chairman. Has the recent turbulence in the markets revealed that shareholders and even assiduous investors who try Q1059 Sir Peter Viggers: Mr Grisay, how much to take an interest in companies’ aVairs are still resource do you devote to shareholder engagement? pretty toothless in influencing those companies? Mr Grisay: This is an area where we are very Mr Chambers: Our investors fall into two parts: proactive. We believe that we have to exercise those who vote with their feet and those who are shareholders’ rights. We have about 15 people engaged with corporations. Those who vote with engaged full time in analysing what companies are their feet simply sell their shares; they do not like doing and preparing our response to that. That is in what they see and they go. In our case most of the addition to about 180 fund management money we manage is in index tracking funds, so we professionals who take those views into have to track index. If the stock is in the index we consideration. I can confirm to you that we were have it, so we are not able to vote with our feet for very active last year, for example in the context of the bulk of our funds. It is very important to us that British banks. To give you an idea, in the course of we do engage. The past 12 months have been a the past 12 months we have had five meetings with particularly sobering period for us in seeing whether the board of RBS, five meetings with some board or not our engagement has been eYcient and members of Barclays and nine meetings with HSBC. eVective. You can form your own judgment on that. Most of what we do is private engagement. We try to I will give you a couple of numbers. During the avoid making public statements with a view to avoid course of the past 12 months we had 26 separate destabilising the companies with which we engage. engagements with the senior directors of the major However, we are quite transparent about what we banks, so it is one every other week. I consider that do. You can check on our website on a monthly basis to be quite a high level of engagement. It was those companies with which we have been engaging relatively evenly spread through the year. In the first and exactly what we have been doing with them. On quarter we met with the chairman/chief executive— an annual basis we publish a very comprehensive in some cases it was both and in some cases one or book, with which I am more than happy to provide Processed: 25-03-2009 21:21:27 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG7

Ev 146 Treasury Committee: Evidence

27 January 2009 Mr Peter Chambers, Mr Richard Saunders, Mr Peter Montagnon, Mr Alan Grisay, Mr Antonio Borges and Mr David Pitt-Watson you, that describes all the engagements we have had investors in the public domain. The other group of throughout the world with a number of companies people who have line of sight are the banks and our activities. Looking at what has happened, themselves and their executive directors and above could we have done more? Yes. In retrospect perhaps that the non-executive directors. One would have to we should have been even more aggressive in conclude that the non-executive directors were not engaging some of these companies and maybe eVective in controlling the activities of the executive voting. directors; otherwise, we would not be where we are now. Q1060 Sir Peter Viggers: You have been active but perhaps there is a question mark over your Q1063 John Thurso: Do you think that that is eVectiveness. Mr Montagnon, in your memorandum particularly so for big financial institutions and it is you have talked about the fragmentation of so complex that the part-time good old boy network investments and said that some groups are less cannot deliver people who are capable of making a concerned. Whom do you have in mind? judgment? Mr Montagnon: One of the features of the market in Mr Chambers: I think that is right. These companies the run-up to the boom was that there was a much are global and quite massive. A lot of the banks still stronger presence of people whose interests were have balance sheets in excess of £1 trillion. They are mainly trading rather than ownership. To some very substantial bodies with which to get to grips. extent that diluted the ability of long-term owners to My view and that of my firm is that non-executive obtain the changes they might have been seeking directors should be more involved and devote from time to time. considerably more time to each non-executive position they hold. Therefore, they should be Q1061 John Thurso: I want to go back to the rewarded for it and, for want of a better expression, question of corporate governance. Before I do so should be able to do a much deeper dive into perhaps I may draw attention to my entry in the companies, speak to people and review businesses Members’ register of interests because I am a further down to get a more all-round view. director of a plc and also chair its remuneration Therefore, they can act as representatives of committee. Mr Saunders, do you concur with the shareholders and other stakeholders on a more comments of Lord Myners the implication of which eVective basis than the way it has worked in the past. is that the non-executives of the banks were culpably I would favour non-executive directors having fewer negligible in the way they behaved and in their posts, spending much more time in each one, being failure to get a grip? much more involved, delving down much deeper and Mr Saunders: I would not endorse the words being appropriately rewarded for it. “culpably negligible”, but non-executive directors along with all other parties—auditors, shareholders Q1064 John Thurso: I want to turn to remuneration and so on—did play contributory parts in the crisis structures. Much has been said about the fact that if that has unfolded over the past year and a half. In you have a short-term remuneration structure you relation to shareholders and non-executive directors, will encourage short-termism in activities. One of the there is a hierarchy of information. As shareholders submissions we have had, from memory that from my colleagues would have no greater access to the ABI, talks about the dangers of short-term information than is available to the market as a investment and the fact that good investment is whole. Obviously, the non-executive directors will about going into a company and staying with it. Is see much more; they will see board papers and so on there a need to have a thorough look at the whole and will have greater access to the state of the way in which board level and senior executive company. remuneration, particularly in financial companies, is handled? Is the current regulation of remuneration Q1062 John Thurso: In a rights issue one of the committees just not up to the job? things required is a going concern statement and that Mr Montagnon: There is a distinction between the is something that is exercising all boards in this normal remuneration of executive directors in listed reporting year. There would have been one produced companies and what goes on in the banks. Because for the rights issues. It is very diYcult to see how the of the nature of banking and the cyclical fluctuation comfort of the going concern statement matches the in revenues you will tend to get reliance on variable reality of what happened subsequently and quickly. pay in banking. That will lead to risk to the business Is that not a matter of concern? Are these non- if it is not properly managed because people will executives capable of doing the work we believe we seize the opportunity to get a bonus. We would say have asked them to do? that this is not necessarily the job of a remuneration Mr Chambers: It is a diYcult set of circumstances. committee whose job it is to look at the The banking industry is a regulated one and we remuneration of the board. It needs to be considered invest in it as such. There is a price to pay for that by the entire board in terms of its impact on the risks regulation. Therefore, one would expect that to the business. For that reason I think it would be regulation to be at least reasonably eVective. Of all useful if there was some reporting on it in the outside people the regulators have the first line of business review where the company talks about the sight in seeing what goes on in the banks. They have general risk to the business. I think it would be information that is not accessible by the rest of us as helpful if the regulator looked into this. Processed: 25-03-2009 21:21:27 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG7

Treasury Committee: Evidence Ev 147

27 January 2009 Mr Peter Chambers, Mr Richard Saunders, Mr Peter Montagnon, Mr Alan Grisay, Mr Antonio Borges and Mr David Pitt-Watson

Q1065 John Thurso: What you are really saying is Mr Pitt-Watson: Is that a question to me? that the remuneration structure for the people below the board is a major risk to the business if it is not Q1070 Chairman: It is a summing up. conducted properly? Mr Pitt-Watson: I am cautious about regulation. Mr Montagnon: It may be. Q1071 Chairman: It needs a solution? Q1066 John Thurso: It could distort the business and Mr Pitt-Watson: I think it needs a solution. therefore the whole board ought to discuss it as part of the risk management process? Q1072 Chairman: What is the solution? Mr Montagnon: Yes. Mr Pitt-Watson: We need to get responsibility and Mr Pitt-Watson: I should like to add one comment accountability into the system and regulation is part on the question of shareholder engagement. I am of that. To me, one of the problems in this crisis is very impressed by what other fund managers round that everybody who was a market participant said, the table have done. If one is looking at shareholder “As long as it is not regulated against I can do it.” engagement I am sure there has been a lot of it with That will not work; what will work is that the banks in the past year, when these issues have been regulation should provide some minimum but in the public eye. But a good deal of the issues we are beyond that people need to behave responsibly and looking at were building up in the business model in therefore they need to be accountable for the way those banks over many years. Whether or not we had they behave. If they do the wrong thing it is made the right people on the board: remember that we as known. fund managers approved everybody who was to go onto the board and also the remuneration schemes Q1073 Chairman: Maybe the regulator needs to ask for the boards. We needed to do that before more questions. September 2007 when the Northern Rock crisis Mr Saunders: On the question of regulation, there is arose, as well as after that period. I guess my a good case in point if we go back to MadoV. There question would be: how do you make sure that are a number of funds in Luxembourg which have shareholder engagement is happening so there is not very substantial exposure to MadoV and a good a crisis rather than how is it that shareholders many retail investors in both France and Germany respond once it arises? have lost a lot of money as a result. That is not the case in the UK. The exposure of the UK retail fund Q1067 Chairman: What you are saying is that this management industry is indirect and negligible. One has been a massive failure of corporate governance? of the reasons for it is that within the UK we have Mr Pitt-Watson: There has been a failure in adopted a super-equivalent piece of legislation to the corporate governance. I believe that if 18 months UCITS directive which is the requirement that the ago we had all scratched our heads people would depositary who oversees the fund manager is in a have looked at a lot of the things we are looking at completely separate group from the fund manager now and recognised there was a problem and himself. That is not a requirement in, say, perhaps something ought to be done about it. I Luxembourg where in one case UBS was both suspect we did not do that because of some of the depositary and manager. That is a piece of super- reasons that have been talked about, namely we are equivalent regulation which can protect investors. all very disparate and primarily a lot of us are trading shares rather than undertaking the task of Q1074 Chairman: I am trying to sum it up so I can being good owners of companies. let you go. Mr Montagnon: If we do need more regulation we Q1068 Chairman: The MadoV case showed that need to look at what purpose it serves. Regulation there is relevance for it in the UK in that MadoV had would be helpful insofar as it creates a framework three auditors. One was a long-term friend from and incentives for operation of the sort of chain of college days and another was a relative, but investors accountability to which Mr Pitt-Watson referred. in the UK did not do suYcient due diligence. Mr Pitt-Watson: In terms of the funds which put Q1075 Chairman: We agree that there was a market money with MadoV, clearly there is an issue. failure. Whatever the solution we have to find it. We could say that the politicians are the legislators. Q1069 Chairman: This morning has been very When a market failure has been identified I am just helpful. To sum up, investors are supposed to carry a wee bit anxious when I hear you say that we should out due diligence and there is regulation by use of the not give you more regulation. There is an issue here. Hedge Fund Standards Board but we still have a way Mr Borges: You are absolutely right to say there to go with that. The recent crisis has shown how due have been market failures in many segments of the diligence even by the most sophisticated investors financial system but not in hedge funds. The hedge can be a second order priority to getting a slice of the fund approach is that those who fail bear the pie and that indicates a market failure by investors. consequences. That is not market failure. It is too short term and therefore it needs a Chairman: We have identified market failure. Do not regulatory solution. upset the applecart. Thank you very much. Processed: 25-03-2009 21:32:21 Page Layout: COENEW [SE] PPSysB Job: 416782 Unit: PAG8

Ev 148 Treasury Committee: Evidence

Wednesday 28 January 2009

Members present

John McFall, in the Chair

Nick Ainger Ms Sally Keeble Mr Graham Brady Mr George Mudie Jim Cousins Mr Mark Todd Mr Michael Fallon Sir Peter Viggers

Witnesses: Mr Robert Hodgkinson, Executive Director of Technical Strategy, Institute of Chartered Accountants in England & Wales, Ms Helen Brand, Chief Executive, Association of Chartered Certified Accountants, Mr Paul Boyle, Chief Executive, Financial Reporting Council, Professor Prem Sikka, Professor of Accounting, University of Essex and Professor Michael Power, Professor of Accounting, London School of Economics, gave evidence.

Q1076 Chairman: Welcome to this session on because exercising their responsibility to make sure auditors and credit rating agencies. Can you the numbers are right is something which is central introduce yourselves, starting with Professor Sikka. to the purpose and everything else relies on that. Professor Sikka: Prem Sikka, Professor of There is perhaps a feeling that six or seven years ago Accounting, Essex Business School, University of they had lost sight of that. Essex. Professor Power: Michael Power, Professor of Q1079 Chairman: If they have lost sight, what can Accounting, London School of Economics. we do, Mr Boyle? Mr Boyle: Paul Boyle, Chief Executive, Financial Mr Boyle: In his answer Mr Hodgkinson was saying Reporting Council. that six or seven years ago they had lost sight of that, Ms Brand: Helen Brand, Chief Executive, ACCA. but as a result of the reforms put in place a few years Mr Hodgkinson: Robert Hodgkinson, Executive ago, following the Enron scandal which this Director at the Institute of Chartered Accountants Committee investigated six or seven years ago, there in England and Wales. has been a significant refocusing within the audit firms on the importance of audit quality. In part that Q1077 Chairman: You are all welcome. We have has come from the existence now of an independent three sessions this afternoon of three-quarters of an regulatory agency,the FRC, which is focusing on the hour each and we want the maximum out of each auditors’ attention to audit quality and the attention session so we are going to ask short question and we has improved in recent years. That does not deal want short precise answers and we will get that with the fundamental questions about whether the information on the record. Can I start then. Do you audit is focused on the right things. Auditors are think auditors asked the right questions of bank currently focusing on what Parliament has asked finance directors over the past few years? Professor them to focus on. It is possible to change that role, Power? but that really is a second question which we might Professor Power: I think we have to backtrack and come to. ask ourselves what the purpose of an audit is. An audit is to determine and evaluate the quality of the Q1080 Chairman: It seems to me the answer is, financial statements. Whether the right questions Professor Sikka, that auditors are doing the right have been asked of finance directors should be seen thing focusing on it, but meanwhile we have banks in that broad context. That is to say, it may not be going down the sink and if that is the case what do reasonable to expect that auditors would be we need to do? Do we need to throw the auditors out challenging business models directly and raising or keep the auditors and bring other new people in? strategic issues with finance directors, that is not If everybody has done their job, why are we in this their job and if we want it to be their job then things situation? would have to change quite substantially. Professor Sikka: My feeling is we need a fundamental change in accounting and auditing. If Q1078 Chairman: Does an auditor have a duty of you look at bank accounts, not a single bank has care other than to the bank, to other interested given us any figures at all about any company’s parties: the FSA, the lender, suppliers, customers, specific assets, liability, income, expenses, credit the general public? default exposure, derivative exposure, information Mr Hodgkinson: The purpose of an audit in statute is simply not there at all. The auditors are too close is clearly addressed to the shareholders as a whole to companies. They get their fees from the and in some of the work that my Institute has been companies, therefore they cannot really bite the involved in bringing stakeholders together to talk hand that feeds them. If the FSA is to liaise with about audits, through the Audit Quality Forum, auditors that creates too many problems. The focusing on that essential purpose of the statutory auditors claim confidentiality on their working audit is something which auditors have been papers and the FSA has basically been operating encouraged to do over the past six or seven years blind, assuming that the auditors would alert Processed: 25-03-2009 21:32:21 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG8

Treasury Committee: Evidence Ev 149

28 January 2009 Mr Robert Hodgkinson, Ms Helen Brand, Mr Paul Boyle, Professor Prem Sikka and Professor Michael Power anybody to any risks, any problems. Our system has average of the income of an audit firm came from really fallen apart and the underlying idea that non-audit services to audit clients, that percentage is commercialised accounting firms, as I put it bluntly, now down around 14%. one bunch of commercial entrepreneurs, can somehow regulate another bunch of commercial Q1086 Mr Fallon: You are avoiding my question. It entrepreneurs, that is company directors, that kind is perfectly possible for there to be some non-audit of model is broken, it cannot work. It has not services that are, in fact, quite closely related to the worked because what we have seen in the current audit. crisis is within days of getting a clean bill of health Mr Boyle: That is correct. from auditors many banks have simply collapsed. We are often told that the market has taken note of audit reports. What we have seen here for the first Q1087 Mr Fallon: What we have been asking for and recommending is a clear distinction between audit time is markets saying, “We do not believe a word V the auditors have told us because all the assets, work and comfort and securitisation work that is o liability, numbers are unbelievable”. Audit reports the balance sheet. You are telling us that is have been totally discounted, financial statements continuing and you are happy for it to continue. have been totally ignored, which has generated a run Mr Boyle: The view we have taken at present is that on Northern Rock and many other banks. is not inconsistent with the independence of the auditor. Q1081 Mr Fallon: A year ago, Mr Boyle, we drew Q1088 Mr Todd: I am just digesting that exchange attention to the fact that the auditors of Northern which I must admit has left me alarmed. Can I just Rock had been paid substantial sums for providing pursue it a little further because I noted some comfort letters for the securitisations oV the balance apparent dissent on this panel at your remarks, Mr sheet that they themselves were auditing and we Boyle. I think you are dissenting, Professor Sikka, is urged you to do something about it swiftly. What are that right? you doing? Professor Sikka: Yes. Mr Boyle: We have indeed taken note of your report and we are nearly complete with our review of the ethical standards for auditors. In five or six weeks we Q1089 Mr Todd: Would you like to expand on will be publishing some proposals to amend the your dissent? standards. We do not think the standards were Professor Sikka: My view is very simple: we have fundamentally inappropriate but there are a couple many kinds of audits in the world we live in, whether of respects in which they could be clarified, it is at airports through the passport controls or specifically in relation to securitisations. health and safety or food hygiene, and in no case are the auditors allowed to act as consultants or advisors to the auditees, the financial audit is here out on a Q1082 Mr Fallon: Would it still be possible after this limb. These kinds of problems you are raising have review for a bank’s auditor to be paid for providing been documented since the 1970s. comfort letters for securitisations oV the balance sheet that itself has been paid to audit? Mr Boyle: It will still be possible, yes. Q1090 Mr Todd: Can I just check whether Mr Boyle is on his own here or that you share his views or that of Professor Sikka? Q1083 Mr Fallon: Why is that? Mr Hodgkinson: Can I oVer the views of the Mr Boyle: Because we do not judge that this Institute. We think that the issue of independence is fundamentally impairs the independence of the one which naturally causes concern. It is the first auditor. port of call. I think we need to recognise that having looked at this as the first issue which was discussed Q1084 Mr Fallon: You are quite happy that the same back in 2002/03, it was very thoroughly examined as firm can be paid for the oV balance sheet stuV as is to whether there should be the kind of blanket bans auditing the balance sheet itself, because we are not? of the sort that are talked about, and the very firm Mr Boyle: In the case of the vehicles that were used conclusion, for example, out of the Co-ordinating by Northern Rock, the Granite vehicles, they were in Group on Accounting and Auditing matters was fact consolidated on to the Northern Rock balance that blanket bans were not appropriate. We wholly sheet. They were on balance sheet in the group support the approach on threats and safeguards that accounts of Northern Rock. is now embodied in the Auditing Practices Board’s independently set standards. Q1085 Mr Fallon: Is it the case with the five major banks that the auditors of those banks have also Q1091 Mr Todd: Let me just move on to what I was been paid for non-audit work of this kind? going to ask about which was whether people have Mr Boyle: I cannot say in detail what each of the unrealistic expectations of auditors. I think this firms have been paid but, yes, each firm receives fees conversation has possibly indicated that one of the for a variety of services. The proportion of non-audit expectations of auditors is that they should make the services has been steadily declining in the last six best money out of a particular client that they can years. It was the case that in 2000 around 38% on selling whatever services they might. Is that fair? Processed: 25-03-2009 21:32:21 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG8

Ev 150 Treasury Committee: Evidence

28 January 2009 Mr Robert Hodgkinson, Ms Helen Brand, Mr Paul Boyle, Professor Prem Sikka and Professor Michael Power

Mr Boyle: I think that is an unfair statement. There Mr Boyle: There absolutely is scope for that review. are prohibitions on services that the auditors may or may not provide and they have a fundamental Q1094 Mr Todd: Because clearly you are not looking obligation and, indeed, incentive to retain their at it with great sharpness so maybe policy-makers independence from their clients because the whole should? value of an audit comes from it being an independent Mr Boyle: We are operating within the framework expression of opinion. If it is an expression of that is currently set out in the law but if you look at opinion which merely rubber stamps— the role of the auditor it is worth looking at it in the context of the broader picture of the financial crisis. I think the most thoughtful and comprehensive Q1092 Mr Todd: I understand that, but if we are analysis that I have seen of the crisis was that set out going to address the issues that I think concern the by Lord Turner in his recent speech. If you look at public here about how risks that have since the range of forces that he identifies that have been crystallised appear not to be identified by audit building up over a number of years, he admits there activity, one of the assumptions that many members that no-one, neither the regulators nor the of the public might make is that the intimacy of that government, put the whole picture together so it is audit group to the management of that company not surprising that the auditors did not spot the prevented proper critical analysis and engagement. problem. It is not their responsibility to do that. Mr Hodgkinson: Can I just make an observation Ms Brand: The problem around expectations might Y lie more in the expectations of what information an about the quality review. This rea rmation of the directors’ responsibility to shareholders having audit is actually going to deliver to the market and I regard to other stakeholders is something that think that is where the expectations gap that has occupied us from 1998 to 2006 in the Company Law been talked about is really the issue. It is the clear Review, so it has recently been exhaustively understanding of what an information audit will and discussed and the auditors’ duties just follow from will not deliver to the market. Where we might make that model of how directors owe duties. improvements, going back to an initial question from the Chairman, I think that the whole issue of risk management is one that could be improved Q1095 Chairman: Do you want to make a point upon for all aspects, including the auditor, and the before we move on? analysis of risk around the low likelihood/high Professor Sikka: I am very sceptical of what the impact risks that are on all our registers but are not institutions are saying here. The FRC has been articulated fully is an issue and that is something that basically asleep on the job. Northern Rock was the the auditor, and all the other stakeholders involved warning, that did not result in FRC scrutinising in the risk management of an enterprise, need to take banks’ accounts and so on. Bear Stearns and a closer look at. Lehman Brothers went bust with a gearing ratio of Mr Hodgkinson: Can I just make an observation 30 or 33:1, Lloyds TSB as at June last year had a about your comment that of course independence is gearing ratio of 34.1 which meant just a 3% change an important driver of quality in what the public in its assets which means it is bankrupt. I do not would expect, but a lot of work has been done, again recall the FRC taking any initiative to scrutinise since 2002/03, to consider quality. There is an Audit bank accounts or anything else. We heard about Quality Forum which I have referred to, but the ethical codes. The last ethical statement issued by the FRC has developed an audit quality framework Auditing Practices Board was drafted by a after exhaustive consultation which says you have to committee consisting entirely of the big four look at the culture of a firm, you have to look at the accounting firm representatives and nobody else and quality of the audit partners and the staV, you have the whole thing is a charade, it has very little to say about ethics at all. At best these statements merely to look at the processes they adopt, you have to look regularise the relationship between the accountancy at the quality of their reporting and other factors, for firm and their clients, there is little that is ethical in it. example related to the governance of the entities they are auditing, which all drive quality. So although independence is an important aspect of Q1096 Chairman: Okay. Professor Power, do you many of those aspects and drivers of quality, I think want to say anything? it is a little bit disheartening for those who are Professor Power: I think there are some serious committed to quality in the firms and the regulatory issues, Chairman, about ethics and independence structure that everything seems to focus on but I think that issue is a complete red herring. I independence. If you are independent that does not would be disappointed if one of the conclusions of enable you on its own to deliver a great audit. this Committee was to tinker with those arrangements. I think the real action is elsewhere and it is down to the operational side of the audit process: what is it that auditors know, what is it they Q1093 Mr Todd: I think one of you has already do, what is it they are capable of doing, who do they remarked about the legal framework within which rely on in order to carry out their work. I think if we you operate. Is there room for policy-makers to open the black box and have a look at that, there are review how this operates, the relationship between some very interesting questions to be asked. I think audit and the customer? the independence issue is a soft target. Processed: 25-03-2009 21:32:21 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG8

Treasury Committee: Evidence Ev 151

28 January 2009 Mr Robert Hodgkinson, Ms Helen Brand, Mr Paul Boyle, Professor Prem Sikka and Professor Michael Power

Q1097 John Mann: How significant a problem is expected and the past where, indeed, it would have going concern status for auditors and for banks, had these self-fulfilling prospects. Are we talking Mr Boyle? about the past or are we talking about the future? Mr Boyle: I think it is a very significant issue and it Mr Hodgkinson: Can I just make a comment there in is one that I know is getting a lot of attention both relation to the present circumstances because there in bank boardrooms and amongst audit firms at the are two aspects of the banks and going concern. First moment. If I may, Chairman, while I have got the of all, there are the banks’ own financial statements floor, I should just correct there is a factual but then there is the potential role the banks play in inaccuracy— using the financial statements of the rest of the economy. The Institute has been trying to draw a lot Q1098 Chairman: Do not go on too long because we of attention to the issue of how banks themselves are taking evidence from diVerent people. This is not respond to references to going concern in their a debate between yourself and Prem Sikka. clients’ and their customers’ accounts which is Mr Boyle: There were some factual inaccuracies in crucial and they play a role in this in both providing his statement about whether or not we are looking at information to help directors prepare their financial bank financial statements. It is a very important statements and then responding. There needs to be issue and it is an issue on which both directors and awareness within banks that they are people who auditors are going to have to exercise judgments. I give information which helps people prepare do not think there is anyone in the country who can financial statements and we are trying to avoid a say with certainty that all of the banks will still be disaster which would arise if banks themselves were trading in 12 months’ time. No-one can know with not aware of their crucial role in the going concern certainty. We understand now that the range of basis being applied throughout the economy. possible outcomes is much wider than we previously understood, so judgments have to be made on the Q1101 John Mann: One final question, Helen Brand. basis of such evidence that is available. You said a few moments ago that auditors had a duty to the market. Is there a duty to the consumer Q1099 John Mann: What is your judgment about the and the general public equally? potential impact of adverse audit opinion on the Ms Brand: In statute the duty is to the corporate banking sector? entity and that is to the shareholders. Mr Boyle: I think it would be potentially very serious but, on the other, hand there was at one time a belief that no-one should talk about the going concern Q1102 John Mann: That is not the market. issue on the basis of the self-fulfilling prophecy, that Ms Brand: I do not think I said there was a duty of if it was talked about then disaster would certainly care to the market. follow. I do not think anyone would be surprised now if in a bank’s financial statements the directors Q1103 John Mann: You did, yes, and I wondered say, “As you will all be aware, there is a credit crunch why. at the moment and our funding position is less Professor Sikka: There is a real issue here about certain than it has been in previous years but we are what exactly an audit is for. What we are hearing is working diligently, taking into account all the that auditors might know that a bank has financial actions that the Government is taking in this country problems but they do not want to tell anybody. We and in other countries to address the position”. I came across this scenario after the BCCI collapse think it is far better now that people in their financial and the US Senate Report noted that the auditors’ statements disclose the fact that there are silence was directly responsible for losses to about uncertainties but nonetheless, having made a 1.4 million depositors. Auditors are paid a lot of judgment, they feel comfortable that they are a going money to make judgments and if they find concern and the auditors then have to make a something they have to tell, simple as that, there is judgment about whether the disclosures made by the no point in keeping quiet, that does not forewarn the banks are satisfactory or not and if they are not regulators or the public, that is their duty. They are satisfactory they have to pipe up. simply hiding behind the fact, I think, that they do not want to upset their clients. Q1100 John Mann: Are you comfortable that your approach to this is suYciently clear to auditors? Mr Boyle: I am very comfortable that the approach Q1104 Nick Ainger: In response to earlier questions is suYciently clear. I think bank directors and from Mr Fallon and Mr Todd, following reports of auditors all understand their obligations in relation the run on the Rock you basically indicated that to this. Of course, we at the FRC are not party to the there had been very little progress at all in addressing discussions that are currently taking place between the conflict of interest issue. In the same paragraph auditors and their banks but in the course of our we made another recommendation and that was that audit inspection work during 2009 we will certainly further assurance should be given by auditors to be looking at this issue. shareholders in respect of risk management Professor Power: I think we should distinguish processes of a company, particularly where a clearly between the current period when everyone is company is regarded as an outlier. Has any progress on red alert and the going concern qualification is been made in responding to that recommendation? Processed: 25-03-2009 21:32:21 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG8

Ev 152 Treasury Committee: Evidence

28 January 2009 Mr Robert Hodgkinson, Ms Helen Brand, Mr Paul Boyle, Professor Prem Sikka and Professor Michael Power

Mr Boyle: That is a recommendation which would on a desk, can take us to where we are now, how you dramatically extend the scope of auditors’ have oversight over that kind of specialism is a very responsibilities. It is a change which could only be specific kind of management and audit or assurance made by statute and the legislators would have to task. I am not convinced that audit, as it is currently give very careful consideration to the law of constituted, is fit for that task but it is one that we unintended consequences in making a change of that need to visit in some sense. sort. It is not the role of the auditors to report to the shareholders on the quality of risk management Q1106 Nick Ainger: You are accepting that there is practices in a firm, that is simply not what they are a real issue here that has to be addressed. asked to do. It is not clear to me that they are well- Professor Power: Absolutely. placed to do that, competent to do that, and it would have a significant impact. We would also have to be Q1107 Nick Ainger: But you are saying perhaps it is careful if we chose to extend that responsibility to not the actual auditors who should be doing it. Who auditors in the UK, which would be a radically should be doing it, the FSA? diVerent practice to that adopted in other major Mr Power: I think we have to re-think what that role international centres, what the impact of that would would be, what the nature of oversight is and what be on Britain’s position, so that would be a very kinds of skills would be appropriate for passing significant change and it is not within the power of judgment on that. The opportunity here is to do the FRC to make that change, that would be a what you rarely have a chance to do and that is statutory change. start again. Mr Hodgkinson: Could I supplement that answer by Mr Hodgkinson: I have to say that without starting saying that in 2004/05 the ICAEW supported the again there is already a regime, section 166, which FRC in doing a review of the requirements for listed can be used by the FSA to trigger work on areas of companies and internal control, the so-called systems and controls that might concern them, so Turnbull Guidance and at that time there was a there is a mechanism. question as to whether the UK should follow the Professor Power: I still think we should start again. United States in having auditors reporting on the Professor Sikka: One of the problems is that the eVectiveness of internal control over financial financial regulators like the FSA do not have access reporting. At that point there was a resounding “no” to the organisations and their management in the from across the UK. I think you might say in present same way and on the same regular basis as the circumstances should we revisit that? We might, but current financial auditors do. This was one reason I think it is important to note that in the US where why I was suggesting that the audits of banks really those requirements have been in place then the need to be conducted by the regulators on a quality of financial reporting has held up, there have continuous basis, with complete access to been very few restatements or withdrawn sets of everything, so that they themselves can weigh up the accounts, as in the UK, but it has not prevented risks. If audit firms were to do that kind of task their financial institutions and corporates in the States profit motive would always intervene and that from getting into trouble because the focus of that motive would always stop them from asking certain reporting was entirely on accounting controls. If you questions and reporting certain matters. My feeling start to get into a far wider field of all the risk related is that accountancy firms are a barrier; they to strategy, it is, as Paul said, transformational in themselves are part of the problem in this particular terms of the role of the auditors and the costs. function and they really need to be removed from Ms Brand: I do think—this is not talking about this role. This role has to be taken by the external—there is a role for internal audit here where regulators—that was one of the original proposals that could come more to the forefront. I think the when the SEC itself was being formed in the 1930s, conversations between the internal audit function recognition that you cannot get private business to and external auditors could be more comprehensive regulate another private business. in seeking to look at the risks which have been identified within an organisation, so you are more likely to get useful information from that type of Q1108 Nick Ainger: Coming back to your point very conversation. shortly, Chairman, what you are saying is in the States auditors do have this function but it has not really changed anything. Professor Sikka is saying Q1105 Nick Ainger: Professors, have you got a view that this should be a responsibility of the regulatory on this? authorities; would you agree first of all that there is Professor Power: Yes, I have. Like the other a significant issue that has to be addressed and that witnesses, I would be very sad to see a Sarbanes- if it is not auditors then it should be the regulatory Oxley type system come into play. I think the authorities? questions are quite simple for me. What additional Mr Hodgkinson: Thank you for the chance to just roles are needed to tackle the causes of what clarify briefly. In the States there is a responsibility in happened? Should auditors be doing them? I think relation to financial reporting. I am not saying it has my answer is there are some additional roles around had no eVect but financial reporting and the risk and risk management. I think the whole reliability of the numbers does not seem to be the question of how boards of directors have oversight issue here. We are talking about wider risk over 20 year old PhDs in maths who, three of them management that is not addressed in public Processed: 25-03-2009 21:32:21 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG8

Treasury Committee: Evidence Ev 153

28 January 2009 Mr Robert Hodgkinson, Ms Helen Brand, Mr Paul Boyle, Professor Prem Sikka and Professor Michael Power reporting in the States or here, but I am saying that across the grain of that client relationship. If I may in these wider aspects of risk there are mechanisms say, I think it is time to revisit that relationship for reporting to the regulator now, for between regulators and auditors to see whether a commissioning special work, and it might be richer set of arrangements can be put in place for worthwhile looking at whether that possibility has information exchange, not just between regulators been used as fully as it might have been and whether and auditors but maybe even between the Big Four there is some benefit of reviewing how that has been themselves. working. Q1113 Mr Mudie: Do you not think in terms of Q1109 Mr Mudie: Just continuing the same theme, banks with system risk we should perhaps think of it is clear from the papers that have been put in by special arrangements that link the regulators to the yourself, by KPMG, that the role or relationship auditors as a matter of course so that even if there is between auditors and regulators has changed. There the happy relationship where the auditor is doing is reference to a diVerent relationship with the Bank other jobs and there is all this concern, the fact that of England when they were the regulator and a they would have to automatically involve the diVerent way of operating. I pick up from your regulator would answer that question to some evidence where it refers to “an ad hoc arrangement extent? with the FSA”. What was put on the record for us, Professor Power: I personally think that should be what was the situation in the old days with the Bank explored; the regulators would have to raise their of England and what has happened since? Then I game to make that relationship work. would like to just pull you forward to try and reconcile diVerent views on what should happen. Q1114 Mr Mudie: I got your paper and as I am What was the old arrangement that might have reading an important sentence I realise my staV have prevented this debacle? not photocopied the end of it, they have left a page Mr Hodgkinson: It is worth recognising that the out. whole risk assessment approach of the FSA is Professor Power: It probably does not matter. diVerent from the Bank of England which had those responsibilities before, but my understanding is that Q1115 Mr Mudie: You say: “The Basel Committee under what was referred to as section 39 of the (2002) developed some general principles . . . ” What Banking Act there would regularly be tripartite did you say after that because it is an important meetings between banks, their auditors and the point on the relationship with banking supervisors? Bank of England to talk about work they had Professor Power: The others can help me here. There commissioned under section 39, the management is high-level guidance about how that relationship letter, the financial statements and so on and, under can be conducted. adiVerent regime that now exists, those meetings are not quite the same and there is a diVerent focus and emphasis. We are not saying there is a magic Q1116 Mr Mudie: When you were both speaking to solution, it was just something to look at as to Nick about it you said you would be in favour of whether we can learn from recent experience. taking a starting point as section 166 or something and you said you would start with a blank piece of paper. Is that irreconcilable? Q1110 Mr Mudie: Professor Power, would you like Professor Power: I am social scientist; I just want to to speak on that? find out what happened. Professor Power: These are private exchanges if they take place so the first thing we—whoever we are— have to do is find out how those exchanges have Q1117 Mr Mudie: That is in terms of investigating happened. but in terms of the way forward; you would like reform and you see the basis of reform starting from this clause, you felt you would like to rewrite the Q1111 Mr Mudie: What did happen in the past whole thing. where there seems to have been a better relationship Professor Power: No, that is not what I said. between auditors and regulators? Professor Power: I am not in a position to answer Q1118 Mr Mudie: What did you say then? that question. Mr Hodgkinson: I was saying we start from where we are and see whether we can improve it. Q1112 Mr Mudie: What is happening now then? Mr Mudie: Tell me what you said then, as I You refer specifically to it: “The question of when an misunderstood you. auditor might report directly to regulators on Chairman: I think you said you would start again. matters of concern has been widely debated and remains a source of tension.” Can you explain what Q1119 Mr Mudie: Start with a clean piece of paper you mean by that? you said, a blank piece of paper. Professor Power: It is the tension between client Professor Power: On the question of providing confidentiality and the public interest, and the assurance about risk management arrangements exchange of information with a regulator which cuts and oversight I would start again, not so much in Processed: 25-03-2009 21:32:21 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG8

Ev 154 Treasury Committee: Evidence

28 January 2009 Mr Robert Hodgkinson, Ms Helen Brand, Mr Paul Boyle, Professor Prem Sikka and Professor Michael Power terms of the relationships that you are talking about appropriate and timely. There is a lot of looking in but in terms of what is oversight and what is it to the black box and if you are somebody in an audit have confidence that it is operating successfully. firm you are very much aware of the Audit Inspection Unit that operates under the FRC. Chairman: It sounds like the declaration of innocence the hedge funds managers gave us Q1120 Mr Mudie: Lastly, you suggested we should yesterday, but there we are. Graham. look at the lessons after examining the period of the financial crisis and how the relationships worked. This is a politician’s way of doing it; in the field is Q1123 Mr Brady: Just taking a step backwards, is it anyone or any organisation actually doing a study of a problem that so much audit is conducted by four what has been happening between the auditors and big firms? the regulators through this period? Professor Sikka: There is a related issue: I do not Mr Boyle: Probably not, yet, but it could be done. think the Big Four accounting firms are fit to There is already a statutory gateway which exists conduct public watchdog functions. In my which allows the auditors to breach their normal submission I have highlighted how they have been rules on client confidentiality to talk to the regulator, involved in running cartels, tax evasion, bribery, Y and those conversations between the auditor and the corruption, many other things; it is di cult to see regulator take place in private because both of them how such entities can actually deliver the public are bound to operate in private. There is a factual interest function. Maybe that is one of the reasons question, which I do not think any of us has the why people in the market chose not to believe the benefit of knowing the answer to, as to how many of unqualified audit report when auditors were saying those conversations are taking place, but in the end all is well and the marketplace were saying “We do we will come back to the fundamental question that not believe you because you have a particular kind if you want to change the behaviour of banks you of a track record.” The domination of the firms is need to ask the FSA to do that because they are the also important in other ways, they dominate the banking regulator and the role of the auditor is to regulatory functions. When you look at the setting report on the truth and fairness of the financial of auditing standards, domestic or international, statements. Those roles are complementary, but they internationally the International Audit Assurance are fundamentally diVerent. Standards Board is the creature of the Big Four firms—it is funded by them. You can look at any auditing standard and one thing you will not find in there is anything about the accountability of the Q1121 Chairman: Just finishing up here, Professor firms themselves, that has been organised oV the Power, you said in response to a comment from Prem agenda, and FRC acts more as a cheerleader rather Sikka that independence is a red herring and we need than a regulator for the big firms. It has really failed. to delve into the black box; can you delve into that black box for us in the next minute? Q1124 Mr Brady: Without starting a debate, FRC, Professor Power: Very quickly it gets to the heart of Paul Boyle, you wanted to comment as well. the expectation issue. Auditors are reliant on a Mr Boyle: If I may. The answer to your question is number of external sources in order to be able to yes, it is a concern and it is a concern that we have function. They are reliant on market prices for been speaking out about for the last three years. assets, credit rating agencies and so on and so forth There are risks that we are all exposed to because we and, very importantly, they rely on management, have only got four firms capable of auditing the and if management is not doing its job or misleads largest global companies. These firms are fragile the auditor or does not know what is going on in the Y economically and you could have a very serious bowels of the organisation it is very, very di cult to situation; that is why it is important that legislators expect the auditor to do better. The direction of my carefully review the rules that get in the way of new comment is that we might be expecting too much entrants of scale entering the market. This is a from this black box in terms of what it actually serious problem and at some point there could be a delivers. It delivers assurance in conjunction with a diYculty. I do not want anyone to say we were asleep whole series of other things working well at the on the job because we have been talking publicly same time. about this for the last three years, including with the European Commissioner, who has responsibility for the relevant law. This is an important issue which we Q1122 Chairman: Do you want to add to that? should not lose sight of. Mr Hodgkinson: Before saying it is a complete black Ms Brand: We support that view and we have box it is worth saying that over the past six years we welcomed the proposals of the FRC as they have have introduced a fundamentally diVerent come forward. inspection regime of audits, so the actual conduct of the audit is now rigorously assessed by the Audit Q1125 Chairman: Professor Power, your point Inspection Unit and their reporting last December about PhDs in the banking industry reminds us of was that UK audit was fundamentally sound and at the financial products that we were examining when least when they were looking at the early stages of we asked the chief executive of an investment bank the credit crunch the audit firms’ responses had been when he came here if he could explain a CDO and he Processed: 25-03-2009 21:32:21 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG8

Treasury Committee: Evidence Ev 155

28 January 2009 Mr Robert Hodgkinson, Ms Helen Brand, Mr Paul Boyle, Professor Prem Sikka and Professor Michael Power said it was not his job to come and explain it. That to do with the continued availability of audit are so was left to the smart people with the PhDs, just a important that someone needs to pay attention to small number of people in the bank, on that issue. that issue. That is the aspect that worries us and the theme is Professor Power: Auditing is one part of a very wide coming out here today. You said in your report to us and complex network of institutions which produce that “financial auditing may only work as designed trust and stability in an economic system, and I do in an orderly and non-stressed world.” If you know not think we understand well the inter- a non-stressed household tell me that but a non- connectiveness that supports this system of trust and stressed world; please expand on that for me. assurance. Professor Power: There is a band width of states of Q1128 Chairman: Robert made the point that there the world, if I can call them that, where audit works is a potential role in systemic risk issues; Prem Sikka, very comfortably, that is to say it can rely on how can we firm that role up and why did no one management representations, it can rely on blow the whistle, or is that an unfair question? management accounts, it is confident that Professor Sikka: I do not think so. Auditors have management is on top of its own organisation, that unprecedented rights; they have more rights than the is the world where auditors are able to do their job police. Without any warrant they can examine any most comfortably and where the incremental document, interview anybody in a company; they assurance that society demands is provided. We are have increasingly been given more and more rights, not in that world. they also have been shielded from lawsuits and basically they have failed to deliver, so the question is how do we reinvent the audit function. My Q1126 Chairman: Are we blaming the auditors too argument is that in the end it is only the regulators much or are the auditors being blamed—we do not who themselves have to directly take on the do that, we are just taking evidence on this. It maybe responsibility for auditing at least financial begs the question from what I have heard, just as a institutions. That way they are not relying on last question, what are auditors for and what is the external parties to alert them or to make them aware. future? Robert Hodgkinson, would you start? That is the way forward. Mr Hodgkinson: We are very much concerned with Chairman: The final question is from George. the future and the solutions. I have referred to the Audit Quality Forum that the Institute hosts and Q1129 Mr Mudie: Where there is a systemic risk— some of the issues that we are looking to take the banks—is there not a case for a parallel forward on our agenda there relate to the potential relationship so that the auditor does automatically role auditors have in systemic risk issues and also report, with the knowledge of the bank, to the making sure that there is wider understanding of the regulator? Whether it costs the FSA money or not, V independence framework. So we as an Institute are they put it in and they ask di erent questions for a very keen to make sure that questions about what deeper audit or a deeper investigation than you get the auditors are for are addressed and that we are not with the normal financial audit. Would that not be seen as being marginalised. very, very useful for at least going further to alert us to a possible crisis in the present arrangements that clearly do not work? Q1127 Chairman: Any comment, Helen? Mr Boyle: It is, if I may say so, a promising line for Ms Brand: As the Professor said there is limited further study. It needs to start with the factual impact that the external audit is going to have in this examination of what communications are presently kind of crisis, stressed situation, but there is room for taking place and then we must remember that the improvement within the audit function which auditors are not currently responsible for changing auditors are now starting to address. the behaviour of the banks, but improving that communication would be a good thing. Mr Boyle: Chairman, audit is a hugely valuable Chairman: This continues from our inquiry into activity and you would really miss it if it was not Northern Rock which Michael made a point to you there. The value of an audit is not in the beauty and on in that with Northern Rock, when I spoke to the elegance of the financial statements that you see, people in the market people were saying “Look, if V it is the di erence between those financial statements you had come to see us we would have told you the and what would be produced if management were problems of Northern Rock”. The business model not subject to independent review, either for over- there was the problem but nobody blew the whistle, optimism or simple error. I had the opportunity to and it is that issue that we are interested in today and work in an environment a few years ago where there taking that up. Can I say I am both surprised and was no auditing; the diVerence is huge and we would delighted to get such an animated discussion with seriously miss it if it was not there. That is why issues accountants, so thank you for that. Processed: 25-03-2009 21:32:21 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG8

Ev 156 Treasury Committee: Evidence

Witnesses: Mr John Hitchins, Partner, PwC, Mr Brendan Nelson, Vice-Chairman, KPMG, and Mr Jonathan Hayward, CEO, Independent Audit, gave evidence.

Q1130 Chairman: Welcome and good afternoon. Mr Hitchins: First of all, Mr Fallon, I would like just Can you introduce yourselves, please, for the to correct that. They made a point that we did not shorthand writer? prohibit non-audit partners working on the audit— Mr Hitchins: I am John Hitchins, I am the leader of so these are tax specialists for example—from selling PricewaterhouseCoopers UK banking practice and non-audit services. I am a banking audit partner. Mr Nelson: I am Brendan Nelson, I am a Vice- Chairman of KPMG in the UK and I am a bank Q1135 Mr Fallon: But that does not prohibit the audit partner. audit partner. Mr Hayward: I am Jonathan Hayward, I am the Mr Hitchins: We do prohibit all of the audit partners Chief Executive of Independent Audit Limited, on the assignment from doing that. Ethical which is an advisory firm providing corporate standards only prohibit audit partners from selling governance advice to organisations including banks. non-audit services so we believe we fully comply with the ethical standards.

Q1131 Chairman: First question, how culpable are Q1136 Mr Fallon: So this is factually wrong is it, that the auditors and are we being too hard on the poor your firm’s policy and guidance specifically permit old auditors? key audit partners to be rewarded for non-audit Mr Nelson: You will not be surprised, Chairman, if I services. say that I think the auditors have actually discharged Mr Hitchins: We disagree with the findings of the their responsibilities diligently in the context of what Audit Inspection Unit on that point. the statutory audit responsibility represents. The last audited financial statements of major financial institutions were to the end of 2007 and of course we Q1137 Mr Fallon: I see. Why should a key audit are currently doing the audits of financial partner be rewarded for selling non-audit services institutions for the year ended 2008. As has been like providing comfort letters for securitisations? discussed in the evidence given to you just before we Mr Hitchins: The key audit partners who are audit sat down, the audit is around expressing an opinion partners are not rewarded for selling non-audit on the truth and fairness of the financial statements services. Specialists are brought into the audit at a and, in the context of the statutory audit partner level to provide advice to the audit team; responsibilities for 2007, auditors we believe they are not prohibited under ethical standards from discharged their responsibilities professionally and selling non-audit services. with care and diligence. They were subject to review by the Audit Inspection Unit who expressed the Q1138 Mr Fallon: Okay, but the key audit partner is overall opinion that auditing in the United Kingdom part of the audit team is he not? was fundamentally sound. The financial statements Mr Hitchins: The question of who is a key audit of those institutions were also subject to detailed partner is a matter for judgment on each audit and scrutiny by the Financial Reporting Review Panel it depends on the role on the audit. and as a result of that scrutiny there have been no restatements of those financial statements. Q1139 Chairman: Thank you. Just to ask a quick question, The Sunday Times of 25 January spoke Q1132 Chairman: Okay. Jonathan. about Deloitte and was saying, firstly, that in 2000, Mr Hayward: I agree with what Mr Nelson has said. the first year that Deloitte took the RBS account it received £4 million for management consultancy, tax and other advisory work, in addition to £5 million in Q1133 Chairman: We have not got you here to agree. audit fees. Then the fee climbed to £7 million the Mr Hayward: I know; but I am afraid in this case I next year and for the 2007 financial year Deloitte’s have to. I am always ready to criticise the Big Four fees reached £31.4 million, having more than tripled if they need to be criticised, but in this particular case in the seven years. If rumours in the accountancy it is correct, there is no evidence to suggest that the world prove correct, this year’s bill will top £40 auditors have failed to do that which they are million. Now that RBS has been forced to surrender obliged by duty to do, the issue is around whether a 70% stake to the government, investors are they should have been doing something else. beginning to question whether the auditors should have spotted problems some time ago. The same is being asked of KPMG, which audited HBOS, and Q1134 Mr Fallon: Mr Hitchins, the Financial PwC which audited Lloyds TSB. That same Sunday Reporting Council did an audit report on Times article said that “the accounting firms are all PricewaterhouseCoopers last year and one of the trembling in the corner, just waiting for someone to points that they picked out was that you specifically start asking these very awkward questions,” allow your key audit partners to be rewarded for according to an unnamed City law-firm partner. selling non-audit services and they suggest that this Why were the accounts of all the banks signed oV is actually in conflict with the ethical standards. How without any problems last year? Without trembling, do you respond to that? can you answer the question? Processed: 25-03-2009 21:32:21 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG8

Treasury Committee: Evidence Ev 157

28 January 2009 Mr John Hitchins, Mr Brendan Nelson and Mr Jonathan Hayward

Mr Nelson: I will do my very best and I can only, Mr Hayward: Indeed, a lot is expected of them and obviously, comment on the financial statements that actually it is a diYcult job to give an opinion on the were the subject of an audit opinion by KPMG. You financial statements of a very large bank. It is an have to go back into the history of this. At the end incredibly complex exercise that takes a lot of of 2006 the world was a very diVerent place to what resource. it is today. Markets were liquid, economies were growing, there was a mood of optimism everywhere Q1142 Chairman: Could you read Royal Bank of and nobody saw any clouds on the horizon, and that Scotland’s or HBOS’s accounts last year situation eVectively prevailed well into 2007. It was comfortably? only in the latter part of 2007 that the world started Mr Hayward: No, that is an entirely diVerent to look a very diVerent place so in fact everybody question and our profession is culpable in that, that was put on notice, with eVect from August 2007 that we have headed for compliance rather than things were beginning to change and change quite communication. We are producing telephone rapidly. When we came to the close of 2007 both the directories of data— boards of financial institutions, their management, Chairman: God help us if you cannot read it. Nick. the regulators, auditors and indeed other interested parties were all aware that the world was starting to Q1143 Nick Ainger: Can we return to the theme of change and so that provided additional focus and Michael Fallon’s question because I am a bit additional emphasis on the audits of 2007. puzzled. Here we have the Audit Inspection Unit, V Nevertheless, audits are e ectively a snapshot in which is part of your industry’s regulatory time and they record events that have already framework as I understand it, making a clear occurred, they do not record events that are still to judgment on conflicts of interest, certainly in occur, so the auditors’ responsibility at the end of relation to Northern Rock but generally, and in the 2007 in terms of looking forward is to be satisfied case of Northern Rock out of £1.8 million fees that those financial statements can be prepared on a charged by PricewaterhouseCoopers £700,000 were going concern basis. That is the primary fees relating to assurance services in connection with responsibility of the boards of those financial the bank’s actions in raising finance, not to do with institutions, and of course at that time there still was the audit service. Could I ask you, Mr Hayward, enough evidence to suggest that the crisis that was what do you think of one of our major auditing going to occur in October would not materialise companies basically challenging a judgment of the within the period that is covered by the going regulator? What does it do for the reputation of the concern assumption, which is 12 months from the audit industry? date of the audit report of the financial statements in Mr Hayward: I agree it makes poor headlines and I question. So the evidence available to auditors, and actually think it reflects well on the regulator that indeed to boards, at the end of 2007 did not they were prepared to stand up for their own ground anticipate the crisis that was going to occur at the and publicise a finding when such an influential and end of September/beginning of October. powerful firm disagreed with them. It is a healthier sign than having everybody reaching behind doors Q1140 Chairman: Jonathan, the point has been in acquiescence. made that the world looks diVerent, but should not the auditors have a professional consistency which is Q1144 Nick Ainger: In terms that now you are essential? Given Mr Nelson’s point about it just basically saying they came to the right judgment— being a snapshot, is that not the best get out of jail Mr Hayward: I have no view on that. I have no card you can find? information that would enable me to comment on it. Mr Hayward: It is a very good get out of jail card, but that does not stop it being correct, it is a point in Q1145 Nick Ainger: What is your view of time snapshot and from the perspective of the PricewaterhouseCoopers actually challenging that responsibility that those auditors have they seem to decision and has the Audit Inspection Unit got any have done a good job. The reason you are finding sanctions that it can use against these answers unsatisfactory is because you wish PricewaterhouseCoopers if they continue to they were asking a diVerent question, as was touched challenge their judgment? on with the earlier group of witnesses, which is Mr Hayward: I have no idea. around the role of auditors possibly in relation to the wider risk picture. Auditors are required only to Q1146 Nick Ainger: Mr Hitchins, it is your report on the statement of account given by company; what sanctions are you risking? directors; the problem you have with this Mr Hitchins: May I just read what we actually said expectation here is that a lot of people would like in our response which has been published in the AIU auditors to play a much wider role in terms of report. “We do not believe that your comments on protecting the interests of investors and of the public the remuneration of key audit partners are at large, wider than that actual specific role of consistent with ethical or auditing standards and we reporting. remain completely satisfied that we observed the principles involved. If it is the considered view of the Q1141 Chairman: But if auditors get £40 million AIU that existing standards or rules need to change from one company you would think quite a lot is then these matters should be referred to the Auditing expected of them. Practices Board [in this case the relevant body] for Processed: 25-03-2009 21:32:21 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG8

Ev 158 Treasury Committee: Evidence

28 January 2009 Mr John Hitchins, Mr Brendan Nelson and Mr Jonathan Hayward review and, if necessary, the amendment of the by yourself then it does not necessarily give great standard.” We are saying that we disagree with their confidence to the regulatory framework within interpretation of the standard; that the standard is in which you operate. our view clear but clearly does not say what they Mr Hitchins: We take our independence extremely think it says and so it should be referred to and I seriously. In this particular instance our reading of believe is part of the review of the ethical standards the rules is—and the rules are still to our mind that is currently being conducted by the Auditing clear—that they do not prohibit the point that the Practices Board. AIU picked up. It may be that they should prohibit it which is why we said to the AIU this should be referred to the rule-maker and if necessary the rules Q1147 Nick Ainger: Mr Hayward, do you want to can be amended. come back? Mr Hayward: I would just like to add that I do think this is one of those angels dancing on the head of a Q1151 Mr Todd: You have possibly not grasped the pin question. We are all getting very exercised over implication of what I was saying which is that you this little technical detail of who may do what among are regulating yourselves, you are disputing with a large number of people. Independence is not the your own regulator who you essentially resource. To same as objectivity; objectivity is what you want in the outside world this seems a perverse circumstance your auditors and these technical issues of but you are obviously comfortable with it. Can I ask independence might or might not support it. One of about the relationship with the regulator of the poorest audits that I have observed in practice auditors? In this banking crisis, in the preparation of was done by an audit firm that had no non-audit the 2007 accounts, was there any communication work because the price for having no non-audit with the regulator over any aspects that were raised work is a considerable level of ignorance about the during the audits? client’s activities. This is a much more complex issue Mr Nelson: Yes, there was a meeting prior to the end than is made out by these little technical, rule- of 2007 which was convened at the initiation of the based details. Big Four with the regulator, the Financial Services Authority,at which the Financial Services Authority were present—in fact the big six accounting firms in Q1148 Nick Ainger: Do you not understand that this the UK were present, a representative from the Bank type of refusal to acknowledge a regulator’s of England was there, representatives from the judgment brings the whole industry into disrepute? Financial Reporting Council, including the People out there say is it right that an auditor of a Financial Reporting Review Panel, were there but bank which subsequently failed and had to be bailed that was a fairly high-level discussion. At that point out by the British taxpayer not only took fees for the nobody got into the detail of the impact of this on audit but also took £700,000 oV that bank for other individual institutions— types of advice. Do you not understand that people out there, now that we are bailing out these banks, Q1152 Mr Todd: What was it, some sort of rhetorical actually say “What on earth is going on?” and do not encounter? consider it counting the number of angels dancing Mr Nelson: To some extent it was the FSA on the head of a pin. explaining to us some of the work that they had been Mr Hayward: I can understand the politics of it, yes, doing of a generic nature in the industry, particularly as a practical matter in terms of— with respect to market risk, there was an opportunity for the firms to talk about some of the issues around Q1149 Nick Ainger: It is not politics, Mr Hayward, valuation of financial instruments, which was going it is reality. Your industry, along with other parts of to be extremely challenging at that year end. There the financial services industry—as John Lawton told were some observations made by the Financial us a few weeks ago people would like to see some Reporting Council then that issues like going public hanging, that is the attitude that an awful lot concern obviously would be pertinent in the context of people out there have. We want to see confidence of closing and I think there was a general discussion around the additional disclosures that would be restored in your industry; do you not think that if required in the 2007 financial statements for the first regulators make rulings then the industry should time following the introduction of IFRS7 in that follow them? IFRS7 required financial institutions to actually Mr Hayward: In general, yes, I agree with you. My provide much more detailed quantitative and observation though was that I do not actually qualitative disclosures around their exposures to believe these rules really serve the further purpose credit risk and market risk— that we are trying to advance here. Nick Ainger: Thank you. Q1153 Mr Todd: I have interpreted this as the FSA was delivering a series of messages to yourselves, it Q1150 Mr Todd: It does make us all think of the was not seen as an opportunity for you to flag up any value of self-regulation in that this is not a regulatory particular queries or concerns that you might have function carried out by a government agency, it is about the task in hand working for your clients. carried out by the industry itself, and if it does not Mr Nelson: Maybe I am not making myself clear. I appear to deliver any obvious leverage and indeed think it was; everybody was well aware as to what the appears to be greeted as a sort of rulebook exercise major challenge was going to be in the context of Processed: 25-03-2009 21:32:21 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG8

Treasury Committee: Evidence Ev 159

28 January 2009 Mr John Hitchins, Mr Brendan Nelson and Mr Jonathan Hayward

2007 and the major challenge in 2007 was going to process was much clearer. Nowadays it is very ad be the valuation of financial instruments that were hoc, it is not a particularly close relationship and the held at fair value in the balance sheets of financial focus of the work that we do in addition to the audit institutions. work now is very much detective in the sense that section 166 reports are generally only convened Q1154 Mr Todd: You obviously had opinions on when the FSA has suspicion or evidence that an those and communicated those to the FSA. institution is failing in some respect to meet Mr Nelson: No. As I have said, it was a very high- particular regulatory requirements, so it tends to be level discussion and we could not discuss individual that you go in to try and find the evidence to present instruments, it was just that that was going to be a to the FSA of the scale of perhaps this failure to meet challenging issue. requirements. In the previous regime it was very much a preventative type regime, i.e. there were Q1155 Mr Todd: Fair enough. In your evidence both more regular examinations in order to impose if you of you two have said that you would have wished for will a certain discipline on financial institutions to more interaction with regulator at various times. ensure that they constantly maintained the Mr Nelson: Yes. requirements in terms of records controls and so on as imposed upon them by the regulator. That role Q1156 Mr Todd: On what sort of terms would that that we had has now gone and so the only role we interaction take place? have is as and when we are required to go in and do Mr Hitchins: If you go back to what used to happen a review under section 166, but that tends to be after under the old Banking Act there was an annual the event. meeting which started oV as between regulator, client and auditor on each individual institution. Q1162 Mr Brady: In the current financial crisis how Then it developed from there into bilateral meetings significant a problem is the greater uncertainty over so we had a meeting with the regulator by ourselves, the going concern status of banks, both for auditors without the client present. Those meetings have and banks? become—ad hoc is probably the best way to describe Mr Hitchins: It is of considerable concern for this set them. They are occasionally called but they vary of year ends. The basic business model of a bank from institution to institution and we believe there is always has a funding gap in it because banks take in some value in increasing the frequency of those in short term deposits and lend it long, it is a function future. in the economy. In normal markets and normal circumstances you can have considerable confidence Q1157 Mr Todd: To give us some examples if you that the banks can meet that funding in the market. can among your clients, did you have meetings Since the collapse of Lehman’s that has not been the about any of the institutions that were your clients case and all banks have had to depend on facilities, with the FSA using that sort of mechanism? largely from the Bank of England but also partly Mr Hitchins: There would have been meetings on from the Government. For this year end we basically some and not on others. have to assess the projections that management have done in forming their own opinion on their funding Q1158 Mr Todd: Ad hoc arrangements. needs, examine those and consider whether the Mr Hitchins: Yes. The protocol is such that they are funding needs shown in those forecasts can be met convened by the FSA. by the facilities that are available in the market which will, in the short term, largely be from the Q1159 Mr Todd: Do they pay you for those Bank of England. If we are able to reach a meetings? conclusion that it can be met from the existing Mr Hitchins: Sorry, does who pay us? facilities, then it is appropriate for management to conclude that the going concern basis is appropriate V Q1160 Mr Todd: Do they pay you for those and it is appropriate for us to sign o on that. If it meetings? appears there is a problem, the first step is actually to Mr Hitchins: The cost of us attending those meetings go and talk to the FSA and the tripartite authorities is part of the audit fee for the institution, the FSA do about what is the best thing to do with that situation not pay us. rather than simply publish accounts and wait and see what happens. Q1161 Mr Todd: I am relieved to hear that. Do you think that one of the outcomes of this that may be Q1163 Mr Brady: Is there anything you would like valuable is a formalisation of the relationship to add to that? between auditor and the regulator and how that is to Mr Nelson: I absolutely agree with John; boards, square with the client relationship, which I think we audit committees and auditors will see going have all learnt is your first concern? concern as probably the biggest issue of judgment Mr Nelson: We would certainly support that. If you this year end. There will be a lot more disclosure in go back to what was being discussed at the previous bank financial statements about the uncertainties of session, the relationship that existed between the the future, but if they become material in the context auditor and the regulators prior to the introduction of the Board’s decision they will have to make that of the Financial Services Authority was a much clear in the financial statements. If that happens then closer one and our involvement in the regulatory the auditors would be required to add what is called Processed: 25-03-2009 21:32:21 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG8

Ev 160 Treasury Committee: Evidence

28 January 2009 Mr John Hitchins, Mr Brendan Nelson and Mr Jonathan Hayward this “emphasis of matter” paragraph but if there was expectation can be met. We are in a situation now, as fundamental disagreement between the auditor and you rightly point out, that bank financial statements the institution then the auditor would have to are now running to some hundreds of pages and consider a qualification. As John said, the reality is indeed in some cases some many hundreds of pages that we are under this statutory duty to go to the and the trend is likely to be that there will be more FSA if we are minded to issue a modified or a pages added in the context of this year because, qualified opinion, so the FSA has the opportunity to again, the response by a number of regulatory take whatever steps it may feel are appropriate in the agencies to the crisis is to require banks to disclose context of that institution before the audit certificate more information about the nature of the is published. instruments they are holding and the degree of risk inherent in those instruments, so you are going to see Q1164 Mr Brady: It is unlikely that it would reach this getting progressively longer. There are initiatives the point of giving qualified accounts to a bank. being taken by the IASB in terms of looking at the Mr Nelson: Absolutely. complexity in financial statements and seeing to what extent financial statements need to be restructured to make them perhaps easier to Q1165 Mr Brady: There has been a lot of debate recently about auditors’ approach to wider issues of understand. The other confusing aspect of financial going concern for the imminent round of financial statements is that financial statements basically now results. How much comfort do you take from the sit in two halves: the front half which is fact that this is now being discussed and that audit management’s commentary on the performance of opinions might not be met with as much panic as the business throughout the year and the second might otherwise be the case? half, which is the audited piece, which is the actual Mr Hitchins: It is very important that it is discussed pure financial statements themselves. The trouble is because it is very important that the expectation gap, that some of the audit information relating to these that an audit opinion somehow guarantees the additional disclosures ends up in the front half of the future of a company, is corrected, that people financial statements, and therefore it can be quite actually understand what we are doing and what the confusing for readers to actually understand what audit opinion is saying. exactly is audited and what is not audited. I think perhaps it is worth looking at financial statements to see if you can be slightly clearer between what is Q1166 Mr Brady: Is there more that you can do to audited and therefore subject to the audit opinion improve understanding of that or to promote that and what is not, because if it is listed as unaudited further? Mr Nelson: The Financial Reporting Council has people tend to draw the wrong conclusion and think issued guidance to directors on matters to consider that as it is part of the financial statements it must be when determining the going concern assumption, covered by the opinion. and I think that just helps give the correct perspective to some of the issues that have to be considered by boards so you can be more assured Q1168 Sir Peter Viggers: Just as doctors are pushed that boards are approaching this in a consistent way. into defensive medicine so I think accountants are Mr Hitchins: That does carry authority because, to pushed into defensive accountancy. Does the correct something that was said earlier, the FRC is Companies Act 2006 help by producing a regime independent of the Big Four, we are not self- where auditors can agree a limitation of your regulating; as our regulator it is independent. We liability, does this help provide a way ahead to pick up most of the bill because that is the way the simpler, more transparent accounts? legislation that established it deemed it to be, but Mr Hitchins: First of all it remains to be seen what that is about the extent of our input. the impact of that legislation is because as yet no company has put forward to its shareholders a proposal to limit liability, so we do not yet know Q1167 Sir Peter Viggers: When an audit is undertaken the auditors produce a disclaimer what impact that will have. However, all that document usually running to several pages; it is legislation really does is provide catastrophe usually pretty impenetrable and leaves the reader insurance for the profession; it is there to try and wondering what the auditor is responsible for, it limit sizeable claims and it does not really impact the having been made very clear what the auditor is not quality of the audit because we are not driven by the responsible for. The bank then produces a report threat of litigation, we are driven by a desire to get running to several hundred pages and the auditor the quality right. either qualifies it or does not qualify it. Have you undertaken any research to discover what the user of the accounts would like to see and whether the user Q1169 Mr Mudie: After all this year or the 18 feels that this is a helpful framework that currently months will you be changing your instructions to exists? your auditors who audit the banks for this year’s Mr Nelson: That is a very interesting question. There audit? is constant dialogue with users of financial Mr Nelson: I would like to get across the clear statements but the trouble is the user community is understanding that auditing is dynamic, it is not so wide that it is quite a challenge to see if every user static. We have to adapt to changing market Processed: 25-03-2009 21:32:21 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG8

Treasury Committee: Evidence Ev 161

28 January 2009 Mr John Hitchins, Mr Brendan Nelson and Mr Jonathan Hayward environments, changing market conditions, Mr Nelson: We have no remit to extend it. changing standards, changing regulation, and therefore the whole audit process continues to be a Q1172 Mr Mudie: You lectured me for five minutes dynamic process. We—and I am sure it is the same on dynamism and how of course you were going to with other auditing firms—have a process of change, but when I say “Tell me the change” you say ensuring that all audit partners who are involved in it is fixed by the law. financial institution audits are kept regularly abreast Mr Nelson: The impression I gained from your of what we are seeing in the marketplace and how we question was that we audit in a very static need to respond to that in the context of our audit. environment and did not in the context of our audit Going back to the issue around complex financial work adapt to the changing environment. That was instruments and how these are valued, we do not do the reason I answered the question in the way I did. that on an individual basis so that one partner is out there making the decision on his own, we look at the Q1173 Mr Mudie: Brendan, if you were watching collective knowledge of the firm in terms of what do this on television and you had lost your job, you we see across the marketplace as a whole, what is the were going to lose your house, you would be pretty collective view of the partners engaged in the bloody angry at the auditors for allowing the banks industry who understand the nature of these to get away with all the oV balance sheet derivatives, instruments and the risks inherent in that, and then the lot. As you go in and audit them the ordinary we seek to benchmark to make sure that there is a person would say “Why the hell didn’t the auditor consistent view emerging, but recognising that in the pick it up?” In an intelligent discussion you are context of illiquid markets you end up with a wider saying to me “Well, it is not our business.” Will it be range of what people would deem to be acceptable your business in future or will there need to be outcomes because the pricing widens as the market discussions and changes, maybe even changes in the becomes more illiquid, and that creates the real law? Have you started those? problem in terms of trying to get a true comparison Mr Nelson: Those discussions clearly will take place between institution and institution. with the Auditing Practices Board, the International Accounting Standards Board, the Financial Reporting Council in terms of the role of the auditor Q1170 Mr Mudie: I struggle with that because the going forward, but I really do want to come back to consistent line up to now is you are not corrupt, you this point about the fact— have not done this for these additional fees, you are not incompetent, you are doing it within strict lines Q1174 Mr Mudie: There is a cold shiver going up my and we the public and we the politicians just do not spine. That does not sound very good to me. understand how limited your role is. Now you tell Mr Nelson: I really do not mean to leave you with me you are dynamic; how does that square with what that impression. The responsibility for financial is happening because I asked the last panel what statements is the board’s; there is a huge number of changes and they have not got round to even initiatives that are taking place to require boards to thinking about it, discussing it, analysing it. Maybe disclose more and more information about the you are ahead of them; tell me how dynamic you are nature of the risks that they are taking within that going to be with this year’s audit. What have you institution. It is not an automatic process that that learnt, what will you be looking out for, will you be additional information is subject to audit and it may broadening these lines that you have consistently be that going forward there needs to be a dialogue to told us are fixed and if only we understood how fixed discuss with the auditing profession to what extent they were we would sympathise with you, so which this additional information, which is now deemed to is it? I will tell you why, Brendan. We have had such be very important to ensure that users of the an august figure as the Bank of England Governor, financial statements truly understand the nature of we have had the FSA tell us if only people in the the risks that these institutions are incurring, and if banking industry and people like yourself had read these additional disclosures are to be provided then our speeches, for the last two or three years we have maybe they should be subject to audit. Let me give been warning about this with speeches in Bristol and you one example. One of the key measures of a speeches here. You have no excuse; the Governor bank’s strength is its capital ratio, the regulatory made his speech, if you are dynamic you should have ratio. The one often quoted is tier one and now in the picked it up. Why did you not? You have now picked current climate the core tier one ratio. That ratio is it up because it has crashed around you, but what are not audited; that is not part of the audit opinion or you going to do this year? Is your audit going to be the audit comfort and yet that is seen as one of the wider than you have done to earn these fees in the key determinants of a bank’s strength. I think there past few years? is a case that we need to look at some of these Mr Nelson: The audit is dynamic in the context of additional disclosures. Another point I would make the statutory responsibility that we have under law; is that for the first time this year banks will have to it is not dynamic in the sense that— publish what are called “Pillar Three disclosures” which will either be published on their website or maybe incorporated in their financial statements. Again, these provide much greater detail about the Q1171 Mr Mudie: So it is not dynamic at all, it is nature of the risks that the banks are running, both fixed by the law. in terms of credit risk, market risk and operational Processed: 25-03-2009 21:32:21 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG8

Ev 162 Treasury Committee: Evidence

28 January 2009 Mr John Hitchins, Mr Brendan Nelson and Mr Jonathan Hayward risk and, more importantly, it gives some sensitivity the behaviour of markets which over the last year or analysis. Again, these disclosures are not subject to two have not been predictable or rational. We just do audit but it is out there for all users of financial not know how things are going to shape up; my institutions to see and form their own assessment. feeling is that the audit profession though is trying its best to work within what it has got to do and is trying Q1175 Mr Mudie: Do you think the four major to be helpful in saying yes to that. institutions could provide the Committee with a list of such things so that we can consider putting them in our report because it is obviously urgent that we Q1181 Jim Cousins: Okay. Is the problem we have get the thing moved on so that we can look people got here in wrestling with this huge construct that in the eye and say that in terms of audit, in terms of has emerged legal powers or is it simply that the task regulation et cetera et cetera we moved as quickly as is so immensely complicated that for an institution possible to make sure this does not happen again. even like a Big Four accountancy firm it is just You have given two very good examples, do you beyond them? think it would be possible for the four institutions to Mr Hayward: It is a combination of the complexity put specific points up to us so that we could have a of the task and the fact that you are having to look look at putting them in the report? John, you are forward into the future in times when nobody really permitted to speak. knows what is going to happen. Mr Hitchins: We can certainly take that away and 1 come back to you with something. Q1182 Jim Cousins: If I was a member of an audit committee of one of these major banks I think I Q1176 Mr Mudie: Does that mean you are going to would be tempted to do what the Danish politician do it? suggested he would do if he was attacked by the Mr Hitchins: Yes. Russians which is simply send a telegram saying “I Mr Mudie: Good. surrender”. The task is enormous, the institutions we have—and this is not a question of individual Q1177 Jim Cousins: Do you actually think you are competence or individual ill-will—are just not capable of working out whether one of our major capable of getting the measure of the situation. Do banks is a going concern? you not even have a hint of that? Mr Hitchins: Yes. Mr Nelson: Let us be clear, the responsibility for determining whether the financial statements should Q1178 Jim Cousins: You are absolutely sure about be prepared on a going concern basis rests with the that. board. If the board have a material uncertainty over Mr Nelson: Yes, in the context of the going concern any significant aspect of that then they are required assumption. to make a disclosure of that in the financial statements so a reader knows what the level of that Q1179 Jim Cousins: Ah. material uncertainty is. As I explained earlier on, in Mr Nelson: Which is a 12-month view; it is not that those circumstances the auditor would issue a we are saying the institution is going to be thriving modified but not qualified opinion and the modified in five years, four years or three years, it essentially opinion would be the emphasis of matter to make is a 12-month view from the date of the accounts and sure the reader of the financial statements was drawn the audit opinion, not the date of the balance sheet. to the disclosure regarding the material uncertainty. If you sign oV at the end of February it is 12 months That judgment has not been arrived at. to the following February.

Q1180 Jim Cousins: You see the balance sheet of a Q1183 Jim Cousins: That is a very carefully worded major British bank is likely to be bigger than and I have no doubt entirely accurate point, but by Britain’s GDP. The underlying assets—if in fact the end of February the British taxpayer will be there are any underlying assets because, as we are supporting trillions of pounds of complex financial discovering, in some cases there are not any instruments, more than half of which are outside the underlying assets—are spread all around the world UK, something that I think very few people have and they have been packaged and repackaged into spotted. More than half of the things that will be hundreds of thousands of complex products which guaranteed are outside British jurisdiction, and in are parked very often in tax havens. Do you actually some cases we do not even know if the underlying think the audit process as we understand it now, and assets are even there. Do you really think any of the as it has been built up in British legislation, is at all Big Four accountancy firms, or even the Big Four capable of coming to terms with that and working working as a cartel together, are capable of giving out whether the institutions we have got are actually British taxpayers the assurance they will require going concerns? from somebody in such a situation? Mr Nelson: Yes. Mr Nelson: If the boards cannot convince us that Mr Hayward: I would be less confident; I share your they are able to prepare financial statements on a question mark over it because to come to that going concern basis then we would qualify. If the conclusion requires one to make assumptions about boards produce adequate disclosure around any material uncertainty then we will issue an emphasis 1 HC (2008–09) 144–II, Ev 450 of matter. If the boards convince us to the standards Processed: 25-03-2009 21:32:21 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG8

Treasury Committee: Evidence Ev 163

28 January 2009 Mr John Hitchins, Mr Brendan Nelson and Mr Jonathan Hayward required under auditing standards that they can before us he was saying that for some audit work continue as a going concern then we will issue an there are only two audit firms. That indicates that unqualified and unmodified opinion. maybe the stability of the market could be aVected and is an issue for policy-makers to look at, is that Q1184 Jim Cousins: In the end, therefore, we rely not correct? on you, not on the audit process, but on the Mr Nelson: Yes. competence and capacity of boards of directors of banks who plainly have already failed us. That is Q1191 Chairman: Also, it is maybe an opportunity your view. to look at the independence of auditors. Mr Nelson: The responsibility for preparing Mr Nelson: You will not be surprised if I say— financial statements rests with the board, it does not rest with the auditor, but if we disagree with the board then our duty is clear. Q1192 Chairman: You would not disagree. Mr Nelson: We would not disagree. If people want to Q1185 Chairman: Okay,very sobering. Jonathan, we look at our independence then we are perfectly are over time but just addressing a few points to you happy for that to be done. do you think that audit committees of banks have performed well in the run-up to the current crisis? Q1193 Chairman: Maybe the bigger issue for us is Mr Hayward: Audit committees of banks generally for policy-makers to say we could make better use of have two roles, sometimes split between two the skills and experience of audit firms to prevent committees but very often in one; part is the audit problems in the financial sector, because the side, which is around the integrity of the financial question that haunts us here is that all the banks’ statements, and that is the side that has had so much accounts were signed oV, seemingly without attention in the years since Enron and that side problems. If auditors are doing their work and seems to have worked pretty well. The other part of everybody else is doing their work and we still end the responsibility is around the oversight of the risk up with a black hole, how do we prevent the black management in these organisations and self- hole in the future? evidently that has not been so successful. Mr Hayward: May I say that I think the present system is geared towards achieving compliance. This Q1186 Chairman: The composition of bank audit situation we are in now is not a failure of compliance. committees: are they suYciently expert in their What you are asking for is something that goes understanding of modern banking generally, do beyond compliance and to get there we will require you think? a system that goes beyond the audit system that we Mr Hayward: Sometimes, but sometimes not. have.

Q1187 Chairman: If it is sometimes not is it some big Q1194 Chairman: Do you think there is an banks that are not? opportunity for us to explore that? Mr Hayward: The role of these committees is not to Mr Hayward: I think there is a great opportunity to go in and audit the detail of what is being done, it is do that and to start with a clean sheet. to oversee to try and maintain a check that the management is doing its job properly. Q1195 Chairman: From what we heard in the first session here there is a need for an immense Q1188 Chairman: Is it to oversee risk? improvement in the depth of interaction between Mr Hayward: To oversee the management of risk. auditors and the FSA. Overseeing the absolute amount of risk that is taken Mr Hitchins: I would say there is a need for that to be by a company is a job for a board really, not a at an individual institution level. There is very good committee, and it is an area where in our experience Y interaction between firms and the FSA at a firm- it is often a bit fuzzy. It is a di cult thing to do and wide level on policy, but there is room for there have been too many attempts to try and make improvement at an individual level. it scientific.

Q1189 Chairman: You have left us with quite a bit of Q1196 Chairman: We think there is an opportunity food for thought on this issue, but if I could just sum for a review and a reflective approach. up what I think you have said there, it is that Mr Hayward: Can I just go back on the question of auditors have done a decent job of fulfilling the there only being four firms? That is in part a duties expected of them in statute, but for us is the reflection of the issues that Mr Cousins was raising; code appropriate. Is that a legitimate area to be it is the complexity of these banks which is why there looking at? are only four firms with the skills and capability to Mr Nelson: Yes. do them. Part of the barrier to entry of a new firm joining that market is the cost of building up that Q1190 Chairman: There are some concerns over the expertise. fact that only four audit firms dominate the market, and indeed I well remember—as maybe some of my Q1197 Chairman: There is a great opportunity to colleagues will—when Howard Davies as chairman reform here at this time, looking at that, is that fair and chief executive combined of the FSA came enough? Processed: 25-03-2009 21:32:21 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG8

Ev 164 Treasury Committee: Evidence

28 January 2009 Mr John Hitchins, Mr Brendan Nelson and Mr Jonathan Hayward

Mr Hayward: Yes. Mr Nelson: It is not a book that you would read Chairman: Lastly, Mr Nelson, given your expertise, cover to cover—it is not a book—but if you have an from what I am told the report and accounts of interest in particular aspects it is quite a good HSBC last year were almost 500 pages. Could you dictionary to look in. with a good malt whisky sit down at the fireside one night and fully understand it, looking at that report? Q1199 Chairman: You think there is maybe a good chance of getting drunk before you understood it. Q1198 Mr Mudie: Do not say you do not drink Thank you very much. whisky; you will oVend the Chairman. Mr Nelson: That is your comment, Chairman.

Witnesses: Mr Michel Madelain, Executive Vice President, Moody’s, Mr Frederic Drevon, Senior Managing Director, Moody’s, Mr Barry Hancock, Managing Director and Head of European Corporate and Government Services, Standard & Poor’s, Mr Ian Bell, Standard & Poor’s, Mr Stephen W Joynt, President and Chief Executive OYcer, Fitch Ratings, and Mr Charles Prescott, Group Managing Director, Financial Institutions, Fitch Ratings, gave evidence.

Q1200 Chairman: Welcome to the Committee. We Q1202 Mr Todd: You probably have also read of saw you en masse in November 2007 so welcome people saying that you were attempting to rate back the usual suspects, but you obviously do not instruments that you did not fully understand have any draw appeal with the exit to the door. I yourselves and that you went beyond your cannot do anything about that, but could you capabilities, so it was not just that you got things introduce yourselves, please, for the shorthand wrong, you actually were not able to get it right writer? because you did not have the ability to do so. Is that Mr Hancock: Certainly. Barry Hancock from a criticism that you also buy? Standard & Poor’s; I run our corporate and Mr Bell: Personally and speaking for the structured government ratings business in Europe. finance group of S&P absolutely not. I personally Mr Bell: Ian Bell, I run our structured finance was in structured finance since 1988, I used to in a business in Europe. previous life put these instruments together, I used to Mr Drevon: Frederic Drevon, Moody’s, I am the create these instruments in a law firm. I think you V Head of European Operations. will find that my sta and myself have had decades Mr Madelain: Michel Madelain, the Chief of experience of this so, no, we do not believe that Operating OYcer of Moody’s. these instruments were themselves too complex in Mr Prescott: Charles Prescott, Fitch Ratings, their structure to rate. That there is an inherent uncertainty about predicting how anything is going running financial institutions. to behave in the future is undoubted, but in terms of Mr Joynt: Stephen Joynt, I am the President and the structures that we were rating, no, I do not CEO of Fitch Ratings. believe that they were inherently too complex.

Q1201 Chairman: Okay, thank you, and thanks for Q1203 Mr Todd: So people like Willem Buiter who coming. The European Commission has stated, “It certainly said exactly that are wrong. is commonly agreed that credit rating agencies Mr Bell: I would have to disagree with Mr Buiter. contributed significantly to recent market turbulence.” The charge levelled at you, at least in Q1204 Mr Todd: I think when you were last here the press, is that you issued over-optimistic ratings some of you certainly were keen to emphasise that a and did not respond quickly enough to market credit rating was only one piece of information developments. Is there legitimacy in that charge? which someone should use in understanding the risk Mr Bell: We have all kind of acknowledged— of a particular business or product. Do you think certainly at S&P and I think my colleagues from the that those who used your ratings grasped that? other firms would not disagree—that when you look Mr Joynt: Maybe I could address that. The ratings at the ratings of the US sub-prime residential in many ways are reflective of the relative credit risk mortgage-backed securities and some of the CDOs and not other risks that might be important to that were backed out of the sub-prime, undoubtedly investors. The most notable ones today are liquidity the assumptions we made about how those would risk, price volatility and price itself so our ratings can perform in the future turned out not to be correct. contribute to investors analysing that, they are not There is no doubt about that. designed to precisely provide that information, Mr Madelain: I would just comment by saying that certainly not alone, and it is very diYcult to think if I look at financial institutions, we rate about 2500 about how those can be helpful in this volatile of those and if I look back over the last two years we environment. had 18 defaults and 35 institutions that moved from investment grade to non-investment grade. I would Q1205 Mr Todd: My question was slightly diVerent like just to put those facts in front of you just to give to that which was what do you think the users some balance to the perception that may have been thought. I understand what you think they were for, created by the sub-prime events in the United States. but what do you think the users thought? Processed: 25-03-2009 21:32:21 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG8

Treasury Committee: Evidence Ev 165

28 January 2009 Mr Michael Madelain , Mr Frederic Drevon, Mr Barry Hancock, Mr Ian Bell, Mr Stephen W Joynt and Mr Charles Prescott

Mr Joynt: There are many types of users and it is there has been a deterioration—I am speaking for quite complicated to answer that question. Many my business, other people around the table can large, sophisticated institutional investors that we speak for other assets—then we will investigate that would meet would tell us that ratings are a helpful deterioration, try to understand it and re-run our complement to them but they have their own models to see how things pan out with the new re- analytical teams, their own staVs, including experts run. At the same time there may be downgrades in duration analysis and interest rate risks. So many because the world has changed so even though the institutional investors, at least as they used the data in the pools show no deterioration we know ratings in the past—today they also might be that something has happened in the world. A classic reflecting on whether they had capabilities—would situation is a downgrade on sovereign, for example, say that they used the ratings only to a limited and then we may downgrade that too. degree. Other investors may have relied on ratings to be all-encompassing, not reflecting as carefully on the risks that they did not cover. Q1210 Ms Keeble: There was a discussion just now about one of the risk factors being price; presumably Q1206 Mr Todd: Do you think regulators were if you see the prices go down you will look and have included in this perhaps over-reliance, just looking at a downgrade. There has been a suggestion that the your labels and saying that tells me all I need to process can become quite circular, both that you know? chase the prices down. Mr Joynt: I think not. Most regulators—bank Mr Bell: No. regulators certainly—we meet with often are sophisticated users of ratings and understand their limitations. In the United States insurance Q1211 Ms Keeble: Or that you can help to drive regulation is split up by State and so possibly they prices down along with short selling. What do you are not quite as sophisticated but the SEC and other say to that? regulators that have used ratings in regulation I Mr Bell: We never downgrade as a result of a price think understand how the ratings are defined and decline. What we do is we look at the price decline how they should be used. because we realised that a lot of people in the market Mr Hancock: We would certainly endorse that. were looking at things, so if we see prices decline it is Certainly the UK FSA will spend a lot of time with more of a note to the analysts saying “You know us to get behind what the ratings are actually saying what, maybe this is something we should look into and, probably, as important as that to understand because clearly the market believes that something is our thinking and our research on the various sectors happening here.” It therefore draws our attention to that we are rating. I would think they are certainly a particular rating but we never downgrade because expert users. the price has gone down; it would only, as I said, be a flag. Q1207 Mr Todd: Others will probably explore this but this comfort of the business model which indicates a reliance on someone who is seeking a Q1212 Ms Keeble: With some of the figures around rating for the funds to pay for your services, do you what happened with some of the Icelandic banks it think that is properly understood by customers as looks very much as if your ratings changed to chase being an area at least of indicated caution when they down what was happening with the banks, which look at your products and what they tell you? Do makes you wonder what is the point of having a you think people realise that? credit ratings agency that would, one would hope, be Mr Madelain: Yes, I do. I think the model is well able to see in advance what the risks are. understood, well publicised and well known. Mr Hancock: It is an area that is discussed an awful lot. We need to be aware of what is happening to the Q1208 Mr Todd: It certainly is now, I agree, it is an prices and we have elaborate systems that our area of criticism. analysts have to analyse all the prices of the diVerent Mr Madelain: I did not say criticise, I said products available in the market, but certainly as Ian publicised. points out it is not a trigger to change a rating and if you use the example of this week or the last couple Q1209 Ms Keeble: Last time you came you described of weeks of Barclays’ share price, which has been up how you set about doing the ratings, and you, Ian, and down all over the place, we have not initiated a gave a particular example. I wonder if you would say change in that rating driven by that because we are what it is that triggers a downgrading and how you looking at the intermediate and long term go about doing that. fundamentals of that business as opposed to the Mr Bell: There is not a one size fits all, it depends short term trading movements. whether you are looking at a structured product, whether you looking at a corporate, a government, a sovereign. There will be periodic reviews, the Q1213 Ms Keeble: One of you, and I should have frequency of which will depend on the type of checked which one—one of the companies— product that you are looking at. If the periodic suggested that there was going to be a downgrade of reviews show that something has occurred, that UK Government bonds. Processed: 25-03-2009 21:32:21 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG8

Ev 166 Treasury Committee: Evidence

28 January 2009 Mr Michael Madelain , Mr Frederic Drevon, Mr Barry Hancock, Mr Ian Bell, Mr Stephen W Joynt and Mr Charles Prescott

Mr Hancock: Not us, we aYrmed it two weeks ago. Mr Joynt: My understanding is that that is moving very quickly forward, that people are trying to reach a consensus in the European Community and have Q1214 Ms Keeble: Which one was it? a proposal as soon as April. Mr Madelain: It was not us.

Q1219 Ms Keeble: April. Q1215 Ms Keeble: Who was it then because it was Mr Joynt: I believe that is the case. In the US it is a well-reported. It was reported in the Telegraph and little bit diVerent with the change in administration it was quite widely discussed on the back of that. It and the review of our regulator, the SEC, together was one unnamed person in one credit ratings with the review of rating agencies. Either relatively agency and on the back of that there was all kinds of soon there will be a proposal put forward to think speculation, so somebody must have known. I mean, about regulation and how that can be more eVective, there are only three basic companies. or they need to study it further. On that I am not Mr Hancock: It is certainly not S&P, I am certain quite certain about the timing but we would hope of that. that both those approaches can find a common way Mr Joynt: It is not Fitch. to oversee rating agencies so that we can operate as a global firm constructively. Q1216 Chairman: Can we look under the table? Ms Keeble: That episode must have brought very Q1220 John Mann: These are questions to Moody’s firmly to your attention the impact that even this one and Fitch. Perhaps you could explain what went unnamed person floating a rumour in the Telegraph wrong January to September in your ratings for the and the consternation that that can cause. How Icelandic banks. carefully do you look or what do you do before you Mr Madelain: In January of 2008 we did place the put out a downgrade in terms of looking at what the ratings of the three Icelandic banks that we rate likely impact is going to be, basically on the real under review. We moved down the rating later in economy because there is really not much of a divide February, we published a research note on the between financial services and the economy. Iceland banks at the beginning of March, flagging Chairman: Is that Jim Rogers you are talking about? the weaknesses we saw in the system. If you remember Jim Rogers, the financier, he made a comment a couple of weeks ago. Q1221 John Mann: A research note for whom? Mr Madelain: To all the users of Moody’s ratings. Q1217 Ms Keeble: No, there was one that was We actually positioned the Icelandic banking system reported and I think Mr Fallon actually repeated it at the time at a level that is comparable to the one of at Prime Minister’s Questions, or somebody did Panama or other systems that are eVectively in terms anyway. If it was not you, somebody else did. of ranking at the fifth level in our ranking structure Somebody did. There was also a question about for banking systems, so we flagged the risks that regulation. Obviously because you work globally the were embedded into the Icelandic banking system. arguments are that regulation has to be global. I The ratings assigned to the bank were of a single A wonder if somebody other than Barry or Ian would category and the reasons for assigning a single A like to comment on that, as to where we are with that rating to those banks, despite the fact that our and how you would see that moving forward. assessment of the financial fundamentals were lower Mr Joynt: I would be happy to comment. I think the than that was that we incorporated in the rating an European environment is moving quite quickly assumption of support by the Icelandic Government through Mr McCreevy and his sponsorship through which actually we see coming for many countries the European Parliament to try to reach a conclusion throughout this crisis, which did not materialise and about a proposal about oversight for rating which led to the situation. agencies. All the rating agencies have been involved in giving commentary about that and generally I Q1222 John Mann: But you could work that out, believe that the issues that are being presented there that was not too diYcult to work out, was it? in a way are constructive for the industry, nothing to Mr Madelain: That the Icelandic banks would not be do with being regulated. We ourselves, at least at supported? Fitch, are implementing many of the procedures that are there or we have the procedures in place so I think we feel relatively constructive about what is Q1223 John Mann: Yes, that they could not be by the happening with the proposals in Europe. We do not government at the time to the level required. agree with every facet of it and some of the Mr Madelain: That was not the view we had or the implementation will be costly and diYcult, but we assumption we made. feel pretty good about it. Q1224 John Mann: But that was the view of other Q1218 Ms Keeble: Can I just ask about timescales commentators, was it not, in April and May? For because things that work in Europe or globally can example, the Scandinavian commentators and be very slow. central banks. Processed: 25-03-2009 21:32:21 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG8

Treasury Committee: Evidence Ev 167

28 January 2009 Mr Michael Madelain , Mr Frederic Drevon, Mr Barry Hancock, Mr Ian Bell, Mr Stephen W Joynt and Mr Charles Prescott

Mr Madelain: That may be the case. To the layman it was very clear therefore; do people actually get to see these special reports or are they Q1225 John Mann: May be? something that just is there in the ether in reality? Mr Madelain: It was not our view at the time. Mr Prescott: We place those special reports on our website and we do have subscribers to our service. Q1226 John Mann: In March you got this report done. The rational local authority, what should they Q1233 John Mann: But it is a special report. It seems have done, based on your report in March? to me that there is an issue here in terms of your Mr Madelain: I do not know what investment report was pretty convincing to the lay reader but guidelines are applicable or know the decision people did not pick it up—they either ignored it or process for investment by local authorities. they did not pick it up. You must put lots of reports out, lots of advice, lots of changes month in and Q1227 John Mann: You do not know. month out; how do people pick up that it is a special Mr Madelain: I do not know. report that needs particular attention? How do you highlight that? Q1228 John Mann: That is not going to be much Mr Prescott: I see what you mean. comfort to local authorities or local authority taxpayers, is it? Is it worth having your service for a local authority? Q1234 John Mann: Looking back are there better Mr Madelain: The people using our service had in ways in which you and others should be highlighting front of them our assessment of the banking system. reports of that nature? There was a very clear explanation of the Mr Prescott: We certainly put it out as a special assumptions that were within our ratings including report but I see where you are coming from, whether the level of support we had incorporated, State people interpret that special report as something that support, so investors who disagreed with our they should read or not—it is up to them really. It is assessment, as the one you mentioned, could make not a normal report, it is a special report. the decision that eVectively our ratings were John Mann: I get thousands of emails. If someone incorporating a form of credit enhancement that was puts something in bold with a red exclamation mark not justified. alongside it then I am either going to immediately delete it because it is a nutcase or I am going to read Q1229 John Mann: I have read your ratings over the it because it is important. There are ways in which period of time and I do not see what would signal, you can highlight. at that stage, anything happening. You are diVerent though, are you not, you did a special report in May, if I recall Q1235 Chairman: Could you give us a quick answer, Mr Prescott: We had been warning about the we are moving on? Icelandic banks for some time. Mr Prescott: There are ways we can think about how we could highlight that. Q1230 John Mann: Sorry, for some time before you did your special report? Q1236 John Mann: Final question: is it the fault of Mr Prescott: Since 2006. In April we put those banks those local authorities that they missed what was on watch and in May we downgraded them and there or is it your fault that you were too slow in your maintained two of them on watch and one of them credit ratings for them to pick up on what was on negative outlook. happening? Mr Prescott: My comment on that would be that we Q1231 John Mann: Why did you pick it up before gave warning and that it was the consequences of April? Lehman and the market closing that caused the Mr Prescott: Our ratings were A-minus which is the issue, so anyone who had read the report I think lowest rating in the A range; we had been looking at would have had ample warning. these banks for some time and the issue with these banks was to do with wholesale banking and liquidity. There had been an improving situation Q1237 Mr Fallon: It was the case, Mr Prescott, was over time so that had been taken into account, but it not, that you did not downgrade Kaupthing below clearly as the issues with banking got worse we felt A-minus until September? that the negative sentiment that existed in the market Mr Prescott: That is correct. had to be pointed out and so we brought out our report, we warned clearly that there was an issue with this and we felt that rating was appropriate at Q1238 Mr Fallon: Why was that? the time. It was only the collapse of Lehman that— Mr Prescott: Because we thought that A-minus was the appropriate rating. It was only when the collapse Q1232 John Mann: I have read your special report of Lehman changed the market and the market and, having read that, your special report would closed completely that these banks found themselves indicate that there were problems, it was very clear. in diYculty obtaining liquidity. Processed: 25-03-2009 21:32:21 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG8

Ev 168 Treasury Committee: Evidence

28 January 2009 Mr Michael Madelain , Mr Frederic Drevon, Mr Barry Hancock, Mr Ian Bell, Mr Stephen W Joynt and Mr Charles Prescott

Q1239 Mr Fallon: At no point before September did Q1245 Mr Fallon: How often do you look at it for a it occur to you that the government of a population sovereign country? of 300,000 people would not be able to stand behind Mr Hancock: We had a very thorough review of all these three enormous banks in the lending they of the major triple-As— had done. Mr Prescott: Our rating was based on the stand- Q1246 Mr Fallon: You downgraded Spain, did you alone rating of the entity, it had nothing to do with not? the government. Mr Hancock: We did indeed, and Greece, and we changed some outlooks on some other countries. Q1240 Mr Fallon: So you never considered the state of public finances in Iceland. Q1247 Mr Fallon: How often do you look at the Mr Prescott: The way in which we were looking at UK figure? the bank was on a stand-alone basis. Mr Hancock: We are looking at the ratings on an ongoing basis. If there were major shocks or changes we would look at the rating again, but at this point Q1241 Mr Fallon: Mr Hancock, it is true, is it not, our best judgment is that the outlook for it is triple- that back in November you did warn about the UK’s A because we have actually said it is a stable outlook. credit rating, your Mr Frank Gill; is that the man? Chairman: You could maybe have helped us before Mr Hancock: He is indeed one of our staV members. because Sally feels a bit misled. She was asking you who made the comment and you saw her— Q1242 Mr Fallon: He warned that the UK might lose its top-notch credit rating, is that correct? Q1248 Ms Keeble: I asked quite specifically because Mr Hancock: He said that, he said that to a it was in the Daily Telegraph and on the Today journalist I believe. Subsequent to that, two weeks programme which is what I was thinking of, but not ago, we had a review of all the large triple-A in this report. Y economies and we a rmed the rating had a stable Mr Hancock: Frank’s comments were many, many outlook. days ago.

Q1243 Mr Fallon: What is it that would trigger a Q1249 Ms Keeble: When I asked you all denied flatly change in your credit rating of a sovereign country that it had happened, but you must have seen it had like the UK? Would it be if there was a series of happened. uncovered gilt auctions or a new budget plan? What Mr Hancock: It was many weeks before the Daily would trigger it? Telegraph speculation of a week or two ago. Mr Hancock: In itself it is unlikely to be a single Chairman: It would be helpful to us if you were alert event. Our group of economists are looking at the on that; it would have saved a bit of a problem long term debt burden, they would be looking at the there. Jim. growth prospects, they would be looking at a variety of other scenarios and indeed the structure of the Q1250 Jim Cousins: I just want to be clear about this economy in coming to that decision. Clearly, as I because two things that are slightly contradictory mentioned, when we aYrmed the rating two weeks have been said here. You have just said that when ago we had a very good look at all of the factors we you are rating the bonds issued by a government you look at and, given that this is an inquiry into the look at the underlying contingent liabilities. banking crisis, we also factor in a degree of support Mr Hancock: Correct. that the Government will provide on account of the banking system so we are actually adding in some Q1251 Jim Cousins: Which would include their contingent liabilities that might arise through the exposure to the protection of their banking system. banking system stress. We add those into the rating You do that as a matter of routine presumably. and, based on all of that, we aYrmed it two weeks Mr Hancock: Certainly. The issue of nationalisation ago with a stable outlook. is one that comes up often.

Q1244 Mr Fallon: But your Mr Gill said “Nothing Q1252 Jim Cousins: Sorry, how does the issue of is forever, we are in the process of assessing whether nationalisation come up specifically? the Government can reverse the damage that is Mr Hancock: Certainly there is speculation in the about to be done to its balance sheet over the next press and indeed the Chairman’s comments in the three years.” FT have raised a lot of issues about the impact that Mr Hancock: Indeed and we did have our formal nationalisation would have on the sovereign rating. credit committee. Frank Gill is one of our members Certainly at S&P our view is that nationalisation in of the sovereign team but no decisions by rating itself does not increase the government debt burden; agencies and certainly S&P are made by individuals it may be a signal of some other issues but in itself alone. The committee met formally and aYrmed the we are looking at the banking system as a contingent rating and left it on a stable outlook. The point I liability as a part of our analysis. We certainly look think he was making is that ratings are constantly at the amount of capital that may need to be injected reviewed and updated depending on the into the banking systems, and that is a very circumstances that are prevailing at the time. important element of our analysis. Processed: 25-03-2009 21:32:21 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG8

Treasury Committee: Evidence Ev 169

28 January 2009 Mr Michael Madelain , Mr Frederic Drevon, Mr Barry Hancock, Mr Ian Bell, Mr Stephen W Joynt and Mr Charles Prescott

Q1253 Jim Cousins: I just want to be clear about from the leveraging of the banking system. We what you have just told us. Are you suggesting that certainly took a somewhat diVerent view; ratings are an article our Chairman writes in the newspaper opinions and other agencies have diVerent opinions. might aVect the credit rating of the UK Government? Mr Hancock: Absolutely not, I am just saying that Q1257 Jim Cousins: That is not what you did. The other two outfits, you are quite clear that you did not obviously it created a lot of discussion which I am do that exercise, looking at the background factors, trying to respond to here to clarify our position. you just looked at the entity itself, and if you had looked at those background factors—I have Q1254 Jim Cousins: I am sorry, I do want to explore absolutely no idea what the Icelandic Parliament this point because it is quite troubling in a way. You was doing in terms of looking at its banks, and the said that discussion of nationalisation of banking chairmen of its committees making statements— entities in a country would aVect your rating of that surely you would have come to a more pessimistic country’s bonds. view of the Icelandic situation than at the time when Mr Hancock: What I actually said was you did. nationalisation in itself does not increase the Mr Prescott: That is why we had the warnings out, government debt burden and in itself would not because we were aware of this. The sovereign rating aVect the sovereign rating. What might lead to a of Iceland was A-plus so it was a reasonable rating nationalisation may lead us to rethink our at the time and we were not expecting the impact of assessment of other factors, but in itself the the magnitude on the markets that the collapse of government debt burden and the sovereign rating Lehman led to. are not automatically impacted. Q1258 Jim Cousins: Are you anticipating any more Q1255 Jim Cousins: But our friends down the end of banking collapses? Having missed out on Lehman’s the line said you only looked at the entity, you did what is your rating of the possibility of another not look beyond it at these other factors that have Lehman-style collapse somewhere in the world? just now been mentioned. Mr Madelain: I would like to go back to what I said Mr Joynt: Yes, it depends how you are looking at the before at the outset. bank. Obviously as time has gone on and there have been lots of government schemes coming in, we now Q1259 Jim Cousins: I am sorry, I do not want you to do bring support into our ratings for banks. This is go back to where you were at the outset, I want you nothing to do with the sovereign issue. to start from where we are now. You missed out on Mr Bell: You can think about it as looking at the Lehman, what are the chances of another banking credit of somebody who has got a guarantee. I am collapse? not saying banks were guaranteed but if you are Mr Madelain: Our ratings incorporate a number of looking at the credit of somebody who has a very assumptions including in a number of countries the powerful guarantor standing behind him you might availability of government support. We believe those give credit to that guarantor. If you have a very weak assumptions are assumptions that are reasonable in guarantor who is not really worth the money of the the current environment and based on the facts we guarantee you would discount it, and I think in some know; therefore we will have to see at the time to cases you have got banking systems with very strong what extent these assumptions prove to be correct. I economies and very strong governments standing cannot today give you any assurance but we are behind them; you would give more credit to the developing opinions, on the basis of central support of that strong economy and that strong scenarios that we develop, on the situation of the government. In a situation where you have got very banks, for example in terms of asset valuations. in big banks with very weak governments standing terms of availability of liquidity, in terms of behind them you do not incorporate much availability of support. So there are a number of government support because you know it is not up assumptions in the development of our ratings. to it. You would have to look at it in each case; it is not a one rule fits all. John Mann: It is total nonsense. Q1260 Sir Peter Viggers: In carrying out your assessment of the UK sovereign position what assumptions did you make about the obligations of Q1256 Jim Cousins: Let us take the example of Royal Bank of Scotland and are you certain that you Iceland because it might be slightly more had a robust assessment of the total commitment? comfortable for us. Using that line of thinking surely Mr Hancock: Standard & Poor’s point of view on you should have spotted that the Icelandic banks this—and I am very happy to supply you with all the were at risk well before you did, using exactly that material we have published on it—assumes that up logic that has been set out to us. to approximately 20% of GDP in the form of bank Mr Hancock: In terms of Iceland we only rated one assets could be problematic in the future, and that is of the banks in Iceland and indeed we started included in our analysis and the numbers for the warning about sovereign itself back in February sovereign, so approximately 20% of GDP by way of 2005 due to the rising imbalances and currency risks non-performing assets as a contingent liability. Processed: 25-03-2009 21:32:21 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG8

Ev 170 Treasury Committee: Evidence

28 January 2009 Mr Michael Madelain , Mr Frederic Drevon, Mr Barry Hancock, Mr Ian Bell, Mr Stephen W Joynt and Mr Charles Prescott

Q1261 Sir Peter Viggers: A completely diVerent have no particular view on how you achieve global subject, moving forward now, a change in consistency, but certainly one of the benefits of regulation. The European Commission put forward ratings is that they create a global benchmark and some quite sweeping proposals in November 2008. therefore if we had a European rating style, a How are you responding to the probability of Japanese rating style and a US rating style all diVerent regulation worldwide and how are you operating in diVerent ways with diVerent rules and adjusting for this internally and externally? Can you diVerent procedures I think that would be very very briefly just summarise your position on this? damaging for the industry. Some kind of global Mr Joynt: As I mentioned earlier we follow carefully consistency, however it is achieved, is therefore very the proposals that they put forward as they have important we think. Finally, the regulatory scheme been moving around. Some of them are things that should be workable. we do already, some of them are procedures that we want to strengthen in terms of identifying, and the Q1264 Mr Love: Let me just press you on that. One management of, conflicts of interest in how we go of the things that was said to us when we went to about assigning ratings and deciding not our criteria Europe was that the standard that was coming out of or approach but the way they have asked us to look Europe was a good deal higher than that in America. at the collection of information, and the How can we ensure that we do not disadvantage transparency with which we present not just our ourselves but achieve a reasonable standard of rating but our analysis and our conclusion. I feel that regulation for the industry? we are moving forward, we are not waiting for Mr Bell: The most important thing is going to be someone to establish a new set of regulations for us consultation and dialogue between the major to follow, we are responsive today to adjusting our industrial powers and major financial centres in process and our thinking to what we would Japan, in Australia, Europe and the United States to anticipate in the main are reasonable proposals. come to standards. I do not think the various regulators are actually very far apart in the things Q1262 Sir Peter Viggers: Thank you, I have to ask that they would want to see from the agencies; it is you to be brief. more a question of making sure that there is Mr Drevon: First of all I should say that as part of dialogue. bringing back confidence in the system we think that the regulatory proposals which have been put Q1265 Mr Love: Is the industry on board on this? forward are very important. It is one of the things Mr Bell: The industry is absolutely on board on this. which will bring back confidence to investors that there has been a change in the regulatory framework Q1266 Mr Love: You are not going to race for the for rating agencies. So we have been in fact engaging lowest standard? with regulators in many diVerent countries in a very Mr Bell: The other agencies can speak for organised and supportive way to have these changes themselves but we are in Europe, we have no desire made in an appropriate way. Clearly there are to leave Europe, it is a very important market for us diVerent regulatory initiatives around the world; and we are here for the duration. they are not necessarily going to be done in a very consistent and co-ordinated way and I certainly V Q1267 Mr Love: One of the things that the European think there is a risk that di erent proposals end up Commission has addressed, to the disappointment creating some conflicts between diVerent parts of the V of some in recent comments, is the whole business world and somewhat a ecting the global nature of model based on issuer- pays. There has been a lot of the markets. So as much as we can when we are comment about this and that we should have an speaking with regulators we are trying to put investor-pays type of model; from your perspective forward the idea that greater co-ordination is going as the industry is talk about an investor-pays to be needed as we move forward. model realistic? Mr Madelain: The key point here in my mind is that Q1263 Sir Peter Viggers: Thank you. Standard & if the issue is about conflict there is conflict with Poor’s? every model. I am sure you are fully aware of the Mr Bell: Very similarly we welcome the regulatory conflict inherent to an investor-pay model: people proposals that are being put forward, we think they who short bonds or short stock have a keen interest are an important part of re-establishing the in seeing a very aggressive downgrade; people who credibility of our industry. We have worked very hold bonds have a very key stake in keeping the closely with the European Commission and ratings stable, so nobody is out of conflict. If you go Members of the European Parliament. The three to a government rating organisation you will also things that we would emphasise in the regulation have conflicts which will be linked to national and the three things which we think are essential are interests, protecting their industries, competition that any regulation protects the independence and against others, regulatory arbitrage—there may be integrity of our opinions—and certainly some of the diVerent types of situations. The key to us is that we text of the European Commission in that respect is believe that the current model is the best model but it very positive—the second thing we think is very needs to be managed eVectively and as we mentioned important is that there should be global consistency. before we can do our share to give credibility to that That does not mean one global regulator, and we model. But we believe that regulation as Processed: 25-03-2009 21:32:21 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG8

Treasury Committee: Evidence Ev 171

28 January 2009 Mr Michael Madelain , Mr Frederic Drevon, Mr Barry Hancock, Mr Ian Bell, Mr Stephen W Joynt and Mr Charles Prescott contemplated will eVectively provide further Mr Madelain: First out I would state that I would assurance to the investors and to the other disagree with the assessment of Mr Fons. But the stakeholders that we are managing properly the issue he raised is one we recognise and actually we conflict. That is the value we see in the introduction have been very vocal on, which is that we view it as of this regulation. essential that the level of transparency that we have today on the corporate ratings side is available on the structured finance side, which means that we Q1268 Mr Love: Does anybody want to add to that? need to have a level of information available to all Mr Bell: Just one thing about the investor-pays market participants which is equivalent to what we model, I think the circle that will not square with the see when we rate corporate or when we rate local investor-pays model is the transparency. What the authority or government or financial institutions. issuer-pays model gives you is the capacity for us to Today that information is not publicly available, it put the ratings and the explanations and the analysis is only available to the rating agency that rates the out for free for everybody to see—potential transaction or to a select group of market investors, putative investors, regulators, policy- participants and we think that is something that makers. If you have an investor-pays model it is needs to be changed. We have been very vocal on this Y di cult to see how that model works when anybody issue, our CEO has made remarks on that and we can get for free what another investor has to pay for. have made a proposal and we think that that is an That is the big problem we see with the investor- area where the regulators and the policy-makers pays models. need to step in and actually make that happen. Mr Love: Finally, by sticking to the same model you are eVectively saying to us that we have to depend on your assessment of your own reputation as the Q1272 Nick Ainger: What about the issuer-pays safeguard for getting it right. Can we do that? What business model, particularly in relation to additional regulation do we need so that in eVect we derivatives, CDOs and so on? do not end up just depending on you being worried Mr Madelain: That issue disappears as soon as the about your reputation? information becomes publicly available because when the information is publicly available, even if we are not retained as the rating agency and we want Q1269 Chairman: Give us a quick answer, we are to express an opinion, we would be in a position to moving on. do that. Mr Madelain: Very quickly what I was trying to say is that eVectively we would rely on regulation to give Q1273 Nick Ainger: You believe that there is you that extra level of comfort that comes from suYcient competition between the credit rating independent regulator that will come back and check agencies to prevent a bank or an issuer of CDOs compliance. The rules and the independence that playing you oV against another one and getting a you are seeking are eVectively in place in the better deal, in other words getting you to do the organisation. business but actually doing it at a lower rate. Mr Madelain: If you make that information Q1270 Mr Love: You are all happy with the available to the public and either one of us or a new European Commission’s proposals. participant is in a position to express an opinion, even without a fee, that issue will be resolved. Mr Bell: We have a lot of comments. Q1274 Nick Ainger: Finally, can I move on to Q1271 Nick Ainger: I want to direct these questions another contribution that was put to the Homeland at the two representatives from Moody’s. Your Security and Government AVairs Committee of the former managing director of credit policy who Senate by Senator Carl Levin who I am well aware finished with you in August 2007 gave written had done an awful lot of work in this area. Part of his evidence to the Committee on Oversight and submission was “Internal emails [these were within Government Reform at the House of credit rating agencies] contained the following: Representatives in October 2008 and part of his ‘Combined, these errors make us look either submission was: “My view is that a large part of the incompetent at credit analysis, or like we sold our blame [about the failures of the credit rating soul to the devil for revenue, or a little bit of both.’ agencies] can be placed on the inherent conflicts of ‘[Our rating] model def[initely] does not capture half interest found in the issuer-pays business model and of the . . . risk . . . We should not be rating it.’ ‘[Credit rating shopping by issuers of structured securities. A rating agency professionals are continually drive to maintain or expand market share made the “pitched” by bankers, issuers, investors . . . whose rating agencies willing participants in this shopping views can colour credit judgment.’ ‘Let’s hope we are spree. It was also relatively easy for the major banks all wealthy and retired by the time this house of cards to play the agencies oV one another because of the falters’.” In the past year you have rated triple-A opacity of the structured transactions and the high bonds which have now been re-categorised as junk potential fees earned by the winning agency.” Do bonds. We have heard the problems that local you agree that unless there is greater competition authorities have experienced because of their belief and more credit agencies Mr Fons’s very critical in the credit rating that you have given to certain analysis will actually continue? institutions including the Icelandic banks. Bearing Processed: 25-03-2009 21:32:21 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG8

Ev 172 Treasury Committee: Evidence

28 January 2009 Mr Michael Madelain , Mr Frederic Drevon, Mr Barry Hancock, Mr Ian Bell, Mr Stephen W Joynt and Mr Charles Prescott in mind the damage that has been done to your Mr Bell: We try to speak to a lot of investors. industry’s reputation, do you worry about the future for the whole industry? Q1282 Chairman: If you are speaking to a lot of Mr Madelain: First of all these comments would not investors you must have some feedback on it. reflect at all the ethics and the work that are taking Mr Bell: What we have found in the past is that the place within our organisation. Second, we are doing investors we speak to tend to be the sophisticated a number of things as we described to your ones because they are the big ones, they are the Committee when we last came and we have done a people we know. It is harder to reach out— lot of work to improve our processes and make them more robust. As I said before there are a number of Q1283 Chairman: Will you make it your job to speak things we believe we can achieve through the eVorts to the unsophisticated ones? we are deploying; we also believe that there is some Mr Bell: We try. improvement that has to be delivered by third parties, including regulators, and we do believe that Q1284 Chairman: So that we get a view on that. assuming those eVorts take place we will be able to CRAs really should have recognised that even continue to provide value and help the market to sophisticated users did not have time to look beyond recover. the ratings; is that fair enough? Mr Madelain: I think the level of resources that are Q1275 Nick Ainger: You believe investors should deployed or were deployed in the institutions that trust you now. were mentioned earlier today in this debate is very Mr Madelain: That is correct. significant.

Q1276 Chairman: Thank you for your appearance. Q1285 Chairman: You have no concerns about Could I just sum up what you have said? You accept sophisticated investors at all in terms of their that some assumptions made by CRAs, particularly understanding. regarding sub-prime markets and CDOs, turned out Mr Madelain: Yes, they have the resources and the to be incorrect. skills and the technology to understand. Mr Madelain: I would not. Personally I think this is an oversimplification of a very complex issue. Q1286 Chairman: That is good for the public record. On Iceland, the points that were made earlier, the Q1277 Chairman: Some of you would accept that CRAs made assumptions that the government proposition. would and could stand behind the banks but this Mr Hancock: Yes. assumption proved incorrect and should have been Mr Joynt: Yes. known to be incorrect even without hindsight. Mr Madelain: I dispute that. Q1278 Chairman: Okay, some of you do, just one does not. You broadly welcome the moves from Q1287 Chairman: Did you make assumptions that Europe and the US to revisit regulation of CRAs but the government could and would stand behind the hope to see global co-ordination in regulatory banks? approaches, is that fair enough? Mr Madelain: We rated the banks incorporating an Mr Hancock: Yes. element of support, so it was an element of the Mr Joynt: That is correct. credit opinion.

Q1279 Chairman: You believe that institutional Q1288 Chairman: Did some of you make investors and regulators are what you call assumptions that the government would and could “sophisticated users” of ratings who understand the stand behind the banks? limitations but accept that some investors continue Mr Madelain: But that was only one element of the to place undue reliance on ratings. rating. Mr Joynt: Yes. Mr Madelain: I would dispute the second part. Q1289 Chairman: But was that an assumption; that is what I am trying to get? Q1280 Chairman: Some investors continue to . . . Mr Madelain: It was one element of the Mr Bell: We do not know whether some investors assumptions. do. Certainly it would appear that some have in the past. Q1290 Chairman: So there was an assumption. Mr Madelain: Yes. Q1281 Chairman: Would that be a good Chairman: That is fine. Thanks very much for your investigative opportunity for you to find out about time and maybe—maybe—we will see you again. some investors? Thank you. Processed: 25-03-2009 21:47:58 Page Layout: COENEW [SO] PPSysB Job: 416782 Unit: PAG9

Treasury Committee: Evidence Ev 173

Tuesday 3 February 2009

Members present

John McFall, Chairman

Nick Ainger Mr Andrew Love Mr Graham Brady John Mann Mr Colin Breed John Thurso Jim Cousins Mr Mark Todd Mr Stephen Crabb Sir Peter Viggers Mr Michael Fallon

Witnesses: Mr Ziggy Sieczko, KSFIOM Action Group, Councillor Richard Kemp, Local Government Association, Mr Neil Dickens, Landsbanki Guernsey Depositors Action Group, Mr Chris Cummings, Director General, Ms Amanda Davidson, Deputy Chair, Association of Independent Financial Advisers (AIFA), and Dr John Low, Chief Executive, Charities Aid Foundation (CAF), gave evidence.

Q1291 Chairman: Welcome to this evidence session Cllr Kemp: We do not get specific advice from the on the banking crisis aVecting every man in Treasury; we get particular advice from the Audit Guernsey. Could the witnesses identify themselves Commission and there are rules agreed with the and where they come from for the shorthand DCLG. That advice is to get the best possible return writer, please? across a spread of investments. There was no advice Ms Davidson: I am Amanda Davidson. I am the to invest abroad, but there was no advice not to. In Deputy Chair of AIFA. I am also a practicing IFA. line with the general guidance which local Mr Cummings: I am Chris Cummings. I am the government was given, a small element—and we are Director General of the Association of Independent talking about 5% of the total investment of local Financial Advisers. government in overseas banking—seems Cllr Kemp: I am Councillor Richard Kemp, Deputy reasonable. Chair of the Local Government Association. Dr Low: I am John Low. I am the Chief Executive of the Charities Aid Foundation. Q1294 Chairman: Do you think the code of practice Mr Sieczko: I am Ziggy Sieczko, the London for Treasury management and investment needs to Coordinator for the Kaupthing Singer & be changed and, if so, how? Friedlander Isle of Man Depositors Action Group. Cllr Kemp: First of all, I think all of us need to be V Mr Dickens: Neil Dickens, a depositor in looking at doing things very di erently in the light of Landsbanki Guernsey and also the Chair of the circumstances. I think they were robust. Certainly Action Group on Guernsey. I am British but live in we will work with CIPFA to amend them in light of California. this report and in the light of the DCLG Select Committee report on Icelandic banking which is also taking place. So change is in the air, change is Q1292 Chairman: To what extent do you think the needed, but we are partly waiting for the results of statement made by the Chancellor of the Exchequer this Committee’s inquiry before moving forward. about the Icelandic authorities’ willingness to meet their obligations exacerbated the situation? V Mr Sieczko: It would seem from the transcript that Q1295 Mr Crabb: Dr Low, how badly a ected have we saw of the Chancellor’s discussions with the Isle charities been by the failure of the banks in the Isle of of Man that the Chancellor’s open air statement Man and Guernsey, as well as the onshore Icelandic saying that the Icelandic authorities refused to meet bank subsidiaries? their obligations in the UK did not quite add up to Dr Low: It has been quite serious. The extent of the what was said in that discussion. To say that was problem is not known because a number of charities defamatory would be putting it mildly. Kaupthing have chosen not to become public on it. We know Singer & Friedlander UK got put into that at least £86 million was tied up with a group of administration as a result of its inability, according charities that were invested. There are figures which to the FSA, to meet its obligations. We have to are in excess of £200 million being suggested partly question seriously whether that inability was from the websites of the banks involved. It is having brought about by the running of the bank or caused a major eVect. We are seeing charities having to cut by such defamatory comments from the Treasury back on services. For example, one of the children’s and from the Chancellor himself. hospices has had to stop its ‘Hospice at Home’ care and withdrawn that care for children because of this. Q1293 Chairman: Councillor Kemp, it was reported that councillors had followed Treasury advice by Q1296 Mr Crabb: Are you aware of any code of investing surplus money in order to deliver the practice produced perhaps by the Charity highest return for taxpayers. Did HMT advise Commission or any other authority advising investing oVshore? charities on how they should invest? Processed: 25-03-2009 21:47:58 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG9

Ev 174 Treasury Committee: Evidence

3 February 2009 Mr Ziggy Sieczko, Councillor Richard Kemp, Mr Neil Dickens, Mr Chris Cummings, Ms Amanda Davidson and Dr John Low

Dr Low: The Trustee Act 2000 sets out the duties of Q1300 Mr Fallon: Councillor Kemp, given the trustees and is the only statutory instrument that evidence we have had repeated today, that the governs the behaviour of trustees, with the duty of Chancellor’s statement was at best injudicious and care and so on. The Charity Commission has issued certainly exacerbated the situation, do your guidance but it is non-statutory guidance on how members believe that there is now a case for the investments should be handled. Mainly this is about British Government compensating you? diversification, taking appropriate advice, review Cllr Kemp: We certainly believe that we have acted and so on, but there is nothing statutory beyond the on the best advice available from ministers, from Trustee Act 2000. Parliament, from regulators, from the credit reference agencies, a whole variety of people. We are asking for two things. One is to be treated equally Q1297 Mr Crabb: In that guidance is there any with every other class of creditor. We have diYculty V reference to investing o shore? in understanding the diVerences between the two Dr Low: No. That is not an issue that the Charity systems because two of the banks are English Commission has a view on. The trustees have an registered so we understand the administration obligation to get the best return they can, taking into system here, but we are not as clear about what is account the risks associated with those investments. happening for the banks in Iceland and particularly My biggest concern is the lack of information to what discussions the Government is having with the trustees about these banks and these accounts. We Icelandic Government outside the ordinary have poor information on credit rating and we have discussions about creditors in a failed situation. We no sense, other than league tables of interest rates, have been helped by the Government in the short about the sustainability and the risk associated with term by allowing us to withdraw concerns about each of these regulated bank accounts. I do not think Iceland from the equivalent of our balance sheet for it has been in any way transparent for the trustees this financial year so we do not have to take it into making decisions about investments as to where the account. We will be looking, if we cannot get the money should go given a balance between risk, money back, for capitalization of the money because sustainability of the bank and the return that is likely some councils would find it very diYcult to pay their to be achieved. sums back in one year, if the crunch came to it. So we would want capitalization to spread it over a period of years, in which case it would be manageable, but Q1298 Mr Crabb: Are you aware of any charities we have had refusal for that at the moment from the that looked at investing overseas and then chose not Government. to for exactly the reasons that you have just described? Dr Low: Anecdotally I have heard of one or two that Q1301 Mr Fallon: What I asked you was whether have considered that and not done it outside the UK. you thought there was now a moral case for the The protection that is available under the Financial Treasury to reimburse councils given the way the Services Compensation Scheme is extremely vague Chancellor himself mishandled the state of aVairs and uncertain. Charities had no easy way of in Iceland. understanding whether they would be receiving any Cllr Kemp: I would make it wider than that because protection or not. Therefore, a number of charities I do not believe it is just the Chancellor; I believe that did look outside the UK and chose not to, but that there are a series of failures within the system. I is anecdotal, I could not give you hard evidence on believe there is a moral right, but it is not just the that. Chancellor’s, it is the credit reference agencies, it is a whole range of things. In some we invested properly on the advice of all those people, including Q1299 Mr Crabb: Finally, what support have you the Chancellor and we should have our money back. received from the Government regarding the charity sector’s losses? Dr Low: There has been very little support, frankly. Q1302 Mr Fallon: Dr Low, is that your position as I was involved with a group of others in the umbrella well? groups working with the sector. I met Lord Myners Dr Low: Yes. Money which is held in trust is publicly and the Minister for the Third Sector regarding the donated money specifically for public benefit. The Icelandic crisis and the eVect on charities. I called for credit rating agencies were suggesting that these were an interest free relief scheme that would not have doubly A-banks right up to the end. It is cost Government anything given their view on the unreasonable to suggest that these banks were any situation, but that was not forthcoming. There was worse than any others. Should a charity trustee be penalised for choosing an Icelandic owned bank an adjournment debate on it and Government which is UK registered as opposed to RBS which simply was not willing to treat charities any had the same rating and yet failed under very similar diVerently to any other wholesale investor. Even circumstances? It is just the way in which though Government has chosen to bail out high net Government is allowing them to fail that is the issue. worth individuals to the full amount, money that is held in trust for public benefit has been put into a pool with wholesale investors, which is grossly Q1303 Sir Peter Viggers: Did you see the crisis unfair. coming? Processed: 25-03-2009 21:47:58 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG9

Treasury Committee: Evidence Ev 175

3 February 2009 Mr Ziggy Sieczko, Councillor Richard Kemp, Mr Neil Dickens, Mr Chris Cummings, Ms Amanda Davidson and Dr John Low

Mr Cummings: I think, along with the rest of the Cllr Kemp: Again it would depend on the range of regulatory structure and policymakers, there were spread. If it was all in one bank in one country, that some indications that the housing market was would be one issue. If it was a range of spreads— overheating certainly, but we were not in a position to judge and foretell the extent of the problems that we now see. Q1308 John Mann: Let us take Iceland then. What would be a percentage investment in Iceland that would have been unreasonable? Q1304 Sir Peter Viggers: Do you think your Cllr Kemp: Perhaps 10%. members are vulnerable to the charge of having mis- sold investors with accounts based oVshore as low risk? Q1309 John Mann: So 10% would have been Ms Davidson: No. In terms of risk, oVshore can unreasonable? present a greater risk for investors, but there are Cllr Kemp: Yes. often very good reasons for advising that a client V should invest o shore. Sometimes it is purely a rate, Q1310 John Mann: Do you give guidance on that? sometimes there can be tax considerations to take Cllr Kemp: No, we do not. into account and sometimes there are benefits from passing money down generations. Q1311 John Mann: Why not? Cllr Kemp: The Local Government Association is a Q1305 Sir Peter Viggers: In your submission to us member body. Individual councils take advice from you said that “it is the product provider’s a number of places. They take advice principally responsibility to ensure there is clarity...regarding from the district auditor, part of the Audit the product’s purpose and its associated risks”. Is Commission which had their own money invested in that not rather passing the buck? Iceland, they take it from the credit reference Mr Cummings: We do not think so. We undertook agencies and they take it on more than half the some work with the Association of British Insurers accounts from Treasury management advisers. which was also shared with the FSA, our regulator, in trying to tease apart the respective rights and responsibilities of each partner. The ABI, as the Q1312 John Mann: You said that money had been people who designed the products, has a invested properly on the basis of advice given, but responsibility for making sure those products are fit Fitch Ratings on 22 May produced a special report for purpose and well targeted and, if the risk profile on Iceland which went to most of your members of them changes, to inform the market. As IFAs we because they pay Fitch for this service and this says have a duty to our clients to challenge the product unequivocally that Iceland is “high risk”. Why did providers to make sure that they are being open and your members continue to invest in Iceland after honest with us, but we can only know what we know 22 May? at the time. The FSA has tried to help this situation Cllr Kemp: Basically they did not. by, for example, in the with-profits area, instructing product providers to produce documents called PPFMs (Principles and Practices of Financial Q1313 John Mann: Some did. Why did those Management) to expose their inner workings, but continue when they were paying Fitch Ratings for unfortunately that is only in the odd case. As IFAs this special report which says quite unequivocally we ask questions and we constantly prod product that Iceland is “high risk”? providers to give us more information, but Cllr Kemp: First of all, there began to be a ultimately they have commercial reasons for disinvestment. As you will appreciate, money is put maintaining the integrity of their product design. in an investment for a period of time. If we were disinvesting now and discussing this, £680 million would have been withdrawn from Icelandic banks. Q1306 Sir Peter Viggers: Do you think the product Two or three councils continued to invest up to the providers were open and frank enough about the last minute. Those who have already conducted their risks involved? own internal enquiries into why it has happened and Mr Cummings: I would imagine that they were how it has happened are robustly changing their caught out by the speed of events in a similar way to Treasury management systems, and we can make the rest of the economy and the UK public. If they evidence of that available to this Committee if you became aware of risks, they should have had a duty would like. of care, not a regulatory responsibility, to expose those risks and keep their customers and us as IFAs informed of the changing risk pattern. Q1314 John Mann: I think it would be helpful. It would be helpful to get your view on why certain councils decided after 22 May to disinvest—perhaps Q1307 John Mann: Councillor Kemp, you said we would like to congratulate those councils on their earlier that 5% of assets invested overseas would wisdom—and why other councils continued after 22 seem reasonable for any one authority. What May to continue to invest. Would that not appear to percentage would be unreasonable? be rather reckless? Processed: 25-03-2009 21:47:58 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG9

Ev 176 Treasury Committee: Evidence

3 February 2009 Mr Ziggy Sieczko, Councillor Richard Kemp, Mr Neil Dickens, Mr Chris Cummings, Ms Amanda Davidson and Dr John Low

Cllr Kemp: No. If you look in detail at what Q1320 Mr Brady: What proportion of your happened after that report, you will find that the depositors that you represent are British expatriate recommendation from the credit reference agencies citizens? went down one grade and they were still high in the Mr Sieczko: From our polls we believe that between investment categories. There are six categories of 55% and 60% of depositors were expatriates. investment and Icelandic banks went down from the Mr Dickens: It is a third in Landsbanki Guernsey. top to the next to the top, so there was a marginal downgrading. Q1321 Mr Brady: For how many of them would it be Q1315 John Mann: It does describe it as “high risk”. fair to characterize them as being wealthy tax exiles? It is an extraordinary report. I would suggest some Mr Sieczko: I would not like to put a number on of your members did not read it. that, but I would say a very small amount of them Cllr Kemp: I think if you read the report and then compared to the people I have been speaking to. look at what happened to the credit references, Mr Dickens: It is certainly not the case. which are the people who get paid to look at those reports, to understand them and then advise people like councils on, you will see that the eVect was not Q1322 Mr Brady: The typical depositor that you are as great as you think it was. I am satisfied the vast representing, could you give an image of the kind of majority of councils, having read that, will have then situation that they were in and why they have put discussed it with their advisers and their advisers their money in those banks? were still recommending they invest. Mr Dickens: The predominant depositor is a depositor from the Channel Islands, Guernsey and Jersey, a high street bank, and then there are a third Q1316 John Mann: Could you also in that note of the depositors who are expats and who, given the include details of what discussions with those who research that we undertook as an action group, it continue to invest they had with their credit reference agency so we can see if there is a weakness seemed very clear are unable—and I myself in what advice the credit reference agencies gave personally was unable to open an account in the particularly after 22 May to your members? A note UK—and had no choice but to open an account in on precisely what happened would be very valuable. the Crown Dependencies. Cllr Kemp: Yes. This is being investigated heavily by Mr Sieczko: It is pretty much the same thing for the DCLG Select Committee and we have presented depositors with accounts in the Isle of Man. Most of evidence to them which we would be happy to them have worked for aid organisations, UK supply here. structural engineers abroad or they have retired abroad. They are hard-working people who have done what the Government told them to do, that is, Q1317 Chairman: Mr Mann is saying that after 22 save up, do not rely on the State and put your money May the credit ratings agencies mentioned that somewhere safe. They were not allowed to open a Iceland was high risk. That being the case, if local UK bank account. A lot of them were in the authorities kept investing there, do you think they Derbyshire Building Society believing it is a UK had total culpability? building society, it is protected and they have been Cllr Kemp: No, I do not because that is only one of left by the wayside now. the elements of advice that local authorities and Mr Dickens: I was just about to add that 94% of others deal with. They have been paying people to depositors in Landsbanki Guernsey are British. A provide Treasury management systems— good number, myself included, had an account with Cheshire Guernsey. We are not tax dodging Q1318 Chairman: Let me get it clear again. Even millionaires. though it says “high risk” you think the local authorities who invested after that 22 May date do not have any responsibility, do you? Q1323 Mr Brady: You both mentioned the diYculty Cllr Kemp: Again, if I could make it absolutely clear, of British expatriates opening bank accounts on the the risk rating went down from the highest possible mainland and yet we have heard from the grade to the next highest and was still in the level in Chancellor, amongst others, that the so-called which the credit reference agencies were advising “know your customer” rules do not prevent that. Is investment. it your view that the British mainland financial institutions have been misinterpreting those rules Q1319 Chairman: But it said it was “high risk”. Is it and misapplying them? not a red alert if someone sees “high risk”? Mr Dickens: I think the “know your customer” Cllr Kemp: We would be happy to supply you with clause is taken to an extreme. With the research that the details of what the credit reference agencies were we undertook as an action group of originally 58 saying and the minimal downgrading that banks but which is now 57 because one was taken occurred.1 over, only two banks would allow a British expat depositor to place their monies there and they had to 1 HC (2008–09) 144–II, Ev 565 be present in order to do that. What it comes down Processed: 25-03-2009 21:47:59 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG9

Treasury Committee: Evidence Ev 177

3 February 2009 Mr Ziggy Sieczko, Councillor Richard Kemp, Mr Neil Dickens, Mr Chris Cummings, Ms Amanda Davidson and Dr John Low to is a UK address. Indeed, if I may add, Simon Bain taxes and better returns and therefore they did not said in the Glasgow Herald, in an article on 8 contribute in any way to the UK Exchequer. Why November, “All banks contacted by The Herald should the UK taxpayer bail out those accounts? were puzzled by Mr Pearson’s statements. The banks Mr Sieczko: It is an interesting but incorrect point, all said that ‘the need for a UK address’ was due to if I may say so. This goes back to our Chancellor the Government’s money laundering regulations”. I making comments about a tax haven in the Irish Sea. tried to open an account after I had left for the You expect a person in his position to know a little United States here in the UK and I was unable to bit more about European legislation and do so. particularly the European Savings Directive under which we all pay withholding tax in the Isle of Man. If you are a UK resident you will pay standard rate Q1324 Mr Brady: Is that your experience and would withholding tax and will be remitted back to the that have been reflected in your advice to Treasury, the same Treasury that is now refusing to expatriates? Would you have advised them that it back us and refusing to help us out at all. Likewise if would be diYcult, if not impossible, to open you are an expat and you happen to be living in the accounts with mainland banks? European Union, Spain, France, Italy,Germany,the Ms Davidson: Yes, indeed because there is also a same thing will apply, the Isle of Man will collect the further declaration that you have to be a UK money and remit the money to the European state resident in order to open some of the UK bank where these people are residents. This is not tax accounts and that would not have been open to avoidance. This is nothing to do with the tax depositors who are not resident in the UK as well as position. Yes, we had good rates in the Isle of Man. the UK address issue. So that certainly would be We did our due diligence on the bank. We had a something that would be taken into account for an parental guarantee. People believed they were doing adviser advising their client in relevant the right thing by saving for their futures. We are circumstances. talking about pensioners here, not about multi- millionaire business people. It is a diabolical accusation to accuse these people of being tax Q1325 Mr Brady: If you are a British citizen who dodgers or going to the Isle of Man for a tax haven. happens to be an expatriate for a period and Mr Dickens: Let me add that £80 million specifically therefore you have to invest oVshore, is it your view from the EU Tax Directive comes back to the UK that it would be reasonable that there should be Treasury from Guernsey every single year. Those some kind of financial safety net provided by this individuals under the EU Tax Directive are taxed at country? source. People like my father on Guernsey and the Ms Davidson: One would hope there would be, but predominant number of people in the bank are taxed what is important is that the depositor should at source and contribute to the Guernsey Exchequer understand what the safety net is. as much as they contribute to the UK Treasury. In the case of expats, I come back to the point with regards to applying for a bank account in the UK, Q1326 Mr Brady: What advice are you now giving what is ironic is that there really is not any diVerence to British expatriates? Clearly they are still bound by between applying for an account in the UK and the same “know your customer” rules that make it applying for one in the Crown Dependencies other diYcult to do one thing. What are you telling them than proving a UK address. That is ultimately the they should do? reason why people place their monies in the Crown Ms Davidson: That depends on their circumstances Dependencies, because they are unable to open an and their tolerance for risk. The process is the same account in the UK. As Ziggy rightfully says, we are in terms of determining what level of risk a client is talking about 80% of the people that banked with prepared to take, that is both whether expatriates or Landsbanki Guernsey, like my father, paralysed, UK residents, and assessing what would be unable to ever work again, that are pensioners. We appropriate for them. In terms of an explanation of have had one who has died, we have had threats of risk, that is an interesting question that comes to suicide and we have several in their nineties who are both UK residents and also non-UK residents. facing their final days not knowing presently if any government is going to step up and help them.

Q1327 Mr Brady: Where should a risk averse expatriate deposit their money? Q1329 Mr Breed: I think that is right. I think you Ms Davidson: In a form of risk-free investment, but mentioned earlier on that it is about a third who were that is very hard to get and they would need to expats. Whilst the stories that you indicated there are understand what risks there would be, including indeed tremendously sad and I think we all what compensation there may be as well. sympathise with those and I am pleased that we have been able to get you to put that on the record, that cannot apply to every one of the account holders in Q1328 Mr Breed: Notwithstanding the reason why Guernsey and the Isle of Man, can it? you and the people you represent were unable or Mr Dickens: There are a number of expats who are unwilling or whatever to put money into the UK, it pensioners, who are based in various places was put oVshore partially because there were lower throughout Europe and who, as a result of the Processed: 25-03-2009 21:47:59 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG9

Ev 178 Treasury Committee: Evidence

3 February 2009 Mr Ziggy Sieczko, Councillor Richard Kemp, Mr Neil Dickens, Mr Chris Cummings, Ms Amanda Davidson and Dr John Low collapse of Landsbanki Guernsey, are now going to Cllr Kemp: We could have done, but, again, we have be relocating back to the UK and living oV the state, the overall advice from the Audit Commission and and they absolutely have no choice. the DCLG under a set of regulations which we work Mr Sieczko: The numbers can be slightly deceiving. to which advised us to get the best possible returns The numbers could be a lot higher than that because given the spread of investment and that would have when people opened these accounts they might well been against the advice from DCLG and the Audit have been expats, but there are a lot of people who Commission. were in the Derbyshire Building Society as a result of expatriate status who are now back living in the UK and they kept their bank accounts. It is a real pain Q1334 Mr Breed: In your exchanges with Mr Mann in the neck to change your bank account nowadays. and the Chairman you indicated that a number of Why would you? It has been a staggering regulatory councils continued on after 22 May. I suspect that a failure that has led to this. number of those were already locked in to three- Mr Dickens: A good number of people have also month or six-month deposits and therefore, whilst stepped up and complained that they were asked to they may well have obtained the information that close accounts that they had in the UK after they left was provided at that stage, their ability to exit those the UK. So it is not just about opening them, it is investments was probably limited. about maintaining them as well. Cllr Kemp: Absolutely. Again, if I could give the figure which I gave before, £680 million would have been redeemed by now, but it was stuck in three- Q1330 Mr Breed: Councillor Kemp, do you think it month, six-month or one-year accounts and it was is right that local government should put funds impossible to remove it. There is a diVerence oVshore? between not putting money in and taking money out Cllr Kemp: Yes, in terms of a spread. It is very which was locked in. diYcult to say what is oVshore and what is onshore to some extent. HSBC is controlled from Shanghai and Banque Santander which controls the Abbey. Q1335 Chairman: Could you provide us with a There is not such a thing as a British bank. One of written memo on that? the things that the Local Government Association is Cllr Kemp: Yes.2 looking at as we go into the future is the creation of local banks to replace some of the mega banks that Q1336 Nick Ainger: Ziggy and Neil have just told us have now grown up. that the majority of claimants are in fact UK citizens, they are not expatriates. Many of those Q1331 Mr Breed: But treasurers would have known people will have sought independent financial advice on individual deposits that they had placed whether on where to put their savings and your members will that was going to an oVshore account or whether it have advised them to put them in these banks. Why was an onshore account. did you give them that advice? Cllr Kemp: Yes, and I think that is an important Mr Cummings: There are a range of reasons that that distinction to make here. We talk widely of Icelandic advice could follow. It starts oV with a client and banks. Of the £1 billion that we largely say was their adviser conducting a getting to understand invested in Icelandic banks, £400 million of that was more about the client’s aspirations, their long-term actually invested in Icelandic bank subsidiaries goals, Amanda mentioned their risk profile and it is regulated by the British Government. We were then a case of the adviser recommending a getting assurances as late as 6 October by Lord diversified approach which will meet the client’s Davis in the House of Commons that these were safe goals. Some clients are very low risk and so investing investments. oVshore would not be appropriate for them. Some are looking for better returns and so better returns Q1332 Mr Breed: So you believe that professional inevitably come with a slightly higher degree of risk treasurers guided by council policies were perfectly and so on. There are a number of reasons to go aware that part of the funds that they were holding oVshore. One of them is in a straightforward bank were going to be invested in oVshore accounts and account those institutions were paying slightly you were entirely happy about that? higher rates of interest than could be got onshore. Cllr Kemp: You missed out an important step. Most There is a tax management issue in that the tax can of those councils have gone for Treasury be deferred for between nine and 21 months before management and external advice in a variety of ways the withholding tax is paid. So from a financial point from people who we pay to be even more aware of of view the return, when clearly expressed from a risk these things than we are. We do not claim to be point of view, made it worthwhile. absolute experts in investment issues. We have strategies, we have professional treasurers, but they Q1337 Nick Ainger: You are accepting that in fact in turn look for professional advice in these areas. banking oVshore or putting your savings oVshore actually does represent a higher risk than keeping it Q1333 Mr Breed: But councillors could have made onshore, are you not? a policy not to put money oVshore as part of their investment profile. 2 HC (2008–09) 144–II, Ev 566 Processed: 25-03-2009 21:47:59 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG9

Treasury Committee: Evidence Ev 179

3 February 2009 Mr Ziggy Sieczko, Councillor Richard Kemp, Mr Neil Dickens, Mr Chris Cummings, Ms Amanda Davidson and Dr John Low

Mr Cummings: That would have been part of the Financial Ombudsman Service, so they could have discussion that an adviser would have had with complained to the Ombudsman if they had not felt their client. the advice was suitable. We would also have talked to them about the credit reference agency and the double or triple-A rating of the institutions. The Q1338 Nick Ainger: So it is a higher risk to put your V notion that we could have explained in advance savings o shore? what would happen with the UK authorities and Mr Cummings: I would suggest that it could be a attitude to the Icelandic banks, I just do not think higher risk. anybody would have had the foresight to explain the circumstances that we saw rolled out over a two to Q1339 Nick Ainger: Ms Davidson is nodding when three-month period. I say it is a higher risk to put it oVshore. Ms Davidson: I am nodding at the “it can be”. Q1343 Chairman: How many complaints have you had from clients about IFAs not giving them advice? Q1340 Nick Ainger: In return for that higher risk I have had emails sent to me on that. there is a higher return and there are certain tax Mr Cummings: We have been in discussions with the advantages. Financial Ombudsman Service on this. We have yet Mr Cummings: Inevitably it is hard to get a higher to see any significant numbers coming through. return without seeing the risk index notching up a Certainly we have issued notes to members, we have degree or two. addressed these issues in our newsletters and communications with members to make sure that we Ms Davidson: In terms of their cash, some clients will are reinforcing the good practice that we see seek advice from independent financial advisers but already exists. some will also manage their own cash. So it is not the case that every client of an independent financial adviser seeks advice on bank deposits because they Q1344 Chairman: So this is a clarion call today for are very fluid and rates are readily available in the people who feel that they have not been given the press and also online. It is a bit of a mix. You should best advice from IFAs to contact you and the not make the assumption that all IFA clients seek Financial Ombudsman Service? advice on deposits. Mr Cummings: We would be very happy to receive that. Q1341 Nick Ainger: In terms of that higher risk that you presumably would have explained to your Q1345 Mr Todd: When Derbyshire OVshore clients, did you also explain to them about the transferred its business to KSFIOM did you notice protection schemes which existed in the Isle of Man any change in risk relating to the parental guarantee? or in Guernsey? Mr Cummings: Both organisations had provided Mr Cummings: Of course, the Isle of Man has a parental guarantees. protection scheme. The Channel Islands are in a diVerent position. As part of the conversation with a client, getting the client to understand the potential Q1346 Mr Todd: Let me just make this clear. One downsides of an investment and the level of was a parental guarantee from a British building consumer protection would absolutely have been society and no British building society has ever gone bust; the other was from an Icelandic bank. Did your part of that discussion. We would have explained not V only the compensation scheme but also the parental members identify a di erence in the quality of parental guarantee oVered? guarantees. For a client the notion that investing in Barclays in Guernsey is more risky than investing in Mr Cummings: It would have been at that point that we would have sought to have taken a view from our Barclays in Godalming or Guiseley is sometimes a regulator, the Financial Services Authority and the little diYcult, which is why it is absolutely essential comfort that it expressed. that that conversation happens.

Q1347 Mr Todd: So the answer to the question is no Q1342 Nick Ainger: So that conversation took place and you therefore would not have advised any of in each case. Were you aware of what could have your clients who had previously invested in happened and what actually did happen in terms of Derbyshire OVshore of any material diVerence in the depositor protection scheme, particularly with their circumstances? the Icelandic banks where people understood that Mr Cummings: We would have brought it to the they were protected and, as it turns out, they have attention of the individual client, it would have been not been protected? part of the discussion and that would have been Mr Cummings: We were absolutely aware of the reflected in the advice that would have been given in notion of risk and we would have explained that to individual circumstances. clients. We would have explained the protection that they get. We would also have explained the fact that if the client is unhappy with their independent Q1348 Mr Todd: I mean ongoing clients who had financial advice, they are covered by the UK-based already invested. Processed: 25-03-2009 21:47:59 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG9

Ev 180 Treasury Committee: Evidence

3 February 2009 Mr Ziggy Sieczko, Councillor Richard Kemp, Mr Neil Dickens, Mr Chris Cummings, Ms Amanda Davidson and Dr John Low

Mr Cummings: Where an IFA was, firstly, aware of profile and no mention of a change of ownership and that investment and we have to respect what the structure. It starts oV by saying that Kaupthing client wants to tell us, we would have covered that in Bank is a Northern European bank. It does not even the annual client review. go as far as saying it is an Icelandic bank. It does go on to say it has got oVshoots in other areas of Europe, including the Nordic countries. It is very Q1349 Mr Todd: Did your members note any non-specific. diVerence in risk profile from the change in parental guarantee that happened when the transfer took place? Q1354 Mr Todd: Have your members explored the Mr Sieczko: The short answer to that particular duty of care that the Derbyshire Building Society question is no, absolutely not, but it goes further owed to them as their customers originally in than that. They went from being members of the securing an adequate transfer of undertakings which Derbyshire Building Society, which is a subsidiary of would guarantee those investments into the future? a UK bank, to being members of a banking Mr Sieczko: My understanding is that the institution in January 2007 that was no longer a UK Derbyshire depositors are indeed looking into that subsidiary but an Icelandic subsidiary. According to and looking to a wider spectrum as well. the Chancellor’s statement to this Committee in answer to Question 119 by Mr Fallon, he agreed that Q1355 Mr Todd: I have had correspondence with the the reason why the Bradford & Bingley depositors building society which has just stonewalled that. were saved in the Isle of Man was because they were Mr Sieczko: It is an ongoing thing. To every single a subsidiary of a UK bank. The fact is that Singer & question we ask to any institution dealing with this Friedlander was a subsidiary of a UK bank up to situation there is a wall of silence. January 2007, including under the ownership of Kaupthing. Q1356 Mr Todd: Have your members had any correspondence with the FSA as to their role in Q1350 Mr Todd: I want to explore a slightly scrutinizing that change in the business? narrower point. At the point that Derbyshire Mr Sieczko: Questions have been asked of the FSA OVshore transferred its undertakings, I have had and I can assure you that the questions are going to correspondence with some investors who have be slightly more stringent after the evidence that you expressed the view that they were concerned about will probably be hearing later on this afternoon from that change and sought to communicate with either Mr Shearer, the ex-Chief Executive of Singer & Derbyshire OVshore or the Derbyshire Building Friedlander who was present at the takeover when Society on this material change in the quality of their Kaupthing took over Singer & Friedlander. The fact investment. Have you had examples of that drawn to that the FSA allowed a takeover of Kaupthing really your attention? needs to be investigated bearing in mind the chief Mr Sieczko: We have had people who actually said executive, the chairman of their audit committee, the they were concerned. finance director and the head of the bank told the FSA that they believed that the people at Kaupthing were not “fit and proper to control a UK bank”. Q1351 Mr Todd: Did they do anything about that? Mr Sieczko: Yes, they did. They did their research on the bank. Q1357 Jim Cousins: It is clear that the deposit protection schemes in the Isle of Man and Guernsey were diVerent. In Guernsey they were eVectively Q1352 Mr Todd: Did they seek to withdraw any of non-existent. There was one in the Isle of Man. Not their investments on the basis of a concern that this only that, but the strategies of the Guernsey had materially altered the risk that they were authorities and the Isle of Man authorities appeared encountering? to have been quite diVerent in terms of their reaction Mr Sieczko: No, not the people I have been in to this situation. Mr Dickens, do you think that the contact with because they did their research in the approach of the Isle of Man authorities is to be public domain and saw the ratings of the Icelandic preferred to the approach of the Guernsey banks were fine and they were not fully informed of authorities? the situation about the change in control or the Mr Dickens: Yes, absolutely. relationship between the banks, the fact that they were no longer a UK subsidiary. Q1358 Jim Cousins: Do you agree with that? Mr Sieczko: You have to be careful what you ask for. Q1353 Mr Todd: What guidance was received by Derbyshire OVshore customers? I have seen copies Q1359 Jim Cousins: This is without prejudice to all of some of the material from investors who have the points that you have made earlier. corresponded with me. Mr Sieczko: The fact is that the Isle of Man does Mr Sieczko: There is a four-page document that was have a compensation scheme and we appreciate that, put out just describing that they were being taken especially compared to the situation our Guernsey over. There was no mention of a change of risk colleagues find themselves in. The Isle of Man Processed: 25-03-2009 21:47:59 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG9

Treasury Committee: Evidence Ev 181

3 February 2009 Mr Ziggy Sieczko, Councillor Richard Kemp, Mr Neil Dickens, Mr Chris Cummings, Ms Amanda Davidson and Dr John Low scheme is unfunded unlike the UK scheme which has Q1362 Jim Cousins: I understand the point you are regular tariVs placed upon banks to fill the pot. We making and I think it is worth considering, but you have been attempting to get written explanations do see the diYculty about this, that were we to from the Isle of Man authorities as to how the extend British regulation and depositor protection compensation scheme will work in practice. After to the Isle of Man and Guernsey how could we do it everything that we have heard and to date, for just for British citizens? You will see in the reasons unknown to us, we are yet to get a clear newspapers the diYculties you get into once you say understanding of how this compensation scheme British “somethings” for British people. Do you see will work. that as a diYculty? Do you have any idea how that Dr Low: I have to say that the compensation scheme could be resolved? on the mainland is not serving charities well. Not Mr Sieczko: From an ongoing perspective that only do the majority of charities have no protection would be something for the international lawyers to at all under the scheme, but because it is a post- deal with and I can see the problems with that. Our funded scheme that will be charged to the banks the issue at the moment is specifically with what banks will be charging charities, especially the larger happened here and what happened in this particular ones, to pay for compensation that the charities have incident in this systematic regulatory failure. The simply not benefited from. Clearly there is an issue fact of the matter is that due to failures from a UK about depositor class regarding charity public Government, from the UK FSA and from the Isle of money and how that is being protected. Man FSC our bank failed. This needs to be put right. However the UK authorities and the FSC in the Isle of Man decide to do it, it is up to them, that is what needs to be done. Mr Dickens: My response is that if you have a British passport—and, of course, that includes the people in Q1360 Jim Cousins: Indeed there is, but I was asking Jersey and Guernsey and the Isle of Man—you about the people who are exposed to the risks of should have the right to open a bank account in the ordinary retail deposits. In terms of where we might United Kingdom because the only thing that is be going with this issue rather than where we have stopping one from having an account in the UK is an come from, where we have come from is clearly address. There are very,very thorough investigations anachronistic, idiosyncratic, incomplete and full of that are undertaken when one opens an account in issues that are not satisfactory. In terms of where we the Crown Dependencies. Practically speaking, the are going for the future, are you saying that in eVect only diVerence is not being able to present the UK what you want is the British system of depositor address. So my response would be to allow British protection and regulation to be straightforwardly passport holders the opportunity to open a bank applied in the Isle of Man and Guernsey? account in the United Kingdom. Mr Dickens: I think the action group welcomes transparency. To that end we would like to be able to open accounts in the UK so that all British citizens Q1363 Chairman: We are taking evidence from the can be treated the same, fairly and equally, contrary Isle of Man and the Guernsey authorities. What to what the Prime Minister has said in terms of all message do you have for us to pass on to them in the British savers being recompensed. Truthfully, as an evidence session? expat, I will be blunt and I will say that I am thinking Mr Sieczko: I guess the message to the Isle of Man about moving back to the UK because I am authorities would be we would like some answers frightened about the 30% that I did get back because regarding the actions of their own regulator, the right now I do not see where I can place it because FSC. I am not sure if that is appropriate, but the there are even questions with regards to the fact of the matter is that 48% of assets of Kaupling Guernsey protection scheme. Singer & Friedlander Isle of Man were placed within a UK bank. The phrase “eggs in one basket” springs to mind. We really need some answers as to why that happened. More importantly, exactly what information was given by the FSA and how does the FSA play a part in that money being in Q1361 Jim Cousins: The Isle of Man? London? Mr Sieczko: I would echo Neil’s sentiments Mr Dickens: We would like somebody to take completely. It is important to note that the UK responsibility. We would like a government to take compensation scheme only actually guarantees up to responsibility. Over the past four months we have £50,000 of depositors’ money. It was the UK been pushed between the British Government, the Government who decided to top up the rest. I think Guernsey Government and the administrator and we need to focus on that and focus on the fact that nobody is stepping up and taking responsibility for it was due to poor regulation on behalf of UK the collapse of this bank. It is all well and good to say authorities that lead to so many people depositing in there is no moral obligation because there was no the Isle of Man because they could not open UK regulatory failure, but at the end of the day the bank bank accounts. The question is should that same failed and the States of Guernsey has continued to gesture be extended to those depositors? I think the receive interest on the deposits in this bank for many, answer is unequivocally yes. many years and indeed from the banking system at Processed: 25-03-2009 21:47:59 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG9

Ev 182 Treasury Committee: Evidence

3 February 2009 Mr Ziggy Sieczko, Councillor Richard Kemp, Mr Neil Dickens, Mr Chris Cummings, Ms Amanda Davidson and Dr John Low large. I think that there should be compensation for Cllr Kemp: My last comment is to say that we are people that placed their money in this bank under a oVering to work with the Government on these parental guarantee. issues. We are part of the public sector, we represent the same people as you do and we would like to be Q1364 Chairman: Dr Low and Councillor Kemp, do involved at a much more strategic level. We are you want to make any final comments? making that oVer of partnership to the British Dr Low: I would call for a separate depositor class Government to try and resolve the issues that aVect for charities because this is public money being held local government. in trust for public benefit. Chairman: Thank you very much for your evidence.

Witness: Mr Tony Shearer, gave evidence.

Q1365 Chairman: Mr Shearer, welcome. Could you Mr Shearer: Yes. My opinion of them hardened over introduce yourself for the shorthand writers, please? the period of time. Mr Shearer: My name is Tony Shearer. I am former Chief Executive of Singer & Friedlander and a Q1370 Chairman: Both in terms of the accounts and director of a number of companies now. in terms of personalities it changed dramatically. How did that occur? There has to be some deeper Q1366 Chairman: Why did you leave Singer & reason for that. Friedlander in October 2005 after the Kaupling Mr Shearer: No, there is not. I was oVered a very takeover, when the initial announcement in April nice and, on the face of it, attractive job by 2005 seems to suggest that you might stay? Singurdur Einarsson in respect of that and I decided Mr Shearer: I left at the end of November. I was not to turn that down because I did not feel that I could happy to continue to be chief executive responsible sit comfortably in that organisation in that way. It to the FSA for a regulated entity with the Kaupling was as straightforward as that. I think it is an group owning that entity. essential part in any environment that you feel comfortable working with the people you are Q1367 Chairman: Did you say in April that “Singer working with and if you are not then the money is & Friedlander is well positioned in its core markets not worth it. and its growth strategy over the last year has yielded good returns for shareholders. The combination Q1371 Chairman: But you were quite sure you would with Kaupthing Bank will allow Singer & have felt comfortable to work with them in April Friedlander to continue to develop this strategy 2005. within a larger financial group”? Mr Shearer: I was not sure. I had serious doubts Mr Shearer: Yes. about them right from the start. Singer & Friedlander, let us be clear, was not the perfect, Q1368 Chairman: Hope turned to despair within a greatest bank. I am not saying that this was an few months. Why did that happen? organisation that was perfect in every way. We had a Mr Shearer: I think there were two reasons. The first number of issues that we wanted to deal with. reason was just an inspection of their public accounts. Just looking at the accounts, particularly Q1372 Chairman: Like? the accounts for December 2004, revealed a number Mr Shearer: The business in particular, particularly of things in those published accounts which caused the asset management business. We had a business me concern and those were things that I passed on to which I thought was a relatively low quality business the FSA. The second thing was meeting the people in the asset management business. I was not happy themselves. I had met them both in London and in with the quality of that. I wanted to shift the Reykjavik and meeting with the people themselves emphasis away from that. I also felt that we had the caused me to form a judgment that these were not opportunity to make a much better proposition to people that I wanted to work with. I take my our clients in the private banking sector. The group responsibilities in the past and, still, where I am had grown up over the years with some significant involved with the FSA very seriously. I think we all subsidiaries which were quite exciting; things like owe it a serious responsibility to make sure that Collins Stewart had been a part of the group. There businesses are run in a way that we think is proper. I was a similar organisation in Sweden in Carnegie. I think an integral part of that is knowing that the thought these organisations had received a great deal people you are working with have the same value of attention and time and the core business which we system that you do and approach it in the same way. had in 2003/04 had received, in my view, very little attention and that is where I thought the Q1369 Chairman: In terms of the inspection of opportunity was. public accounts, you would have looked at that before April 2005 and you would have made an Q1373 Chairman: Can you outline the role at the assessment of the personalities you were going to be time, before the takeover, of Singer & Friedlander’s working with from April 2005. Isle of Man oYce? Processed: 25-03-2009 21:47:59 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG9

Treasury Committee: Evidence Ev 183

3 February 2009 Mr Tony Shearer

Mr Shearer: Sorry, I am not quite sure I understand management team. They were all pretty similar the question. young people, a board of directors who, I think, except for one person who was either Danish or Q1374 Chairman: Could you outline the role of Swedish, I cannot remember which, were all people Singer & Friedlander’s Isle of Man oYce at the time from the same community within Reykjavik. of the takeover? Mr Shearer: It was a subsidiary of the bank. We had Q1379 Chairman: You did say that was 2004 when quite a complicated group structure. It was a wholly they were inexperienced so you had doubts then, but owned subsidiary of the Singer & Friedlander you still welcomed them in April 2005, did you not? Group. It was doing a similar private banking Mr Shearer: I had doubts right from the beginning. operation. It had a bit of a trust business which was Let us be clear what my responsibilities and a serious problem, a really bad quality business in obligations were then, Chairman. My obligation my view and so I took steps to close that trust was made very clear to me and that was to do what business down. Leaving that aside, it had a small was right for the shareholders and the shareholders asset management business and in addition it also alone. The board were absolutely told that they had had a private banking business where it took in no responsibility at all to anybody else—customers, deposits and lent money out to customers. It was a staV, depositors, you name it. If we had accepted small scale mirror image to some extent of the UK shares in Kaupthing as part of the oVer then that business. would have been an entirely diVerent matter. We would have had to assess it, “Hey, you are getting Q1375 Chairman: Why do you think Kaupthing some shares in Kaupthing and we think these are purchased Singer & Friedlander? Were there ulterior good pieces of instrument”. My chairman and I, motives there? when we saw Sigurdur Einarsson in early 2005, made Mr Shearer: I do not know for sure. I think they were it absolutely clear that the only thing we would looking for an acquisition. They wanted to grow. contemplate was cash, and that was because we There was a limited number of companies around simply did not trust them. for them which were possible targets in that way. I think they thought that we were relatively cheap Q1380 Chairman: Witness your double-barrelled because we were not making an adequate return on shotgun approach to the FSA on the television last capital in the shareholders’ eyes, and therefore I night and your leaked memo to the Committee in think they thought this was an opportunity to buy us The Times this morning, why are the poor FSA in and it would be a good fit for them. this? You mentioned that the FSA was pointed to the information that would indicate that Kaupthing was Q1376 Chairman: You would not have questioned not “fit and proper”. What information was that? them technically at that time? When was it conveyed to the FSA? Mr Shearer: They first bought their shareholding, Mr Shearer: First, whatever happened on the 9.5% or 10%, something like that, in November television last night or in the papers this morning is 2003, and that seemed a very strange transaction. absolutely nothing to do with me. I took a call from None of us had ever heard of them. We did not know Channel 4 News yesterday afternoon and I said, “No. who they were. We had to do some work on them. I am not participating in this”. They had got We then met them at a social lunch. At no stage did information which was on the record— we ever have any discussions about the business. They did not come along to us and say, “Look: we Q1381 Chairman: Okay, keep going; that was an have just bought 9.5%. Tell us about your business”. aside only. We did roadshows at the end of the published Mr Shearer: Okay, fine. In respect of the question, accounts. At the year end and the half year we did “What information?”, the information that I roadshows and went out to the major shareholders. provided to the FSA was really no more than just to Anybody who had got 1% or 2% we went to see, sat point out to them what was in the public domain. down and talked to them and met with them. They did not want that. It was quite extraordinary. Even Q1382 Chairman: When did you provide it? when they went to 19.5% they still did not want one Mr Shearer: It was in April 2005. There were two of our roadshows. They were very diVerent. They separate things. I had a phone conversation— ran their business in a very strange way,and certainly when I went to Reykjavik and spent a couple of days Q1383 Chairman: In April 2005 you provided this in Reykjavik in 2004 I realised it was a very diVerent information to the FSA and you said to them, “This operation. company is not fit and proper”? Mr Shearer: In my opinion that was correct. Q1377 Chairman: What did you realise? Mr Shearer: That it was a very diVerent operation. Q1384 Chairman: But you still had a relationship with them until November 2005. Q1378 Chairman: Yes, but what do you mean by “a Mr Shearer: Can I just answer that question? Yes, I very diVerent operation”? did, because my obligation was to the shareholders Mr Shearer: Everybody there was incredibly young. to do the right transaction and to get the maximum It was a young group of people who were very money for the shareholders. That was my legal inexperienced. There was not a balance among the obligation and I had no other, and therefore, in Processed: 25-03-2009 21:47:59 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG9

Ev 184 Treasury Committee: Evidence

3 February 2009 Mr Tony Shearer doing that, part of that, which was made very clear Mr Shearer: There are a number of parts to that to me by the advisers concerned, was that I could not question. Firstly, the FSA had already approved resign and walk out the door. I had to help in the them. I forget what the trigger points are, but in transition. order to get to a 19.5% shareholding they had already had approval to some extent, so they had started oV down the approval process. Was I Q1385 Chairman: Was it wise to make such a surprised? I do not know. My issue was two-fold. positive statement in April 2005? One was, as I said to the Chairman, that I had a duty Mr Shearer: Absolutely. to pass on to them the information I had. The second thing was that I did not want to go out there with a Q1386 Chairman: Even though they were not “fit recommended oVer from the board of Singer & and proper”? Friedlander and find the FSA then publicly turned Mr Shearer: All I was doing was expressing my view. that down and said they were not fit and proper; we It is up to the FSA to make their judgment. That was would have all looked incredibly stupid, and so it the point that was made to me by the advisers. The was fine for the advisers to say, “You have got no point the advisers made to me was, “Tony, your obligation”. That is why it was important to me to obligation is to do the right thing for the go and say to the FSA, and by the reaction I got from shareholders. It is for the FSA to decide whether the FSA—I passed on the information and my they are fit and proper, but if you have a view and a colleagues passed on information too because they feeling then you have an obligation, as we all do. We had meetings there, and I think the questions that we have an obligation the whole time to the FSA to tell were raising were both about the quality of their us things that concern us”, so we had an obligation earnings, about the way they were managed, about to pass on what we thought and our views to the the corporate governance issues. I thought there FSA. It is up to the FSA then to take a decision to were very substantial issues there. follow it or not. Q1391 John Thurso: You go on to say that you feel Q1387 John Thurso: Just as background, one knew that the FSA should have been further alerted by the Singer & Friedlander and it would be correct to say fact that the heads of both risk and compliance of that they were a private bank of the order of Hoares the new Kaupthing Singer & Friedlander were or Coutts or Drummonds. Those are the sorts of subsequently dismissed for voicing their concerns banks that you would regard as competition for about the way the company was being managed and clients. specifically about its attitude to risk. These seem to Mr Shearer: Yes, Rothschilds, Close Brothers, parts me to be absolutely damning criticisms of a complete thereof, yes. lack of any kind of control by the FSA. Am I getting this right? Mr Shearer: I think there are a number of things Q1388 John Thurso: So generally viewed as slightly there. First, I had made my position clear. I had two conservative wealth preservers with a good list of fellow executive directors—the finance director and clients? the head of the bank. Their intention was to stay. Mr Shearer: That is where we tried to position They both left, one of them before I had gone at the ourselves. We tried to position ourselves around end of November. The finance director had being a traditional bank with traditional values announced he was going, and then the head of bank which will help the clients that have got surplus announced shortly after, I think in December or money. We will take it and put it on deposit and then January, so to me that was another red flag that had when they need a loan we will lend the money to gone up to the FSA. Then, when subsequently the them. head of credit and the head of risk—I do not know because I have only heard the story from the head of Q1389 John Thurso: The point being that that is the credit and the head of risk side and I do not know brand image that most of the clients would have had what action the FSA did or did not do at that time and would have carried on for some years after the in respect of that, but yes, I would agree with you. I transaction took place? think after the event there were some serious issues. Mr Shearer: Absolutely. Q1392 John Thurso: We have just had a case where Q1390 John Thurso: You have made very clear the the Government have been obliged to admit point that you had a duty where you would have regulatory failure with Equitable Life and therefore been advised by your financial and legal advisers as some form of compensation will be forthcoming. Do to what you had to do in respect of the shareholders you think that we are heading in the direction of in relation to an oVer. Reading your memos, both of similar action with regard to the actions of the FSA them, which I found very interesting, you make it in this case? clear. You say, “My short experience of Kaupthing Mr Shearer: I have not got a clue. I think that is and its management led me to believe they were not completely outside my field of competence. If you fit and proper people to control a UK bank”, and like, my evidence is my knowledge, both specifically you went on to describe how you made these points about their actions and generally about the to the FSA. Were you surprised that the FSA, in circumstances surrounding a bank in that your words, “rushed their approval through”? circumstance. I could not answer your question. Processed: 25-03-2009 21:47:59 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG9

Treasury Committee: Evidence Ev 185

3 February 2009 Mr Tony Shearer

Q1393 John Thurso: Fair enough. You wrote to Mr Mr Shearer: Paul Shirley was his name. I forget his Sants in 2008 after he had told this Committee that title. He was the person who headed up the team. Northern Rock was the only instance of regulatory failure at the FSA, and you got what you describe as “a rather pompous reply” from a Ms Dunn. You Q1398 Chairman: You say there, “Other of my wrote again on 27 May but never received a colleagues, including the Chairman of the Audit response. Did you get anything in the pompous reply Committee, the Finance Director and the Head of which gave any explanation for their conduct? the Bank, went to see the FSA and made similar Mr Shearer: No. I should say I am not 100% sure comment”. With whom did they meet? that it was before this Committee that Mr Sants Mr Shearer: I was at that meeting too with them. We appeared. I saw it on television, and it was in that met with Jonathan Fiskell, Kevin Halpin and context, so I may have been wrong as to whether it James Dresser. was in front of this Committee. It looked like this sort of forum and committee. Q1399 Chairman: Do you have a minute of that meeting? Q1394 John Thurso: He is quite a regular attender. Mr Shearer: No, I do not. Mr Shearer: To some extent I had some sympathy with Mr Sants because, whatever I felt, he could not possibly be responsible. The person responsible is a Q1400 Chairman: Was there a minute taken of the diVerent issue and I am sure you will be seeing him meeting? at some stage, but Mr Sants was not responsible at Mr Shearer: There was a partner there from Y that stage and I know how di cult it is when you go Slaughter and May, who attended the meeting, and into a job: you do not know where the bodies are I believe he took a minute of the meeting. buried, and I thought I was genuinely doing him a favour by saying, “I saw you on television. There is an issue here”. I thought what I would get would be Q1401 Chairman: On your behalf? a phone call, “Can you nip round for a cup of coVee Mr Shearer: My Chairman has asked him whether and a chat and tell me what you think and what you he could release that minute to us but he said that we know and we will have a look at the files?”, but no, I were not his clients, that Singer & Friedlander was got nothing other than the letter from the Ms Dunn. his client, and since we were no longer at Singer & Friedlander we could not see the minute. Q1395 John Thurso: Just to summarise your evidence before I hand back to the Chairman, is it fair to say that the sale to Kaupthing was a good Q1402 Chairman: So we could write to Slaughter oVer for the shareholders and your responsibility and May? was to accept a good cash oVer? You had serious Mr Shearer: Yes. concerns about their abilities and whether or not Chairman: Okay, thanks. they were fit and proper which you raised with the appropriate regulatory authorities, who decided that Q1403 Nick Ainger: Again, briefly on this issue, they were fit and proper, or certainly did not decide because it is so important, you believed and your that they were not fit and proper; that Singer & fellow directors of Singer & Friedlander were Friedlander was an old-establish British private flagging up to the FSA your genuine concerns that wealth bank with a strong brand and that therefore the customers of that bank thereafter could expect a Kaupthing were not fit and proper to run a British similar degree of confidence to that which they had bank? That is what you are telling us absolutely on enjoyed in the past and they have been very seriously the record, that you took every step you thought was let down by the regulatory system? reasonable to inform the FSA of that fact? Mr Shearer: I am not going as far as the second part Mr Shearer: Yes. It was not up to me to make the of your statement. determination. What mattered to me was that I got the information to the FSA and I was satisfied that they had the information that I had in order to make Q1396 John Thurso: You can agree the evidence if their determination. you leave the conclusion to me. Mr Shearer: What happened to them after I left is something that I do not know the detail of, so I could Q1404 Nick Ainger: And your fellow directors, the not comment on that. Chairman, the Head of Bank, the Finance Director, all went with you to the FSA. Was there more than Q1397 Chairman: Just before I pass on, can we go one meeting or was there just one meeting back to your memorandum where you say that your Mr Shearer: I had a phone call. I also went to one short experience of the Kaupthing management led meeting specifically on this point. There were lots of you to believe they were not fit and proper, and you meetings with the FSA. For instance, I went back the passed that on in April 2005, you said. You said that day after that with Kaupthing and we talked about that was shared with most of your colleagues and process and stuV, but those were two meetings you called the FSA and passed your views on to specifically talking about reservations. Others went them. Who did you speak to in the FSA? later or called later and had conversations later. Processed: 25-03-2009 21:47:59 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG9

Ev 186 Treasury Committee: Evidence

3 February 2009 Mr Tony Shearer

Q1405 Nick Ainger: So it was not a single meeting? Mr Shearer: I will need to check that. Mr Shearer: Correct. Q1412 Mr Todd: Could you check that, because the second question is allied to that: do you possess any Q1406 Nick Ainger: Other directors of the bank were notes of the various conversations that you held with still flagging up this issue between presumably April FSA oYcials at any time during these transactions? and August when the deal was finally completed? Mr Shearer: I will need to check and come back to Mr Shearer: Yes. I cannot remember the exact you. Will I come back to the Chairman? timescale. Chairman: Yes, just send us a note with maybe the names of the directors of your bank who had gone because I think we will be writing to them as well.3 Q1407 Nick Ainger: Were you shocked that the FSA did not either step in or, as subsequently happened, did not appear, as far as you were aware, to take a Q1413 Jim Cousins: Mr Shearer, can I take you back very close look at the operation of what became to something you told our Chairman which I found Kaupthing Singer & Friedlander? quite interesting? This is about the period between Mr Shearer: I think to some extent I have already April and November, which must have been a diYcult period for you. You told our Chairman that answered that question. No, because they had your advisers, the advisers of Singer & Friedlander, already been through some hurdles to get to the had told you that you could not resign, that your 19.5% approved. Did I think that they should have? duty to the shareholders was to see that acquisition You are saying was I shocked? I suppose the answer deal through. is no. Did I think that they should have taken more Mr Shearer: That was the thrust. I cannot remember action? The answer is clearly yes. whether it was done in exactly those words.

Q1408 Nick Ainger: But you went along and had a Q1414 Jim Cousins: And these advisers were who specific meeting to voice your concerns and fellow exactly? directors, in other words you were not the lone wolf Mr Shearer: We had two sets of advisers. Slaughter on this, you were not the single whistleblower of it. and May were the lawyers, Cazenove were the Was it all the board that felt the same or was it just investment bank. those that had had direct dealings with the people in Kaupthing? Q1415 Jim Cousins: Those advisers who were telling Mr Shearer: We had a seven-person board. I think you that you had to stay in post, you had to see the five of the seven one way or another made their deal through, were Slaughter and May, the legal positions known to the FSA. advisers? Mr Shearer: No. I think that is taking it into the wrong context. I do not think that it was being said Q1409 Nick Ainger: In answer to some earlier in that way, “You have to do it. There is no way in questions from the Chairman, he asked you why you which you cannot do it”. In terms of the facilitating thought that Kaupthing were interested in Singer & of a bid and making sure that it— Friedlander after your visit to Reykjavik and you saw that these were basically young—you did not Q1416 Jim Cousins: You will understand this might use the term “barrowboys” but if there is an turn out to be an important point, but you are quite equivalent— clear that in some reasonably clear setting the Mr Shearer: No, they were highly educated people advisers, which included the two people you have who had got lots of— mentioned, gave you the advice that you could not Chairman: Let us have a last question. and should not resign; you had to see the acquisition through? Mr Shearer: Can I put it a diVerent way? The advice Q1410 Nick Ainger: On reflection now, do you think, that I was given from my recollection was that I had and John Thurso described your bank as one with a to put the interests of the shareholders over my own, high reputation, not particularly high profile, that in so this was not an opportunity for me or any of the fact the purpose of Kaupthing taking over Singer & other executives to negotiate new packages or new Friedlander was to give them kudos, to give them a anything. Given that this was a cash oVer that solid reputation to their new operations in the should clearly be recommended to shareholders at United Kingdom? Do you think that was part of the the level it was, we had to do everything we could to reason why they chose you? facilitate that and make it go through. I cannot say Mr Shearer: There are all sorts of ways in which I I had a big problem with this. It was very much a could speculate. I do not know the answer to that transitional period of time. It was supposed to be a question. couple of months. I think it went on for a bit longer than that and went to the end of November, and during this period I was still very much in charge of Q1411 Mr Todd: Is the only written communication the bank. It was not as if I was being asked to do that was made with the FSA the one summarised in anything diVerently over that period of time. The appendix 1 of your note, which refers largely to cross-shareholdings? 3 HC (2008–09) 144–II, Ev 472 Processed: 25-03-2009 21:47:59 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG9

Treasury Committee: Evidence Ev 187

3 February 2009 Mr Tony Shearer changes happened after I left. On my very last on to the FSA; I probably did not, but I got a phone afternoon I chaired the Credit Committee meeting in call round about 1 or 2 January 2005. I remember it exactly the way that I had done every week. because I was skiing in France and it was a call on behalf of the Takeover Panel and they wanted to Q1417 Jim Cousins: But it is clear from something know why our share price had risen so rapidly in a else you told the Committee much later on, because couple of days, and so I laughed and said, “I think you were asked for a minute of your meeting with the the reason you will find is that Mr Einarsson, who is FSA, and you told the Committee that Slaughter the Executive Chairman of Kaupthing, gave an and May had said you could not have the minute interview a couple of days ago, like the 29th or 30th they took on that occasion because their client was December, and in it he made it very clear that he was Singer & Friedlander and you had no relationship going to bid for Singer & Friedlander, so it is not with them. Do I understand from that that the surprising therefore that the share price has moved advisers you have just referred to continued in their up”. It is also not totally coincidental that because relationship with Singer & Friedlander after the they were marking the investment to market in their acquisition? balance sheet they took that profit through the profit Mr Shearer: I do not know that, no. I do not know and loss account, so something like half the profits the answer to that at all. Kaupthing’s adviser was of the Kaupthing Group were coming from profits, Deutschebank and I do not know what they did on trade investments substantially which were being after that. marked to market. The actual amount of profits that were coming from what I would think of as banking was less than 10% of the profits within the group. It Q1418 Sir Peter Viggers: Did it occur to you to put was those sorts of things. They were all there in the your concerns in writing? public domain. That is the first thing I would say. Mr Shearer: No, I do not think it did. What I was The second thing I would say is, “Look: I have met really saying was two things. My concerns related to these people. You will be meeting these people information which was in the public domain, in the yourself. That is my assessment. At the end of the end the report and accounts. What I was saying to day it is for you to make the assessment, but my them was, “If you go and read the annual report I assessment is they are not the sort of people that I think you will find that the directors have borrowed want to work with”. £19 million in order to buy shares in their own Chairman: I think we have gone round the houses company. They have got options to put those shares this morning and it has been very helpful to us. We back to the company. They are on four-year will maybe be writing to you again because your contracts. There is not anybody on the board who is second memo begs quite a number of questions as outside the Icelandic pool. There is not the well, and as a result of the information you have experience of international banking. A large part of given us we will certainly be in correspondence with the profits come from marking investments to a number of other people. Can I thank you for your market.” For instance, one thing that happened, and attendance this morning, Mr Shearer, it has been I am not sure whether the detail of this was passed very helpful to us.

Witnesses: Hon James Anthony (Tony) Brown MHK, Chief Minister, Isle of Man, Mr Mark Shimmin, Chief Financial OYcer, Treasury, Isle of Man, Mr John R Aspden, Chief Executive of the Financial Supervision Commission, Isle of Man, Deputy Lyndon Trott, Chief Minister of Guernsey, and Mr Peter Neville, Director General, Guernsey Financial Services Commission, gave evidence.

Q1419 Chairman: Welcome to the Committee Mr Brown: Tony Brown, Chief Minister of the Isle of session. Before we begin, I would like to place on Man, and again thank you. record that Guernsey and Isle of Man are self- Mr Shimmin: Mark Shimmin, Chief Financial governing Crown Dependencies. They have their oYcer, Isle of Man Treasury. own legislative assemblies, legal and fiscal system Mr Aspden: John Aspden, Chief Executive of the and UK legislation only extends to them with the Financial Supervision Commission on the Isle of consent of the islands’ administrations. Although Man. for the sake of convenience we have asked witnesses from the Isle of Man and Guernsey to appear Q1420 Chairman: Welcome and thank you for together, we fully understand that they face diVerent coming to this banking crisis inquiry. The UK problems in respect of the repercussions of the Government represents both Guernsey and Isle of banking crisis and may well be seeking diVerent Man at international level. Have you at any time felt solutions to these problems. With that statement, that the UK Government’s position and your own can I ask you to introduce yourselves for the are at odds because of the matters under discussion? shorthand writer, please? Mr Trott: Our day-to-day relationship with Her Mr Neville: Peter Neville, Director General of the Majesty’s Government is through the Ministry of Guernsey Financial Services Commission. Justice and in recent months the immediate point of Mr Trott: Lyndon Trott, the Chief Minister of contact has been with Lord Bach. The relationship is Guernsey, and thank you for inviting us here today. very good. On the matter of the issue regarding Processed: 25-03-2009 21:47:59 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG9

Ev 188 Treasury Committee: Evidence

3 February 2009 Hon James Anthony (Tony) Brown, Mr Mark Shimmin, Mr John R Aspden, Deputy Lyndon Trott and Mr Peter Neville

Landsbanki and the liaison with the Icelandic Mr Aspden: We were disappointed, Chairman, authorities, that day-to-day engagement has been because at the end of the day we have had a lot of transferred to the Treasury,but our relationship with contact with the FSA on a lot of issues and our the Treasury is a positive one. We have weekly evidence as well gives a practical example of another telephone calls with them and I am happy with the one that we had a very successful relationship on, so relationship. when this came along and there was a total absence Mr Brown: Thank you, Chairman, and again thank of any communication at their behest, we felt you for the opportunity to help you in the inquiry. severely let down. From our side, certainly we have a very strong and healthy relationship with the United Kingdom through the Ministry of Justice. Again, in this Q1426 Chairman: And yourselves in Guernsey, how situation we have been working with them and the do you feel in terms of the relationship with the United Kingdom Treasury. I think it is fair to say FSA? initially the UK Treasury aspect of it did not get up Mr Trott: Again, perhaps I can defer that question to speed as quickly as we would have liked, but to the Director General of the GFSC and in doing so certainly since we have been working with them on make the point, Chairman, that that body is entirely a regular basis that seems to be improving. independent of the Government of Guernsey. Mr Neville: We have a history of a very close working relationship with the FSA, so it was Q1421 Chairman: How would you characterise the disappointing that things did not work as we believe UK Government’s response to the Icelandic crisis? they should have done. In the past we have had Mr Brown: In relation to the Isle of Man? relations with them in relation to a number of cases. In some of those we have had some robust Q1422 Chairman: Yes. discussions in terms of split-capital investment trusts Mr Brown: The Ministry of Justice, which is, of and Northern Rock, and as a result of that we course, our main route for dealing with the United discussed very clearly with the FSA the need for Kingdom Government, have been supportive and close co-operation and information exchange in certainly where we have approached them there has respect of cases that we were dealing with. The not been any problem at all. As I said initially,I think diYculty in the Landsbanki Guernsey case is that we there has been a slow start to the United Kingdom understand that the FSA believes that it could not Treasury understanding the situation and clarifying and should not have passed us more information our constitutional position and, of course, also our than it did in terms of the changed liquidity international identity framework, which is a situation, the dependence on the parent and on the relatively new agreement signed in 2007, which of action it was planning to take. We also accept that course gives some sort of steer as to how we deal with there were some fast-changing circumstances, international matters. exceptional circumstances. The problem was that we did have an MOU (Memorandum of Q1423 Chairman: Lyndon? Understanding) with the FSA, we had assurances of Mr Trott: Her Majesty’s Government has been able information exchange and co-operation. The FSA to get an undertaking that all creditors regarding knew of our concerns in respect of the fact that we Landsbanki (Guernsey) and indeed the whole did not want there to be any Icelandic risk in respect group, will be treated fairly and equally and that we of the UK bank, with which 25% of the Landsbanki consider is a very positive statement. Guernsey assets were placed, and we did not want there to be any dependence on the parent for Q1424 Chairman: You have heard the criticism of liquidity, and we got the assurance from the FSA the FSA in the last session, but, Tony, your that there was only limited Icelandic risk. We submission suggests that you feel there has been a believed we could rely on the FSA because they had breakdown of communication with the FSA over greater information and greater influence and, KS&F(IOM). Is that a fair description? therefore, we were very surprised when Landsbanki Mr Brown: Yes, Chairman. From our point of view Guernsey failed, partly because it could not recover we were disappointed in relation to how matters from the UK bank the money deposited with it. unfolded because we do have a Memorandum of There are two things that I think go to the heart of Understanding with the FSA and with our FSC, the enormous concern we have for the Landsbanki both, of course, regulators independent of Guernsey depositors in respect of the FSA’s actions. government, who have a Memorandum of Firstly, there was limited information given to us on Understanding in case of issues that happen. It may the subjects I mentioned and they did not tell us they be helpful, if you are content, Chairman, for Mr were limiting information, we believed that we had Aspden, who is the Chief Executive of our FSC, to an open channel of co-operation. Secondly, we think give more detail on that, but certainly we were that the actions they took may have prevented disappointed in the way things happened, that we repayment to Landsbanki Guernsey and may have were not given advance notice which we would have created some kind of preference for other creditors. expected. That is the concern that we would like the FSA to recognise and help us work with the UK authorities Q1425 Chairman: Do you want to add anything, to put pressure on the Icelandic authorities and on Mr Aspden? the Icelandic parent to repay the money under the Processed: 25-03-2009 21:47:59 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG9

Treasury Committee: Evidence Ev 189

3 February 2009 Hon James Anthony (Tony) Brown, Mr Mark Shimmin, Mr John R Aspden, Deputy Lyndon Trott and Mr Peter Neville undertaking that they have given. However, there is Mr Aspden: Correct. a second and, if I may suggest, a much wider concern I have in this respect, and that is the danger of Q1429 Mr Brady: Have there been previous protectionism which comes in as a result of failure of instances where that has not happened and that have co-operation between two regulators. Cross-border caused a problem for you? co-operation is absolutely vital if you are going to be Mr Aspden: Not of any significance, no. able to protect depositors. You can only act on the basis of information you have. International trade and finance, it seems to me, depend entirely on cross- Q1430 Mr Brady: So over a period of years in both border financial services, and indeed global recovery cases, Guernsey and Isle of Man, you got into a depends on that, so a major issue for all jurisdictions, quality of relationship with our regulatory authorities that led you to believe that you had that and I have seen this in international bodies, is the reasonable expectation of a ready exchange of need for cross-border co-operation. I think that the information both ways? protectionism that we have seen here does not serve Mr Aspden: Correct. us well and what we would like to do is raise the Mr Neville: I would say that we have had some concern we have about the need for removing the experience of diYculties in the past, particularly over barriers—legal, political and attitudinal—to cross- Northern Rock, where we had initially to press very border co-operation. hard to find out which of the tripartite authorities we should be talking to about the guarantee of the Q1427 Mr Brady: Can I pursue some of those points, deposits, and, secondly, to discover the nature and but also from an Isle of Man perspective? You have extent and enforceability of that guarantee, so there both got a Memorandum of Understanding with the were reasons why we had had correspondence with FSA, so was the previous experience of that co- the FSA about the need for cross-border co- operation—and I suppose I am asking John Aspden operation and that is why we had received some in particular—one that would have led you to expect specific assurances. more proactive behaviour on the part of the FSA, that they would normally have given you more Q1431 Mr Brady: Finally, can I press you again, Mr information in these regards? Aspden? The situation regarding the administration Mr Aspden: Very much so. In fact, the largest border and the fact that your FSC, I understand, still geographical category of any financial institution on has not had access to the court papers referred to in the Isle of Man is from the UK, so by definition we your submission to the Committee, does that have very frequent and very good contact with them surprise you? all the time; hence the memorandum. The evidence Mr Aspden: It does. As our evidence says, the order that we have submitted also refers to Bradford and papers for going into administration of the UK bank Bingley, and I think this is reasonably in the public have been sealed. We wrote to the FSA in October domain now so one can talk a little bit about that, requesting those documents. We heard nothing from but that was a situation where the press, financial them until either December or early January when commentators and the financial markets clearly saw they said they could not provide the papers but could that the health of Bradford and Bingley was we be more specific on what we wanted to know, and declining, and in the weeks leading up to that not they finally provided a two-page email to me last only did we have a very close relationship with the Friday with some answers to that. Other than that FSA on that but the FSA actually sent a senior we have no further information, including on some director to the Isle of Man at our invitation to meet of the issues also contained in the evidence in terms our Board to explain the issues, to gain our of what the various position limits were at the end confidence in buying in essentially to the macro when the bank went into administration. solution to the group, which was exactly what we did, because, picking up on Peter’s point, the last Q1432 Mr Brady: Have they advanced any thing you want at a time like that is everyone going explanation or reason for excluding you from this for every little bit they can and bringing the pack of information? cards down. It worked extremely well on that. Of Mr Aspden: No. course, the diVerence is that Bradford and Bingley is a British bank, it is core to the centre of the retail Q1433 John Mann: A lot of decent savers have got system, and KSF was not perceived as such, so no V V their savings at risk. How much are you o ering doubt that is an argument for a di erence in them back? treatment, but actually the whole ethos of co- Mr Brown: The Isle of Man has a Depositors’ operation between regulators goes far beyond whose Compensation Scheme which will come into host, whose home, particularly in dealing with an operation if the bank goes into liquidation and that international finance centre like London. scheme provides for individual depositors up to £50,000 and for companies, charities and so on up Q1428 Mr Brady: So normally there is a two-way to £20,000. street. You gave information to help the UK authorities, you received information in return Q1434 John Mann: So individual depositors from without necessarily having to ask for it? you will get £50,000? Processed: 25-03-2009 21:47:59 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG9

Ev 190 Treasury Committee: Evidence

3 February 2009 Hon James Anthony (Tony) Brown, Mr Mark Shimmin, Mr John R Aspden, Deputy Lyndon Trott and Mr Peter Neville

Mr Brown: Every individual. Mr Brown: The situation in the Isle of Man is exactly as reflected in the United Kingdom until recently in Q1435 John Mann: Why have you not increased the terms that we have a Depositors’ Compensation that? Scheme, and again I remind you that the United Mr Brown: Because that is in line with the Kingdom only upgraded its scheme from October of international norm. It follows the UK, and in fact 2008. What we do is we have a scheme that will the UK, as you will be aware, increased theirs in provide, as I say, up to £50,000 per individual October up to £50,000. depositor. It is a broad scheme, it follows the international norm, and, of course, we have not yet got the bank into liquidation. Q1436 John Mann: So you do not intend to go beyond that? Q1440 John Thurso: Can we expect similar problems Mr Brown: We are reviewing the scheme. We have because of lack of clarity, lack of information with had a Depositors’ Compensation Scheme since 1991 institutional investors at some date in the future with and we have introduced an amendment to recognise your lack of transparency? the present situation, and we have also made it clear Mr Trott: We are certainly not a non-transparent to our Parliament that we will be reviewing that jurisdiction. You will be aware that very recently we scheme during this next year to see whether or not we signed a tax information exchange agreement with need to appraise it even further, and, of course, Her Majesty’s Government, having had a double naturally that will involve consultation with taxation arrangement in place since the 1950s, so I diVerent parties. am afraid I have to strongly refute any suggestion that we are untransparent, or indeed, for that matter, Q1437 John Mann: And what about yourselves? unco-operative in any way. The point you make Mr Trott: You will be aware, Mr Mann, that there is about institutional investors is a valid one. They are no international regulatory requirement for a not covered under any deposit protection scheme, Depositors’ Compensation Scheme, but, unless, of course, there is a blanket government notwithstanding that, in November of last year the guarantee given, and that raises all sorts of issues States of Deliberation in Guernsey unanimously regarding moral hazard which we may touch on approved one quite similar to the one that exists in later. Certainly with regard to the institutional the Isle of Man in so far as each retail depositor up deposits in the island, we have seen from the end of to £50,000 will be protected through a post-funded the third quarter 2008 to the end of 2008 an increase and bank funded scheme in the unlikely event that of 15%. We believe that clearly makes a statement there should be another bank failure. that Guernsey remains a well-regulated centre.

Q1438 John Mann: The savers who have put money Q1441 John Mann: So you are making even more in, how much are you giving them back? money, so savers should be even more in Mr Trott: Already the Landsbanki Guernsey is in anticipation? Is there any rational reason why I or administration, a Royal Court appointed position. any other individual saver should put any money Landsbanki savers have already received 30% of into any accounts under your jurisdiction? their monies back, and in some cases that is far in Mr Brown: Certainly as far as the Isle of Man is excess of the £50,000 that they may have expected to concerned, and it has been well recognised, we are a receive under conventional depositor protection well-regulated transparent jurisdiction. People who schemes. The administrator assures us he is working put their deposits there should be aware that there is extremely hard to secure further substantial a compensation scheme and that has served us well, payments and I have no reason to disbelieve him. It and our commitment to do the best for the is important, I think, that the Select Committee depositors is well-known. understands why Guernsey did not have a depositor Mr Trott: It is important to make this point as well, protection scheme in place prior to November of last Chairman, if I may, that the issues that have beset year. Something approaching 93% of the £160 billion Landsbanki Guernsey and the equivalent in the Isle worth of sterling equivalent deposits in the island are of Man are not a result of any activities being institutional corporate, or fiduciary deposits. 7% are undertaken in the island, high-risk activities if you retail deposits, the likes of you and I depositing in a like, that have helped destabilise international high street bank. There are a lot of investment banks financial markets; quite the contrary, both islands in Guernsey which usually only take deposits from have been subjected to the importation of contagion high net worth clients, amounts in excess of that has its origins elsewhere. We have not £250,000, so there was a genuine and understandable contributed to it. I hope that helps, Mr Mann. reluctance on behalf of some of the industry to support a compensation scheme prior to this. Q1442 Chairman: As someone else said, this is a synchronised global downturn. Q1439 John Mann: So what you are saying is you Mr Trott: Of that there is no question. make huge amounts of profit out of people investing because of your oVshore island status, but if a Q1443 Mr Fallon: Mr Brown, the Depositor Action consumer does invest and something goes wrong Group which raised the issue of the culpability of the they will not get all their money back? UK Government for the crisis around the Icelandic Processed: 25-03-2009 21:47:59 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG9

Treasury Committee: Evidence Ev 191

3 February 2009 Hon James Anthony (Tony) Brown, Mr Mark Shimmin, Mr John R Aspden, Deputy Lyndon Trott and Mr Peter Neville banks, and in particular the statement by the Mr Brown: The answer to the question is that, Sir, we Chancellor that the Icelandic authorities were are responsible for our aVairs and we accept that. unable to fulfil their obligations, do you agree that that exacerbated the situation? Q1449 Mr Fallon: But I am asking you whether Mr Brown: Certainly we were concerned about that depositors with you in the Isle of Man are right now being said. It may be helpful if you are happy for Mr to seek redress from the UK Government. Shimmin to cover that point, but from our point of Mr Brown: I would not necessarily know why that view the Isle of Man’s stance in this matter has been would be in terms that I can understand the pretty straightforward. The situation arose without argument about the freezing of the assets, which, of us being aware of it until we were advised of it and, course, we have concern about. As far as the therefore, we were not very able to, if you like, situation for the Isle of Man is concerned, we are manage it straightaway because, of course, we were accepting our responsibilities and endeavouring to unaware of it happening. rectify the situation.

Q1444 Mr Fallon: Mr Shimmin, did the Q1450 Mr Fallon: But are they right to seek redress Chancellor’s statement exacerbate the situation? from the UK Government? Mr Shimmin: From the Isle of Man’s point of view, Mr Brown: I think that is a matter of opinion for given the lack of information that we had, as Mr them. I do not think the UK Government is Aspden has talked about, in relation to the FSA, it responsible for the financial aVairs of the Isle of made the situation more diYcult to manage in the Man. Isle of Man. Q1451 Nick Ainger: Can I ask this question to John Q1445 Mr Fallon: Mr Brown, the Chancellor in his Aspden? As the regulator of KS&F(IOM), can you statement to this Committee, described the Isle of explain to the Committee your understanding of Man as “a tax haven sitting in the Irish Sea”. How why KS&F(IOM) transferred £550 million to helpful was that statement? KS&F UK? Mr Brown: Clearly, it is not a statement that carries Mr Aspden: The reason was, as our evidence said, as any weight. If you look at the basis of how the Isle of the regulatory authority on the Isle of Man in the Man is structured, the Isle of Man is a well-regulated early months of 2008, we were concerned at the country, it has a diverse economy. It applies country risk presented by the amount of deposits international standards to the highest level and has lent from the Isle of Man operation directly to a full system of direct and indirect taxation, Reykjavik. In fact, in the regulatory body we were including a full national insurance system. If you discussing this in January and February and, as the look at all the components of how the Isle of Man evidence says, in March we came to the view that we operates, it reflects very much how the United did not want to incur any Icelandic risk. In fact, to Kingdom operates, so that statement was my recollection—I have not got the figure here—the unfortunate and does not reflect the status of the Isle figure was larger at that stage, somewhere in the of Man. order of £700 million. Having told the institution that, it was obviously for them in Reykjavik to come up with their response to the fact that we wanted no Q1446 Mr Fallon: He went on to add, “a tax haven Icelandic exposure. The Kaupthing Bank, although sitting in the Irish Sea leading to perhaps people not an Icelandic bank, conducted a significant amount being clear as to what the diVerent rights and of its treasury operations through London, and in responsibilities are”. Were people unclear? fact many banking groups, as I am sure you know, Mr Brown: As far as I understand it, they would be centralise their treasury operations and London is a advised if they are putting money into Isle of Man very natural habitat for that. They came back with banks by their advisers, and certainly all the a proposition that the most convenient thing to do, information is available if they wish to know more apart from some reduction in exposure from the about the Isle of Man as to our autonomy, in terms figure I have just said, would also be to have the of we are fiscally autonomous, so it is not a lack of money transferred to the London operation, and information there, and certainly people should be then we got into the dialogue I have already referred able to identify that and, as far as we know, many do. to in the evidence with the FSA about the terms on which that placement would be made. Those are the Q1447 Mr Fallon: Do you think depositors in the circumstances. Isle of Man are right now to look to the UK Government for redress? Q1452 Nick Ainger: But this transfer represented Mr Brown: The Isle of Man takes the stance that we V almost half the assets of KS&F(IOM). Were you not are responsible for our a airs and we have a concerned, particularly bearing in mind your Depositors’ Compensation Scheme and we have previous concern about the relationship with the also introduced some early payment schemes to help Icelandic parent company,that this transfer would in overcome the present situation. eVect destabilise KS&F(IOM)? Mr Aspden: No, we were not because first of all the Q1448 Mr Fallon: So what is the answer to my concept of upstreaming, if I may use that as a general question? concept where bank deposits or funds are Processed: 25-03-2009 21:47:59 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG9

Ev 192 Treasury Committee: Evidence

3 February 2009 Hon James Anthony (Tony) Brown, Mr Mark Shimmin, Mr John R Aspden, Deputy Lyndon Trott and Mr Peter Neville upstreamed from one company to another within a whether you have got the resources to pay out the banking group, is by no means unique to the Isle of £50,000 per depositor if they have £50,000 on Man. It happens in many jurisdictions, including in deposit. many onshore jurisdictions as well, so this is nothing Mr Brown: First, I would say that is not the case. The new. Of course, it was a significant amount of the Isle of Man Government has been very active in balance sheet. However, it was money lent to endeavouring to find a way forward that we believe another what we call Zone A bank, which is a bank will be in the best interests of all the depositors and from an OECD country which could also enjoy IMF a better option to just going straight into liquidation. borrowing facilities—that is one of the criteria that As far as the DCS is concerned, the Isle of Man we look at—and, based on that, and then in Government has earmarked £150 million to put into particular based on the discussions we had, the that and the banks have earmarked £200 million to assurances and the information we got from the go into that. We will pay out on the basis of the FSA, I do not think a money market exposure of scheme, if it is brought into operation, and we that is particularly out of the ordinary, not just in the believe that the net cost to us will be somewhere in Isle of Man but generally in the banking industry. the region of £50 million, so from our point of view we are satisfied that we have the resource to do that. Q1453 Nick Ainger: Your written evidence to us Something like 71% of eligible depositors will receive 100% of their deposits within two years, so from our indicates that you think what you now know about V these circumstances is that you had imperfect point of view we believe the scheme is e ective. information provided to you by the FSA at the time. That is my understanding of what you have said in Q1457 Nick Ainger: Can I just ask you about the two your submissions, that what you now know of the years? So if the company does go into liquidation circumstances of KS&F was not what you were some depositors would have to wait up to two years being told at the time by the FSA. Is that correct? to get their money? Mr Aspden: No. We were told various things by the Mr Brown: I think the point is that with liquidation, FSA. We had various understandings and you are of course, they would be paid out from the bank side, quite right, I have put that in the evidence. Whether then the DCS, and, of course, it has to be or not that subsequently turned out to be true in acknowledged that we have introduced early terms of what the London position was with the payment schemes to help those who are finding London bank in relation to the limits and everything themselves in diYculties, so therefore we have an referred to in our evidence, I am afraid I do not early payment scheme at the moment of up to know, and the reason I do not know is that no £1,000. We have a new scheme going to Tynwald, our information has been forthcoming. Parliament, this month which will increase that up to £10,000. Taking the whole package, we are satisfied Q1454 Nick Ainger: But have you formed a view that the scheme will operate eVectively. from what we have now seen has happened to KS&F here that perhaps what you were being told at the time by the FSA was not strictly accurate? Q1458 Nick Ainger: If you have got this scheme in Mr Aspden: The only view I have formed is the fact place which you believe will cover, with support that if all the understandings that we had, which are from the Isle of Man Government, all of the referred to in the evidence, had been adhered to I depositors for certainly up to the £50,000 mark, and would not have thought that the London bank there will obviously be many more that will have would be in quite the predicament that it appears more than £50,000 on deposit and they will lose out, to be. you were referring earlier to comparing your scheme with the UK scheme, but in fact the UK scheme pays out much sooner than that. Is there no way that you Q1455 Nick Ainger: I put it again to you, that if you can match the UK depositor protection scheme in had known then what you think has happened with terms of the time of payout? KS&F, would you have approved or not raised any Mr Brown: I think what we have done is introduce a objection to the transfer from KS&F(IOM) to scheme that we feel is appropriate to the Isle of Man KS&F here in London? in terms of how we operate the system that we have. Mr Aspden: If you are saying to me if we had thought Again, we have had a scheme since 1991 but if I may, that the limits and so forth that are in the evidence Chairman, to cover that point of payout, Mr Aspden would be broken or not adhered to, and if you are will have a better understanding of the detail, so saying in advance would we have gone along with it, perhaps I can ask Mr Aspden to deal with that. the answer is no. Mr Aspden: So far as the scheme is concerned, the Depositors’ Compensation Scheme, the rate at Q1456 Nick Ainger: Can I move on perhaps to Tony which it will pay out will depend entirely on the rate Brown? Accusations have been made by people who at which it is funded, so not just the amount but also have got a direct interest in these matters that the the speed with which it is funded, and it can be reason that KS&F(IOM) has not gone into funded not only from Government and not only liquidation or bankruptcy or administration is that from banks, but it is also able to borrow on its own you are concerned about the eVect it will have on account, so if we were able to activate a borrowing your depositor protection scheme, in other words facility for it, we could come within the two years. Processed: 25-03-2009 21:47:59 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG9

Treasury Committee: Evidence Ev 193

3 February 2009 Hon James Anthony (Tony) Brown, Mr Mark Shimmin, Mr John R Aspden, Deputy Lyndon Trott and Mr Peter Neville

Q1459 Nick Ainger: So it is still two years or below? Q1463 John Thurso: You mentioned that one of the Mr Aspden: Or below. reasons why you would like to see the documents is recoveries. Given the evidence that we heard earlier from Tony Shearer of the pretty lax approach the Q1460 Nick Ainger: But nothing like the speed at FSA took to the creation of KS&F, and given your which, if you had the depositor protection scheme quite proper dependence not on any guarantee but that is enacted in this country, depositors can get on a degree of comfort, how appropriate would it be their money back? Nothing like that? for the Isle of Man authorities, whether Mr Aspden: No, perhaps not. administrator, liquidator or even the Government, Nick Ainger: We are looking at months and possibly to take legal action against the FSA in the United years for some depositors? Kingdom for their failures in this regard? Mr Aspden: I cannot speak for the Government but Q1461 John Thurso: One of your concerns from your that would not be something in the role of myself as written evidence is the sealing of the documents a regulator. relating to the KS&F UK’s administration. Can you just explain what diYculty that causes you? Q1464 John Thurso: Who would you like to look Mr Aspden: First of all, it was what happened to the at that? UK bank that brought our bank into the position it Mr Brown: I think the answer is that we would have is in at the moment so, first of all, given the fact that to consider whether that was an appropriate action. all of us in the administration and in the regulatory body have been on the receiving end of questions as to why what has happened has happened, I think Q1465 John Thurso: Let me oVer you some free that is a natural thing and a worry. Number two, it is advice. You appear to have two elements to this. You extremely important for us to know why it went into have one side which is really you get decent legal administration from the point of view of beginning advice that says, “It is a good case, you should go for to make our own assessments as to what recoveries it”, and I have got a suspicion you would probably might come, because if it had been, for example, a get that without too much trouble, and you have also massive fraud that had wiped out half the balance got the small problem of foreign relations. We might sheet, that would have vastly aVected it. The third not have much of a navy but I suspect we could point is that our Liquidator Provisionally in the Isle probably retake the Isle of Man. Is that not the of Man has also been taking steps in relation to the problem, you have got a balance between what you provisional liquidation, and clearly he wants as legally might be able to get your hands on and the much information as he can get in order to facilitate fact that you have got a big brother government over his work. This has been one of the major problems here who already regards you as a bit of a pain in the in being able to tell depositors what “p” in the pound neck tax haven in the North Sea that ought to be they might eventually get, because it is not just an taken out? Is that not the core of the problem? Isle of Man calculation; it is a London-based Mr Brown: I think it is worth making the point that calculation as well. My final point is at the end of the we are a valuable contributor to the UK economy. day I think it is only fair and right that if a bank is Certainly we have to politically weigh up that brought down in London, which then has that balance and consider the implications of any actions consequence in the Isle of Man we should know, and we take and we would always do that. some of your colleagues have referred to transparency, I think it is totally untransparent that Q1466 John Thurso: More seriously, is not the point that can happen with that sort of consequence on that Her Majesty’s Government, given that she is depositors without proper disclosure being made. Queen of all of those territories, ought to take a far more sympathetic view and a more responsible view and take that on board themselves? Q1462 John Thurso: Can I come back to the fact that Mr Brown: We certainly made the point to Her you have stated that it was the trouble in the UK Majesty’s Government about the situation and our bank that caused the problems? Obviously, you are concern about it. an independent jurisdiction but you will probably have felt that you could rely on the institution set up by Her Majesty’s Government, the FSA, to be a Q1467 Mr Todd: I think this is mostly for Mr reliable source of information. To what extent were Aspden. Can I explore the role of your own you depending on the FSA’s quality of guarantee or organisation in examining the transfer of whatever, or their approval of the London operation undertakings between Derbyshire OVshore and to give you comfort in the Isle of Man operation? KS&F(IOM). When that happened, did you Mr Aspden: I would not say that we were depending scrutinise the fitness of KS&F(IOM) to take over on a guarantee from the FSA, or indeed formal those undertakings in your island? What was the role approval, but I think you will have gleaned from our of the FSA in advising you of any relevant evidence that our understanding of those limits information about that? referred to in the evidence would have given us the Mr Aspden: In relation to the role of the FSA in protection that we understood we would have in advising us of any information, other than the fact relation to that transaction. to the extent that the UK was regulating or Processed: 25-03-2009 21:47:59 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG9

Ev 194 Treasury Committee: Evidence

3 February 2009 Hon James Anthony (Tony) Brown, Mr Mark Shimmin, Mr John R Aspden, Deputy Lyndon Trott and Mr Peter Neville supervising the London end of Derbyshire and had Regulator, the FME in Reykjavik, we took a locus in that, I cannot really recall anything specific additional steps, and I do not think it is referred to beyond that. in our evidence, to establish a Memorandum of Understanding with the regulatory body there and Q1468 Mr Todd: They have accepted that as we requested them to come and visit the Isle of Man, regulators of the Derbyshire Building Society, which and they did. at that time was already in some diYculty, they were expressing some interest in that transaction and had Q1471 Mr Todd: In all this contact which took place some liaison over it. I would welcome a separate you did not get any of the disquiet that we have summary of that arrangement if you could and any heard from Mr Shearer? discussions that took place there. What did you do Mr Aspden: I did not get— yourselves? Mr Aspden: First of all, at the time of the acquisition, of course, the entity of Kaupthing, Singer & Q1472 Mr Todd: You must have met some of the Friedlander (IOM) Limited was already a licensed same people. bank on the Isle of Man, so by definition they were Mr Aspden: We have not— already approved in that status as a licensed body. That took us some way down the track. The other Q1473 Mr Todd: Finally, the FSA has thus far said issue that we looked at at the time was to satisfy that they are unable to disclose advice they gave in ourselves that depositors in the Derbyshire (IOM) the matter that John was pursuing earlier, the were made aware, as you have heard in previous transfer of cash to London, that they have not been evidence this morning, of the transfer of deposits. prepared to disclose that certainly to Members of The other thing that we were clearly interested in was Parliament who have enquired about it. Are you in looking to see how the business of Derbyshire (IOM) a position to give us more information as to the would be subsumed within the Kaupthing, Singer & information you received from the FSA, perhaps Friedlander (IOM) entity and then in particular how copies of any material that you think is relevant to those funds would be aggregated and managed in the our inquiry in this? new enlarged entity. Mr Aspden: The only thing I could do, and I have not got copies with me, but we certainly have file Q1469 Mr Todd: Did you take any view of the notes of each of the discussions that we had with the diVerence in parental guarantee that would seem FSA at the time, and I am talking about March to obvious from the commonsense perspective, which May 2008, and then we also wrote a letter to the FSA is that a British building society has never gone bust, setting out our understanding of what we had been and as the parental guarantor of Derbyshire oVshore told. accounts, whereas the same could not be said of Mr Todd: That would be very helpful to have.4 Scandinavian banks? Did you take any perspective on that and feel that was an issue which required Q1474 Sir Peter Viggers: Following that point, the some thought? Isle of Man authorities would have no objection to Mr Aspden: I think the main thing we thought of at any dialogue with the FSA being disclosed to us if we the time, and actually it was not a regulatory V asked the FSA for that information? requirement but was o ered by the bank, was the Mr Shimmin: No. provision of the shortfall guarantee from Kaupthing Bank hf in Reykjavik in respect of the entire entity of the Isle of Man, not just Derbyshire. That was not Q1475 Sir Peter Viggers: Thank you. Then from a formal regulatory direction, therefore it did not Guernsey’s point of view, Guernsey has also need to follow any standard form set by us as expressed concern about the manner in which the regulator or whatever but, nonetheless, at the time I relationship with the FSA works and has expressed think it oVered an important overlay of comfort. that concern in writing to the FSA. Does Guernsey have any objection to us asking the FSA for copies Q1470 Mr Todd: You perhaps heard Mr Shearer’s of that dialogue and correspondence? thoughts on when Kaupthing, Singer & Friedlander Mr Neville: None at all. The thing I would say is I was acquired. Did none of those over the maturity of have had correspondence with Hector Sants. the Kaupthing management team and their ways of Obviously our concerns are in the context of us still building up shareholdings occur to you to scrutinise wanting to understand the FSA’s point of view but at some stage when you were examining KSF(IOM) Hector Sants has confirmed to me he understands we which was a direct subsidiary of Kaupthing in are here today and there is no problem with the Iceland? Did you not give any thought to any of releasing of that information as far as I am those issues? concerned. Mr Aspden: Indeed. In fact, members of the Reykjavik bank actually came to the Isle of Man and Q1476 Sir Peter Viggers: Thank you. What visited us on a number of occasions. There was prompted you to undertake your own review of your certainly an Icelandic director of the London bank work relating to Landsbanki? who was also on the board of the Isle of Man entity. Indeed, because of our lack of familiarity with the 4 HC (2008–09) 144–III, Ev 662 Processed: 25-03-2009 21:47:59 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PAG9

Treasury Committee: Evidence Ev 195

3 February 2009 Hon James Anthony (Tony) Brown, Mr Mark Shimmin, Mr John R Aspden, Deputy Lyndon Trott and Mr Peter Neville

Mr Neville: In these circumstances where a bank has Q1479 Sir Peter Viggers: How did you fix the limit? gone down it is quite normal for a regulator to take Mr Trott: £50,000 for retail deposits is an industry a good hard look at itself and see if there are any standard. In terms of having a cap on the ultimate lessons to learn. From our point of view it was a liability the industry would take, there were some natural response. I wanted to know if there were any sophisticated calculations done that took into concerns that we needed to address. I wanted to account the eVects should there be one or two bank make sure that a lot of the concerns that were being failures. That is a scenario, I have to say, that is expressed by the depositors were addressed by an extremely unlikely for a variety of reasons. independent party who could actually take a hard look at us and say whether we had done a good job Q1480 Sir Peter Viggers: Okay. Will the scheme or not. In the event we were obviously satisfied with cover those aVected by the Landsbanki collapse? the result. Mr Trott: It is not retrospective, so the answer to your question is no. Again, I would repeat that the Landsbanki Guernsey depositors have already Q1477 Sir Peter Viggers: The conclusion of the Foot received 30% of their deposits back and in some Review was that there was no regulatory failure. Are cases, as I mentioned earlier, that is far in excess of you using that conclusion as cover to not apply the £50,000 limit that is now in place. Importantly, public funds to compensate the Landsbanki the Administrator has made very clear that he depositors? anticipates further distributions to those depositors Mr Neville: That is a question more for the Chief later on this year. Minister than myself. Mr Trott: We take the view, Sir Peter, in Guernsey Q1481 Sir Peter Viggers: What was your response? that the taxpayers should not bear the risks of banks Were you surprised that the UK Government used failing. I am confident to know that is the view of the the Anti-terrorism, Crime and Security Act 2001 to TSC because I quoted those words directly from protect the UK’s position with regard to your report, The Run on the Rock. The answer to Landsbanki? your question, therefore, is no. The reality is there Mr Trott: It is an area that I would not feel was no regulatory or governmental failure regarding comfortable commenting on, but I am sure that if the placing into administration of Landsbanki the UK Government felt it was justified it probably Guernsey Limited. It is also important for me to was. make a couple of other points while I am speaking. I have not ever heard any informed source refer to Guernsey as a tax haven. I have heard many sources Q1482 Mr Brady: Following on from Mr Todd’s questions to Mr Aspden, you said you had written refer to us as a low tax jurisdiction, and there is much a letter to the FSA to confirm the contents of your justification for that. When we are talking about the discussions with them. When did you write that retail deposits that are placed in Guernsey and in the letter? knowledge of the risks that existed beforehand, and Mr Aspden: May 2008, something like that. those risks certainly in terms of retail deposits up to £50,000 are much less today, one needs to understand that when Guernsey signed up to the 27 Q1483 Mr Brady: I think you are going to send us a bilateral agreements with EU Member States with copy of the letter and that would be helpful. regards to the Savings Directive there was an Mr Aspden: I will. expectation that there would be significantly more tax, if you like, received by EU Member States from Q1484 Mr Brady: When we have asked the FSA that activity. The reality is it was much less. Why? about discussions with FSC with regard to the Because the depositors in Guernsey preferred to transfer of the £530 billion they have always denied disclose their undertakings to their relevant tax there was any guidance given. Would it be a authorities. It is further evidence, I believe quite reasonable interpretation to say that the reason for strong evidence, that Guernsey is not a tax haven, far the discrepancy between their version and the Isle of from it, but, as I stated earlier, a low tax jurisdiction. Man version is you are basing your comments on a series of discussions over a period of months which gave rise to expectations and they are simply denying Q1478 Sir Peter Viggers: You have recently that they gave specific advice in the days leading up announced the introduction of a deposit protection to the transfer? scheme. Why was there not one before? Mr Aspden: I think you are quite right. There is one Mr Trott: I partly answered that ahead of time additional point, and that was it was erroneously earlier when I responded to Mr Mann. There was reported in the press that the FSA had required, or little appetite in the island amongst the banking whatever, the transfer of that money. That never fraternity for a scheme. The reason for that was that happened and we have never alleged that. a very small part of the deposit aggregate in the island is, in fact, retail deposits. The majority of the Q1485 Jim Cousins: Mr Trott and Mr Brown, in the business that is undertaken is invest banking and an future would you like to see financial services awful lot of fiduciary deposits are included in that regulation and depositor protection put on a figure. common UK-wide basis? Processed: 25-03-2009 21:47:59 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PAG9

Ev 196 Treasury Committee: Evidence

3 February 2009 Hon James Anthony (Tony) Brown, Mr Mark Shimmin, Mr John R Aspden, Deputy Lyndon Trott and Mr Peter Neville

Mr Brown: Certainly from our point of view we group of international and private banks. The loan would be happy to contribute to any discussions guarantee scheme which the British Government is about that. To prejudge whether or not that is in in the process of working on, how much of the £124 everyone’s best interests is something we need to billion roughly that is with those international and thoroughly discuss with the UK and other parties to private banks in Guernsey might be covered by the see whether it is to everyone’s benefit. loan guarantee scheme that the British Government Mr Trott: With regards to depositor protection, has in mind? there are issues regarding moral hazard that one Mr Neville: Unless I misunderstand the question I needs to take into careful consideration. As far as do not see that the UK guarantee scheme would be retail depositors are concerned, £50,000 does seem to relevant to the deposits placed in Guernsey. Perhaps be a pretty standard norm, so I think we are I misunderstand the question. probably already there. With regards to greater regulatory co-operation, I think my colleague, the Q1487 Jim Cousins: If the financial instruments Director General of our independent Financial which were being guaranteed were located in Services Commission, made clear earlier there is Guernsey the guarantee would extend to Guernsey. room for additional scope between home and host Mr Neville: I am not sure I understand the context nations and that is one of the reasons for this inquiry, of that to the Guernsey banks because we would be I am sure. looking at deposits within the Guernsey banks Mr Neville: May I add that we do actually apply which would be covered, as far as the retail exactly the same standards, the international depositors are concerned, by the depositor standards, which are applied in the UK. Any protection scheme. regulator can only regulate to the extent of the information it is provided and that is why I think not Q1488 Jim Cousins: No, I realise that. I am talking only between us and the UK but also between all about the banks’ own financial instruments. jurisdictions we need better co-operation to make Mr Neville: Are you talking about the use of special V sure that the regulators are able to assess the risks of purpose vehicles based in o shore centres? the businesses that they are regulating, the risks that those businesses are taking in their jurisdictions. Q1489 Jim Cousins: Yes, exactly. Therefore, I do not think there is any diVerence in Mr Neville: There are very few special purpose standards but what does need to be improved is co- vehicles based in Guernsey. I am aware of one or operation. two, but as far as the position so far is concerned I am not aware of any special purpose vehicles in Guernsey that have been involved in any way in any Q1486 Jim Cousins: Mr Neville, just one further banking problems so far. question to you. You have supplied some very Chairman: Thank you very much for your evidence. interesting information about deposit placing in We are very grateful that you took the time to come your jurisdiction. The figure you have given us is across particularly in this inclement weather. Thank £141 billion, roughly 88% of which is placed with a you very much. Processed: 25-03-2009 22:12:50 Page Layout: COENEW [SO] PPSysB Job: 416782 Unit: PG10

Treasury Committee: Evidence Ev 197

Wednesday 4 February 2009

Members present

John McFall, in the Chair

Nick Ainger Mr Andrew Love Mr Graham Brady John Mann Mr Colin Breed Mr George Mudie Jim Cousins John Thurso Mr Michael Fallon Mr Mark Todd Ms Sally Keeble Sir Peter Viggers

Witnesses: Mr Alex Brummer, Daily Mail, Mr Lionel Barber, Financial Times, Mr Robert Peston, BBC, Mr Simon Jenkins, Guardian and Mr JeV Randall, Daily Telegraph and Sky, gave evidence.

Q1490 Chairman: Good afternoon and welcome to suppose the issue for me is the counter-factual. If we this session of the Banking Crisis, the Role of the had delayed in any of the cases which have caused a Media. Can you introduce yourselves please and bit of frisson, what would the benefit actually have where you come from for the shorthand writer? been? I do not know whether it is appropriate to go Mr Randall: IamJeV Randall, I am here into the three or four stories which have made a few representing Sky and the Daily Telegraph. waves which we have done over the past 18 months Mr Barber: Lionel Barber, I am the Editor of the or so, but I would argue in the case of each of them Financial Times. there was a public interest in disclosing what was Mr Peston: I am Robert Peston, the BBC’s going on—Northern Rock, HBOS, Bradford & Business Editor. Bingley, Royal Bank of Scotland—and I also find it Mr Brummer: I am Alex Brummer, the City Editor diYcult to people, in fact I would argue very of the Daily Mail. strongly, that where they are today is precisely where Mr Jenkins: Simon Jenkins from the Guardian. they would have been whether we had or had not shared that information with the general public. Q1491 Chairman: You are all welcome. Many Therefore the bit of the argument which slightly submissions to this inquiry have stressed the escapes me is, what would be gained by a period of importance of maintaining press freedoms even delay or a bit of censorship. I am not sure the world during periods of financial instability, and that is a would be any diVerent. sentiment which I share. However, is there a case for journalists to exercise self-restraint and temporarily Q1494 Chairman: We have until 10 to 4 and all my delay publication of a story, perhaps for a few hours colleagues want to ask questions, so we will try to or a day or two, where there is a risk that immediate have brief questions and even briefer answers. publication would trigger widespread market Mr Peston: Sorry. turbulence or lead to the collapse of a particular institution? Robert? Q1495 Chairman: Everyone will have their Mr Peston: Well— opportunity but, Alex, you go at the end because we have something special for you. JeV? Q1492 Chairman: Sorry, I just picked you at Mr Randall: I agree with Robert. In the case of random! Northern Rock, and I guess that is what you are Mr Peston: It seems to me that there are two related driving at, it was a deeply flawed bank with a broken issues here. At the risk of sounding slightly pompous business model, it did not collapse because Robert and pretentious— very cleverly revealed it had asked for help, it collapsed because it was a bust business. Had Robert Q1493 Mr Fallon: Go on! delayed it for a couple of days, would it have made Mr Peston: —it seems to me there is a public interest any diVerence, would it today be a solvent bank, in letting millions of people know what is going on absolutely not. I think he was perfectly justified in with their banks and what is going on with the putting out the story when he did. economy, and if their banks are weaker than they Mr Barber: There is a diVerence, Mr Chairman, think to be the case then there is a public interest in between restraint and self-censorship. The fact is, as telling them such, and telling them the more general JeV and Robert have alluded to, there were rumours problems we have been experiencing with the going around for a long time, months, before about economy.I can only speak for the BBC but we do not Northern Rock’s financial health, its excessive broadcast, publish on the blog, stuV without giving reliance on wholesale funding and nobody wrote it huge amounts of thought, obviously going about it because at that stage they were rumours. through a massive detailed verification procedure, There are also very clear rules, at least at the and I will talk to senior editors about what we do, Financial Times, that before we publish stories we but at the moment where I feel that the story is being want two sources, we also do not publish stories nailed down and the wider social public interest is which we know, we think, may have a big impact on served by publication of course we just publish. I the market, and if they are anonymous quotes we try Processed: 25-03-2009 22:12:50 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG10

Ev 198 Treasury Committee: Evidence

4 February 2009 Mr Alex Brummer, Mr Lionel Barber, Mr Robert Peston, Mr Simon Jenkins and Mr Jeff Randall and identify them as best we can. Overall, I think the Mr Brummer: Anything to help sales! conclusion is absolutely clear, Northern Rock was operating a flawed business model and they were Q1498 Chairman: On page 81 you say, “The BBC’s caught out, so nothing the BBC and the way it was V Business Editor had a brilliant scoop but the reported would have a ected the outcome. normally cautious broadcasting network had inadvertently precipitated a crisis.” You went on, on Q1496 Chairman: Simon Jenkins, mindful of the page 204, to say, “The BBC’s excitable reporting of letter the Chief Executive of the British Bankers’ Northern Rock’s troubles may have contributed to Association sent to the Select Committee for the vehemence of the run on the bank.” Culture, Media & Sport, where she complained Mr Brummer: I did write that and Robert and I have about the procession of leaks and said, “more discussed it on occasions. What I thought was that astounding, in all cases it is the BBC via their the tone of the report rather than the content of the Business Editor, Robert Peston. He is of course report may have made people slightly unsure what perfectly entitled under the current Market Abuse was going on. I am still of that view. However, we rules to use this information but it is also quite clear have to bear in mind here that most of the response that the market turbulence caused was was really the result of the poor systems that extraordinarily substantial and has been particularly Northern Rock had, that they had computers which damaging both for the institutions involved, the broke down, they had very few branches so the sector, its customers and the UK economy.” She says queues built up very quickly. Indeed when I think that it is not a BBC-bashing exercise but perhaps the back on the episode now, I actually think Robert did BBC acted injudiciously in this regard. Given everyone a big favour. He did them a big favour by everybody is agreed up to this moment, I am looking alerting small depositors, they were taking a foradiVerent point of view. perfectly rational decision to withdraw their money Mr Jenkins: I am not sure I can give a diVerent point because what was going on behind the scenes, which of view. Let’s take a hypothetical. In this case, I think none of us could see, was the big, wholesale those people involved can legitimately say they were depositors, the big operators in the money market, acting in a considered fashion. They were not going were moving their money out by the billions. So they to be telling a lie. They were not intending to wreck had inside information, they knew what was going an otherwise valid bank and they were acting in the down, the small depositors did not, so he alerted public interest. I assume the reason for your question them to that. Maybe if he had a more calm, is, let’s suppose those assumptions were the case, traditional BBC voice it may have not quite seemed let’s suppose a reckless journalist went on the like it did, but I was not arguing with him doing the radio—and radio is of course 24/7 and you do not reporting, I was only arguing with the tone of the have the pause we get eight hours before the stuV reporting. Also to mention, he did mention in that gets read and people can respond immediately to report that everybody had deposit insurance of up to what they hear on the radio—suppose he or she just £35,000—as it was at that moment because it has decided they were going to go on the air and say, been extended to £50,000 since—they would be “This is a dud bank, sell every penny you’ve got in covered by that deposit insurance, which was an it”, the consequence of which being the destruction important fact to get out there. That is something of a bank. Presumably the reason why you are asking which I think the papers have done throughout this these questions is, you want to know if there is some crisis, they have referred to the safety nets which new regulatory framework which ought to restrain exist and let people know about those. journalists from doing that, otherwise you are describing the world as it is. All I would say to that Q1499 Mr Fallon: Mr Peston, it has been suggested is to me the interesting question is, is it like war? that one of the reasons for your success is your During the Falklands, newspapers were constantly closeness to the Treasury. Do you have particular being told, “If you publicise this information right access to the Treasury? now it will jeopardise our troops”, and that did Mr Peston: Mr Fallon, I think you will not be indeed happen on one occasion. Most newspapers surprised that the one area where I am accepted that without there being a formal statutory uncomfortable talking in public is about sourcing, of framework to control them. But the truth of the any sort. Over the years, I have benefited from matter is that there is the old saying, “I am a private conversations with members of this responsible journalist, you are an editor and he is a Committee and I think it would be very unlikely any censor”, we are all in this game and we are all trying of those members would wish me to divulge those to be responsible. I think one of the virtues of sorts of chats. If you will forgive me, the one thing I established news media organisations is they are to a would say is, I have been a journalist for 25 years, I certain extent trained to be responsible. I am much have done political journalism, I have done business more worried about the bloggers sphere where journalism, I like to think I have decent contacts in anything can go out. I am glad it was Robert and not the City, I have decent contacts in Government, in a blog which did what happened to Northern Rock. Whitehall, the regulators. When I do a story it is normally a process of putting together a jigsaw Q1497 Chairman: Alex, your book, The Crunch—a puzzle. It is very, very, very rarely in my line that very good book which I have read, and actually I somebody has rung up and said, “I have a corker for loaned it but my colleague, George Mudie bought it, you, here you go” and handed me something on a so that is good news— plate; it almost never happens. I know a bit about Processed: 25-03-2009 22:12:50 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG10

Treasury Committee: Evidence Ev 199

4 February 2009 Mr Alex Brummer, Mr Lionel Barber, Mr Robert Peston, Mr Simon Jenkins and Mr Jeff Randall banking, I have been a banking editor in the past and for years I looked like a bit of a plonker because actually on Lionel’s paper, the FT, and in the the share price went up and up and up and the fact I summer of 2007 when markets closed down I said I thought this may be heading towards some concluded this was likely to be the biggest story of kind of an accident looked wrong; I looked like an my career and I immersed myself in it and more or idiot. However, when wholesale markets, the market less everything I have done since then has been a for mortgage-backed securities, closed down in process of talking to hundreds of people working out August 2007, because I was aware that much of their the trends and working out what the stories were. funding came from that source, this was a bank I kept a very close eye on. Because plainly unless those Q1500 Mr Fallon: All right, but do you have markets re-opened it would have a very big problem, particular access to the Treasury? Do you have a pass it was a story I followed over a period of weeks, and to the Treasury? there came a moment on that particular day, which Mr Peston: I am perfectly happy to say that I do not was 13 September, when I felt the pieces fitted have a pass to the Treasury. together and then I telephoned a chap called Peter Horrocks, who is the Head of Television News, and Q1501 Mr Fallon: How often are you in the we talked about how we would get it out, and we Treasury? broadcast it. Mr Peston: No more often than I am in big banks. I do not know, is the answer. I am sure if you asked the Q1505 Mr Brady: So as long as it is true and you are Treasury they have a record of when I turn up. A few confident it is true, you publish? times a year; I do not know. Mr Peston: Multiple sources, absolutely.

Q1502 Mr Fallon: It has been suggested the senior Q1506 Mr Brady: Lionel Barber, you took I think a oYcial in charge of this whole area in the Treasury, slightly diVerent tack in response to the Chairman’s the Second Permanent Secretary, John Kingman, question in referring to the publications about was a former colleague of yours and therefore might Northern Rock, you made a point about the fact the have been in a position to help you confirm business model was bad as being a part of the particular stories. Is that right? justification for it. Mr Peston: I am simply not going to get into who I Mr Barber: It was not a justification for publishing talk to about any story. I know lots and lots of the story,Mr Brady,it was an explanation. Our job is people, including you, and I talk to lots and lots and to explain and I pointed, as my journalist colleagues lots of people. have done, to the fact they were shown to have pursued a flawed business model which was Q1503 Mr Fallon: But the suggestion has been that excessively reliant on wholesale markets, and when you have had access, I understood in the Treasury or those froze over in the summer of 2007 they were in indeed through the banks, to preferential deep trouble. That was reflected, Mr Brady, in the information and that might well have been in the share price which was an indicator something was interests of those giving you the information as up. much as yourself? Mr Peston: I can say that I have never felt I was in Q1507 Mr Brady: But from your point of view, as an receipt of preferential information from any source editor of the newspaper, it would have made no at all. What I do is I try and understand what is diVerence had the business model been sustainable if happening in the world, and then I talk to as many it were not for publishing a story that was true? people as possible to work out whether my ideas Mr Barber: I am not sure I understand your about where stories might go turn out to be correct, question. and I have never felt I was getting special help from any source at all. Q1508 Mr Brady: My point is, if you thought the Q1504 Mr Brady: Mr Peston, you said earlier in business model was potentially sustainable into the response to the Chairman that you go through a long term but there was a piece of news which came process of thought and verification and you publish to you which could destabilise a company, you when the wider interest is served. Has there ever been would still think it right to publish? an instance where you have decided that the wider Mr Barber: There are other factors in judging interest would not be served by publishing a story whether to publish a story rather than the judgment you knew to be true? made by the Financial Times or the BBC about Mr Peston: No. I, however, have delayed whether the business model is sustainable, and those publication until I am absolutely certain of all the would be the movement of the share price and what material information. I have discussed, for example, financial advisers are saying and what analysts are in the past the process which led me to broadcast saying. about Northern Rock, for example. This was a story I have been following in some ways for years Q1509 Mr Brady: Have any of you during the actually. In 2003 I first identified Northern Rock as present crisis been under any pressure, either from a bank whose business model I was a little bit regulatory authorities or financial institutions or concerned about, it seemed to me it was growing far from the Government or any other quarter, not to too fast, I wrote about it in the Sunday Telegraph publish or delay publication? Processed: 25-03-2009 22:12:50 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG10

Ev 200 Treasury Committee: Evidence

4 February 2009 Mr Alex Brummer, Mr Lionel Barber, Mr Robert Peston, Mr Simon Jenkins and Mr Jeff Randall

Mr Brummer: There was one occasion involving alarm, and then, not all of the 1.3 million, but many, Northern Rock, much after the events of the many thousands went to the branches to, again, find summer of 2007, towards the end of that year and out more about what was going on. When they got early into 2008, when we as a paper came across a there they discovered they could not find out because document which could have been highly damaging there were these queues of like-minded people, and I at that point to Northern Rock at the point that the think, certainly from the YouGov research, what sales process—which eventually ended up in actually happened was savers became very anxious, nationalisation but we did not know it was going to simply because they could not find out from the end up in that way—could have been badly institution what was going on. I think also Northern damaged. At that point in time, we were asked by Rock made a bit of an error itself in the way that it people at the highest level if we would restrain disseminated the information. They put out an ourselves from publication because it was felt we announcement to the Stock Exchange which was in might cause a second run on the institution. At that language which most ordinary people found point in time, everybody knew what the insurance impenetrable, and the piece about the Bank of situation was, that their deposits were safe and those England was on page two and in very technical who had wanted to get their deposits out had done language. It is not surprising to me, in those so, but we still did not want to cause a problem circumstances, that people got anxious, and when which might prevent it from being rescued if there they turned up at the branch and saw these queues was a rescue in the process, so we did hold oV on that they thought actually the sensible thing to do in these story. We were asked at the highest level to do so, so circumstances was to play safe and ask for their we did show some self-restraint. That really fits in money back. I think the Governor of the Bank of with what my colleagues have been saying, which is England said to you that he also thought that was a we do not run things out of spite or because we do rational reaction. I think the other important point, not like an institution, we carefully check what we which has been alluded to by my colleagues, is that are doing, we double-check with sources. When we what led to the collapse of Northern Rock was not check with those sources and they come back with an the retail run, it was the wholesale run: it was the overwhelming case, as they did on this occasion, institutions refusing to fund this bank. Northern about a potential problem if we run the story, we Rock, frankly, would have collapsed, it would be think very carefully about it before we do so. where it is today, irrespective of whether there had Mr Barber: Just for the record, I took a diVerent been that retail run. It was plainly a big story at the view on that matter and we did publish the time that the money was being withdrawn by retail document, or parts of that document, and investors, but that was not what did for Northern Blackstone, the financial advisers to Northern Rock, Rock. took us to court and sought a High Court injunction— Q1511 Mr Breed: Did you think that the filming of Mr Brummer: I think we might be talking about two the queues outside the branches, for very legitimate V di erent documents. We did publish the first reasons, added to the sense of panic? document after you had given us the privilege of Mr Peston: I think this is a very delicate issue, is it publishing it first. I am referring to a second not? It was very diYcult for broadcasters, and we are document which related to an emergency process at not the only broadcaster, not to show those queues. Northern Rock to close the bank down which we did I think it is also unarguably the case that pictures of not run. the queues did reinforce the concern—of course they did. Q1510 Mr Breed: Mr Peston, rightly or wrongly, were you responsible for the run on Northern Rock? Q1512 Mr Breed: With the benefit of hindsight, Mr Peston: I have obviously given a lot of thought to looking back at your actual report and the filming this and the answer is, no. Alex and I agree on most and what subsequently happened, would you have things; we do not agree on the tone of my broadcast done anything diVerent? that evening. I have obviously reviewed it a few Mr Peston: I think it is very diYcult. In my times, and I do not think it was excitable, but the broadcast, for example, I not only referred to deposit more material point is this. There are two points protection, I also said the fact that the Bank of really. There were structural reasons why Northern England was lending this money to Northern Rock Rock was more prone to a retail run than most meant that the immediate danger of a collapse due banks. As you know, it had kept its number of to a shortage of liquidity, a shortage of funding, was branches to an absolute minimum; it was obsessed gone. I said that I did not think this bank would now with controlling costs. It had 50 branches and it had collapse, as it were, but it did not stop people getting something like 1.3 million savers. You are probably very anxious, because, of course, we had not seen a aware that YouGov did an opinion poll, a survey, of bank rescued in this way by the Bank of England, what people who banked with Northern Rock not within people’s living memory, as it were, so of thought in the hours after we broadcast. Most of course it caused anxiety. I think what was striking them thought: this is an interesting story, this is a big was the behaviour of Bradford and Bingley, which I story, it plainly is a matter of concern, we want to think Richard Pym talked to you about when he find out more, and they went to the website and, came to see you more or less a year later, as it were, because there was not suYcient server capacity, the when they were faced with a similar report in the website kept crashing, which caused them a degree of newspapers about problems, and what they then did Processed: 25-03-2009 22:12:50 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG10

Treasury Committee: Evidence Ev 201

4 February 2009 Mr Alex Brummer, Mr Lionel Barber, Mr Robert Peston, Mr Simon Jenkins and Mr Jeff Randall was they flooded their branches with staV, they made You were asking about pulling stories. There was an sure they had appropriate server capacity, they made occasion with, in fact, Bradford and Bingley where a sure that information was available and, even couple of our regional oYces said that they had though a lot of people over a particularly important pictures of people queuing to get their money out of weekend tried to get their money out, there were no Bradford and Bingley, and we did not run them queues because they had learned, in a sense, from the because we checked with the institution and we then structural failings of Northern Rock. Of course, checked back whether this was genuinely evidence of there are always lessons for the media, and we have a run or just not enough people turning up on the thought about them long and hard, but there are also day. It turned out that this was not a run but simple lessons for banks about how to deal with these sorts ineYciency on Bradford and Bingley’s part. For of crises. whatever reason, they had not had enough people in the branches, and so of course we did not run those Q1513 Chairman: Therefore would a delay have pictures, but also there were enough checks and allowed Northern Rock to get its business in order balances in place to make sure that the checks were more so that it would had the additional Internet made before the pictures went out. Let us be clear, we capacity, it would have had extra staV in the just do not run anything in a sort of thoughtless, branches? “Let us get it out because it looks like a good story” Mr Peston: I did not know that they did not have kind of way. It is just not our approach. enough server capacity. How could I have known Mr Jenkins: I once thought it would be a good idea if until it was tested, as it were, and, I will be honest newspapers published every year the stories they had with you, it maybe was a failing on my part but, of not published, just to show how responsible they had course, it was only after the event that I realised the been, to persuade you that sometimes we do not weakness for Northern Rock of having so few publish things because we have been responsible. branches relative to the number of their customers. That would be inherently ludicrous. If I may say so, So it is a sort of hypothetical question which is I think Northern Rock is a bad example of the thesis impossible to answer. you are trying to establish. This was a dud bank and Mr Randall: On that point, Mr McFall, the idea that I think to tell newspapers not to say it is a dud bank somehow a delay would have given Northern Rock any stage would have been ridiculous. I personally breathing space, the problem for Northern Rock think much more serious was the predicament that was its management was in denial. I remember very many financial journalists found themselves in over well the day after Robert’s report all hell had broken RBS, Barclays, Lloyd’s, Bradford and Bingley, lose. Up on the website was a message, which was where it was fairly clear the Government, knowing intended to be comforting, which said, “Do not it was about to acquire large chunks of these banks, worry”, the phrase was something like, “this is a well were, I sense, using the press to force down the share run bank.” Well, clearly, by then it was an insult to price. There you have ministers and oYcials de facto the public’s intelligence. So I do not think giving insider trading, using journalists to that end. It Northern Rock 24 hours or 48 hours would have relates to what Mr Fallon was asking earlier, but he saved it. did not go that far. I would like to know from internal government sources how far they Q1514 Chairman: I saw that very same message, investigated subsequently who was leaking and for because about 20 or 30 people rang me at my home what purpose, because it was clearly designed to rig and I went onto the website as well. the market, in my view. Mr Barber: Two very quick comments. First of all, the queues actually came after the Government’s Q1517 Nick Ainger: Let us talk about the story that oYcial response, not after the broadcast from the was not told, and that is the run up to this crisis. Will BBC. The second point is that naturally people were Hutton has said of journalists, “We lost our senses, concerned because the Government was not able to all of us journalists and politicians. We suspended immediately answer the extent of support our judgment and we are paying a big, big price. The guarantees for people’s deposits. reporters were guilty of accepting what the business community told them in a way that would not Q1515 John Mann: Was the panic worse because it happen when reporting on other issues.” Alan was the BBC that broke the story, Mr Peston? Rusbrider, in his submission to us, also highlights Mr Peston: I genuinely do not know. I think it is this issue, and he said that the media failed to spot very unlikely. the cracks in the financial system because too many business journalists were fixated on the stock rather Q1516 John Mann: You talk about thinking long than the debt market. Simon, from your perspective, and hard in the aftermath, but considering the would you agree with your colleagues Will and BBC’s special status as a public service broadcaster, Alan? what conclusions have the BBC drawn about the Mr Jenkins: I am a bit suspicious, when all the appropriateness of your rules for business reporting? policemen and all the monitors have failed, that they Mr Peston: I do think that the rules that we followed turn round and blame the press for not helping them before and subsequently are pretty demanding out. It just does not wash, I do not think. There are actually. We did learn, obviously, the power of plenty of journalists who were saying something was images on the public mood, and there was an going wrong here and they have been quite willing to example actually, there was an occasion actually. come forward and say so, needless to say.I think that Processed: 25-03-2009 22:12:50 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG10

Ev 202 Treasury Committee: Evidence

4 February 2009 Mr Alex Brummer, Mr Lionel Barber, Mr Robert Peston, Mr Simon Jenkins and Mr Jeff Randall the more general point which Alan is making on that accept this but it lies in global imbalances, with note is true, and I say this as an outsider from this Americans not saving enough and China saving too world. I think there is extraordinary closeness much, but the crucial point here is that editors are between British business journalism in the City in prepared to put warning signs on company coverage the same way that there is extraordinary closeness on the front page if they think that things are going between British political journalism in Westminster, wrong—they certainly open up their op-ed page— and these are essentially unhealthy relationships but if we were to put stories which were warning which tend to lead to the sort of mishaps that you about worries or doubts about individual have described. I certainly felt in the unfolding of the companies’ business models, first of all, we would credit crunch that the relationship between the press, definitely have lawyers on our backs for wider commentaries, think-tanks in the City—the irresponsible journalism, pure speculation and, obsession with banking and bankers and bonuses second, we have a job to report what the and big money—has led them and us to neglect the governments are saying, what the banks are saying underlying strength or weaknesses of the economy about the state of health of the economy. If you and has led government into rescuing banks, remember, in 2005/2006 everybody thought the City splurging ludicrous sums of money on banks and yet of London was top of the world and I seem to fighting shy of nationalising them at the same time. remember certain politicians talking about I totally agree with the Chairman’s article on bank abolishing boom and bust. We put that on the front nationalisation. If you are going to nationalise a page too. bank, nationalise the bloody thing, do not just throw Mr Brummer: I think that what my colleagues say is money at it and say you are not quite nationalising. true, that there has been a lot of early reporting out there. In 2002, again, doing the same thing, blowing trumpets, I remember writing about Northern Rock Q1518 Nick Ainger: Let us go back again to the and securitisation in a very sceptical way. For the period before Northern Rock. Robert has said that V privilege of doing that I almost got my head beaten he felt in 2003, and he wrote an article to that e ect, up by Adam Applegarth, but we got through that that this was a bank with a flawed business plan, but moment quite well. The truth is that The Daily Mail he seemed to be on his own then. Were not other throughout this period was ridiculed in Private Eye journalists thinking the same thing or was it the on a regular basis for predicting that house prices climate at the time, where we had apparently steady would crash. It became a running joke. So there were economic growth. There was lots of credit available warnings out there all the time. I think if there was for anybody who wanted it, there were high levels of a failing, the failing was that people like myself, city employment and for any journalist to say, “Look V editors, did not really push these stories hard enough out, we are headed for the cli ”, their editors would into the rest of the paper. Some of us could see what not have published, would they? was happening. We were writing about warnings Mr Barber: Who can say nonsense first! issued by Bank for International Settlements in Mr Randall: At the risk of blowing my own trumpet, Basle, who were very good on this subject, some of if you care to look at the BBC website, in December the Bank of England’s financial stability reports 2003 I wrote about excessive debt; in 2004 I was were quite predictive in this area, and there are whole beginning to bore my colleagues: people thought areas outside the cash markets, which we all follow, that I was a doomster, I was dismissed as someone the share markets themselves and the derivatives who had a grudge against the Government, someone markets, which were ballooning, which we did not who was talking Britain down; in May 2006 I wrote really get to grips with very well in a way which was a piece for the Daily Telegraph which said, “Ten understandable to our reader. The other thing to reasons why it is all going to go horribly wrong”, and remember is that business journalists are in a very I included in that issues such as US debt, public unfair competition. We are individuals working finances out of control, house prices detached from against some of the richest organisations in the reality, et cetera. Once again, I can remember the world with some of the most powerful critics of the Daily Telegraph saying this was just a communications experts working for them. Young journalist with a grudge against the Government. It financial journalists in that situation, some of them is not true. It is not just me—I recommend you read recovering a situation, found that very diYcult. Fantasy Island, written by Larry Elliot from The Mr Jenkins: By an extraordinary coincidence, you Guardian, who superbly disaggregated Britain’s have got all five journalists who predicted the credit problems, and he foretold things in a book that was crunch here. published at the beginning of 2007—plenty of journalists said, no, we have got to stop this. Martin Wolf from the FT likewise. Q1519 Nick Ainger: Are you the only five? That is Mr Barber: I hate to toot our own horn here, I was the point. not intending to oVer you a cut-rate subscription to Mr Jenkins: If you wanted the serious root of the the FT, but if you had had the subscription you problem, it was the housing market. That is what I would have seen, at least three years ago Gillian Tett, read about. This was going to bust and there was no the capital markets editor, specifically warning purchase in writing that story other than doing it about the risks in credit derivatives. These are the over and over again in a political community. You sophisticated financial instruments which are in part were hyping up the housing market like there was no to blame for the problem. Second, Martin Wolf tomorrow. alluded to part of the problem. The Chinese do not Chairman: We have to move on, Mark. Processed: 25-03-2009 22:12:50 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG10

Treasury Committee: Evidence Ev 203

4 February 2009 Mr Alex Brummer, Mr Lionel Barber, Mr Robert Peston, Mr Simon Jenkins and Mr Jeff Randall

Q1520 Mr Todd: Mr Barber, you have produced for Q1523 Mr Todd: So to the outside person, how do us a perhaps rather high-minded defence of the role they make their judgment in understanding the of the media in oiling the financial markets and profusion of information that is presented to them, improving information flow. Perhaps you could set other than, as I was suggesting, looking at brand that into a real world environment of competition names they trust and trying to work out that that is within the media, the inevitable potential coarsening something worth listening to and that is not? of communication that that will bring, particularly Mr Barber: It is all down to the brand. with the lowering of barrier to entry in the light of comments. It is now readily available on the web— Q1524 John Thurso: Simon Jenkins, can I come back Robert’s own blogs which are produced presumably to something you said earlier firstly. I have had a lot at the minute. It sounded to me like the kind of of emails from small shareholders in Bradford and document that might have been written 20 years ago Bingley who are complaining at the role of the media in the FT that I knew well then but perhaps was in reporting it and the diminution in value and likely harder to place in the real world of a competitive compensation that they are going to get. We had environment in which everyone has their say and Richard Pym in to give evidence to us and one of you are competing for a tiny bit of space in the things he said was, “We saw Robert Peston’s blog at public mind. 4.50 and at that point we realised things were not Mr Barber: Mr Todd, I will try not to sound too looking good.” Basically that was quite a factor. You high-minded. I would agree with you when you said that you think the Government were point out that the market for business and financial manipulating the share prices of the banks that were information has been transformed by the Internet their targets. Are you really telling us that the and the lowered barriers to entry. Paradoxically, Government or the Treasury had that level of business journalism has gone mainstream. Many of confidence? the newspapers have actually expanded their Mr Jenkins: Firstly I was borrowing a phrase from business coverage and financial coverage, and if Mr Fallon “it is said that” or “it has been heard there was ever a story which was technical and which that”. Secondly, I do think they have that level of has gone mainstream, it is the credit crunch— confidence, yes. Insider trading is as old as the hills. enormous amounts of space have been devoted to You do not normally expect it of government when it—but your real point—is it true that the quality of dealing with ordinary people’s money, shareholders journalism in this country or elsewhere has been and banks. I am only repeating what is said. I think compromised by lowered barriers to entry—the rise it is a line of inquiry you might care to follow up with of blogs, the fact that we now live in a 24-hour news government, but quite clearly there was a massive cycle, I would argue that, yes, it has increased interest to the taxpayer in suppressing the price of competition, but from my own personal experience these shares and the price of the shares duly fell. It of the Financial Times, we have entered that area. We fell following information in newspapers, and on have a financial blog, Alphaville—that was the one broadcasts and blogs, that the Government was that broke the story about the Northern Rock going to be intervening or the share price was going prospectus—but we apply the same standards in to collapse. You do not have to put two and two together and make too much to realise what could terms of quality as any print advertiser. have been happening and what does normally happen anyway when people are manipulating bear Q1521 Mr Todd: What this becomes, therefore, is the markets. It would be almost odd for the test of the strength of a brand, since the multiplicity Government not to have done it, but I think it would of sources that are available to people is challenging. be unethical. How far the journalists involved with Mr Barber: Exactly, Mr Todd. The fact is if you that were knowingly being used in that way I just do publish wrong information and you are in the not know. financial journalism business, you will be out of business because the brand is absolutely critical. Q1525 John Thurso: I am happy to believe they made a mammoth cock up, because I think that pretty well explains the universe, but do any of the Q1522 Mr Todd: The other bit of reality intruding on others here really think that this was a semi- your high-minded model is the resourcing of the deliberate act by the Government? communicators whom you were dealing with. That Mr Peston: Since it was, in the case of Royal Bank was the point that Mr Jenkins made. These are of Scotland and HBOS, my blog and my Radio Four people who have highly paid advisers supporting broadcast that led to the dramatic falls in share them in their communication, and understanding prices, and I know the history of how I got that story, their motivations as to why they might be wishing to I absolutely do not believe, for what it is worth, that tell you certain things and not other things is part of there was any conspiracy here and that I was, in a the challenge which, again, I think is sharper now sense, an instrument of manipulation, but, again, it than it was a few years back? is also important to think about the economic Mr Barber: It is certainly tougher in the current substance. It was a fact that these banks needed recession, and the structural challenge which I capital and, therefore, the share price was wrong. referred to in terms of the Internet and the lower When I put in the public domain that the banks barriers to entry plus the decline in print advertising needed capital, of course the share price fell. The certainly is challenging the newspapers today. notion that this was a false market is crazy. In fact, Processed: 25-03-2009 22:12:50 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG10

Ev 204 Treasury Committee: Evidence

4 February 2009 Mr Alex Brummer, Mr Lionel Barber, Mr Robert Peston, Mr Simon Jenkins and Mr Jeff Randall what then happened was the correct price was country: people were allowed to go along in this established because the information was then in the stupor believing that ever more debt would be okay, market place. Whether that had come from me or borrowing up to the gills would be all right; nobody whether it had been divulged at a later stage, the rang the bells, or too few of us rang the bells. So I share price would have fallen and the subscription think we would be doing our readers and ergo the price would have been what the subscription price public a disservice if we did not get right to the heart turned out to be irrespective of where I got my of the matter, and, let us face it, Britain’s economic information from and who I talked to. I also just and financial woes are very severe. think it is to misunderstand the nature of the market John Thurso: I absolutely agree with that, and process to somehow believe that the Government completely agree that what we need is for that to be got a better deal as a result of the fact that, as it properly reported. Is there not a danger, however, happens, I put the information into the public that you swing the pendulum too far and that as we domain. start to get to better things that does not get reported Mr Brummer: I would say that almost the opposite which lengthens the time we are in recession? is probably the case, because every time the share price fell it meant that the Government was going to Q1527 Chairman: Robert, you can answer that have to put in more capital in some way or other, before moving on. Why on the BBC News behind provide more support, so it had no interest in getting the news reader is the graph always going down? those shares prices down. The moment that Mr Peston: As I understand it, that has now Lehman’s failed it was absolutely clear, and it was changed, but it did go down for a bit because it went clear not to us on this table but to experts, the short- down for a bit. I think the absolute imperative for us sellers, the people who study the balance sheets of and all the media is to give people the information these banks, that these banks were in deep, deep that they need to make judgments about their lives, trouble, that they had far too much toxic debt on their investments, their savings, their jobs and all the their balance sheets and the markets had frozen over rest of it, as it were, and some of the news will not be and they were going to need assistance. It was not the particularly cheery. At the moment what I am Government creating that atmosphere, it was a spending a huge amount of time thinking about is reality check to what had been going on over the what are, to use the controversial phrase, green previous months, and that is what caused those share shoots? What are the things which would tell us that prices to fall. we are over the worst? What are the indicators? Also, what kind of an economy are we going to be in as and Q1526 John Thurso: Let me ask you a completely when we are through this particular acute crisis, diVerent question, if I may. We have been talking because I think there is a hunger to know what 2010, very much about the past. Can I turn you towards 2011 and onwards will be like. I and rest of my the future? There was an interesting article in one of colleagues at the BBC are devoting a huge amount papers that said the reversal of the old saying that of time to all of that and certainly we are minded that good news is no news, that actually there is so much we do not want to tell a monotonous, gloomy story. bad news now that good news is news worthy. What What we want to do is give people the information should be the role of the media for the future? Is that is useful to them. Lionel is right: we cannot there an onus now on the media to help restore pretend everything is tickety-boo when it is not, but confidence by restoring the balance of good news similarly we do not want to have one rather gloomy and not to peddle doom and gloom, as it were? theme—of course not. Mr Barber: I do not think if we put happy talk on the front page it is either going to be good commercially Q1528 Sir Peter Viggers: Lionel Barber, you have or editorially. This just does not make any sense. We described the trouble you have taken to check have to tell it the way we see it using multiple sources, sources and accuracy, but Richard Lambert, the and there is no way of hiding the fact that this Director of the CBI, at a speech in December, was country is going to have a very tough year at least. quite critical of some journalism. He said that The economy is in recession, we have just come oV, unsubstantiated rumours were passed on, editors as Simon has mentioned, a huge credit boom where should do more to kick the tyres on unsourced everybody thought they could get wealthy quickly quotes, should be doubly certain about the accuracy on the back of rising house prices. We have a and quality of the work they are reporting. Who do correction and it is going to be paid for, and The you think he had in mind? Are you concerned about Financial Times is not going to say everything is fine unsubstantiated rumours or unattributable stories when it obviously is not, but we will try and have the being passed on by other people? odd humorous story to perhaps temper what will be Mr Barber: As a former editor of The Financial a very gloomy year. Times—. I hope Richard Lambert is not resigning Mr Randall: I agree whole-heartedly. It is not the job from the Financial Times! of broadcasters or newspapers, certainly not their news sections, to jolly along the public. Our job is to Q1529 Mr Todd: I am sure it will happen. tell them what is going on. You could argue the Mr Barber: He made, I think, two very salient reverse, but it would be a dereliction of duty if we points. The first is the use of anonymous quotes, sprayed them in solar, in happy juice, and say, “You negative quotes, from analysts or bankers regarding carry on as it was, old son.” In fact you can argue for companies. These can be very damaging and, too long that was the prevailing sentiment in this therefore, we at the FT at least are very careful in Processed: 25-03-2009 22:12:50 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG10

Treasury Committee: Evidence Ev 205

4 February 2009 Mr Alex Brummer, Mr Lionel Barber, Mr Robert Peston, Mr Simon Jenkins and Mr Jeff Randall how we use those quotes because we know they can talking to the chief executive of some of the banks. aVect share prices. They are a matter of opinion. We When you say to them at the end of the are not saying we would not use them, but we need conversation, “Would you be willing to put that to know who they are and why they are making those onto the record?”, they always say, no, they are comments. The second point is (and I think this unwilling to put their necks out there. It is part of the pertains particularly to the crisis) we were very philosophy under which they work. So it is very careful to avoid using the word “panic”. We only diYcult. Going back to the original Richard used it twice. Once was in late September when Lambert article, I make two points about it, and essentially Wall Street was melting down and you think I made these in print, so it is not a great secret. could see the share prices had crashed through the The first point I would make is that he talked about floor, and so we thought that was justified in a his cleaning lady, I think it was, who came into the headline, but we do not use words like that that are oYce in tears because she had read of the problems emotive, that can clearly have a very destabilising at the Bradford and Bingley. She would have been in eVect on markets, especially if they are written in a even more tears had she not known about those paper like The Financial Times. problems in the Bradford and Bingley and had not had the good sense to move her deposit or get her Q1530 Sir Peter Viggers: How much pressure do you investment out at that point. Secondly, Richard is a put on sources to give their names? great journalist, he was a great editor of the FT, but Mr Randall: I do not put any pressure on sources to I thought it ill-behoved him early on in this crisis as give their names. It is up to them, but what I do is the Director General of the CBI to talk about Britain weigh up their credibility and their integrity. I was as a banana republic. That kind of made what he once taught at journalism school that there is no said subsequently slightly less relevant to this crisis, disclosure without motivation. So when people I think. disclose something to me I try to work out what that motivation could be, and if they are happy go on the Q1533 Sir Peter Viggers: There is quite a well record, then so be it, and if they are not I weigh up structured financial journalist profession handing why they are not happy to go on the record. out press releases and information to journalists. Do some journalists take that undigested and print it? Is Q1531 Sir Peter Viggers: Simon Jenkins, as a former that a criticism that should be levied? editor, should editors be doing more to stamp out the Mr Brummer: Going back to what I was saying publication of stories with unattributed sources? slightly earlier, I think that most of the financial Mr Jenkins: It is a hot debate. The New York Times journalists operating on desks at national had and may still have a rule that negative newspapers today were not around during the last unattributed quotes are never used, at least in financial crisis of any kind of any seriousness. I, quotation marks—that may be a subtle fortunately, or unfortunately because I am getting distinction—for the very good reason that quite old now, was around during the nineteen journalists can simply make them up, and it is a seventies when we had a huge financial crisis, a UK convention in this place that journalists do use financial crisis, which saw dozens of banks go under, derogatory unattributable quotations because it is a huge banking rescue and so on, so I have seen it all assumed that men of honour at Westminster would before, but I think a lot of the people who are never dream of making it up. You can pull the other working in financial oYces at the moment have only one, is what I say. We did sort of try at The Times to seen boom times, and they took the press releases abolish that particular journalistic style. I just think that they saw, they took the briefings they got, they it is hugely risky. You jeopardise your relationship went to the press conference and listened to the with the reader. The reader does not necessarily bullish talk. Right up to the very end some of the believe it when you have got “A leading Whitehall or bankers were talking in the most bullish terms about City source said yesterday . . .” Who was it, you recovery, about the famous ABN AMRO takeover want to know? Why is he not prepared to give his by Royal Bank, which destroyed Royal Bank of name? There must be a reason. In that case put the Scotland. Even at the press conference in 2008 they reason in print. But if you are using this, I think, were still boasting about how much income they highly damaging journalistic technique of an would get out of that takeover. People just took it anonymous quote from someone which is damaging down and wrote it because the bankers were someone else, I think you have a real obligation to believed, and I think a lot more scepticism is your reader to be extremely explicit as to why you are required. not giving the source. Mr Barber: One of the very important aspects of this crisis involves the opaqueness of the banking system. Q1532 Sir Peter Viggers: Mr Brummer, do you think We know about the shadow banking system oV the rules should be changed about attribution? balance sheet vehicles. This was a very, very diYcult Mr Brummer: I do not think they can be changed, aspect of the financial system for journalists to because I think if you are operating in the area we report on. There was very little information work in, in financial journalism in particular, available. It was not even available in annual economic journalism, I just do not think there are reports, financial institutions and when we first people out there, particularly senior people. It is became aware of this problem and the risks quite interesting, because everyone assumes that you associated, we tried to talk to people. None of them are talking to junior oYcials, but you could be would talk. Eventually Gillian Tett, who was one of Processed: 25-03-2009 22:12:50 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG10

Ev 206 Treasury Committee: Evidence

4 February 2009 Mr Alex Brummer, Mr Lionel Barber, Mr Robert Peston, Mr Simon Jenkins and Mr Jeff Randall the early warners of what was going on, had to Q1538 Mr Mudie: Lionel, every person from the publish information based on emails on the Governor of the Bank of England, the Chairman of condition that those people were warning about the the FSA, everybody has come before us and pointed risks in structured investment vehicles, in credit out some article they wrote in 2006 or 2004 et cetera, derivatives that they would not be named or even and said, “I told you, I warned you”. In Alex’s book have their firms or associations mentioned. he actually brings it up to date and says the question to the Governor of the Bank of England is, “Why Q1534 Chairman: JeV, maybe you could answer this. didn’t you do something about it instead of just I asked the Vice-Chairman of KPMG when he came making speeches?”. The same to the press: you are before us if he took HSBC’s annual report and sat key and you have more information than we have. with it one night, at the end of the night would he Why could you not bring forward the story? understand it, and he said no.1 Where would we be Mr Barber: I want to just go on record as if we had got a situation like that? What do we do? congratulating Robert Peston for his scoop. The fact What is the recommendation for going forward if the is we did raise questions but we were not in the best brains cannot understand? business of trying to drive Northern Rock out of Mr Randall: Chairman, I think it is pretty clear that business. the sources of this credit crunch are twofold: too much debt and not enough information, and, Q1539 Mr Mudie: Just let me ask this question. frankly, Lionel is correct, the banks did not put out When Northern Rock broke it was like pulling teeth there the information that everybody needed, not with the Governor, it was like pulling teeth with the just the financial press but their own investors, their FSA, and one particular part was that we could not own employees. They did not know what was going understand why he had not pursued a deal with on and, I suspect, right up to the very top, people did Lloyds TSB. Alex spells it out now in his book. The not understand what was going on. I believe you will way we were dismissed by the press I thought we be talking to the former chief executives of Royal were wide of the mark, but now Alex spells it out in Bank of Scotland next week. It should be show time. his very good book The Crunch that everybody I will be tuning in and I hope you ask him that should buy. Months later, when we have taken all question. Did he understand what was going on with this abuse and senior figures have said things that all this fancy whizzy stuV? were not exactly helpful, have withheld information, Chairman: Okay, thanks, JeV. George? it is now history and none of you seems to have been able to put it together. Q1535 Mr Mudie: Just following on the same point Mr Randall: The trigger, Mr Mudie, was in the with Lionel, I am not angry at Robert. I think he did summer when the wholesale markets froze over, his job and I really am sad to hear that the Financial literally. Times and the Daily Mail had these rumours for months, you said, Lionel. You have accurately—and Q1540 Mr Mudie: I know that. Even our milkman Alex Brummer in his book described the parts that knows that now. led to the crisis that hit Northern Rock. You had all Mr Barber: Yes, but that is the point. People were that story and you could not bring it home. Do you asking why we did not do anything in January. not kick yourself that Robert got the scoop and you Mr Randall: Mr Mudie, with all due respect, I do not could not put the pieces together and get a story that think you realise how hard it is sometimes to nail would have saved a lot of people a lot of heartbreak? down the truth, given that we have a huge industry Mr Barber: Mr Mudie, we do not— out there which is generating huge numbers of fees to distort the truth. Can I just tell you something? This is how tough it is. On 8 October last year the Q1536 Mr Mudie: If you are going to be rude it is Daily Telegraph ran a front-page story saying that as Mr Ainger. part of the Royal Bank of Scotland rescue its Chief Mr Barber: I will try and remember that. Executive, Fred Goodwin, would go, the Chairman, Tom McKillop, would go, they had been replaced by Q1537 Nick Ainger: So will I. Stephen Hester and Philip Hampton. The day that Mr Barber: The point is we were being responsible. that came out RBS issued an on-the-record denial, We were not just reporting rumours. Gillian Tett, in called the proprietors of the Daily Telegraph her column, written the day after Northern Rock demanding an apology and Alistair Darling, in front received some, in retrospect, worthless City banking of the cameras, also denied it. Five days later it was award for being the best bank of the year, actually true, so when you say why do we not nail down the wrote a column raising serious questions about the truth, sometimes we have to rely on people in business model of Northern Rock, but that is not the positions of seniority to tell us the truth. same as saying, “Northern Rock is in trouble. The shares will go down. It may go bankrupt”. I can Q1541 Mr Mudie: I accept that. Being in Parliament assure you the writ would have been on my desk the 16 years you understand how hard it is to get to the next day. We could not do that. truth on anything, but The Sunday Times get a rumour about the Lords and bad behaviour, The 1 Note by KPMG: Mr Nelson replied “It is not a book you would read cover to cover—it is not a book—but if you have Sunday Times take action and The Sunday Times ran an interest in particular aspects it is quite a good dictionary a very important story that brought it all to a head to look in.” (Q1198) and we can do something about it. This story is key, Processed: 25-03-2009 22:12:50 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG10

Treasury Committee: Evidence Ev 207

4 February 2009 Mr Alex Brummer, Mr Lionel Barber, Mr Robert Peston, Mr Simon Jenkins and Mr Jeff Randall this story is front-page, a knighthood in it for Q1545 Jim Cousins: Allegedly. breaking it and you do not bring it home. You have Mr Brummer: Allegedly. But what we always think all the parts. Were you afraid of legal action? about when we are writing on our financial pages Mr Barber: No, we are certainly not afraid of legal and across the paper is not the big battalion City action. In fact, I have got a record of all the libel suits investors who Lionel’s paper obviously has to think that have been threatened by well-heeled Russian about much more carefully. We are always thinking oligarchs with City law firms being paid huge about private investors, depositors, ordinary people amounts of money trying to intimidate the Financial and their money. I think that their interests have Times and other publications from publishing the been very ill-served throughout all of this period. kind of information that you are talking about. The What we have tried to do as much as we can through fact is we did raise serious questions about Northern this period is alert those people, the vulnerable Rock and everything changed in the summer when people in our society, to what their rights are, how the wholesale markets froze over. they can recover their money if their money has been lost, and we all made a terrible mistake, all of the papers. We ran a “Best Buys” column. The Financial Q1542 Chairman: Simon’s point about the cosy Times ran it, we ran it, the Daily Telegraph ran it, relationship I think has reinforced what you said. which had Icelandic banks at the top of the “Best Mr Jenkins: Yes. I think it is slightly fruitless trying Buys”. We said that they oVered the best interest to search for whose fault it is that we did not know. rates. We all ran that table, produced by an Everybody has been taken completely by storm, if independent organisation which produced “Best not by surprise, by this. I do not think anybody Buys”, and we actually led some people into those comes out with clean fingers. We could just ask of “Best Buys”. As soon as we realised the mistake we you the same question you are asking of us, “What had made we removed all those influences, so we are have you been doing all this time?”. The answer is, trying to protect their interests as much as possible, we really did not know the full force of what was but I do not think that the bosses of the big banks about to be unleashed on us, and that is the truth of really cared a toot about widows and orphans. They the matter. It is sensible to ask, what do we do to never have done. As far as they were concerned what avoid it happening again? It is sensible for the press they cared about were their bonuses, their profits. to ask, was this like a war in retrospect? Should we The faster they drove those banks, the higher the have been more restrained than we were? I think on gearing they put into those balance sheets, the more the whole we could not have been because we just did profits that they produced the higher their bonuses not know at the time what it was going to be like. I went and it went right down the line. I think that was still think in retrospect I would not have done it any the purpose of those banks and I think that is what diVerently or had it done diVerently. we have now got to stop, and the widows and orphans did not come into this calculation for them at all. Q1543 Chairman: Since you have all been virtuous, the Committee produced a report on Northern Rock and that led the way in taking forward and you all Q1546 Jim Cousins: Mr Barber, I wonder if I could agreed on that. ask you, because you, I think, and I am slightly Mr Jenkins: We are all clean. misquoting you, used the term, “We do not use the Chairman: We are in the same camp as you, okay? word ‘panic’”, do you not think, and I am not inviting some discussion on how it occurred, after the run on Northern Rock in terms of how it was Q1544 Jim Cousins: The bosses of the big banks, portrayed both here and, of course, abroad, one of when they used to come in front of us, occasionally the main objectives of policy-makers and regulators used to use a phrase, “widows and orphans”, to has been at all costs to avoid a repetition of anything describe the savers whose savings they were using to like that in their own jurisdiction? promote their businesses and their lifestyles. I am Mr Barber: If that is true, Mr Cousins, then I would referring, of course, to the time before they all went ask you to place a call to Hank Paulson and ask him into internal exile on golf courses and grouse moors why he decided to let Lehman Brothers go down, and racing circuits. Mr Brummer, I wonder if I could given that many believe that intensified the ask you, because you, I think, were the first of the financial crisis. panel to make reference to this, do you think the so- called “widows and orphans”, as a result of the Q1547 Jim Cousins: Of course, Lehman Brothers financial events of the last 18 months or so and how was not a deposit-taking bank in the retail sense, the media have betrayed them, anticipating the and, of course, there were very powerful people in behaviour and the reaction of the people once the United States who still wanted to cling on to their described dismissively as “widows and orphans”, are belief in moral hazard. That is true too, is it not? now a very significant market force in their own Mr Barber: Yes, but, Mr Cousins, the fact is that right? Lehman Brothers was such an important player in Mr Brummer: I think this is a very fundamental the wholesale market, it was hugely more important question. I obviously work for a mid-market than little Northern Rock, and its demise is widely populace paper with a large number of widows and regarded by experts and policy-makers as being a orphans (I do not know about orphans but a lot of critical moment in this financial crisis which actually widows anyway) among other people. intensified the problem. Processed: 25-03-2009 22:12:50 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG10

Ev 208 Treasury Committee: Evidence

4 February 2009 Mr Alex Brummer, Mr Lionel Barber, Mr Robert Peston, Mr Simon Jenkins and Mr Jeff Randall

Q1548 Jim Cousins: It is absolutely correct that the The great advantage of what we do as business fall of Lehman Brothers— journalists, as opposed to what I used to do as a Mr Barber: I should point out, if I may, Mr Cousins, political editor, is that we deal in facts. We do not that, interestingly, after the attempt to find a private very often deal in views. So long as I am absolutely sector solution to Northern Rock there was a period confident that the facts are correct then I am happy of eerie calm for many months, and it was only in to broadcast or publish and that is what it comes late summer, in September, particularly with the down to. problems in the US housing market—Fannie Mae and Freddie Mac—and the demise of Lehman Q1551 Mr Todd: High-minded twaddle! Brothers, that the crisis went into a much more Mr Peston: No, it is not high-minded twaddle. serious phase. Mr Jenkins: A theatre critic can destroy a play. A gossip columnist can destroy a politician. As Robert Q1549 Jim Cousins: After the fall of Lehman says, it has got to be based on some sort of fact, but Brothers we then had the second-wave eVects on our no-one is pretending that journalists are not own banking system, and indeed, arguably, third- influential. They are highly influential, and so is wave eVects still lie ahead of us. I wonder if I could Robert. This is ridiculous. ask you, Mr Peston, because your stories led the Mr Peston: I am not saying I did not have an news media on not all but most of these key events— influence but what I am saying is that I take comfort Northern Rock, the fallout from Lehman Brothers, in whether or not what I am writing about is true the knock-on eVect of RBS, HBOS, you mentioned and, frankly, something that people have a right to them all yourself; indeed, your blog is called Peston’s know about. That is what it comes down to. If I feel Picks, if I can slightly remind you of the point that that people have a right to know that a bank they Mr Brummer made earlier, are you entirely thought was sound is not as sound as they thought comfortable with the fact that you are now a market it was, of course I am going to broadcast. force in your own right? Mr Peston: I am a journalist by vocation. Q1552 Jim Cousins: Mr Randall, I wonder if I could Occasionally I think I am going to grow up and do ask you then, do you think Mr Peston is just a a proper job and then I cannot think of anything I journalist like any other? would enjoy as much and therefore for 25 years all I Mr Randall: I think he is a master of his art. I doV have really done is think about how to get stories my cap to him. When you work for the BBC clearly that are going to be of interest and relevance to the you work for Britain’s most influential media readers or, these days, the viewers and listeners of the organisation. I say that as someone who used to organisation for which I work. Although, over a work for the BBC. Whether you like the BBC or not, period of many years, since long before I joined the its Ten O’Clock News on a good night will go out to BBC, have I noticed that some of my stories have six or seven million people. No other organisation in had an impact on, for example, share prices, these this country has that reach, so, yes, the BBC has things are in a sense peripheral. I am not saying they duties and obligations which bear down on it, but I are unimportant; of course they are important, but would say this. Just because the rest of us work for you cannot make a decision about whether or not to privately owned organisations I do not think we take do a story based on whether a share price is going to our duties and obligations any less seriously.We may move up and down, for example, so as far as possible have fewer viewers or listeners or readers but we take I simply screen out issues like what kind of influence them just as seriously. I am going to have and concentrate exclusively on working out whether a story is a genuine story, Q1553 Jim Cousins: So, where Mr Peston is getting the verification, getting multiple sourcing concerned, you are not telling us, “Thank you, Mr and all the rest of it. President, the BBC are waiting”, to relate to your own adverts? Q1550 Jim Cousins: Yes, but my question really was Mr Randall: Look: that was a smart piece of not about your motives; I do not challenge them. My marketing by Sky and it had a little dig in the ribs of question really is about the position you are now in the BBC. Surely you will allow us that. The fact is in terms of our own financial markets. There are that the BBC, of all organisations, is big enough and consequences, whether or not you intend them, ugly enough to take that little dig in the ribs. about the things you do and the things you say. You are a market force in your own right. People on your Q1554 Mr Love: Taking into account the discussion own blog tell you that. Are you comfortable with we have just had and whether Mr Peston moves that? markets or whether, as Mr Jenkins says, journalists Mr Peston: There are two things. One is that as an are influential, Mr Brummer, in response to the organisation we think about the social and economic speech by Richard Lambert on 7 December you consequences of everything we do, so it is part of our said, “It was not journalists who drove down the (ghastly phrase) “DNA”, as it were, and so of course price of HBOS shares on the fateful day of 17 I am comfortable in the sense that I think through September when it was forced into a merger with before I do anything what the possible implications Lloyds TSB but the short sellers”. Are you entirely are. The important point I would make though is innocent in all of that, and when I say “you” I do not this, and it sort of got lost in the conversation you mean the Daily Mail. I mean the journalist were having earlier about unattributable sources. profession in this country. Processed: 25-03-2009 22:12:50 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG10

Treasury Committee: Evidence Ev 209

4 February 2009 Mr Alex Brummer, Mr Lionel Barber, Mr Robert Peston, Mr Simon Jenkins and Mr Jeff Randall

Mr Brummer: Are we entirely innocent? Of course, would rather trust the mob, because it is more likely we are never innocent of anything. There is no doubt to be telling the truth, and the closer you get to the that in the period leading up to that date, if I have mob, and we are quite close to the mob, I frankly got the date right here; hopefully I did—17 believe we are more likely to be telling you the truth. September, we would have been asking questions, as If you wanted to sit here and ask the Chancellor of Robert would have been, as all the journalists on this the Exchequer all these questions I do not think you table would have been, about Halifax Bank of would get a very clear answer. I hope you are getting Scotland. There was a known weakness in the way slightly clearer answers from us. that bank was run, in its book, in its exposure to the mortgage market, and in particular its corporate loans, which we all knew about, so we will have Q1558 Mr Love: We had the hedge funds in front of reported on some of those problems, and indeed we us not so long ago and we did not get clear answers will have reported about some of its toxic debts and from them because as far as they are concerned they laid that out in the paper because we were getting are not into short selling in any major fashion at the numbers on a regular basis, so we may have fuelled present time. Mr Peston? a knowledge which the short sellers latched onto. I Mr Peston: I only want to draw on a point which I actually think the short sellers were almost certainly think has been slightly alluded to, which is that quite ahead of us in many ways. Many of them took out a lot of the information that gets disseminated which V their short positions months before we knew a ects share prices gets disseminated outside of the information about HBOS. If you go back to March established media. For example, when it came to of that year, 2008, I think some of the short positions rumours that were driving the share prices of a were set up. I have spent time with hedge funds, for number of these banks, that was information that instance, on this issue. I went to one hedge fund, was going from the internal Bloomberg, the email almost overlooking Buckingham Palace, actually, system, for example, from hedge fund to trader, from where they had an analyst who laid out to me over a trader to investment manager. There is a lot of luncheon the pecking order of banks which he information that gets circulated and drives share thought were in trouble. He was a brilliant analyst prices, that is, as I say, outside of the media we who had been through their credit books. He represent. actually understood what a synthetic CDO was, although I believe somebody from Credit Suisse Q1559 Mr Love: In a sense we have got the wrong came here and did not know what a synthetic end of the media before us today because you are at CDO was. the top of your game, if I can put it that way. You may well influence markets, but there is another Q1555 Nick Ainger: Deutschebank. whole set of media that will influence individuals and Mr Brummer: I do apologise to Credit Suisse. I am perhaps even City institutions. sure they are much better. Mr Peston: I am really talking about the City institutions. Obviously, there has been a lot of focus Q1556 Nick Ainger: It was just the Chairman. on the private investor blogs but there is also an Mr Brummer: Oh, it was only the Chairman. He had astonishing amount of information that gets been through the books and he laid it out. This guy transmitted from professionals in the City and these was absolutely right, the pecking order he had of are people controlling hundreds of millions of who would go first and in what order. Northern pounds and so there is, in a sense, a sort of rather Rock was already gone. It went Bradford and hidden dissemination of highly price-sensitive Bingley,Alliance & Leicester, HBOS, RBS. That was information that I know the FSA is trying to come the order and he was bang on the money and their to grips with, but the volume of this stuV is positions were out there on that piece of analysis. enormous and even for the FSA to find out who is They were doing the analysis which the regulator being told what and when is immensely diYcult. should have been doing, the Financial Services Authority, and never did. Q1560 Mr Love: Let me ask one final question. There is supposed to be a regulator for the media, the Q1557 Mr Love: Just taking that, if I can Press Complaints Authority. I will not ask you your characterise a phrase that Mr Jenkins used earlier opinion of it because I suspect that that will not take on, it is said that the media may unwittingly or us very far, but is there a need in this area, especially, wittingly have been used by the short sellers in if I can say, when the atmosphere in the City, indeed exactly the way you said to further their interests. Mr in financial institutions generally is very diVerent Jenkins, would you like to comment? between 2007 and today,for some basic regulation to Mr Jenkins: Mr Love, I just think this whole ensure that the panics, the crashes, the rushes that conversation is about an organic whole which is may well be out there do not happen because of called a market. At one end of the market is the slipshod comment or journalism? Chancellor of the Exchequer. At the other end of the Mr Barber: Absolutely not. We do not want market is a crowd running down the street statutory regulation. screaming, “Panic!”, and we are all part of that, including the press. If you are asking me would I rather trust the Chancellor of the Exchequer or the Q1561 Mr Love: I am not thinking about statutory mob running down the street shouting, “Panic!”, I regulation. Processed: 25-03-2009 22:12:50 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG10

Ev 210 Treasury Committee: Evidence

4 February 2009 Mr Alex Brummer, Mr Lionel Barber, Mr Robert Peston, Mr Simon Jenkins and Mr Jeff Randall

Mr Barber: I think you need to tread, if I may say so, pieces of this puzzle but I think nobody understood Mr Love, rather carefully in this area. Regulating the that the impact of this financial crisis on the press will not solve the problem. This is a matter of economy would be so severe. For that reason, yes, a catastrophe of management of risk. There were there will be a severe recession in this country. You failures in regulation. You should not be looking at are already seeing a severe recession in Europe and a the press as in any way responsible. There are things severe recession this week in Asia, and we do not that the media should do in terms of improving the know, frankly, how long this may last. What we do understanding of financial markets and also know is that banking is going to be a lot less understanding, for example, that five years ago the remunerative than it has been in the last five years. debt markets were a lot more important than the Mr Peston: For me the big unanswered question is equity markets, and that transferring resources and how a system of distributing risk, the securitisation having better training will help in the business that that you have heard so much about over the last year certainly the Financial Times is in, which is or so which was supposed to make the world a safer explaining what is happening. place, ended up making it a much more dangerous Mr Jenkins: If you are asking a diVerent question, place. One of the really shocking disclosures of the which is not statutory regulation but, “Is there a case past few months is that all those loans and risks that for an F-notice for finance?”, I think it is a good we thought the banks had sold to investment question, but all that would mean in these institutions all over the world, and Alan Greenspan circumstances is probably a telephone call from the told us that the sale of all this stuV meant that Governor of the Bank of England to an editor broadly we could be confident that we were in for saying, “Please lay oV this for five hours because we this period of remarkable unbroken prosperity, it are going to rescue this bank”. I think it would be an turns out remained on the banks’ balance sheets. It odd editor who would not at least take that call. raises questions about why the regulators did not There are gradations. The diVerence between editing know the stuV was still there. It raises questions and censorship is a fine one. I would not regard that about the policy of governments all over the world, as censorship; that is information. We are not and I have to say it also raises questions about deliberately trying to be irresponsible. If the whether there was fraud. For me that remains the big situation is explained, if the consequences of unanswered question. publicity are clear, then most journalists, I think, Mr Brummer: I think we have been through 1929, we would respond to that, but that is not statutory have had our crash. The markets have crashed, the regulation. banks have crashed. They have been saved, but the diVerence this time is that people have moved Q1562 Mr Love: No. It was not statutory regulation around the world to address some of these problems that I was talking about. What I was suggesting was very rapidly. We have poured money into the banks, that the press complaints regulation simply is not we have poured money into the credit markets, we regulation and we need it to be something agreed have had a big devaluation here in Britain of the with the industry that could at least give some pound, so actually we have taken a whole lot of reassurance that things are being dealt with properly. measures to ease the situation and I would not be Mr Jenkins: I do not think the case is proven for that. that surprised—and this is coming from an ace pessimist—if those famous Shriti Vadera “green Q1563 Chairman: We are moving on now. In shoots” began to pop up in places because we have response to Mr Mudie’s question, is it not the case done all that stuV. That must be the great hope, that that you have all done your bit but, like the we have learned the lessons of the 1930s and we have individual who discovered Elvis, you did not sign taken the right kinds of steps. What I do believe, and him up? You did not make the impression. It was left this is why I absolutely agree with Robert, is that it to Colonel Parker to take the initiative and make his would be nice to think that some of the people who name globally and give a glorious future for Elvis. In got us into this mess would be investigated and your last comments, each of you, how can you make prevented from working in the financial community your name globally and tell us what the real story is again in some way. Unfortunately, we do not seem to so that we can best inform our report? have a regulatory system in this country which is Mr Randall: Crikey! What you are saying is, where capable of bringing that discipline to the system and are we now? Is that it, a bit of crystal ball gazing? keeping them out from where they are at the moment. As far as journalism is concerned, all I Q1564 Chairman: Yes. would say is that, yes, it has been fantastically Mr Randall: Are you prepared for unrelenting complicated and I do think that we would all benefit, gloom? Personally, even now I do not think the however long we have been around, from a little bit general public understands the scale and the depth of more training and a bit more education on some of problems facing the British economy. Those of us these more complicated matters. If that means who have been saying this for some time I think have spending a week in the Bank of England, a week in been vindicated, the optimists have been the FSA and so on, just to improve that rounded confounded and I think we are going to go through education that we need in these products (of course, at least two years of economic misery. if we went to the FSA we might not learn anything), Mr Barber: I would like to engage in some Chinese it would be a good thing. self-criticism here and say that, yes, the Financial MrJenkins:Weareallinarealmwherefewofusknow Times and the journalists’ profession in general saw anything, so anything you say has an air of unreality Processed: 25-03-2009 22:12:50 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG10

Treasury Committee: Evidence Ev 211

4 February 2009 Mr Alex Brummer, Mr Lionel Barber, Mr Robert Peston, Mr Simon Jenkins and Mr Jeff Randall to it. I feel that when the history of this period is parliament and banks, bonuses and banks. Everyone written, and it will be written in hundreds of books, is obsessed with banks. They are bankrupt; they are doubtless by many people around this table now, the useless. Weshould be spending this money on the real most extraordinary thing will still be that once we saw economy, on stimulating demand and doing what a banking catastrophe on our hands we did not Keynes said we should do. We have saved and saved declare those banks bankrupt; we hurled £200 billion and saved and blown it on banks—crazy. of subsidy at them. Rather than spend that money on Chairman: The issue of responsible financial productive industry, maintaining demand and journalism was brought to our attention and that lending money direct to firms we simply wasted was the reason you were invited here today. I think stupefying amounts of money on banks. I have to say, the Committee have found that an excellent debate and I have said it before, I think the reason is that the and I think it will be hugely helpful to us. I think we entire leadership of the economic community is could say today that press freedom has ruled in this obsessed with banking. We have spent the whole room. I have just one announcement—Alex, your afternoon discussing banks, the press and banks, book will not be on sale as you go out of the door.

Witnesses: Mr Adrian Coles, Director General, Building Societies Association, Mr Iain Cornish, Chief Executive, Yorkshire Building Society, Mr Neville Richardson, Britannia Building Society and Mr Graham Beale, Chief Executive, Nationwide Building Society, gave evidence.

Q1565 Chairman: I am going to start, I do not know Q1567 Chairman: Welcome. We are starting early where Mr Richardson and Mr Cornish are but, because we are finishing at 4.55 sharply so could you Adrian, can you introduce yourself please and Mr introduce yourselves for the shorthand writer please. Beale. Mr Richardson: I am Neville Richardson, Chief Mr Coles: I am Adrian Coles. I am Director General Executive of Britannia Building Society. of the Building Societies Association which is the Mr Cornish: I am Iain Cornish, Chief Executive of representative body for all 55 building societies in Yorkshire Building Society. the UK. Mr Beale: Graham Beale, Chief Executive, Q1568 Nick Ainger: Practically all of the Nationwide Building Society. demutualised building societies have either gone belly-up, been nationalised or been taken over by another larger bank. What is your view? You were Q1566 Chairman: Welcome. We will finish at 4.55 on responding to the Chairman about what you the button so I want to get as much information out thought was positive about the building societies’ of you as possible before that. Adrian, building model, why do you think all those that demutualised societies are very diVerent creatures from banks. Do V have now either disappeared, been taken over or you believe that your di erences leave you better been nationalised? placed to weather the financial storm? Mr Coles: I would prefer to concentrate on the Mr Coles: Yes. The record so far shows that to be the positives of the mutual model rather than the case. Building societies have not, so far, needed any disadvantages of the demutualised model but I public support; no taxpayer support has been suppose to put some points forward on your necessary. The diYculties that have emerged in the question, I think it is the stock market inducement to building society sector have been sorted out by the deliver short-term returns, to concentrate solely on building societies and I think I would advance three the shareholder without looking after the customer reasons for why building societies have done better in a way that a mutual institution does, and the in the market over the last 18 months. They are incentive that there is if you want to deliver mutual, they are owned by their customers. They are shareholder returns of taking excessive risk that does not driven to increase shareholders’ returns and not exist in the mutual model. profitability and dividends. They are driven to increase customer service, and all the market Q1569 Nick Ainger: Has anybody else got a research that we have done shows our customer comment? service records are better than those of other Mr Beale: What I would add, and reinforce Adrian’s institutions. They are better trusted. They have comment, is that if you look at the plc model, the better levels of service, better value for money. They motivation there for the directors is to give the adopt a much lower risk model as well and that has shareholders a return, and to give that return they been a very prudent approach over the last 18 are eVectively motivated to take risk. Within the months. They are not allowed by legislation to do building society model, we are actually motivated to particular things that the banks have indulged in. do the opposite because there is no true risk capital They are not allowed to fund themselves big time in within the building society model and for a saver the wholesale markets. They are not allowed to trade who puts £10,000 with Nationwide or any other derivatives, currencies or commodities and I think building society they have every expectation that at that overall approach to business, reinforced by the end of the term of that deposit they will get their legislation, has stood them in very good stead over £10,000 back and the interest, and we have to run the the last 18 months or so. business accordingly. I think the motivation within Processed: 25-03-2009 22:12:50 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG10

Ev 212 Treasury Committee: Evidence

4 February 2009 Mr Adrian Coles, Mr Iain Cornish, Mr Neville Richardson and Mr Graham Beale the building society is to give an honest return and, Mr Cornish: Roughly we halved our new lending in fact, oVer honest rates to both savers and between 2007 and 2008, and there are a number of borrowers, and to try to get the balance between the reasons for that. We were obviously more cautious two we are not motivated to make additional profit ourselves in the context of our housing market where for a shareholder to take. house prices were falling by, as it turned out, about 15%. Although we make very little use of wholesale funding, we do have some wholesale funding and Q1570 Nick Ainger: Is there any risk, given the that became extremely constrained, and latterly in current climate we are in, that any of the existing the year we found ourselves competing for retail building societies would consider demutualising? funds with the Irish banks in particular but also, to Mr Coles: I think the attractions of demutualisation some extent, Northern Rock. There were a lot of are severely tarnished so it is highly unlikely that any pressures. I would also say there was not as much building society would like to demutualise but to say demand for mortgages. Potential borrowers and that it would never happen in any circumstances consumers themselves are being very cautious about would be a step too far. taking on new lending in this environment. Mr Cornish: You would have to win an overwhelming vote from your members and I cannot imagine the proposition we could put to them that Q1574 Mr Breed: Was much of that new lending would make them vote that way. actually just refinance? Mr Cornish: Yes. I do not have the exact percentages but I would guess between two-thirds and three- Q1571 Nick Ainger: We have had submissions from quarters of it would have been refinanced, yes. the University of Manchester about the future for those banks which are currently nationalised, Bradford & Bingley, for example, Northern Rock, Q1575 Mr Breed: How concerned are you about the that perhaps the Government, rather than returning impact of competition, particularly with obviously them as a bank to the market, should consider the Government’s involvement in Northern Rock, mutualising them, any views? Lloyds, RBS and Bradford and Bingley? Mr Richardson: As a principle, it is a good principle. Mr Cornish: I am concerned about unfair The mutual model does work, it is focused entirely competition not competition per se. I would describe on customers and it has been proven to work. With it as a trickle rather than a flood but it is very galling my own society, Britannia, we remutualised the when you see money going back to Northern Rock Bristol and West business some years ago. There because they are perceived to be more guaranteed would be complications, clearly many complications than we are, or going back to Irish banks where there with doing exactly what you have said, but the is a diVerent guarantee. I think another aspect which principle behind it would clearly be a good idea. hinders us disproportionately to the banks is the Financial Services Compensation Scheme where we Q1572 Nick Ainger: Anybody else? are picking up a disproportionate amount of the bill Mr Cornish: I think that is right. Inevitably you relative to the failed institutions. would have to put capital into that business, the members would have a call and you would almost Q1576 Mr Breed: You were not particularly have to rule out the possibility of demutualisation impressed with the Government’s response in the alongside that because otherwise they could put Banking Bill to those of us who actually raised that capital into it and then the members could vote for with them in Committee stages? demutualisation and take that capital away again. Mr Cornish: No, maybe Adrian will know more about this than me, I think we have been very Q1573 Mr Breed: Mr Coles, can you give us an unimpressed with the response from Government overview as to how the new mortgage lending across having raised this issue. the building society sector has held up over the last Mr Coles: Yes, that is right. Just to add to the 12 months or so? competition point, clearly there is going to be more Mr Coles: New mortgage lending is well down in the intense competition from National Savings over the building society sector compared with 2006 and next year or so. The target for National Savings’ 2007. I cannot remember the exact figures, I would inflow has been increased from £4 billion to £11 guess around a 40% reduction in 2008 compared billion and that is going to have a significant impact with 2007. If you look at the most recent figures for on building societies in the very low interest rate net advances in the fourth quarter of 2008, the most environment we are in. Moving on to the Financial recent quarter we have got data for, these are very Services Compensation Scheme, we have raised small figures now so you can get a high market share issues about the recoveries process at Bradford and on a very small amount of business but building Bingley—who is going to get the money back first, societies took 62% of the market in the fourth the Government or the Compensation Scheme, and quarter. Recently building societies have been the therefore the people funding the Compensation main lenders in net terms if you take account of Scheme, and what is happening to the interest being repayments into the market, but they have certainly paid by Bradford and Bingley borrowers—which not been immune from the overall downturn in the have not been adequately answered by the market place. Government so far. Processed: 25-03-2009 22:12:50 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG10

Treasury Committee: Evidence Ev 213

4 February 2009 Mr Adrian Coles, Mr Iain Cornish, Mr Neville Richardson and Mr Graham Beale

Q1577 Mr Breed: When you say “not been because you need to hold high levels of liquidity in adequately answered”, have they been answered at uncertain times to reassure savers and some of it has all? gone to repay wholesale funds. Mr Coles: They have chosen to answer a series of questions that we have not put to them that cover Q1580 Mr Mudie: You have covered the field there less important issues. so I do not know which is which. What is the major driving force limiting mortgages? The Government have said they want it back to 2007 levels. I am not Q1578 Mr Breed: Finally,are you getting a fair crack sure it is wise in the housing field but certainly the of the whip in respect of the Government’s corporate field, yes. They say that so what is the initiatives, fair access to any of the Government’s main driving force stopping you? initiatives and interventions? Mr Beale: I think the most influential issue is a Mr Coles: I think most large building societies have restriction in the access to credit. If we go back to the been able to access the special liquidity scheme and pre-crisis days it was very easy in the UK to get a a number of medium sized building societies have loan of 100% of the value of the property or even instigated covered bond programmes as a result of more, and that included if you had some form of that scheme, so that has been good. Societies of any impaired credit history. Today if you do not have a size are eligible for the recapitalisation scheme and deposit of at least 15%, and if you do not have a the credit guarantee scheme so I think a fairish crack clean credit history, that access to credit is not of the whip. I think one area where we were slightly available. disappointed, I hope we never have to use it, the Asset Guarantee Scheme is available only to Q1581 Mr Mudie: So that means you have no institutions with assets above £25 billion, so that customers because they are broke? does seem to be discriminatory against smaller Mr Beale: What it means is that large segment of the institutions but, as I say, that is theoretical at the market pre-crisis, which was about a third of the moment. market place, today there is nobody with the risk Mr Beale: Can I pick up a point. In terms of access to appetite to lend to that category of borrower. the initiatives, I agree with Adrian that we have been given the access, however there are some complications with the legal structure that governs Q1582 Mr Mudie: Are you talking about yourself? Mr Beale: No, I am not because one of the building societies and in particular there is one diVerences in the way that building societies operate provision, which is section 9 of the Building Societies I would say is the issue about attitude to risk, we Act which we have been asking for amendment to have never lent 100% loan-to-value, we have never for a long, long time because it prevents a building lent excessive amounts. society being able to oVer a floating charge on its assets. Now you might say that is a very good thing, and generally I would agree with you, but in terms of Q1583 Mr Mudie: I am sorry, I am trying to be quick accessing things like some of the Government for the Chairman. One of the reasons why mortgages initiatives where you are exchanging your own assets could not be taken up, and I know of one or two for Treasury bills and then you need to swap instances personally, is that most building societies Treasury bills for a cash form, without being able to are doing 65% only, so you have to have a very, very oVer a floating charge that process of transforming a big deposit. Now that is a decision of the building society, is it not, so you may have customers wanting T-bill into cash, we are heavily restricted. So we have to take a mortgage but because you are imposing this ended up using a third party balance sheet to do that deposit requirement they are no longer customers or and we have now exhausted their capacity. There are they do not become customers. That is what I am constraints which we have raised. trying to get at. Are you scaring customers away by Chairman: Okay. I will tell you what you can do, your loan-to-value? because it is important to have this on the record, Mr Beale: We are oVering loans up to 85% loan-to- write to us after the Committee meeting and we will value. make sure we get those pieces of information conveyed. Q1584 Mr Mudie: 85%? Mr Beale: Yes. Q1579 Mr Mudie: You have said mortgages are down from 2007, is this policy on your part? Q1585 Mr Mudie: Say it loud because you are on Mr Coles: I think it reflects both policy on building television, you may get more customers. societies’ part to be more careful on who they lend Mr Beale: 85% loan-to-value and I think that is to, and the terms on which they lend. I think it sensible given the market conditions. reflects, as Iain said, the downturn in the mortgage market. It reflects the fall in house prices and the Q1586 Mr Mudie: I am not arguing with that. You expectation of further falls which is reducing the are 85% so you are 15% which is diVerent. I looked interest of borrowers. It reflects, also, the availability on the net and a couple were 65%, almost all the of funding. Building societies have been very mortgages were 65%. attractive to savers, lots of funds have come in but Mr Richardson: I have something to add to that not all of that money has gone into the mortgage because we too are 85% as well. The thing to add to market, some of it has gone in to increasing liquidity that is the fact that if somebody is a loyal customer Processed: 25-03-2009 22:12:50 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG10

Ev 214 Treasury Committee: Evidence

4 February 2009 Mr Adrian Coles, Mr Iain Cornish, Mr Neville Richardson and Mr Graham Beale of ours who is a current borrower who comes to Mr Coles: Building societies can only get 50% of replace a product and their loan-to-value now would their funding from wholesale markets, and the be much worse than that, we will replace the typical figure is 30%. product. So we will keep loyal to customers who Mr Beale: The disruption to the wholesale markets have been loyal to us. That has not been the case in which are well-rehearsed are impacting on building many of the shareholder banks who have societies as well as the banks. To the extent that encouraged customers to go away. funding is restricted, it will restrict our ability to lend. If I can give you an example, before the crisis Q1587 Mr Mudie: Let me ask another question and we would really operate our business model on a my colleague will come in and ask his question which market share, we would say we want to do 10% of the he was speaking to me about when you were market or whatever, we moved to a cash flow model answering. What is your capacity then for and basically we would lend according to the cash mortgages? You have got 20% of the market. You that we could bring in to the business. So a year ago have £230 billion out of £1.23 trillion. we brought in £9.1 billion and we lent £8.9, so Mr Coles: 20% is right. broadly matched it. This year, so far, we have only Mr Cornish: It is defined by a number of things. brought in a small fraction of that £9.1 billion which will reflect on what we can lend to borrowers. Q1588 Mr Mudie: Are you sold up? I am trying like hell to get from you that the Government wants you Q1595 Mr Mudie: A last question. You are only 20% to lend more. There are people out there, first-time of the market and the banks have been behaving buyers who want, whatever their problems, to get in themselves badly and getting themselves into all a new house. You are portraying yourself, and I sorts of trouble and their future is in doubt et cetera, think quite rightly, as the better lenders in the does this mean we have got real trouble for people market. Now, are you lending to your capacity? buying houses in the future, just a total lack of Mr Cornish: Yes. capacity because you are limited, from all we have said about your present level? There are kids coming through now who are going to want a house. They Q1589 Mr Mudie: Is that for the market then? Is that obviously cannot get through from the mutual side for the sector? That is not just you? because you are spent up. Now, you multiply that Mr Cornish: I can only answer for us. through and we are in serious trouble in terms of people getting a mortgage in the future and we are Q1590 Mr Mudie: I will come back to you but, dependent on the banking sector sorting itself out. Adrian, is that your view of your sector? Mr Cornish: The fact is the capital markets remain Mr Coles: Yes, it is my view. I think the building completely gummed up and you can see that societies are lending as much as is prudently sensible remaining that way for up to two years, there is a lot at the moment. They are restricted by the funds of capital market maturities still to take place. I do available. not think that is true in the long-term, but in the short to medium term it is going to be diYcult to get a mortgage and you would have to say will there ever Q1591 Mr Mudie: That is that word, prudence, I be a return to 125% loan-to-value, eight times thought that had been abolished. income mortgages and should there be. I would Mr Coles: No, it is a very important word to the FSA argue very strongly that there should not be. at the moment. Q1596 Mr Mudie: A building society model that is Q1592 Mr Mudie: It is of no help to us in terms of based on six depositors for the one mortgage is getting information. What capacity are you clearly not designed for the need in modern Britain, operating at then? is it? Mr Coles: In terms of funding availability, 100%. Mr Cornish: I think it means that the whole economy has to make an adjustment, so perhaps it will be Q1593 Mr Mudie: So you know it is not prudence, important for individual borrowers to save before you are spent up. they borrow. Mr Cornish: There are other constraints. Clearly we Chairman: Again, some written submissions to us have to retain a very strong capital position and we after this meeting on how do we ungum the market. have to retain a high level of liquid assets. If we took the policy decision today we wanted to double our Q1597 Sir Peter Viggers: Building societies lending we could only do that if we could raise the collectively have £380 billion of assets, of which £250 funding and, frankly, you cannot do that, certainly billion are residential mortgages. Where is the other not on any stable long-term basis. If you want stable £130 billion and is it marked to market? long-term funding, the only game in town is Mr Coles: The bulk of that is building society Government guarantee schemes and that is liquidity. It is the funds they hold so they can return expensive and the extent to which we can use that is savings to savers when they turn up at branches and limited anyway. want to withdraw their funds. It is the funds they hold so they can make mortgage loans when Q1594 Mr Mudie: You do have an element of mortgage applicants come in. You have to keep a wholesale funding, has that given you problems? buVer stock so that once you have made a mortgage Processed: 25-03-2009 22:12:50 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG10

Treasury Committee: Evidence Ev 215

4 February 2009 Mr Adrian Coles, Mr Iain Cornish, Mr Neville Richardson and Mr Graham Beale promise you have funds available even if no savings Mr Coles: If you are accountable to customers then funds come in. Building societies keep, typically, it is more likely you are going to oVer a higher level about 20% of their funds in liquidity. There is some of customer service. The market research we have commercial lending, there is a little bit of unsecured done shows huge diVerences between customer lending, a little bit of overdraft, a little bit of credit perceptions of how good customer service is in card lending, but the bulk of that diVerence that you building societies compared with banks. Certainly have just identified is their liquid assets and typically high levels of customer service is certainly something the FSA require building societies to hold above 20% that all financial institutions should aspire to. of their total assets in liquidity.

Q1603 Mr Todd: There has been a round of mergers Q1598 Sir Peter Viggers: That would be marked to in the sector which have engaged all of your societies market where that is appropriate? here. Your remark, Mr Beale, about the rather Mr Coles: Most of it would be in the form of deposits conservative approach of this sector is belied with other financial institutions where the book perhaps by some of the behaviours that led to the value is equal to the market value because there is mergers that have taken place. I am a customer of not a market value for deposits. the Derbyshire, for example, I should say that straight away, now your customer. Can you perhaps Q1599 Sir Peter Viggers: Turning to the other side of outline where some of the continuing risks lie in this the balance sheet, there is a 50% limit on wholesale sector because that kind of behaviour obviously has funding of which building societies on average have led to the requirement for the sector to absorb its 30%. Is that because they do not wish to take up the own faults? remaining 20 or is there market diYculty in Mr Beale: I think that is an important point, that we obtaining it? have been able to self-regulate in that sense and look Mr Coles: In the past they have not wished to take it after the issues within the sector. I would say that the up but, as Graham was saying earlier, it will now be vast majority of building societies remain very solid diYcult to expand your wholesale funding for the reasons that we have already discussed. percentage because of the state of the markets. Inevitably,you will always get the odd exception and Mr Beale: Structurally, if you look across the sector, I think typically where building societies have 30% or thereabouts is the average gearing that you expanded their activities and gone into areas of risk would have on a building society balance sheet. that they either have not fully understood or where they did not have the right resource in place to be Q1600 Sir Peter Viggers: Can you give us a feel of able to deal with them that for a few small instances, the market? Is the market becoming harder? More Derbyshire is one, the risks were beyond the capacity diYcult? of the balance sheet and that was where we were able Mr Beale: I think that we got oV to a very good start to go in and use the resource we had got to come up and I know why certain comments were made about with a resolution whereby we have preserved the signs of recovery, but since the disclosures about identity and presence of Derbyshire but we are Royal Bank of Scotland it has gone backwards dealing with the risks on our balance sheet. again. I would say there is not an issue in funding the balance sheet but the length of funding is getting shorter and shorter and shorter, so it is constantly Q1604 Mr Todd: What I was hinting at was those revolving. The diYculty is getting any length to the risks are there, up to now the sector has been able to balance sheet in the wholesale markets. absorb its own errors, but there must be a point at which that can cease to be the case. Your society could not be, obviously, absorbed within the Q1601 Sir Peter Viggers: There is reference in your building society sector if something went wrong. submission to building societies operating rather as What do we need to be aware of there? Clearly there utilities. Do you think banking should be are diYculties in the model, errors can take place and characterised as a utility? Is there a model here that maybe we need to look a little bit more critically at banks could follow? the model than discussion has so far shown. We are Mr Coles: Yes, I do. There are some basic banking all probably supporters of mutuality but I think we services without which the economy cannot should not have too much of a halo attached to function: payment, ensuring that people can pay for you all. goods and transfer funds between each other, looking after savings, ensuring that people can pay Mr Beale: I do not disagree with that but I think you their bills, these are basic functions. There is an have got to look at the fundamentals and it is a fact argument for ring-fencing them and not allowing that the building society sector has got more capital them to be contaminated by more speculative than the plcs. The average tier one sector is in excess ventures on the part of banks. of 11%. The regulatory structure prevents high gearing, it prevents trading in the more esoteric instruments, it prevents making markets. Q1602 Sir Peter Viggers: So the model that one could follow perhaps in the future would be banks becoming more like building societies with Q1605 Mr Todd: The Butterfill Bill, I think, loosened customers rather than shareholders as their priority? your ability to borrow in wholesale. Processed: 25-03-2009 22:12:50 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG10

Ev 216 Treasury Committee: Evidence

4 February 2009 Mr Adrian Coles, Mr Iain Cornish, Mr Neville Richardson and Mr Graham Beale

Mr Beale: With the approval of the regulator. Mr Coles: It would not be possible now, Mr Coles: And with the approval of Parliament unfortuantely, under the regulations today to set up actually. The secondary legislation has not gone the Ecology Building Society because the minimum through yet so we would not advocate it at the capital required by the regulation is a million moment. pounds. How do a group of ecologists get together a Mr Beale: There are lots of safety nets in place that million pounds? They would not be able to do that really will prevent a wholesale failure of the building now. The one area of growth of financial mutuals is society sector. credit unions. It is diYcult to see under current regulations how a new building society could be established unless there was scope to turn a large Q1606 Mr Todd: The other area that has tended to credit union into a building society, and there is no cause concern is perhaps the slightly, it is hard to say legislative scope to do that at the moment. this at the moment, old-fashioned governance model Mr Todd: So that is an area that we might perhaps of building societies that many people have criticised explore. in the past, wither there are needs to sharpen that. As I said, my own society managed to head oV down a pretty disastrous channel with its existing Q1609 Jim Cousins: Can I first of all point out I am governance. Is there something that we can learn a member of the Nationwide and Britannia Building about how to govern these societies better to limit Societies and, Mr Beale, you will be pleased to know that risk? I have a small outstanding mortgage with you which Mr Beale: Clearly, and the regulator has my ambition is to repay quickly so you can lend it to acknowledged, in terms of the supervision and somebody more deserving. understanding of the business models it has not Mr Beale: Thanks. really been where it should be and that would acknowledge the Northern Rock and I think it applies across the whole of the financial services Q1610 Jim Cousins: The Financial Services sector. What I am seeing instantly, and we are in the Compensation Scheme levy has been mentioned process now of having our regular review with the already. How significant is this as a charge on the FSA, is they are stepping up a gear to make sure that societies? the governance and the competence that reside both Mr Beale: It is hugely significant. If you take the levy within building societies and the regulation outside at its maximum, which is a billion pounds for the is in place and is up to scratch in terms of what is whole of the industry, and you express that as a required. percentage of the profit for the whole industry, it represents about 2.5% profit in the industry. If you then apply the allocation rules based on the amount Q1607 Mr Todd: Finally, this is something which of deposits that you hold, for the banks the 2.5% some of you may want to put something in on later. becomes 2% and for the building societies it If we were to encourage a flowering and a growth of becomes 15%. the mutual sector, and perhaps encourage the development of small specialised mutuals that were addressing particular market needs, and there are Q1611 Jim Cousins: Can I stop you there just to still some well-run small societies around, are there explain that. That is because of the nature of your things that we should be looking at which would deposits, is it? help that to happen? Are there barriers to entry Mr Beale: It is because we are predominantly retail which would stop a mutual being set up now to serve funded. We have already said that retail funding is at a particular need? least 70% typically of the funding on a balance sheet, Mr Richardson: I do not think there are significant which means that you get relative to the banks a barriers. The mutual sector is a very, very diverse much more disproportionate cost of the levy and sector and ranges right from mutually run schools that is why it is allocated that way. through to the very big financial services Mr Cornish: I think the other reason is we organisations and to the Co-operative Group, a deliberately suppress our profitability because we very, very large organisation. There is a significant want to give value back both to savers and spread of mutuals available. With the recent changes borrowers through more attractive interest rates, so in legislation, the Butterfill Act that was referred to we have this combination of deliberately lower earlier, that gives opportunities for diVerent types of profits and a formula which penalises. I think that mutuals to work better together in the future. 15% is calculated on 2007 profits. Profits this year Mr Cornish: Clearly in terms of financial mutuals the across the whole industry are going to be much, big issue would be raising the capital. I do not think much lower, so that 15% is going to be a much higher that is insurmountable. It is going back 25/30 years figure. I cannot talk about our own overall results now, but the Ecology was set up by just a group of because we are in a closed period, but in terms of people coming together being willing to give the quantum of the charge it is moving around a bit money. because accountants are calibrating it, so to speak, but it is going to be in the order of £15 million to £20 million for us. The charge that HBOS have said in Q1608 Mr Todd: There are some small really one of their statements is that it is going to be about successful ones. £200 million, roughly ten times our scale of charge Processed: 25-03-2009 22:12:50 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG10

Treasury Committee: Evidence Ev 217

4 February 2009 Mr Adrian Coles, Mr Iain Cornish, Mr Neville Richardson and Mr Graham Beale and they are more than 30 times our size as a themselves out of diYculties if their funding was business. That just gives an idea of the starting to go wrong and to the quality and riskiness disproportionality. of the lending. All the things that have gone wrong Mr Beale: It is also highly likely either for the in this crisis you would look at in trying to ascertain financial year that is just ending or in the new the risk profile of businesses going forward. financial year that for some societies this will be the diVerence between making a profit and making a Q1615 Ms Keeble: Looking at the compensation loss. schemes, and there are issues about the pension protection fund which is probably similar to the FSCS and the impact on the businesses, do you feel Q1612 Jim Cousins: Mr Coles, these diYculties seem that any existing schemes or planned schemes would very specifically to have come about because of the be able to cope with the really major collapse of a huge charge that was put on the Financial Services bank? Compensation Scheme following the Bradford & Mr Cornish: They clearly would not. The failure of Bingley situation and in particular the fallout from Bradford & Bingley and relatively small Icelandic the Icelandic banks. There has been this huge banks has wrought a lot of damage on the sector. borrowing on the scheme which has got re-exported Had HBOS gone the same way of Bradford & in the form of additional levies. Do you have any Bingley it would have taken all of us down with it, I specific proposals you could put to us that could think it is fair to say. mitigate the eVects of this on the building society sector? Q1616 Ms Keeble: In terms of the significance of the Mr Coles: Yes. It is particularly galling, to reinforce impact of the levies which you have to pay, do those your point, that those institutions that funded actually pose any risk to your business at all? themselves in the riskiest way on the wholesale Mr Cornish: Not in the sense that we are very markets are paying the smallest amount into the strongly capitalised. We have a 14.5% tier one capital scheme. I think we would believe on the building ratio which is very, very high, so we can absorb it. It society side now that some form of risk related is not a question of it threatening the business but funding, perhaps related to the FSA’s assessment of ultimately, as a member owned business, any your capital requirements and liquidity additional cost that falls on us has to come from the members over a period of time and that will be in the requirements, might be a more sensible way forward V than a pure straight line on the amount of deposits form of not being able to o er the same attractive interest rates we would otherwise have been able to that you have attracted. What it means is that if you do. are fundamentally deposit-based and have adopted what has turned out to be a very safe method of funding yourself, you are penalised for that and that Q1617 Ms Keeble: I wanted to ask Graham Beale a cannot be a sensible way forward, it does not bit about the business models. If you look at some of incentivise institutions to fund themselves in what the profiles of what was happening at the early stage has turned out to be the most sensible way, and we at least of Northern Rock and yourselves, for example, there were some significant diVerences but must find some alternative approach. also some similarities. I wonder if you can say which Mr Cornish: I think as long as it is risk-based it were the most significant diVerences in the business should also be pre-funded so that you put into it models between yourself and Northern Rock. Also, before you go bust and make a claim on it, so to you referred to your borrowing getting shorter and speak. shorter, and presumably your lending profile remains the same because it is mortgages. Does there come a point where you get into real diYculties Q1613 Ms Keeble: I just wanted to ask a bit more because of your diYculty even with your restricted V about this. If you did have some sort of a di erent exposure to wholesale markets in getting wholesale scheme for organising financing so it did not impact funding? so heavily on organisations which have had a good Mr Beale: In terms of the first question, I would say track record, what specifically would be the criteria the big diVerences between our model and the that you would look at? You have mentioned do it Northern Rock model were the quality of the assets proportionate to the risk, but how would you and the quality of lending. We never did the high judge that? loan-to-value of 125% loan-to-value lending, so we Mr Cornish: I think it would be for the FSA to judge were always very happy with quality of the business that and if it was not before it certainly will be now. that we were writing.

Q1618 Ms Keeble: That only becomes a problem if Q1614 Ms Keeble: Just so we can know what some people default, does it not? of the things are that they might look at. Mr Beale: Correct. The second point is that the loans Mr Cornish: I think it would be several things. It that we write we keep on the balance sheet. The would be their funding model, how much resilience business that we write we hold on our balance sheet, they kept within the business themselves, so how but with Northern Rock they would package it and much capital they held relative to the risks they were sell it on to somebody else. That was what happened taking, how much liquidity they held to get to Northern Rock, the confidence fell away, they Processed: 25-03-2009 22:12:50 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG10

Ev 218 Treasury Committee: Evidence

4 February 2009 Mr Adrian Coles, Mr Iain Cornish, Mr Neville Richardson and Mr Graham Beale could no longer securitise, they could no longer Q1622 Ms Keeble: So these things that were Triple fund, and their model collapsed. We fund everything A-d, if you actually dug down into the reports that ourselves. On your second point about the wholesale the ratings agencies did you would have found what markets getting shorter and shorter, we tend to use the assets were actually worth, is that what you are the wholesale funding to generate our liquidity and saying? some of the other assets on the balance sheet. Most Mr Cornish: You would see the breakdown of the of our lending for residential lending is secured assets in terms of the loan-to-values, the average size against or funded by retail deposits, and there is of the loans, the default position on them. always a churn but we are very happy that the risk profile and the length of the funding for retail will more or less match the length of our lending. Q1623 Ms Keeble: The Government is saying in its present support for the mortgage market that one of the things it wants to look at is the possibility of Q1619 Ms Keeble: Can I ask a further question increasing, is it loan-to-value or loan-to-income about the securitisation. You must have seen the ratio? Do you think it is wise to go down that route questioning that we did of Northern Rock and their given the problems we have got? vehicles, and I cannot remember some of the names Mr Beale: No. of Northern Rock’s vehicles now. Do you think that enough attention has been paid to that issue because at the time they seemed to be very robust about the quality of the assets? Do you think that we have Q1624 Ms Keeble: You do not think so. What is the explored that issue enough? Do you think there were maximum, do you think? issues that were not resolved about the quality of the Mr Beale: We are at 85% loan-to-value and we will securitisation? do around 4% loan-to-income, but it is particularly Mr Beale: The quality of the securitisation is really important that you look at the quality of the determined by the quality of the underlying assets. underlying income and that determines the multiple rather than an absolute equation. Some of the issues we are dealing with today are a direct consequence Q1620 Ms Keeble: Yes. of imprudent lending in the past. It would be a Mr Beale: It is madness to think that a loan-to-value disaster if we were to go back to the conditions ahead of 125% is a safe asset. The securitisations tended to of the crisis. blend the assets so that you had some very risky assets with some very safe assets and people were looking at the blend rather than the actual Q1625 Chairman: In terms of loan-to-income, how composition of it, and I do not think that has been much would you give? I remember years ago it used fully understood. It is only now when the impact of to be two and a half times income. What would the recession on the UK starts to bite that you will you give? see unemployment rising and that is when you will Mr Beale: The most we would do today would be see defaulting occurring and you will see a lot of the four times. If somebody has got income of £50,000 losses crystallising at very large amounts where you and no other obligation you have to lend four times. have that highly leveraged lending. I think you will If somebody has got £50,000 income but they have see that on balance sheets like Northern Rock as got a car loan, an HP payment and a credit card to being a main problem going forward. pay oV then clearly you would bring it down. Really Mr Cornish: There is a particular relevance there to it is not the multiple, it is the quality of the income Bradford & Bingley more than Northern Rock and their other obligations. because they had securitisation vehicles as well. They put the good mortgages into covered bonds and left the poor quality ones on their own balance sheet to the extent that the losses from those loans Q1626 Chairman: If you are looking for a ceiling you exceeded the capital they had got left. That will start are talking about four? coming back to us as well through the Mr Beale: Yes. compensation scheme. Mr Richardson: Can I also say that from a building society perspective— Chairman: Sorry, we are moving on. Sorry, Neville, Q1621 Ms Keeble: You say that there were good Sally distracted me. loans and bad loans. When we asked I think we got diVerent answers from what you are saying. Who should do the due diligence and how accessible is Q1627 Ms Keeble: I have heard on the radio some of that information? Can people find it out? the private housing developers still advertising Mr Cornish: There are very comprehensive reports properties saying, “We’ll give you a 75% mortgage; on securitisation vehicles, covered bond vehicles, the if you haven’t got the 25% don’t worry, we can sort ratings agencies have to ascribe a rating to them and that out and you can repay it over so many years, a lot of information about the performance of the blah, blah, blah”. Is that the sort of Northern Rock loans in those vehicles is publicly available. of the future? Processed: 25-03-2009 22:12:50 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG10

Treasury Committee: Evidence Ev 219

4 February 2009 Mr Adrian Coles, Mr Iain Cornish, Mr Neville Richardson and Mr Graham Beale

Mr Beale: I think it is an attempt to circumvent some markets we are going to use it to do 85% loan-to- of the controls and the underwriting criteria that are value mortgages, that would pretty rapidly in place. evaporate on us altogether.

Q1628 Ms Keeble: Circumvent, that is quite strong. Q1632 Mr Breed: Two quick points. Because you Mr Beale: If we are lending against a new build had a more prudent lending policy than anybody property we are very careful about the valuation and else, does that mean your current default and, also careful about the source of the deposits and the therefore, repossession record is significantly lower ability to service the debt. than the banks? Does it mean that? Mr Coles: Yes. Q1629 Chairman: Neville, as a fellow co-operator I have got to give you your say. Q1633 Mr Breed: So your experience at the present Mr Richardson: Thank you. The straightforward time has meant you have had far fewer defaults and building society model is one that is easier to look at far fewer repossessions? because we do not have to pay for external Mr Beale: These guys are in their closed season, but shareholders. That means we are concentrating on if I refer to our interim results at September, the the customer and a lot of the conversation we have average default rate as measured by the Council of been having so far is about what sort of lending Mortgage Lenders was 1.33% and we were at 0.4%. should we do from the business perspective, and that is quite right, we should avoid risk because we have Q1634 Mr Breed: Secondly,are you having problems to look at the protection of the business and the today in securing term deposits from people? In membership, but also we have to look at the other words, are they only giving it to you on a sort customers and what can the customer get access to. of seven day basis or are you able to encourage If we are not careful we get into almost a financial people to lend to you one month, three months, six exclusion argument of saying we could restrict risk months, 12 months? and restrict risk and then nobody gets a mortgage. Mr Beale: Is this in wholesale or retail? We have that balance all the time of saying it is not just about loan-to-value, it is about aVordability. If Q1635 Mr Breed: In retail. people can aVord to pay and they are a member of Mr Beale: In retail, yes, people are very happy to ours then we have to be looking to lend to those commit for one, two, three years. people to buy their house. Chairman: One question from Nick and one Q1636 Mr Breed: In terms of confidence and trust, question from Colin to tie this up. all that has happened in the past with Northern Rock and everything else is not having a major eVect Q1630 Nick Ainger: My question might be multi- on the building societies? faceted. In response to George Mudie’s questions Mr Richardson: Quite the opposite. In fact, during you were saying that you were lending up to 85%, the time in the autumn and winter when people were but is that true for first-time buyers as well? getting far more concerned about the shareholder Mr Richardson: Yes, it is. banks, we were all taking in significant amounts of deposits from customers who trusted and felt they Q1631 Nick Ainger: So it is across the board. You would get a fair deal out of building societies. have told us about the four times income model, but Chairman: Finally, you said that you could spend the key is not only for those first-time buyers but for 50% more this year, where would you get that the wider economy, particularly our construction money? industry, that we actually do get first-time buyers back into the market. You are saying you are lending Q1637 Mr Mudie: No, you did not say that. I was as much as you can, but what would you ask us to pointing out that last year you spent 50% more. maybe recommend to free up so that you are able to Where the hell did you get that money last year that lend more using your prudential models which you has suddenly disappeared this year because you have have described already, particularly aimed at first- said that you are lending to capacity and only giving time buyers? I am thinking of what the Prime something like 50% mortgages this year? Where did Minister said at Prime Minister’s Questions about the money go? using local authorities also to provide mortgages Mr Cornish: The reduction in the availability of again, which I certainly benefited from back in 1980. wholesale funding and, as interest rates start to fall, Mr Cornish: Like Graham and Neville we lend at a slight reduction in the amount of retail funding. A 85% loan-to-value, but we will only do a relatively relatively significant proportion of retail funding small amount of that. I think James Crosby covered comes from capitalisation which people then do not this issue very well in his final report and he was withdraw as interest rates fall and that amount of basically saying if we want to kick-start the housing capitalised interest automatically falls. market there have to be vehicles which allow us to do Mr Coles: And the requirement to hold more funds more of this relatively high loan-to-value, not in liquidity form these days from the FSA. excessively high loan-to-value, and that probably means greater government guarantees around Q1638 Chairman: Adrian, a brief answer to this securitisation vehicles, as simple as that. The little question. Is the future mutuals, and what do plcs funding we can get, if we went out and told the have to learn from mutuals? Processed: 25-03-2009 22:12:50 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG10

Ev 220 Treasury Committee: Evidence

4 February 2009 Mr Adrian Coles, Mr Iain Cornish, Mr Neville Richardson and Mr Graham Beale

Mr Coles: I think the future is mutuals. If you look Q1639 Chairman: Just like the Nationwide’s latest at the mutual model, it is lower risk, better customer promotion, is it not? What have you got? Repeat it. service, better pricing, so send the banks into our Mr Beale: We are safe, dependable, reliable. branches and they will learn a lot. Chairman: Excellent, what a finish! Thank you very much. Processed: 25-03-2009 22:28:06 Page Layout: COENEW [SO] PPSysB Job: 416782 Unit: PG11

Treasury Committee: Evidence Ev 221

Tuesday 10 February 2009

Members present

Mr John McFall, in the Chair

Nick Ainger John Mann Mr Graham Brady Mr George Mudie Mr Colin Breed John Thurso Jim Cousins Mr Mark Todd Mr Michael Fallon Mr Andrew Tyrie Ms Sally Keeble Sir Peter Viggers Mr Andrew Love

Witnesses: Sir Tom McKillop, former Chairman of RBS Group plc, Sir Fred Goodwin, former Chief Executive of RBS Group plc, Lord Stevenson of Coddenham, a Member of the House of Lords, former Chairman of HBOS plc and Mr Andy Hornby, former Chief Executive of HBOS plc, gave evidence.

Q1640 Chairman: Good morning and welcome to Q1642 Chairman: Sir Fred, one of the members of the banking inquiry, and thank you for your the public said to me this morning, “Do the attendance. Can you introduce yourselves, please, institutions know what they have done to ordinary starting with Lord Stevenson. people’s lives, families and jobs?” Everyone in the Lord Stevenson of Coddenham: Dennis Stevenson, room pays some form of tax to the UK Government, former Chairman of HBOS. and the UK Government has forwarded shed-loads, Mr Hornby: Andy Hornby, former Chief Executive lots of money, to your institutions. What are we of HBOS. getting? In terms of your approach, some people say Sir Fred Goodwin: Fred Goodwin, former CEO of you have been hesitant to say “sorry”, so I am giving RBS. you your opportunity now. Sir Tom McKillop: Tom McKillop, former Sir Fred Goodwin: Thank you very much for that, Chairman of RBS. Chairman. I apologised in full, and am happy to do so again, at the public meeting of our shareholders back in November. I too would echo Dennis Q1641 Chairman: Thank you very much. May I start Stevenson’s and Tom’s comments that there is a by saying this is an opportunity for you to provide profound and unqualified apology for all of the your side of the story. Maybe my first question has distress that has been caused and I would not wish been leaked if we look at the papers this morning; there to be any doubt about that whatsoever. maybe all the questions have been leaked. However, is “sorry”, the hardest part, Lord Stevenson? Q1643 Chairman: And it has aVected ordinary Lord Stevenson of Coddenham: No, Chairman, and people? thank you for giving us the opportunity, right Sir Fred Goodwin: It has aVected everyone. upfront, because there has been a lot of talk about Mr Hornby: I would just like to both repeat what has the “s” word. You have given me the opportunity to already been said and to stress, Chairman, that we repeat what both Andy and I said to our deliberately started our written submission with a shareholders when we met them at the EGM, that we full and frank apology. I am very sorry about what are profoundly and, I think I would say, has happened at HBOS; it has aVected shareholders, unreservedly sorry at the turn of events. Our many of whom are colleagues; it has aVected the shareholders, all of us, have lost a great deal of communities in which we live and serve; it has clearly money, including of course a great number of our aVected taxpayers; and we are extremely sorry for colleagues, and we are very sorry for that. There has the turn of events that has brought it about. been huge anxiety and uncertainty caused in particular for our colleagues but also for periods of Q1644 Chairman: We have got a range of questions time for our customers. I would also say, Chairman, we want to put to you and get on the public record, we are sorry at the eVect it has had on the because the aim of this inquiry is: a) to find out how communities we serve. There is nothing sudden, we arrived at this situation; b) how we get ourselves there is no turn of events; we said it publicly at the through this present severe economic recession; and EGM and we have felt it throughout. c) what the future of regulation in the financial Sir Tom McKillop: Thank you, Chairman. I would services will look like. On that point, were you fooled echo Dennis Stevenson’s comments. In November into thinking that the “great moderation”, with low of last year I made a full apology, unreserved interest rates, low inflation and easy access to credit, apology,both personally and on behalf of the Board, would be a permanent state for the economy? Ben and I am very happy to repeat that this morning. We Bernanke’s “great moderation”, it is going to last were particularly concerned at the serious impact on forever? shareholders, staV and, indeed, the anxiety it caused Lord Stevenson of Coddenham: The question is: did to customers. I would very much echo Dennis’s we believe the view which came out not so much of comments. Ben Bernanke but Mr Greenspan and indeed, let us Processed: 25-03-2009 22:28:06 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG11

Ev 222 Treasury Committee: Evidence

10 February 2009 Sir Tom McKillop, Sir Fred Goodwin, Lord Stevenson of Coddenham and Mr Andy Hornby face it, most people throughout the world, that we Sir Tom McKillop: I think modern banks are a good were in a permanent state of cheap money, and deal more than that. They oVer a wide range of everything was the best in the best of all possible financial services, so I think that is a fairly limited worlds? I have to say, speaking for myself, of course definition. you take note of what the major regulators say and what the opinion leaders say and, yes, that period of Q1647 Chairman: Does that need updating, Lord a decade, where the supposed Chinese deflation Stevenson? Because we ended up with the utilities lowered rates of interest et cetera, that was quite a and the casinos, and the casinos got us into bother. compelling argument. I would not want you to Lord Stevenson of Coddenham: Could you read it out think, however, that we slavishly worshipped that again, Chairman? doctrine. If I take you back three years, or thereabouts, for example, we took a decision which Q1648 Chairman: The Oxford English Dictionary was widely criticised at the time on all sides to lower V our share of the housing market from 30% to 20% definition says: “an organisation o ering financial just when the views you have summarised were services, especially the safe keeping of customers’ prevailing, and we took that out of good money until required and making loans at interest”. Lord Stevenson of Coddenham: I think it is pretty countercyclical caution; and there have been a accurate. “Financial services” covers a wide range. number of other decisions of that kind. I think I referred in our memorandum to the fact that about five years ago we deliberately took a P&L hit so as to Q1649 Chairman: Did your organisation live up to lengthen the maturity in wholesale markets: but yes, that definition? Chairman, the prevailing view—best exemplified by Lord Stevenson of Coddenham: We certainly aspired Mr Greenspan’s testimony on the Hill, which I to. As our evidence to you made clear, we got hit remember watching regularly, is bound to have an by— influence on us and most other people in the world. Q1650 Chairman: Could I interrupt you. Just a word here: has it lived up to it? Q1645 Chairman: When the tripartite authorities Lord Stevenson of Coddenham: In everything we came before us—the Bank of England and the FSA tried to do, yes, and we hit the first major market in particular—they said they had sent warnings out failure in wholesale markets, as did virtually every to the banks and they cited January 2007 and April other bank in the world. 2007. Sir Fred, why do you think that those warnings were not heeded? Sir Fred Goodwin: I am not sure that they were not Q1651 Chairman: Andy Hornby,did it live up to that heeded. As you can imagine, I have gone over this definition? time and time and time again in my own mind as to Mr Hornby: Clearly, there is a definite need for what was the point at which we should have seen this banks to focus on simplicity going forward, no-one diVerently, and I keep coming back to at the time would argue with that. That is the clear message of there was a view, not that things would continue what has happened. forever, there was a definite mood that the economy in this country and generally was going to slow Q1652 Chairman: I am just asking a simple question. down, that financial markets were going to slow Did it live up to the definition of the safe keeping of down; but at no point did anyone get the scale or the customers’ money? speed at which. That is really what has been so Mr Hornby: We have worked extremely hard to damaging about this slowdown. It was not that our provide the safe keeping of customers’ money. We business was premised on everything continuing to have already agreed that the loss of liquidity in the go upwards forever; but that things could turn as market—- quickly as they did, I do not think anyone saw. I do not think, in fairness even to the Bank of England, Q1653 Chairman: I want to get on with other that they really saw that it was going to turn this questions. Did it live up to the definition? quickly. Everyone I think saw that it was to turn at Mr Hornby: I would say we certainly aspired to and some point, but for it to turn in the way it has and so we clearly did not foresee with enough clarity—- profoundly and globally I think is the part which has just caught everyone out, and it was not possible at Q1654 Chairman: But there is a question mark there, the time to envisage. is there not? Mr Hornby: Because of the clarity with which we did Q1646 Chairman: Sir Tom, in my preparation for not see the complete closure of wholesale markets. this I looked up the Oxford English Dictionary definition of a “bank”. It says: “an organisation Q1655 Chairman: Sir Tom, a straight answer? You oVering financial services, especially the safe keeping come from Irvine, a straight answer. of customers’ money until required and making Sir Tom McKillop: Dreghorn actually but near loans at interest”. Does that definition need enough! I think as events have turned out, we updating? Do we need to contact the Oxford English required help to fulfil those obligations. Dictionary again? Chairman: So it did not live up to it. That is fine. Processed: 25-03-2009 22:28:06 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG11

Treasury Committee: Evidence Ev 223

10 February 2009 Sir Tom McKillop, Sir Fred Goodwin, Lord Stevenson of Coddenham and Mr Andy Hornby

Q1656 Mr Brady: One of the things we want to apology we have made earlier about the situation we establish is how far the remuneration policy of the have found ourselves in, not just myself but all the banks contributed to the crisis by rewarding perhaps other executive directors were encouraged to take all the wrong kind of risk-taking. Sir Fred, I think in of their cash bonuses in shares. To put it in 2007 your remuneration was £4.1 million or perspective, in the two years that I have been Chief thereabouts, of which about two-thirds was in the Executive I have lost considerably more money in form of a bonus. Mr Hornby, I think the figure for my shares than I have been paid. I think that is you was about £1.9 million, about half of which was showing I have been aligned with shareholders’ bonus. Could you tell us, please, what those figures interests. I do agree with your broader point that would be for 2008? that should be a philosophy generally and that some Sir Fred Goodwin: There is no bonus being paid for way of making sure that annual cash bonuses are not 2008. paid in isolation but are tied into share ownership over the next three to five years is the right way Q1657 Mr Brady: And your remuneration? forward. Sir Fred Goodwin: My salary for 2008 would be Chairman: Could I ask if you could all lean forward £1.46 million. because you cannot be heard clearly. Mr Hornby: There will be no bonus at all payable for 2008. Clearly my salary was roughly in line with the previous year. What I would stress, can I just be very Q1659 Mr Brady: I am sure you will be aware of the clear on one thing, you picked up the salary and measures that President Obama is taking in the bonus: last year, in common with every single year United States not just to cap salary levels but also the for the previous eight years, I invested my entire cash requirement to introduce a clawback provision for bonus in shares. I have never received a single penny bonuses from the top 25 executives and banks that of cash bonus during either the two years I have been are receiving assistance. Could I ask the two former Chief Executive of HBOS or in the previous seven chairmen of the banks: do you agree that this is a years when I was on the board of HBOS. My wise route to take? interests have been entirely aligned with Lord Stevenson of Coddenham: I am not familiar shareholders and I never received one single penny with the detail of President Obama’s suggestions. I of cash bonuses. of course receive no bonuses, just to be quite clear, so in a sense I can speak reasonably objectively. If you have a system, the one Andy Hornby has Q1658 Mr Brady: Thank you. Looking not just at described, where short-term bonuses are not short- yourselves but at other senior executives in your term bonuses because they are invested straightaway banks, how would you respond to the charge that in shares and cannot be realised for three or four you were rewarded handsomely for current years, then I actually do not think I would approve performance, but insuYcient regard was paid to the need to secure long-term shareholder value? of some system of clawback. I would rather not be Sir Fred Goodwin: I think there are a variety of drawn—frankly until three weeks ago I have had my elements to the remuneration package and there are head down trying to get the right result for HBOS— also share ownership requirements, and there are and I do not have a perspective certainly on the also share-related schemes which, relinquished as American situation. If short-term bonuses are paid V part and parcel of the remuneration policy which is out short-term in cash I think that is a di erent approved by the shareholders each year, link our matter and I can understand why people are interests into the longer term performance of the concerned about it. company; and considerable losses for me and my Sir Tom McKillop: I believe there is a need for a colleagues who have shares in the company and fundamental look at remuneration policies in share options in the company over the last year particular parts of banks. You have to diVerentiate reflecting what has happened to the company over between retail banking and, let us say, more the last year. Like Mr Hornby, I too invested my investment banking type practices where bonus last year in shares in the company, and so remuneration is very high, largely driven by bonus, there has been a significant penalty. I have never sold almost completely driven by bonus. I believe that a share in Royal Bank since I joined and have always these events which have occurred and the situation held a large holding, and that would apply to most we are now in should give everyone an opportunity of my senior colleagues. I think there was a longer to look fundamentally at remuneration practices term link there to the performance of the company going forward: but I do believe it need to happen beyond just the current year. across the board in a fairly coherent and consistent Mr Hornby: I would go even further than that. There way, otherwise you will see tremendous arbitrage; is no doubt that the bonus systems in many banks you will see people moving around, going to other around the world have been proven to be wrong in places, diVerent organisations. I do not think this the last 24 months, in that if people are rewarded for can be eVectively carried out in a piecemeal way— purely short-term cash form and are paid very and that is a big challenge. substantial short-term cash bonuses without it being clear whether those decisions over the next three to five years have been proven to be correct, that is not Q1660 Mr Brady: What contribution did rewarding the right type of behaviour. At HBOS I remuneration policy make to the failures at both of would say, and it is not in any way drawing back the the banks represented here today? Processed: 25-03-2009 22:28:06 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG11

Ev 224 Treasury Committee: Evidence

10 February 2009 Sir Tom McKillop, Sir Fred Goodwin, Lord Stevenson of Coddenham and Mr Andy Hornby

Sir Fred Goodwin: We have looked back at that very Mr Hornby: I do not have any formal banking specific issue and obviously we have done a lot of qualifications. I have an MBA from Harvard where work to try and understand what happened, how it I specialised in all the finance courses, including happened and why it happened. One of the features financial services; and before I took over as Chief of how this all came about, you go back and look at Executive two years ago I was a Director of HBOS the positions which have given rise to the losses. The for seven years. traders were trading within limits that would have Lord Stevenson of Coddenham: Like Andy, I have no been set; there were not any rogue elements to it; they formal banking qualifications. I have of course been were conducting activities which they were Chairman of the Bank for 10 years; and before that authorised to conduct, which we knew they were I was initially, for about 20 years, an entrepreneurial conducting and they were conducting them within businessman and I have run large businesses since the limits based on what we believed the risks to be. then. At the heart of this I think there was an issue not Nick Ainger: I just wanted to get it on the record about risk recognition but about how the risk was because one of the recommendations that we made calibrated. They were holding positions in what we in the run on the Rock was that all senior staV of perceived to be triple A securities and they turned banks, chief executives, chairmen and so on, should out to be worth 5 or 10 cents in the dollar. The risk have a banking qualification. I am grateful for the was recognised but in the risk systems it was information you have given us. Can I just return to quantified as being very small: it turned out to be what Graham Brady was saying in relation to the very large and it was wrong, but at the time people bonus issue. There was a report yesterday saying that were doing what they were authorised to do and the bonus culture is in the DNA of the banking what they thought they were doing. I find it hard, system, and yet you are accepting, all four of you, looking at the specifics of the case, to point to that there are serious problems relating to the bonus remuneration as being a cause of what happened on culture. Can you explain to me, and to literally the ground. I would agree with the thrust of the millions of people out there, why you have a system remarks which have been made around the table that where people are paid what appears to many people this is something which should be looked at as part to be a decent salary but they can then maybe have and parcel of what to do to prevent this sort of ten times that salary as a bonus. People understand situation arising again. “bonus” as being a bit of a top-up on their salary,not Mr Hornby: I think there is always room to make ten times their salary. How on earth did the banking sure that remuneration is even more closely tied for system allow this to develop, where people were the long-term. I have already outlined for myself the having these huge mark-ups on their salary and, as two years I have been Chief Executive and for other a result, it would appear that they were not doing executive directors they were taking their cash their job of the prudential side of banking; they were bonuses in shares, which they were holding for taking real risks and it was not their money they several years, in my case, for nine years and never were risking? sold a share through that period. I think what you do need to do in all banks is look several layers down Q1662 Chairman: We are doing bonuses tomorrow the ladder as well and to keep asking the question: because you have departed. We are looking at the are you making sure that annual bonuses are being chief executives and chairmen who are in tomorrow, tied in for the long-term? I do think there is more so give us brief answers on this. work to do there in all banks. I personally would Lord Stevenson of Coddenham: I think there is think the solution where rewards are paid out over probably a distinction between investment banks three to five years as opposed to annually is the right and commercial banks. Andy Hornby,who I am sure overall direction. you will address that question to, will correct me if I Mr Brady: Thank you. Obviously we will be am wrong, but I do not think there is anyone in returning to this with the current directors of the HBOS who has multiplied their salary by ten times banks tomorrow. on a bonus. I would go slightly further and—in response to the question asked earlier on as to what part did remuneration play in the problems we Q1661 Nick Ainger: Let us start with you, Sir Tom: faced—while, as Andy has made plain, there is what banking qualifications have you got? always scope for improving the remuneration Sir Tom McKillop: I do not have any formal banking system, Andy has put that the further down it goes qualifications. I was five years in . . . the better, in HBOS you are dealing with a bank Sir Fred Goodwin: Whether you would call them which deliberately some years ago created a system banking qualifications or not, but I have a degree in for its most senior executives whereby the bonuses law; I qualified as a chartered accountant; I was in they got (which were nothing like ten times their public practice, including auditing banks for a salaries) were automatically reinvested in shares and number of years; I was involved in winding-up banks held for a period of years. Chairman, the FSA and then looking at providing advice for banks; I brought out its ideal picture before Christmas, did it was Chief Executive of Clydesdale Bank; and I was not, and it was remarkably close to what we are a Chief Executive of Yorkshire Bank before I joined doing. I am not saying, at all, that we got it right the Royal Bank of Scotland group in 1998 as Deputy because, as Andy has said, we must improve; but we Chief Executive. are not one of the banks that is paying ten times Processed: 25-03-2009 22:28:06 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG11

Treasury Committee: Evidence Ev 225

10 February 2009 Sir Tom McKillop, Sir Fred Goodwin, Lord Stevenson of Coddenham and Mr Andy Hornby salary in bonus. With bonuses, we are increasingly but the rates and currencies businesses, for example, moving towards a culture of putting them into long- has probably had a record year in 2008. It is buried term holdings, so you do not get them straightaway. within all of the figures—I do not demur from your Sir Tom McKillop: This is a question I have thought characterisation of where the bank is—and the a lot about. Just to put it into context: the average people sitting there will be expecting to be rewarded salary in RBS is just over £27,000; the maximum based on their performance. That is the dilemma bonus for the vast majority of those people is 10%; where Stephen and his colleagues in management and the average payout is about 5%, just so we have and the new Board will have to square the loop. a perspective. Not everyone is in this class; we are a long way from that. I have given a lot of thought to: Q1665 Chairman: Andy Hornby, just so we have on why is it that investment banking has developed this the public record that we do not take your line bonus culture? It is seen as a very people-related completely, but in 2007 your salary was £940,000. activity; that specialist knowledge and contacts are You say you had two cash payments of £449,000 and very important, that is very transportable; but also I £254,000, which you turned into shares. I would think an important element may be the history of submit to you that that has really insulated you to a these investment banking-type activities. They were large extent. There is a real comfort zone there when largely not carried out initially in publicly listed people say, “Look, you’ve got a million pound companies; so they were partnerships; there was a salary”. I want that on the record, we are not very high payout history in these kind of accepting your point of view fully. Your million partnerships; and they have become public pounds people see as a very generous million companies but those practices have carried over into pounds. these publicly listed companies and, because of the Mr Hornby: Chairman, I accept, along with all other competitive pressures to recruit the key people, they FTSE companies— have escalated if anything. I think there is quite a lot Chairman: Okay, but it is very important for our of history to be unravelled here if we are going to get inquiry. to the right end point. Q1666 Mr Fallon: Sir Tom McKillop, let us get back Q1663 Nick Ainger: There are reports which we have to what went wrong. You were chairman of this all seen that RBS is an institution which has just mess. ABN Amro, how much did you overpay? announced it is writing down £20 billion of its assets; Sir Tom McKillop: In retrospect we bought ABN it has announced that it is likely to make a loss of up Amro at the top of the market, so anything we paid to £8 billion; its shares have fallen by over 90%; and was an error. four months ago the taxpayer had to bail it out, and if they had not done there would not be RBS. Yet, Q1667 Mr Fallon: What is the answer to my this bonus culture indicates that RBS may well have question? How much did you overpay for ABN been seriously considering paying out major Amro? bonuses in that institution. How on earth could they Sir Tom McKillop: Everything we paid basically has even agree that there should be any bonus, given not been worth— I am giving you a very straight those circumstances and the fact that the people out answer. I could say, “50%”, but what diVerence there believe that it is taxpayers’ money that will be would it make? In fact, we are sorry we bought paying those bonuses? What would you have done in ABN Amro. those circumstances, Sir Fred? Sir Fred Goodwin: I do not know what the Bank is thinking of doing. The dilemma with all of us, as Q1668 Mr Fallon: The statement you gave out on 19 Tom has mentioned, is that it is highly competitive January, and you were still Chairman then, market. Many of the remuneration practices have attributed a write-down of £15-20 billion. Was most been imported from the United States. As London of that ABN Amro? has emerged as more and more of a global financial Sir Tom McKillop: £15-20 billion in January that services centre a lot of these practices have come was the goodwill write-oV, and a significant part of across from the United States. This has been a source that is ABN Amro. of angst within banks if you talk to other bank chief executives who have activities in this area for years Q1669 Mr Fallon: How much is Amro? and years. It is very diYcult for an individual Sir Tom McKillop: I could not tell you. We did not institution to make a change unilaterally. break it down explicitly, I do not think.

Q1664 Nick Ainger: It is the culture then? Q1670 Mr Fallon: You were the Chairman; you must Sir Fred Goodwin: It is absolutely a cultural thing. It know what the figure is? How much have you lost is an area where people and teams do move around on Amro? the market; and if amounts are not paid and people Sir Tom McKillop: If you read the press do not feel they are appropriately remunerated they announcement it said that is work in progress. The will move. It is very much a cultural issue. I am sure goodwill assessment will be done by the end of the Stephen Hester will explain the position tomorrow year. That had not been completed. These were but many of the businesses within the group are estimates. I would basically submit that the bulk of doing extremely well; many businesses within GBM what we paid for ABN Amro will be written oV as are doing extremely well. I do not know for a fact, goodwill. We paid about £10 billion. Processed: 25-03-2009 22:28:06 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG11

Ev 226 Treasury Committee: Evidence

10 February 2009 Sir Tom McKillop, Sir Fred Goodwin, Lord Stevenson of Coddenham and Mr Andy Hornby

Q1671 Mr Fallon: Why did you and your Board Q1676 Mr Fallon: Did the regulator, the FSA, warn allow Sir Fred to go ahead with this huge deal you or your Board about the size of this deal, or the without an escape clause when ABN had already strain it would put on your funding? pre-sold LaSalle, when the credit crunch had already Sir Tom McKillop: No, the deal was approved by the begun, and when everybody else said you were FSA, by the Dutch regulatory authority. paying too much? Sir Tom McKillop: The premise that we allowed Sir Q1677 Mr Fallon: Sir Fred said in October that the Fred to proceed implies that this was driven by Sir jury is out on ABN. Now that it appears to be back, Fred, which is not the case. When the announcement how would you summarise it? Sir Tom, I am asking of the ABN Amro merger with Barclays was made you. You were in charge of this Board. You have the Board received a presentation from our strategy destroyed a great British bank; you have cost the group and the executive team, an analysis of the taxpayer £20 billion; how would you now summarise ABN Amro businesses; we looked at that in that deal? considerable detail. The Board had 18 meetings Sir Tom McKillop: The deal was a bad mistake—I between March when we received that first analysis have already indicated that. following the announcement by Barclays and ABN, in which ABN Amro was considered at every one of Q1678 Mr Fallon: So you failed? those. There was no proposition to buy ABN Amro Sir Tom McKillop: We did in fact make a bad at the first meeting; it was an analysis session. At mistake in purchasing ABN Amro. At the time it did every stage the whole Board considered this and not look like that. It is easy in retrospect. I could give were unanimous in the steps we took. It is wrong to you many, many statements, many bits of evidence characterise it as a proposition driven by Sir Fred that support that at the time we bought that, when that the Board were unable to stop. we made that acquisition, there was widespread support for it. Yes, there were some voices saying it Q1672 Mr Fallon: None of the non-executives was overpriced, but we received 94.5% shareholder wanted a re-think. Okay. Did they fully understand approval; we received regulatory approvals; there the additional pressure that a £50 billion deal like was a very good financial case. this would put on an already fragile UK inter-bank market? Q1679 Chairman: Sir Fred, others have said it was Sir Tom McKillop: Of course we understood, but it hubris on your part. As one person said, “It cost the was not £50 billion, it was £10 billion for us. We paid Royal Bank of Scotland its mighty status”. You paid £10 billion for it. three times market value. Indeed the gossip in the market at the time was that RBS and Barclays were Q1673 Mr Fallon: But the total deal was £50 billion? bidding up, but Barclays were putting the price up Sir Tom McKillop: Our part of it was £10 billion. knowing that you would go the whole hog and at the The prospects, the financial returns potentially on end of the day they were quite happy to see you going the deal, were improved when LaSalle was not out and there were smiles in Canary Wharf and available. So far from LaSalle, we are very happy we Barclays’ headquarters when you did it, and it was did not get LaSalle; and the financial numbers just hubris that brought it down on your part? actually improved without LaSalle, so we did Sir Fred Goodwin: I have read those comments as proceed. well, Chairman, but they are not true. I think the Chairman has explained the background to the Board’s report. Q1674 Mr Fallon: Why were you and your non- executives unconcerned about RBS’s funding gap— Q1680 Chairman: It was a bad mistake, Sir Fred? the gap between your liabilities and assets—which Sir Fred Goodwin: I am just explaining the context. seems to have doubled in three years to over £160 At the time it did not seem like a bad mistake. Our billion, is twice the size of Barclays’ funding gap, and shareholders approved the transaction in August of was a third of the total of all six British banks’ 2007. Barclays’ shareholders approved it in the funding gap? Why were you unconcerned about it? middle of September 2007. After the Barclays Sir Tom McKillop: We were not unconcerned about shareholders approved it—and Barclays stayed in it. We had a plan. When we acquired ABN Amro the fight to get ABN Amro right to the end and there was a capital plan and a funding plan in place. revised their bid terms up—our bid stayed the same The problem was, no sooner had we acquired ABN throughout. We got to 17 September 2007 and ABN Amro then the world changed dramatically and we Amro reconfirmed their earnings estimates for 2007 were unable to implement that plan, and therefore and specifically stated that credit market we ended up with the funding requirements you markdowns had not aVected them. They specifically indicate. stated that their credit portfolio and credit outlook was good. Again, that may seem hard to believe now, Q1675 Mr Fallon: Why did you and your Board not but at the time that fitted into the context. fully understand the risks of your increasing overdependence on the wholesale funding markets? Q1681 Chairman: It is a question of due diligence? Sir Tom McKillop: I believe we did understand what Sir Fred Goodwin: There was due diligence done we were doing, in the belief that that plan was going earlier in the year on ABN Amro. These were to be executed successfully. statements that were made to the public market. We Processed: 25-03-2009 22:28:06 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG11

Treasury Committee: Evidence Ev 227

10 February 2009 Sir Tom McKillop, Sir Fred Goodwin, Lord Stevenson of Coddenham and Mr Andy Hornby raised funds for the ABN Amro transaction in late group risk that reported into internal audit which September—they were eight times oversubscribed. reports direct to the audit committee and, therefore, So the view at the time, and we could only work to the senior non-executive. based on the view at the time— Chairman: We are coming back to that with the non- executive directors. Q1687 Ms Keeble: Do you accept that the risk committees and risk directors might be reporting or might have to whistle-blow around actions taken by Q1682 Ms Keeble: I wanted to ask first, Sir Tom, you the executive and, therefore, a separate reporting mentioned there were some voices of warning raised line to the non-execs can be a good line of defence about this deal. Did any of those come from your and, indeed, was put at a group audit meeting and own internal risk management people? the person was ticked-oV for doing it? Sir Tom McKillop: No, there was an awareness on Mr Hornby: Let me be absolutely clear, every single the funding—the question of the funding plan and division in our business has its own risk committee the capital plan. which is attended by two non-executive directors; so there is not just a straight line, there is an automatic Q1683 Ms Keeble: No, internal voices inside the line whereby non-executive directors are reviewing Bank were raised about it? the risk performance divisions entirely Sir Tom McKillop: The analysis threw up the issues independently through that structure. that would have to be managed in the integration, but this was essentially the same kind of plan that had been very successful on the integration of Q1688 Ms Keeble: A separate independent reporting NatWest so, yes, there was a full analysis by internal. line from the overall risk director to the non-execs, would that not be a useful separation of responsibilities? Perhaps Lord Stevenson would like Q1684 Ms Keeble: I wanted to ask some other issues to respond? about risk management and compliance in Lord Stevenson of Coddenham: I agree, and that is particular for HBOS, because you will be aware of actually what happened. It is a very important area the accusations made by a former employee that the you have opened up. I would say HBOS had very sales culture at HBOS outpaced the risk elaborate systems of risk management and stress management in compliance systems. Do you accept testing, worked out over the years and, it is not too that those particular functions were overstretched? much to say, hand-in-hand with our regulator, who Mr Hornby: No, I do not accept that at all. Indeed, was present all the time. I am very happy to give it in I think the particular accusation you are referring to detail or to brief the Committee because I think it is referred to an internal review conducted by us and an important issue you raise. We could go back over using external resource back in 2004. There is a the record, there would be very few Board meetings whole series of internal reviews constantly done and where risk was not considered with the risk director reported back to the Board. There is an extremely present briefing the Board on a major risk issue, and rigorous analysis done each year under what we call the Board was all over it. As Andy has referred to, the “three lines of defence”, which is I think standard there were three levels of risk management below it for most major banks. very carefully structured. I know the Committee is looking to the future—I do think we will not be the Q1685 Ms Keeble: But they all failed, did they not, only bank in the world which had very elaborate risk at the end of the day, those three lines of defence? management systems, where indeed the Board was Mr Hornby: To say that they failed is not right; in involved heavily (which is the thrust of your point), that, as we have laid out very clearly in our but where in truth we failed to consider some of the submission, the diYculty that HBOS encountered extreme scenarios that have actually happened. I was significant reduction in availability of wholesale think that is one of the questions that came forward. funding from August 2007 onwards, and it got much steeper when we had actually continued to fund ourselves very successfully through a 12 month Q1689 Ms Keeble: You appointed a new risk director period because we had previously elongated our in 2005 who apparently was a sales manager and had wholesale funding; and following the collapse of no experience of risk management or compliance. Is Lehmans we found those wholesale markets even that the case, or can you say what the person’s harder to satisfy. qualifications were? Mr Hornby: This is going back to before I was Chief Executive under the previous Chief Executive James Q1686 Ms Keeble: Looking through the structure Crosby, but he appointed Jo Dawson who is a very which I think comes from your annual report, there experienced banker and had a career previously at seems to be no reporting line from any of the risk NatWest and then at HBOS; and there was a view committees or from the risk directors to the non- taken, which I endorse, that good skills and real exes? broad awareness of banking being brought to that Mr Hornby: I will allow Dennis to expand in a job was going to be helpful. minute but just to be clear: the group risk director reported direct to the chief executive, and the three lines of defence meant that, first of all, you had Q1690 Ms Keeble: The qualifications of the current divisional risk accountability which reported into risk director are what? Processed: 25-03-2009 22:28:06 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG11

Ev 228 Treasury Committee: Evidence

10 February 2009 Sir Tom McKillop, Sir Fred Goodwin, Lord Stevenson of Coddenham and Mr Andy Hornby

Lord Stevenson of Coddenham: Peter Hickman, who Executive I was then faced with the collapse of is the outgoing risk director of HBOS (and I do not wholesale markets, followed by the events on quite know at what stage), was a career partner in Northern Rock; so it has been an extremely stressful Ernst & Young who joined us five or ten years ago, time and we have spent, with huge support from who is obviously a trained accountant with huge Dennis and the Board, that entire two years trying to specialist knowledge of the banking system. The make sure of three things: first of all, we cut— point I would make is, Jo Dawson, the person you are talking about, is a quite outstanding executive, Q1696 John Mann: I am interested in the question of who had total access, to take your point, to the whether if events had gone slightly diVerently if there Board, to me and everyone else and was constantly could have been others here rather than you facing confronting the Board on risk issues. the music, or whether you are particularly personally culpable? Q1691 Chairman: Sir Tom, before we move on, you Mr Hornby: No, I do not feel I am particularly say due diligence was done on ABN Amro earlier on, personally culpable. but the deal was completed in October 2007. I remember, along with my colleagues in this Committee, sitting here with the Governor of the Q1697 John Mann: Sir Fred Goodwin, how much Bank of England in September talking about worse could it have been at RBS if you had not been Northern Rock in crisis and here, a month after the in charge? earthquake has hit the financial services industry, Sir Fred Goodwin: I fully accept my responsibility in your organisation signed up to ABN Amro. Can you the matter we are talking about. I would imagine say to us hand on heart here that the due diligence that there are others out there who think, “There but was done in October and you were still very happy for the grace of God”. It was a fact, and all the more with it? numbing, that after a rights issue, right through until Sir Tom McKillop: The due diligence was done in the middle of September, we were moving forward May, as Fred said, and then there were a series of positively. It was post-Lehman’s that the collapse in meetings with the senior people of ABN Amro to confidence, the collapse in markets, just came round determine if there were any further developments. and hit us and we were caught at that point. It was very sudden and very sharp. It could have happened to others. Q1692 Chairman: But that is six months before, Sir Tom, but here we had an earthquake in the autumn? Sir Tom McKillop: There were a series of meetings Q1698 John Mann: I keep hearing about the and, as Fred indicated earlier, ABN Amro came out requirement for brilliance. People keep on telling us, with a statement in September of that year which and telling me all the time, “We need to attract the was very clear about their financial position and, most brilliance”. Are there people out there who are indeed, their views on the status of their business in more brilliant who could have done a better job than the middle of all of this which was very reassuring. you with RBS? Sir Fred Goodwin: There may well be. It would seem Q1693 Chairman: It does not sound very convincing, unreasonable for me to conclude that there were not. Sir Tom? At the time we felt that the rights issue had got the Sir Tom McKillop: It was very reassuring, I assure group back on track; it had dealt with the capital you. issue; we were moving forward; we had published Chairman: We are going to look into that further, our interim results; and the funding markets came to particularly the present Board. a complete halt post-Lehman’s and it was a crisis of confidence that brought this about. Q1694 Mr Fallon: A year and four months later you are telling us your £10 billion is worth nothing? Q1699 John Mann: What it seems to lots of people Sir Tom McKillop: I am indeed. I think that is is when things go into a downward spiral then this indicative of the scale of dramatic change that has extra brilliance, for which huge amounts of money taken place that has aVected many banks around has to be paid, seems to have less relevance; the world. therefore, why has it got relevance in terms of how things go forward in terms of remuneration? Let me Q1695 John Mann: Mr Hornby, are you personally be precise, is your pension linked to the share value culpable, or is it essentially bad luck that leaves you of the Bank? to be facing the music for your industry today? In Sir Fred Goodwin: No, my share schemes are linked other words, are there bankers out there at the to the share price of the bank; and my shareholding moment who are thinking, “There but for the grace is linked. of God go I”? Mr Hornby: I have already said on behalf of the Q1700 John Mann: Is your pension? Many Board we accept full responsibility and have pensioners in this country have seen their pension go apologised for the events that have taken place, so down because share values have gone down. Is your please do not in any way suggest that I am trying to pension going down because it is linked to the share avoid personal responsibility. I have been CEO for value of the Bank? just over two years and it is clear in that time within Sir Fred Goodwin: No, because I am in a defined eight to nine months of taking over as Chief benefit pension scheme. Processed: 25-03-2009 22:28:06 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG11

Treasury Committee: Evidence Ev 229

10 February 2009 Sir Tom McKillop, Sir Fred Goodwin, Lord Stevenson of Coddenham and Mr Andy Hornby

Q1701 John Mann: It is a good job because the share Q1708 John Mann: What is the mood of the staV in value has gone down from, what, 550 to around 20p. the Bank at the moment? Should it not be linked? Should not your pension be Mr Hornby: Mr Mann, I have already said at the linked to the share value of the business you ran? start I have apologised profusely— Would that not be fair? Sir Fred Goodwin: No, because pension schemes are Q1709 John Mann: I know, but what is the mood at not generally allowed to invest in the company the moment? which is providing them. Mr Hornby: I think there is obviously considerable concern. They are going through a very major Q1702 John Mann: As a principle, would it not be merger. There is considerable concern about long- fair that your pension, which is quoted as being term job security. I believe we have handled a very rather a high pension—over eight million I have seen diYcult situation to try and deliver the best result for quoted—would it not be fair to other pensioners in 80,000 colleagues. Britain that your pension was linked to the share value of the bank that you ran? Q1710 John Mann: What is a COA2 form? Sir Fred Goodwin: No, my pension is the same as Mr Hornby: I have never used that precise form. everyone else in the Bank who is in a defined benefit pension scheme. It is determined in the same way as anyone else, and anywhere else, in a defined benefit Q1711 John Mann: A COA2 form is the form that pension scheme. I am not seeking to not be linked to your Bank sent me in your last week in charge. It sent the share price performance of the Bank; that was me it. I am a customer of 40 years, and it sent me it, achieved through the shareholding in which I have a change of address, but I have not changed my lost a lot of money; it was achieved through the address. It then sent me the bank account of a Mr medium and long-term incentive plan, in which I and Mrs John Mann; but it was not my bank have lost a lot of money. Between the end of 2007 account it was somebody else’s bank account. I put it to you that there is a bit of a meltdown in terms of and now I would estimate I have lost somewhere in V the region of over £5 million in the decline in value the morale of the sta . on shares that I have put into the company. I bought Mr Hornby: I apologise for that mistake. shares on the day we completed the ABN Amro transaction—more than a year’s salary. So the Q1712 John Mann: Is it not true that yesterday, in an decline in share price in RBS has aVected me. I am internal staV review, over half the staV speaking to not complaining but it is highly germane to this their own management said they were de-motivated, conversation, but my pension is not linked. and that 82% of the staV said they were worried for their jobs? Mr Hornby: Mr Mann, it would be extraordinary, Q1703 John Mann: No, but you do not appear to which is why we have laid it out in our submission, have done too badly out of the last eight years. I if this had not caused de-motivation. It has been an would be tempted, considering that your bank extremely diYcult 12 months for us. They have gone originated in Tudor times, to ask what Henry VIII through extreme concern; they have gone through a would have done to you, but instead I want to ask major merger; they are waiting to see how their job Mr Hornby: what is the average ago of HBOS staV? situation pans out over the course of the next two Mr Hornby: The average age I believe would be in years. All I would say is, I believe profoundly that the low 40s. the deal with Lloyds TSB provides the best solution possible in very diYcult circumstances. I hope, and Q1704 John Mann: What is the average number of I believe it to be the case, that that morale will years’ service of HBOS staV? improve over the course of the next two years. If you Mr Hornby: That is changing according to the look at the history of HBOS, good staV morale has diVerent divisions, the diVerent mergers, but the been very strong. average service level has been around ten years. Q1713 John Mann: What staV tell me you told them Q1705 John Mann: How much is JSA for an adult in the two years you were in charge, “We are a safe of, say, age 42? bank”. That is what my mother told me 40 years ago. Mr Hornby: I beg your pardon? “Join the Halifax—it’s a safe building society”. That is what you said. You said repeatedly in the last two years to staV, “We are a safe bank”. What staV are Q1706 John Mann: Job Seekers Allowance? writing and saying now is: “I have felt so ashamed to Mr Hornby: I do not know the precise amount but it work for the Halifax. It has now hit home that many is a very low quantity of money. of us will lose our jobs and that the name of the Halifax, which me and you grew up with, will be Q1707 John Mann: Because that would be the profile erased from the high street and many, many, many of the bank staV and I think it is your age as well. I more”. It is not surprising that they cannot manage do not know whether you are going to be relying on to get the bank accounts of someone like me right in £60.50 of Job Seekers Allowance? that situation, is it not? Mr Hornby: I accept the fact I am a similar age to the Mr Hornby: I agree entirely. I think colleagues have average age. been through a horribly stressful period. Processed: 25-03-2009 22:28:06 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG11

Ev 230 Treasury Committee: Evidence

10 February 2009 Sir Tom McKillop, Sir Fred Goodwin, Lord Stevenson of Coddenham and Mr Andy Hornby

Q1714 John Mann: Is not the thing that really what particularly my colleagues are going through annoys them—I know from letters I have seen—that and I do not diminish customers and shareholders you are still being paid, are you not? Is it £60,000 a as well. month? Mr Hornby: Mr Mann, I have a short-term Q1719 Chairman: Could I just pick up a point Andy consultancy arrangement with Lloyds TSB which, Hornby made to John Mann. You said, “I don’t feel can I just stress, Lloyds TSB asked me to do. I am particularly personally culpable”. What exactly are you apologising for? We have been told that you have coached extensively, meticulously by PR Q1715 John Mann: £60,000 a month— people and lots of money has been spent. The papers Mr Hornby: That is correct. tell us that, Sir Tom. Are you expressing sympathy because your PR advisers advise you to do so? Q1716 John Mann:—which would be 36 of the lower Mr Hornby: No, let me just stress, I have already paid staV jobs in the Bank. 36 of them could be paid apologised several times on behalf of myself and the each year out of that money. The question they are whole Board for what has happened. The precise asking is: considering the failure, why is failure being question I was asked of whether I felt purely rewarded? Why are you still getting this money? Is it personally culpable, I think we all take responsibility to cut their jobs? for what has happened in the two years I have been Mr Hornby: Can I just say three things: firstly, I have running the company. I fully accept my own role already agreed with Lloyds TSB this arrangement within all of that and I repeat the apology. will not last for more than three months. If Lloyds TSB still want me to help them after the three month Q1720 Chairman: Sir Tom, I want to nail down ABN period I will certainly carry on for as long as required Amro before we move on. Let us say ABN Amro had and will do it for free and provide Eric Daniels with an incentive to talk-up the deal with you. I would all the assistance that he looks for; secondly, can I suggest to you that the due diligence you did in May, just please reiterate in terms of your impression followed by meetings, and signing it at the height of about rewards for failure what I outlined earlier; that the crisis meant that you fell for their line hook, line I have invested early single penny of my bonuses in and sinker? my time with HBOS into shares; I have lost Sir Tom McKillop: I do not believe that is the case. considerably more money over the last two years for Banks in particular have very,very public disclosures the period I have been Chief Executive than I have to make. There are lots of filings made in country of earned; and I share all your concerns for staV origin, obviously, but also for a bank like RBS or morale; and I really do hope and believe that the ABN Amro in the United States—very full future under Lloyds TSB will allow that morale to disclosures of the nature of their business, any issues get back to where it was 18 months ago. It will take that are in those banks, the litigation and so on. All time and I accept there is job insecurity. of those public disclosures were gone through in enormous detail. We had 15 work streams looking at the due diligence. 15 diVerent sets of activities; all of Q1717 John Mann: In your final year one of your those reported to the Board on the due diligence. branches handed out a cabbage to staV who were not deemed to be performing well. Is that a super epitaph on your time in charge? Q1721 Chairman: It is mighty mystifying when we Mr Hornby: I think you are referring to an incident have got an impairment in your trading update of a couple of years ago. I thought that was a very £15-20 billion. We will come back to that with the unfortunate incident that we followed up internally. present lot. Sir Tom McKillop: That is an estimate of goodwill; it does not mean that the businesses in ABN Amro Q1718 John Mann: Sir Fred, in the public eye, in the are worthless. media, you are perhaps taking a much harder hit than anyone on this. This is not actually to get to Q1722 Sir Peter Viggers: Of the first Government you—I am interested in the culture. Is it that you are rescue package in October 2008, Sir Fred, you an aberration? Is it that you are someone with a memorably remarked: “This isn’t a negotiation, it’s diVerent moral compass in terms of what motivates a drive-by shooting”. To what extent were you able you; or, in your view, are your integrity and ethics to negotiate with the Government over the terms of representative of the trade and profession of the support oVered to RBS, to start with? bankers? Sir Fred Goodwin: That was a comment I made after Sir Fred Goodwin: I think, reflecting on everything the negotiations and it was intended as a private that has happened, there is certainly cause to comment to one of the other participants but it has question some of the judgements that we have made, obviously got out. It really was neither a criticism and that is reflected in how things have turned out. nor a complaint. I think of necessity this was all I am not aware of a basis for questioning my happening at an extremely rapid rate. The rate of integrity as a result of it all. I could not be more sorry deterioration which took place—and you will have about what has happened. I am not going to go back heard from many other witnesses about the impact through all of that again; but I have invested a lot in of Lehmans on 15 September and the catalogue of RBS, and I do not mean financially, over a very long failures which came after that—by the time we got period of time and it is of great distress to me to see through into that week, Monday 6 October, the 6th Processed: 25-03-2009 22:28:06 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG11

Treasury Committee: Evidence Ev 231

10 February 2009 Sir Tom McKillop, Sir Fred Goodwin, Lord Stevenson of Coddenham and Mr Andy Hornby and 7th saw a collapse in bank share price, a collapse reasons why the sums in relation to those two banks in our price, a collapse in the FTSE, and a real are higher than might have been anticipated”. How collapse in confidence. Leading up to that over the on earth could they get that so completely wrong? preceding three weeks or so there has been an Sir Fred Goodwin: I think what they were doing on increasingly frequent interaction between the banks 13 September was trying to estimate what losses generally and the tripartite authorities, and the going forward would be. They were not trying to put banks collectively and the tripartite authorities as in place what the provision should be as at October. people were becoming more concerned about how They put in place, as Lord Turner described it, their the market was developing, and in that week it just assessment of what that extreme stress scenario tipped over the edge. I think in a perfect world the would look like, and put in place what they thought tripartite authority would have liked a little bit was suYcient capital in the Bank to allow the Bank longer to pull the plan together, but it was very clear to endure that. The capital ratios that were created to everyone that it had to happen there and then and in October by the investment by the Government there was an enormous amount of eVort put into it. would come down if those stresses all flowed There was not a lot of negotiation. There simply was through. It was a projection of the future they were not the opportunity for a lot of negotiation. My uncertain about, rather than anything to do with the comments were absolutely not a criticism or a past. In terms of what we said to Legal and General, complaint. what we said to the whole market when we announced our results at the end of February in 2008 was that we had no plans at that time for a rights Q1723 Sir Peter Viggers: Your comments, Lord issue. That was in response to a question and, in Stevenson, on the negotiations, insofar as there were fairness, it is one of these things where you cannot be negotiations? half doing a rights issue; you either have plans to do Lord Stevenson of Coddenham: The question is: were one or you do not. We did not have plans to do one. we able to negotiate? My recollection is that we had The Board had not sanctioned a rights issue at that two meetings, I think. At the first meeting it was time; we did not think we needed a rights issue. We made clear to us that if we wished to have access to posted trading results in March and the situation government liquidity schemes they wished us to have changed very rapidly. more capital; that was the trade. They did ask us what we thought was the necessary amount of capital, and they sent us away and we worked it out. Q1726 Sir Peter Viggers: I simply do not understand There had been prior notice of that and we had (you how the FSA, who you say knew you very well, could call it a “negotiation”) a “discussion” about could have made cautious provision in October and, the amount of capital. I think the amount of capital three months later, there is a £28 billion write-down, that eventually we ended up with was somewhat which is the largest ever. How could it possibly diVerent but not very diVerent from the original deteriorate at that speed? amount. So to that extent you could say there was a Sir Fred Goodwin: I am not privy to all that went on. negotiation. But, the commonsense of the matter You can ask Mr Hester and I am sure Mr Hester can was that post-Lehmans, with the liquidity frozen, explain that tomorrow. At the time there was a there was not much negotiation. trading update given to the market at the beginning of November. That was the last trading update I was involved with, and it was outlined to the market that Q1724 Sir Peter Viggers: Returning to RBS, having the Bank expected to incur further credit mark- assured Legal and General in the spring of 2008 that downs; it expected to incur credit losses; and it there were no circumstances under which you would expected it was probable there was going to be a need to do a capital raising, and then six weeks later goodwill write-oV of some scale. All of those things you did a capital raising leading to them asking for were said at the beginning of November but they both the Chairman and the Chief Executive to stand were not able to be quantified at that time. It is clear down, as we have heard, the FSA, the regulator, that the credit markets deteriorated very badly again must have been over you like a rash. How well did in the latter part of the year. I am sure that has fed the regulator know you by October? through into the numbers. There has been some Sir Fred Goodwin: The regulator knew us very well further deterioration; I know this from what I have long before October. Because of the size of RBS we read about the public documents about what have are monitored under a close and continuous regime happened; there have been credit losses from so there is an ongoing and close relationship with the lending; and goodwill write-oV has come through. It FSA. There is no evidence to me to suggest that the was all flagged but not quantified in the FSA lacked any understanding of the organisation. announcement that was made at the beginning of November. Q1725 Sir Peter Viggers: What I am trying to reconcile is a statement made by the Chancellor of Q1727 Sir Peter Viggers: How can it be that the FSA the Exchequer in the House of Commons on 13 made cautious provision and three months later the October where he says: “The FSA has taken what it Prime Minister says he is “angered by reckless loans regards as a cautious view, having regard to the to foreign customers. A write-oV of £2.5billion to Mr diYculties faced in the economy now, as to what the Blavatnik a Russian oligarch”. How could this liabilities of the banks might be. That is one of the possibly happen? Processed: 25-03-2009 22:28:06 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG11

Ev 232 Treasury Committee: Evidence

10 February 2009 Sir Tom McKillop, Sir Fred Goodwin, Lord Stevenson of Coddenham and Mr Andy Hornby

Sir Fred Goodwin: I can see why the confusion Sir Fred Goodwin: I am sorry, I think the perhaps arose, but the FSA did not make any Chancellor’s statements reconcile exactly with what provisions in October. The Bank did not book any happened. further provisions in its books. Capital was put into the Bank, which would enable the Bank to meet Q1731 Mr Breed: Sir Tom, you said earlier that you those losses as and when they came through in the do not personally have any banking qualifications. future. There were no provisions booked in October. How many members of your board have banking It was flagged at the beginning of November that qualifications? there would be further provisions and they could not Sir Tom McKillop: I do not have any banking be quantified at that time, and it could not be certain qualifications, but I was on the board of Lloyds TSB whether the Bank was going to make a profit or a for nearly six years and obviously have been in loss. It was very clear and very stark what was said. positions as chief executive— Unlike the time of the rights issue, when we announced the rights issue we said the amount we Q1732 Mr Breed: How many members of your were raising and we said what we thought the board have? provisions would be. At the time the capital was put Sir Tom McKillop: The board of RBS had over 300 in in October—and again this is not a complaint, this man or women years of financial services experience was moving at flying speed—all that was done was and over 160 of those years of experience were with the capital was put in which would allow losses as the non-executive directors. they came through, based on the FSA’s estimates of what might happen, to be met. The provisions were not booked, and there was no discussion as to what Q1733 Mr Breed: How many members of the board the P&L eVect would be. The announcement that had banking qualifications? was made to the market was very clear. If you go Sir Tom McKillop: I would need to go through them, through that announcement it is remarkably a number: Joe MacHale, Colin Buchan, Bob Scott, prescient in terms of what it said might happen. Peter Sutherland—

Q1728 Sir Peter Viggers: So taxpayers’ money was Q1734 Mr Breed: And they would have participated invested in banks known to contain toxic assets in core decisions? without provision for future down rating? Sir Tom McKillop: —Larry Fish, so quite a number Sir Fred Goodwin: No, I would not characterise it in had formal banking experience. that way. The 13 October was not an accounting period end. There was not a provision to be booked. Q1735 Mr Breed: When you became chairman of the The bank was not publishing financial statements. bank were you approved by the FSA at all? Were you What the training update at the beginning of interviewed? Was the FSA in any way involved in November said was what was likely to happen for your appointment as chairman of the bank? the rest of the year, it was giving an outlook. What Sir Tom McKillop: The FSA has to approve any the announcement the bank made on 19 January did director of a bank, yes. was alert people to the fact that when the results come out some time later this month the number will Q1736 Mr Breed: Did they interview you? be diVerent from what some of the analysts had Sir Tom McKillop: No, they did not interview me. pencilled in. There is no double-counting. There is nothing happening that was not envisaged in Q1737 Mr Breed: So it was just a paper exercise that V October. I am sure the quantum of it is di erent from they signed oV? what was envisaged. Sir Tom McKillop: They saw the full account of my history. They had approved me being on the board Q1729 Sir Peter Viggers: Do you think the of Lloyds TSB. investment of taxpayers’ money was made after due diligence? Q1738 Mr Breed: Looking at the risk management Sir Fred Goodwin: It was not made after due side, did you undertake yourself any training or go diligence in the form of an exercise. The FSA knew through any sort of educational experience to enable a lot about the group, so there was knowledge. The you to participate fully in any of the risk FSA ran their model. It was the FSA which management decisions? determined how much capital they wanted to put Sir Tom McKillop: Every director joining RBS goes into the business. I would consider that to be through a very full induction programme involving diligence. In the ordinary sense of a team of people exposure to each of the businesses and sessions with going in to do an exercise called due diligence, there risk, finance and so on and I went through that simply was not time. process. In fact, I committed a very significant amount of my time ahead of becoming chairman to Q1730 Sir Peter Viggers: It does not reconcile with getting to know the bank as well as I could and that the statement by the Chancellor of the Exchequer, “ included detailed discussions with risk. Indeed, . . . having regard to the diYculties faced in the before I joined the board I carried out due diligence, economy as to what the liabilities of the banks might including talking to outside directors, reviewing the be. That is why it took what was regarded as a high level control documents and reviewing the cautious view.” Arrow reports from the FSA of the bank. Processed: 25-03-2009 22:28:06 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG11

Treasury Committee: Evidence Ev 233

10 February 2009 Sir Tom McKillop, Sir Fred Goodwin, Lord Stevenson of Coddenham and Mr Andy Hornby

Q1739 Mr Breed: So you felt that, in terms of the risk shareholders. The second thing, which I think management aspects of the bank, you were qualified perhaps is more important, is we pulled back further through experience, knowledge and everything else on our mortgage market shares, which fell to 14% to enable you to participate fully when you were net lending in 2007 and down to 8% in 2008, which talking about complex financial instruments and was considerably below the historical average. If we anything which might involve the risk management go back to 2002/03, HBOS was operating at around of the business? a 25% share of net lending. The third thing is we Sir Tom McKillop: I would not describe myself as an recognised the fact that the wholesale markets were investment banker with knowledge of every complex getting an awful lot more diYcult. We had already financial instrument, but, yes, I think I had a pretty considerably extended the longevity of our good understanding. wholesale funding. If I look back and say what could have been done diVerently, there is no doubt that if Q1740 Mr Breed: Lord Stevenson, you did not have we could have gone even further on that over the any personal banking qualifications. How many previous five years that would have been a beneficial members of your board had banking qualifications? situation. Lord Stevenson of Coddenham: The majority of our executive directors were career bankers. I suspect all Q1745 Mr Breed: So you are saying you responded of them had banking qualifications. I know of two to the concerns raised by group regulated risk? who definitely did because I just happen to have Mr Hornby: Yes. There was a constant dialogue. talked to them about it or remember it from their CVs. In terms of the independent directors, we had the former treasurer of Bank of America, which is Q1746 Mr Breed: Did you actually change the model highly relevant to the thing we have been through, of the business in response to the concerns raised by we had the person who had been head of all legal group regulatory risk? matters in compliance and risk for Standard Mr Hornby: Every month when we are looking at Chartered, and we had Tony Hobson who had been asset growth we would be having a dialogue both the long serving finance director of Legal & General. with the finance function and with the risk function in order to try and get to what we consider to be Q1741 Mr Breed: So overall you had a good breadth appropriate levels of investment. of experience on the board to be handling that? Lord Stevenson of Coddenham: Yes. We set it and Q1747 Mr Breed: With the exact science of planned it that way. hindsight, did you perhaps recognise that those siren voices warning you of the problems lying ahead were Q1742 Mr Breed: You may well have become a lot more relevant than you gave them cause to be chairman before the FSA or at about the same time. and, in fact, that any changes you made were Did the FSA formally approve your appointment? relatively insignificant, which then ultimately led to Lord Stevenson of Coddenham: I believe they did. I the demise of the bank? think there is a fit and proper person regime. Mr Hornby: I really do believe we listened to siren voices very carefully. It is clear with the benefit of Q1743 Mr Breed: So they did not interview you? hindsight that, over many years of reliance on Lord Stevenson of Coddenham: I do remember going wholesale funding, that left us in a vulnerable and having conversations with Howard Davies. I do position. I do believe, though, particularly when you not know if that was part of the fit and proper person got to 2006-2007, that we recognised the lines. We regime. It was round about the time that I became tried to increase deposit growth and grew deposits chairman. They went through a formal process of faster. agreeing me. Q1748 Mr Breed: But that was all too late. If you had Q1744 Mr Breed: Mr Hornby, you have explained taken notice of what was being said to you a couple the three levels of defence as such. Is it not the truth, of years earlier you might not have got into that however, that the siren voices, particularly from position. your group risk manager, were warning you that Mr Hornby: I think if you look hard at the facts from things were going in the wrong direction for quite 2006 and 2007 when I took over as CEO, we did try some while? Is it not true that you overrode that and and preserve capital, we stopped the buyback ignored those voices which were saying to you and programme, we reduced asset growth and we pulled the board that there was real risk in the business back on mortgage market share. Of course, looking model of the bank? back, I would have liked to have done even more and Mr Hornby: No, I would not agree with that. I took I concur with the views that other people have said over as CEO in September 2006. Let us look at the on the panel. We did not fully prophesize the set of actions that were taken in the next 18 months complete closure of wholesale markets post- to minimise our risk position. The first move we took Lehman’s when wholesale markets were operating was to stop share buyback programmes in order to on an overnight basis. We did prophesize reductions preserve capital. It was recognised that the economy in liquidity. I believe there are very few people in the was going to get an awful lot more diYcult and world who foresaw the complete collapse and I therefore I was extremely keen to make sure that we regret that because clearly I would have tried to pull tried to pull back on handing capital back to back even more. Processed: 25-03-2009 22:28:06 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG11

Ev 234 Treasury Committee: Evidence

10 February 2009 Sir Tom McKillop, Sir Fred Goodwin, Lord Stevenson of Coddenham and Mr Andy Hornby

Q1749 Mr Breed: As an ex-retail agent, do you Q1754 Mr Breed: If the bank failed and went into believe you are fully qualified to run a bank? liquidation then surely all those contracts which Mr Hornby: I actually had been on the board of were then entered into by the bank would have failed HBOS for seven years previously. I believe I had as well. acquired a lot of banking knowledge during that Sir Tom McKillop: That may be the case. seven year period. When you look at the balance of the team, I had a finance director with over 30 years Q1755 Mr Breed: Is that your understanding, Sir banking experience, a head of corporate banking Fred? with over 30 years experience, a head of treasury and Sir Fred Goodwin: I could not be sure, but employee international with over 30 years banking experience related contracts usually have preference in and a head of retail who was a lifelong banker. When liquidation. I do not know is the answer. you look at the executive team, those five key people had over 150 years of banking experience. Q1756 Mr Breed: Lord Stevenson? If they had failed Q1750 Mr Breed: Sir Fred, you were involved in then there would be no contractual arrangements in banks in the past and looking at their regulatory terms of service agreements. systems and risk management systems. Did you ever Lord Stevenson of Coddenham: I imagine they would override any recommendations from your risk have a legal claim on the assets. management team or the Risk Management Committee in terms of pursuit of the expansion of Q1757 Mr Breed: It would be the same as a creditor, the bank? which would be nothing. Sir Fred Goodwin: No. I would find this easier to Lord Stevenson of Coddenham: I cannot see where reconcile in my mind if there had been a siren call they would be in the queue. that had been overlooked or overturned. As we go back through—and we have had occasion to do this more than once—the siren call is not there. It is Q1758 Chairman: Andy, you said in answer to Colin easier now to go back and see things, but we did not Breed that, in terms of the creation of the reliance in see it. the wholesale market, you did something about it as chief executive, but you were a Board member before that, from 2001. Was there any time on the board Q1751 Mr Breed: The acquisition of ABN Amro was when you voted against it? one of about 26 or 27 acquisitions that you made in Mr Hornby: No. In the period before I was chief a relatively short period of time. It has been executive—and Denis was chairman through this suggested that the vast majority of those acquisitions period—as reliance on wholesale funding was were perhaps not as bad as ABN Amro, but they growing so we tried to increase the longevity of the were not considered great value for money when wholesale funding. From memory the amount that looked at in the cold light of day subsequently. How was maturing within one year fell from 60% to about do you respond to that? 47% of the wholesale funding as we tried to reduce Sir Fred Goodwin: It is diYcult to respond. I think, of the longevity. I accept the fact that with the benefit the 24, most of them would be extremely small. Some of hindsight we could have done even more. would be better than others. As to the generality of it, they were all acquisitions that we were happy to undertake. They all went through the appropriate Q1759 Mr Tyrie: Mr Hornby,you have said that you governance process. A number of them would have listened very carefully to siren voices, although been approved by our shareholders, as the ABN presumably you shouldn’t listen to siren voices but Amro transaction was, and they were all done for the perhaps to air raid sirens. Lord Stevenson, you have best of motives. It is a reality in business that you said that you exercised good countercyclical caution. have to make judgments, you have to try and predict You have also said, Mr Hornby,that HBOS had very the future and you do not always get it right. As to elaborate risk testing systems in place, or perhaps it our previous acquisitions, I cannot think of one was Lord Stevenson. Your ex-Head of Group oVhand that was a glaring mis-step in the way that Regulatory Risk tried to use those very systems to ABN Amro clearly was. protect the bank and, when he tried, he says that he was subject to “threatening behaviours”. Is that Q1752 Mr Breed: But they were not startling true? successes either. Mr Hornby: Absolutely not. Sir Fred Goodwin: I do not think they need to be startling successes; just successes is fine. Q1760 Mr Tyrie: He has made it up, has he, when he says, “My team and I experienced threatening Q1753 Mr Breed: Sir Tom, is it your understanding behaviours by executives when carrying out our that if RBS had been allowed to fail rather than to be legitimate role . . . ”? bailed out then all bonus contractual arrangements Mr Hornby: I have absolutely no recognition of would have ceased with them, so there would have what he might be referring to. I assume you are been no contractual future bonus systems? referring to the period way before I was chief Sir Tom McKillop: I could not answer that from a executive. I really do not know what is being referred legal point of view, I just do not know the legal to. All I can say is that in my experience of watching details of all the contractual arrangements. HBOS executives interacting with risk professionals Processed: 25-03-2009 22:28:06 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG11

Treasury Committee: Evidence Ev 235

10 February 2009 Sir Tom McKillop, Sir Fred Goodwin, Lord Stevenson of Coddenham and Mr Andy Hornby both before and after I was CEO, I saw people in a Mr Hornby: As we outlined in our submission, we constant dialogue and really trying to face head on did try and make radical changes. We have all into issues. I do not recognise that behaviour. accepted the fact that the balance sheet growth that had been built up over many, many years meant that Q1761 Mr Tyrie: He says that board minutes failed we did end up over-reliant on wholesale funding. We to record his expressions of concern that the bank would have liked to have predicted an even greater was going too fast. Is this true, Lord Stevenson? contraction in wholesale funding markets. I think it Lord Stevenson of Coddenham: No, it is not true. would be diYcult. I accept the fact we did not fully prophesize it. I do not believe that was because we Q1762 Mr Tyrie: He has made that up as well, has were not listening to the risk function. he? Lord Stevenson of Coddenham: We are talking here Lord Stevenson of Coddenham: I think that is using about our retail business. At any point in time, of an emotive phrase. People say things. I am familiar course, we are reviewing our risk management and with the episode and the issue. I think I am right in the balance between sales and caution at any point saying that as a result of the allegations we in time. Just to be absolutely clear and we would be commissioned a very extensive independent study of happy to supply backup on it, we did a clear review everything together with the FSA which clarified of it, at the end of which the FSA regarded the this, which is the basis on which you are getting such matter as closed. We are very happy to give you all a robust response from us. If I am right about that, the information you need to back that up. I think it would be absolutely in order, though I shall check, for that to be made available to you. Q1767 Mr Tyrie: So it is the FSA that also got it wrong, is that your suggestion? I hope you do not Q1763 Mr Tyrie: So all these completely disagree with the view that the statements of caution unsubstantiated allegations the FSA themselves he was making on the points of substance were would not recognise, is that what you are saying? wrong, that you should have gone hell for leather Lord Stevenson of Coddenham: The allegations with all these sales and that the balance of risk that were made. you took at the time was right. You began with an Mr Hornby: If you go back to 2005, there were a apology today. whole series of reviews that we were constantly doing Lord Stevenson of Coddenham: I do not disagree internally often with external help and always in with that at all. It is the right frame of mind for any conjunction with the FSA. The FSA personally banking. It is a balance. reviewed the sales culture you are referring to and we made sure that we implemented all the recommendations with very close co-ordination Q1768 Mr Tyrie: So you got it wrong but in your with the regulator. It is as simple as that. That would defence you are saying the FSA got it wrong as well, be the case with all the various risk management is that right? reviews that have been done over the last eight years. Lord Stevenson of Coddenham: No. What you have referred to were some allegations that were made Q1764 Mr Tyrie: Did the FSA uphold your which were independently investigated and the FSA repudiation of all his allegations? were satisfied with them. I am very happy to provide 1 Mr Hornby: The FSA—this is before I was chief you with all the backup to that. executive so I cannot speak for every point of detail here—were very clear that our action plans that we Q1769 Mr Tyrie: I will just ask the same question put in place on the back of all the various risk again. You agreed that you got it wrong, that you did reviews that had been done were logical and they not correctly assess the risk. Everyone is agreed that monitored our performance against them. banks did not do that. You are therefore presumably agreeing that Mr Moore correctly identified one of Q1765 Mr Tyrie: Is it not the case that the FSA in these risks to which due attention was not paid. Is their report wrote, “There is a risk that the balance that correct? of experience among senior management could lead Lord Stevenson of Coddenham: I would say it is not to a culture which is overly sales focused and gives correct. I understand the thrust of your question. inadequate priority to risk”? The fundamental mistake, if that is the word, that Mr Hornby: That clearly is in the report. We went HBOS along with many other banks in the world through everything with them in huge detail. If you made was failure to predict the wholesale collapse of look at the balance of the senior team, we had wholesale markets. Mr Moore’s allegations were colossal banking experience, an average of 35 years. nothing to do with that. They concerned a perfectly reasonable area for concern which I and my Q1766 Mr Tyrie: I am not challenging that there are colleagues have been constantly concerned about, experienced people there; I am challenging that they which is the balance between the sales culture on the used this experience eVectively. I am not suggesting one hand and caution and integrity on the other. The that your bank could have possibly escaped the area, as we have said in our submission, which has crisis, all banks have been hit; I am challenging the caused HBOS problems has been the collapse of view that you did not take reasonable steps in light wholesale markets. of very clear warnings that were being made from within your bank. 1 HC (2008–09) 144–III, Ev 664 Processed: 25-03-2009 22:28:06 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG11

Ev 236 Treasury Committee: Evidence

10 February 2009 Sir Tom McKillop, Sir Fred Goodwin, Lord Stevenson of Coddenham and Mr Andy Hornby

Q1770 Mr Tyrie: You are saying that even with the Q1775 Mr Mudie: That is Adam Applegarth. advantage of hindsight you got the balance between Mr Hornby: The balance sheet growth that we put the sales culture and the risks that it might generate on, no one is taking away responsibility for that and correct. You are unrepentant about the judgments we are very clear on that in our submission. I think you made even with the advantage of hindsight. Is the point which Denis is making and which I that correct? completely comply with is about the complete Lord Stevenson of Coddenham: You are forcing me closure of wholesale markets in the way that they did into a corner. completely close. We did take a lot of premeditated My Tyrie: I was just trying to get a straight answer actions in order to try and reduce our reliance on Lord Stevenson of Coddenham: The truth is that those markets. Clearly if we had seen the fact that there is no absolutely correct balance in any part of they were going to close entirely coming we would our business or any other bank’s business. I think if have done even more even earlier and even quicker. you were to examine our retail business over the last We do accept the fact that the building up in the few years you would find that we had not got it very balance sheet over many, many years meant that we wrong, particularly the thing you are talking about. were reliant on wholesale funding. The contrary Just to be absolutely clear, going right back to what point is that we did try. We would have liked in both Andy Hornby and I said at the beginning, we retrospect to have done even more. We did take fully accept that we failed to predict what happened action to recognise the risk there. in wholesale markets. Q1776 Mr Mudie: Nobody is suggesting you did not. Q1771 Mr Tyrie: You said that you had not got it You ran a business in a way that got caught out when very wrong which must mean that you got it roughly the market conditions changed. I interrupted you right. Is that right? and said Adam Applegarth. He got abused right, left Lord Stevenson of Coddenham: Right. The other side and centre for his extreme model. You ran not of which is— exactly the same sequence but a flawed model. You ran something that when the market conditions changed your business is in a very bad way and you Q1772 Mr Tyrie: Why are you apologising if you got are an ex-chief executive oYcer. it roughly right? I am left bewildered now. Mr Hornby: Yes. It actually goes back many, many Lord Stevenson of Coddenham: It is apples and years in that the former Bank of Scotland business lemons. We are apologising for what happened to was largely reliant on wholesale funding that did not our business and we have made it plain that the key have a retail deposit base in the UK. factor that aVected what happened to our business was the collapse in the wholesale markets. That is not the issue that Mr Moore is raising and you are Q1777 Mr Mudie: I know that. We are all aware of raising. that. Just accept it. Do not try and equivocate, et cetera, et cetera. You did something that was applauded whilst you were making a lot of brass. It Q1773 Mr Mudie: There are shades of Adam turned out to be dodgy when the market conditions Applegarth here, ie there was nothing wrong with changed. We can move on when you say that is it to you, it was the market and the extreme credit crunch, decide how we can adjust external factors or even the breakdown of wholesale markets. Is that what internal factors to prevent this sort of thing you are saying? happening again. Is that not the way forward? Lord Stevenson of Coddenham: No. Mr Hornby: I completely agree. We have already said that the building up of reliance on wholesale markets was what has left us vulnerable. Q1774 Mr Mudie: What are you saying? We did not bring you here, contrary to what the press think, to cause you public humiliation. We brought you here Q1778 Mr Mudie: That means risk. What Andrew is to find out what happened, to hear how we avoid it questioning is the fact that you sacked a barrister, a happening and what steps we should take. There are fella who had been complimented at various times two chairmen here. What is causing the anger in the by various people. A senior figure prevented him public’s mind is that you are in denial. Your group from putting something in the board minutes which risk manager said you were selling too fast, too much said you were running a risk here. He says in his and it was very risky and you sacked him. You come memo to us, “When I was Head of Group to this Committee and you say to Andrew, “He got Regulatory Risk at HBOS, I certainly knew that the it wrong. We got it right.” You are the ex-chairman bank was going too fast (and told them), had a and he is the ex-chief executive oYcer who got it cultural indisposition to challenge (and told them) right. Why are you the ex-chief executive and ex- and was a serious risk to financial stability . . . and chairman if you got it right? consumer protection (and told them).” That is what Mr Hornby: What our submission clearly says is that he is saying. You equivocated when Sally asked you the balance sheet growth that had been put on over and you further equivocated when Andrew asked many years, from the inception of HBOS in 2001, you. You sacked this fella. He took you to an meant that we were overexposed to wholesale industrial tribunal and he won. We are told you paid funding when the wholesale funding markets closed. him undisclosed damages and put a gagging order That is indisputable. on him. In fairness to a bank learning lessons, it Processed: 25-03-2009 22:28:06 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG11

Treasury Committee: Evidence Ev 237

10 February 2009 Sir Tom McKillop, Sir Fred Goodwin, Lord Stevenson of Coddenham and Mr Andy Hornby seems to us in the Committee with this document Mr Hornby: No. What I said was she had many that you did not want anybody being blunt with you years of working in the banking industry, including about the risks you were running. in risk management. Lord Stevenson of Coddenham: I understand exactly what you are saying. First of all, I remember the Q1784 Mr Mudie: How come your chairman said incident very well. It was taken very seriously by the she did? Board at the time, with the Chairman of the Audit Mr Hornby: She had not had a formal risk title, but Committee, Tony Hobson, doing it. We she had many years of working in the banking commissioned an independent study into it. I am industry within risk. If you talk to the chief executive very happy to provide all the materials to the who took the decision, he made sure he strengthened Committee about it. I do think that in a number of the risk function alongside in response to the report areas it is a fact that very carefully arranged risk and in response to all the other actions. management systems developed over the years with our regulator did not spot scenarios coming out that Q1785 Mr Tyrie: You have made specific denials on have come up. The stress testing did not stress test a wide range of issues raised by Mr Moore which adequately. I am being very open. There is nothing taken together appear to challenge all the in denial about that. I am just being very open about substantive points that he has made, that the risk it. How that is changed in future is a hugely culture was out-of-kilter in your bank and you important issue. appear to be blaming everything on the collapse of the wholesale markets. You will correct me if you Q1779 Mr Mudie: Not only did you sack him, the think I have misinterpreted what you have just been person you appointed in his place had never carried saying. His allegations are very specific and detailed. out a role as a risk manager of any type before. The He said at paragraph 2.13, for example, “I told the individual had primarily been a sales manager and Board they ought to slow down but was prevented was a personal appointment of the Chief Executive from having this properly minuted by the CFO. I OYcer and was against the wishes of other directors. told them their sales culture was significantly out of Does that not worry you, if that is true? balance with their systems and controls.” Is it true Lord Stevenson of Coddenham: It is not true. The that he was prevented from having his concerns board took it very seriously. It was a major properly minuted? preoccupation. The board was briefed on it by the Lord Stevenson of Coddenham: I am not aware of chairman of the audit committee with personal that communication. We took it very seriously. We responsibility on it. We delayed the appointment of had over a nine month exercise investigating it. May the person you are talking about, who is an I suggest that we make that available to the outstanding executive, until the independent review Committee? You would be free to talk to the FSA had been carried out and until the FSA and about it who were involved in it. The one thing I can ourselves were happy with it. assure you, there is no denial, anything to do with risk is taken very seriously by the board. Q1780 Mr Mudie: Andrew made the point that, at Q1786 Chairman: Paul Moore said that prior to the end of the day, you sacked your group risk fella HBOS, from 1995 to 2002, he was a Partner with for the warnings he gave you. Now, four years later, KPMG’s Financial Sector Practice specialising in it turns out he was right and you were wrong. regulatory services and advised a number of Mr Hornby: This incident you are referring to was FTSE100 companies. He says in paragraph 3.19 that with the former chief executive back in 2005. he was dismissed by the then Chairman, James Crosby, who said, “The decision was mine and mine Q1781 Mr Mudie: You were on the board then. alone” but refused to explain why. He then goes on Mr Hornby: I was on the board. When James to say that what this has led to is “ . . . millions of proposed the appointment, as he did, of Jo Dawson people in excessive debt, 10,000s who will lose their to take on that role, I, along with many others, jobs and many more whose balance sheets have been thought it was a very good appointment. She had impacted by the precipitous fall of the HBOS share huge banking experience built up over many years. price . . . ” That is his accusation which is on the record. To be fair to yourselves, if we engage in this correspondence it will help us because we want to be Q1782 Mr Mudie: In risk? fair to everyone. Mr Hornby: In many matters very pertinent to risk Lord Stevenson of Coddenham: Yes. management. Q1787 John Thurso: I want to look at the issue of Q1783 Mr Mudie: We are arguing about risk. You corporate governance and the role of non-executive sacked this fella and then you appointed someone directors. Before I do that, can I say to you all that else who this gentleman is suggesting had no—and I my constituents will appreciate the full apology you did not mention a girl or her name in fairness to the have given because I have rarely had so much anger individual—risk experience of any kind. Your expressed to me over the last few days. I did not chairman says that the individual who gave us this is know that my constituents knew the Treasury telling lies on this point. Can you just confirm that Committee existed let alone what was going to be you are saying she had risk experience? happening today. It is because so many businesses Processed: 25-03-2009 22:28:06 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG11

Ev 238 Treasury Committee: Evidence

10 February 2009 Sir Tom McKillop, Sir Fred Goodwin, Lord Stevenson of Coddenham and Mr Andy Hornby are today in danger of failing, because they cannot the risk appetite. Every year it reviewed that get sound businesses and because they cannot get formally and it would review the risk appetite for that money. I think that is appreciated. Let me turn every part of the business anew and, if necessary, do to the question of corporate governance. Every time it more often. we get bankers from failed banks appearing in front of us we get the refrain—and I have heard it this Q1790 John Thurso: Do you think non-executive morning—that we could not see it coming, it was directors with an institution as complicated as a wholly unpredictable and it was this great financial bank and dealing in things that we have learned even tsunami that arrived out of nowhere. At the base of full-time bank execs did not understand are actually all this is a failure to calculate, measure and manage capable of having any relevance in the process? risk and we have seen it before. If you look at Lord Stevenson of Coddenham: That is a very leading Salomans in 1992, if you look at long-term capital in question which could apply to all complex 1998 and many other examples, actually the core is businesses. We talked earlier on in response to the there. What I really want to find out is what role the question from Mr Breed about the composition of non-executives can and should play and what they the board. I think boards have to be very carefully did play and whether there are lessons in that. and thoughtfully composed because you need to Perhaps I can start with you, Lord Stevenson. What have people on them who can really burrow down part did your non-executives play in the oversight of and understand what is going on. I referred, for risk and the risk management strategy? example, to John Mack, the former treasurer of the Lord Stevenson of Coddenham: I will have to Bank of America who really understands the elaborate a little bit to answer your question on the treasury function. Secondly,and this reflects no more structure that Andy Hornby mentioned to you. Each than conversations I have had with prospective of our businesses had a risk function. Then there was directors, you need to have people who are prepared a separate independent group risk function which to invest a lot of time in learning. If you take Basel had five committees for each category of risk, II, that is less on the agenda now than it was, the liquidity risk, asset and liability, market risk, members of my board had to go through session operational risk, et cetera, which met regularly on a after session on it; it was like being at school and monthly basis and has met more often in the last 12- being educated on it. HBOS is a comparatively 18 months, particularly on liquidity. Then there is simple business in the scheme of things. We did not the audit committee which operates independently. do investment banking. We did not have a lot of the As we have been referring to so far, there are complexity of other businesses, but it is still a large subsidiary audit committees which we call risk complex business. For directors to be able to add committees for each business and each of those value (a) it is a good idea to have some directors who committees was chaired by a non-executive member have been there done it, which we did, and (b) you of the board with at least one other non-executive should not have any directors who are not prepared member of the board on it. At the level of each to invest a lot of time in going up the learning curve. business, quite aside from what was happening on the Board, which I will come to in a moment, there Q1791 John Thurso: Are there any were at least two members of the board regularly recommendations out of this experience that you meeting to consider all the risk issues in each of those would make for the role of the non-executive future businesses. Let me come to the board. As I said composition of boards? earlier on in response to the question from Ms Lord Stevenson of Coddenham: You are asking a Keeble, there was a direct line between the head of question which I do not think I have got a precise risk and the board and, of course, to state the answer to. Perhaps I could go back to the exchange obvious, the chairman of the audit committee was we had with Mr Mudie. I do think that there are real on the board and a very important member of it. issues about how stress testing is carried out and risk management takes place. I imagine we are not unlike Q1788 John Thurso: Was there a direct line from the many other large banks, but we stress tested head of risk straight to the chair of the audit regularly. In answer to your question, I would be committee? very confident that the non-executives really got Lord Stevenson of Coddenham: Yes. underneath the stress testing that was carried out. We would have serious debates about it, looking at Q1789 John Thurso: So he could circumvent the possible scenarios. The question is why we did not CFO if he chose to? foresee certain scenarios. The question is whether Lord Stevenson of Coddenham: Yes, as could I, as there could be a category of non-executive director could he. It would be instructive to just look, if you who brings that to bear. I do not know. want to pursue it, at our board meeting agendas in recent years where I think you will find there has Q1792 John Thurso: Where I think I am going is that hardly been a board meeting without a substantive I am coming to the realization that a board of part- chunky discussion on risk. I think it is relevant and timers will never actually be able to deal with things I understand the frustration, but all issues on risk that are as complex. Whether that goes to other were fully ventilated at the board. That does not industries, I do not know, but there is a heck of a mean to say we got it right, but there was a diVerence between a £500 million company in the completely open society, I do assure you. Basically hotel industry, which is relatively straightforward, the board, quite rightly, was responsible for setting and a £100 billion company dealing in complex Processed: 25-03-2009 22:28:06 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG11

Treasury Committee: Evidence Ev 239

10 February 2009 Sir Tom McKillop, Sir Fred Goodwin, Lord Stevenson of Coddenham and Mr Andy Hornby

financial instruments. It may well be that the senior Q1794 John Thurso: I want to pick you up on two independent has to be a full-timer who is paid to points that you mentioned earlier, one of which was make life diYcult and that is his job. that you said that at every stage the board were Lord Stevenson of Coddenham: The issue of non- unanimous in their decisions, this was regarding executive pay that you raise is an interesting one. ABN Amro. Obviously when the board makes a When I became chairman I looked at what was then public decision, it is a decision and people do not called the Section 39 FSA Report, which is the dissent from that. Was the board truly unanimous all equivalent of the Arrow reviews that I am sure you the way through? Was nobody saying, “Hang on, are familiar with, which had some fairly harsh things guys, this looks a bit odd”? Was anybody dissenting? to say about the audit committee process, et cetera, Sir Tom McKillop: Thank you for the opportunity et cetera. I then looked at actually what was required to put a bit of colour on this because I think it would of the audit committee and I realised it was huge, so help to understand how the board of RBS and we re-specified the job. We had to get someone with indeed, in my experience, a number of other boards hugely relevant experience who was paid to devote a would work. In RBS we typically have a dinner the lot of time to it, which we have done and I think that evening before the board meeting and during the has stood us in very good stead. I am broadly course of that whole evening there is extensive discussion of whatever the matters of the day are. So sympathetic to where you are coming from. We put there is lots of air time for ideas, views, what is going a lot of trouble and time into this. There is a lot of on in the economy and so on. I think the input from talk about not enough bankers being on boards, but a whole range of well-informed non-executive it is very diYcult to get non-executives with banking directors is very important in setting the framework experience on boards. I know because I have been V for a company. Your suggestion of having maybe there. We put a lot of time and e ort into getting a one full-time independent director risks missing out board with enough experience of having been there on that. It will be interesting to see what Sir David and done it. Walker’s review comes up with. Typically there would be a lot of discussion the evening before and we would deal with all the formal matters of the Q1793 John Thurso: I think you need a few who are board during the course of the next day.Doing it that not bankers. Those have to be prepared to invest a way meant items did not suddenly come on the table lot of time. Sir Tom, I think you are quoted as saying proposed by the executive for a decision and a vote that the RBS board non-execs were not a group of was taken. There would be a consensus building, an “patsies”. We have evidence here from one of your exchange of views and an enormous amount of principal shareholders who told us that they had challenge went on. In the ABN Amro deal, for been putting pressure on you to get rid of the CEO instance, everyone wanted to do some part, but there and on the senior independent to get rid of you. How was a spectrum of opinion about which elements of do you square what he told us with what you said? the business we should take or make an oVer for. Sir Tom McKillop: What he said was absolutely That is an example of the kind of discussion that accurate. It was one part of a collection of inputs would take place. from the major institutional shareholders. There were other institutional shareholders who had quite Q1795 John Thurso: Do you not think that iterative contrary views. All of those meetings which were consensual process leads to “deal-itus” where the held with the institutions were minuted, the desire to end up doing a deal takes over from summary of all of that was put to the whole board everything else? and it was all considered by the board. There were Sir Tom McKillop: No, I do not. I think there is a institutions which were very keen to ensure that Fred danger that that could be the case, but that was not Goodwin stayed because of his experience in the my sense of what happened in the RBS board. integration of NatWest. There was some very, very strong lobbying to see that he was not removed. Q1796 John Thurso: You said something which I Likewise, there were institutions who wished me to thought was remarkably profound at the beginning, stay. I can assure you that at the time of the April which was to draw our attention to the historical rights issue I spoke with each director, got their views diVerence between the investment merchant banking on all of this individually, the non-executive culture which has come about almost entirely from a directors met as a group without me and the whole partnership background, where the whole point is at board met. I indicated to the board at that time that the end of the year everybody chops up any money I would step down if that was in the best interests of there is and they all get a bit of it, and the commercial the bank and indeed I have reiterated that on several retail banking background which is traditionally a occasions over the course of the last year. I would joint stock company in which fairly staid and always do what is in the best interests of the bank. conservative Scotsmen actually end up conserving There was never a question of trying to hold on. The and guarding the money of ordinary people. I put it evidence you received was one piece of input and it to you that one of the problems is that these two was not the general view. Indeed, I understand ABI cultures actually simply cannot mix, that non- consulted a number of shareholders in a meeting and executives have no idea how to get a handle on the there was not an agreement that they should seek the swosh-buckling investment types and that the only removal of the chief executive and myself. We need way we will deal with this is to get some form of to see it in that context. glass ceiling. Processed: 25-03-2009 22:28:06 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG11

Ev 240 Treasury Committee: Evidence

10 February 2009 Sir Tom McKillop, Sir Fred Goodwin, Lord Stevenson of Coddenham and Mr Andy Hornby

Sir Tom McKillop: It is a very interesting subject for Q1801 Chairman: When I look at the board of Royal discussion. There have been lots of discussions Bank of Scotland, you had the brightest and the taking place on the universal banking model, ie will best. You had Sir Peter Sutherland, who was investment banks survive per se. It looks as though chairman of BP and Goldman Sachs and the they are all moving away from being pure investment director general of the World Trade Organisation, banks unless they are very “boutiquey”. There is a you had Bob Scott, the senior independent director, really interesting discussion to be had here. Around the former group chief executive of Aviva and ex- our board table we did have several non-executive chairman of the board of the Association of British directors with real experience of investment banking Insurers, and you had Steve Robson, a former and they brought that experience to bear in the audit Second Permanent Secretary to the Treasury. He was committee and so on as well as round the general there with Terry Burns when the tripartite authority discussion. The larger an organisation becomes and was established. I could go on. The best and the the more complex it becomes then you can argue the brightest were there, Sir Tom. There has to be more diYcult it is to control it. That is a subject that something more fundamental here. Do you not has merited a lot of discussion. I would point out, think that the vulnerability was greater than you however, that in this crisis as many, if not an awful realised because of the sheer complexity of the lot more, small banks, single line banks, have gone products or inadequate monitoring and that perhaps down than big banks or required funding. There are you did not understand the complexity? We had the many,many single business line operations that have auditor from KPMG here and I asked him, if he sat suVered in this crisis. So it is not just a matter of the down for a night and looked at HSBC’s books for size of the banks. the night, could he fully understand it and he said no. Even the brightest and the best cannot understand Q1797 John Thurso: The really phenomenally that complexity. We could not have better qualified economy shaking problems have been the world size people. There has to be systemic problems here. I put institutions with tendrils in every business. it to you that the expansion of new financial Sir Tom McKillop: I would submit that Lehman’s instruments increased the complexity to such an was the trigger for so much damage and Lehman’s extent that people did not really understand them. was not a universal bank. Sir Tom McKillop: I agree with the thrust of your question. I would say the four best things I have read around this crisis are the speech from the Governor Q1798 John Thurso: I have to say, 99% of my of the Bank of England recently in Nottingham, constituents feel that if a great black hole opened up Lord Turner’s lecture at the London Economics and every merchant banker in the world and Group, the Financial Stability Report and also the arbitraged trader and credit derivative inventor IFF report. disappeared down it the world would be a better place and could we get back to Captain Mainwaring Q1802 Mr Love: Nothing from the Treasury running a bank we could trust! Committee? Sir Tom McKillop: I recognise that sentiment! Sir Tom McKillop: I have not read anything yet. Maybe the magnum opus is to come! A very common Q1799 Chairman: Sir Tom, you mentioned a dinner theme comes out from all of these that I would the night before the board meeting. Was the finest subscribe to. malt served the night before? Sir Tom McKillop: No. These were working dinners, Q1803 Chairman: Lord Stevenson, do you accept the Chairman. thrust of what I am saying? Lord Stevenson of Coddenham: I think you are Q1800 Chairman: What do you think your following on from what Mr Thurso said. These are qualifications as a chairman were for this job? The large complex businesses even when, as in our case, reason I am asking that is not to have a go at you they do not do investment banking activities and it because I respect the distinguished career you have is a very challenging question as to who are the had in the pharmaceutical industry, but there is right people. something deeper here we have got to get to. Why do you think you were qualified to be the chairman? Q1804 Chairman: The Governor of the Bank of Sir Tom McKillop: I had a very strong numerate England has almost said the same thing in his background. I am a mathematician and scientist by evidence to the Committee. If it is a complex background. I carried out post-doctoral research in financial product and if we have got the brightest an applied mathematics institute in Paris, so I am and the best there—and you are one of the brightest certainly numerate. I had five years on the board of and the best, Sir Tom—there is something we need Lloyds TSB. It was not the same bank as RBS to do to remedy this situation. became, I accept that. I also have had extensive Sir Tom McKillop: Can I give you my own view here experience of chairing organisations and being chief of what has happened? Securitisation, the originate executive of one of the world’s largest and distribute model, was seen as a stabilising pharmaceutical companies. I was involved in major influence in the financial systems. It has been cross-border mergers and indeed in really complex discussed in many forums that I have participated in. transactions. I think I had a fairly good This was distributing risk. This was making the understanding of these matters. whole system more stable. It has not turned out that Processed: 25-03-2009 22:28:06 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG11

Treasury Committee: Evidence Ev 241

10 February 2009 Sir Tom McKillop, Sir Fred Goodwin, Lord Stevenson of Coddenham and Mr Andy Hornby way. It has turned out completely the opposite to say he has not got a specialist financial background. expectations. Everyone has been surprised about Charles Dunstone made a huge investment of time in that, the regulators, the companies and the banks going up the learning curve of the risk management involved in it. function and yes, he did bring to bear serious challenges at various points. We innovated having Q1805 Chairman: For four or five years we have had risk control committees. We thought the whole thing the best and the brightest before us and when I asked was too big to have one audit committee, it was too the question, “What is the risk?” they say, “Mr complex and we wanted to disaggregate it. There is McFall, times are diVerent. When you went into a perfectly good argument which says, “In an ideal your bank 30 years ago the bank kept most of the world wouldn’t it be good to have people chairing risk. It is now sliced and diced and it is parceled oV. and leading those committees with a more specialist Mr McFall, with Amaranth, the hedge fund that understanding?” went down, $7 billion, do you know what happened? There was not a ripple in the financial sector. So you are way behind the times.” Q1811 Mr Todd: I think one can say he provided Sir Tom McKillop: This is a diagnostic of the challenge in terms of the retail techniques and the underlying thinking. This was stabilising. What approach that might be taken in that sector and happened when Lehman’s went down is that people normally a very supporting challenge, I would realised they did not know where this distributed risk imagine, but perhaps not one which would was and then a freeze took place There was a necessarily look at the area of risk itself in retail complete lack of confidence, you did not know who banking. That is what I am hinting at. I am going you could deal with and the whole thing cascaded back to the issue of the culture of your bank, as to from there. whether the decision making in making that key appointment suggested, not that we wanted to Q1806 Chairman: I put it to you that Peter challenge the senior executive who was at that time Sutherland, yourself and others, Steve Robson, did Mr Hornby, but instead was a supportive figure who not understand it, not because you did not have the would actually more suggest additional ideas for facility, but because of the complexity of it and improving the innovation in retailing, and that is therefore, as far as the future is concerned, we need perhaps not what people would have understood as to do something about that. the function of the chair of a risk committee. Sir Tom McKillop: We had no idea of the speed and Lord Stevenson of Coddenham: As it happens, I think the interconnectedness and how quickly it could all Charles Dunstone fulfilled the role extraordinarily have turned out. well, but I should have explained earlier on that for some years now, recognising the point that we are Q1807 Mr Todd: I want to explore the HBOS risk discussing, we have tried to recruit—and this is very control arrangement again because, turning to the unconventional—outsiders to risk committees who memo that Mr Moore has sent us, he draws have specialist risk financial backgrounds. I think I attention to the process of deciding who would be in am right in saying that when Oliver Page retired, charge of the risk control committee for retailing. who was an ex-FSA person, we recruited him to the How did you make that appointment? You have retail committee. mentioned this committee-based approach to risk led by a non-exec. Q1812 Mr Todd: You will forgive us for not being Lord Stevenson of Coddenham: The chair of each risk entirely reassured by that reference. committee must be an independent member of the Lord Stevenson of Coddenham: He has a specialist board. cradle to grave understanding of risk management. Similarly John Ormerod, the former senior partner Q1808 Mr Todd: And this one was. in one of the accountancy firms, et cetera. Lord Stevenson of Coddenham: However, there have been situations where we have deliberately recruited people to the board because we saw the need for Q1813 Mr Todd: I am more making the point that it someone with the relevant experience. is the culture that perhaps that particular appointment suggests to me as an outsider. Let me Q1809 Mr Todd: The person who was selected for turn to another area of challenge which is the this post was Charles Dunstone, who I think most institutional shareholders. Sir Tom, you have made people would regard as an extraordinarily reference to discussions over the specific issue of experienced and high quality entrepreneur. whether Sir Fred should be persuaded to go. Can I Lord Stevenson of Coddenham: And a retailer. look more at the ongoing relationship with institutional shareholders? How did that work in Q1810 Mr Todd: Would he be the appropriate RBS? person to be a challenge to the business in terms of Sir Tom McKillop: As chairman, I made sure I the risk profile in retailing? oVered to visit and discuss with the top 20 or so Lord Stevenson of Coddenham: Anyone who knows institutions every year on all kinds of corporate Charles Dunstone knows that he is a serious governance matters, on anything that they wished to challenge as a general proposition. The no “patsie” feed into the board. During the course of those I applies to him in spades! Charles would be the first to invariably invited them to telephone me and let me Processed: 25-03-2009 22:28:06 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG11

Ev 242 Treasury Committee: Evidence

10 February 2009 Sir Tom McKillop, Sir Fred Goodwin, Lord Stevenson of Coddenham and Mr Andy Hornby know any input they had for the board. Some would came under huge pressure to make a similar follow up on that and some would not. On average announcement and you feel it. In fact, Andy I would speak with them twice a year. Hornby’s predecessor, James Crosby, is to be greatly commended because I remember we discussed it as a Q1814 Mr Todd: Characterise that relationship. board and this illustrates other points which have Sir Tom McKillop: That was my relationship, but been raised today. We discussed it as a board, and then you have the investor relations programme James said to the board that the regulator has his or which is led by the chief executive, the finance her view as to what our capital level should be, but director and so on. we need to work out the level of capital that we think is right for the business and so we refused saying it Q1815 Mr Todd: I am more looking for whether at publicly, but we were definitely under that pressure. any stage any of these institutional shareholders expressed any concerns as to the business model, the Q1819 Mr Todd: You are presenting yourselves approach to acquisitions of your bank or were they gently as victims in this process? merely challenging you perhaps to deliver higher Lord Stevenson of Coddenham: No. What can be earnings for their shareholders? quite plain, the denial, absolutely not. What is is Sir Tom McKillop: There is no doubt—and my what is. The institutions are the shareholders and it experience of my institutional shareholders goes is our job to remember— back beyond the bank—it would be a very unusual institution that was not seeking a company to grow Q1820 Mr Todd: But remember our job is to look at and to deliver more earnings or better dividends or their role too. whatever. That is a kind of given, that they would Lord Stevenson of Coddenham: Yes. Broadly I would always be pushing the organisation to perform not disagree with their finding. better and I do not blame them for that. With that kind of background you would get into very Q1821 Mr Todd: Can I turn to one of the other specifics. I had been chairman for just under three challenge areas, which is the FSA relationship. In years. I would say the drift from the most both institutions I would assume that you had an institutional shareholders was increase the dividend, almost implanted FSA presence, a very regular share buybacks, return capital, do not sit on capital oversight on a constant basis. Tell us a little bit about and run a very eYcient balance sheet. that in your experience. Yes, let us start with you, Sir Tom. Q1816 Mr Todd: Raise your leverage. Sir Tom McKillop: I met with the FSA perhaps twice Sir Tom McKillop: That would be the body of in the course of a year as part of the close and opinion that I was receiving in the early phase. Of continuous. The FSA also met with the non- course, as it went through, towards the end of 2007 executive directors as a group and would present to people became much more preoccupied with capital the board as part of their normal process. Beneath ratios and saying you need to consider raising your that there was this close and continuous process that capital ratios, which is why in January 2008 I went Fred referred to and that was very regular at all levels out on a very deliberate programme across all the through the organisation. major institutions to take their views on, “If we need to increase our capital, what mechanisms would you Q1822 Mr Todd: Just again for our understanding, prefer? Asset disposal, rights issues and so on.” I was do you recall alarm buttons being pressed at some having those kinds of discussions and feeding all of point, the FSA beginning to express concern? When that into the board so that we could frame options, did that happen, if it did? but even then you would have a very wide Sir Tom McKillop: When I joined RBS I was very diversification of views. pleased to read the Arrow Reports. There was clearly an improving relationship, and a good Q1817 Mr Todd: Can I explain my theme. This is relationship. That was confirmed in the Arrow about challenge, if you like, to the bank. What you Reports and the discussions with the board. There are reinforcing is the commonsense view that was a very full and open relationship. In addition to actually through the good times these guys were not the meetings I have referred to, when we get in to challenging at all, except in the sense of “please give 2008, when there is concern about capital, on two us more”, yes? occasions I had conversations with the Chairman of Sir Tom McKillop: By and large. the FSA about the options that the board were considering on capital. He was certainly Q1818 Mr Todd: I would assume that is roughly encouraging us to raise capital at that point. what your experience was at HBOS? Lord Stevenson of Coddenham: A simple example, Q1823 Mr Todd: Yes. I think it is fair to say that after Basel 2. The general view was that Basel 2 would Northern Rock the FSA probably started pressing lower the amount of capital required for housing buttons in all sorts of places because it was fairly finance organisations and I cannot remember but obvious they had not been doing much in that one of the other mortgage banks announced they business at all. Is it the same sort of experience in had reached agreement on Basel 2 with the FSA and HBOS? there was going to be less capital employed, which is Lord Stevenson of Coddenham: I think Andy should obviously good for shareholders. Immediately we pick that up. Processed: 25-03-2009 22:28:06 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG11

Treasury Committee: Evidence Ev 243

10 February 2009 Sir Tom McKillop, Sir Fred Goodwin, Lord Stevenson of Coddenham and Mr Andy Hornby

Mr Hornby: Just to describe the way the relationship Sir Tom McKillop: At the discussions I participated worked, I will keep it brief. The close and continuous in, for instance at the International Monetary arrangements meant that not only would each Conference, and IMF type meetings, I would say divisional chief executive meet very regularly with lots and lots and lots of very well informed people the FSA, certainly that dialogue was constant in genuinely imagined that was the case. every division and you typically had a diVerent part of the FSA looking after diVerent parts of the Q1828 Chairman: You thought risk was taken oV organisation to make sure there was proper your books? expertise. The second part of it is that the FSA not Sir Tom McKillop: No, not that risk was taken oV only had regular meetings with every senior your books, you could never assume that, no, no, no, executive director but would meet regularly with but you had more stability— Tony Hobson, who chaired our audit committee, and to whom the risk committees—to go back to the Q1829 Chairman: You must be precise. It is originate earlier discussion—formally had a route up to and distribute, which means it is oV your books, so report. Mr Tyrie that was done, Chairman, you can did you think with originate and distribute you still look through Tony Hobson’s diary and I would be had the risk on your books? very surprised if you do not see him in meeting not Sir Tom McKillop: Some of it is oV balance sheet, only before every set of results but at least a not all of it is oV balance sheet because it is quarterly update in between to go through the trends distributed. There are technical matters here. We are of the business purely from an independent director not talking about the balance sheet per se, we are standpoint as chairman of the audit committee. talking about whether or not— Chairman: I just want to clear, do you feel that risk Q1824 Mr Todd: It sounds a very comfortable, was dispersed? comforting relationship, not one— Lord Stevenson of Coddenham: No. Q1830 Mr Mudie: You must let him finish. We are Mr Hornby: Clearly you mentioned Northern Rock not talking about the balance sheet, tell us what we and the vast majority of my time period running the are talking about. business was post-Northern Rock. Sir Tom McKillop: We are talking about a general phenomenon here where you have a whole series of Q1825 Mr Todd: Although your executive loans or whatever the assets are that are backing the experience precedes that. distributed product and by these being distributed Mr Hornby: Yes, indeed, but even in the executive rather than held by single institutions it was period before I think there was a good and fair perceived that would be a stabilising influence on the degree of challenge. A lot of store, as Sir Tom has whole financial system. That you will find in already said, was placed around the Arrow Review abundance in all of these reports. That was a process and making sure that everything was perception widely held. properly followed through. Lastly, I think the most important thing is the degree of belief the FSA must Q1831 Chairman: Sir Tom, I cannot understand you have that they are hearing about issues quickly. because the reason is this, if you are the Chairman and you have an originate and distribute model, and Q1826 Mr Todd: Okay. The last area of challenge is they tell you the risk is dispersed, then you can look short selling and hedge fund activity. HBOS was at your company’s books and talk to your staV. Were claimed to be subject to rumour mill activity to you quite content that the risk was dispersed and you reinforce short selling. Was that something you did not realise it would come back to you? You had complain about or do you instead compliment some a £28 billion loss last year. of these people on their prescience in understanding Sir Tom McKillop: We never imagined the parts we your business better than quite a lot of other were holding, a large part of it was triple A or super people did? senior, we never imagined, as Fred said earlier, that Lord Stevenson of Coddenham: I think you have to could end up as 10 cents in the dollar. distinguish between short selling, which is illegal, based on spreading false rumours, and short selling. Q1832 Mr Fallon: Lord Stevenson, you have put up As I mentioned earlier in this room I have no truck a lot of smoke about your dependence on the at all with the former and we suVered from that in wholesale markets, but can we just look at the other March. Rumours were circulating that were issue in your submission, your exposure to the UK completely and categorically untrue and were property market. It is a fact, is it not, that your immediately denied. As regards short selling, we are highest paid banker, your head of corporate lending, widely quoted as being against it and I have to tell Peter Cummings, was lending £40 billion of your you in all frankness we are agnostic. It is a very £100 billion loan book to construction and property diYcult issue and I very much hope that the Treasury companies? Select Committee will shed light on it. Lord Stevenson of Coddenham: Yes.

Q1827 Chairman: Okay. Sir Tom, just a quick point, Q1833 Mr Fallon: He said as recently as February who are the disembodied people who are expecting 2008, I quote, “Some people look as if they are losing risk to be defused by the originate and distribute their nerve, beginning to panic even in today’s model? Are you one of them? testing property environment, not us”. Did not one Processed: 25-03-2009 22:28:06 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG11

Ev 244 Treasury Committee: Evidence

10 February 2009 Sir Tom McKillop, Sir Fred Goodwin, Lord Stevenson of Coddenham and Mr Andy Hornby of your directors spot in February 2008 that you Lord Stevenson of Coddenham: I do not know the might be a bit over-exposed to a falling property context of the quotation but my judgment, and I market? would be nervous about taking it out of context, is Lord Stevenson of Coddenham: Yes. We were already what in practice they were doing, and this was the by then lowering our growth, as it turned out by not public position of the business, was we were in a enough. I would say to you absolutely frankly it is situation where we were already rationing capital, I quite clear, with the wisdom of hindsight, that we make it quite clear to you we were, our public were over-exposed, that we lent too much at the position—I suspect that is where the quote has come wrong parts in the cycle. Simple as that. from—was saying if we have to choose between customers we will stay with our existing long-term Q1834 Mr Fallon: I want to be clear about the customers. The answer is read literally it is a mistake. governance here. Sir Tom talked us through the dinners they had before every board meeting and so Q1839 Mr Fallon: You have said what they were on. What happened on your board? Was Peter doing, this was your business, you were the Cummings running an empire within an empire? chairman. Lord Stevenson of Coddenham: Absolutely not, and, Lord Stevenson of Coddenham: No, we were, I am given the risk management system I have described, quite happy to put “we”. it would have been quite impossible for anyone to do it. On the issue of property, the fact is we made some mistakes and that is the bottom line. Q1840 Jim Cousins: Sir Fred, your successor at RBS has said, “RBS leveraged itself too much in good Q1835 Mr Fallon: How did your board allow him to times”. When did you form that view of RBS? invest 40% of your loan book in property as late as Sir Fred Goodwin: Relatively recently, Mr Cousins. February 2008 and take equity stakes in all these As Tom mentioned earlier, we had run a tight companies? balance sheet for a very long time. It was something Lord Stevenson of Coddenham: He was not doing which was openly and regularly discussed with our that in February. You are talking about an historic shareholders. We had been encouraged to keep it accumulation. Clearly, given the deterioration in that way, to do new share buy-backs and to increase markets and the deterioration in asset values, we lent the dividend. We increased the dividend by 25% two too much and his division lent too much. That the years in a row, in 1995 and 1996. 1997 was only 10%. board was hugely engaged in it, I can assure you. That was the path we were on. When we came up to Hardly a board meeting passed without issues, not the ABN Amro transaction we proposed a funding just about that part of our business but also the mechanism there again to the market. We were very housing finance part of our business which I am glad transparent about how it would be funded and the to say we retreated from, we lowered our share much leverage which would be applied within that. As earlier. But there is no question, Mr Fallon, we made market conditions started to tighten up, late 2007, mistakes. early into 2008, we were focused more on the funding side and conditions eased somewhat, not back to Q1836 Mr Fallon: At what point did your board where they had been previously but we were funding realise you were over-exposed in property? the bank relatively well. During the course of 2008, Lord Stevenson of Coddenham: I put it diVerently. the period from May to August, we raised about £20 The Bank of Scotland has always been a specialist in billion of new funding. We raised £3 billion of new commercial property. The exposure as a percentage funding in the beginning of September 2008, and of the balance sheet to commercial property has not then Lehman’s happened. The degree of leverage increased dramatically over time, that is not what became a material issue quite late on in the piece as has happened. Looking back, with the wisdom of the funding started to dry up, but it was something hindsight, we did not foresee the deterioration in which was very transparent about our model all asset values that took place, it is as simple as that. along and it even predates me.

Q1837 Mr Fallon: What is the answer to my Q1841 Jim Cousins: The Bank of England assessed question? At what point did the board realise that in October 2008 that the combined losses of British your bank was over-exposed to the property market? banks were about £123 billion, that was as at last Lord Stevenson of Coddenham: We were constantly October, much of it, of course, incurred outside the reviewing it through diVerent systems. The reality is UK. What do you think the position of RBS was at when asset values started to tumble out of bed is the that point when you were still in charge? What was short answer. We had already started to go back in their contribution to that £123 billion of losses and 2006, as Andy Hornby has described, and we how much of that loss had come from outside the continued in 2007, pre-Lehman’s, during the UK? summer of 2007 we were reducing growth very Sir Fred Goodwin: I do not have a precise figure to sharply and turning away deals and of course post- hand but a big part of it would have come from the Lehman’s we did virtually nothing. United States. The positions that we held, and the credit market write downs, not all, but would be Q1838 Mr Fallon: That is not what Mr Cummings preponderantly coming out of the Greenwich said, he said, “not us”, “we were not losing our nerve Capital business which was a business we had in the in February 2008”. United States. Processed: 25-03-2009 22:28:06 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG11

Treasury Committee: Evidence Ev 245

10 February 2009 Sir Tom McKillop, Sir Fred Goodwin, Lord Stevenson of Coddenham and Mr Andy Hornby

Q1842 Jim Cousins: Coming to Greenwich Capital regularly positioned it in the top half a dozen banks directly,of course it is a matter of record that is where in the United States for credit. It has had its issues, the biggest bonuses were paid. The accounts show a but the Citizens’ story in that respect is a good one loan book of well over $100 billion and virtually no and it is a distinct story from Greenwich Capital cash. When did you form the view that this was not insofar as Greenwich is involved in the sort of a well-founded business? products we have touched on a number of times this Sir Fred Goodwin: I think the issues at Greenwich morning. Citizens does not have those, Citizens is a started to really come home in March 2008. As we much more straight forward operation. moved through 2007 the problems in the sub-prime market were becoming apparent, but in the first Q1846 Jim Cousins: Because there was leveraging instance they related to people who had made direct between Citizens and Greenwich Capital. loans to people who were sub-prime. We had as a Sir Fred Goodwin: The positioning of funding and matter of policy never done that within the group so financing around all the group companies was that seemed like an issue which was sitting over here. organised from the centre. Insofar as there was sub-prime in our book it was wrapped up in instruments which had an investment Q1847 Jim Cousins: What do you think now are the grade credit rating and in many cases had monoline losses on Greenwich and Citizens? insurance with them as well. It was only as we Sir Fred Goodwin: I do not know. progressed through 2007 that we got to the place where by December 2007 we had in our trading Q1848 Jim Cousins: You do not know? statement announced we were going to be taking 1 Sir Fred Goodwin: I no longer have access to that provisions of £14 billion against the position that we information. held. We still reported record profits after taking that provision. We thought at that time that that Q1849 Jim Cousins: What were they when you left? provision was enough to deal with the issue. It was Sir Fred Goodwin: By the time I left, the only as we got through in to March 2008 that the announcement that was made on 4 November would valuations dropped on the back of the Bear Stearns capture that, at that point credit market write downs collapse, the valuations fell away and that was what in total were about £9 billion. triggered the process which took us into the rights issue to go and raise more capital. That is not to say 1 Q1850 Jim Cousins: What was the figure? that £14 billion was not seen as a serious matter but Sir Fred Goodwin: I think £9 billion was put forward we thought that was the end of it, it was only in in the table that was published on 4 November. It March 2008 that it really started to look a lot bigger. was £1° in RBS for 2007, about £900 million in ABN for 2007, these do not all relate, some of this relates Q1843 Jim Cousins: It is important to bear in mind, to leverage finance as well, there was £5.9 billion of course, that Greenwich was not an acquisition it which we announced at the time of the rights issue in was yours, as was Citizens, another United States which we booked our results, the interim results for financial institution, one of the largest providers of 2008, and it was announced there was another £200 car loans in the United States, one of the largest million in the third quarter of— providers of home loans against equity in homes, one of the largest mortgage providers in the United Q1851 Jim Cousins: But you will see, Sir Fred, the States. British taxpayer is now standing behind these loan Sir Fred Goodwin: No, not mortgages. books. It is standing behind one of the largest car loan businesses in the United States. Do you not Q1844 Jim Cousins: When did you form the view now have a lot of concern about that? that it would be sensible to have doubts about the Sir Fred Goodwin: It is a fact that the taxpayer is way the Citizens business was going? standing behind a large part of the business. This has Sir Fred Goodwin: I think we would adopt a healthy always been in the business, this is not a new scepticism throughout but the other thing you have development. The credit quality in the US has not mentioned— deteriorated as it has deteriorated in the United Kingdom, but we are a bank and we do lend to Q1845 Jim Cousins: A healthy scepticism people to buy cars, we lend to people to buy houses, throughout. that is part and parcel of the business that we do. Sir Fred Goodwin: One of the features you have not Citizens is a very large bank. The rankings will all mentioned about Citizens is it was also one of the have changed now as there has been bank biggest deposit takers in the United States. Citizens consolidation in the United States but their had a very well balanced book of business. operations in the United States would have made us Traditionally, in fact, it had a preponderance of about the sixth largest bank in the United States. We deposits and lent a lot of money to the US have 27,000 people working for us in the United Government. It came from a background of States. preponderance and got to a more balanced position a number of years ago, but we maintained a fairly Q1852 Jim Cousins: I do not take the view that healthy scepticism and credit quality in Citizens for British debts only are for British taxpayers, I do not some time. We did not do any sub-prime lending by take that view. Does it not cause you concern, Sir choice or by policy. Citizens’ credit quality has Fred, that a lot of the support the British Processed: 25-03-2009 22:28:06 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG11

Ev 246 Treasury Committee: Evidence

10 February 2009 Sir Tom McKillop, Sir Fred Goodwin, Lord Stevenson of Coddenham and Mr Andy Hornby

Government is making, a lot of the loans the British Q1858 Jim Cousins: You have this vast loan book in Government is about to guarantee are not loans the United States—car loans, securitised vehicles, in inside the United Kingdom, they are to support Greenwich Capital well over $100 billion—was there these activities of yours in the United States? any discussion of exchange rate risk? Sir Fred Goodwin: That has been part and parcel of Sir Fred Goodwin: Perhaps I could answer that. our business model throughout. We are an international bank, we have operations in Europe, Q1859 Jim Cousins: I am sorry, I am asking the we have operations in Asia, we have operations in Chairman of the board. You will understand why the United States of all kinds. We take deposits, we governance issues are primarily for the Chairman. lend money. Sir Tom McKillop: As a specific it was not a major topic at the board but I am sure it would have Q1853 Jim Cousins: The day after Lehman Brothers featured in the audit committee discussions. went down you circulated on your internal networks inside RBS a statement that RBS was in a strong financial position and doing good business in over 50 Q1860 Jim Cousins: You do not recollect anything? countries around the world. That was not right, Sir Tom McKillop: I do not recollect any major was it? discussion apart from the normal risk that a bank of Sir Fred Goodwin: It was at that moment. our sort has, a major international bank has huge flows of money across all currencies, that is part of your day-to-day business. Q1854 Jim Cousins: It was at that moment, even after all those events. The day after Lehman’s, that was right? Q1861 Jim Cousins: Do you recollect any discussion Sir Fred Goodwin: The day after Lehman’s not much at the board of the diVerence between the way you had happened. What happened after Lehman’s was record securitisation vehicles in British accounting in the ensuing fortnight. Lehman’s is now widely and in American accounting and in particular the accepted, even more widely recognised than it was at diVerence about when you can say such a the time, as being the trigger. The day after securitisation has taken place and has been solved? Lehman’s there was a need in the business for our Do you recollect anything of that? people to have reassurance. At that point we had Sir Tom McKillop: In the early phases of this recapitalised the bank, we had published interim through 2007 certainly not. Awareness has grown results which were well received. The consequences about these details, they have been in the press and of Lehman’s in direct first instance did not look so on. These things have become more aware in the dramatic to us. You have raised a very important course of 2008. point. The issue which brought RBS to the position was a loss of confidence in the bank, it was not Q1862 Jim Cousins: Do you recollect any discussion specific losses at that point, it was not the capital of whether and how you should record on your own ratios at that point, it was concern about what was balance sheets the exposures you were taking on coming down the pipe. The day after Lehman’s that through ABN Amro, through Greenwich, through crisis of confidence in the bank and in the financial Citizens and a variety of others? system generally had not matured. It rapidly built up Sir Tom McKillop: Every time we were reporting over the next fortnight. results there was extensive discussion of those sorts of matters and that would be preceded by intensive Q1855 Jim Cousins: Sir Tom, I wonder if I could ask discussion with the audit committee and the external you, do you recollect any discussion at the board of auditors. the enquiries that the Securities and Exchange Commission were making into the mortgage book of RBS in the United States from May 2008? Q1863 Jim Cousins: Sir Tom, have you either asked Sir Tom McKillop: Into the mortgage book? for or been given any legal advice on the nature of criminal negligence? Sir Tom McKillop: I have not asked for any advice Q1856 Jim Cousins: The enquiries that the Securities on criminal negligence. and Exchange Commission were making, the investigation they had mounted into your mortgage loan activities in the United States. Q1864 Mr Love: Sir Fred, can I ask you, following Sir Tom McKillop: We were notified that the SEC on from those questions, how leveraged was RBS at was investigating a whole series of banks, including the time of the Lehman’s dissolution? us, who were engaged in securitisation of mortgages. Sir Fred Goodwin: I think there would have been a Yes, we were aware of that. We had no specific variety of diVerent ways of looking at the leverage information of what they were after or what their ratio. concern was. Q1865 Mr Love: I am just looking for a rough idea, Q1857 Jim Cousins: Do you recollect any discussion order of magnitude. of exchange rate risk? Mr Fred Goodwin: Towards the higher end but there Sir Tom McKillop: Of exchange rate risk? Exchange would be others higher than us. We would have loans rate risk is always there. to deposit. Processed: 25-03-2009 22:28:06 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG11

Treasury Committee: Evidence Ev 247

10 February 2009 Sir Tom McKillop, Sir Fred Goodwin, Lord Stevenson of Coddenham and Mr Andy Hornby

Q1866 Mr Love: What was the ratio? that we were going to need to support, the spotlight Sir Fred Goodwin: 110% but there would be others fell on us and our share price dropped 60% or so in similar to that, there would be some higher and some two days. lower. We were to the right of the middle, we were at the higher end of the middle. Q1871 Mr Love: Listening earlier on, I got the impression that you accepted that ABN Amro was bad timing. Was it a bad decision? Q1867 Mr Love: Mr Hornby, can you tell us what it Sir Fred Goodwin: I think that, as we currently sit was for HBOS? here today, I can only say that it was a bad decision. Mr Hornby: Yes, our loans and advances were Who knows in years to come, but right here and around £450 million, our customer deposits were right now it was certainly mistimed and I think that, about £250 million, therefore the percentage of one if we knew then what we know now, we would not to the other was around 57%. have taken the risk of finding out.

Q1868 Mr Love: The reason I ask that question is Q1872 Mr Love: Well, let me come back to that and that one of the reasons the hedge funds gave for us let me just ask, Andy Hornby, was it rapid growth not being too worried about their activities—and that was your downfall? these are meant to be high risk organisations—was Mr Hornby: In our case, as we outlined in the they claimed that their leverage was much lower submission, it was the combination of being than the banks. Why would that be? Has the world property-based on one side of the balance sheet with turned upside down in banking? a significant reliance on wholesale funding on the Sir Fred Goodwin: There are a variety of diVerent other, so it was the total reliance on wholesale leverage ratios so I would like to make sure that we funding. are comparing like with like. I am not sure that we have just compared like with like. Our loans were Q1873 Mr Love: Okay, let me come back to that. Sir 110% of our deposits, that was the position we were Fred, I read with interest the biography you gave to in. As to measures of leverage of a hedge fund, I us which tells us that you were number one in think those would be diVerent. I find it a hard Scotland on Sunday’s annual power list for several comparison to make. I am not trying to avoid the years in a row, European Banker of the Year in 2004, question. European Business Leader of the Future as well. Did any of that go to your head? Sir Fred Goodwin: I would like to think not. I do not Q1869 Mr Love: Do you accept the point they made know that being number one in the Scotland on that they were not as leveraged as the banking Sunday’s power list is something you would wish for. system? I do not think that these are things have gone to my Sir Fred Goodwin: I find it hard to take hedge funds head and, even if they went to my head, they did not in the generality. There are hedge funds and hedge go to my Board’s head. funds and some of them that I have seen are pretty highly leveraged. I am sure there are some that were less leveraged. Q1874 Mr Love: Can I ask you, Mr Hornby, you were a Managing Director in Asda before you were 30 and you were the CEO of HBOS before you were Q1870 Mr Love: I do not want to get into a technical 40. Did your reputation as a wunderkind aVect you discussion of the matter. Let me move on because all in any way? of you have made the point that no-one predicted the Mr Hornby: I really do not think so, no. consequences of Lehman’s and the seizing up of the wholesale market, so we all share responsibility in Q1875 Mr Love: You do not accept that that evokes that, yet you were the executives of two of the three any consideration? We have asked the question the banks that have had to access public funds. Why did other way round, but let me ask it to you. This you have to access them and not the other banks? I Committee thinks that a banking qualification is do not want you to tell us what the other banks do. quite important. Do any of you think a banking Why did you find yourself in the position of having qualification per se is important? I only want to hear to access money from public sources? from someone who does because I am assuming that Sir Fred Goodwin: I think it was a combination of you do not consider it a particularly important events. We were larger, we were by far the largest of consideration. Right, can I then move on and ask, the banks that have accessed the support. The Mr Hornby,were you brought into the bank for your business mix, we had business in these areas and I marketing skills rather than for your banking skills? think, by virtue of the ABN Amro transaction, our Would you accept that as a rationale for why capital ratios were lower than some of the others’, somebody was plucked out of Asda to take over at so, coupled together, I think, when it came to that HBOS? point about loss of confidence, there was a general Mr Hornby: I was not, to be clear, Mr Love, brought loss of confidence in the financial system, but the in to take over HBOS, I was brought in to run a spotlight shone on us for that very key moment at division of, what was then, Halifax and then became the beginning of December when we saw the share HBOS, as part of a very well-balanced team where price come down and when rumours did leak about everybody else on that board had 20 to 30 years’ banks being supported in the UK, and our line was banking experience. Processed: 25-03-2009 22:28:06 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG11

Ev 248 Treasury Committee: Evidence

10 February 2009 Sir Tom McKillop, Sir Fred Goodwin, Lord Stevenson of Coddenham and Mr Andy Hornby

Q1876 Mr Love: But you said earlier on that do the job. I can assure you that it has not been part- aggressive growth was very much at the centre of time in the last many months, but it has been a very what HBOS was at during that time. Would you full-time commitment which has been made. accept that, while things were going well, we were living in benign times, if I can put it like that, that Q1879 Mr Love: Lord Stevenson, do you accept any was a sensible strategy and it may well have hit the implied criticism that perhaps, having brought Mr V bu ers when things changed? Hornby in to expand the business, to do the Mr Hornby: I think that the good performance of marketing, you maybe took your eye oV the ball? the business through the years when it was growing Lord Stevenson of Coddenham: Can I make clear that clearly showed that good profit growth was being we brought him in because of his reputation as a delivered, as has proven to be the case now. We manager and a leader and not because of his would have liked, in retrospect, to have delivered less marketing reputation, just to be absolutely clear on of that growth through wholesale funding. that. In response to the question you asked Sir Tom which you are now asking of me, no, I feel very Q1877 Mr Love: Sir Fred, I think your original comfortable that an engaged part-time chairman reputation is of a somewhat aggressive accountant, who develops the right relationship with his board, if I can put it that way, but you soon developed a or her board, and the chief executive can do the job reputation for takeovers, the National Westminster adequately. I think the question that has been raised Bank being a very successful one. Did you become around this table as to the need for specialist enamoured with your own reputation for takeovers knowledge with increasing specialist business is a so that a natural consequence of that would be that, highly germane one. I would like to think I have invested the time to go up the learning curve. when you took over ABN Amro, which I think quite a lot of comment at the time suggested, it was a takeover too far? Q1880 John Mann: Sir Fred, you made the Sir Fred Goodwin: I do not think so. I do not think extraordinary statement to Mr Cousins in response I got overly enamoured with my own reputation. In to a question in that you defended the strong fact, if you look back over the period of my tenure, financial position and good business position of the by far the bulk of the growth we achieved was bank on 16 September and, three weeks later, the organic growth and it did not come from Government was having to stick in £20 billion of acquisitions, but, you are right, NatWest happening capital to keep the bank going. I put it to you that right at the start and being such a long, drawn-out you do not like criticism, do you? You like people exercise to get the deal completed, it all went who bring you the good news and you do not like extremely well. I and my colleagues were associated people who bring you the bad news. with that and a lot of folklore went on around that. Sir Fred Goodwin: No, that is not correct. I do not Since then, the transactions, and there have been a think anyone likes bad news, but you have got to be number, but most of them have been quite small. a realist in my job and I have had plenty of bad news ABN Amro, as I think Tom explained earlier, the to deal with, as you can well imagine, so I cannot live process for ABN Amro, the Board were enthusiastic in denial of the facts and I have to accept the good about ABN Amro, our shareholders voted for ABN news and the bad news. Amro by an overwhelming majority, so, if they had concerns, it did not manifest itself when they were Q1881 John Mann: But, with respect, you are in given the opportunity to vote on it. Similarly, denial of the facts. Your own staV say that you brook Barclays’ shareholders voted on it in the middle of no criticism and you are still defending the great September, so there was still enthusiasm and, at that position of the bank on 16 September and we are time, it seemed like a good thing to do. I bought a lot listening here, thinking, “Well, hang on a minute, of shares in it the day it happened and I thought it three weeks later the Government’s having to put in was a good thing to do and we were excited about the £20 billion to keep that bank going. Those two prospects the business brought. The rest, I do not things do not add up”. Is not part of the problem want to go back over it, but I am happy to, if you with your bank and your leadership that the culture want me to. created was one whereby you lived for the good times, you wanted the good times, and you did not want any criticism, and you wanted people to give Q1878 Mr Love: No, I do not need you to go over it. you the solutions, not to identify the problems? Can I ask the two former Chairmen the same Sir Fred Goodwin: No, I do not agree with that question and that is that one of the real central characterisation, Mr Mann, but to go back, I was concerns about governance issues is whether or not responding to Mr Cousins’ question about the basis part-time directors, including part-time chairmen, for the memo being sent and I was trying to explain are really up to keeping a proper tab on the work of the basis for the memo being sent and I make no the full-time directors, in particular the CEOs. How more or less of it than that. My management style is would you respond, Sir Tom, to the concern that Sir something that evolves and changes, depending on Fred’s reputation rather overwhelmed the board? the circumstances, but I believe I have led the bank Sir Tom McKillop: I do not think that is the case. As in a responsible fashion with my colleagues and I far as my own position was concerned, I had an have been equally receptive to bad news and good agreement and my letter of agreement with the bank news. Of course, I wanted solutions rather than said I would commit whatever time was necessary to problems, but you cannot exist in a job like mine by Processed: 25-03-2009 22:28:06 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG11

Treasury Committee: Evidence Ev 249

10 February 2009 Sir Tom McKillop, Sir Fred Goodwin, Lord Stevenson of Coddenham and Mr Andy Hornby ignoring problems, and I do not have a track record Sir Fred Goodwin: No, it was not sub-prime in our of ignoring problems or leaving problems undealt hands. We were doing it as agents for other people. with.

Q1882 Mr Mudie: Securitisation has been important Q1887 Mr Mudie: Yes so, but I asked you again V to both organisations, and Tom and yourself have then, when you got stu from other people, did you referred to it specifically in terms of RBS. You both dissect it before you passed it on, and you said yes, referred to credit agencies, the fact that they had a so you must have been aware of the sub-prime part. good rating. Now, this has puzzled us since this Sir Fred Goodwin: Absolutely, and I am agreeing started 18 months ago because we kept being, and with that, but that is what— have continued to be, told by the credit agencies that banks were too-sophisticated users of ratings and they were not so naı¨ve as to rely on ratings blindly, Q1888 Mr Mudie: But then, as a banker, a in other words, they would take the security, they sophisticated banker, could you pass these on with would dissect it and they would decide on the risk triple A, knowing the content, knowing that the themselves. Now, Fred, you said that ratings plus houses that were being sold were being built and insurance were okay and Tom said just ratings. Now, mortgaged in America, all over America? are you telling us that you were not that Sir Fred Goodwin: These were knowingly being sophisticated then and that the ratings agencies are originated by professionals and sold on to trying to palm some of the blame oV on to your professional investors and rated by their agents. The good selves? content was known and, when I say “dissect” it, Sir Fred Goodwin: It may be both, but that goes, I what I mean is that that was the essence of what we think, to the heart of an important issue. The were doing. We were taking a pile of sub-prime loans originate and distribute model started oV at a and packaging them up to diVerent— relatively simple level and we were intermediaries in it, so we were bringing things in, packaging them up and selling them to investors. The reason that so Q1889 Mr Mudie: Yes, but you cannot pass them on much reference is made to the credit ratings is that as triple A. that was the language, if you like, that we talk to Sir Fred Goodwin: Some of it you can. investors in. We had our own ratings systems and assessments for risk, but, because the investors were wanting to buy, if you like, in a currency or language Q1890 Mr Mudie: Then Tom said he bought them as that they understood, that was the rating of the triple A. ratings agencies. So we could sit and produce this Sir Fred Goodwin: You can pass some of them on as securitised product until we were blue in the face and triple A and the others are more junior. The attach our own ratings to it, but we would not sell interesting thing in all of this is that there was any of it to investors because investors wanted the actually latterly a bigger appetite for the junior independent rating and the ratings agencies were tranches than the seniors because the junior paid to rate these— tranches, because of higher risk, had higher yield. This business went on for a long time and many Q1883 Mr Mudie: Fred, what did you buy when you other people were doing it. They were, so-called, bought the stuV? Did you dissect it? “sliced and diced” and, if that was all that happened, Sir Fred Goodwin: Yes, that was the essence of the we would not be sitting having this conversation business to begin with. today, I do not think, about this subject. As the industry went on, there became more and more Q1884 Mr Mudie: Well, why did you not pick up the demand from investors for more and more, so we sub-prime stuV contained within those securities? started to get into doing the exercise with synthetics Sir Fred Goodwin: We did pick up some of the sub- and other products related to sub-prime. One of the prime stuV in them. consequences of this was that it magnified the eVect and individual loans were being referenced more Q1885 Mr Mudie: And you sold it on? than once. That is why you got a big multiplication Sir Fred Goodwin: Yes, but what we did was as an that went on and that is why, when the music intermediary, so there were those people originating stopped, some of these were still held. It was thought sub-prime mortgages who did not have the ability that the junior tranches had been sold, that the most themselves to package them and distribute them, so risky piece had been sold and was out there we packaged them and distributed them, and that somewhere with someone else, and at least we were business can be conducted largely without incident holding the super-senior and, in many cases, with and, when the music stopped, it cleared, as we would insurance gone up and an investment-rate monoline expect it to clear, so we had inventory which flowed against it one of the first shoes to drop in relation to either back to the originator or— this was that the monolines’ credit rating started to come down because then you get too much exposure Q1886 Mr Mudie: Fred, you said something very to this one thing and that began a process which had important there and let us clear it up. Were you now led us to a place where the monolines have had aware of the sub-prime content of these securities to be written down and we have had to write down because, if you were, you were part of the problem. the underlying— Processed: 25-03-2009 22:28:06 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG11

Ev 250 Treasury Committee: Evidence

10 February 2009 Sir Tom McKillop, Sir Fred Goodwin, Lord Stevenson of Coddenham and Mr Andy Hornby

Q1891 Sir Peter Viggers: Can I ask each of you, did you asked Lloyds to make an oVer or whatever, but you personally understand the full complexity of it was reported widely that this was the Government these vehicles that your clever young men were pushing that ahead as a solution to the then- creating? perceived crisis. Fast forward five or six weeks and it Lord Stevenson of Coddenham: The short answer is becomes utterly clear that we have got a wholly yes. We did not have many. diVerent set of circumstances, namely that every bank is in trouble. Did you at any point consider Q1892 Sir Peter Viggers: And you could dialogue going it alone and just being 100% nationalised, with these brilliant young gentlemen making up thereby leaving Lloyds without the problems you these vehicles and you— have and yourselves just being dealt with? Lord Stevenson of Coddenham: We did not have lots Mr Hornby: I think it is fair to say that, when we of brilliant young chaps making them up, Sir Peter. looked at the options we had, we looked at the Mr Hornby: We were not major players in this kind benefits of pushing ahead with the Lloyds merger of market, Sir Peter. which, we felt, provided three benefits: first of all, Sir Fred Goodwin: No, I would not. That is part of vastly improved funding; secondly, greater security the secret of how you risk-manage it. for colleagues over time, although clearly, when the Sir Tom McKillop: You said “full complexity” and I integration comes together, there would be job would say no. losses, but we believed it would be, in the long term, a much stronger business; and, thirdly, benefits for Q1893 Nick Ainger: Just following on from that, shareholders. That was appraised against the pros from what Sir Fred was telling us, are you not and cons of going it alone, as you would call it, which culpable in some way. The excuse that we have had we perceived to be of higher risk and, more constantly is pointing the finger at the credit rating importantly, not in the benefit of long-term agencies, that they give the CDOs and so on triple- stakeholders. A ratings, but you are saying that you actually did really deep due diligence, knew that there was a Q1898 John Thurso: After the problems had substantial element of sub-prime and yet you still generally become known, did you have any carried on dealing with them and ended up with discussions with the Chancellor or the Treasury as to them on your books. Are you not culpable for that? that option because he testified to us that the Sir Fred Goodwin: We did not end up with those on decision was an entirely commercial one? our books. That is what I said. Mr Hornby: Yes, it was an entirely commercial one and we looked at the options we had. We were very Q1894 Mr Mudie: But you said that as— aware that we now had, post the announcement of Sir Fred Goodwin: The willing buyer and willing the Lloyds deal, security in terms of capital agreed, seller. This was a business which was conducted and we had funding agreed, and I think anything that there was no secret about it and there was no endangered that by our sort of reappraising would subterfuge involved. Again, just to be absolutely have been the wrong thing to do. Dennis, though, is clear, I am not pointing the finger at the ratings on public record of equally saying that, had anyone agencies, and I go right back to the opening chosen to come in with another oVer, with another statement made— proposition for the board, we would have of course considered it. Q1895 Nick Ainger: Well, you are the only one who is not. Sir Fred Goodwin: Well, what I am concerned about Q1899 Chairman: You have all said that the banks actually, and I think it was referenced by a number were victims of an unprecedented event, the collapse of other members here, is that it is just too simple if of wholesale funding, and, as the bosses, you did not you want to blame it all on me. If you want to blame foresee that. Now, in future, therefore, when these it all on me and close the book, that will get the job financial tsunamis come along, the same excuses done very quickly, but it does not go anywhere close could be made, but, because of the unique nature of to the cause of all of this. banking, and the future crisis may well happen again, which one of these three propositions are you Q1896 Nick Ainger: I appreciate that, but, as one more aligned with: first of all, if it happens again, the final question, you appear to have lost £400 million taxpayer accepts the risk and takes it on the chin, as in the MadoV scandal. Who did the due diligence on happened here; secondly, relying on regulators to that of putting £400 million into what turned out to spot where the risks are when the banks do not see be a pyramid scam? and to clamp down accordingly to prevent bank Sir Tom McKillop: That was an investment made by failure; or, thirdly, the Government taking action to ABN Amro and it went through all the ABN Amro separate risky investment banking from traditional risk assessment processes, but it was completed retail banking? before we were involved. Lord Stevenson of Coddenham: I cannot say to you that any one of them convinces me in the long term. Q1897 John Thurso: Mr Hornby, one quick question If you want, the nearest I can get to it is that, in the regarding the merger: last autumn, before we became event that there is another major market failure in aware that there was a general problem throughout the wholesale markets, I very much hope that the the banking system, Lloyds made an oVer for you or central banks of the world have a clear position on Processed: 25-03-2009 22:28:06 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG11

Treasury Committee: Evidence Ev 251

10 February 2009 Sir Tom McKillop, Sir Fred Goodwin, Lord Stevenson of Coddenham and Mr Andy Hornby their attitude to banks using wholesale finance and a Q1902 Chairman: Okay, it is not your fault then. clear position as to what they will do in the event Lord Stevenson of Coddenham: No, just to be quite there is a market failure. plain, I am not saying that at all. Q1903 Chairman: Andy? Q1900 Chairman: You have not answered my Mr Hornby: Chairman, I very much agree with question, Lord Stevenson. something that Lord Turner said in one of his recent Lord Stevenson of Coddenham: I am afraid I cannot initiatives, that the challenge now is for banks and because you asked me to choose one of the three. regulators to make sure that, through the good times, both enough capital and enough liquidity is maintained in the system. That means that banks in Q1901 Chairman: Because I want the banks to be the future will have to keep too much capital and safe places for their customers and it is the same liquidity through the good times in order to make question I asked at the very beginning: how can we sure that there is more for the bad times. ensure that banks are safe places for customers to Sir Fred Goodwin: Picking one from those three, I would pick number two, but I would not believe it put their money and that they feel confident in? That Y is what the public at the moment are feeling angry was su cient on its own to address this. Sir Tom McKillop: I would say the same, but I think about. there are some things which do need to be addressed, Lord Stevenson of Coddenham: I understand that do need to be done which we perhaps have not very well, and rightly so, and I am trying to respond discussed today, but which I am sure that you and to your question, Chairman, but I am telling you your Committee will discuss. very straight that neither of the three I find a Chairman: Can I thank you for your time. It has convincing, reassuring part about the future, but I perhaps not assuaged the public’s anger, but we are would think number two with a clear definition of hoping to have a fundamental look at this and your what the central bank and the Government’s view is answers on the record this morning will be helpful to when markets fail. us, so can I thank you for your attendance. Processed: 25-03-2009 22:38:12 Page Layout: COENEW [SE] PPSysB Job: 416782 Unit: PG12

Ev 252 Treasury Committee: Evidence

Wednesday 11 February 2009

Members present

John McFall, in the Chair

Nick Ainger John Mann Mr Graham Brady Mr George Mudie Mr Colin Breed John Thurso Jim Cousins Mr Mark Todd Mr Michael Fallon Mr Andrew Tyrie Ms Sally Keeble Sir Peter Viggers

Witnesses: Mr Eric Daniels, Group Chief Executive, Lloyds Banking Group, Mr John Varley, Group Chief Executive (Board and Executive Committee member), Barclays, Mr Stephen Hester, Group Chief Executive, RBS, Mr Anto´nio Horta-Oso´rio, Chief Executive, Abbey, and Mr Paul Thurston, UK Managing Director, HSBC, gave evidence.

Q1904 Chairman: Welcome to the Banking Crisis institutions (and I think John gave a very good Inquiry that the committee is undertaking. Can you answer and analysis of that) and the public’s day-to- introduce yourselves for the shorthand writer, day experience of us in terms of our services; and please, and your organisation? every day each one of the institutions here is serving Mr Horta-Oso´rio: I am Anto´nio Horta-Oso´rio, many, many millions of customers, generally doing representing Abbey, a subsidiary of Santander. it well, of course with exceptions, and what we need Mr Daniels: Eric Daniels, representing Lloyds to do as fast as possible is get back to the situation Banking Group. where the public see us for the services we are Mr Hester: Stephen Hester representing Royal Bank providing and not for the headlines, and I agree of Scotland. 100% with that. Mr Varley: John Varley, representing Barclays. Mr Thurston: Paul Thurston, Managing Director Q1907 Chairman: Eric, just quick response from for the UK for HSBC. you. Mr Daniels: I think that there is probably a fair Q1905 Chairman: Welcome. Before I came across, amount of misunderstanding on the part of the my good friend, the ex-Deputy Prime Minister, John public about the bonus systems in banks. I think, Prescott, presented me with 23,000 signatures first of all, we have to distinguish between regarding bonuses not to be given, and I have had investment banks and commercial or retail banks. lots of emails over the past week or two, and letters. One of the things that is not well understood— As institutions why do you think you are hated so much by the public? John Varley, give me your view Q1908 Chairman: The letters I am getting in these considering you made a point in January about this. responses are about retail banks. Mr Varley: Mr McFall, I entirely understand why Mr Daniels: I do understand, Chairman, but I think this is a matter of concern and interest and, in some that perhaps it is not well understood that about cases, anger, because if you look at the failure in the two-thirds of our employees who receive bonuses banking system over the course of the last two years, make about £17,000 a year. The average bonus that it is clear that the banks have contributed to that we give is about £1,000. This is something where, failure and it is clear that part of that problem has again, we have seen lots of very high bonuses for been the issue of compensation, and I think that is very specialised positions. That is not something what we are hearing and, if I speak for my own that Lloyds TSB does. organisation, it is important that we listen and that we respond, and one of the things that I hope will Q1909 Chairman: I have been on the media in the come out of your work and the work that we are all past week and I have been lauding the fact that individually doing as institutions is a compensation workers in branches who get between £15–25,000 a structure for the industry that looks right for the year deserve their bonuses, but we are looking at the future. It is very clear to me that, not all, but some, traders, and we are looking at investments, and we aspects of it in the past have not served either the are looking at the casino aspect. It is in respect of industry or society well. that issue that I am thinking about bonuses, Eric, not the branch members. I want quickly to ask all of Q1906 Chairman: Mr Hester, obviously 23,000 you to confirm for the public record how much against RBS and the bonuses. From your role in the money from the public purse you have received for job maybe you can give us a fresh perspective on why the purpose of recapitalisation. you think the public have turned oV you so much. Mr Horta-Oso´rio: We have welcomed the scheme in Mr Hester: I think I would agree, in the first case, October too, but we have not used any government with everything that John has just said, but there is money. clearly, at the moment, a diVerence which we have to Mr Daniels: We have received 13 billion in equity get away from between the public’s view of banks as and four in preference shares. Processed: 25-03-2009 22:38:12 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG12

Treasury Committee: Evidence Ev 253

11 February 2009 Mr Eric Daniels, Mr John Varley, Mr Stephen Hester, Mr Anto´ nio Horta-Oso´ rio and Mr Paul Thurston

Mr Hester: We have received 15 billion in equity, five Mr Thurston: We have been, in concert with all of the billion in preference shares. The preference shares banks, asked not to make any indication whatsoever are in the process of being converted to equity and of any utilisation of the Special Liquidity Scheme— there will be an oVering to our shareholders of that that was a rule set by the Bank of England—but I amount. can say that we have no requirement for liquidity Mr Varley: We have not taken government money. support or capital support. Mr Mudie: British Government money. Q1916 Chairman: You can understand where we are Q1910 Chairman: We will come back to that. Maybe coming from. for the sake of Mr Mudie, other governments’ Mr Thurston: Yes, I do. money. Mr Varley: If you ask are there sovereign wealth Q1917 Chairman: Where the taxpayer is giving this funds who have invested in Barclays, Mr McFall, the money out, it is important from a transparency view. answer to that is, yes. Mr Thurston: We have required no support from the taxpayer. Mr Varley: What I would say, Mr McFall, is that, as Q1911 Chairman: We are coming on to other issues you refer to, there have been structures put in place on that. Paul. both to guarantee wholesale liabilities and to create Mr Thurston: HSBC has not taken any taxpayer’s special liquidity arrangements. Our position is as money in the UK. HSBC’s as to utilisation of the Special Liquidity Scheme. On the wholesale guarantee, there, as you Q1912 Chairman: To RBS and Lloyds. For the know, there is a market price levied for the public record can you, please, confirm what purchasing of those guarantees, and we have percentage of your organisation is now owned by the purchased some of those guarantees and we have taxpayer? Eric. issued debt as a result of it. Mr Daniels: Forty-three per cent. Mr Hester: RBS are significant users of the scheme. Mr Hester: It is 58% and would rise to 70% if the I am afraid I am under the same restrictions as to shareholders do not take up their rights. amount. Mr Daniels: We have used both schemes, and we are under restrictions as to amount. Q1913 Chairman: What does the taxpayer get in Mr Horta-Oso´rio: We have a similar position as return? HSBC. Mr Daniels: The taxpayer, hopefully, will get a very good return on their investment, but, as you know, the preference shares have a coupon rate of 12% and Q1918 Chairman: On a general point, would you the equity will depend on what our shares price is in accept that over the last ten years the profits of your several years, which hopefully will bring better rates industry have been privatised but the risks of return. socialised? Stephen Hester. Mr Hester: I hope that the taxpayers will get a few Mr Hester: I think that there is an extent to which we diVerent things. First, I would echo Eric. It is our job are all learning the interrelationships in banking and to restore value to the shares of RBS and allow the society, and I think we have learned that in one sense taxpayer to sell out at a profit, but also we have a of that word they are socialised, although it would huge business here in the UK; we serve many also be the case that banks, of course, have been the millions of customers. Forty per cent of all payments biggest taxpayers to the economy over many years in the UK go through RBS and the stability of our until now. Now the reverse is happening and that is institution and our ability to lend more into the UK, a source of enormous sadness and disappointment. which we are now doing, is something else that this money enables us to do, and we will do more of it. Q1919 Chairman: The reason I asked that is I have Finally, from a financial stability standpoint, the looked at Woolworths as an example: 27,000 people financial stability of RBS, I think, is highly in the unemployed at Christmas. The banks get £336 UK’s interest. million of their money back from Woolworths; £100 million given to tier-one creditors; only 140 out of the 815 shops sold; the stock liquidated before Q1914 Chairman: Of the Government schemes— Christmas. Twenty-seven thousand people recapitalisation, the Special Liquidity Scheme, the unemployed, and the Government pay their discount window, the Credit Guarantee Scheme, the unemployment. I think the banks are going to be in Guarantee Scheme for Asset-backed Securities and a privileged position compared with other sectors of the Asset Protection Scheme, the latter two not the economy. Is that correct, Mr Varley? running yet—what use have each of you made of the Mr Varley: What I would ask is that you judge us by various other initiatives like these by the Treasury? reference to the commitment we make to the Mr Thurston: HSBC has not required any form of economy. If I look at all the banks in front of you capital or liquidity support. today, but certainly speaking for Barclays, I know that we take that responsibility with great Q1915 Chairman: You have never used the Special seriousness. If I look at our own lending activities Liquidity Scheme? here in the United Kingdom in 2008 and I judge, for Processed: 25-03-2009 22:38:12 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG12

Ev 254 Treasury Committee: Evidence

11 February 2009 Mr Eric Daniels, Mr John Varley, Mr Stephen Hester, Mr Anto´ nio Horta-Oso´ rio and Mr Paul Thurston example, in the area of business banking, whether shareholder? Is it ministers telling you what to do, is that is small businesses or medium-size enterprises it their agency, UKFI, which the Chancellor says is or large business, those balances grew 14% year on working with you on management incentivisation, year. I think that is an indication of commitment to or in the end is it the RBS Board? Who decides? the economy. Mr Hester: I believe that technically it falls to the RBS Board, but I could not imagine the RBS Board Q1920 Chairman: You have not answered the doing something over the violent opposition of the question I posed. The question I posed was: there are majority of its shareholders. As you say, we have one 27,000 unemployed as a result of Woolworths and shareholder who is a majority,and so we are working the banks have been saved by the taxpayer, the very closely with UKFI to try to get the right taxpayer has stood behind them; so banks are in a solution. privileged position. Given that you have not taken any money from the Government, is that not the Q1926 Mr Fallon: So it will be ministers, in the end, case, Anto´nio? who will have to be content with your proposals. Is Mr Horta-Oso´rio: But we have not taken any money. that right? I thought this relationship was arm’s length. Q1921 Chairman: No, but given that you have not Mr Hester: I cannot characterise it like that. What I taken, you are in a position to look maybe more would characterise it as saying is that I think all objectively and say, look at how other industries are public companies try hard not to do things that their treated. Look at how the bank was treated. The bank shareholders would oppose, and so in working was pretty privileged in that the taxpayer stands through the very sensitive issue of pay at the behind it and it is standing only as a result of the moment, and specifically on the recapitalisation taxpayer, whereas other industries and individuals conditions UKFI has, if you like, rights of have to go to the wall. discussion on pay, we are trying to make sure that Mr Horta-Oso´rio: I would agree with you that UKFI are on board with what we do, but, as I say, I banking is a critical industry to the United think the decision rests with the Board and, Kingdom, it is one of the major financial industries obviously, if there were to be a diVerence between in the world, and that is why Santander decided to UKFI’s view and our judgment of the views of our invest heavily in UK banking. other shareholders, then the Board would need to take that into account and, I think, probably make Q1922 Chairman: And privileged, Eric. that issue public and up for more debate. We are not Mr Daniels: I do not necessarily think about it in at that stage yet. those terms. What I would tell you is that Lloyds was, in fact, I think well capitalised. I did not think Q1927 Mr Breed: Mr Varley,talking about the whole we needed state aid or capital. The facts are that issue of bonuses and pay and such, it has been HBOS had no chance of accessing capital, the reported that one of your employees has been paid capital that was required by the FSA in October, the staggering amount of £40 million in order to and, therefore, had to take the state package. As devise the best tax avoidance schemes possible so Lloyds in taking over HBOS, we said that as long as that Barclays can avoid paying legitimate UK HBOS was going to take the capital that in fact corporation tax. Is paying somebody that staggering Lloyds would as well. So I do not believe that we are sort of amount to avoid tax an appropriate way for in a privileged position. What we did is we took the a UK bank to perform? state capital in an eVort to not only takeover HBOS Mr Varley: The starting point is that I think we need but to promote public stability. to be careful in giving credibility to all media reports about pay and banks at the moment. In some cases Q1923 Chairman: If you had not bought HBOS, do they are accurate and in some cases they are not you think you would have been in the same position accurate. as Paul and Anto´nio? Mr Daniels: I believe that we are, indeed, well Q1928 Mr Breed: Are they accurate in this case? capitalised today and I believe that the HBOS Mr Varley: They are not accurate in this case. I said acquisition was a prudent one. Very clearly, over the earlier that it is important for us to be both receptive next two years, as the economy goes through and sensitive to the spirit of the age as it relates to recession, HBOS and their higher risk portfolios will compensation at the moment. If I go to your have some issues. question about Barclays as a taxpayer, if I look at the amount of tax that we have paid to the Inland Q1924 Chairman: Do you think you would still have Revenue here in the United Kingdom over the had to take government money, irrespective of course of the last five years, it totals about £10 whether you had taken HBOS or not? billion, and I think it goes right to the statement Mr Daniels: No, we would not have had to have made by Stephen Hester a moment ago, which is that taken government money had we not bought HBOS. I think it is in the interests of this economy here in the United Kingdom for banks to be profitable and Q1925 Mr Fallon: Stephen Hester, could you clear for banks to create employment opportunities as a up for us who is going to decide RBS bonuses, given result of that and for banks to pay the taxes that go that you have the taxpayer as the majority with those profits, and that is what we do. Processed: 25-03-2009 22:38:12 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG12

Treasury Committee: Evidence Ev 255

11 February 2009 Mr Eric Daniels, Mr John Varley, Mr Stephen Hester, Mr Anto´ nio Horta-Oso´ rio and Mr Paul Thurston

Q1929 Mr Breed: If you had not undertaken the tax Q1934 Mr Breed: So, basically, the bank got away avoidance schemes, how much more would you have with it, with the Government forgetting rather to paid in tax? cancel those service contracts? Mr Varley: I do not recognise the statement that we Mr Hester: I would just make an additional point, if have undertaken tax avoidance schemes. What we I may, that while I agree 100% with the public are required to do, as you understand, as a publicly sentiment and share it myself in terms of unjustified owned company—by that I mean having rewards where they arise, it is interesting to note that institutional shareholders—is to manage our tax actually, so far, when banks have gone bust (and the aVairs eYciently, but there are very prescriptive and most recent example was Lehman’s but we could use clear laws governing tax in the United Kingdom Bear Stearns before that) the vast majority of the and, of course, we take it seriously that we have an employees quickly got rehired with, indeed, obligation to abide by those. guaranteed bonuses extant at quite high levels.

Q1930 Mr Breed: But you will be aware that a number of schemes have emerged in the courts in recent years as to precisely that as exactly what you Q1935 Mr Brady: Yesterday Andy Hornby told us are doing: implementing complex tax avoidance that there is no doubt that the bonus systems in schemes to lower the amount of tax that you pay to many banks around the world have been proven to the Exchequer. be wrong in the last 24 months, and he particularly Mr Varley: That is not what we do. Indeed, what I highlighted short-term cash bonuses as being part of have just said to you about the amount of tax that the problem. Sir Fred Goodwin went on to say that we pay would be irreconcilable with the proposition this should be looked at as part and parcel of what that we are seeking to avoid payment of tax. to do to prevent this sort of situation arising again, thinking perhaps more of those banks that are not in Q1931 Mr Breed: One of the issues that surrounds all receipt of public support at the moment. Have you this is the fact that the taxpayer is putting moneys done anything to change your remuneration into banks, and they would expect them, therefore, structures yet in the light of this experience? to undertake their normal payment of tax. Mr Mr Thurston: At HSBC have been going through a Daniels, now that you are in receipt of taxpayer’s period of adjustment on the bonus and incentive money, will you stop implementing tax avoidance arrangements across the whole bank for some period schemes? of time. There are three key elements to this, I believe. The first is that you get the measures right, Mr Daniels: I would tell you that we do not do that the measure of success is not just driven by anything other than adhere to the spirit and the letter short-term profit but by measures that include of the law, and so I think that this is something— quality of the business, the risk management in the business; the second, it is the quantum of bonus that Q1932 Mr Breed: So you do not undertake tax is paid and making sure that is in line with the avoidance schemes? relative success of the business and the returns to Mr Daniels: The law is very clear about the amount shareholders; and the third is the method in which of tax we have to pay, and we adhere to that strictly. those bonuses are paid. We are increasingly moving towards deferral of bonus payments so that there is no immediate cash payment but there is a payment Q1933 Mr Breed: Mr Hester, lastly, I said yesterday over a period of time. That process has been moving to the witnesses that if RBS had failed and patiently along, as suggested by the Chairman of this gone into receivership, all the bonus and service committee, and our remuneration committee at this contracts would have fallen with them and, moment in time are conducting a critical review of therefore, anyone picking it up would have been able the payment levels. to start from afresh. The fact that the taxpayer has Mr Brady: Has Barclays done the same? come in via the Government in order to prevent that taking place means that many of the bonus contracts and service contracts still exist. Do you believe (a) they should do, bearing in mind they would have fallen if it had failed, and (b) should the Government Q1936 Chairman: Could we see that then? Could have actually ensured that before it put taxpayer’s you send us that information? money into banks it received a commitment from Mr Thurston: Once we publish our results, that bank to ensure that all such bonus contracts announcements will be made on the bonus and would have been null and voided? incentive payments in HSBC. Mr Hester: I think this is very, very diYcult territory, Mr Varley: The system that we use, Mr Brady, at the and I think it is rightfully the subject of public moment, is that the more senior the executive the debate. Clearly, simply from my position, what we greater the deferral and the greater the component of have to do is obey the law and so we are in the the bonus opportunity that comes in shares to create position of having to obey the law as opposed to alignment with our external shareholders. That having to make it. system has been in place for some time. If you ask me Processed: 25-03-2009 22:38:12 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG12

Ev 256 Treasury Committee: Evidence

11 February 2009 Mr Eric Daniels, Mr John Varley, Mr Stephen Hester, Mr Anto´ nio Horta-Oso´ rio and Mr Paul Thurston whether we are reviewing our structures today, the that a growing proportion of those bonuses are paid answer is, yes. We have actually been conducting in shares so that you align more fully the interests of that review for some months now, and our intention senior executives with shareholders. Having said is that at our Annual General Meeting we will share that, I think those are decisions that should be with our external shareholders the outcome of that pushed forward by shareholders through the review. The thrust of that review will be to try to remuneration committees. ensure that the sort of safeguard that you are referring to is available, because I think it is important that bank boards are in a position where Q1941 Mr Brady: But again it is work in progress. they can have some retrospection of performance. Mr Horta-Oso´rio: There are several steps in There are many systems in place that facilitate that, Santander already taken in that direction. but whether they are as extensive as they should be is what we are reviewing at the moment. The one other thing I would say is that, as you know, the Financial Q1942 Nick Ainger: Do you all accept that the Services Authority here has published its own views premise which was put in Hector Sants’ letter to all about best practice in compensation for banks, and chief executives of 13 October last year, saying there is a dialogue going on between all of us and the basically that a major contributor to the current FSA at the moment to triangulate their assessment crisis was, in fact, the bonus driven culture which of best practice with how we perform. I am quite had led to short-term decision, high risk taking, reassured by what I have seen so far as we have been which got many of you into serious problems where through that triangulation exercise. you had to go to the taxpayer? Would anybody demur from that position? You are all happy. Hector Q1937 Mr Brady: But you agree there is a problem Sants believed and other organisations, the and you have not yet got it right, you would say. You Counterparty Risk Management Group and the are changing your procedures again. You have not International Institute of Finance, all said the same yet got the system in place that you want. thing. So the reason that we are here is certainly at Mr Varley: I think that it would be, in my view, least very much partly driven by the bonus culture, strange, given what has happened in the world over driving high risk investments which then went the last two years, for any bank to make a judgment wrong. Does anybody disagree with that? that all is well in the compensation structure. It is Mr Varley: Could I just make one qualification, absolutely right, as I said a moment ago, that we which is that I think it is not a sort of binary subject, should listen, we should understand the views of the it seems to me. If Mr Sants was suggesting, and I world about this subject and we should be prepared think he was, that this was a contributor to the issue, to respond and act. We have, under the guidance of then I would not demur from that at all, but is it the our Chairman and a senior independent director in genesis of the problem? I would demur from that. Barclays, a review going on at the moment and that will, I am sure, create change. Q1943 Nick Ainger: But it was part of the problem. Q1938 Mr Brady: You will be getting rid of short- Mr Varley: Yes. term cash bonuses altogether. Mr Thurston: I think I have to endorse that and say Mr Varley: No, I think it would be wrong to say that that, clearly, as part of the industry, it is not we will be getting rid of them, because if I go back to unreasonable to say that was an element of the the comments that have been made earlier, for problem, but I would have to say that not all banks example, about our branch staV, it would be natural are the same, not all banks were driven to the same for our branch staV to be paid in cash. forms of behaviour.

Q1939 Mr Brady: I am talking about more senior Q1944 Nick Ainger: Anybody else? executives. Mr Horta-Oso´rio: I would endorse the comment. Mr Varley: For senior executives, as I say, as they become more senior, as their compensation opportunity grows with that seniority, the ratio of Q1945 Nick Ainger: We note what HSBC say, and I shares rises very significantly. am sure Standard Charter would say exactly the same thing as well, and perhaps Santander too. Q1940 Mr Brady: A quick comment from Abbey. However, the Policy Group of the Counterparty Mr Horta-Oso´rio: I would agree with what has been Risk Management said that remuneration, they said, and especially in investment banking, as you believe, should be based on practices that apply to were mentioning, there were clearly, in my opinion, senior executive management and they should be flaws with the bonus system and there are two based heavily on the performance of the firm as a criteria in my opinion that should be in-house going whole. Mr Thurston, how big a fall has there been in forward. Number one, as was mentioned, the the share price of HSBC in the last 12 months? bonuses do not only refer to one year but have a Mr Thurston: In the last two years it has fallen by multi-year process in their concession; number two 40%. Processed: 25-03-2009 22:38:12 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG12

Treasury Committee: Evidence Ev 257

11 February 2009 Mr Eric Daniels, Mr John Varley, Mr Stephen Hester, Mr Anto´ nio Horta-Oso´ rio and Mr Paul Thurston

Mr Varley: About 70%. Q1950 Nick Ainger: Mr Hester, your share price has Mr Hester: Over 90%. fallen by over 90%, you have had to write-oV 20 Mr Daniels: About 80%. billion of assets, you are predicting an eight billion Mr Horta-Oso´rio: Around 50%. pound loss, you have announced you are making 2,300 staV redundant and you are now 70% owned Q1946 Nick Ainger: Should you be paying any by the taxpayer. You are not considering paying bonuses based on the recommendation from the anybody, other than your lowest paid staV, any policy group of the counter-party risk, who made the bonus, are you? suggestion it should be based on the performance of Mr Hester: As you know, I have been at the bank for the whole group? less than three months, and this is one of the topics Mr Thurston: Whilst HSBC’s share price has fallen that I wish I was not having to spend so much time (and that, I am sure, is a factor that the wrestling with, because there are other very Remuneration Committee of the Board will look at important things we have to do to get RBS back to in their determination on pay levels within HSBC), strength again, but, of course, I do have to spend I would say that our share price has performed better time on it and, as I said earlier on, I empathise 100% than most of the peer group in the banking industry, with the public mood. It would give me no joy that our market capitalisation, which two years ago whatsoever to pay any bonuses to anyone, and if was 50% over the combined total of all the other that was a responsible thing to do, I would banks, is now 200% of the combined total of the recommend that in a heart beat. I do think that other banks, but we continue to pay dividends to banking pay in some areas of the industry is way too shareholders. high and needs to come down, and I intend us to lead that process. Having said all that, in RBS, although Q1947 Nick Ainger: Why are my constituents that we have not made decisions, what I am clear about bank with you writing to me to complain about your is there are no bonuses at the board level. performance? Mr Thurston: About HSBC’s performance? Q1951 Nick Ainger: But that was a requirement of the bail out. That was not a decision that the Q1948 Nick Ainger: If everything is going so well, board made. Mr Thurston, why are you cutting back on Mr Hester: I would be very clear about that in any overdrafts, and so on? It would appear that, in fact, event. There will be no bonuses of any sort to anyone you are not doing very well, or else you would carry at all associated with the losses we have made, on in the same way that you were in 2007. 2008 has whether high or low, throughout the organisation, been a disastrous year for you, has it not? and, indeed, many of them have been fired. There Mr Thurston: HSBC has continued to increase our will also be in RBS a reduction in bonuses, both in support of personal customers and business cash, greater than any bank that I know of in the customers in 2008 over 2007, and we have world, and, even when we take account of deferred committed to providing increased support next year consideration, greater than any bank I know of in as well. the world. RBS ranks currently tenth in the losses it has announced, and so I do agree that we have to be Q1949 Nick Ainger: Mr Varley, again, 2008 was not extremely stringent on this subject, and I believe that a good year compared with previous years, and yet RBS should lead the industry and I intend to do that. you are considering cash bonuses as well as share The diYculty, and I am sorry to give you a long packages for your staV. Why, bearing in mind the answer but I think it is an important subject, that I collapse in your share price? have to agonise about and wrestle with is that, for all Mr Varley: The first thing I would say is that the the very good public policy issues that we all know, executive directors are not receiving a bonus for we also at RBS have a bank where it is very 2008, and one of the significant contributors to that important that I can engage 177,000 staV in getting decision was what had happened to our share price, us out of this and in rebuilding strength, in serving because our shareholders have had a very diYcult 40 million customers, and, frankly, protecting the time and we should acknowledge that in the way in taxpayer against a balance sheet that is more than which the reward structures operate. If I then look at two trillion pounds in size. So somehow I need to the broader subject, our profits are down 14% in engage our staV to have the best people stay with us 2008 versus 2007 and our variable compensation, or and to attract better people to replace the ones we bonuses, have fallen 48%, and that is on average. got rid of who got us into the mess. Probably The way that the system operates is that the more something like 176,500 of our 177,000 staV actually senior the individual, then the greater that reduction. did what they were asked to do last year and made We have a number of responsibilities to a number of profits, and, therefore, when we consider how to stakeholders in this area and, I said before and I say treat them, aside from the issue, if you like, of it again, we listen carefully to what we are hearing incentivising them, the issue is how much worse can from you and others on this subject, but I believe we treat them relative to any other bank in the world, that we have behaved responsibly in ensuring that and that it is what we are wrestling with in order to the reduction in the variable compensation of the balance, on the one hand, the very proper public staV at Barclays very significantly exceeds the policy issues and, on the other hand, the need for the reduction in our profits year on year. taxpayer to have RBS regain its strength. Processed: 25-03-2009 22:38:12 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG12

Ev 258 Treasury Committee: Evidence

11 February 2009 Mr Eric Daniels, Mr John Varley, Mr Stephen Hester, Mr Anto´ nio Horta-Oso´ rio and Mr Paul Thurston

Q1952 Chairman: We are not finished with the Q1959 Chairman: Anto´nio, Andy Hornby of HBOS bonuses. We will come back to that, maybe not told us yesterday that he took all his bonuses in today but certainly in the weeks ahead. Mr Hester, shares, but he still managed to run HBOS into the you say that you have got to obey the law. I think ground. So is paying bonuses in shares really a that was in answer to Colin’s question. If your safeguard, as you indicated? shareholders rule that you should not be paying Mr Horta-Oso´rio: I think, as was previously bonuses, would you have to accept that? indicated, that the bonus is an important part of Mr Hester: I suppose, in the end, we have to do what correcting the situation but, as was said before, it is our shareholders say. Obviously, as individuals, if we not the only part. are being asked to break the law, we may not be able to do that. Q1960 Chairman: I want to point out to you that the company was run into the ground. Q1953 Chairman: You would not be breaking the Mr Horta-Oso´rio: The fact that you align law in every singly case, surely. You would have to shareholders with the interests of managers is a key look at the legal requirement. point, in my opinion. It is an important thing but not Mr Hester: We are dealing in hypotheticals. I think enough. You have to have the right organisation and you would not want to have— you especially have to have the right team and the right people in each of the jobs.

Q1954 Chairman: I will tell you, Mr Hester, what we Q1961 Sir Peter Viggers: The rescue in October 2008 do not want. We do not want a blanket statement by was projected as a plan to save the banks. Did you you. We want to know on behalf of the taxpayer expect it to be a definitive and final resolution for the exactly what the arrangements are. So I would be problems? grateful if you could provide us with information of Mr Thurston: I think the UK Government was one what your contractual obligations are so that we can of the quickest to respond and deal with that, but I get a real understanding if the taxpayer really needs think the situation has exceeded anybody’s to bear this burden. expectations over the whole course of events back Mr Hester: I will do that. through 2007 and 2008. Mr Varley: I think it felt at the time as though it was Y Q1955 Chairman: Eric, you mentioned to me that necessary, but it was unlikely to be su cient to deal you would not have had to take government money with an economic downturn. if you had not taken over HBOS. Is that correct? Mr Hester: I would agree with Mr Varley. Mr Daniels: That is correct. Mr Daniels: I agree. Mr Horta-Oso´rio: Me too.

Q1956 Chairman: Previously you said to me you Q1962 Sir Peter Viggers: The Royal Bank of believed the acquisition of HBOS was a prudent Scotland and Lloyds signed an agreement with the acquisition. Government on 13 October. One of the terms was Mr Daniels: Yes. that over the next three years the availability and active marketing of competitively priced lending to Q1957 Chairman: How can you square the two home owners and small businesses would be statements? How can an acquisition be prudent if it maintained at 2007 levels. What does this mean in pushes your company towards nationalisation and practice? the brink? Mr Hester: I can speak for Royal Bank of Scotland. Mr Daniels: We thought that the HBOS acquisition, In fact we have exceeded that target. As at the end of in the short-term, would be painful. It has turned 2008 our lending in those categories was more than out, given that the economy has turned down even 10% higher than the 2007 levels, and obviously we further, to be a very true statement but we also announced a range of initiatives in terms of delaying believe it is strategically a very good acquisition and the point of house repossessions, in terms of will prove to be so in a couple of years. guarantees on overdrafts to small businesses and a variety of other such initiatives, but the simple fact is that these commitments, while they were Q1958 Chairman: Stephen, you said about bank commitments that were sensible to make in the bonuses. Would you agree that in future bank bonus context of welcome government support, for which scheme contracts should have a clause that states we are grateful, they are also sensible for our “should the state have to assist your organisation, business. We have huge businesses here. We want to the scheme is nullified”? support our customers and we are very pleased to Mr Hester: I do not think that there should be do so. guaranteed bonuses. I think it is something that Mr Daniels: There are two very explicit should be avoided. I do think that substantial commitments and, as you have mentioned, they amounts of bonuses should be paid in deferred form regard availability of product and then the same so that they are vulnerable to claw back if there are level of marketing. Lloyds TSB has complied. In future losses, whether in terms of state rescue or any terms of lending to individuals we have lent about other future losses. 20% up in 2008 versus 2007. That is versus a market Processed: 25-03-2009 22:38:12 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG12

Treasury Committee: Evidence Ev 259

11 February 2009 Mr Eric Daniels, Mr John Varley, Mr Stephen Hester, Mr Anto´ nio Horta-Oso´ rio and Mr Paul Thurston increase of about 4%. In lending to companies, we mortgages of 30% as well. Our capital ratio at are up about 10% verses the market up about 5%. So Santander level is one of the highest of the industry. the product is clearly available and we are, in fact, It is above 7% in quarter year one, and therefore, in exceeding the levels of marketing in 2007. our specific case, the continuing lending to the UK economy is perfectly compatible with our capital Q1963 Sir Peter Viggers: Have your risk position on the one hand and with the level of our management systems improved suYciently for you profitability on the other hand. to be confident that you will not be building up yet another cycle of write-oVs? Do you feel confident Q1967 Sir Peter Viggers: It is quite an upbeat story about that, Mr Heston? coming through so far, but how do you value your Mr Hester: I think, frankly, the risk management untradable toxic debt, to move on to another systems at RBS need a lot of change, and I cannot subject. Mr Varley. do it all in a couple of weeks, and so we need to keep Mr Varley: I think the best test of the reliability of upgrading and keep improving. We are putting in the valuations in a bank’s balance sheet is whether, major changes as we speak, but it will take some time when it liquidates part of the assets that one is to get those absolutely right. I think there is also a talking about, they are liquidated in line with those risk of moral hazard as the Government and valuations. So there are a number of techniques that ourselves balance support of customers, because, we all have to deploy here and have various layers of obviously, eventually we all need to save more and assessment to ensure that the assessment is genuinely borrow less, and it is trying to get the balance in objective. The ultimate assessment, of course, is by allowing the economy to adjust gradually so that one’s external auditors, but I think where the rubber borrowing is not withdrawn swiftly,but there is some hits the road, if I may put it that way, Sir Peter, is moral hazard sitting around in there that we all have when a bank is seeking to close out positions that it to watch out for. has. In our own case, we liquidated nine billion pounds of positions in the sort of asset classes that Q1964 Sir Peter Viggers: Mr Daniels, are you you are referring to during the course of 2008, and confident? we did those in line with the valuations that we had Mr Daniels: We are very comfortable with our risk adopted, and I think that is the answer of the market systems. They have stood us well during the last to the question that you raise. several years and they helped us to avoid the impact, or a great part of the impact, but we are clearly not Q1968 Sir Peter Viggers: The reaction of fair value completely immune. We think that the HBOS accounting with regulatory capital requirements: acquisition will test our systems. Very clearly, we are can this lead to a vicious circle where you are called going to have to put the Lloyds systems into HBOS, upon to set aside more capital and this casts doubt and that will be a challenge for some time to come. on your own balance sheet? Mr Varley: What I would say is this. The impact of Q1965 Sir Peter Viggers: Members of Parliament are pro-cyclicality, which comes out of the Basel getting a lot of stories about small business finding it regulations, is something that is quite diYcult for us diYcult to get capital and, indeed, householders to wrestle with at the moment because I think that finding it diYcult to get mortgages. I am surprised by when the Basel authorities put those regulations in the upturn in your activity. Is the shortfall being place they would not have envisaged that borne elsewhere, Mr Thurston? governments and regulators all around the world Mr Thurston: As far as the industry statistics would have been supporting the banking system in indicate, and this is from the lending panel reports, the way that they have and are, and, frankly, I would the major UK banks are, indeed, continuing to lend, argue for a change in those regulations through time, but clearly some of the foreign banks, some of the because I think we need to revert to the standard Icelandic banks have pulled out of the market, some which used to operate, which is that in good times of the specialised mortgage providers have pulled banks are building their capital reserves. It seems out of the market; so it is likely that the overall idiosyncratic, in any event, to have bank reserves supply of lending has fallen whilst the major banks being required to be built under the Basel regulations are increasing their share of the lending pie. at a time when, as you rightly say, the Government and governments all around the world are urging us Q1966 Sir Peter Viggers: You are coming under to lend more. pressure from government, all of you, to strengthen your capital ratios, strengthen your balance sheets Q1969 John Thurso: I want to ask about corporate generally. How do you square this with the wish of governance, but before I do that I would like to government that you should be more open in your follow on from a point Sir Peter has just made. Can lending? I come back to HBOS, Mr Daniels. You told us Mr Horta-Oso´rio: In our case, as you know, we (which is certainly what I had understood) that announced our results last week and we are Lloyds TSB was in a pretty good position. You had supporting the UK economy along with the acted conservatively, you had good risk objectives that we have. We increased our lending to management and, had it not been for the HBOS small and medium size businesses last year by 30% acquisition, you would probably not, almost and we have had a net lending market share in certainly not have required any public money, you Processed: 25-03-2009 22:38:12 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG12

Ev 260 Treasury Committee: Evidence

11 February 2009 Mr Eric Daniels, Mr John Varley, Mr Stephen Hester, Mr Anto´ nio Horta-Oso´ rio and Mr Paul Thurston would be in the same boat as HSBC—a rather nice Scheme goes ahead, we will commit a further place to be. Are you seriously telling the committee amount. So I think the issue is the big banks will that with all that prudence and avoidance of risk, need to expand to fill the gap left by the withdrawal you actually walked into that purchase without any of the foreign banks, and what we are all trying to pressure from anybody? work out is by how much and through what Mr Daniels: We believe it is a very good purchase. mechanisms, and that is the process that is going on Again, the economy is far worse than we had and the process of engagement with government. forecast at the time, and I think anyone had forecast at the time; so we will have a period where it will take Q1974 John Thurso: Let me, Mr Daniels, come you a while for us to get HBOS to perform at the level to. Can I say that in Caithness, Sutherland and that we would like, but we believe it is a strategically Easter Ross there are not that many foreign banks! important element for the Lloyds Banking Group. Most of the lending was done by the RBS, or HBOS, or Clydesdale Bank. I have heard that Lloyds are Q1970 John Thurso: In retrospect, is that actually doing quite well. In your answer to the Chairman in the best value for Lloyds TSB shareholders to have this vein, I was interested that you said Lloyds TSB undertaken that transaction? is lending more and you did not mention HBOS. Mr Daniels: We believed it was at the time and we Specifically, on Monday morning I had a meeting continue to believe that. with a company worth approximately four million that has banked with HBOS for 40 odd years. It has Q1971 John Thurso: You might say that; I am not positive cash flow; it can meet its interest payments; sure I would go with you. Let me move on to what with a 50% hair cut on its assets it is still twice loan- Sir Peter said. What I am hearing from all the to-value; so it is precisely the kind of company that constituents that talk to me who are in small ought to be being looked after. On my advice they businesses and medium size businesses is: Where is went to their corporate manager in Inverness, who all this money promised to us that has gone in at the told them he had no money and he had never heard top?” Whenever I speak to bankers at a top level, of any government schemes. On my advice again, he they tell me they are shovelling it in perfectly happily went to the head of that section in Edinburgh and at the top, and whenever I ask a question of a received exactly the same story. They said they minister, they say everything is rosy in the garden would be very interested to know where their funny and everything is working. How do you make sure MP got these notions from that there was some sort that what the Government is seeking to achieve by of help available. How on earth do I help my putting money into banks, by the loan guarantee constituents when your bankers do not know schemes and all the other things, actually results in Tuesday from Wednesday? businesses that would otherwise be in serious Mr Daniels: I apologise if that in fact was the case diYculty getting the assistance that we think we are with that particular customers, and if you would be promising them? Mr Hester, can I start with you? kind enough to give me the customer’s name what I Mr Hester: As I have mentioned, in fact we are would be happy to do is to look into it personally, significantly exceeding the targets that we agreed but, as you know, HBOS had tremendous amounts with the Government in terms of lending and then a of funding diYculty during the last few months of whole variety of other support to customers. the year. We took over on 19 January. Very clearly one of the things that we have to do is to put in not Q1972 John Thurso: That is presumably an only our governance that has served us well but our aggregate target. practices across the board. Because of the funding Mr Hester: Absolutely; in a sense it has to be. restrictions, or the lack of funding that HBOS had, they had to restrict their lending. Despite that, they Q1973 John Thurso: How do you reconcile this. actually did increase in 2008 over 2007, but the These are not apocryphal stories. These are actual specific policies, and so on, we very clearly will have businesses that I know about and do not want to to take a look at and I would be very happy to take name here because I do not want the suppliers to a look at this specific incident. withdraw. Mr Hester: I think the point was made by HSBC Q1975 John Thurso: Thank you very much. Can I that in fact there is a gap in the market from the turn, finally, to the question of corporate disappearance of other lenders, mostly international governance, and perhaps, Mr Thurston, since your banks, foreign banks, probably similar to the gap company, as it were, has not had to go for any help, that RBS will create in other countries when we draw yesterday we were told by Sir Tom McKillop and by back from certain other countries, and so even Lord Stephenson of the amount of hard work that though the major banks are expanding, it is possible had been put in by the non-executives in their that they are not expanding by enough to fill that institutions, how much time it took, how much gap. As I understand it, it is for that reason that the training they had. There is a general view amongst Government is seeking to get the major banks to the public that most boards of non-executives are a commit even more expansion to fill the gaps. At RBS happy little decoration of the great and the good, we committed an extra six billion pounds in like lights on a Christmas three that do not provide connection with the conversion of the preference much. Clearly, the truth will be somewhere between shares a few weeks ago, and if the Asset Protection the two. Can I put it to you that the problem is that Processed: 25-03-2009 22:38:12 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG12

Treasury Committee: Evidence Ev 261

11 February 2009 Mr Eric Daniels, Mr John Varley, Mr Stephen Hester, Mr Anto´ nio Horta-Oso´ rio and Mr Paul Thurston international banks operating across all the banking cultures simply do not mix? Is it that corporate disciplines are actually too complex to be governed governance just cannot take care of the swash by a traditional exec/non-exec format? buckling side of the business? Mr Thurston: We have, as you well know, an Mr Varley: I saw the comment, and to me it was a executive chairman, and we do believe that it is very very interesting comment. Going back to your important for a group of our size and geographic question about governance and the composition of reach— boards, I certainly find it very helpful around the Barclays Board table to have three of our non- Q1976 John Thurso: Which is to clarify he is in executive directors who have significant investment contravention to the model code. banking experience. I am not suggesting for one Mr Thurston: There is clear separation of moment that you want to have on a bank board a responsibilities between the Chairman and the CEO non-executive director cadre that is made up of but he is an executive. With the scope and breadth of former bankers, but I think it is extremely desirable our activities, that is important. Our board of non- to have at the board table people who understand executive directors at a group level has a number of the industry and, in particular, the most esoteric leading businessmen and women who have run parts of it, and that would cover the investment businesses on a multi-national basis. In the UK bank banking world. It is no coincidence in our case that we have a board of senior people, we have an audit we, including our chairman, have an investment committee, which is one of the key committees which banking background. That is a very conscious oversees the risk management of the board: there are decision. I certainly find it very helpful as a chief three members of that, they are all non-executive, executive to know that I get that challenge from each of them has 30 years’ of experience in either the people who understand intimately the financial banking or financial services or accountancy services industry and even the more abstruse parts business. So it does require significant experience in of it. those roles. John Thurso: We are going to write a report. We are going to make recommendations. Would you all like Q1977 John Thurso: Mr Hester, can I come to you? to reflect and give us a measured, written response? I look at RBS, a once proud Scottish banking Chairman: In answer to our question yesterday to Sir institution, British banking institution, brought to Tom McKillop, I put the puzzle that we had Sir Peter its knees. I look at those names on that non- Sutherland, a former EU Commissioner, chairman executive board and say to myself, how come none of Goldman Sachs. We had Steve Robson, number of them said, “No, this is nuts”? You have come in, two at the Treasury when the tripartite authority was new broom, and I am sure are going to do a great job. established. We had Jim Currie who works at the What would you like to see done to make sure that EU. We could go on. Either people are stupid or kind of thing does not happen? What is the lesson in there is something systematic. These people have an this for corporate governance? excellent track record so there must be some Mr Hester: This is a really, really diYcult question. systematic issue and problem here. We have to push Obviously, I was not there in the past, so I cannot at that because I am coming to the view that maybe comment on that other than to say that I think that banks are diVerent from other organisations and the criticisms being thrown around are, in some what we need in boards. If you can contribute to that cases, harsh but, obviously,the mistakes are there for for us, it would be very helpful. all to see. I think that all companies struggle with the non-executive balance, and it gets down to humans rather than process, and it is really incumbent that Q1979 Mr Tyrie: I wanted to ask one follow up you have an executive that wants strong challenge question to Mr Daniels about the HBOS deal. You and that gives information to enable it, and it is said that it was a very prudent one. What due equally important that non-executives understand diligence did you do before you went ahead with that, because it is their job to help the companies that deal? succeed. Helping the company succeed does not Mr Daniels: As a publicly traded company, there is always mean saying, yes, to the chief executive, it can a limited amount of diligence that can be done in an mean a challenge, constructive challenge, but I have acquisition. That said, we put approximately 5,000 to tell you, I am not sure this is an issue of process. man days into the diligence eVort. A great part of I think it is, unfortunately, an issue of humans and that was done by people that we had hired as experts, their behaviour. accounting firms, investment banks and so on, in an eVort to value the portfolios properly. Q1978 John Thurso: Mr Varley, one of the things that came out of yesterday’s session was the fact that Q1980 Mr Tyrie: If you had had more time, how the investment merchant banking side came out of many man hours would you expect to put in? V the partnership tradition, which is a wholly di erent Mr Daniels: If we had unlimited access, which is not V culture, wholly di erent way of taking risk, wholly permitted by the law— diVerent remuneration. Banks came out of stock holding, people owning shares. Is it the case that we ought to really go back to something akin to Glass- Q1981 Mr Tyrie: To a similar company but with Steagall where there is a separation, because the two more time. Processed: 25-03-2009 22:38:12 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG12

Ev 262 Treasury Committee: Evidence

11 February 2009 Mr Eric Daniels, Mr John Varley, Mr Stephen Hester, Mr Anto´ nio Horta-Oso´ rio and Mr Paul Thurston

Mr Daniels: We probably would have put in end of it is not anti-competitive. We have not had the somewhere around three to five times as much time ability to study the details of what the combined as we put in. entity will be like and how it will operate.

Q1982 Mr Tyrie: Since you have only just taken over Q1990 Mr Tyrie: Do you think we are going to be on 19 January, how can you be so confident that it able to unwind it? was a very prudent deal? You must be still doing the Mr Thurston: I am not sure. due diligence now. Mr Daniels: We very clearly are learning and Q1991 Mr Tyrie: Mr Varley? assembling a database in order to be able to run the Mr Varley: I think what was done had to be done at company well. the time. I also take some comfort from the fact that the European Union takes an interest in the Q1983 Mr Tyrie: How comfortable are you about competitive landscape and will have an overview as the quality of the assets? Is it better, worse or about to whether there is any distortion. If you are asking the same as you thought on the basis of the very whether there will be any distortion, I believe not. incomplete due diligence you did? Mr Hester: I agree with my colleagues. Mr Daniels: The outcomes that we have seen thus far are within the ranges that we forecast. Q1992 Mr Tyrie: Do you want to add anything? Mr Daniels: No. Q1984 Mr Tyrie: You are very confident you are not Mr Tyrie: I am amazed by those replies. I would suddenly going to have to come forward to us and to have thought you would be very concerned in the the public to tell us that there is a whole basket full of long term about competition in your industry. All I toxic assets which you had not foreseen being there? can suggest is that you come forward with some Mr Daniels: Based on what we have seen thus far, we other deal which can give you a disproportionate believe that we are well capitalised as a group. slug of some other market.

Q1985 Mr Tyrie: Do you think this was a Q1993 Chairman: On the issue of due diligence, a commercial transaction? Do you think it should be very experienced, senior, distinguished individual described as such? said to me, in terms of the complexity of some banks Mr Daniels: I believe it should be. as organisations, that it could take a year to go through books and fully understand what is on the books, what are the risks and obligations. Is that Q1986 Mr Tyrie: You do not think there was a way oV the wall for you? political element to this deal? Mr Thurston: It would depend on the size of the Mr Daniels: I believe that it was a good deal for organisation and the nature of its business. Lloyds TSB. Q1994 Chairman: You could envisage something Q1987 Mr Tyrie: Do you think there was a political like that with the complex organisations we have element to this deal? today? Mr Daniels: Very clearly, there was a clearance by Mr Thurston: That would be a very large, complex government to help us with the Competition acquisition for that length of time. Commission so to that extent, yes, there was involvement by government. Q1995 Mr Fallon: Stephen Hester, your majority shareholder, UKFI, has the objectives of protecting Q1988 Mr Tyrie: I want to ask the others here and creating taxpayer value, maintaining financial whether they have any concerns about the fact that stability and promoting competition. How can all there was that political element and therefore those objectives be reconciled? competition was being reduced in the industry. Do Mr Hester: In my engagement with them so far, not all feel obliged to comment but, if you do want which has been significant, I think that they have to add something, perhaps we can go right to left. been behaving like a very engaged institutional Are you concerned by the diminution of shareholder in relation to what I will call the competition? strategic and shareholder value type issues. They do Mr Thurston: I think it is something we have to look have other mandates that are not about shareholder out for in the future in terms of the way these value but are to do with the lending commitments, businesses are managed to ensure there is no pay and those sorts of things, which are a little more diminution in competition, as we should do in all political in terms of the engagement we have with such cases. them. Nevertheless, I certainly have no fears at the moment in terms of the way UKFI specifically are Q1989 Mr Tyrie: You do not think there will be? going about their job. Mr Thurston: I think it was the right decision to put aside the competition rules at a time of crisis, to take Q1996 Mr Fallon: Eric Daniels, how can they decisions. I think that is understandable, but we promote competition at the same time as protecting have to make sure that in doing so what results at the taxpayer value? Processed: 25-03-2009 22:38:12 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG12

Treasury Committee: Evidence Ev 263

11 February 2009 Mr Eric Daniels, Mr John Varley, Mr Stephen Hester, Mr Anto´ nio Horta-Oso´ rio and Mr Paul Thurston

Mr Daniels: What we have seen thus far has been a international, global operations and yet protect our reasonably even handed treatment. We are early in UK customers and lend more to creditworthy the relationship. We will watch it unfold but, so far, segments in the UK. That is our plan. I have not seen any conflict among the objectives. Q2004 Mr Fallon: Overall, lending in the UK will Q1997 Mr Fallon: Stephen Hester, what is the increase? strategy to repay the taxpayer? What is the time Mr Hester: That is our plan. frame? Mr Hester: We obviously have a really huge job to Q2005 Mr Brady: Stephen Hester, you said earlier I do. It is my belief that it will be a three to five year think that you wished you did not have to spend so process. Clearly, the length of the process will much of your time on pay and bonus issues. Are you significantly depend on how long the economic finding your contact with UKFI is downturn is because that slows things up, but three disproportionately focused on those issues? to five years is the planning horizon that I have for Mr Hester: I do not really feel like casting stones at getting RBS back to stand alone health and enabling the moment. I think we should all be very grateful— the taxpayer to be free and hopefully make a profit. Q2006 Mr Brady: I was only asking for an answer. Q1998 Mr Fallon: Does that depend on current Mr Hester:—for government support. The price of lending levels? government support must be to build confidence on Mr Hester: Current lending levels are of course an behalf of government that we are proper stewards of aspect of that but I think there are many bigger the support. I do not resent the time spent building aspects that will determine how fast that process is. confidence either in government or in all the other people who are trusting us to get back. We have to Q1999 Mr Fallon: Eric Daniels, what is your strategy explain ourselves and build and rebuild confidence. to repay the taxpayer and what is your time frame? Mr Daniels: It is very hard to signal a time frame. Q2007 Mr Brady: Your answer is that you are not Part of the issue is that repaying the taxpayer really critical of it but that is taking up the greater part of means, in the case of UKFI, when they decide to sell the contact with UKFI? the shares. Our best strategy is to serve our Mr Hester: We are taking up a significant amount of customers extremely well so that they prefer to do time with government, which I think is appropriate. business with us. That will allow us to be profitable and hopefully that will make our share price rise. Q2008 Mr Brady: Specifically on pay and bonuses? That will give UKFI the option of deciding when Mr Hester: On many issues. As much on strategy as they wish to sell the shares. pay and bonuses but certainly most recently on pay and bonuses. Q2000 Mr Fallon: What is the time frame? Mr Daniels: If I could call the stock market, I would Q2009 Jim Cousins: Mr Hester, you told us a little not be doing what I am doing. earlier that your balance sheet was £2 trillion. Mr Hester: More than, sadly. Q2001 Mr Fallon: Is it less than the three to five years that Stephen Hester mentioned? Q2010 Jim Cousins: How much of that balance sheet Mr Daniels: I would certainly hope so. is outside the United Kingdom, bearing in mind that the United Kingdom taxpayer is now your majority Q2002 Mr Fallon: What impact will the more rapid shareholder? repayment of taxpayer support, Mr Hester, have on Mr Hester: It is not a figure on which it is easy to be your ability to lend to home owners and small precise, because we have very many cross border businesses? flows that involve people on two sides of borders, Mr Hester: If I am understanding your question but I think it would be accurate to say that correctly, clearly, if we deplete our capital base, we something like two thirds of our loans would be could lend less. If I understood your question international and a larger amount of our securities correctly, repaying the taxpayer quickly, if that and derivative contracts. meant depleting our capital base as opposed to finding capital from somewhere else, would have Q2011 Jim Cousins: Mr Daniels, what is your that consequence. position with regard to that issue? Mr Daniels: We are primarily a UK based bank. Q2003 Mr Fallon: The three to five year timetable Approximately between 80 to 90% of our business is you have given the Committee presumes lending at here in the UK. current levels? Mr Hester: I am expecting us to follow diVerent Q2012 Jim Cousins: Mr Hester, I can tell you can see strategies in diVerent parts of our business. Overall, the immediate diYculty that the British taxpayer is the Royal Bank of Scotland has to significantly standing behind a set of operations where two thirds reduce its balance sheet and that means lend less. of the loan book is outside the United Kingdom. However, I believe that we can do that through our What can you say to British taxpayers, who may well Processed: 25-03-2009 22:38:12 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG12

Ev 264 Treasury Committee: Evidence

11 February 2009 Mr Eric Daniels, Mr John Varley, Mr Stephen Hester, Mr Anto´ nio Horta-Oso´ rio and Mr Paul Thurston not be able to get car loans themselves, but who find more immediate burden on the taxpayer. I do not themselves supporting as taxpayers car loans right think there is a right or a wrong answer, but I think across the United States? those are the issues that have to be weighed. Mr Hester: I think I would say the following: the only part of our business where we are expanding lending is in the UK. Everywhere else we are Q2017 Jim Cousins: Have you started to discuss a reducing it and that process will continue and indeed structural separation of your least well performing probably accelerate. Secondly, governments assets with UKFI or with the Treasury? everywhere around the world are supporting the Mr Hester: We are engaged with the Treasury in financial system and supporting banks of all exploring the asset protection scheme that they have nationalities. If I look at just RBS, while of course announced and I am hopeful that we will make use our greatest support is coming from the UK, we do of it and that that will allow us to lend substantially benefit from support programmes of the Fed in the more into the UK. I believe that there are potential United States, of the European Central Bank, of the provisions of that scheme to fund assets as well as to Australian Central Bank, of the Japanese Central insure them, although my understanding is the Bank. I am sure most of my colleagues at this table principal thrust is the insurance thrust at this stage. have their own dealings with these central banks. It is very important that the world not retreat into a Q2018 Jim Cousins: Is it your intention to put any of process of isolationism, whether on trade or on your badly performing assets outside UK financial services, because that will make it worse for jurisdiction into the government’s loan guarantee everyone. We all have to work together. It is a cliche´ scheme? but it is true. We do. Mr Hester: In our case, given how international we are, the assets that we would put forward for the Q2013 Jim Cousins: Do you have access to the scheme would be from many countries, including the Troubled Assets Relief Programme or to its UK but also including non-UK. If we restricted it successor that has been mounted? only to the UK, its use for us would be of limited Mr Hester: At this juncture we have not had direct value. Because in a sense balance sheets are fungible, access to the Troubled Assets Relief Programme. As support that we receive for non-UK assets enables us to its successor, the details are not fully available yet. to do more in the UK and that is something that I We do have significant support from the Fed though, hope we will do, I want to do, we are doing and is a as I believe all international banks do. very important element to the scheme.

Q2014 Jim Cousins: Do you regard yourself as being eligible for the Troubled Assets Relief Programme? Q2019 Jim Cousins: You will clearly be aware that Mr Hester: Phase one we were not eligible for. there is likely to be a very strong reaction by UK taxpayers to the idea that they are helping to fund Q2015 Jim Cousins: For phase two, the story is still the loan guarantee scheme which is supporting bits to be read? of your balance sheet which may be quite dodgy, Mr Hester: I do not know. which are thousands of miles away from the United Kingdom. Mr Hester: That is why I think it is very, very Q2016 Jim Cousins: Are either of you advocates, Mr important that, if the scheme goes ahead, we and the Daniels or Mr Hester, of a so-called bad bank where government can demonstrate that there is something your least well performing bits of business would be in it for the UK taxpayer over and above financial separated oV and would become presumably the stability and the investment in us in the form of complete responsibility of taxpayers? extra lending. Mr Hester: The problem, as with many of these issues, is that the same term is often used for diVerent things. If we take the distinction that I would draw, Q2020 Jim Cousins: In general terms or case by case? insurance schemes, of which there are a number in Mr Hester: Both. the US, proposed here and in Switzerland as an example, may insure a bank against risk with various arrangements around the premiums, but the assets Q2021 Jim Cousins: What steps do you think would stay on the balance sheet and need to be funded by bring about the nationalisation of either the Lloyds the bank. More conventionally the term “bad Group or RBS? What steps are you taking to bank”, although that is sometimes also used for avoid that? insurance schemes, would mean that the risk is taken Mr Daniels: Nationalisation would be a result of oV the balance sheet of the bank and funded. The burning through our very considerable capital which advantage of that is that one of the problems in this I do not believe we will do. It is impossible in this current crisis is banks’ inability to fund very large kind of environment to forecast how bad things can balance sheets when funding markets dried up, so it get or how quickly we will recover, so it is hard to would alleviate that additional problem of banks make a definitive statement, but from everything which goes beyond the capital ratio. The that we see today we are well capitalised and we disadvantage is that it is more complex to agree the believe we can continue to do business successfully pricing than a simple insurance policy and has a and grow our business. Processed: 25-03-2009 22:38:12 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG12

Treasury Committee: Evidence Ev 265

11 February 2009 Mr Eric Daniels, Mr John Varley, Mr Stephen Hester, Mr Anto´ nio Horta-Oso´ rio and Mr Paul Thurston

Q2022 Jim Cousins: I wonder if I could ask you the Q2029 Chairman: Stephen, on the point about same question, Mr Hester, which is perhaps a more derivative contract obligations, it has been powerful question in your case. mentioned to me that some people in the City may Mr Hester: Everyone at RBS is working flat out to be wrong, but I would like you just to knock it down try to rebuild our strength and repay the support of or whatever, that the RBS has, say, up to £1.3 billion people who depend on us and repay the people who of derivative contract obligations on their books. have supported us. We will do that regardless of our Mr Hester: We have, in terms of notional contracts, shareholding base. However, I do believe that it is many trillions of derivative contracts in terms of the not in the public interest to nationalise us. I think balance sheet recording of that. Because we have not that point of view is taken by governments published our year end results, I cannot give you the everywhere around the world in respect of banks figure. At the last balance sheet, it was some £500 everywhere around the world, in all the major billion and will be significantly higher when we countries. I believe that it is taken by the UK reveal our balance sheet for the year end. Government. The furore that banks are currently in, in the public eye, demonstrates rather eloquently the diYculties of public ownership and bank operations. Q2030 Chairman: I heard it was £1.3 billion. You are I think it would not be in people’s interest. I hope it saying it is £500. does not happen. I hope we can remain strong Mr Hester: In the last balance sheet, it was some enough for it not to happen, but whatever our £500 billion and it will be substantially higher in or ownership we will try to rebuild the strength of this next balance sheet. institution and support our customers. Jim Cousins: The British taxpayer is standing behind Q2031 Chairman: I would not mind if you you. Can I ask you both to make the Committee communicated that to us at the right time. aware of any legal actions you may be aware of, from Mr Hester: Of course. for example tax authorities or regulatory bodies or groups of people with an interest in your companies, who may be bringing issues of fiduciary duty to the Q2032 Ms Keeble: I wanted to ask something about attention of whatever courts they have access to? short selling and also about risk. John Varley, The British taxpayer will be defending them Barclays are supportive of its stock market value just alongside you and therefore it is in the public interest after the short selling ban was lifted. The hedge fund that we should be aware of that. If you could do that managers, when they came here, said that it was not it would be helpful. I am not asking you to do it down to the short selling. Do you agree with their right now. analysis? Mr Varley: In a normal market, I would be in support of short selling. It is an ingredient of a Q2023 Chairman: On the bonus aspect, did you take normal market. I do think it would have been helpful any legal advice on breaking contracts regarding had the ban remained in place. That is partly for bonuses? Have you ever taken any legal advice? reasons of form and partly for reasons of substance. Mr Hester: We have. It is an ongoing process. We are taking more and more legal advice. I do not want to recommend a single penny of bonuses more than is Q2033 Ms Keeble: Did they contribute to your share in the interests of our shareholders. I have nothing to price fall? gain from that. Mr Varley: I will try and come to the answer. I apologise for being slow in doing so. There clearly Q2024 Chairman: Have you taken any legal advice has been some shortening of Barclays’ shares. Now on that, Eric? there is a disclosure regime, as you know, which is Mr Daniels: On the contracts? designed to ensure that there is transparency. The second point though is the point of form as opposed Q2025 Chairman: Yes. to the point of substance, which is that the Mr Daniels: Yes, we have. perception of the ability of hedge funds to short stock at a time of instability itself feeds instability, Q2026 Chairman: Is that ongoing? which is why as I felt as I did about the lifting of Mr Daniels: No, it is not. the ban.

Q2027 Chairman: What is the answer? Q2034 Ms Keeble: Stephen, you said previously in Mr Daniels: The answer is that for the HBOS response to other questions that you had seen some employees their remuneration was decided by weaknesses in RBS and what had been done contracts and by the board of HBOS before we took previously, particularly around risk management. over on 19 January. All policies after 19 January What were those weaknesses? What do you want to and— see improved, just briefly, because I want to ask the others that as well? Q2028 Chairman: Those are legally binding and Mr Hester: Unfortunately, it is a long and rather cannot be broken? detailed question. The most important thing is some Mr Daniels: Correct. They will be the responsibility very big elements of control which I think we can of the Lloyds Banking Group thereafter. improve. Processed: 25-03-2009 22:38:12 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG12

Ev 266 Treasury Committee: Evidence

11 February 2009 Mr Eric Daniels, Mr John Varley, Mr Stephen Hester, Mr Anto´ nio Horta-Oso´ rio and Mr Paul Thurston

Q2035 Ms Keeble: Control of risk? both the structures and the culture of the risk Mr Hester: Control of risk and rules on size and management inside HBOS? Would you agree with concentration, types of risk and amounts of risk the criticisms? which we can improve from what we have at the Mr Daniels: A lot has to do with the risk appetite moment. There are many other aspects to risk which which is set by the management and the board. I am afraid will take almost a book to answer. Whenever a strategy is drawn up, either implicitly or explicitly—in the case of Lloyds it is very explicit— we set risk parameters and a risk appetite. That Q2036 Ms Keeble: Do you want to put those in a note to summarise the main points? includes liquidity risk, credit risk, market risk and so Mr Hester: Of course, these are of interest to the on. Then we put in a governance structure that whole market and at our year end results in two rigorously monitors and measures, so whenever we weeks’ time we will be saying some things on this and get close to a limit we examine it carefully and then other matters. If I may, I will leave it at that. we see whether we want to make the necessary adjustments.

Q2037 Ms Keeble: When we had your predecessors in, Tom McKillop was reduced to speechlessness Q2041 Ms Keeble: John Varley, I wanted to ask you when he was asked about the value of the ABN also about the Gulf deal and the decisions taken Amro deal. As you have trawled through the around that because quite a number of paperwork and what happened, what is your commentators have said that put Barclays at some analysis of how they have got that call so badly risk. Why did you agree to the ratchet clause? Is there wrong? What was wrong with their risk a serious risk that you might need to go for more management? capital and the clause would be triggered? Mr Hester: The risk management of ABN Amro? (The Committee suspended from 4pm to 4.15pm for a division in the House) Q2038 Ms Keeble: When your predecessors were Mr Varley: First of all, on the anti-dilution clause, it looking at that deal, why did they assess it wrongly? is a pretty standard feature of these sorts of security Mr Hester: I am afraid I am not in a position to instruments—convertible notes—and in the know what they did and did not do an dhow they generality it is a standard feature. If you look at the reached those conclusions. I do not want to be an issuing of such instruments during the course of the apologist but I want to be fair. With many of the last two years for bank recapitalisations, again, it things that have gone wrong in the world, in the has been quite a common feature. That was why it banking system and at RBS, the sadness is that they was included. were there for all to see: the lack of saving, the excessive consumer spending, the house price boom, the trade deficits. When we turn to the banking Q2042 Ms Keeble: According to some of the system, it was there for all to see that RBS had a literature that is going around, a number of the leverage business model and that ABN Amro banks that have used this have ended up in very doubled up that risk, how it was funded, the substantial diYculties. The issue is really what shareholders’ approval and everything. Many of the assessment you have done as to whether you will issues were judgments honestly made on very big need to raise capital. things that have turned out to be very badly wrong, Mr Varley: Which takes me to your second question, but they were judgments that were very visible to which is whether we have enough capital. As you many. know, the capital requirements were reset by the Financial Services Authority in October of last year. Q2039 Ms Keeble: Eric, you have also talked to We have a capital plan which we have agreed with others about the risk and about what you saw. When the Financial Services Authority. We have your predecessors came in, they were very defensive significantly increased the amount of capital that we indeed about the risk management structures. What have in Barclays since then. We now run ratios that is your assessment of what happened with HBOS? are not just a bit but very substantially above the Why did they get it so badly wrong? regulatory minima that are required of us and with Mr Daniels: I think there were two principal issues. that surplus of course goes very significant loss The first was the funding issue. As you know, banks absorption. The loss absorption itself is do not go bankrupt usually because of credit but strengthened if the bank is profitable and Barclays usually because of liquidity. They had a wholesale have made profits during the course of 2008. funding model. When liquidity dried up across the world last year, HBOS clearly had some problems. Q2043 Ms Keeble: Why did you decide to go for that type of a deal rather than look at other means of Q2040 Ms Keeble: That is about their model. What raising extra capital? Why did you choose to do it was it about their risk management which meant through a particular dealer rather than perhaps that it did not become obvious to them that they again going out to existing shareholders first, which were in serious problems, particularly given that we would perhaps have been more the norm? Why had evidence that we all saw about problems about Amanda Staveley? Processed: 25-03-2009 22:38:12 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG12

Treasury Committee: Evidence Ev 267

11 February 2009 Mr Eric Daniels, Mr John Varley, Mr Stephen Hester, Mr Anto´ nio Horta-Oso´ rio and Mr Paul Thurston

Mr Varley: On your last point, Amanda Staveley is run into the same situation. You would need to get not employed by Barclays. She is not employed as an money. The Labour Government is going to oVer agent of Barclays. She was employed by one of those you money and this time round you do not want to who invested in Barclays. On your broader point, spurn it but there is something in your agreement. you are right that in normal circumstances our What is the agreement? instinct, our practice and indeed our history would Mr Varley: We had a choice, just as you are saying. have been to have oVered the opportunity to We could have taken money from the UK. subscribe to our existing shareholders. That would be an absolutely normal thing for us to do, but as Q2047 Mr Mudie: I am not worried about that. I just you know the circumstances were very far from want you to put on record the diVerent rumours that normal. We needed speed, certainty and size. We are going about. What is in this deal? Are you made the decision that we did to recapitalise in the restricted from taking government money and, if so, way that we did. Looking back on it, given the how long does the restriction last? Thirdly, how can extreme fragility of the sentiment in the markets at you get out of it if you need to? that time, I am very glad indeed that we managed to Mr Varley: We would not be restricted from taking raise the capital that we did raise at that time. government money; nor were we restricted back in October from taking government money. We have Q2044 Ms Keeble: If you did not employ her, how chosen not to take government money. I put that in did she come to get all the publicity for negotiating the following context: is it a natural pursuit of the the deal and the £40 million fee? Is it true that there British Government to deploy taxpayers’ money was another £300 million in fees and commissions more than it has to— paid? What was the government scrutiny that was applied to the way that those commissions were paid Q2048 Mr Mudie: I will save time for you. I am not and who were they paid to? worried about that aspect. You are absolutely saying Mr Varley: Those who subscribe for stock on such that all these authoritative reports that have been in occasions, particularly if they subscribe in size as the newspapers and the financial papers are happened on this occasion, may choose to have nonsense. independent advisers. As it happens, the Abu Dhabi Mr Varley: Our freedom of choice is maintained. interest chose to employ Amanda Staveley. The way in which she was remunerated was a decision for them, certainly not for us. Q2049 Mr Breed: When the history of this sort of financial saga is being written, probably the collapse of Lehman Brothers is going to feature very large. In Q2045 Ms Keeble: Paul Thurston, everybody else your opinion, was the Lehman failure a symptom or said that the warnings were on the wall and there for a cause in the collapse of the wholesale funding all to see, but they did not see them and your markets? company clearly did. Why did you take such Mr Daniels: I find that very diYcult to answer. I am V di erent decisions apparently from some of the not intimately familiar with Lehman. The other businesses here? confidence that was shaken around the world when Mr Thurston: I think we have always been relatively Lehman fell clearly upset and paralysed the markets. conservative as a lender. We also had extensive business in the United States and saw what was happening in the United States with the housing Q2050 Mr Breed: Did it impede your own bank’s market there. As a result of that, we continued to ability to borrow on the market? look at all our business across the whole world in Mr Daniels: After Lehman weakened, the markets terms of what was the risk profile and the risk got very short indeed. It was almost impossible to appetite we had. We have never believed in running fund term lending. Lloyds, as you know, is one of the our business on the basis of lending more money most creditworthy banks. Our triple A rating is than we have in deposits. We have always had something that is rare, so we have no trouble controls on every country around the world in the funding. We fund more cheaply than many other diVerent currencies that we have, making sure that institutions. The issue is that the tenor with which we we are managing our funding as well as our could borrow was shortened considerably after liquidity position. Lehman.

Q2046 Mr Mudie: Mr Daniels maybe six months ago Q2051 Mr Breed: At any time did you feel that the would not have thought he was going to need bank’s position was threatened in any way because government money. You spurned the opportunity to of that freezing up of the market? get money from the Labour Government and went Mr Daniels: It is very clearly worrisome when the instead to the Middle East for more expensive loans that one makes are of a greater tenor than the money. This might worry some people because there deposits. Then you have a fundamental mismatch. are diVerent details in the press that part of that agreement stops you taking government money Q2052 Mr Breed: Might it even have aVected the should the need arise. Could you put on the record survival of the bank? what that clause is? If I were an employee or a Mr Daniels: If things got really severe enough, yes, customer of Barclays, I would worry that you would it could. Processed: 25-03-2009 22:38:12 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG12

Ev 268 Treasury Committee: Evidence

11 February 2009 Mr Eric Daniels, Mr John Varley, Mr Stephen Hester, Mr Anto´ nio Horta-Oso´ rio and Mr Paul Thurston

Q2053 Mr Breed: Anto´nio, could we talk about Q2058 Chairman: How much did you lose? what may be referred to as “the MadoV aVair” and Mr Horta-Oso´rio: We lost 20 million euros. Santander’s investments? I think some of us are quite surprised, bearing in mind the history of your Q2059 Chairman: That is still quite considerable bank and the good acquisitions you have made and for people. perhaps good investment decisions. What did you Mr Horta-Oso´rio: According to the total size of the do in terms of due diligence on MadoV before you bank and the total fraud which was $50 billion, that put quite substantial amounts of customers’ funds is a very small amount. Within our total asset into it? management we had a significant amount of money Mr Horta-Oso´rio: We are as you know a bank which and a small percentage of our customers who is very prudent in terms of risk management and invested in these funds. We are absolutely convinced, controls. In order for you to be aggressive as we have already said publicly,that we followed the commercially, you should have certain areas such as due diligence procedure, as did many other banks risk management, auditing, control and compliance around the world but despite that we have decided as very strong areas. to compensate our private customers. On top of this, because we are in the UK, I would like to add that Q2054 Mr Breed: What happened with MadoV? we have no UK clients at Abbey who invested in Mr Horta-Oso´rio: It is in our opinion absolutely those funds. impossible to stop all frauds. This, as you know, is a fraud that was very wide, of very high dimensions, Q2060 Chairman: It is not that I want to fall out with supervised by the SEC and the company and the you but I do not believe you in terms of how the bank person involved previously had a very high went about its structure because, again, Harry reputation. Marcopolis says, “What I saw and when I saw it. I was repeatedly ignored after an eight and a half year Q2055 Mr Breed: As a very minimum, most people period between May 2000 and December 2008. would have looked at the auditing arrangements. Detailed, repeated warnings to the SEC.” That was The auditing arrangements in terms of MadoV when it could only have been a $3 billion fraud which consisted of a 78 year old man living in Florida, one ended up with a $50 billion fraud. When you get a qualified accountant and a secretary. What sort of one man accounting team who was a college friend due diligence did you do on that? of MadoV and he has two of his family in auditing, Mr Horta-Oso´rio: It is easier to say that with surely to goodness, with a big company, you should hindsight. have exercised suYcient due diligence? Mr Horta-Oso´rio: I sympathise with your Q2056 Mr Breed: Absolutely, but why did you not comments, but if it had taken five minutes for do it? anyone probably it would have taken five minutes Mr Horta-Oso´rio: We have strong due diligence for the SEC as well, which supervised those funds. processes. We are absolutely convinced we followed them as we normally do and, as you know, we Q2061 Chairman: The SEC did not take him on, decided to compensate all of our private clients as a because your man was the chief executive of commercial decision. NASDAQ and it was the old boys’ club. When you are investing other people’s money, you should have Q2057 Chairman: I do not think we are going to get adequate due diligence. That is the point I am trying a sorry out of you today, are we? I looked at the to make to you. congressional hearings and there was a man called Mr Horta-Oso´rio: Yes, and I agree with you. On top Harry Marcopolis who reported this from 2000 to of that, we have oVered to reimburse those 2008 to the Securities Exchange Commission in the customers. United States. If you look on YouTube, you will see his evidence. I looked at it. He said, “The Key Tip- Q2062 Mr Mudie: Yesterday we were speaking to the OV. It took me five minutes to figure out he was a bankers and we accused them of being in denial. I do fraud. I basically read his strategy description and not think we could accuse you of that because I do knew that that was not the source of his returns. not think we have largely got to that. This is about Then I knew right away by looking at his looking at a bank crisis and how we got here and performance chart.” He made an illustration to the your part in it. That is very important because, at Committee and he said, “His performance chart was some stage, we are going to get out of it. It is going a 45 degree angle without any variation. It only went to be a diVerent world, regulation etc. It is important in one direction: up. It never had any variation like we know where it started, who was to blame and the market does.” That was a key tip-oV. If it took what we have to address. Mr Varley, I hope you do Harry Marcopolis five minutes, why did a credible not think I am picking on you, but in response to the bank like Banco Santander get duVed up on it? Why Chairman’s first question about the financial did you lose 2 billion euros on it? I put it to you that markets and how unpopular they were, you accepted your due diligence was absolutely and utterly duV. there was unpopularity and you said, “I have to Mr Horta-Oso´rio: Banco Santander did not lose two accept that we contributed to that.” That is on a par billion euros. Santander had a small amount with William Biscard’s remarks on New Year’s Day invested in those funds. on Radio 4 when he was asked, “Did the banks Processed: 25-03-2009 22:38:12 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG12

Treasury Committee: Evidence Ev 269

11 February 2009 Mr Eric Daniels, Mr John Varley, Mr Stephen Hester, Mr Anto´ nio Horta-Oso´ rio and Mr Paul Thurston contribute? Were the banks to blame?” “Well, partly. Q2065 Mr Mudie: You have a majority now. That Maybe 40%. Maybe 60%.” You are busy rewriting could be 51%. history, it seems to me, so that when we come to Mr Varley: I did not actually say a majority. I said redrawing the new world our memories are dimmed, the single, biggest contributor among a number of but you are on the record. You are on the record as players would be the banks. That was what I was saying “Contribute.” How big a contribution? I am trying to say in any event. not talking about you. I am talking about the financial markets. Mr Varley: I understand. There is a chain that goes Q2066 Mr Mudie: I still want you to define how big something along the following lines: for a variety of is bigger. Mr Varley: I am not being obstructive to your reasons, a very great deal of easy money—cheap Y money is what I mean by that—was made available question. It is very di cult to be spuriously scientific for the world over a long period of time. Some of about that percentage contribution. What I hope those were policy reasons. Some of those were you are hearing me say and what I certainly intend reasons that were driven by events such as 9/11. For to say is that it is right for the banks to shoulder a substantial part of the blame because I think that we a long period of time, cheap money had been made have contributed to the problem. available to the world and, as a result of that, asset prices rose as we know. You saw that all around the world and in multiple asset classes. As asset prices Q2067 Mr Mudie: We could have had this rose, yields fell. People with falling yields needed to exuberance in the normal fashion, with all the increase their risk appetite to maintain yield. There money floating in. What is diVerent in this situation was around the world a significant and very is that you were party, as an industry, to noticeable increase in risk appetite. That risk manufacturing instruments that contaminated the appetite was fuelled by the banks. I accept that. It financial world, that we are still trying to clear out of was partly fuelled by the risk appetite of the buyers our system. It is not the usual thing about deflating but it was certainly fuelled also by the inventiveness and getting everything cooled down. The whole and innovation of banks. In part—and I system is contaminated and we do not know where acknowledged it earlier; I say it again—I think the we are because we do not know the value of any of compensation structure in the banks contributed to these instruments. the fuelling of that pursuit of yield. What we need Mr Varley: I think it is fair to say that, alongside the now is a period of time when asset prices stabilise. If real economy, there was constructed for a variety of you ask me singly what is the most important feature reasons—and I think the banks contributed to this of the normalisation of markets, we need to see the as well—a debt driven, financial economy that was stabilisation of asset prices, particularly in US being developed. The two got out of touch with each housing. other. What we are doing at the moment is going through the pain of bringing those two back into touch with each other. I would not want you to Q2063 Mr Mudie: You are going too fast for me now. conclude that everything about this trend over the We have got to the stage where it could be borrowers course of the last years is culpable or wrong, because but it is largely yourself. The old age pensioner in it is perfectly clear to me that the securitisation of Florida who got a £450,000 mortgage. She was 92 assets, as an example, has created the opportunity and a cleaner. It was her fault that she took the loan for people to buy houses all around the world which and bought that house. Are those the two people you would not otherwise have happened. That is all to blame? Are you blaming yourselves? Are you the social good. blaming the borrowers? I would ask you which proportion. If you are saying “contributed”, what would your contribution be? Q2068 Mr Mudie: I understand that but I am also Mr Varley: I wish I could be that precise. giving you the opportunity to diVerentiate between securitisation and securitisation that has at its core duV securities or toxic securities. That is the point. Q2064 Mr Mudie: As Mr Daniels answered earlier, There is securitisation you can control hopefully and “It was within the range”, we will let you do it within keep economies from overheating, but that is not the the range. problem this time. The problem this time is, even if Mr Varley: You are very kind. I do not think it is we brought it down, we do not know which security both borrowers and lenders who are uniquely to is good or bad. Do you know how many there are? blame. There are a number of players in this drama. There are 64,000 diVerent ones, all with triple A They include governments, central banks and they classification. That is how deep the poison is. It was certainly include banks. If you ask me as I sit here the financial markets. It was not the borrowers. It today, “Is it understandable that the public was not the government. It was not the regulators. It sentiment is that the banks have the majority of was your industry that put in that contamination blame?”—in other words, if you think about blame that we are all suVering from. attributable to any particular sector, is the largest Mr Varley: The starting point, as I said a moment particular sector the banks?—I think that is a ago I think, was the pursuit of yield. I have perfectly understandable and reasonable acknowledged, I hope you feel clearly, that the conclusion. fuelling of that pursuit was something for which the Processed: 25-03-2009 22:38:12 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG12

Ev 270 Treasury Committee: Evidence

11 February 2009 Mr Eric Daniels, Mr John Varley, Mr Stephen Hester, Mr Anto´ nio Horta-Oso´ rio and Mr Paul Thurston banks have a lot of responsibility. I think it would be be doing it, but these two individuals are the only wrong to characterise all securitisation as bad. I am individuals where the Chancellor could look me in not sure whether you are doing that. the eye and say,“I have an agreement and I will make sure you stick to it.” Q2069 Mr Mudie: I did not say that. I went to the Mr Daniels: One thing bears clarification. Our trouble of separating securitisation as a principle, agreement, at least with Lloyds TSB, is very which I think definitely has the ability to expand explicitly around availability and level of marketing. economies certainly in the developing world. Lovely, It does not guarantee a level of lending, although in but when you do it with toxic securities and nobody the case of Lloyds we have increased our lending knows what the hell is in them, with a bad starting quite a bit. The reason why the amount was not put point, and even sophisticated bankers as we had into the agreement was because we have to maintain yesterday and even the regulators do not know what prudent credit standards. is in them, but they pass them on gaily in huge amounts, it was always bound to finish in tears, was Q2075 Mr Mudie: That is very useful. That is the it not? I am not asking you to say sorry but that is first time a banker has given us information without very much something the financial world should us pulling teeth. What we have is a commitment to accept and want to repent over and not want us to immediately restore and maintain availability and think we contributed to this. active marketing of competitively priced lending so Mr Varley: I accept your point. SMEs at a level at least equivalent to that of 2007. This is why I am asking you these questions, because Q2070 Mr Mudie: Mr Daniels, you gave me a hard I am desperate to get a marker down as to what is on stare. It was like being looked at by a Mafia don. I the table and what is meant in this agreement. Are do not know whether I should ask these questions. you saying that you do not recognise that, at least Mr Daniels: I am not sure whether I have received a equivalent to the figure in 2007? promotion. The last time you compared me with Mr Daniels: Yes, but I completely agree. The level Bill Clinton. that is referred to is the availability and the level of marketing. Q2071 Mr Mudie: You will understand I am understandably reluctant to accept anything a Q2076 Mr Mudie: Tell me, just a simple lad, what banker tells me now. This is going back to where you that means. The way I read this, you are agreeing to agreed with the government to get this money, RBS deliver at least the sum that you gave in 2007. and yourselves. It is not a trick question. Can either Mr Daniels: I do not believe that is the of you tell the Committee specifically how much interpretation. That said, Lloyds TSB more than money you put into small businesses last year, 2008? delivered the sum that we lent in 2007. Mr Daniels: I can certainly calculate it for you. I do not want to risk giving you a bad number so perhaps I may write to you on that. Q2077 Mr Mudie: Let us put it on the record. What is your interpretation? Q2072 Mr Mudie: I would prefer you to write to the Mr Daniels: My interpretation is we have to have the Committee. What about you, Stephen? availability of competitively priced products and the Mr Hester: Our small business lending was up 10% level of marketing that was extant in 2007. last year. Obviously it slightly depends on how you define it but, as we would define it, it would be £2 Q2078 Mr Mudie: Stephen? You would not have billion on 20 billion. Our total aim was 20 billion and been party to this at the time of the negotiation but we increased by 10% so that was two billion, but it do you agree with Eric? slightly depends on how you define “small business.” Mr Hester: I am not sure we disagree. It is our That would be our definition. responsibility to lend more than we did in 2007 provided that there are people who want to borrow Q2073 Mr Mudie: Eric, will you get me a figure? from us. Obviously you cannot lend to someone who Mr Daniels: I will get you a figure. I can hazard a does not want to borrow. There is a caveat in that guess but I would much rather give you a precise respect, but I am very clear. It is our goal to lend figure. more in 2007 and we are lending 10% more and we will go further. There are no ifs, buts or caveats. Q2074 Mr Mudie: We have had the Chancellor here and we have not got a straight tale out of the Q2079 Mr Mudie: You said “provided”. Eric has put Chancellor either. I am concerned about my another interpretation on this. You two screwed the constituents who think that the government has Chancellor then, did you not? achieved an agreement with the banking industry Mr Hester: That is an outrageous thing to say and that it is going to deliver loans for mortgages at 2007 simply not true. levels and small business spend at 2007 levels. Will you confirm it is just the two gentlemen in the middle, yourself and Stephen, because you have Q2080 Mr Mudie: You were not there. borrowed this money? You may wish to do it, John, Mr Hester: It is still an outrageous thing to say and and being the kind lad that you are you will probably it is not true. Processed: 25-03-2009 22:38:12 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG12

Treasury Committee: Evidence Ev 271

11 February 2009 Mr Eric Daniels, Mr John Varley, Mr Stephen Hester, Mr Anto´ nio Horta-Oso´ rio and Mr Paul Thurston

Q2081 Mr Mudie: I say outrageous things all the Q2087 Chairman: The two billion figure was right? time. You got 37 million and you have agreed to Mr Horta-Oso´rio: Exactly. I confirmed that to you reach the levels of spending. You did not stop there. and I also told you that that out of a commercial You said “provided” and Eric, fair enough, puts a decision Santander decided to compensate those diVerent interpretation on it. I am interested because private customers. it is vital for the people out there who are queuing up for loans or losing their houses that this agreement Q2088 Chairman: In terms of the Royal Bank of sticks. Even if the Chancellor had got you both, his Scotland, Stephen, earlier on we were talking about idea of the agreement was that you were going to do the credit derivatives and exposure. I said 1.3 billion. this. Adding the two together, what proportion of I meant 1.3 trillion. That is a matter for the record. the UK lending to SMEs do you two corner? Mr Hester: Unfortunately, until we publish our year Mr Daniels: We have approximately a 20% market end results, I cannot comment. share of SMEs, about 100,000 customers. Mr Hester: I believe we have about 30%. Q2089 Mr Tyrie: This commitment to maintain levels to those of 2007 lending includes the phrase Q2082 Mr Mudie: 50%, so half of them. Do you “competitively priced”. It is widely held that spreads accept these figures? have widened and the cost of lending has therefore Mr Thurston: We have 16%. gone up proportionate to base rate, which obviously Mr Varley: We have 20 but this is going to add up to has fallen. Was any definition given of more than 100% quite soon. “competitively priced” or are you free to decide for yourselves what that means? Q2083 Chairman: Is it solely a story of risk appetite? Mr Hester: UKFI are in the process of defining it. Some, in their eyes, were taking high risks when they The way I define it is that we have to be in the best took on complex products that were rated triple A. half of the market in terms of most favourable prices Was it the financial system that hid the risk but to customers. advertised the return? Mr Varley: It would be true to say that the financial system did not properly understand the risks. Q2090 Mr Tyrie: It is a relative measure. Mr Daniels, could I have your view? Mr Daniels: There is no definition but I would agree Q2084 Chairman: You were not very forthcoming that in-market parameters would probably make a with George in terms of an apology. I am going to great deal of sense. mention somebody. You probably do not want to hear his name. He is a certain Robert Peston. He interviewed you on 20 December and I have your Q2091 Mr Todd: I want to explore the relationship comments here. I do not know if it was Christmas with shareholders. You in your remarks, Mr Varley, and you were merry, but you said, “Mr Varley told referred to the search for yield. What were the the BBC that the banking industry was going priorities of institutional shareholders when they through what he called ‘a public relations crisis and questioned your bank as the years 2006-07 must apologise for what went wrong. We have to unfolded? Were they interested in the business model have a banking industry in which consumers and in and the risk profile of your bank or were they simply some cases that trust has broken down. I ask myself pressing you to improve yield to shareholders? I do I feel the industry should be self-confident about think Mr Hester is a bit away out of this since he was recreating that trust through time. I do feel that, but not around then, but to the other four, what would it starts by saying sorry’.” Do you agree with that? characterise that relationship during that period? Mr Varley: I do. I said it. Mr Horta-Oso´rio: I can tell you that during 2006 and the first half of 2007 there were, as you were saying, Q2085 Chairman: You are saying sorry. Good. less stringent risk criteria, more interest in asset Anto´nio, you said that Santander only lost 20 growth and less prudence and less focus on funding million euros. and risk criteria. Mr Horta-Oso´rio: Around that. Q2092 Mr Todd: That was characterised by Q2086 Chairman: Press reports say Santander shareholder representations? clients lost up to 2.3 billion euros. What I want on Mr Horta-Oso´rio: No, by investors and analysts. In the record from you is this: are you claiming that spite of that, in our specific case, as you can see from they did not advise or help clients to invest in the data, during 2006 and 2007 we decreased our MadoV? Are you being economical with the truth in market share targets of mortgages and of making the distinction between Santander’s own unsecured lending. funds, which are the 20 million, and those invested on behalf of clients, because your own funds and Q2093 Mr Todd: What I am looking for here is were those invested on behalf of clients should have the there institutional shareholders crying wolf about same due diligence. problems in this sector and not being listened to, as Mr Horta-Oso´rio: I think I made that very clear. I simple as that. told you that Santander itself had lost around 20 Mr Daniels: The quick answer is, in the case of million and clients around two billion. Lloyds TSB, no. Processed: 25-03-2009 22:38:12 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG12

Ev 272 Treasury Committee: Evidence

11 February 2009 Mr Eric Daniels, Mr John Varley, Mr Stephen Hester, Mr Anto´ nio Horta-Oso´ rio and Mr Paul Thurston

Mr Varley: I wish I could give you a very simple which was the dynamic provisioning, the fact that answer. The reason I struggle to do that, Mr Todd, you should provision and increase the banks’ capital is because there is not a homogeneity of view or in good times so that you can weather the bad times. expectation from our investors. Q2097 Mr Todd: You have had lots of admiring Q2094 Mr Todd: I am more expecting examples. reviews for that, I agree. Obviously individual investors make their own Mr Horta-Oso´rio: Not being Spanish, as you know, decisions for all sorts of reasons. The picture that is I think the Bank of Spain was quite prudent in doing emerging is of a fairly complacent institutional that. It was very uncommon at the time. That shareholder base which was merely interested in allowed the Spanish banks to have a substantial yields for your institutions and not interested in how amount of anti-cyclical provisions. Just to give you you achieved those yields or whether there were an idea, in the case of Santander it represents about hazards involved. 2% of the assets as anti-cyclical which is ƒ6 billion. Mr Varley: I think that is a bit unfair, frankly, to institutional investors, but of course their natural line of movement if they disagree is to sell, that is Q2098 Mr Todd: Really quite material. A lot of you their natural line of movement. So if they have a will have read the FSA’s internal audit document on particular problem with a business model or a risk Northern Rock which described their experience of profile or an absence of growth or excessive growth, regulating a UK bank. Did any of you look at that they vote with their feet. and say, “Yes, that is our experience as well”, poorly documented meetings, lack of regular contact? This was through the period 2006-07. We are trying to Q2095 Mr Todd: They would not normally do that learn from this. Believe it or not, we are not trying to without saying a word about it. blame you entirely, there are other people who we Mr Varley: Again, practices are very disparate. need to improve the performance of and I am trying Mr Thurston: In 2006 I think there were a number of to understand that. commentators who were suggesting banks like ours Mr Varley: Mr Todd, what I would say is we were probably over-capitalised, ought to be certainly did read the document you are referring to returning capital, should be leveraging the balance and if we stand back from all the drama of the last sheet, so most of our discussions with institutional two years I would say that one of the learning points investors were about going through our risk model should be that although at the institution specific with them and explaining to them why we believed level there was, I think, pretty good transparency in strong capital and strong liquidity. and flow of information, all the transparency and all the prudential supervision in the world at the Q2096 Mr Todd: That is a broadly, I think, institution specific level would not have prevented confirmatory set of answers. Can I ask about the the crisis that has occurred. What that tells me in any relationship with regulators, and if I can bring in the event is the big issue here, and in a sense the big miss, two wings in this football formation here because was the absence to spot the systemic risk that existed. you two would have particular experience of a I think one of the learning points for me as I think regulatory environment outside the UK, and so about this is that we need to create the wherewithal would you, Mr Daniels, and be able to compare the and the structures in regulatory supervision going experience between other countries and our own. forward that ensure that it is the explicit obligation What is your perception of the relationship with the of a member of the regulatory body to be looking out FSA with your institutions in the run-up to this for the big systemic risks because I think it is a failure period? What comparisons do you draw? of systemic risk that characterises the history of the Mr Hester: We deal with around 500 regulators last two years. around the world in 83 diVerent countries and we try to work closely with all of them. We produce an Q2099 Mr Todd: Although the Northern Rock awful lot of information. We have always sought experience showed lots of sloppiness at the very close contact with them and I hope there was institutional level. Specifically, when you read that close contact with all of our regulators throughout document, if you did, did any of it have any the period. In recent months we have probably seen resonance with you or was this a unique failure a build-up in the amount and frequency of amazingly delivered at one UK institution? Any of information required but there have always been you? Mr Daniels? continuous meetings at all levels. At the FSA we Mr Daniels: I believe that John’s answer is right that have very structured levels of meetings with all there may have been specific failures against a members of management on a very frequent basis. particular institution, but the key lesson is that this Mr Horta-Oso´rio: We share the same view in that we crisis is diVerent from every other that we have have a presence in more than 50 countries and deal experienced. It is global in nature and it has systemic with all of those regulators. One example which may risk at the heart of it. be especially interesting for the Committee is the example of the Bank of Spain which was quite diVerent from what was done throughout the Q2100 Mr Todd: I buy all that and we can no doubt world—I am not referring specifically to the UK— address you. It may help you if I ask a final question, and which is now quite commented on, as you know, which is have you noticed a change in your Processed: 25-03-2009 22:38:12 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG12

Treasury Committee: Evidence Ev 273

11 February 2009 Mr Eric Daniels, Mr John Varley, Mr Stephen Hester, Mr Anto´ nio Horta-Oso´ rio and Mr Paul Thurston relationship with the FSA since the Northern Rock Q2106 John Mann: Let me ask Mr Hester because it experience? Let us start down the end here with our was Mr Goodwin who said yesterday at our hearing Portuguese friend. that RBS held positions in triple-A securities which Mr Horta-Oso´rio: From my quite frequent contact turned out to be much higher risk than anticipated. with the FSA I can tell you that I see them You just rated them as a six, so quite useful to you. acknowledging that things were not correct in the Mr Hester: Actually I said seven. I can still add up case of Northern Rock and I see them trying to anyway! address what they think and what they report was not done correctly, as you have just said. I see that Q2107 Chairman: We have the same problem with culture when I speak to them. you as with Anto´nio! Mr Hester: You were asking for a simple answer to Q2101 Chairman: Give us a brief answer each of you a complex question. The world needs some to Mark’s question, but very brief. shorthand of credit analysis because many people Mr Daniels: I think we see a great deal more activity who use financial markets do not have the resources from the FSA and a lot more requests for and time and expertise to do the work themselves, so information. the world does need credit rating agencies and we Mr Hester: I have dealt with many regulators need them to be as good as they can be. around the world and I think the FSA is one of the best, but I think all regulators around the world, Q2108 John Mann: But a simple issue is whether you including the FSA, were not concentrating enough having a financial relationship with them and paying on liquidity, it was the most under-developed bit of them is in your interests. regulation, people were concentrating on capital, Mr Hester: If I may. However, people like banks or and I think that was the problem. major institutional investors ought to have their own Mr Varley: The relationship has intensified a lot for resources to be capable of second-guessing rating all the reasons that you can imagine. agencies, which many people do not. We seek to do Mr Thurston: As I said before, we have had more that and, of course, we, along with many others, contact, more information requests and a bigger size made the same errors the rating agencies did in of supervisory team. I would agree with Stephen that respect of these securities. there was far less attention on liquidity than on the capital. Q2109 John Mann: Let me ask Mr Varley the second question. There is a vacancy for a senior position in Q2102 John Mann: I have got four questions and the the Financial Services Authority; would it be first one is to all of you. If you would, please, a one appropriate for a current or recent banker to be word answer. I would like your marks out of ten on considered for that position? the credit rating agencies and how important they Mr Varley: I am very much in favour of those who are or not for your business, with one being of regulate the industry having had practitioner minimal importance and ten of huge importance. If experience, so my one word answer to your question you could rate them one to ten, we will start with Mr would be yes, why not. Thurston and work down. Mr Thurston: I do not think I can put a number on Q2110 John Mann: My third question is on culture it. What I would say is that they— because here we have banks, all of you paying credit rating agencies for advice back, so a commercial Q2103 John Mann: Give it a go, a number. relationship, and recent bankers becoming Mr Thurston: No. They are an agency and you regulators overseeing you. Has the culture in British would have to take no substitute. banking from your perspective, what you have seen, changed at all in the last four or five months? Mr Horta-Oso´rio: This is my second stay in Britain Q2104 John Mann: That is easy. You rate them one because I was here 15 years ago. My impression of to ten, are they of low importance or high the British financial system is very high. importance? Notwithstanding the systemic issues that were just Mr Thurston: They are an indicator, so five. described, I think the British financial system is of a Mr Varley: I would be higher than that, probably high standard. In the last six months specifically, as at six. I think you can hear from the comments around the Mr Hester: Seven. table, I have seen a lot more emphasis on risk Mr Daniels: Six. management, liquidity, controls and capital Mr Horta-Oso´rio: Seven. considerations, no doubt.

Q2105 John Mann: So you all disagree then with Mr Q2111 John Mann: It is the culture I am interested Blankfein of Goldman Sachs who identifies this in. Is there a southern Mediterranean culture that is outsourcing of risk management as one of the key diVerent from, shall we say, a North Atlantic culture problems. of banking? In other words, is there more risk Mr Daniels: I think he was referring to something aversion in the culture and traditions that you have somewhat diVerent. When you ask a question of— coming out of in banking than the traditions in Processed: 25-03-2009 22:38:12 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG12

Ev 274 Treasury Committee: Evidence

11 February 2009 Mr Eric Daniels, Mr John Varley, Mr Stephen Hester, Mr Anto´ nio Horta-Oso´ rio and Mr Paul Thurston

Britain that these gentlemen and their predecessors contractual arrangement with HBOS staV in have had? Has there been a change in that culture relation to bonuses could be honoured and the critically in the last four or five months? advice you received was, yes, you had to honour Mr Horta-Oso´rio: With absolute transparency, Mr them. Can you understand the anger that will be felt Mann, it is not a matter of British or Mediterranean, by Nissan workers who have lost their jobs, other as I said at the beginning it is a matter of how you people who are on short-time working, other organise institutions and which people you put in companies that are asking employees to take a pay each of the key functions. It is much more given to cut, not because they poor companies, not because that, which I could refer to as culture. they are ineYcient and not productive, but because of the failure of the banking system? Do you Q2112 John Mann: Anyone could have said that in appreciate the fact that we have got to try and restore the last 10, 20, 30, 40 years, could they not? It does confidence not only in your banking system but in not mean anything. the wider economy and by paying bonuses in a Mr Horta-Oso´rio: Let me give you a precise company which has received £17 billion from the example. In terms of risk management, we in taxpayer to bail it out, do you think that is going to Santander believe that you should have the risk help us restore confidence? management function totally separate from the Mr Daniels: I completely appreciate your point. You commercial function. In the case of the bank, the risk asked whether we had consulted in the case of HBOS management function does not report to the and, yes, we did. Do I appreciate that can cause a businesses until the boards and even at board level it huge degree of discomfort in society, yes, I do does not report to the CEO, it reports directly to the appreciate that. chairman. Q2117 Nick Ainger: But their contracts have been Q2113 John Mann: So you do have a diVerent ripped up. Nissan workers have had their contracts culture. ripped up, people who are on short-time working Mr Horta-Oso´rio: I am giving you a specific have had their contracts ripped up. Bearing in mind example. I do not think that culture is specific to what is happening, not just in your banks but in being Mediterranean or British, it is specific to a other banks was well, do you not think given the bank which in this case is Santander. I think it is circumstances, given according to the former Chief important that you have that dichotomy between Economics Advisor to the Treasury that we are risk managers and business managers so you can probably entering the worst recession ever, that you come to the best decision. In the last resort, in my should be saying to your staV, “Given these opinion, the risk manager should have the final circumstances and that we want to restore word. confidence and get people appreciate banking the same way that they used to, you are not going to get Q2114 John Mann: Your competitors here in your a bonus or if you are going to get a bonus it is going view, in your assessment, have they moved to be a lot less than Mr Varley is even oVering as suYciently in that direction for their own good? well”? Do you not think that would be a way Mr Horta-Oso´rio: As you heard from Stephen, it is forward? What worries me about all of today’s very early days to assess the changes that have been session is that I do not get the feeling that you made. It would not be appropriate for me to appreciate that the gold rush is over, that times have comment because I do not know the inside of the moved on dramatically, that we are facing a huge organisation and the changes that are being made problem economically and you have got a part to but you can ask around the table. play in it. Do you not think you ought to now admit that you are not going to pay bonuses anything like Q2115 John Mann: I will ask my final question to Mr you have in the past, never mind what legal advice Hester. We are all pulling together, I think the quote you have received? earlier was we are all working hard, although 2,300 Mr Daniels: As we said before, we will always observe the law, both the spirit and the letter. That are not going to be working hard for much longer in V your banks. You have those staV to face, whoever was said in a di erent context but— they are, and there may be more to come, you have your predecessors and their actions, even potentially Q2118 Nick Ainger: Are you talking about the their share dividends that will come because they criminal law or the civil law? have not given up all their shares for the future. You Mr Daniels: I think that we have to refer to both, do have the whole mess, consumers, small businesses, we not. That answer is a partial answer. Perhaps a the economy. My question to you is very simple: can wider answer is that Lloyds, as you know, is a retail Britain trust its bankers? bank primarily and as such we never paid out the Mr Hester: I think you can trust the bankers to do kinds of bonuses that other banks did; investment the best that they can. banking is completely diVerent. John Mann: Very convincing then. Q2119 Nick Ainger: I accept that. Q2116 Nick Ainger: Mr Daniels, in reply to an Mr Daniels: As I have mentioned before, the vast earlier question from the Chairman, you said that majority of our employees earn fairly modest wages you had sought legal advice on whether the and the bonus is an integral part of their contract, if Processed: 25-03-2009 22:38:12 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG12

Treasury Committee: Evidence Ev 275

11 February 2009 Mr Eric Daniels, Mr John Varley, Mr Stephen Hester, Mr Anto´ nio Horta-Oso´ rio and Mr Paul Thurston you will, with the company and they are fairly Q2124 Chairman: So the decisions RBS made were modest bonuses. I think that our people performed diVerent. well. We did not do everything perfectly, that is very Mr Hester: The impact on RBS was the bigger clear, and for that I am sorry, but I think for the environment. people who worked very hard during the year and performed well it would be a real violation of our Q2125 Chairman: That is fine, I am quite happy with agreement with them if we did not, in fact, pay that. Have we hit the bottom yet? bonuses. Now, that said, for our more senior Mr Varley: I do not think so. I talked earlier about managers and for the total bonus pool it will be the key ingredient of normalisation being the down and down considerably from prior years. bottoming of asset prices and I think we have some way to go. Q2120 Nick Ainger: Do you not see that there is a cultural problem here, and John Mann was referring Q2126 Chairman: Paul, do you think we have hit to it as well? One commentator has said, “the bonus the bottom? culture is in the DNA of the banking system”. We Mr Thurston: No, not yet. now know that this led to serious problems and Mr Varley has accepted that it was a major contributor Q2127 Chairman: Okay. Stephen? to how we ended up with the crisis. Do you not think Mr Hester: I think in the economy, no. It is possible the bonus culture has got to change or else in a year that the disruption of financial markets will be less or two’s time we will be exactly back where we are bad this year than last year. again? Should we not be paying people what they are worth rather than, in some cases, rewarding them to Q2128 Chairman: We have not hit the bottom yet? the extent of ten and 20 times their basic salary? Mr Hester: From an economic standpoint that is Mr Daniels: I do not disagree with you that correct. behaviour can be driven by compensation. I do not think we are in disagreement but what we are aiming Q2129 Chairman: Okay. Eric? at is two diVerent audiences. The recipients of the Mr Daniels: Not yet. bonus that I am referring to are people like you and Mr Horta-Oso´rio: 2009 will be tougher economically me, they have relatively modest salaries. than 2008. Nick Ainger: I will swap your salary for mine! Chairman: We will finish that now because you are Q2130 Chairman: So we have not hit the bottom yet. going to submit evidence to us on that. Appetite for risk has been a central theme of the testimony to this Committee. Does the concept of Q2121 Ms Keeble: I have just one question about the more narrow banks oVer a solution to the problem? future of regulation which is probably the Holy Mr Thurston: I am not convinced that it does Grail in all of this. The Bank of England has talked because if you look at some of the banks that got about a macro-prudential instrument, the building into considerable diYculty you might say they were societies have talked about simpler models, John narrow banks. They were either retail and Varley, you spoke about having a countercyclical commercial banks or stand-alone investment banks. liquidity rule and, Stephen, you talked about people I think there is a value in having a universal bank so still have to do it and it is how you get people to do long as you have the appropriate control systems, the regulation. What would be the single thing that but to be able to develop debt capital market you would do to make regulation more eVective in instruments for your corporate customers rather the future? than to create very sophisticated models. I think Mr Thurston: I think it has to be more than one there is a very important customer— thing. It has to be to look at the capital rules and the pro-cyclicality of that, to look at the accounting Q2131 Chairman: I am reminded of the building rules and the way that regulators’ attention has been societies when they came before us that they never focused on liquidity. I think that is a critical get into trouble and their maximum limit for requirement. wholesale funding is 50%. Is there something to learn there? Mr Varley: I would very much agree with what Paul Q2122 Chairman: We will take that as a submission said, I think he puts it well. There are many lessons, if you could write on that to us, that would be good. but one of the lessons of the last two years is that risk Stephen Hester, Santander and HSBC are still concentration in a concentrated business model is standing, why is RBS not still standing? unsupportable, and you see that in the wholesale Mr Hester: RBS became cruelly exposed to a funded mortgage banks and in the bulge bracket downturn which has proven to be the greatest of investment banks. modern times. Mr Hester: I agree, you can go bust in all shapes and sizes. Q2123 Chairman: Of its own volition, its own Mr Daniels: Agreed. business decisions, its direction? Mr Horta-Oso´rio: I think diversification will Mr Hester: Clearly RBS’s exposure was about increase your security but it increases your decisions that RBS made. complexity, so you have to make a trade-oV between Processed: 25-03-2009 22:38:12 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG12

Ev 276 Treasury Committee: Evidence

11 February 2009 Mr Eric Daniels, Mr John Varley, Mr Stephen Hester, Mr Anto´ nio Horta-Oso´ rio and Mr Paul Thurston being bigger but more complex and being smaller. Q2136 Chairman: But not crazy risks. Smaller is not a solution either as you saw in Mr Varley: The right risks. Northern Rock or Bradford & Bingley. Q2137 Chairman: Exactly. Stephen? Mr Hester: We are going to rebuild RBS to stand- alone strength and along the way we are going to Q2132 Chairman: As John Mann said to you, in rebuild it around our customers and to support our Spain with the central bank the culture seems to be customers, and that is our mission. a bit diVerent there. Mr Daniels: The next year or two perhaps will be Mr Horta-Oso´rio: There are examples, as I said, of incredibly tough for shareholders as well as the Spanish Central Bank which are very useful and customers. We are committed to working with our customers through these times and helping them if you want me to give you another one, the Spanish Y Central Bank also never allowed oV-balance sheet work through their di culties. We are committed to restoring the reputation and the share price of the variables to be deconsolidated from the balance bank. sheet and, therefore, the banks had no incentive to Mr Horta-Oso´rio: Santander at its heart is a retail do them because they were fully consolidated. bank. We lent substantially to the UK economy last year as well as substantially increasing deposits from the public. We are committed to continuing to do so and this is not just words, during these tough times Q2133 Mr Todd: It would be really useful to get a in the last nine months we have acquired two paper from you setting out some of those institutions in diYculties, Alliance & Leicester and comparative experiences. If you can spare the time to Bradford & Bingley, have doubled our presence in write it, it would be very helpful to us. the UK and brought an additional £1 billion in Mr Horta-Oso´rio: Of course. capital into the country showing our confidence in the UK economy.

Q2138 Chairman: Eric Daniels, a last point. As you Q2134 Chairman: Two or three years ago if you had know, yesterday there was a memorandum provided asked a member of the public about banks in terms to us by the former HBOS employee, Paul Moore. I of trusting banks you would probably have been want to be fair to everyone here. I asked Lord reasonably high up but now, given your comments, Stevenson if he would submit a memorandum to us Mr Varley,I would suggest you are right down. What and I think it is very important because the Select is your message to the public about your Committee does not want to get in the middle of any organisation and the banks and the financial services employee-employer relationship, whether it is a industry? What are you going to say to them? present or past employee, and therefore I would be Mr Thurston: Banks rely not just on capital and grateful if you could communicate with the liquidity, they rely on trust and confidence, and I Committee and put your submission in. If Sir James think it is one of the critical aspects of what we have Crosby wishes to add to that submission we would been through in the current crisis that that trust has be grateful. been put under duress and has been tarnished. We Mr Daniels: I would be happy to give you a view. have a lot of work to do and now is the time for us This happened in 2005 from my understanding, long to rebuild that trust working with our customers at before Lloyds banking group had anything to do the most diYcult times for them in their personal with HBOS, so I am not sure how much might we will be able to add on the subject. lives, in their businesses, in helping them through the current crisis. That is the way we will rebuild the Q2139 Chairman: I think it is very important trust, but we must also make sure that not all banks because it is a merged company now and the image are seen in the same way. and trust element of the company is important. You have a story to tell here. It is in the line of fairness that I want you to submit that. Mr Daniels: Thank you, Chairman, we will. Q2135 Chairman: John, a personal comment to the Chairman: I have found this session incredibly public. helpful. You are the banks that are standing, you are Mr Varley: I would say we must acknowledge our important to the country. We want banks to work, contribution to the problem, we must apologise, but we want the economy to work, we want both to take we must not lose our appetite to take risks because place, so with that in mind I am grateful for your the members of the public, whether they are attendance today and I look forward to any businesses or households, need banks which are submissions that you have agreed to provide us with. prepared to take risks, and we are. Thank you very much. Processed: 25-03-2009 23:50:38 Page Layout: COENEW [SO] PPSysB Job: 416782 Unit: PG13

Treasury Committee: Evidence Ev 277

Wednesday 25 February 2009

Members present

John McFall, in the Chair

Nick Ainger John Mann Mr Graham Brady Mr George Mudie Colin Breed John Thurso Jim Cousins Mr Mark Todd Mr Michael Fallon Mr Andrew Tyrie Ms Sally Keeble Sir Peter Viggers Mr Andrew Love

Witnesses: Mr Hector Sants, Chief Executive, Lord Turner of Ecchinswell, Chairman, Financial Services Authority, and Ms Loretta Minghella, Chief Executive, Financial Services Compensation Scheme, gave evidence.

Q2140 Chairman: Welcome to our Banking Crisis liquidity; things to do with published accounts, inquiry. Loretta, can you introduce yourself for the things to do with the coverage of institutions such as shorthand writer, please? hedge funds, and which will also be setting out Ms Minghella: Thank you, Chairman. Loretta proposals relating to remuneration, credit rating Minghella, the Chief Executive of the Financial agencies, credit default swaps, the organisation at Services Compensation Scheme. international level and commenting upon the Lord Turner of Ecchinswell: Adair Turner, Chairman resources and style that we need to do our job. I of the Financial Services Authority. think we should be just absolutely clear: this is not a Mr Sants: Hector Sants, Chief Executive of the small change, it amounts to a revolution. Financial Services Authority. Q2142 Chairman: In your Economist lecture, which Q2141 Chairman: We have a lot of questions to put was an excellent lecture, you made the point that the to you today, so I am asking my colleagues to have “huge inherent system-wide risks and the cycle of short questions, yourselves to have short answers irrational exuberance was close to reaching a crisis and given that the financial services industry has a point”. Do you think the FSA was captured by the language all of its own could you make your answers markets and captured by the markets in that almost simple, so that they are intelligible to both us and to everyone in a senior FSA role comes from a banking the wider public who have a great interest in this background? subject. If I cut across you, do not be oVended—I Lord Turner of Ecchinswell: I do not think that that want to move on because we have all these questions is at all fundamental to why there was a failure across to ask. One of our witnesses, I think it was Will the world to see that we were at a point of Hutton, said that bankers were now privately saying unsustainable irrational exuberance, because I think that they “badly, badly need some regulation”. One that failure also existed among many economists, wonders how we allowed things to get to a state central bankers and finance ministers, who come where even the bankers are calling for more from a diVerent background; who do not come from regulation. In answer to a question from myself at a market practitioner background but come from a the Liaison Committee, the Prime Minister made the theoretical economics background. Indeed, I think it point that the FSA should “. . . look at the position is important to realise that up until 2006 and even of capitalisation of banks and on the basis of the into 2007 the world was awash with erudite, risks that they are taking, with short term bonuses authoritative arguments put forward not just by for employees, they can be tougher in their bankers who had a self-interest in it but by regulatory standards.” Are you capable of being theoretical economists who thought that they were tough with your regulatory standards, bonuses and looking at this in a disinterested fashion, who were other areas for bankers now as a result of this arguing that the world, as a result of the catastrophe? development of structured credit and derivatives, Lord Turner of Ecchinswell: The answer is yes, we had become less risky. That is there in the IMF think we have, broadly speaking, the legal powers to global financial stability report; that is there in do what we need to do, and I think we have to realise documents produced by Chicago School that after what has occurred we need a fairly economists, etc, etc. So I think there was a very complete change in the structure of banking fundamental intellectual failure. I think it regulation and the style of bank supervision. I do not encompassed people who had a self-interest because think we should at all underestimate that it is not just of their role as bankers themselves but I think it was a change at the margin; it is absolutely fundamental. far, far wider than that. I will be producing a report on March 18, attached to which will be a number of FSA discussion papers, Q2143 Mr Fallon: In your evidence to the which will propose fundamental changes to the way Committee you included a stunning sentence that that we regulate capital, the way that we regulate the failure was not inadequate supervision of any Processed: 25-03-2009 23:50:38 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG13

Ev 278 Treasury Committee: Evidence

25 February 2009 Mr Hector Sants, Lord Turner of Ecchinswell and Ms Loretta Minghella specific institution, but a failure to recognise philosophy where all the pressure on the FSA was systemic-wide risks. That is a kind of Nuremburg not to say: “Are you looking more closely at these defence, is it not? business models?” but to say: “Why are you being so Lord Turner of Ecchinswell: No, I do not think I said heavy and intrusive? Can you not make your it was not a failure; I said the most important failure. regulation a bit more light touch?” Let us be absolutely clear: the FSA has accepted entirely and has, I think, been more open than any Q2146 Mr Fallon: But what is the point of a other institution at apologising for the fact that it regulator that has cost us, I think it is, £400 million made specific failures in the supervision of Northern this year, that employs 2,500 people, is given ten big Rock. That is absolutely clear. We, in no way, British banks to supervise and allows five of them attempt to deny that, and that is clear and has been to collapse? said at this Committee before. However, the point I Lord Turner of Ecchinswell: We have to get it right was making was that the far more important failure for the future. You can say exactly the same about: was the failure to see the overall systemic risk. So it is “What is the point of the US regulatory a matter of what is the most important failure rather authorities?” because— than denying that there was a failure. There was a failure in the supervision of Northern Rock—that is Q2147 Mr Fallon: You are from the FSA. What we absolutely clear. want to know is: is the FSA actually fit for purpose? Lord Turner of Ecchinswell: It is going to be fit for Q2144 Mr Fallon: Was there not also a failure in the purpose, given the changes that we are going to supervision of the other four banks that collapsed? make and we are making, and which have been set Lord Turner of Ecchinswell: In relation to those, the out in a supervisory enhancement programme and most important failures were the failures to see the will be set out in more detail in my report on March systemic things. We have not become aware, we do 18. I said earlier, these are not minor changes; these not believe, that in the way that we were looking at are a revolution in approach. the supervision of those other banks there were the Mr Sants: Perhaps I might— similar categories of failure that there were with Northern Rock. Having said that, and I am very Q2148 Mr Fallon: No, I want to ask Lord Turner this happy to come back to this, we were supervising stuV. Do you actually understand what these banks people like HBOS within a particular philosophy of are doing? the way you do regulation which I think, in Lord Turner of Ecchinswell: Let me put it this way: I retrospect, was wrong. I have, you will not be have read over the last two weeks the reports that we surprised to know, spent the last few weeks reading produced in HBOS in 2002, 2003 and 2004; I have through, for instance, the HBOS file, all the way also read very, very detailed stuV on RBS, which we through the diVerent things that we reported. I think are producing as background to the stuV which has it is a competent execution of a style of regulation been talked about in the press and which we are all and a philosophy of regulation which was, in familiar with, which is the possibility of an asset retrospect, mistaken. protection scheme. These are completely diVerent documents which reflect a completely diVerent Q2145 Mr Fallon: But HSBC or Standard Chartered philosophy from one which is focused on structured did not make these kinds of mistakes. Why did you systems and procedures to one which is focused on allow banks like HBOS, RBS, Bradford & Bingley understanding the fundamental economics of the and Northern Rock to be run by people without any banks we are dealing with. It is a fundamental financial qualification; to lend out so much more change; it is a change which was in place already for than they had on deposit; to make acquisitions that about six months, led by Hector Sants before I were reckless? joined last September, but it is one we need to Lord Turner of Ecchinswell: On your first point, the intensify and deepen. degree of financial qualification, I do not think you will find that that is a diVerentiating feature between Q2149 Mr Fallon: Have you seen Barclays’ trading the management and top executives of HSBC and statement of two weeks ago? Standard Chartered, on the one hand, or HBOS or Lord Turner of Ecchinswell: Of course, we have seen RBS, on the other. I think, therefore, we have to Barclays’ trading statement. decide how important formal qualifications are, and that should be based upon the fact that it is a Q2150 Mr Fallon: Have you seen it? discriminating variable as we look at what occurred. Lord Turner of Ecchinswell: Well, I have looked at What is the case in relation to HBOS is that we had it, yes. a philosophy of how we did regulation which focused on organisation structures, processes, Q2151 Mr Fallon: There is a section entitled: systems and whether the reporting lines were correct. “Unobservable profit”. What is “unobservable It fairly overtly said that it was not the function of profit”, Lord Turner? the regulator to cast questions over the overall Lord Turner of Ecchinswell: I would have to say I do business strategy of the institution. You may find not know the answer to that specific line item which that surprising and I think, with hindsight, I find it you have raised with me, but I can assure you that surprising, but that is the case, and I think it is also we are crawling through the issues of the profit of the the case that that existed within a political banks that we are regulating. Processed: 25-03-2009 23:50:38 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG13

Treasury Committee: Evidence Ev 279

25 February 2009 Mr Hector Sants, Lord Turner of Ecchinswell and Ms Loretta Minghella

Q2152 Mr Fallon: If you do not know what those called level three. These are assets where there “unobservable profit” is, you are the Chairman of is not, at that point, a liquid market to which you can the— refer—ie it might be a CDO or a CDO squared, or Lord Turner of Ecchinswell: I did not know that that something like that—where if you called up at that line was there, but I am sure we do understand what point and asked for a quote you would not get a is in that line. I have not read that particular line and quote. So you then have to try and work out what focused on it. the value of that is on the basis of a model. Sometimes you try and do that with other Q2153 Mr Fallon: It comes just after a paragraph observable instruments, ie by cross-reference to that tells us that, as a result of the most recent stress other markets. I was asked this question and I think test, there is potential to increase the fair value of I was asked it within the context that this was a trick Barclays by up to 2.4 billion or to decrease the fair question which was going to find us out— values by up to 3 billion. So when Barclays tell us Q2155 Chairman: No, the reason you were asked they have made 6 billion profit, how can we believe this question, Lord Turner, is very simple. We had it? Brendan Nelson of KPMG before us, the Chief Lord Turner of Ecchinswell: That is a much more Auditor, and I asked him quite simply that if he had straightforward thing to argue. When you do stress HSBC’s statement of accounts before him and he tests you are looking at a wide range of scenarios. I looked at them, could he understand it? He said he think the idea that there is, as it were, a truth as to could not understand it.1 The fact is you, in the what losses will be over the next year, and that sophisticated language, could maybe understand it, people are hiding it, is a fundamental intellectual but this is not understandable to the ordinary mistake, if I may say, because it fails to realise that person. At the end of the day, what we have found in what we are trying to do in stress tests is to consider this Committee is that there has been a massive the future, and the future is not determined yet; it failure of corporate governance. I put it to you that depends upon the course of the economy, it depends the type of non-executives on these boards, the best on the course of financial markets. So, yes, we are and the brightest, cannot understand what is deeply involved with running stress tests with happening. It is not because they are of limited Barclays, as they are themselves, and those intelligence. That is the issue here. If we cannot put inevitably have wide degrees of uncertainty. That is things in simple language, then we have had it. That inherent, that will always be the case, and that is is the reason why you have been asked it. good supervision, not bad supervision. Lord Turner of Ecchinswell: I accept that point and I accept entirely—and I think it is the case—that Q2154 Chairman: I have given you pages 102 and there has been the development within the trading 103 of Barclays’ trading report, and I have books of banks of instruments so complex that they highlighted the various sections for you, Lord have become very diYcult to understand, that they Turner. The report says that Barclays has assets of have required these “unobservable inputs to value”, almost £45 billion, measured using unobservable which is deeply unsatisfactory, and I think, given the inputs almost twice a year before, and they talk changes which we, with international agreement, are about “vanilla” and “exotic” products. This is how putting into the capital which is required against they describe vanilla products—it is important for trading books, it is unlikely that these things will the public record. “Vanilla products are valued using exist in future on anything like the scale that they simple models, such as discounted cashflow or Black existed in the past. I have also said, which I said in Scholes models. However, some of the inputs are not my letter earlier, that I am not convinced that these observable.” They then go on to exotic products and instruments added much to the sum total of human say that they are over-the-counter products that are welfare, and their disappearance we should not relatively bespoke, not commonly traded in the regret. markets and their valuation comes from Chairman: That is a satisfactory answer for us sophisticated, mathematical models though some of because if we are talking about £45 billion, which is the inputs are not observable. a heck of a lot of money, we have got to understand Lord Turner of Ecchinswell: Can I explain what this where that £45 million is, and the question for me is is? I will explain precisely because I now understand how you prevent bank staV from making over- the context of it. Within the valuation of things optimistic judgments for using the faulty pricing which are in the trading books of a bank, which are models we have seen when valuing these assets. We valued on a fair value basis, there is a categorisation are on the same lines here, that things need to of assets which is known as level one, level two and change, and I am quite happy with that answer. level three, where, at the end of the spectrum which is level one, you are dealing with an instrument—an Q2156 Mr Tyrie: You have given us a pretty clear example might be a traded Treasury bond which is a statement that you think the framework of particular maturity of Treasury bond where there is regulation was mistaken, in retrospect. Are you large and immediate liquidity available every day— criticising your predecessors or are you criticising where, at five o’clock in the afternoon, you can the system? definitively say: “The value of this is X” because you 1 Note by KPMG: Mr Nelson replied “It is not a book you could, at five o’clock, sell it for X plus or minus a would read cover to cover—it is not a book—but if you have very, very small amount because it is a liquid an interest in particular aspects it is quite a good dictionary instrument. There is then a spectrum and there are to look in”. (Q 1198) Processed: 25-03-2009 23:50:38 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG13

Ev 280 Treasury Committee: Evidence

25 February 2009 Mr Hector Sants, Lord Turner of Ecchinswell and Ms Loretta Minghella

Lord Turner of Ecchinswell: I think there was a Lord Turner of Ecchinswell: I think there was philosophy of regulation which emerged, not just in something wrong with the system but you used the this country but in other countries, which was based word “structure” and— upon too extreme a form of confidence in markets and confidence in the ideas that markets were self- Q2163 Mr Tyrie: So did you, actually. I wrote down correcting, which therefore believed that the what you said as you said it; you also came out with fundamental role of the supervision of financial the word “structure”. institutions, in particular banks, was to make sure Lord Turner of Ecchinswell: I think that was a that processes and procedures and systems were in misunderstanding. What I said was that there was a place, while leaving it to the judgment of individual philosophy of regulation which when it went into an management to make fundamentally sensible organisation like HBOS was asking questions about decisions. As Alan Greenspan said, that is the its internal structures and systems rather than about intellectual framework which has received an its strategy. extraordinary challenge. Q2164 Mr Tyrie: We are going to have a new Q2157 Mr Tyrie: What I am trying to get at is philosophy on the 18th. You said that the FSA is whether you think this is the specific fault of your going to be fit for purpose. Do we take it from that predecessors or whether you think this was the fault that it is not fit for purpose now? of the structure and system of regulation. Lord Turner of Ecchinswell: It is a long way through Lord Turner of Ecchinswell: I am not convinced it a set of necessary changes. I think it might be helpful was the fault of the structure, if you mean by that the if Hector Sants described the very significant separation of banking supervision from the central changes that have been driven through the bank, because I think there is very good analysis that supervisory enhancement programme which was suggests that the relative success of diVerent already well in place before I became Chairman. authorities around the world at dealing with the Mr Sants: I will keep it very short but, just to make financial problems that we face is pretty much totally the point, I do believe that for the last 12 months we independent of the way that you organise the have put in place a significant set of changes to our structures. supervisory processes—ie the processes that we as a national regulator can control. As Lord Turner has Q2158 Mr Tyrie: So you are saying it was your said, there are many other things in the regulatory predecessors? architecture structure system that also needed to be Lord Turner of Ecchinswell: No, I think there was a changed for that supervision to be eVective, not least philosophy of how regulation was done. of which a whole series of the rules which we are not directly responsible for. In terms of changing that Q2159 Mr Tyrie: Where did this philosophy come supervisory philosophy, so that going forward we from, Lord Turner? look at the business models, we look at the risks, we Lord Turner of Ecchinswell: I think it was rooted in make judgments about the future, we have the right V particular political assumptions at the time, where quality of sta which has a good mix of industry all the focus on people like the FSA— practitioners who understand the sort of issues we have just been talking about but, also, others who take a more dispassionate view with a professional Q2160 Mr Tyrie: So it was just a general idea in regulatory background, we are well down that track. the ether? I believe the FSA is a fundamentally diVerent Lord Turner of Ecchinswell: No, it was expressed in organisation to that which it was 12 or 18 months speeches on both sides of the House but which ago. We have not quite completed that programme, suggested that the key priority in regulation was to we are about two-thirds of the way through, but any keep it light rather than to ask ever more searching suggestion the FSA is not currently fit for purpose I questions. would completely reject; we are a fundamentally diVerent business delivering to a diVerent Q2161 Mr Tyrie: While you were listening to those supervisory philosophy to the one that has been speeches and breathing that air which generated this described. philosophy, were you also infected? If you had been running the FSA without the advantage of Q2165 Chairman: This word “philosophy” has been hindsight, would you have made the same mistakes? bandied about, and maybe we can just tie this up, Lord Turner of Ecchinswell: I fear I would have, yes. Lord Turner, because is it the philosophy of an I think hindsight is very valuable and it is a question independent regulator to roll over under the rubric I have asked myself as to whether I would have. I did of political philosophy? If it is, what assurance can have intellectual doubts, which I expressed in a book you give us in the future that you are going to be I wrote in 2001 which has some comments upon the independent? fact that we might have financial market Lord Turner of Ecchinswell: I think that is a good deregulation overdone, but those doubts were not as question. All I can say is that I am absolutely deep as they should, in retrospect, have been. determined that as long as I am Chairman it will be independent. I also think that it is the nature of such Q2162 Mr Tyrie: In which case it sounds as if there a huge shock to the world that has occurred that was something wrong with the system. round the world regulators will be able to be more Processed: 25-03-2009 23:50:38 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG13

Treasury Committee: Evidence Ev 281

25 February 2009 Mr Hector Sants, Lord Turner of Ecchinswell and Ms Loretta Minghella independent. When I talked about philosophy, I institutions according to a philosophy that was think some of the most important points about this based upon structures, systems, processes and things are, if you look at the style of the reports that we were like that, and between the two of us there was not doing back in 2003, 2004 and 2005 on the banks that enough focus on what we now call (and I think is a existed at the moment, there is just an assumption good phrase) macro-prudential analysis on that it is not clearly the role of the FSA to cast doubt identifying what is the overall big picture of what is upon the whole business strategy of the going on and identifying what we are going to do organisation. As I said, that may be surprising, but about it. I think, in future, and again it is a point that that was either an implicit or sometimes close to an John Gieve made in his valedictory letter at the LSE explicit assumption—and it sometimes was an last week, it is much better to have an overlap than explicit assumption. You will find in statements, in an underlap, and it would be better in future for us consultation papers of the FSA, for instance, in to be both involved and intensively involved in those 1999, on the way that we do the approval of debates about what we think the situation is and approved processes, very strong statements that the what we do about it. responsibility for ensuring that people have the right competences is on the business itself rather than for Q2168 Sir Peter Viggers: You were not there in the the FSA to do. So it is quite telling, when you read FSA, but if there was a structural fault was it not the back, how permeating that overall approach is. FSA’s prime responsibility? Were they not the prime Chairman: I am still not clear about how mover responsible for identifying this? independent you are going to be, but we will move Lord Turner of Ecchinswell: I think, in retrospect, the on and you can, maybe, think about it and come FSA should have been more involved in sectoral back to me. analysis, but that was not what was believed at the time. I have to say that I think if we were to roll back and the FSA had come out in 2004 and had started Q2166 Sir Peter Viggers: IambaZed by this. If it aggressively challenging the mortgage banks to cut was not the responsibility of the FSA to look at back on lending, I suspect that the predominant overall strategy—you have said that, perhaps, you reaction of many people, including perhaps many were not concentrating enough on the overall people in this House, would have been to be telling business strategy—whose was it? us that we should not be holding back the extension Lord Turner of Ecchinswell: As I have said earlier, I of mortgage credit to ordinary people; that we were think there was a (at times implicit and at times preventing the democratisation of home ownership. absolutely explicit) philosophy, for instance, So in hindsight, yes, it would have been better if we expressed by people like Alan Greenspan that it was did, but I suspect we would have been pushed back not the role of regulators to interfere with what the politically if we had. market did. If you see the debates going back to the Mr Sants: We do not have a financial stability US about the expansion of sub-prime and debates in mandate, so people were primarily focused on the US where people said: “You ought to be stopping individual firms, as Lord Turner has said. this sub-prime explosion of lending”, you are getting Lord Turner of Ecchinswell: I think that is a good a quite explicit push back from academics and point. We feel that both we and the Bank of England people like Mr Greenspan saying: “No, that’s should have formal financial stability responsibility; wrong; we should not be preventing financial market it should be defined that both of us have a significant innovation. These things are self-correcting. You role in macro-prudential analysis and in thinking may think that this is a boom but none of us know about overall financial stability. If you go back, the whether it is a boom.” That was not simply situation in legal terms was that we did not and nor something that the FSA did on its own; that was the did the Bank of England. absolutely dominant intellectual conventional wisdom of the years running up to 2007. Q2169 Chairman: For the record, this Committee in its Northern Rock report specifically asked for an Q2167 Sir Peter Viggers: Ben Bernanke referred to overlap between the Bank of England and the FSA. the “great moderation” with low interest rates, low It is not overt enough for us, at the moment, and inflation and easy access to credit, and so on, but did what we worry about is it is dependent on the FSA think this was going to be a permanent state personalities, as the TPA was at the beginning, and for the economy? Looking at the tripartite I think there is a bit of work to do there. As you arrangements, who did the FSA think was know, we wanted a beefed-up financial stability responsible for overall business strategy? responsibility. Lord Turner of Ecchinswell: I think Mr Paul Tucker, Lord Turner of Ecchinswell: I accept that entirely, the new Deputy Governor of the Bank of England, yes. has used a very good phrase in this respect. He said that between the FSA and the Bank of England there Q2170 Colin Breed: Mr Sants, according to the was so much desire to avoid overlap that there was FSA’s website, individuals must be shown to be fit an underlap, ie that there was a Bank of England and proper before they become approved persons focus on monetary policy focused on the pursuit of a eligible to run controlled functions. Can you tell us: specifically defined inflation target; there was, at the what is the process for assessing someone’s FSA, a focus on the supervision of individual application for such status? Processed: 25-03-2009 23:50:38 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG13

Ev 282 Treasury Committee: Evidence

25 February 2009 Mr Hector Sants, Lord Turner of Ecchinswell and Ms Loretta Minghella

Mr Sants: This picks up on Lord Turner’s earlier Q2173 Colin Breed: So on the basis of going forward comments, so there is a change in our approach here, then, what, in your view, makes someone a fit and but looking back historically,which I think probably proper person, particularly in respect of, say, a risk refers back to some of the earlier questioning, as was director or someone involved in the risk have demonstrated in the material, if you go back management of a large bank? over time, and Lord Turner referred to 1999, the fit- Mr Sants: This is a diYcult question because, of and-proper process was primarily focused on course, competency is about saying: “Do you think probity. There was a full review done of visible facts they will make judgments which, when you see the in relation to the probity of the individual, and that consequences of those judgments, you will be happy process goes through a formal review process. There with?” So it is a judgment about a judgment. By was not, historically, in the philosophy of the FSA, definition, I have to say we cannot set ourselves up as was mentioned already, formally, publicly set out, here as infallible if we go down this track; there will a competency remit, nor was a competency review be occasions when, no doubt, our judgment will be done. The view was taken that it was for the firms to disputed by the firms and the individuals, but clearly, determine whether the person they were putting as we have already said, in setting out this process forward was competent for the role. There was, I (and we will be developing this further, by the way, believe, although I was not around at the time but over the coming months) we certainly need to look my colleagues tell me, a very extensive debate for technical competence in respect of risk between the industry and the regulators at the time management (the particular question you were of N2, around this point, I am told, the industry was asking), the ability to understand the data, the types very, very clear that competency is a judgmental of accounts we have just been referring to and matter and it is a matter for firms to decide as to understand the fundamentals and to apply that whether they consider people to be competent, not practically to the role in question. Whether we can for the regulator. They did not want the regulator say for certain that will necessarily lead to a better reaching that view. Going forward, if I may finish, outcome shareholders, of course, is a matter of we have already announced a set of measures to greater debate. change that approach, and we will be seeking and have already begun a process to judge competency Q2174 Colin Breed: So experience would be an which includes for significant, senior appointments important factor in determining somebody’s ability Y (we do not have su cient resource to do it for to be a fit and proper person to do risk management? everybody who is approved with us) at major banks Mr Sants: Either experience or a set of relevant an interview process which is now established, and formal qualifications, absolutely, for a senior going forward directors of major deposit taking person. Obviously, you have to allow people to institutions, for example, will be, and indeed have develop through the process but if we are talking been since the procedure was put in place, about a senior person then you need to be able to interviewed, and we will be taking a view on demonstrate competency. You might be able to do competency. Historically, that was not what we were this in the interview process but, yes, you would need doing and it was explicit in our regulatory to demonstrate competency. philosophy that that was not what we were doing.

Q2175 Colin Breed: One of the charges levelled Q2171 Colin Breed: Thank you. So historically, against HBOS is that they appointed a group risk basically, as long as you had not been convicted of director who did not have any risk management fraud or something and you were honest, you were experience. In what circumstance can someone be quite happy? approved to do risk management if they do not have Mr Sants: That appears to have been the approach any risk management experience? of the organisation, historically,but it was an explicit Mr Sants: We are back to the answer I have already one which the industry and the debate at the time given you in terms of what I would describe the new reached a collective conclusion on, as I understand. approach going forward—

Q2176 Colin Breed: But in the previous regime you Q2172 Colin Breed: As you are aware, when we said that that sort of competency— interviewed some of the executives from RBS and Mr Sants: Would have been a matter for the Lloyds and such, they indicated to us that there was company. no, really, great formal process, at least as far as the FSA was concerned, prior to their appointments. You accept that that was probably an oversight or Q2177 Colin Breed: —was a matter for the company. a mistake? So in that particular instance, then, it would have Mr Sants: It is not a regulatory philosophy that been the company’s decision, and perhaps a not either Lord Turner or I would agree with, in the light particularly clever decision, to undertake that the of circumstance, and going forward it is not the one FSA would not have any role. Going forward now, we are going to be having, and they are right in you are saying that if they were preparing to do that saying that that was the case when they were you may well say: “No, we are not prepared to accept appointed. that person as a fit and proper authorised person”. Processed: 25-03-2009 23:50:38 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG13

Treasury Committee: Evidence Ev 283

25 February 2009 Mr Hector Sants, Lord Turner of Ecchinswell and Ms Loretta Minghella

Mr Sants: Quite so. immediate future because nobody will buy them Colin Breed: Thank you very much. because they have been shown to be in some sense toxic and, at least for a period of time, whatever we Q2178 Chairman: How many people in senior do on regulation they will not be bought. However, positions have you found not to be fit and proper in looking forward longer term, one of the things that the past? we did realise and has been recognised across the Mr Sants: I would have to give you a written answer world—and the Basel Committee has already got on that. I suspect, in all honesty, for the reasons I proposals in the public domain to address it—is that have described, going through the screen that we we were not demanding enough capital against the have described, not that many. proprietary trading books of banks, and we are going to very significantly increase the capital required against that, and that also will lead to the Q2179 Chairman: It could be zero? disappearance of that. Mr Sants: I do not think it is zero but I think it is a very small number. I can give you a written answer.2 That is for, precisely, the reasons we have just Q2181 Ms Keeble: Do you not think that, in fact— described, which is given that we would only I take the point about the capital and the liquidity broadly, in the past, reject people based on and so on—with quite a number of these products it Y observable facts of probity, as we have just was the lack of due diligence and di culty about discussed, the firms of course know that and they are assessment and pricing of risk that was the real issue? not going to put forward people who do not meet How would you improve that through tighter those criteria. Actually rejecting a form does not regulation? necessarily mean that screen did not have some Lord Turner of Ecchinswell: There are two issues eVect, but undoubtedly this approach would mean here: the indirect lever is through the capital that the vast majority of people that firms were requirements that we set against the trading books of comfortable with would be allowed to take up those banks. I think we now realise, and the world realises, jobs. That was the approach prevailing at the time. that we had that wrong, not by 10 or 20% but by a factor of several times—there just was not enough— Q2180 Ms Keeble: I wanted to ask Lord Turner about the regulation of complex instruments, Q2182 Ms Keeble: By 200 or 300, do you mean? because there has been discussion of the fact that Lord Turner of Ecchinswell: Yes, 200% or 300%. We they were under-standard. You said just now that will be increasing the capital required against you thought that some of these instruments had not categories of trading books by several times, not by V contributed to the sum total of human welfare and 10 or 20%. That will make a significant di erence to would not be missed, which is a very Philistine the incentives for companies to have very large comment, in some ways, for a regulator. Could you trading books of complicated activities. I think the expand on your comments and say which issue which we might have to address is whether you instruments, in particular, would be on your hit list? could ever imagine a regulator saying: “That Lord Turner of Ecchinswell: I am not sure why you product should not exist because it is too are using the word Philistine there, but let me complicated.” Regulators, so far, have been wary of explain. It is certainly a comment which would be that degree of ability to step in and simply say: “I am oVensive to somebody who believes in an extreme going to product regulate”, but I certainly do not version of eYcient market theory,who would believe exclude it. Indeed, in the “open issues”, the final that if something had been innovated by a private chapter of the report that I will be producing on sector, profit-making firm then we could assume by March 18, it will put, not for definitive conclusion that very fact that it must be beneficial socially and but as an open issue, whether in future there are economically. What I clearly set out in my lecture some categories of financial product where we was that I think there are particular features of should simply say we think this is too complicated financial markets why that is not the case, and for anybody to actually deliver in a risk managed whereby you can have financial innovations in fashion. financial markets which survive for a long period of time, which fundamentally extract what economists Q2183 Ms Keeble: You also, in that lecture, call “economic rent” from the rest of society rather identified some of the institutions which have been than adding value to the rest of society and which particularly associated with some of the more create significant risk. That is a complex theoretical complex products which might need tighter argument that is something I believe. What did regulation, and you mentioned in particular the happen with the more complex forms of securitised mutual funds and the hedge funds. I am sure you do credit is that we were doing things where the possible not want to pre-empt your March report, but could benefits to allocated eYciency, which people argued you just say what your thinking is there and how you existed, were pretty trivial and which were creating, are thinking that you might regulate? through their complexity and the fact that they were Lord Turner of Ecchinswell: The issue relating to so diYcult to understand, huge risk. I think that mutual funds is not fundamentally a UK situation, some of the more complex things that existed will not because we do not have this category of mutual exist in the future. I think they will not exist in the funds; the issue is mutual funds in which you make an investment but which then give you a close-to- 2 HC (2008–09) 144–II, Ev 569 categoric promise that they will not, as it is called, Processed: 25-03-2009 23:50:38 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG13

Ev 284 Treasury Committee: Evidence

25 February 2009 Mr Hector Sants, Lord Turner of Ecchinswell and Ms Loretta Minghella

“break the buck”—ie they will not allow the value of Lord Turner of Ecchinswell: Yes. your investment of £1,000 to go below £1,000—and who, thus, end up performing a bank-like Q2187 Ms Keeble: Is it full time? function—a product which is not legally a bank Lord Turner of Ecchinswell: Yes, I would say it is deposit but has the economic characteristics of a about 80 hours a week. bank deposit. As it happens, we have almost no such Mr Sants: I concur with that. It is definitely full time. institutions. So that issue of extending the regulatory boundary is fundamentally an issue for the US Q2188 Mr Todd: You have turned down your bonus, authorities, not for us. Mr Sants, have you not? Mr Sants: I have. Q2184 Ms Keeble: And hedge funds? Lord Turner of Ecchinswell: On hedge funds, I think Q2189 Mr Todd: Does that reflect a view that that we certainly believe that we need to gather enough would be a reward for failure? information on hedge funds (and this will require Mr Sants: No, not at all. I just took a view that in the more information from them) to assess what risks current climate, the overall economic circumstances, they are creating at the macro level and an individual it would not be the right thing for me as the chief institution level, and if at any time we believe they executive of the financial regulator not to do. I also have become suYciently bank-like in their activities felt this was important in relation to a topic to which or large in their scale that they are systemically no doubt we will return; we have mentioned it important, then we should extend bank style capital already, namely, compensation structures. This is an and liquidity to their activities. We need that power. area I personally have always been very interested in. I believe that the regulator should take much greater Mr Sants: We should also recognise that we regulate interest in ensuring we have eVective compensation hedge fund managers here to a standard which is structures within banks and financial institutions above the rest of the world. So a good first step, quite which seek to minimise risk, and indeed certainly do frankly, is that the rest of the world catches up with not incentivise risk. That is something I said very us. In this area we are ahead of the game. We can go early on in speeches and have been looking at since further, but the first step, actually, is the rest of the I have joined the FSA. I have felt, in terms of my world catches up with us. authority to speak on that topic from a personal point of view, that that was not going to be helped in Q2185 Ms Keeble: You might have seen, Lord the debate if I had taken a bonus. Obviously, Lord Turner, the suggestion from Dr Danielsson of having Turner can comment in more detail on our the complex and securitised interests traded on individual incentive plans but I strongly believe, in exchanges. I wonder if you had considered that and respect of calendar 2008, that it is right that the thought that that might increase transparency and relevant FSA employees are able to receive confidence. individual performance pay. Lord Turner of Ecchinswell: We are certainly very interested in the credit default swaps market—CDS Q2190 Mr Todd: I was going to ask how many have market—of getting as much as possible of that followed your example. trading going through clearing systems and central Mr Sants: I do not think anybody else in the FSA counterparties, so that you net out not only on a will be volunteering to forgo their bonus, which is bilateral basis but a multilateral basis a lot of the what I have done, unsolicited in any way huge, nominal value of these instruments which are whatsoever. outstanding. That is covered in my review and it is something that the FSA is deeply involved in Q2191 Mr Todd: So what is the typical payment of discussions with the Federal Reserve in the US and a bonus within the FSA? the EU Commission about how we progress that. It Mr Sants: To be quite clear, the press have run very is important to realise that about 75% or so of the speculative articles. We are going through a process CDS market is probably not of a suYciently which is assessing individual performance and then standardised form that it would be possible to put allocating a performance pay against those into a central counterparty clearing arrangement, individuals. We have not completed that exercise yet because these are bespoke and therefore are, almost but, relative to the potential pot of some £21 million, by definition, over-the-counter products. However, not other figures which have been reported in the in that segment where we can make progress there is press, that obviously works out at £7,000 or £8,000 a clear belief that we should try to do so and we are per employee. I should make the point that the FSA trying to drive that. works on a total compensation system. These payments are part of the overall pay of an FSA employee. It is an individual scheme. It is not an Q2186 Ms Keeble: Can I just read back to you FSA bonus that is distributed to all on the back of something you said back in July when things were some general judgment about the FSA. very much calmer and we were interviewing you about your three-day working week, amongst other Q2192 Mr Todd: You will have noted, I think, a things? You said, “What is absolutely clear is this is piece in The Spectator about the terms of departure a job where, if a crisis happens, it has to be eVectively of one of your members of staV who left after full time”. Northern Rock. I assume you noted that, did you? Processed: 25-03-2009 23:50:38 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG13

Treasury Committee: Evidence Ev 285

25 February 2009 Mr Hector Sants, Lord Turner of Ecchinswell and Ms Loretta Minghella

Mr Sants: I think from memory that was a comment Lord Turner of Ecchinswell: Okay.3 about the managing director, who obviously had a board contract, so it is really for Lord Turner to Q2200 Chairman: Also the bonus as a percentage of comment on and, to be fair, he was not there at the the basic salary; I think that aspect is important. time. Obviously, the executive board members have Lord Turner of Ecchinswell: It comes to 15%. That is specific contracts. the maximum that it can be this year. That was agreed in the budget for 2008 and 2009 which was agreed by the board a year ago, at the beginning of Q2193 Mr Todd: So, just to clarify for the record, it. That was the figure. was the payment referred to in The Spectator piece accurate, and, secondly, was that the contractual Q2201 Chairman: So that is the maximum that obligation to that particular individual? anyone can get, 15%? Mr Sants: I am at a slight disadvantage here because Lord Turner of Ecchinswell: No. Individuals can get I am not sure which individual you are referring to. more. The 15% is the total bonus pool. That is the I assume you are referring to the retail managing average. director. Q2202 Chairman: Perhaps you could give us an Q2194 Mr Todd: Yes. indication of what the— 4 Mr Sants: The numbers for that were published in Lord Turner of Ecchinswell: Okay, we can do that. our accounts for last year, so obviously they are already in the public domain, and I assume The Q2203 Mr Mudie: The obscene thing about this is Spectator can correctly read our accounts, without that the low-paid can reach the dizzy heights of 10% looking at the article I cannot tell you oV the top of but the top brass, with their obscene salaries my head. The figure was determined by the compared to the lass at the bottom, can have 100%, remuneration committee, not by myself, and it was 200%, 300%, which all piles down to an average of deemed to be the right award to pay. 8% or 9%, we hear. Is this the same with the FSA? Mr Sants: 35% is the answer to your question. Lord Turner of Ecchinswell: 35% is the absolute Q2195 Mr Todd: I asked a diVerent question, which maximum. was, was that the contractual obligation to that Mr Sants: There is a maximum set by the board, individual, the minimum required on severance of which, in respect of this— that person’s contract? Mr Sants: There is the issue of the precise amount Q2204 Mr Mudie: Yes, but what I am asking is, is the required by contract and what was deemed to be the lowest member of staV able to earn 35%, because the right practice relative to the FSA’s severance policy. banks have this quaint habit where there is a limit on That was a matter for our remuneration committee what the low-paid can have but no limit on what the to comment on. I believe it was in line with the senior staV can have? Are you saying the lowest-paid practice of the FSA. in the FSA can earn 35%, they have got a scheme which allows them to do it, or are they limited to 10% but you have a scheme that allows you to hit 35%? Q2196 Mr Todd: Does Lord Turner want to Mr Sants: That is the current structure. comment? I know you are at a disadvantage. Lord Turner of Ecchinswell: I am at a disadvantage Q2205 Mr Mudie: So you do have that? because I was neither chairman nor on the board and Mr Sants: 35% is the maximum for everybody taken certainly not on the remuneration committee. across the board.

Q2197 Mr Todd: But you realise the reasons why Q2206 Mr Mudie: For everybody? these questions are asked? Lord Turner of Ecchinswell: Yes, for everybody. Let Lord Turner of Ecchinswell: I do understand the us be clear. The present scheme does have the same reasons why they are asked but I just do not know potential amounts for everybody and the FSA is an the answer to those particular questions. That had institution which has gone down the road over the happened before I joined. I would, however, be very years of somewhat moderating base salary in order willing to talk about the overall philosophy of the to have a significant element of performance-related performance related pay if you want me to do that. pay which does relate to our secretaries who have been working flat out over the last year on the pressures, et cetera, as well as to the chief executive, Q2198 Mr Todd: Can I suggest, so that we speed the though in this case Hector has decided to waive it, time, that it would be useful to have that set out in a and I think he has explained that the reason why he note to us on the future plans for remuneration wants to do that is to put himself in a position so that within the FSA? he can engage in this debate without people saying Lord Turner of Ecchinswell: On severance or on—? that he has a self-interest in it, and I think that is a very good thing for him to have, entirely voluntarily, done. Q2199 Mr Todd: On both, because this issue of rewards for failure relates both to bonuses and to 3 HC (2008–09) 144–II, Ev 570 severance terms for those who have failed. 4 Ibid,Ev570 Processed: 25-03-2009 23:50:38 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG13

Ev 286 Treasury Committee: Evidence

25 February 2009 Mr Hector Sants, Lord Turner of Ecchinswell and Ms Loretta Minghella

Q2207 Chairman: It would be good if we got the up with a process whereby, on a regular basis, we are salary scale ranges and maybe the maximum bonus having detailed discussions of the macro situation, that people got because in terms of the culture of including the most senior people at the FSA and the bonuses there is a feeling in the public about why it most senior people at the Bank, with the technical is that the financial services industry is almost experts looking at the data developing a point of unique in that some people need two or three times view of the macro situation and developing a joint their basic salary to get them out of bed in the point of view as to what we are going to have to do morning while most people go to work for a basic about it. Where there clearly is something which salary. more purely relies on the Bank side is, if you think Lord Turner of Ecchinswell: I do think that is an you are using these tools not only to keep the important point and, if I may just say it, I think it is financial system robust but also as an extra tool of unfortunate that we have, in the process of this macroeconomic management and inflation debate about bonuses, confused the very reasonable targeting—and that is where it gets complicated— concerns about people receiving enormous multiples there are a lot of ways to organise this. I think they of salary for things which have turned out in need to be debated, but however it is done we need retrospect to be harmful to their institutions and very intense joint working between us. now to the taxpayer with the bonuses paid to people Chairman: When we produce our bank inquiry of much more modest salaries as performance- report we will be looking further at international related pay, which has been again, whether we agree regulation in the macroeconomic aspects as well as with it or not, the flavour of the month of human the consumer issues, so if you could have those resources’ approach in the public sector as well as the discussions with the Bank of England and come private sector over the last 10 years. back to us with information at a later date it would be helpful to us. Q2208 Chairman: That is why as a committee we have always distinguished between the utility aspect Q2210 Mr Cousins: Lord Turner, in the year 2006 at of the banks, where they have the branches and the annual general meeting of the Royal Bank of people doing a good job, and the casino aspect. It is Scotland the then board of directors marched to the therefore important that we drive that home. rostrum while the bagpipes played the tune from Mr Sants: Can I say a couple of very quick things Brave Heart. What we have to ask ourselves is what and I think they might help with the wider debate? regulatory system, what system of accounting, or We are proposing to be much more transparent in what actual regulator can control that kind of greed, our next report and accounts around our pay ranges pride and out-of-control locker-room culture? and we hope that sets the example for the approach, Lord Turner of Ecchinswell: I think that regulators in at below board level, obviously, that we would like the future can do a very much better job than in the our firms to take. I just would like to make a point, past in leaning against the winds of exuberance, and and I am sure you will give me a moment just to exuberance includes organisations being convinced make this point, with regard to FSA staV in calendar that they are on a roll which is unstoppable, et cetera. 2008 in respect of this 15% pool. These people have I also think that only regulators or central banks can worked unbelievably hard to mitigate these do it. I think we have a fundamental issue here problems. They have worked all night. They have rooted in human nature and institutional cultures worked all weekends. The idea that we have not tried whereby, if we leave the leaning against the wind with every sinew to address the issues that have come entirely to boards of directors and management, it out of the crisis I think is misplaced. We are talking will not happen to suYcient extent. I think that about recognition of a huge eVort by our staV in the human nature and institutional cultures do have a last 12 months and I just feel I have to say that. tendency for, as it were, the animal spirits of capitalism to get out of hand and be self-reinforcing, Q2209 Chairman: Just to clear up a point earlier, and I think that is our job, in the famous statement Lord Turner, there has been a suggestion that the of one of the chairmen of the Federal Reserve, to Bank of England should be in charge of the macro “take away the punchbowl before the party gets out prudential tool beyond interest rates to temper the of hand”. excess of credit booms. Could the Bank or yourselves have that instrument or should it be Q2211 Mr Cousins: But were the auditors simply not shared? doing their job in those situations, and how could Lord Turner of Ecchinswell: I think however you they be made to do their jobs? define the legal responsibility for it, and I think there Lord Turner of Ecchinswell: Can I just be clear? I is a variety of diVerent ways that you could structure think this is a very important point which gets to the the relationship which go from the Bank spelling out role of published accounts in this. At the moment the its analysis and us having to publicly say what we are philosophy of the published accounts of banks as of doing about it, or the creating of a joint forum in the retailers or manufacturers is quite overtly not middle or the Bank being able to say, “No, we really forward-looking, both in relation to the trading think you have got to change the capital regime”, books that we earlier discussed and in relation to the whichever way we structure that relationship, and I banking books, the stuV which is not traded but think it is possible to argue the pros and cons of it, simply a standard mortgage or a loan to a corporate. de facto it will only work if there is a very deep The overt philosophy is that what auditors should discussion between us, and I believe that we will end do is reflect information currently then available, so Processed: 25-03-2009 23:50:38 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG13

Treasury Committee: Evidence Ev 287

25 February 2009 Mr Hector Sants, Lord Turner of Ecchinswell and Ms Loretta Minghella in the trading books you say, “If I were to sell this agreement on this appropriate balance between instantaneously today what could I get for it?”. That these diVerent ways of thinking about the is the value you have to put down and you are not information which is in published accounts. allowed to put down a lower value for cautious reasons. In relation to the banking books, you are Q2213 Mr Cousins: The Financial Stability Forum clearly told that you must only work on an incurred was raising some of these issues in early 2008. loss basis, and an incurred loss basis means that Nothing seems to have happened so far and what there must already have been an event or a reason were the FSA doing in that period of late 2007 and believe that an event has occurred such that you throughout 2008, with the powers they had, the know that somehow or other a loan is under threat; section 166 powers, to look deeper? somebody has not paid on time. You are not only not Lord Turner of Ecchinswell: Can I be clear? The FSA encouraged; you are not allowed in January 2005 to has no powers to change accounting standards. We say, “At the moment people are all paying my have no powers whatsoever. Accounting standards mortgages back on time but I know from history are set by the IASB and the FASB. that there is a cycle and therefore I want to put something aside for a rainy day”. This is a very Q2214 Mr Cousins: You have the powers to look at major issue. We believe, as many people believe, that how those accounting standards are being used. there is a value not only in regulatory capital but Lord Turner of Ecchinswell: Yes, but I think the somewhere in the published accounts, maybe as a biggest issue is the accounting standards, not how movement to reserve or at the bottom end of the they are being used. Having said that, you have also P&L, in having something which is what the Spanish identified something which is also an important part call a dynamic provision in reserve and what the in the shift of the philosophy that we will have for the Financial Reporting Council have proposed as an future. I think we will be much more involved in the economic cycle reserve, some process within the future, whatever the accounting standards are, in published accounts of more looking forward and looking at the variability in specific ways of how that saying, “Things look good now but history tells me is implemented in diVerent banks and saying, “Hang there are cycles so I have to aim oV with some on. Why is this bank using this approach and that caution for the future”. I think it is very important bank using that approach?”. That is an issue which to realise that not only is that not encouraged at the we have got much closer to over the last four or five moment; it is not allowed at the moment. The months as we have been involved with the Treasury philosophy of accounting is that you reflect the facts and the Bank of England in understanding things which currently exist, not an expectation of the facts which we need to understand for the purposes of the that will exist in two or three years’ time. recapitalisation programmes, and I think going forward we will be much more actively involved in debates with the auditors and with the banks about Q2212 Mr Cousins: Your own recent report, and what is the range of particular ways of implementing indeed a number of other reports done by the whatever the standards are and who the outliers are European Central Bank, the SEC, the IMF, and should they be coming in line. However, I do throughout 2008 were expressing growing concerns stress I think an even more important issue is the about whether the system of accountancy standards standards overall. and accountancy performance was adequate to the task in hand, but so far nothing has been done on Q2215 Mr Cousins: The regulators themselves in that front. What is going to be done on that front? 2008 were starting to recognise that there were Lord Turner of Ecchinswell: This is under intensive changes in the American system of accounting which debate within the Financial Stability Forum on were producing new situations and a growing which I sit. We were in fact debating this just two divergence between the accounting systems in days ago at a meeting. We will be debating it again Europe and the accounting systems in the United at a major meeting of the Financial Stability Forum States which perhaps was making it possible for which meets in two weeks’ time here in London; we products that in theory were sold, in fact, to be are the host of it, and the debate between regulators warehoused. Is this something that the FSA looked and accountants about how we meet both the at then? Is it something that it is looking at now? This requirements for clear communication of facts to issue of the results of the divergence between the shareholders, which is where the accountants come accounting systems in Europe and the United States from in this debate, but also the desire of regulators was on the agenda in 2008. to have something that recognises systemic risk and Lord Turner of Ecchinswell: I think Hector should economic cycles, is a debate which is intensely going come in in a minute but I think this issue of the on and we in the FSA attach considerable divergence of accounting standards is relatively importance to getting a correct resolution of this minor compared with the longer term issue. I think debate. Having said that, this is an area where it is we have to separate two things here. When we very diYcult for us to go it alone because we simply entered the downturn and when a lot of assets which cannot run a system, certainly not in Europe and were in the trading book became deeply illiquid and ideally not indeed in the world, where we have therefore, as we discussed earlier, diYcult to value, diVerent accounting systems in one part of the world there was an extensive debate about the freedom from another part of the world. It is an area where with which banks should be allowed to move it from are going to have to try to get international the trading book to the banking book and to change Processed: 25-03-2009 23:50:38 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG13

Ev 288 Treasury Committee: Evidence

25 February 2009 Mr Hector Sants, Lord Turner of Ecchinswell and Ms Loretta Minghella the approach. There were debates about whether question that the use of ratings has been a major there was a commonality of approach in the US and contributor, one of the many,to the crisis, and I have in Europe. I do not think these are fundamentally to say that is both in the way that those ratings were diVerences at the end of the process but I think it is produced but also in the way they were used by the in some senses a less important issue than getting the investors and used in the selling process by the whole approach right for the long term. investment banks. It is not just the credit rating Mr Sants: I think, again, it is important to emphasise agencies themselves that need to change their this point. The FSA is not responsible for setting practice but also those that use the ratings. There is accounting standards. We can influence them. The also an issue that these have become very deeply fact that there is some divergence between the US embedded in the regulatory architecture, so when and the UK on accounting standards historically has they change they have knock-on eVects across the no doubt encouraged some business to be done in board in terms of the way companies can fund the European regime—it is a European regime—and themselves. We support change in this area and we not in the US, but I do not think that has been a are taking that forward through the European central cause of the recent sets of events. If you are agenda. My point rather is that we did not have a asking, since the crisis unfolded—I am not sure you national remit to take it forward locally because they are, but there seems to be a bit of an undertone to are not based here. this point—has the FSA taken a deep-dive interest in ensuring they know what is inside the institutions and that those models, the levels two and three Q2219 John Mann: That is one significant problem. analysis that we were referring to, which it is the I come to a second one that may impinge on your responsibility of the auditors to audit, are ability to do your job as eVectively as you might like. nevertheless reasonable models to apply, the answer OVshoring in UK dependencies, of which many of is yes. As Lord Turner said in his opening remarks, the oVshoring centres are, of course, British we have fundamentally changed our supervisory dependencies, how much is that a problem in terms style so that we now have detailed risk management of your inability to oversee what is going on in places position information on the banks. We know what is like Belize, the Cayman Islands, Gibraltar, et cetera? in the banks. Of course, knowing what is in the bank V is not the same as being able to forecast that you will Mr Sants: There are two di erent issues here and be worth in a few months’ time but it is not a there is a wider philosophical point the Chairman may want to pull out here, but in practical terms, of question of lack of visibility to the regulator of the V specific positions or the valuation models which course, I do not think the o shore problem is a their auditors are using. significant contributor per se to the prudential oversight of the major banks because they are not normally domiciled in those types of location, so in Q2216 Mr Cousins: One last point. That is what you terms of the principal discussion to date I think I are doing after the crisis has unfolded. I would just would not draw attention to that. However, there are like to know when you think that was. What was this two key issues. The shadow banking sector, to use moment of crisis? the phrase that has been used, which includes the Mr Sants: I have been quite clear that we have hedge funds we referred to earlier and various other changed the supervisory style fundamentally since I types of structures that are used to facilitate, if I can took over, which happened to coincide with the use clear language, to finance transactions, these crisis, ie, July/August 2007. We have put in place our types of structure are not, as we reflected, as new programme for the last six or nine months. We transparent to the regulators as they should be. So have been doing this since the crisis began in varying we support ensuring that firms cannot use these degrees and now much more intensively, ie, for the types of devices to escape the oversight of the last 18 months. regulator. That is an issue, and the other issue, of course, is consumer protection. Q2217 John Mann: Mr Sants, how can you do your job properly when the credit rating agencies are so poorly regulated? Mr Sants: There is no question: we support extra Q2220 John Mann: That is two issues. How many regulation of credit rating agencies. Again, I have individual consumer complaints have you received always hesitated to do this because we keep drawing in the last five years? attention to the fact that there are things not Mr Sants: Sorry—in aggregate? necessarily in our direct area of responsibility, and I apologise if I am doing that again but, of course, the major credit rating agencies are located in the US. Q2221 John Mann: Yes. We are a national regulator. Therefore, initiatives to Mr Sants: I would have to come back to you. Many strengthen— thousands go through our consumer contact centre in a year and we normally have something of the Q2218 John Mann: The banks that you oversee, as order of 5,000 or so whistleblowing-type alerts to us they told us, use the credit rating agencies. in a year and so forth. Over five years I am afraid it Mr Sants: Absolutely, and we support further is not something I have to hand immediately.5 fundamental reform in the regulatory regime that is applied to credit rating agencies. There is no 5 HC (2008–09) 144–II, Ev 570 Processed: 25-03-2009 23:50:38 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG13

Treasury Committee: Evidence Ev 289

25 February 2009 Mr Hector Sants, Lord Turner of Ecchinswell and Ms Loretta Minghella

Q2222 John Mann: Tell me about the toxic debt of Lord Turner of Ecchinswell: No, I think that is the financial institutions that you regulate. What is it completely wrong. I cannot recognise what you have in total? How much of that is unsecured debt of UK said at all. We need, along with the Bank of England, consumers and how much of that is the secured to have a point of view as to what the macro mortgages and other debts of UK residents? situation is, which as best as possible has a point of Mr Sants: Of course, it depends how you want to view about how the future develops. On the basis of define toxic debt. We are back to the point that we that, that is one input to the way that we regulate. We cannot say with certainty—nobody can say with require capital to be put against businesses. We have certainty—how assets will perform in the future. If a very strong liquidity regime. We are going to be you use the word “toxic” as being something that increasingly involved in the accounting side. We are moves to an almost worthless valuation and is very regulating and we are looking very carefully at debt. diYcult to value at the current time, that is a I do not understand at all how you took from what prediction about the future. In general, to your Hector said the idea that toxic debt is outside our consumer point in the UK, as we have discussed here regulation. It is absolutely what we are focused on. before, UK mortgages have generally performed to I am afraid I simply cannot understand your point date pretty well, though, of course, arrears numbers at all. are rising, as you will know from the public data, and Mr Sants: And I think you misunderstand the term we have not had the degree of problems that we saw “outcome”. The whole point of outcome, as I sought in the US market. to explain earlier, is that we want the supervisors to supervise, ie, to give consideration to whether the Q2223 John Mann: Do you classify them as toxic actions which companies are taking are leading to debts? consequences which work in the best interests of Mr Sants: No. We would only classify in that society, consumer and the markets. We want them to category, on the basis of general terminology, the think ahead, anticipate, think what is going to sub-prime group, which is 5% to 7%. I think there are happen next, think whether what is going to happen considerable potential risks around some areas of next is going to work for society. That is what we self-certification but even if you added in self- mean by outcomes-based regulation. It is always certification you would only come to about 20%. diYcult to capture that in one word but the point is The vast majority of mortgages in the UK we would clear. They need to be forward-thinking, braver, not in any way see as toxic debt. intrusive and get involved.

Q2224 John Mann: Is that 20% of UK mortgages? Mr Sants: I am saying there are 5% to 7% of UK Q2226 John Mann: Finally, if a consumer comes to mortgages in the classic sub-prime category, which is you with a complaint, such as they have been lent far a lot less than in the US, and the other category too much credit or they have been lent far too much where you would raise some questions as to how secured and unsecured loans, you have not acted on they would perform in the future would be pure self- that in the past repeatedly as the FSA. Any of the certification where the consumer has indicated what complaints I have ever seen you have never acted their income was, and in many cases that may not upon, not one, even when challenged on this now be the case and thus the consumer will be Committee on them. Do you intend to act on those challenged to service that debt. complaints and intervene in the markets, in other words, using consumer complaints as an indicator of Q2225 John Mann: So there are problems identifying a culture within financial institutions that means the toxic debt, there are problems in regulating UK they are cavalier in their attitude? dependencies, problems of the credit rating agencies Mr Sants: In terms of the narrow point, and Lord and regulating them, and none of them is specifically Turner will want to comment on the philosophy, I your responsibility.My final question is to you, Lord completely agree with you, which is that consumer Turner, and that is on your philosophy. Your complaints are a tool which the regulator should regulatory philosophy, and we have here your take into account when making judgments about current business plan for the next year, changes from whether firms are managing themselves properly in the principles-based regulation to the outcomes- compliance with our regulations. I come back to the focused regulation but nowhere in it is the point that as part of the reforms we have introduced anticipation-based regulation. At the same time you over the last 12 months consumer complaints are have produced this macroeconomic financial now a key factor in our assessment of the outlook, in other words, you are overlapping the performance of firms and whether they are Bank of England’s role and the Treasury’s role delivering what consumers want them to deliver. To entirely by suggesting, “Here is the macroeconomic your narrow, narrow point, if a consumer has been outlook”. Do we not need a regulator in this country, sold an unsuitable product we will take action, we do and is not the weakness and your weakness in your take action. If you have any constituents where you philosophy that you are passing the buck on feel we have not properly followed through please regulation, that we do not have a regulator, that we feel free to contact me. Suitability is critical to the need a regulator, and that what you are doing is current regime. There is a philosophical question we dressing up vagueness in terms of moving into the have already touched on as to whether we should do overlapping rather than the underpinning of actual more and that takes you back into the product-rate regulation? basis. Processed: 25-03-2009 23:50:38 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG13

Ev 290 Treasury Committee: Evidence

25 February 2009 Mr Hector Sants, Lord Turner of Ecchinswell and Ms Loretta Minghella

Q2227 Chairman: Lord Turner, give us a quick Lord Turner of Ecchinswell: I am well aware that answer. there are many intelligent commentators, including Lord Turner of Ecchinswell: The quick point is that very close friends, who are arguing exactly that point again I am a little bit surprised at your questions and I think they have good arguments. Let me just because, on the issue of the conduct of how people express again what I put in my lecture on this debate. sell things, that is what we have been very intensively I think there are very major issues about how we involved in over the last 10 years, and indeed some make sure that proprietary trading activity does not people have criticised us for being more focused on contaminate the ability of banks to perform their conduct than on prudential issues. That has been fundamental functions in commercial and retail very much the focus. We have looked at consumer banking, and clearly there have been instances where complaints. We have fined companies for mis- that has occurred. If you look at the management selling. The involvement in that has been central. In report which the board of UBS developed and then the past the focus has entirely been on the selling published on what happened in UBS, it was clearly style. It has not been on saying a 100% mortgage is a case of profits and funding made in the retail and by definition wrong. We are going to raise the issue commercial bank being used to fund a blow-up of a as to whether we need to get more directly involved proprietary trading activity, so it is a very major in product regulation by saying a mortgage of a issue. What I am just a little bit cautious about is that particular type is definitionally wrong whoever you we cannot, as it were, go all the way back to a are selling it to. There are pros and cons to that clearing bank of the 1950s and, as it were, the which I think we need to debate and it is not merchant banks of the 1950s, because I think we straightforward, but in the past we have been have to live with the reality that that extreme absolutely centrally involved in the process, so separation existed in a world of fixed exchange rates, monitoring and regulating the conduct of business capital control, very limited global cross-border and fining firms who are wrong in the conduct of operation of corporates who needed to be serviced business, and on the whole most people have by banks, much smaller international trade and capital flows, and I think that that account of, “I criticised us for being too focused on that and less want them to be a narrow bank and an investment focused on whether the banks were going to go bank” really does not deal with banks which, to take bankrupt. the point that was mentioned earlier—I think reference was made to banks like HSBC or Standard Q2228 John Thurso: I want to ask you some Chartered, are inherently global banks which have questions about corporate governance and done better than most at avoiding some of the remuneration at board level, the top end. It seems to problems, they are deeply involved in this process of me that both of those things come back to a kind of lubricating a global economy in a world of floating core philosophy question which is around what has exchange rates and which, in order to do that, been called the narrow bank or the Glass-Steagall cannot be entirely away from things that happen in question or whatever. In order not to have a lengthy trading rooms, markets that need to be made, V question and answer, can I put something to you and derivative products that are legitimately o ered. take this forward a bit? Broadly, investment merchant banking came out of the tradition of the Q2229 John Thurso: If I can just ask you on that, partnership—their own money, trading, dealing, those two banks are the exception. If you look at all making large profits and topping up the profits our banks that are native and not work-based in the amongst themselves at the end of a particular time Far East, if you look at all the big American banks, period. Broadly, the clearing traditional banks came you are talking of eight out of 10 going down and out of stock companies with shareholders and a two surviving. Should we not be building a model on much more prudential approach. A number of the eight that went down, not the two that survived? witnesses—Sir Tom McKillop was one of them— Lord Turner of Ecchinswell: I think we have to build made the point that actually these are so diVerent as a model that deals with the reality of a global philosophies that you cannot put them together and economy. What I will say is that I think we will put if you wish to have the full regulation of the money through changes—more capital for trading books, utility you have to disaggregate the gambling side diVerent approaches to credit rating agencies, tighter which the Chairman referred to at the beginning— control of risk, which, while it will not produce the Jon Moulton, Will Hutton; there is a whole list of extreme version of, “There are narrow banks and people. Recently, for a completely diVerent reason, I investment banks”, I think it probably will produce happen to have been talking to quite a lot of a significant number of banks which de facto look institutional investors and I would say 80% of them, like the narrow banks that these people will want. I who are quite big investors in RBS, or were in these think several of our British banks may say, “We are banks, have the same view. Lord Turner, you have not going to get into that proprietary trading”, I expressed the opposite view, or you have expressed think there will be less of that proprietary trading doubt as to that view, and said you remain being done in total than there was before, and I think unconvinced. Can you say why you are not we will look very carefully at those banks which are convinced when there seem to be so many intelligent still involved in both activities to make sure we are commentators in the City and elsewhere who feel asking searching questions about how funding and that a return to Glass-Steagall is something few support are transferred from one institution to the should aim for? other. That is, I would say,the approach which to my Processed: 25-03-2009 23:50:38 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG13

Treasury Committee: Evidence Ev 291

25 February 2009 Mr Hector Sants, Lord Turner of Ecchinswell and Ms Loretta Minghella mind one of the best reports which has been Lord Turner of Ecchinswell: We agree with you. produced, that is, Paul Volcker’s report for the Mr Sants: Fundamental reform is needed here. Group of Thirty, has put forward. I think Paul Volcker has thought more deeply about this than many people. He has not come out in favour of a Q2232 John Thurso: We have got a yes we will move radical unwinding of Glass-Steagall, but he has on. Remuneration. You have talked earlier on about talked about a philosophy which is very much in line the remuneration practices, I have mentioned the with what I have just suggested. two philosophies. What is your view, in a few short words, of the practices that have been prevalent in financial services that have been most disruptive, or Q2230 John Thurso: I want to move on because time bad if you like, and what are you looking to see is limited, but can I just put this one point to you? emerge as being good practice? The real problem is that we have discovered that the Lord Turner of Ecchinswell: We think that poor money utilities are too important to the system to be practice has played a role, it is diYcult to know how allowed to go down. What we have ended up having, big a role in what has occurred. I think the most because we have got the casino attached to the extreme forms of poor practice are where you have money utility, is the taxpayer saving the casino. bonuses which are very large multiples of base salary What we need is a system that allows the casinos to so that somebody is incredibly focused on what they fail so that the utilities can be saved. are going to get for their bonuses, where that bonus Lord Turner of Ecchinswell: I think it is possible to is based on one year’s profit or even in some imagine that you would create banks narrow enough circumstances one year’s revenue, and without that they were not in the casino. I think the idea that taking account of risk, and where it is paid either we can with certainty create casino banking such wholly or primarily in cash and immediately. I think that we could definitely say it would fail and we if you have such structures, and there have been such would never rescue it is a delusion. I think that structures, they will create incentives to the bank and would take us down the path in precisely the we need to change it. opposite way that Sally Keeble suggested of saying it does not matter what the hedge funds do or the investment banks do because they are non-systemic. Q2233 John Thurso: Short-term bonus out, Long I think whatever we do to these structures we have to Term Investment Plan (LTIP) good, pay in shares have everybody in the regulatory environment more than cash. because what we realised on the evening of Bear Lord Turner of Ecchinswell: Just be careful of not Stearns in February—which was not a commercial over-stating what we will achieve by that. The head bank but when it went down it was systemically of Lehman Brothers owned a hell of a lot of the stock important—is that although I could have some of Lehman’s so when people are convinced by sympathy with the idea that there are narrow banks irrational exuberance, the fact that they own a lot of the idea that we will ever define the casino the stock of the company, they are still taken in with suYciently tightly that it is not systemically their own rhetoric. important I think is a delusion. Q2234 John Thurso: Last question, and I hope this Q2231 John Thurso: Can I move on to the next point is relatively yes or no. We had evidence from Mr because it is about corporate governance? It has Moore in regard to allegations, if you like, with been put to me that these things are so big that they regard to HBOS. Can I ask you, are you satisfied are not only unmanageable; they are ungovernable, with the report that was done by KPMG? and certainly the evidence we have had from those Lord Turner of Ecchinswell: I have read the report by who are no longer running the banks did not give KPMG. I think it dealt eVectively with the issues any confidence. The Chairman in his opening which were specifically raised. They concluded that remarks referred to “the great and the good, none of the processes had been reasonable and that the whom could see it coming”, and you indeed have person who was appointed to replace Mr Moore was talked about leaning against the wind and the fact appropriate. I think that was an appropriate way to that will never happen by corporate governance. Is proceed. We have talked earlier about the whole not the weak point in this that the risk assessment philosophy of how we approach some of these risk side is not covered as a major point within the non- things is diVerent from what it was at the time but on management side? Could you not envisage a model, the narrow issue of things to do with the dismissal of for example, where the senior independent or Paul Moore, I think that was an appropriate process. somebody other than the chairman and the chief executive, not a part-timer who was also running another company somewhere else but actually had Q2235 Chairman: Can I just add, Paul Volcker to be there two days a week, had a fully resourced yesterday at Columbia University made a speech staV and actually had to have a specific and he stressed the importance of preventing responsibility, and had the line management for the financial institutions large enough to pose a threat to risk assessment department so that he or she could the entire system from engaging in risky behaviour lean against the wind eVectively? I see you nodding, such as running hedge funds or trading on its own Hector, would you like to have a crack at it? accounts. Are you in favour of allowing institutions Mr Sants: The answer is yes, that is certainly to be complex only if they are not systematically something we have done. important? Processed: 25-03-2009 23:50:39 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG13

Ev 292 Treasury Committee: Evidence

25 February 2009 Mr Hector Sants, Lord Turner of Ecchinswell and Ms Loretta Minghella

Lord Turner of Ecchinswell: I am very much in including depositors, creditors and ultimately favour of Paul Volcker’s statement on this. I think taxpayers”. I am sure you remember the letter. Why we have to accept that there will be some large did it take you until 13 October to write that letter? complex financial institutions which will be doing Mr Sants: I think, back to the earlier point, we are some things which we associate with investment taking a more intrusive approach to regulation since banks like making markets in government bonds, the late summer of 2007. We have been progressively providing forward FX cover, FX swaps, et cetera, developing those themes. You do not rush out and but will not be doing nearly as much proprietary just write a letter upfront. The traditional FSA trading as they have done in the past. approach, which I think is right, is that you do not engage rhetoric first, rather you visit the firms, you Q2236 Chairman: The core of my question is how do see what is going on. You do so to make certain of we ensure the safe banks whilst letting the exotic the facts, you need to be sure that it is true. Prior to element go its own way that does not pose a systemic that letter we made a series of thematic visits to the threat? That is the issue for us here. firms to address the issue. We are back to the debate, Lord Turner of Ecchinswell: I think the crucial thing to be frank, we have had here a number of times. is we have to look at the totality. There was a fundamental change/shift in the Mr Sants: I was going to draw out another point in regulatory philosophy in the FSA which kicked in the debate, just very quickly. Surely, to a degree, from the second half of 2007. That does not get what it is about is ensuring that risk in the institution delivered in weeks, that takes a number of years to can be well managed. Part of managing that risk is deliver. Furthermore public letters need to be diversity so we do need to be careful, when we are in properly researched in the market place. I think a this narrow banking debate, that we do not suddenly matter of months to deliver that is not unreasonable. create a new risk which is lack of diversity.When you look at the funding issue it is not as simple as saying Q2240 Nick Ainger: The bonus culture which we retail good, wholesale bad, it is more complicated have had lots of evidence about and the chief than that. executive and chairmen of banks that you regulate have said it exists, they agree with you in your Q2237 Chairman: We know that. summary that it has had a major impact on the Mr Sants: The answer to your question: what we major cause of the credit crisis but it is not new— need is institutions where the risk can be well Mr Sants: I am agreeing with you, I think that takes managed. If the risk becomes too complex to be well us back to the earlier argument. managed then the regulator should narrow that. Chairman: We have had unsung witnesses here who came after the press, namely the Building Societies Q2241 Nick Ainger: You as a regulator must have Association, who did not get themselves into trouble been aware, from the regular headlines that and that has made quite an impression on us. appeared both on the front and in the financial pages of newspapers, that there were massive—and I mean massive—amounts of money being paid out to Q2238 John Thurso: The point is that the level of risk individual bankers, to traders and to dealers which that is acceptable if you are running an arbitrage clearly must have had an impact on the level of risk V operation is wholly di erent from the level of risk that those individuals were taking and yet it was not that is acceptable if you are running a clearing bank. until October 2008, more than a year after Northern If you put the two in the same organisation you get Rock had got into the situation it is, that you wrote the worst of both worlds. That is the point. to the chief executives and said, “We think there is a Lord Turner of Ecchinswell: If we have some problem here”. You have been asleep on the job, elements of more risky businesses the aggregate risk have you not? for an institution which has deposit taking Mr Sants: I think that is a rather over-used phrase institutions cannot be allowed to rise to a level of a and in this case is wholly inappropriate. pure wholesale one I think is where we are coming from. We are just trying to be careful about taking the argument to the next level and saying, let us just Q2242 Nick Ainger: How many letters— have none of those activities in these institutions. Mr Sants: Because we talk to firms without writing There are potential other debates to be had around to them. We actually talk to them all the time. We that point. have been on this case throughout 2008 but to write a public letter with clear assertions of substance Q2239 Nick Ainger: Mr Sants, you wrote a letter about the industry as a whole, that needs to be dated 13 October to all chief executives in those properly researched which requires engagements banks that you regulate. If I could just quote one with the firms. We regulate the firms. That is a public part of the letter. You said, “It would appear that in document which needs to be properly researched many cases the remuneration structures of firms may beforehand. Personally I have been very, very have been inconsistent with sound risk management. focused on this agenda from taking over in the It is possible that they frequently gave incentives to summer of 2007. I can assure you the firms know our staV to pursue risky policies undermining the impact views but, of course, the amount of payments is a of systems designed to control risk and to the matter for the firms rather than the structure and as detriment of shareholders and other stakeholders, we have discussed before, historically in the context Processed: 25-03-2009 23:50:39 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG13

Treasury Committee: Evidence Ev 293

25 February 2009 Mr Hector Sants, Lord Turner of Ecchinswell and Ms Loretta Minghella described in the prevailing market climate, Q2245 Nick Ainger: It was not until October 2008 regulators did not historically engage with those that you apparently did anything about this? issues anywhere in the world. Mr Sants: Not true. That is completely untrue and not a reflection of the facts. Q2243 Nick Ainger: Did you have any discussions Lord Turner of Ecchinswell: Yes. The Financial with RBS about what they were proposing to pay Stability Forum, for instance, in its April 2008 out in this round of bonuses because the information debate, into which the FSA have put in input, that was being quoted in the press a few weeks ago defined this as a key area to look at. There has been was that they were considering paying £1 billion in a Financial Stability Forum working group looking bonuses at a time when they were going to be losing at this under the leadership of Philip Hildebrand, the £8 billion in trading losses and they were going to deputy governor of the Swiss National Bank, since write down £20 billion of assets. Did you have any April last year. By the time I joined in September discussions with Stephen Hester, the chief executive there were already lots of papers for me to read on of RBS, about the level of bonus that he was this issue. It is just not factually correct that there intending to pay? was nothing going on either in the FSA or Mr Sants: I had discussions, we had discussions, I internationally before the more recent public focus had discussions with Stephen Hester about the on the issue. mechanisms and compensation structures which Mr Sants: I gave a speech in May 2008 on the subject they are using in respect of the 2008 pay round to and the previous chairman also gave a speech on this ensure that they are consistent with our views on the matter earlier in 2008. If you check your records you subject which are set out in the letter you have. As will see we are on the record many months before has been said before, the quantum as opposed to the October 2008. mechanism is not an area of our direct remit. There is a wider question here which I think the Chairman Q2246 Nick Ainger: The bonus culture did not start might like to add to. in 2007, it was many, many years before that. Lord Turner of Ecchinswell: I think it is important to Lord Turner of Ecchinswell: What I entirely accept, realise two separate responsibilities here. The focus and this is very clear in the document which the of the FSA, and indeed of the international Financial Stability Forum will be producing, is that discussions of this issue, because it is something both regulators across the world and management where the Financial Stability Forum is close to until this crisis really failed to focus on the fact that having an agreement for a code of conduct which we remuneration structures, the structure of hope to be able to apply equally across all financial compensation, could play a crucial role in the centres, that focus is not on the level of pay, it is on incentives to take risk. Now again you may say, the way that the structure of remuneration can create “Well surely they should have noticed it” but within incentives either for excessive risk taking or risk the document which the FSF will produce it makes management. There is a completely separate issue as that point absolutely explicitly that we need to to institutions which have received large amounts of integrate incentive structures into risk management public money, what should be their appropriate in a way which really was not done in the past. response in the period while they are receiving public Chairman: Do you want one question on that before money to the bonuses that they pay or indeed to we move on, Sally? their total remuneration but that issue is really for the Government as a very large or in one case the Q2247 Ms Keeble: Just a brief one. When you came majority shareholder of these banks, that is not for before us previously you accepted that there was, in us. Our focus is on the long-term issue and then there fact, a relationship and it was perceived wisdom that is this separate issue. The core issue in relation to there was relationship between the remunerations in appropriate bonuses within the firms that receive particular the bonuses and the risk taking. You said, public money is with Government, which is also the “The responsibility to look at the structure of how way that it has been approached in the US where the bonuses are paid, what they are paid for, and in there is a clear distinction between a set of long-term what they are paid and how they aVect risk taking, standards in which regulators have an interest and that is our responsibility”. You are suggesting that it short-term things which are legitimately somewhat was well-known but it was not dealt with, which is a political because large amounts of public money slightly diVerent point from the one you are have been provided. making now. Lord Turner of Ecchinswell: Are you referring to Q2244 Nick Ainger: Is not the truth of the matter what I said when I came before this Committee that if there had not been a drive in the media, in this before I was appointed? Committee, raising the profile of the bonus culture, that perhaps nothing would have been done? Your Q2248 Ms Keeble: No, I think it was the next actions have not come from your regulatory role, it evidence session after that, which was when you is a reaction to the anger and disbelief of many came with the Governor. people out there when they see the credit crunch Lord Turner of Ecchinswell: Then I would say we had happening and still banks were driving the bonus by then accepted it was our responsibility. I think if culture. you roll back to 2005–06, it was not believed to be Mr Sants: We went on the record on this many the responsibility and if we had suggested it was the months before. responsibility then we would have been met with a Processed: 25-03-2009 23:50:39 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG13

Ev 294 Treasury Committee: Evidence

25 February 2009 Mr Hector Sants, Lord Turner of Ecchinswell and Ms Loretta Minghella wildfire of criticism from the industry which I think Lord Turner of Ecchinswell: It is obviously the case would have received some significant support from that at the end of the boom period, as people have politicians as well. often commented, that a set of frauds which had Ms Keeble: It must have been known about. been covered up have been revealed. We are continually trying to make sure that we are tracking the possibility for this stuV as closely as possible. It Q2249 Mr Breed: Two quick questions. Firstly, to has not been so far, in the UK, a major part of the what extent do you think potential hedge fund story but it is an area that we do focus on. failures present a threat to their prime brokers? Mr Sants: We should also just make clear here, in Lord Turner of Ecchinswell: I think our best terms of the focus of this debate, that certainly we judgment would be to only a relatively limited extent primarily focus on market-related and perimeter at the moment. It is an area which, as we said, we issues in terms of our criminal prosecutions. want to gather more information on but I think it is Conventional financial fraud should be taken important to realise that contrary to the belief that forward by the lead agency in that respect which is hedge funds are all incredibly highly leveraged, some the SFO. Although obviously we do require firms to of them in particular strategies are reasonably highly have adequate systems and controls. To be clear leveraged but quite a lot of them are not terribly therefore we are not the lead agency on the highly leveraged, they are leveraged 2:1 or conventional financial fraud of the type you have something like that rather than 10:1 or so in a bank just referred to. and indeed that leverage has already come down quite significantly over the last year. Because there is not enough international gathering of data we Q2252 Chairman: But you will have noted, possibly, cannot be precise on this but it is quite possible that an article in The Times yesterday by Ken average levels of leverage in the vast majority of Macdonald, a former Director of Public hedge funds have come down from a bit above 2 to Prosecutions, where he says both the SFO and FSA not much above 1 in the course of the last year. We have failed. He is coruscating everyone, including cannot exclude the possibility that there are the politicians. He says, “Our system for regulating particular hedge funds in particular strategies which markets and for prosecuting market crime is are a risk but I think it is not an area where we believe completely broken. If you mug someone in the street there are huge risks at the moment. Hector, would and you are caught, the chances are that you will go you like to comment. to prison. In recent years mugging someone out of Mr Sants: The key point is the point you made. The their savings or their pension would probably earn hedge fund standard board itself has said they you a yacht.” He said that financial deregulation has believe leverage has come down to around 11 and of caused a growing distance between wealthy and 2 powerful individuals and the agencies designed to course the prime brokerage industry has seen police the behaviour. This has led to a corrosive loss significant change, that having been a major factor of trust and no-one in Britain has any confidence in the demise of Bear Stearns and Lehman’s so they that fraud in the banks will be prosecuted. Now he have adjusted their systems in the light of those is asking for a new financial regulatory law events. There is a risk, there is always a risk but I enforcement authority that inspires respect and fear think it is a diminished one. when it is needed. We are not going to get that but what can you give us today from the FSA that you Q2250 Mr Breed: You are not looking at any really seize about the issue of fraud and what do increased regulation on hedge funds at the present others need to do? I know you are interested in the time? issue of plea bargaining. Is the Government still Mr Sants: Back to our earlier point, I think, we do dragging its heels on that? regulate the fund managers in the UK. We would Mr Sants: I hope you do believe from the earlier certainly like global standards of regulations to conversation that I personally am very focused on come up to ours and we would like to go further; as the issue of taking forward the FSA to achieving real Lord Turner said earlier, we would like to increase credible deterrence which means real eVective our ability to properly assess the very point you are sanctioning in the areas where we have lead bringing up which is the financial stability impact of responsibility. In the last 18 months we have worked hedge fund failures. We see them essentially as hard to bring forward criminal prosecutions in the wholesale vehicles so we are not so much concerned areas that we focus on. I readily agree with you that about individual failures, hedge funds have failed in historically the FSA was not tough enough; our the past, they will fail in the future but the overall sanctions were not strong enough to achieve credible global regulatory architecture would benefit from deterrence in the areas we are responsible for. I think greater visibility of systemic risk. We need to work our actions in the last 12 months demonstrate we are with the US in particular to achieve that. We have addressing that and we have a good track record been at the forefront of pushing that argument and beginning to build. It takes a while to achieve we will continue to do so. credible deterrence. On the general fraud point, the point raised about the tolerance here of society of white collar crime, the approaches taken towards a Q2251 Mr Breed: How concerned are you at the level of sanctioning, is a good point to raise for moment about the levels of fraud which seem to be public debate. I think it should be seen as a far more appearing within a number of financial institutions? serious crime than sometimes when you look at the Processed: 25-03-2009 23:50:39 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG13

Treasury Committee: Evidence Ev 295

25 February 2009 Mr Hector Sants, Lord Turner of Ecchinswell and Ms Loretta Minghella outcome of the legal process, it appears to been. We Lord Turner of Ecchinswell: We are driving change. welcome that debate opening up. We work closely For instance, we are in the process of hiring about with our colleagues in the SFO to help them identify 280 people and we are two-thirds of the way through and I hope vigorously prosecute, going forward, it. If you want to call that two-thirds fit for purpose these areas. On plea bargaining, we believe it is and one-third not quite then you can do that. coming in to the next session of Parliament. We hope it is. There are some other powers we would like and we are going to continue to develop the theme that Q2260 Mr Mudie: No. I did not use the words it is Parliament needs to equip us if we are going to going to be fit for purpose. deliver. Mr Sants: We need—

Q2253 Chairman: I heard it was jammed in the Q2261 Mr Mudie: Hector, you are not going to Ministry of Justice. overrule your Chairman are you? Mr Sants: I fear that it is maybe not getting the Mr Sants: No, I was going to give you an prominence that we would like and we would explanation of what I meant which is to say there are welcome any help you can give us to continue to two things we have highlighted here. There is a make the point. There is no question that criminal regulatory architecture. We are talking in plain prosecutions require a diVerent set of powers and the language that everybody out there can understand FSA needs to be set up as an eVective criminal and at the moment people associate with the FSA prosecutor if it is going to do that. the whole of the regulatory process. They do not, of Chairman: As a result of this I will write today from course, want to hear the distinctions of responsibility the Committee’s point. within that, which I quite understand. The regulatory architecture is not fit for purpose. The supervisory changes that are required to deliver Q2254 Mr Mudie: Can I clear up one point very eVective supervision to the earlier point are two- quickly. When Andrew Tyrie opened up he asked thirds to 80% done and in the core areas are currently you whether the FSA was fit for purpose. Your delivering. answer, Lord Turner, was, “It is going to be fit for purpose”. Then a few minutes later Hector said “it is fit for purpose”. We cannot leave the room with this Q2262 Mr Mudie: Lord Turner, three of my dubiety. Who was correct? Is it fit for purpose or is it colleagues have raised, and you certainly had an going to be fit for purpose? interesting dialogue with the Chairman about Lord Turner of Ecchinswell: I think we are in the macro-economic management. You said you were process of putting in place changes which are making going to be revolutionary about the changes that you it fit for purpose. are pushing forward. When I saw your evidence you raised everything bar what of the structure was right between the tripartite authorities. Does that mean Q2255 Mr Mudie: It is not fit for purpose as we sit? you think it is a done deal? Lord Turner of Ecchinswell: Do you know— Lord Turner of Ecchinswell: I will tell you exactly what I think. I do not think it is a crucial issue. Q2256 Mr Mudie: No, no, I am not being funny. If Looking at the diVerent ways around the world in you were a politician, you are a politician. which you organise where conduct of business is Lord Turner of Ecchinswell: I think people before done, where prudential regulation of banks is done, these committees have come and made where you put prudential regulation of insurance grandstanding remarks about how the institution companies and whether you combine it with the they have taken over is not fit for purpose and it has central bank, whether you call it what some people not made much diVerence— call a twin peak system, I have become convinced looking around the world that this is one of the least important issues. However you organise it there will Q2257 Mr Fallon: Surely not. be problems with that form of organisation that you Lord Turner of Ecchinswell: —so I am a little bit then have to guard against and therefore it is more V wary of this stu . I think these are easy words. important to get other things right rather than to shift the boxes around. Q2258 Mr Mudie: Can I just get an answer. Is it fit for purpose or is it going to be? Q2263 Mr Mudie: Except, Lord Turner, I would Lord Turner of Ecchinswell: We are in the process of come back to you and say one of the things that putting in place a whole load of changes. For worried us after Northern Rock was the apparent instance, within the supervisory enhancement things being left to one another but also the inability programme which Hector is putting in place— of someone to say, “I take the decision”. I have now seen you, heard you, a very intelligent, articulate Q2259 Mr Mudie: No, I have read the papers. I am man. I can see you having a good philosophical just a simple man asking a simple question and you decision with your opposite number, right, the are saying to me, “It will be” but you have to live Governor. At some stage somebody is going to say, with the implication of that, that at the moment it is “I have heard your arguments but I am going to take not fit for purpose. this decision” Now with your overlapping I am not Processed: 25-03-2009 23:50:39 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG13

Ev 296 Treasury Committee: Evidence

25 February 2009 Mr Hector Sants, Lord Turner of Ecchinswell and Ms Loretta Minghella sure I am alone on the Committee in saying I am not going on inside an institution or inside what has been sure who is going to say “I am going to take the going on between a group of people who are decision on this”. committing some type of oVence you do need a Lord Turner of Ecchinswell: I think it is recognised whistle-blower. We take the whistle-blowing very that at the time of Northern Rock, I think it was seriously. I have to say, and I can go into the detail if John Gieve who said the dancing was more John you want to, I can assure you that with regard to all Sargeant than Fred Astaire in his recent lecture. the recent ones that have had publicity on the matter, Lord Turner and I have reviewed the files on their Q2264 Mr Mudie: He actually raised the question of cases and all of them were extensively interviewed by shifting some things back into the bank. FSA staV, there are copious notes of those Lord Turner of Ecchinswell: He did raise that but he discussions which we have both read and which also said that he did not think that was at all the show that they were listened to extremely carefully. priority or necessarily a good idea. Q2268 Mr Mudie: We will see. Q2265 Mr Mudie: No, he said it would be costly. Mr Sants: You can be assured that we do take them Lord Turner of Ecchinswell: I have extensively very seriously.I do take them very seriously.They are discussed it with John. central to your point of achieving successful prosecutions and I quite agree with you that they Q2266 Mr Mudie: £80 million and new staV in 12 need to be encouraged. months. Lord Turner of Ecchinswell: Let me go back to the Q2269 Mr Mudie: Can I change the subject for my point. I think it is the case that since Northern Rock last points? The building societies when they were in what have been a series of areas which have before us were understandably upset about the required quick decisions and crisis management compensation scheme and the funding of it. To decisions both in relation to individual institutions them, almost universally well behaved in the current and in relation to things like the overall climate, they seemed to be paying an unfair share of recapitalisation of the banks, the October things, it. They raised this with you. Do you accept that there have been decision making processes within there is any fairness in the building societies’ the tripartite which have been successful. I think the argument that the eVect on their profits is greater system has worked and shown it can work even in than the eVect on the profits of those organisations crisis. that have caused the problem? Do you think there is any fairness and are you looking at it? Secondly, and Q2267 Mr Mudie: Two other matters. I was listening probably more importantly, can you do anything to you with some pleasure when you were asking for about it? If the answer is yes, you have it in your gift, sanctions et cetera but I was disappointed—and we are you looking positively at their complaints? will see what happens when all the facts are on the Lord Turner of Ecchinswell: The overall issue is we table—about your dismissal of the whistleblower, are aware of their concerns and it is something which this KPMG was right. That is not the question. The we intend to review, whether the precise balance of V Chairman and myself and I do not know how many the di erent fee pools in relation to the FSCS is others have received a letter from another individual correct for the future. You will appreciate it is Y who raises allegations about this Italian litigation di cult to change the rules from where they were in that is going on 35 billion local authorities and a the past, and there is a value in having pools quite British based company. This was drawn to the wide. I do not know whether Loretta Minghella attention of the FSA and his letters were not even would like to comment on this issue, which is on the answered. I am going to send it to you. Do you take Financial Services Compensation Scheme. whistleblowers seriously? Pushing a point, if you put Ms Minghella: Thank you very much, Lord Turner. yourself out on a limb in America, they will even Just to add to that, I think we are all very conscious change your identity and look after you. It seems in of the fact that the compensation scheme has to be this country whistleblowers take the decision, often funded by the live industry and that does mean that for mixed motives but often a large part of it is in the good firms pay for bad firms that have gone, so there public interest and they are hung out to dry.Since the is always an element of unfairness about any of the hearing we had I have had three or four letters from bills that we produce for people. We do recognise Y people who have had very bad experiences because that these bills are going to come at a di cult time, they said the wrong things to people in charge of the which was precisely why we agreed with the institutions. Do you take them seriously and are you Government that we would take the loans for all looking seriously at not giving them identities or these compensation bills that we have paid on an anything like that, but giving them more protection interest-only basis for the first three years and that than they apparently have not enjoyed in the past? we would only start to repay the principal— Mr Sants: On the first point, we take them extremely seriously. To my general point earlier, which was Q2270 Mr Mudie: I am sorry for cutting you oV but, about getting the ability to encourage people to again, the Chairman is trying to catch my eye to shut come forward in respect of insider dealing, we have me up. That is all stuV I have read. The basic point been very clear that really without those type of is do you accept there is unfairness in the manner in witnesses it is very diYcult to bring prosecutions. which the scheme is now working towards building The reality is in order to get an insight on what is societies who have a diVerent method of raising their Processed: 25-03-2009 23:50:39 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG13

Treasury Committee: Evidence Ev 297

25 February 2009 Mr Hector Sants, Lord Turner of Ecchinswell and Ms Loretta Minghella brass so they have more deposits and, therefore, as complexity, but the building societies are facing a it is based on deposits, they are paying more? Your very tough time and the decision on helping them Chairman handed it over to you and I thought he will not be held up because of the complexity of the was doing well because he seemed to be very EC and international situations. sympathetic in indicating that as soon as the Lord Turner of Ecchinswell: I accept that point, that opportunity arose you were going to look at this we could make progress and we need to look at the with the complaints in mind. Was that what you were UK thing. We do need to look at these wider issues going to say? as well but I accept the point that that should not Lord Turner of Ecchinswell: We are going to look hold up us looking at that particular issue. at this. Mr Sants: We will not be able to retrospectively revisit that which has already been done. Q2271 Mr Mudie: I am happy for you to let Loretta Mr Mudie: No, but an earlier decision was taken. continue. Ms Minghella: Mr Mudie, actually Lord Turner is Q2275 Chairman: Loretta, we have not asked you not my Chairman. too many questions. Maybe it is because you are the success amongst the witnesses here today.Five banks Q2272 Mr Mudie: Is he not? have gone down since September 2008. How has Ms Minghella: No. The FSCS is an independent your organisation coped with that increasing organisation and the rules are, indeed, a matter for workload and are you adequately resourced for that? Lord Turner and not for the FSCS. It is worth Ms Minghella: Chairman, thank you. I think on the bringing out that at the moment the tariV base for whole the FSCS has managed very well in really very building societies and banks is what share do they challenging circumstances. If you think back, we have of the retail deposit base in the UK and what were an organisation that in the last financial year share do they have therefore of people who are paid 16,000 claims and in the whole of our existence protected by the scheme. They pay in proportion, I in the first seven years we paid £1 billion of think, in part for the benefit that they have of being compensation. We were faced not with one bank able to say to their retail protected depositors, “You failure in September but in the space of two months are protected by the FSCS”, which is an important we had five bank failures, four of them in a fortnight. protection which they will need to contribute to. I think you might have feared that we would not Having said that, I do think it is time to look again have coped with that but, in fact, we have been at the way the scheme is funded. One of the things coping with that. We have paid over £20 billion in that has come out over the past few months is that compensation. We have been doing our own job, we of course we have had the money that we have have been acting on behalf of the Government which needed to pay the claims as they have fallen due, but has been oVering amounts above our limits, we have the bills are coming at a diYcult time and this does been acting in place of the Icelandic scheme for the raise the question again of whether or not there time being that should have paid the first portion of should be an element of pre-funding for the scheme each Icesave claim. We have been protecting people which I think will now come back onto the agenda. in the end who have had nearly three million Lord Turner of Ecchinswell: I wanted to add that we accounts between them. We have operated three feel that this issue does need to be looked at within diVerent ways of paying during that time, one of the wider context of the whole way that we run the which we have always used, which is the manual scheme and the pre-funding, and also issues relating process; that has been in place for four of the five to the European dimension of this and how we failures, but we have also been using two new ways should deal in future with situations like the of compensating. In Bradford & Bingley we made a Icelandic banks and whether we should have pre- one-oV payment of £14 billion on 29 September and funding with some element of European that meant that people went to bed on Sunday night organisation of pre-funding because otherwise if we banking with Bradford & Bingley and woke up on ever had a situation like a small country with very Monday banking with the Abbey. Also, in Icesave, large banks, as we did for Iceland, we are ultimately we took an electronic Icesave banking platform and dependent on the deposit insurance or the backstop turned it in a matter of days, in fact, into an on-line fiscal resources of a country which cannot do it. compensation platform. Through that platform we There are some very wide and complicated issues paid 190,000 people in a number of weeks. both in relation to the UK and also in relation to how the European Single Market operates. Q2276 Chairman: I have heard informally that you have done well. I am looking for answers on the Q2273 Mr Mudie: You are like a minister who just public record. We have heard from the banks in the speaks and takes every piece of information and it past seven days that the seven-day deadline for fills a space. I have heard all this, I have read all this, compensation payouts is unworkable and robust in I understand all this. I am specifically asking— their approach, but you are pressing ahead with this Lord Turner of Ecchinswell: We will look at that tight deadline, and quite right. Have the banks specific issue, I can assure you. accepted your position yet? Ms Minghella: The FSA’s proposals on seven-day Q2274 Mr Mudie: I am not being rude; I am making payout are out for consultation at present. I am the point that you are faced with a lot of complicated absolutely convinced that we will not be able to problems and you have extended it to add to the deliver seven-day payout without all the changes Processed: 25-03-2009 23:50:39 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG13

Ev 298 Treasury Committee: Evidence

25 February 2009 Mr Hector Sants, Lord Turner of Ecchinswell and Ms Loretta Minghella that the FSA is putting forward. You have already Lord Turner of Ecchinswell: I am not yet ready to say made important changes in Parliament by enacting it is patently obvious what the answer is. All that I the Banking Act. That gave us four of the key am signalling is that this is clearly an issue which we ingredients we need for speedy payout. The FSA has will look at and we will certainly take that argument some very important ingredients to deliver. Then the very seriously. banks must put in place systems which deliver up-to- date accessible data which the FSCS can rely on at the point of failure. One of the diYculties we have Q2281 Mr Love: We will come back to this, no had in the failures that we have dealt with, doubt, in future sessions. At the weekend, the Prime particularly in relation to one of them, is the lack of Minister in an article in The Observer magazine said immediate availability of the data we need to get the that he was asking the Financial Services Authority right money to the right people. Whatever the banks to look at how in the future we should “control” new feel about it, I am firmly behind the FSA’s proposals. mortgages for more than 100% of house value. You said earlier on in response to Mr Mann that you are looking to have more involvement in product Q2277 Chairman: There is also the issue of single regulation. Can you tell us which direction you are customer view of accounts on their data. The only moving in as far as 100% and over 100% mortgages bank that came before us that said they had that was are concerned? Santander; no other bank has that. As a Committee Lord Turner of Ecchinswell: In the review that we we feel that is important and maybe the banks are produce in three weeks’ time we will be signalling not not doing enough on that at the moment. Are there a definitive answer to our proposals on this but still challenges there for you? signalling that we can certainly see a strong Ms Minghella: I think if the FSA goes ahead and argument for us getting more involved in product imposes rules then the banks will have no choice but regulation than we have in the past. We will be to put in place a single customer view. committing that by the third quarter of this year we will be producing a review of the mortgage market which by then will have our proposals. The issue of Q2278 Chairman: Will you do that, Lord Turner? whether you should regulate maximum loan-to- Lord Turner of Ecchinswell: We are going through value or loan-to-income, because actually loan-to- the consultation at the moment, but certainly we are income is a slightly better predictor of whether consulting with the intention that that is the people get into trouble than loan-to-value, so if we direction in which we are going. are going to go down that route we have got to decide what is the appropriate one, is clearly Q2279 Mr Love: First of all I want to come back to something which is on the table. In the past it has not the issue of building societies. I want to ask Lord been the overall philosophy of the FSA and it has Turner very directly about the issue of fairness not been encouraged by the political system that we relating to the building societies. They are, I think, should get involved in this; we have regulated by common consent the lowest risk financial services conduct and sales. Some authorities around the organisation in the marketplace. Indeed, not one world are involved in the process of regulating either building society has gone bust without the cost being loan-to-value or loan-to-income ratios, many do, picked up by the rest of the movement in its history. but many do not, and we will look at that In the pension protection fund there is a remit that international experience. On loan-to-value ratios, risk has to be taken into account in the charge that there can be some arguments against it. Some people is made to those pension funds. Does it not seem will say is it not better for somebody to have a 100% reasonable and fair that that should be taken into loan-to-value mortgage than for them to get a 90% account in relation to the building societies, which loan-to-value mortgage and then get the other 10% V are much lower risk than any of the other o an unsecured debt, a credit card, et cetera? organisations that are levied for this purpose? Whatever we do we need to make sure that we do not Lord Turner of Ecchinswell: As Loretta has said have unintended consequences. I think we can see already, the previous approach which has been used considerable merit both in relation to the defence of was to make the levies when something goes wrong consumer interests and in relation to the proportional to the scale of the benefit being macroprudential issue about guarding against delivered, ie, relative to the retail deposit base. That excessive booms and busts in looking at the issue of has been the rule in the past and I do not think we mortgage regulation either through the loan-to- can change it now. You are quite right to say that one value or the loan-to-income route, or some has to raise the issue of whether that is the best way alternative. Just one point in relation to that: if we do to do it or whether one should look on something that, I do not think we can simply narrow it to the which is related to some other basis of it. 100% issue. Actually, only about 0.5% of mortgages were ever over 100%. I think the bigger issues might be should we be into 85% or 90% and what do you Q2280 Mr Love: It is patently unfair that when there think about those issues, and those are important is little likelihood of a building society actually issues, they require some thought. We can see a getting to make use of this fund that they should be prima facie case for a quite significant shift in the charged on exactly the same basis as those who are previous philosophy of British regulation in this very high risk organisations. area. Processed: 25-03-2009 23:50:39 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG13

Treasury Committee: Evidence Ev 299

25 February 2009 Mr Hector Sants, Lord Turner of Ecchinswell and Ms Loretta Minghella

Q2282 Mr Love: I would suggest it is a revolution in customers of classic retail and commercial banking the thinking of the FSA to move down the route of from harm that might occur from risky proprietary product regulation, but in the circumstances that is trading. That is absolutely clearly an objective and probably the appropriate response. I note what you we have really got to think through how that is say about the diVerent levels, but have you as yet, eVected. and I am not asking you to say because it will be published in a few weeks’ time, thought on a level of Q2284 Mr Love: In doing that, and I understand loan-to-value or loan-to-income that you think why you and everyone would want to take into would not be acceptable for the future? consideration some of the real complexities that exist Lord Turner of Ecchinswell: We were not intending in this area, you also said in your speech that you in the review that we publish in three weeks’ time to want to insulate the commercial banks from be that specific. We are intending by the third quarter adverse impacts. of this year to complete the detailed research work Lord Turner of Ecchinswell: Yes. on the pros and cons of this, how this works in other Chairman: Before you answer that, I am extending international environments, which I think we need this session to quarter past five. We have a number to go through in order to make appropriate decisions of people to come in and I have got questions for the on the way forward. That is when we will be specific public record, so let us get on with it. Give us a quick about this. answer and then we can move on. Is that your last question, Andy? Q2283 Mr Love: Can I bring you back to this very interesting discussion that we had earlier on about Q2285 Mr Love: It is now my last question. All I the separation, or proposed separation, of really wanted to get your opinion on was that you commercial and investment banking? Can I put to are confident that in the complexity of the modern you that round this table I suspect we would wish to world you can construct a system that will be as best reflect consumer concerns in this matter? Of course, as is possible for a regulator to protect the consumer when you look at investment in commercial interest into the future. banking, there are millions of people where their Lord Turner of Ecchinswell: Protect the consumer incomes and resource is tied up in commercial interest but also, of course, the taxpayer interest banking and in investment banking a much smaller because let us realise that when things are too big to number generally of high worth individuals are fail ultimately it is not the depositors that suVer, it is involved. I read your speech on this matter and, the taxpayer that suVers. I think it is very important indeed, comments, including from the Prime to realise that in getting the balance of regulation Minister, in relation to this matter. Do you think we right we are often focusing on minimising the are taking fully into account the consumer interest in potential cost to the taxpayer because ultimately this area? there is a size of bank beyond which we eVectively Lord Turner of Ecchinswell: I agree that the guarantee the depositors. consumer interest is very important in this area and I agree it is a very important debate and it is a debate Q2286 Sir Peter Viggers: Looking at the heart of a that we have got to get right. I am sympathetic to financial problem at toxic assets and the Asset many of the points made about avoiding detriment Protection Scheme, the Government announced the to retail and commercial customers arising from Asset Protection Scheme on 19 January and it is proprietary trading investment bank activities. clearly unresolved and controversial. You may even However, to make the correct decisions on this we do be going from today’s meeting straight to another need to really think it through. Hector made the meeting on that subject. Can you reassure me that point earlier that narrow banks can get into trouble you have taken full account in your discussions with as well. I would point out that although this is the Government or its manifestations of the analogy of worst global banking crisis that there has ever been, Lloyd’s of London which had a spiral where there the worst domestic banking crisis that there has ever were uncertain assets which needed to be parked for been was the US banking crisis of 1929–33 and large a while. It was diYcult to value them and, therefore, numbers of narrow banks went bankrupt at that a vehicle was created called Equitas where these time and part of them went bankrupt because they toxic assets could be managed oV separately. Have had highly regionally concentrated portfolios of you taken full account of that parallel? assets. The original concept of securitisation, which Lord Turner of Ecchinswell: I do not think it is then ended up in investment banks, was that we were something where we have explicitly looked at the going to get round that problem and we were not Lloyd’s of London/Equitas parallel, but now that going to have the problem of banks excessively you mention it we are well familiar with it. I think the dependent on their regions so that if the bank went one thing I would stress about the particular down the region went down. I simply say let us not challenge of an asset protection scheme at the leap to immediately iconising an old-fashioned moment is that the discussions are often presented as regional bank. There are benefits in diversification. if there is within the books of the banks, if we only In answer to your point, yes, indeed, in this issue of looked closely enough, an absolutely definable set of how having gone through this crisis we think about “toxic assets” which are bad and other assets which the shape of banks for the future, we need to have are good. I think up until the middle of last year, or regulations in relation to capital and in relation to even the third quarter of last year, that was not a bad risk management which clearly defend the characterisation. There were things that had come Processed: 25-03-2009 23:50:39 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG13

Ev 300 Treasury Committee: Evidence

25 February 2009 Mr Hector Sants, Lord Turner of Ecchinswell and Ms Loretta Minghella out of sub-prime in the US, there were these fancy Q2288 Sir Peter Viggers: Is there a danger for banks structured debts which were bad and the broad mass to pay the insurance fees which require them to of corporate and mortgage lending seemed to be participate in the scheme that this will either further good. The challenge we have at the moment, and it is worsen their capital provision or lead to their the huge challenge in working out how much capital creeping nationalisation? banks need or how much asset protection they need, Lord Turner of Ecchinswell: I think I had better leave is that we are now in an environment where the that for the statements which the Chancellor may financial crisis itself has produced an economic make over the next few days. downturn and that economic downturn is now producing bad assets among what were previously Q2289 Mr Tyrie: You mentioned that you have perfectly good creditworthy customers. The big developed a set of scenarios to try to work out what challenge, and this is the challenge which regulators the best course might be. Would you be prepared to and authorities, and as much as anything this is as publish those? much a problem which treasuries and central banks Lord Turner of Ecchinswell: I think we have as for us throughout the world are facing, is the more generically talked about what the scenarios are in that this occurs the less easy it is to actually say, “I terms of the depth of the recession. Hector, have we walk into the books of the bank, that is the bad asset, done that? carve it oV and here is the separate stuV”. Within the Mr Sants: No, we have not to date. It is something work that we have been doing, extensive work on the we could give consideration to. Having said that, Asset Protection Scheme, in order to work out how you need to understand— large a scale that should be and what assets are within it, we are not just involved in an exercise of Q2290 Mr Tyrie: It sounds a pretty cautious reply looking at what the assets are today; we are involved to me. in an exercise of various scenarios of what might Mr Sants: We need to think it through. I will expand happen in future. We do believe that we are a little bit to say, of course, we are not applying a set progressing towards proposals that make sense in scenario to the banks which is uniformly the same this area. for each one.

Q2291 Mr Tyrie: Of course. Mr Sants: For each single one, going back to the earlier discussions, we look at each individual Q2287 Sir Peter Viggers: Is the Asset Protection position. Scheme an alternative to the establishment of a so- Lord Turner of Ecchinswell: The answer is we could called “bad bank” or a precursor to the creation of not possibly do it in that detail. We need to give a “bad bank”? consideration to it. Lord Turner of Ecchinswell: I think in itself it could be either, let us be clear. The other thing I will say is Q2292 Chairman: Take it away and write to us on it.6 nobody in this crisis who has been in it for more than Lord Turner of Ecchinswell: The general macro- two months excludes anything as to what might environment, okay, there are arguments for and happen in six months’ time. We have all learnt that against. there are unpredictable developments and that the development of the macro-economy is not certain. I Q2293 Nick Ainger: Can I start with the takeover of am sure that the Chancellor would say and has said the Singer & Friedlander bank by Kaupthing and to this Committee the same thing: we cannot exclude the evidence that we have had from Tony Shearer, any options. At the moment the way that the Asset the former Chief Executive of Singer & Friedlander. Protection Scheme is being thought about is as an He has told us, and he has put in further submissions alternative to a straight bad bank approach because as well, that he was expressing real concerns to FSA in formal terms it is thought of as a form of insurance staV that he felt that Kaupthing were not fit and and loss sharing if losses exceed a certain level rather proper people to be running a British bank. A than an outright purchase. Clearly one could meeting was arranged on 14 April 2005 with three consider a bad bank as well. Having said that, bad members of staV of the FSA: Jonathan Fiscal, Kevin banks work best when there is a very clearly Halpern and James Dresser. That meeting was definable set of assets. If you go back to the Swedish attended by Mr Shearer, who was then the CEO of bad bank experience of the 1990s, the Swedish banks the bank, Paul Selwyn-Swift, who was the Finance had made some very bad lending in particularly Director, and Jonathan Spence, who was the head of commercial real estate, but a lot of their lending to the bank. At that meeting we are told that they raised the broad Swedish economy and caucus was real concerns about Kaupthing. I wonder whether perfectly okay. There was an environment where you you want to review the statement that was issued by could with quite a high degree of certainty say, “This the FSA after Mr Shearer’s evidence to this is bad and this is good”. I think we are in a more Committee in which the statement from the FSA complicated situation at the moment. As we got into said that the FSA had made a full assessment, a recession we are likely to see, unfortunately, bad consulted the Icelandic regulator and, as the home assets spread throughout the broad mass of SME regulator confirmed, there was no reason why the lending. That is always what happens in a recession and that makes it more complicated. 6 HC (2008–09) 144–II, Ev 570 Processed: 25-03-2009 23:50:39 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG13

Treasury Committee: Evidence Ev 301

25 February 2009 Mr Hector Sants, Lord Turner of Ecchinswell and Ms Loretta Minghella transaction could not go ahead, then the transaction back in April 2005, did the alarm bells not start to went ahead. The FSA, presumably following that ring that there was something seriously wrong with evidence to us, have conducted some inquiry or this bank? whatever. Can you tell us anything more because it Mr Sants: Two points. First, the general point. In does seem that here we have not only an individual fairness to the then FSA staV, even when the change but three other directors of a bank saying that they of control was allowed to go through they did put in did not think that these individuals who were place a number of mitigating actions against proposing to take over the bank were fit and concerns that we, the FSA, had which we had proper people? identified independently of Mr Shearer’s Mr Sants: I have indeed, as you would expect, as representations, which included asking for two indeed has Lord Turner, reviewed the files and I am independent UK non-executives, some additional looking at the very minute of the meeting in front of controls around liquidity and other additional me now on 14 April and I can confirm the actions with regard to governors. To the particular individuals concerned had the meeting with the FSA point on the individuals, I have to say I am looking oYcials. This goes back to our earlier point of us at the withdrawal forms for the two who claimed taking whistle-blowers and other people bringing they were dismissed. They are required to be honest information to our attention very seriously. It was in a withdrawal form, and it is a criminal oVence not obviously an exhaustive meeting and it looks to to be so, and these withdrawal forms do not say they me—obviously I was not present at the time—to be were dismissed. According to my records, they do an extensive note of the meeting. I have to say that not tell the FSA they were dismissed. These are our note, and I recognise that this is our note and I forms that they signed and are required to fill out. can only comment on what is on our files, does not make any comments about the fitness and propriety Q2295 Nick Ainger: The point about the non-execs of senior management. I just say that as a matter of was taken immediately after the takeover. fact in relation to the note; I cannot obviously Mr Sants: In response to the change of control. comment on what was said. What is the case and is absolutely true, as was reflected in the background to Q2296 Nick Ainger: It was not in relation to the fact the statement we issued, is that a number of issues that the key people, the senior executives, were were brought up, such as cross-holdings and leaving the bank over a space of six months. Can I organisational structures and so forth, all of which, move on? and I understand Mr Shearer has acknowledged Mr Sants: Other actions were taken during this that, were in publicly available information. I think period, but I think I am being asked not to give you a he acknowledges that he was not whistle-blowing in comprehensive description. There is mitigation that the sense of bringing us information which was not took place during the period. There were other in the public domain. He and his colleagues were actions. highlighting a number of issues which were in the public domain which absolutely are appropriate issues to highlight in the context of a change of Q2297 Nick Ainger: Can we move on then to the control, certainly very appropriate in the context of KSF Isle of Man and the evidence we received from the way that we would be looking at these issues Mr John Aspden of the Financial Services going forward. Having said that, even at that time in Commission in the Isle of Man to this Committee. 2005 each one of these issues was then brought up We asked if he could provide supplementary with the lead regulator. I have to say the reality of the evidence about the exchange of correspondence situation here, to be quite clear, is the lead regulator between the FSC in the Isle of Man and the FSA here in this case was the FME, it is the Icelandic bank, in London. He has provided us with an exchange of and we are obliged to take their word as to what is correspondence. I will not quote the whole thing, but the situation; it is not for us to question another EEA the important thing is he wrote, or someone wrote— regulator. They addressed those points and, indeed, it has been redacted—on 21 May 2008, to someone in the case of cross-holdings had made a capital in the FSA asking four questions. I will only put to assessment mitigation for it. The issues were you one of the questions. It is item four in that letter. addressed and we had proper responses from the I do not know if you have got it? Lord Turner of Ecchinswell: Yes, we have it in front lead regulator, which we are obliged to take at face of us. value. Whether that throws open the question of quality of regulation in Europe is a wider philosophical point, but I have to say the issues were Q2298 Nick Ainger: It says: “Possible interbank addressed properly. placing by Kaupthing Singer & Friedlander Isle of Man Limited with KS&FL. If Kaupthing Singer & Friedlander (Isle of Man) was to make a large Q2294 Mr Love: So the meeting took place and you interbank placing with KS&FL maturing at site in are satisfied that sensible decisions were taken as a less than the eight days maturity band, would the result of the information received from the Icelandic UK FSA be in a position to confirm that adequate regulator. However, in the autumn of 2005 the liquidity is maintained by KS&FL to repay that finance director left, in January 2006 the head of the interbank deposit should it be requested to do so by bank left, and in February and March the head of Kaupthing Singer & Friedlander (Isle of Man) risk and the head of compliance were asked to leave. Limited?” The reply, which is the same date, states in Given those circumstances and what you were told relation to that particular question: “Item C. The Processed: 25-03-2009 23:50:39 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG13

Ev 302 Treasury Committee: Evidence

25 February 2009 Mr Hector Sants, Lord Turner of Ecchinswell and Ms Loretta Minghella

FSA applies cumulative mismatch limits to KSF of Mr Sants: No, I think it is not true as expressed. Our 0% at site to eight days and of -5% at site to a month. rules, and more generally because it is a wider These limits apply to the whole of KSF’s book and framework, the “Know Your Customer” rules do thus would cover any deposits received from KSF not preclude UK banks oVering accounts to oVshore Isle of Man—your question four.” Was the purpose UK citizens. What does appear to be the case, and of that letter of 21 May to give reassurance to the has been the case, is that only a very limited number FSC in the Isle of Man that any large deposit that of banks have chosen so to do. I would recognise would be placed in the London bank would be perhaps the point, to come back to the point about secure and covered? recognising consumer issues, that they might well Lord Turner of Ecchinswell: The purpose of the letter have found it diYcult because the banks chose not to was to confirm, as we did do, to the Isle of Man oVer them. There are banks that do it and we did regulator what the liquidity regime was that was in some research with the BBA to assure ourselves to place. That was the liquidity regime that was in that eVect. It is not to do with our rules. place, which I have to say was more onerous than our normal liquidity regime that we put in place in Q2303 Mr Todd: Could you share that with us, not 2005 in response to some of our concerns earlier. We here but separately? confirmed that regime was in place. Whether that Mr Sants: Happy to.7 provided suYcient assurance to the regulator on the Isle of Man was for them to decide. We are another, Q2304 Mr Todd: It would be helpful if you could add as it were, host regulator and our job under our to that note a clarification of how you think your MoU with them is to provide them with rules apply to someone in those circumstances so information; it is not for us to make judgments on that we understand them clearly. that information. We accurately answered their Mr Sants: Yes.8 question and that regime was indeed in place with the bank. Q2305 Mr Todd: Lastly, on the Derbyshire relationship, Lord Turner will recall our brief Q2299 Nick Ainger: Can I just come back because exchange at an earlier hearing in which you used the this is important. The FSA has been accused of words “it is a sorry situation”. Have you reflected instigating this transfer. further on what we have learnt from this sorry Mr Sants: Yes, which there is no evidence of at all, situation and whether there is anything that we need as you can see. to be sorry to some of the customers about? Lord Turner of Ecchinswell: If I could ask Hector to just tell you the facts on it and then I would like to Q2300 Nick Ainger: Can you clarify that, that you make a general comment. never made any approaches to the London branch of Mr Sants: I think Lord Turner broadly covered the this bank to say, “You need to get further assets into principal points with you last time. A transfer of your bank”. Was any attempt ever made by the FSA ownership to a company in the Isle of Man which is to influence a bank so that this transfer from the Isle owned by an Icelandic company is obviously a of Man to London took place? matter for those regulators to approve those Mr Sants: No. transfers. I repeat again, we have no oversight arrangements on companies and the regulatory Q2301 Mr Todd: So the correspondence we have is structure in respect of this issue. At the time the the sum of the relationship on this matter between transfers were made the consumers were properly the FSC and the FSA? informed. We have looked at the letters and reviewed Mr Sants: To the absolute best of my knowledge, them personally,as Lord Turner referred to last time. and I have made a comprehensive investigation of What is a reasonable observation, and I think this is the files and talked to those employees of the FSA a point that prompted Lord Turner’s earlier who were involved in the incident and are still comment, is even if you were a customer and you employed. I did actually meet the Isle of Man received a letter saying you are being transferred to regulator personally and he made no suggestion to the jurisdiction of the Isle of Man, the letter is clear me that we had in any way encouraged them to make about that, clear you are being transferred out of the this transfer. I am completely mystified as to where FSA’s jurisdiction, if you are a term depositor you this idea has come from. do not have the opportunity to say, “I don’t like that and I will terminate my term earlier”. If you are a demand depositor in receipt of clear information, Q2302 Mr Todd: I asked a simple question and which they were, they can make a decision. initially you gave a very simple answer, which was absolutely great. Can I ask you about your “Know Q2306 Mr Todd: Should the FSA have been more Your Customer” rules as they apply to those seeking active in protecting the interests of the customer in to make investments in banks in the UK. You will those circumstances? have heard that the justification maybe for not Mr Sants: I think it comes back to the European V Y choosing o shore accounts is the di culty of their framework. establishing their residency and proving their identity. Could you set out whether you feel the 7 HC (2008–09) 144–II, Ev 570 position that they have expressed is true or not? 8 Ibid,Ev570 Processed: 25-03-2009 23:50:39 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG13

Treasury Committee: Evidence Ev 303

25 February 2009 Mr Hector Sants, Lord Turner of Ecchinswell and Ms Loretta Minghella

Q2307 Mr Todd: As I made absolutely clear before, People are very keen that the prospectuses are the parental guarantee of a British building society is processed quickly and eYciently, that is part of significantly diVerent from the parental guarantee of delivering an eVective capital market. an Icelandic bank. Mr Sants: Lord Turner may want to elaborate in a Q2311 Mr Fallon: So the answer is yes? moment on what takes us back to what we would see Mr Sants: For a certain group of individuals in as some significant issues about the current respect of non-supervisory functions. Is that a European home/host regime which we absolutely problem? believe there are. There is no basis for us overruling a judgment by the Icelandic regulator within the Q2312 Mr Fallon: It would certainly be a problem if framework that we are currently operating. they were supervising those institutions, would it Lord Turner of Ecchinswell: This is the general point. not, because it would mean that they would have a As you look at the whole of this story it occurs within strong disincentive to challenge firms if their the context of a particular way of running the single appraisals, their pay, their bonuses, even their market at the moment and the idea that one has to promotion prospects were adversely aVected by respect the judgment of the ultimate home negative feedback? supervisor irrespective of which country they come Mr Sants: This is one question in a vast array of from or whether there would be fiscal resources to performance measurements that we use specifically support that judgment in extremis. We think there around directing the provision of other FSA are huge issues here about the way that we need to services. We ask that question in a relationship organise this and major changes are required. management conversation which senior executives conduct with the firm. It is a de minimis part of any Q2308 Mr Todd: Just so that I can sharpen this conversation with any individual. It is designed to further, even if their main focus is not taking assist primarily our listing authority responsibilities deposits in their own country but actually deposits which are a critical part of looking after the City of from our citizens and— London and seems wholly reasonable to me, I am Lord Turner of Ecchinswell: Yes, that is the way that afraid. it has worked in the past. Q2313 Mr Fallon: How can you be sure that it is not a disincentive for those staV to challenge firms Q2309 Mr Todd: One has to say is that reasonable. I vigorously? think the Chancellor has already made that remark. Mr Sants: Because it is a de minimis part of the Lord Turner of Ecchinswell: We have tried to run a process. It is a question that is asked once a year only European single market in retail banking services as by a very small number of responsible senior if retail banking is the same as retail or executives who are well capable of using their manufacturing, and that you can run a European judgment and discretion. single market without some category of European supervision of supervision or co-ordination of Q2314 Chairman: I have a couple of questions for supervision which goes beyond what we do for V retailers and manufacturers, but I do not think we the record. Once this crisis is over how di erent will can. I do not think we can run a European single the financial services landscape be from what market in retail banking without significant changes consumers could have expected in 2006/07? Should in the regime. you be managing expectations of what will be available in terms of credit availability and consumer choice in this post-crisis world? Q2310 Mr Fallon: Can I just come back to your Lord Turner of Ecchinswell: Some of the biggest failure to supervise these banks properly. Is it still changes will not necessarily be immediately obvious true, Mr Sants, that the appraisals of your staV are to retail customers. Some of the biggest changes are partly based on feedback from the very firms that going to be a very significant downsizing of the scale they are supervising? of proprietary trading in structured credit and Mr Sants: Within the supervisory structure we have derivatives and those sorts of activities which an individual who is responsible for handling the developed in the particularly complex form of interface between a regulated organisation and the securitised credit. Across the world, there are going FSA. There are a number of services which those to be less people involved earning very significant institutions take from us which are separate from salaries in fixed income trading, that is clearly going supervision, such as prospectus approval, listing to occur and, by the way, that has some significant requirements, processing of registration forms and consequences for the UK economy because we so forth, and as you would expect, which I think is happened to do quite a lot of that in the past. In wholly reasonable, as part of assessing those relation to ordinary consumers, I think what we have individuals’ roles we do indeed ask questions as to got to try and distinguish is the landscape as it will whether they act as an eVective point person for eventually be and also the landscape over the next directing the bank to the various parts of the FSA few years. The landscape as it eventually will be we and handling the interaction with the FSA which is hope will be as good, if not better, for consumers as separate from the direct supervisory process. As a it was in the past, as good in the sense of there will large independent regulator providing a number of still be the range of products which have been diVerent services, I think that is absolutely right. available in the past. To go back to the conversation Processed: 25-03-2009 23:50:39 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG13

Ev 304 Treasury Committee: Evidence

25 February 2009 Mr Hector Sants, Lord Turner of Ecchinswell and Ms Loretta Minghella about loan to value ratios, I think that may well liquidity was, in his words, “a public good”, so involve not some of the excessive lending that there should be available from the public sector for events was in the past. The particular challenge we have outside, what he calls, “ordinary market over the next year or so is to make sure that there is conditions”. How will you balance this adequate lending and that is very much something consideration with the moral hazard arguments not solely for us but us as part of the tripartite made by the Governor in drawing up your liquidity discussions. proposals? Lord Turner of Ecchinswell: The desire for a short Q2315 Chairman: As I mentioned earlier, we are answer for that really is a bit much! Willem Buiter is interested in the consumer angle, so that is helpful to absolutely right, if you designed a private liquidity us. Should capital provision be dynamic? Is there regime without the lender of last resort support anything at the moment stopping you from which was suYciently tight to make sure that banks introducing counter-cyclical requirements for the did not go bankrupt, you would essentially do UK banks now? serious harm to the real economy because you would Lord Turner of Ecchinswell: We could go it alone, it not have a banking system which was able to do would be much better to get a global agreement. I do maturity transformation on behalf of the real not think it makes a diVerence if we spend another economy. Therefore, liquidity is always a balance of year to get a global agreement, for this reason: the central bank, lender of last resort, support plus capital regime of the British banks right now and for appropriate regulation, and we simply have to get the next year is so intricately wrapped up with the that balance right. It is very diYcult to say anything macro-economy and the debates amongst the other than it is an inherent balance and there is a tripartite about the asset protection scheme, balance to be struck there. recapitalisation, et cetera, that we are as it were not V proceeding on a classic rule basis for the next year in Q2319 Chairman: That is helpful. We started o the any case. It is a very managed process. So in that session talking about philosophy and we will end up sense it is not fundamental we have the new rules. We talking about regulatory philosophy. There has been are clear that we want the new rules to include a much talk about that, which the FSA shared with politicians and markets. It seems to us what you are significant element of counter-cyclicality and we are V driving with our international colleagues to get an saying is that a hands-o approach has been taken agreement on that. by the FSA on that but today both you and Hector have said that you will change. It is easy now to threaten tougher keeper supervision because the Q2316 Chairman: This could provoke a long answer regulatory philosophy has changed, would you not but we do not have time for it. What is your view of accept that we need a regulator which is not the Basel 2 capital rules? Need tweaking or ripping dependent on public and market opinion and it is up? One or the other. your job to be unpopular at times and in fact take the Lord Turner of Ecchinswell: Significant adjustment punches when the party is going wildly? Can you but not ripping up. give any assurance you are going to do that? Lord Turner of Ecchinswell: I agree that entirely, we Q2317 Chairman: Okay. A technical question: have to try and create a culture where it makes it should oV-balance sheet items attract a capital likely that will occur. I have to say that is probably a charge and, if so, how would you enforce this? bigger challenge for our successors because the likely Lord Turner of Ecchinswell: Yes, and I think we have date of the next party is ten to 15 years’ time, but the the powers already to do that. We simply say, if this crucial challenge, both in the FSA but also on things oV-balance sheet item has the economic substance like macro-prudential analysis at IMF and that you are taking a liquidity or a capital risk, a international level, is to try at least to take the solvency risk, we have the right to demand capital opportunity of this crisis to reinforce institutional against it, or a liquidity rating for it, as if it was on mechanisms so that we do not, in ten to 15 years’ balance sheet. We have those powers, we are largely time, do it all over again. doing it and we can get that right for the future. Chairman: Okay, I was 100 per cent certain I wouldn’t keep us to time, I have not, but it has been Q2318 Chairman: Lastly, Willem Buiter warned a fascinating session and I thank all of you, Loretta against requiring banks to hold suYcient liquidity to particularly, your answers have been very helpful cope with the worst case scenario, claming that to us. Processed: 25-03-2009 23:45:45 Page Layout: COENEW [SO] PPSysB Job: 416782 Unit: PG14

Treasury Committee: Evidence Ev 305

Thursday 26 February 2009

Members present

John McFall, in the Chair

Nick Ainger John Mann Mr Graham Brady Mr George Mudie Mr Colin Breed John Thurso Jim Cousins Mr Mark Todd Mr Michael Fallon Mr Andrew Tyrie Ms Sally Keeble Sir Peter Viggers Mr Andrew Love

Witnesses: Mr Mervyn King, Governor, Mr Paul Tucker, Deputy Governor elect for Financial Stability, Mr Andy Haldane, Executive Director, Financial Stability, and Mr Andrew Bailey, Executive Director, Banking & Chief Cashier, Bank of England, gave evidence.

Q2320 Chairman: Governor, welcome to you and key principles around the January banking package your colleagues to this Banking Crisis inquiry. Can I to try to restore confidence, of which today’s ask you to introduce yourself and your colleagues announcement is the logical extension and, indeed, for the shorthand writer, please? you can see it as putting the flesh on the bones of that Mr King: Yes, thank you, Chairman. On my right is announcement in respect of RBS itself, are, first, to Andrew Bailey, the Executive Director for Banking, actually find out what really is on the balance sheet who led the work on the resolution of problems in of our major banks. That is not something that is Bradford & Bingley. On my left is Paul Tucker, the easy to do or can be done quickly. The Government new Deputy Governor for Financial Stability,who is has made a start on it now, the assessment today is just two business days away from taking up his a preliminary assessment and it will require a much duties. On his left is Andrew Haldane, our new longer and more detailed assessment contract-by- Executive Director for Financial Stability who took contract to find out exactly the position of the his post on 1 January. balance sheet. That has to take time and, of course, it is aVected by the fact that the losses that could Q2321 Chairman: Governor, you may be aware there arise on any of the assets on the banks’ balance is a statement by the Chancellor on the Asset sheets may change as the nature of the world Protection Scheme today at half past 11, so one or downturn becomes either more or less severe. It is two colleagues will depart for that but we will keep not a fixed picture, it changes over time. There needs the session going and I will be here along with other to be a continuous process of finding out what is on colleagues. When you were before the Committee in the banks’ balance sheets to give confidence to November you did say that the “single most pressing investors and prospective investors in banks. The challenge to the domestic economic policy” was to second is that having done that it is important that get bank lending going again. I wonder if you still the Government underpins the balance sheets of the hold this view, although today’s RBS statement after major banks, and it has made quite clear that it will some terrible news indicated that new lending was do that. It can do that in a variety of ways. One is by going to take place. Are you more confident now? In injecting capital directly, the other is by providing answering the question, given the RBS situation, insurance for a fee against a certain group of assets how can we ensure that we get confidence back into and the third is just by being willing in the end to the banking system and trust restored to the banking ensure that if a bank finds itself in a position where system? It was obvious from our session with the the level of its capital threatens to fall below the chief executives that they readily admitted that trust absolute minimum, and what matters here is not the has been lost and it is a very important point to be fancy regulatory capital ratios but just equity, the able to keep the public with us on this. amount of core Tier 1 equity, if that falls below a Mr King: I think you have hit the nail on the head in critical level then the Government will step in and the word “confidence”. The developments since last put enough capital into the bank to ensure it is a September/October have demonstrated the going concern. Those two aspects, to my mind, are extraordinarily damaging consequences of a loss of about all a Government can do to ensure that confidence. We have seen this in two quite distinct confidence comes back into the banking system by areas, one of which is relevant to today’s hearing and first of all making it absolutely clear that there has the other one of which is more relevant to the hearing been a thorough, independent audit of the balance we will come back to in March on the Inflation sheets and, secondly, that there is a promise of Report. The first is a lack of confidence in the enough capital to maintain our largest banks. In banking system which became extreme in the return for that and in return for access not only to diYcult days of mid-September to early October last the Asset Protection Scheme but also to the Credit year. The other is lack of confidence in the world Guarantee Scheme, which is a fundamental part of economy, which fell oV a cliV in October/November the package that was announced in January, which last year. Let me stick to the first. I think the three is to enable banks once they have got enough capital Processed: 25-03-2009 23:45:45 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG14

Ev 306 Treasury Committee: Evidence

26 February 2009 Mr Mervyn King, Mr Paul Tucker, Mr Andy Haldane and Mr Andrew Bailey then to go out and obtain the funding that they need running central banks, they all have to talk to each to finance the lending, banks should then sign a other. That is true in the United States or Canada or lending agreement. If you put those three principles, Germany or France. You have got to have some if you like, together, together with detailed proposals mechanism by which these bodies talk to each other. for the mortgage market, the ability of Northern We call it the Tripartite, but it exists in every other Rock to extend mortgages and the lending proposals country and in every country these same problems for the corporate sector, that is the asset purchase have been observed. facility that we are involved with, those are the five point plan that was announced in January. Q2327 Mr Fallon: It does not seem to have done anything, does it? Q2322 Chairman: Just to be realistic, Governor, you Mr King: I hope in this hearing we can try and get to mentioned what is on the balance sheets and that will a discussion of what were the problems that arose. I take time. do not think that you should see either the cause of Mr King: Yes. the problems or the answer to those problems in terms of a process, a process of communication or Q2323 Chairman: We have found in this Committee committee. in terms of statements and accounts of banks it is very hard to read and when the KPMG chief auditor Q2328 Mr Fallon: It was nothing to do with the said that he could not fully understand after a night’s architecture then. Andrew Haldane, in your speech reading, say, HSBC’s accounts, there is an issue here. last week you talked about the credit boom and you Mr King: It requires a detailed forensic analysis of said: “A collective blind eye was turned to the exactly what is on the balance sheet. resulting risk”. Does that include the Bank of England? Q2324 Chairman: This will take quite a bit of time, Mr Haldane: I was referring in there very largely to six months or a year maybe? the private sector banking community rather than Mr King: It will certainly take many months in my the authorities. Certainly within our Financial view. You can form a preliminary view and you need Stability Reports from 2003 onwards we spoke with to put in a provision to underpin the balance sheet increasing volume and force about the build-up of now. How much capital banks will need in the end is risks within the system. Looking back at that, all we impossible to tell because in large part it will reflect had really was our communications through things developments in the world and our own economy like the report but in those reports we tried to lay that are impossible to predict with any precision. bare what we thought were the emerging build-up of There needs to be this combination of underpinning system-wide risks. the balance sheet and getting this process going of an independent exhaustive analysis of what is on the Q2329 Mr Fallon: You do not accept that the Bank balance sheet. has any collective responsibility for the blind eye that you referred to? Q2325 Mr Fallon: Governor, looking back over this Mr Haldane: The Bank has a responsibility for mess, it was the Tripartite—yourselves, the FSA and contributing to the assessment of system-wide risks the Treasury—that were supposed to be holding the and through our reports that what was what we did. system together. Sir John Gieve, the Deputy As I say, the limit of our actions are that we can Governor, said “The Tripartite’s footwork may have communicate about those risks rather than owed more to John Sergeant than Fred Astaire”. necessarily impose diVerent outcomes ourselves on John Sergeant became a joke, was the Tripartite a individual institutions, that is not our responsibility. joke? I think we played our part in alerting the banks and Mr King: I thought John Sergeant was rather the wider world to what some of those emerging popular actually so I think it is a rather inapt threats were. There is a natural limit to how far those comparison. You need to recognise that the words can take you in addressing those risks, I think. Tripartite is not a decision-making body, that is the most fundamental thing to recognise. It is a body Q2330 Mr Fallon: So you are not accepting which communicates among the three players collective responsibility for the blind eye that was involved in this, each of whom have distinctive turned? responsibilities and you hold accountable for the Mr King: I think the Bank of England has accepted decisions that they take. You cannot have the responsibility for those things for which it was Tripartite taking decisions which are the proper responsible. I do not think we can be responsible for responsibility of each of them. It is a body which actions taken by others. shares information and communicates what each player is doing, but it is not a decision-making body. Q2331 Mr Brady: You now have a statutory responsibility to protect and enhance the stability of Q2326 Mr Fallon: There were ten big banks and at the financial systems in the United Kingdom. Once the end of it five have now collapsed. Whatever the the current crisis is over where do you see the main system was it did not work, did it? thrust of that work being? Mr King: That has been true around the world. Mr King: I think the first thing I would like to say to Around the world, wherever you find people doing the Committee is that it is pretty clear that you and banking supervision, running finance ministries and others will expect the Bank to play more of a role Processed: 25-03-2009 23:45:45 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG14

Treasury Committee: Evidence Ev 307

26 February 2009 Mr Mervyn King, Mr Paul Tucker, Mr Andy Haldane and Mr Andrew Bailey than in fact we did, but you also need to recognise Q2335 Mr Brady: Is there a danger that after this that we do not have any powers at all other than crisis has passed that financial stability might drift dealing with banks that have already failed. In terms away from being the focus again? How do you stop of dealing with banks that are growing and living, we that happening? do not have a single power now that we did not have Mr King: No. I think it will be a very long time before. We literally have the power only of our before that would happen. It will be very much part speeches, our reports, and the words that we use of our focus. Mr Tucker is thinking hard about the when speaking to others in the Tripartite process. I increased resources that we need in order to do that hope you will remember that when you try to hold and we have already allocated more resources to that us accountable for things where we simply have work. To repeat, all I would say is that apart from the absolutely no powers to take any actions. We have special resolution authority and the oversight of clearly put in place a mechanism now for payments system, more involved though we might implementing the special resolution regime, for be, we are still limited in the end merely to writing which we are statutorily responsible. We have a new reports. I want that to be clearly understood because responsibility for the oversight of payment systems, it is no good coming back to us in a few years’ time or will have when that comes into eVect later this saying, “Why didn’t you do this, that and the other?” when you in Parliament—it is your vote, not year, but insofar as ongoing banks are concerned we ours—voted for an Act that very clearly defines our do not have any more powers at all. We are still very powers. I am happy with that, but do not hold much at the point where we will have to channel our people accountable for things for which they are not thoughts and views through the Financial Stability responsible. Report and through speeches.

Q2336 Mr Brady: Conversely, in the past one of the Q2332 Mr Brady: Are you saying you should have things you have perhaps been criticised for was being additional powers in that respect? excessively focused on monetary policy. Are you at Mr King: That is a matter for you to decide. I hope all concerned at the moment that there is not Y that your inquiry, when you reflect on this— su cient focus on monetary policy and the danger of inflation coming back in the future? Mr King: I certainly am concerned that people who Q2333 Mr Brady: As part of that inquiry I want to try to influence the way the Bank evolves may say, know what your view is. “This is a great opportunity to change the focus of the Bank”. Our clear and unique responsibility is for Mr King: I do not want to judge that and it is not monetary policy and we must never, ever forget that. really for me to say. I do think what does matter, and I can give you my personal assurance and that of this is a point I have made before, is that there has to every member of the Monetary Policy Committee be a matching between responsibilities and powers. that we are totally focused on that and we are not going to allow a great inflationary surge. The problem at present is not that the amount of money Q2334 Mr Brady: Governor, you said that when we in the economy is growing too rapidly threatening a seek to hold you accountable for any future events big inflationary surge, it is that the amount of money that may take place we must be aware of the fact that in the economy is growing too slowly. That is why we you have not got these powers. What powers would have asked the Chancellor for powers to engage in you like to have? asset purchases in order to increase the amount of Mr King: I am not saying necessarily the Bank money in the economy and I would expect that to should have powers. First of all, we should ask happen over the next few months. ourselves what are the lessons from this and are there powers that someone should have that did not exist Q2337 Chairman: Governor, just to clear this up before. We had the same process, if you remember, because I have heard murmurs from some of my after Northern Rock when I said to you that the colleagues, you did say “we only have the power of most important lesson from that was that Britain did our words”. Mindful of your comments to us when not have a special resolution regime which other you came on Northern Rock and the limitations, countries had. I went out of my way to say I am not legal impediments, EU directives and whatever, if saying the Bank should have that power, but you are not clear with us at the moment and somebody should have it. You then wrote your legislation is put in place which is inadequate you or report, it was very influential and we have the your successor can come back and say, “Well, my Banking Act now which creates those powers and hands were tied because of A, B, C, D or E”. Are means that the trigger is with the FSA and the actual there more powers that you would like? decisions on how to resolve that are with the Bank of Mr King: There are two things I would say at this England. That may or may not be the right outcome, point. One is that the Act does not give the Bank the but at least it is clear who has got the responsibilities. right to request information from banks. I regret All I am asking you to do is to be very clear, going that. I think the FSA have clearly said that they will back to Mr Fallon’s question, that you hold people try hard to give us the information that we want but accountable for things for which they have powers, I find it very hard to see why, if people feel the Bank not for things over which they have no influence or should play a major role in financial stability, we control at all. should not have the right to request information Processed: 25-03-2009 23:45:45 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG14

Ev 308 Treasury Committee: Evidence

26 February 2009 Mr Mervyn King, Mr Paul Tucker, Mr Andy Haldane and Mr Andrew Bailey from banks. We do not have that. We have to Mr King: That was the view of the regulators who persuade the FSA that the data to be collected are were looking at the capital around the world. It was appropriate and they have to make their own mind not a UK view and we were not the regulator. This up on that. More important, I suspect, looking was the view of the people who actually had the ahead, and I hope this will be the subject of your information about the balance sheets and the losses inquiry, is that we should ask ourselves what are the at that point. At that point, if you worked out the lessons behind this financial crisis, are there powers potential losses on sub-prime lending then they were that somebody needs to have in order to try to lessen not large enough to erode the capital cushion of the risk that this will recur, and once that has been banks, but what happened was that the risk premia sorted out then and only then should you come back in the world changed and that reduced the value of to the question of who should exercise those powers. the assets to the banking sector and meant that their In some ways it is less important who exercises the liabilities had not fallen but the assets had and that powers and more important to think through the clearly eroded significantly. If you remember, I came question of what those powers should be. to you in January 2008 and said that the banks at Chairman: That has been helpful. that point needed more capital.

Q2340 Ms Keeble: Right through this crisis, and I Q2338 Ms Keeble: You said that you had the power have listened very carefully, every time there has of words and you said just now you needed to know been a suggestion that there should be some other what is on the balance sheets of the banks and there measures or steps taken or something should happen needs to be the promise of enough capital to protect you have been very resistant to that, I have to say, the major banks and, of course, there is the and it has given the impression that the Bank is announcement that is coming later today. At the end running after the event rather than shaping events. of 2007 you said: “The UK banking system as a Mr King: Can you give me an example of where you whole is well-capitalised. They have a large capital think that? I argued earlier than anyone else that the cushion, they can take the conduits and vehicles that banks in Britain needed more capital. they set up in recent years back onto their balance sheets. It will take a little time and the banks will Q2341 Ms Keeble: You argued against the provision have to make lower profits than they would have of any extra lever to influence the system and you wished, but there is no threat to the stability of the argued against that quite consistently, I have to say. banking system”. Given that you might not get all Mr King: When you say “any extra lever”, what the information that you want, but you do get an lever do you mean? awful lot of information, how could you have got it so wrong? Q2342 Ms Keeble: Anything. It is in the evidence. I Mr King: All the central banks asked the regulatory asked would you favour anything other than the bodies around the world, not just the UK, we asked setting of interest rates and you said that is all that the US regulators, the European regulators, the the MPC does because it has responsibility for Japanese regulators, and their view at the time was inflation and that lever is not working. The very clear, that in August 2007 they said banks are impression that is given through all of that is that the well-capitalised and the losses that will occur are not Bank is running after the event rather than shaping large enough to erode the capital cushion. What I events. I think this was the question that Graham think no-one anticipated at that point was that the was asking. We are going to want to fight the next risks to the balance sheet as a whole became larger war, not the last one. during 2008 and became horrendously high in Mr King: With great respect, I totally disagree with September 2008 after the failure of Lehman your suggestion. In September 2007, a matter of five Brothers. The leverage in the banking system was days after Northern Rock failed, I came before you suYciently high that what started oV as looking a and spelt out what I thought should be our response. well-capitalised banking system quite quickly Very largely what I said to you at that session became an under-capitalised banking system. One of appeared in the Banking Act, we do now have a the lessons from this is that the amounts of capital special resolution regime. I said that the banks in that banks were required to hold were simply too Britain needed more capital and they have now got low. more capital. I do not think the Bank has been running behind this at all. What I was very clear on was that the role of a Monetary Policy Committee Q2339 Ms Keeble: As my constituents tell me always was to set monetary policy and the bank rate and I you are not responsible for global, you are did not think that other instruments were responsible for here. Given that we have a very appropriate to the setting of monetary policy, but sophisticated banking sector, and I have always that is not to say that other instruments are not thought of it as being the best in the world and that appropriate for dealing with financial stability puts you in a very privileged position as the questions. Governor of the Bank of England, were there no discordant voices in the Bank or was the information Q2343 Ms Keeble: When we get to dealing with the not analysed properly that you did not see the storm aftermath of what is happening now, not looking at that was coming and said there was no threat to the it with a vast amount of sophistication. it is likely to stability of the banking system? be high levels of unemployment, public spending Processed: 25-03-2009 23:45:45 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG14

Treasury Committee: Evidence Ev 309

26 February 2009 Mr Mervyn King, Mr Paul Tucker, Mr Andy Haldane and Mr Andrew Bailey cuts that will depress demand, very low levels of Mr King: The powers to set prudential supervision interest rate deflation and manufacturing limited, for individual institutions are there. What is not therefore presumably increased pressure for imports. there, I think, is the ability for the supervisor to say, What are you going to suggest? What proposals do “Without forming a judgment about your individual you have for dealing with the real challenges of bank, we think that the speed at which banks as a ensuring financial stability? What are you going to whole are expanding is creating risks and we think ask us for? that all banks should have higher capital Mr King: What you have described is not financial requirements, if you like as an eVective tax on the stability, it is what is happening in the economy at growth rate of the banking system”. That is the idea large. behind so-called counter-cyclical capital requirements and I think there is a very important Q2344 Ms Keeble: I know, it is macro. debate to be had about the precise form that they Mr King: If you want to talk about the economy at should take, but I do think there is a strong case in large—I think this is why we are coming back in principle for introducing something like that. I am March—we have already spelt out the right plan of not saying that the Bank should necessarily have attack on that front. One is considerable monetary that power, that is an issue to be discussed down the easing, and we are now moving into a situation road, but it is worth working out first what is the where the Bank will be conducting asset purchases to right form of the additional prudential supervision increase the amount of money in the economy. that is needed and then asking the question who Secondly, the measures designed to ensure that should actually do it. banks will lend in a more normal manner than they have been. Bank lending halved in 2008 relative to Q2349 John Mann: What sort of timescale would 2007. The commitments that have now been made you put as being pressing in relation to that? will significantly increase that. There has been a Mr King: I do not think it is pressing, we have time measure of fiscal relaxation. Most importantly, and to think this through carefully. The reason I do not I would say most importantly of all, this is a think it is pressing is I do not think you will find worldwide downturn and it is absolutely vital that many banks engaging in wild risks for some every country around the world plays its part in considerable time. Until the people who can dealing with that problem. I went to the G20 meeting remember this episode have disappeared from the last Sunday in Berlin and every leader round that scene, only then will we find ourselves back in the table was committed to playing his or her part in same old cycle. taking measures to reflate their economies in order to limit the length and severity of the downturn. All of Q2350 John Mann: There appear to be a number of them were very, very clear that this a worldwide loose ends that no-one wants to pick up. I will pick downturn which hit with extraordinary ferocity up one, the credit rating agencies and who supervises last October. them, one can see why they are loose ends, but oVshore, not least with British Dependencies— Q2345 John Mann: I hear what you are saying, Mr King: All of these things are crucial. Governor, and it is easy to pick quotes from the past, et cetera and say you got it wrong. Q2351 John Mann: How are we going to get who Mr King: I am sure we got things wrong, and should be taking the responsibility for getting obviously so. behind them? Mr King: It depends on which issue you look at. If you take the question of oVshore tax and regulatory Q2346 John Mann: I want to choose just one, not to havens, I am now convinced, I think, that say you got it wrong. You were dancing around a Government leaders for the first time in my little bit in terms of Graham’s question on what experience are determined not just at G7 but at G20 powers you should have or who should have them. level to do something about this. It is very important In July 2006 the Bank’s report stated: “Several and requires governments to work with other structural developments have helped strengthen the governments to do something for which there will be system over time, including continuing significant lobby groups that will lobby hard against improvements in risk management and more it. I think the experience has been suYciently sophisticated ways of distributing risk”. That did uncomfortable that governments will now work and not prove to be particularly accurate. The power to take action, but it requires international agreement. actually get behind that and see what was happening has to rest with somebody. Mr King: Absolutely, and it was the prudential Q2352 John Mann: Similarly with credit rating supervisor. agencies? Mr King: In the Bank I think we are going to think very hard about the extent to which we and other Q2347 John Mann: Are those powers there in your central banks rely on credit ratings as an indicator of view? access to our operations. We do not allow anyone Mr King: No. with a given credit rating automatic access, we always do a second check, but there is a good deal to Q2348 John Mann: Are there things we need to be be said for downplaying the role of credit ratings in doing? its entirety. The credit rating agencies did move into Processed: 25-03-2009 23:45:45 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG14

Ev 310 Treasury Committee: Evidence

26 February 2009 Mr Mervyn King, Mr Paul Tucker, Mr Andy Haldane and Mr Andrew Bailey areas where they did not have appropriate expertise in a debate about what the outlook is and what the and there were conflicts of interest. The diYculty consequences would be for the banking system. I with them is the last thing you want is to have think, and I have talked to Adair Turner about this, government-owned credit rating agencies because if that he would welcome the Bank’s team under Andy you do that the government that owns it will never Haldane saying to the FSA, “Look, our judgment is find its debt ever valued in any way that is accurate that this group of banks or the banking system as a and people will lose faith in the rating. Who rates the whole seems to us to be facing some quite serious raters is a very diYcult question. There are a very problems which you have not really taken on board” small number of them. It is like accounting firms, we and maybe that will be a better way forward. have a tiny number of accounting firms, so that creates diYculty in having independent switching between them, and it is even worse in terms of rating Q2354 John Mann: My final question is on the same agencies. These are issues that are very important. It theme. Adair Turner used the term “mis-selling”, would be a mistake to rush into judgment about the which the FSA uses a lot. Should they not have been answers to it, but what is very important is that we looking at mis-lending, in other words a consistent ensure that these items do not disappear from the policy in certain financial institutions to be mis- radar. The danger with taking too long is that people lending to consumers, the totality of which has get bored and forget the question and we must not created a particular problem, only one part of the do that, but equally we must not rush decisions on it. problem but a significant part of the problem? If they had regulated properly, and if they do regulate Q2353 John Mann: Clearly people can blame properly, would not that element of it be rather easy politicians, Parliament, governments, for not to do something about if the regulation is strong highlighting these questions more succinctly and as enough? a higher priority previously, so we should not be Mr King: I agree with the objective, I am not so sure ducking our responsibilities. My final questions are how easy it will be to do it. In some ways we have on the Financial Services Authority where the Bank been through a natural experiment. We have been has a place on the board. In their Financial Outlook through a period in which the UK had light-touch it seemed to me that Lord Turner is trying to do your regulation, the Americans had pretty intrusive job. They seem to want to go into governance and regulation, hundreds if not thousands of bank your role rather than their role. There seems to be an examiners sitting and working full-time inside the inherent reluctance there to have regulation as if in banks, in Europe we have had governments deeply V some way regulation is a dirty word that must be involved in the banking system and di erent systems avoided. Do you have concerns about the way in in Asia. Every single one of them failed to spot the which they are attempting to usurp your role? seriousness of the risk-taking that was going on. The Mr King: I do not think it is to usurp the role. Up lesson I would draw from this is not to expect too until 2007 I worked very hard with Callum much from regulators. The real problem that any of McCarthy to ensure that we did not have the sort of them would have faced was that if they had said to traditional turf battles that I have seen very often in banks in the City before 2007, “You are taking big government. I thought it was very important that we risks”, they would have been seen to be arguing not have those turf battles. In retrospect, I rather against success. The people in the banks would have regret that because I was held accountable by this said, “Well, who are you to say we are taking too big Committee and many others for things which had risks? We have got far brighter and more qualified absolutely nothing whatsoever to do with the Bank risk assessors than you have got. We have made of England. The fact that it was not on paper our massive profits every year for almost ten years. We responsibility made no diVerence at all to whether have paid big bonuses. The City is the most you thought we had played a role in it or should be successful part of the UK economy. How dare you held accountable for it. It would have been better tell us that we should stop taking such risks. Can you had we probably played more of a role. To that prove to us that the risks we are taking will extent, having some overlapping responsibilities in necessarily end in tears?” and of course they could an area where if things go wrong it proves very not. For an ordinary regulator going about their critical maybe better with two people looking at it business, they would have been confronted with this than just leaving it to one person. What are the massively diYcult task of actually persuading incentives? When we produce a macroeconomic people, persuading you, that they should have been assessment for monetary policy we are concerned to taking action against institutions that looked very look at the most likely outcome and the balance of successful and highly profitable. I think the same risks around it. When the FSA look at the macro was true of employees inside the institutions and outlook they are bound to want to focus on the worst from anyone outside. Any bank that had been possible outcomes and what could go wrong. That threatened by a regulator because it was taking very easily leads into the press being able to say,“Oh, excessive risks would have had PR machines out in these are diVerent assessments”. They are not full force, Westminster and the Government would diVerent assessments. We have to look at all the have been lobbied, it would have been a pretty lonely range of outcomes when setting interest rates; they job being a regulator. are only concerned with the worst possible Chairman: We heard that from Adair Turner outcomes. I am very happy to engage with the FSA yesterday. Processed: 25-03-2009 23:45:45 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG14

Treasury Committee: Evidence Ev 311

26 February 2009 Mr Mervyn King, Mr Paul Tucker, Mr Andy Haldane and Mr Andrew Bailey

Q2355 Mr Mudie: I think this has been a very that old-time bank supervisors always used to say, thoughtful and useful session because it is and I remember when I joined the Bank, that there unimportant now and it is not on to start looking for are only two kinds of banks you need to look at, scapegoats and who did what to whom, it is really banks that are losing money and banks that are looking to the future to see where our institutions are making a lot of money. Those are the two kinds of best positioned to deal with it. You have only made banks you have got to regulate very carefully. If the one suggestion as to how it could be improved in banking system is expanding too rapidly we must terms of the Bank of England. We now have an not be taken in by the promotion of, “Our financial overlap in financial stability. It is interesting how centre is so successful that we should indulge in self- John Gieve described it in his speech. On the congratulation”, maybe we should just say, “Hang question of your last remarks you said that you are on, perhaps there are too many risks here” and build in a better position and you have pointed out the into the system the kind of proposal that Professor regulator cannot do it. You said at one stage it is for Goodhart and a group that he wrote a report with this Committee to decide what the responsibilities made about trying to raise the capital requirements are or how they should be changed, et cetera, but you as the growth rate of the Bank increases. Keep it are in a key position in terms of being the Governor simple. The Basel regulation, for example, achieved of the Bank of England, the most important nothing because it was wildly too complicated. position, the most influential position. It would be useful if your colleagues could put a paper up to us. Q2356 Mr Mudie: Going away from regulation, on You referred to discussions with the FSA. Governor, financial stability now it is a statutory duty and it the FSA have put 300 new staV on. They are pre- seems to be limited to bank notes or something like empting decisions. They have spent £80 million-odd that. Is it not the case that this is not the time now to in their budget putting staV on. How does Paul deal beef that up and explain to you what we wish of you with financial stability against that army? It would to do in terms of financial stability? be very useful if you were prepared, with the support Mr King: Yes. of your colleagues, to put a paper up to us with some discussion points that we might want to knock about and even discuss in this sort of session with other Q2357 Mr Mudie: Giving you the responsibility and, witnesses. just as we have with interest rates, giving you the Mr King: Let us start to try and put some points independence to do it because that is the answer to forward now. It seems to me there are three big no regulator, nobody would be able to cool the lessons from the recent experience. The first one, and economy down when you thought it was I have made this point before, I do not want to “excessively exuberant”, which is the phrase, is it labour it, is I do think that failures in the not, but you can because you do it all the time with interest rates. international monetary system led to imbalances in Mr King: Yes, absolutely right. The trouble is that capital flows between countries that created the what you have given us now is a statutory objective conditions of remarkably low interest rates and of financial stability but without any instrument to encouraged risk-taking and that has to be tackled use. I hope your inquiry will look at what are the somehow. It is not a question of financial stability right kinds of instruments. but it is vital. It is getting back to the objectives of Bretton Woods that were never achieved of imposing symmetric obligations on surplus countries and Q2358 Mr Mudie: Can you not suggest some? debtor countries. Deep down, if that had not been Mr King: We can. Counter-cyclical capital the problem I think we would not have seen a lot of requirements and there is the business of whether what we are seeing in the financial sector. I think that you have dynamic provisioning of reserves. It is a bit is fundamental too. The second one is in terms of glib somehow just to use these phrases because one regulation. I repeat the comment I made just now of the things you immediately realise when you use that with the best will in the world I find it very hard the phrase “counter-cyclical capital requirements” is to think that we will solve the regulatory challenges that a cycle is not the same everywhere in the world. by creating more committees, processes, etc. One of the big challenges we have got is how on earth Committees are useful and they have their place and do you reconcile international banks with national they are important, I am not saying we should not regulations. Are you going to have a bank that have them, but they are not the answer to operates in two countries where in one country the fundamental challenges to regulation. No regulatory cycle is expansionary and in the other system in the world really dealt well with what contractionary and one authority tries to ease the happened. Why was that? I think that was because capital requirements because of the state of the cycle the nature of risk is very hard to assess and you and the other one tries to tighten them. There are cannot easily prove a counterfactual. It is very hard major issues here about the extent to which banks to say to someone who appears to be very successful, having become internationalised are then outside “What you are doing is potentially damaging to the our ability to impose— rest of the economy”. The conclusion I draw from that is there is a lot to be said for trying to build in Q2359 Mr Mudie: On a bank level, when you very simple, very robust mechanisms to put some consider Lloyds before they took over HBOS, how sand in the wheels of the expansion of the financial they were run whilst everybody was getting sector. We have to say to ourselves one of the lessons exuberant, if we as a country were less inclined to get Processed: 25-03-2009 23:45:45 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG14

Ev 312 Treasury Committee: Evidence

26 February 2009 Mr Mervyn King, Mr Paul Tucker, Mr Andy Haldane and Mr Andrew Bailey exuberant whilst the others were doing it we might the losses are incurred in financial areas outside the end up in a better position as Lloyds did before they United Kingdom. We had the most extraordinary took over HBOS. situation of British taxpayers writing oV some 2.5 Mr King: I do not think you will find a central billion which was finance advanced to a Russian banker will disagree with the proposition that we oligarch. I find it quite extraordinary that more has should never get over-exuberant. not been done. Mr King: It is deeply shocking. All of us took pride Q2360 Sir Peter Viggers: Do you share my in our banks being successful international banks incredulity that so much public money has been and if you are a successful international bank you spent trying to rescue the banking organisations are going to be lending overseas and this is the without more closely identifying the good assets consequence of it. from the bad assets? The parallel being Lloyd’s of London which tried to deal with this matter by Q2362 Sir Peter Viggers: Returning to the creating Equitas and relegating toxic assets to that discussion we had about under-lap and overlap, and area. I have had many discussions on this and felt I think it was Lord Turner quoting Paul Tucker in that this was an area that was going to be examined evidence before us yesterday, if you are to have your but nothing seems to have been done. revised contribution, a diVerent pair of eyes looking Mr King: There are two aspects to this. One is how at financial structures, do you have the resources to the money has been spent and has there been an do that? Are you satisfied that you will have adequate investigation into the balance sheet. I do suYcient financial resources? not think it is fair to say that the money has been Mr King: We put to the court of the Bank recently a spent in a way that is irresponsible because we did revised budget which included significant increase in not understand the deep nature of the balance sheet, resources for looking at banks, for understanding because so far no-one has been buying assets of an financial stability, and that will be published in our unknown value. The schemes that have been put in annual report later in the spring, so you will see that. place have either been lending to banks with We have not gone in for expansion on the scale of the significant margins of collateral which have FSA, but then we are not responsible for looking at protected the taxpayer or injections of capital where the details of individual banks. We are responsible the taxpayer has acquired ownership in the for forming a broad view. My feeling is if you look institution. I do think it is a shame that we do not back at the lessons from this, the most important have already a detailed examination of the balance lesson is to think big, stick to first principles. If you sheet of the major banks and this needs to be done had just looked at the details of what banks were independently. It is no accident, I think, that the doing I think you would have got very misled. It is United States announced yesterday that is what they somehow just saying, “What on earth is happening are going to do with 19 large banks. The equivalent to the scale of lending and the sheer complexity of number of banks here would be about four or five. instruments?” It is simple questions but where We need to do that in order to get to the bottom of people must not be afraid of the answers, and I think it. One of the problems, of course, is that a year ago that means very talented, very experienced people people used the phrase “toxic assets” as if they knew who are willing to speak out and that is not easy. It what toxic assets meant. They thought toxic assets is not numbers here. The Americans had tens of were anything related to sub-prime mortgage thousands of people involved in monitoring their lending. Unfortunately, the assets which are financial sector but it did not help one jot. It is not generating losses now go way beyond that. The numbers, it is quality and the willingness to sit back downturn in the world economy means that this and most of all take an independent view. It is no distinction between toxic and non-toxic is a lot more good being subjected to regulatory capture. This is a elastic, so it is important to keep monitoring the point where we have got to be willing to say, “What balance sheet because the scale of potential losses is going on in the City is not in the nation’s interest” keeps changing and at some point it will go down. and that is not something which many people have Some of these losses may yet be written back into asked the Bank of England to do in the past. balance sheets once the world economy starts to recover. We are where we are and what is important Q2363 Sir Peter Viggers: You have described the now is that for this limited number of major banks loneliness of the regulator who might perhaps in we have a detailed independent asset-by-asset audit 2006 or early 2007 have blown the whistle and taken of what actually is on the balance sheet because only the music away while the party was going. If anyone then can the Government really work out what is the is to fulfil that lonely role, it must be the Bank of appropriate price to pay for insurance or price to pay England, must it not? for the assets or how can you split a bank between Mr King: It is the regulator as well. I suspect the “good bank/bad bank” and work out how much the challenges that they will face will be a lot easier over taxpayer should be willing to invest in, say, the the next ten years and it will be many years before “bad bank”. banks have forgotten this episode and have got themselves back into a state of mind where everyone Q2361 Sir Peter Viggers: The amounts involved are starts to think that it is acceptable to take more risks so very large it still astounds me that more was not and then we will go back in the cycle again. The real done in terms of analysis months ago. For the Royal challenge is to build into the institutions something Bank of Scotland, as I understand, six-sevenths of which bequeaths to our successors our institutional Processed: 25-03-2009 23:45:45 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG14

Treasury Committee: Evidence Ev 313

26 February 2009 Mr Mervyn King, Mr Paul Tucker, Mr Andy Haldane and Mr Andrew Bailey memory of the dangers of relaxing regulation too Mr King: No, we are not. I understand from a much and of not having a framework which builds in political perspective that you may want to make that some sand in the wheels to a rapid rate of expansion. point, but I really do think that is a wild exaggeration. For some reason that I have never Y Q2364 Sir Peter Viggers: On learning the lessons, are entirely understood, the O ce for National there any common features which distinguish the Statistics has decided that when the Royal Bank and business models and practices of the survivors Lloyds are added to the Government’s balance sheet amongst the banks as opposed to the slain? that they add the liabilities but not the assets, apart Mr King: Lower leverage. Most financial crises in from the very short-term assets. That gives a wholly the past have been characterised by excessive misleading impression. The debt that is incurred as a leverage, borrowing, debt, and that has been true result of putting money into or lending to banks is here too. I made that point in my Mansion House not the same as debt that is incurred by spending speech in June 2007 and was booed for making that money on goods and services where the whole debt point. I asked the question rhetorically. I said, “Are is there to be repaid out of future taxes. Much of this we really so much wiser than the financiers of the additional debt will be repaid by selling the stakes in past?” The answer is we are not. It is excessive the banks or repayments of the loans that the public leverage. If you want a lesson from the regulatory sector as a whole has made to these banks. Even if area, one of the big lessons is that we developed a you were to take the view that these banks have very sophisticated approach to regulation based on absolutely no assets at all, which would be an absurd the models which firms themselves were using. You view in my view, the increase in national debt still could argue about whether the models were accurate leaves us way below the levels at which Britain or not and in good times it did not actually matter emerged from the Second World War and we coped very much whether the models were right or not, you with that. I do think that public debt matters. We got it approximately right, but what did matter was entered this crisis with levels of public borrowing that when times were unexpected and things went which were too high and that made it diYcult, but we badly wrong the models were useless and yet have not actually engaged in as big a fiscal relaxation regulation was based on it. A simple approach to as many other countries in recognition of that fact. saying that any institution whose leverage ratio is The Chancellor has very clearly recognised that above a certain number should be subject to much there will need to be a path of fiscal consolidation in more detailed supervision might well be a step the future and it will take time and it will not be very forward. It is not just restricted to banks, but it is comfortable, but we will have to do it. It is a million mostly banks. Banks were the most leveraged miles away from saying that we will need a path of institutions. One of the reasons why I think the UK fiscal consolidation to saying that the UK is like authorities have tried to persuade our European Zimbabwe where we should go into administration, partners not to get so excited about hedge funds is that is wholly irresponsible, and I know you are not that hedge funds were not the most leveraged suggesting that. institutions, the banks were, and it was the problems Mr Love: He was suggesting that! that arose at the heart of the banking system. 40 years ago if you had asked any of the clearing banks coming before this Committee what fraction of their Q2366 Mr Breed: It was an opportunity for you to balance sheet was in liquid short-term assets they give that confident reply and I think it is important would have said about a third and the answer now is that we do realise that. Having said that, might not 1%. There has been a massive change in the balance we get to a situation where the banks may well have sheet structure of our banking system and it is not come out of this situation long before the taxpayer? surprising, therefore, that you make more money in Mr King: There is no doubt that part of the process banking doing that because you are using the assets here in order to help the wider economy is to get the in a riskier form and most years that generates a banks back into a position where they are higher return, but it means that when things go recapitalised and can start to lend again and operate wrong the costs are so much higher, so excessive as normal— leverage is the common theme. I do not think it tells you exactly what you would do as a result, but that Q2367 Mr Breed: Business as usual. is something we should remember and build into the system. Mr King: —well before the level of public debt will have come down to the levels at which we started, absolutely. The burden of this will take time. Q2365 Mr Breed: Governor, you indicated a little while ago that you bemoaned the fact that you did not have a detailed enough information analysis of Q2368 Nick Ainger: Governor, it is recognised and the banks’ balance sheets and so on. Do you have a you mentioned earlier about the complexity of the detailed enough assessment of the Treasury’s financial instruments which led to lack of balance sheet bearing in mind everything that has transparency,unscrutinised risk and this was a major been piled on it in the last few months, not least, of contributor to the current crisis. In his evidence to us course, today’s announcement in respect of the Asset Dr Danielson suggested that one way of addressing Protection Scheme? Are we moving towards the issue of complexity and lack of transparency in considering whether UK plc ought to be put into the market eYciency with all these instruments was administration? actually to end the over-the-counter trading of these Processed: 25-03-2009 23:45:45 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG14

Ev 314 Treasury Committee: Evidence

26 February 2009 Mr Mervyn King, Mr Paul Tucker, Mr Andy Haldane and Mr Andrew Bailey instruments and actually put them across exchanges. greater transparency. Exchanges can do something Have you done any work on that? Is any thought else as well. For the most vanilla instruments they being given to that within the Bank? can preserve a little bit greater liquidity. It has been Mr King: Yes, there has and I will ask Mr Tucker to quite striking that during this episode the equity reflect on this in a minute. The one point I would markets have been incredibly volatile but have not make to you at the outset is the key thing from our frozen at any point. If you go back to 1987 when the point of view is not so much that trading takes place equity markets did freeze, they recovered rather on an exchange because there are many instruments, more quickly than the over-the-counter markets but it would be desirable for people to be able to have over the past year or so. Yes, we will be transact if they wanted to but do not generate interested in this area. enough business to justify an exchange. What does matter is a clearing house so that we actually have a register of how many transactions there are, a Q2369 Nick Ainger: Everyone is agreeing on this. method of ensuring that those who engage in Mr Tucker: Yes. liabilities on one side are clearly matched on the other side. One of the problems of Lehman Brothers failing, and it still is going to take many months to Q2370 Nick Ainger: I think the FT carried an article sort out the details of many of those contracts, was that the Governor of the Bank of France is arguing a most extraordinary outcome really that all these within the Eurozone that perhaps Paris should be the contracts were not done through clearing houses in centre of this clearing house and so on, but who is a way that would enable the counterparties to get actually taking this forward? Everyone seems to out of it. I think clearing houses rather than agree that it is a good idea but who is actually going exchanges is the key from our point of view. Let me to make it happen? ask Paul to take that forward. Mr Tucker: There are various industry groups Mr Tucker: I think the Governor has made the big pursuing it. The ECB, the Banque de France, the point. Stepping back a second, if we are going to FSA, the New York Fed and the Bank are all have a financial system, domestically and involved in this. As you say, there are issues about internationally, in which the capital markets play an cities and so on but those should be second order. important role, and I cannot foresee that going away and in that sense we are going to continue living in a Q2371 Nick Ainger: Thank you. Can I move on now very diVerent world from the world that prevailed 30 to remuneration. Governor, a year ago you told this or 40 years, then we have to ensure, and the Committee: “I think that the banks have come to authorities have to take an interest in the integrity of realise that they are paying the price themselves for the functioning of those capital markets. I imagine having designed compensation packages which that was the starting point for the evidence you received earlier. I think, in a way, the authorities provide incentives that are not in the long run in the across the world have perhaps been too timid on that interests of the banks themselves and I would like to front over the past 10 or 15 years because often for think that would change”. That was 12 months ago. the banks and dealers, at least at desk level if not at In October, Hector Sants wrote to the chief CEO level, they will be slow in developing central executives of the banks making a similar point. infrastructure because it will tend to reduce the Judging by the announcement last night and this margins that they make on individual pieces of morning that Fred Goodwin is going to receive a business. We should take an interest in that area. I pension of £650,000 a year for life from a pension pot absolutely agree with the Governor that the key part of apparently £16 million from a bank which he led of this is central clearing houses. First of all, a health to a situation where today they have announced warning about that. What central clearing houses do these huge corporate losses, has anybody been is they bring all the risk into one place and, therefore, listening to what you said 12 months ago? it means that the risk integrity of the clearing house, Mr King: Apparently not, but, as I said, we used the there is nothing more important. They are more or power of words, I made the point. The FSA did less invisible but if one of them gets into trouble, and respond by saying that they would take this up and perhaps over history two have got into trouble, I think you will find that in the future the design of capital markets more or less shut down. That is compensation packages will look very diVerent manageable provided the regulators and the central because boards and management of banks will banks are on top of it. There is a debate now about realise that it is not in their own interests to oVer whether credit default swaps should be cleared these packages. The real question about the pension through a central counterparty, a central clearing for Fred Goodwin is not a debate now about house, and I think that they should. There is a debate whether you should undo a contractual entitlement, about whether it matters whether it is in the EU or the real debate is how on earth was it that at the time in the euro area of the EU or the UK or the States shareholders, boards, the financial press, all thought and it is a great shame that is intruding into that it was a great idea to reward people in this way.These debate. What matters is that the global marketplace bonuses were absolutely astronomic. It was a form should get pieces of infrastructure that work and of compensation which rewarded gamblers if they have integrity. There is potentially a role for won the gamble but there was no loss if you lost it. exchanges as well. Clearing houses can ensure It is obvious that if you do that you will give common margin standards, common valuations and incentives to people to gamble. Processed: 25-03-2009 23:45:45 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG14

Treasury Committee: Evidence Ev 315

26 February 2009 Mr Mervyn King, Mr Paul Tucker, Mr Andy Haldane and Mr Andrew Bailey

Q2372 Nick Ainger: Everyone is talking about trying it was extremely diYcult to get anybody to use the to restore confidence but this sort of event undercuts power of words in the way that you yourself and undermines that confidence in the system. suggested this afternoon might in future be Mr King: What undermines it, I think, is the way appropriate. What confidence can you give us that people behaved in the past. you are going to come out of the traps earlier? Mr King: Let me explain the nature of the problem. I Q2373 Nick Ainger: Do you think that Fred did speak about house prices. I gave a speech in 2005 Goodwin should announce that he is going to take which had quite a big impact; it was all over the front far less than that £650,000? pages of the usual tabloid press. I got a lot of letters Mr King: I am not going to jump on the bandwagon saying “How dare you talk about house prices! I of a rather unappealing sort of vengeance, to be have failed now to sell the house I was on the verge honest. He will have to think about his position, and of selling.” There were a lot of comments that I others will. The real question here is not whether he should not be intervening and making comments is entitled to his pension, which I presume is a about house prices but I did. It had an eVect for a few contractual entitlement, although I do not know the months and then went away. I think one of the facts so I am not going to comment on that, the real diYculties is to know how to judge this balance question that we should be concerned with here is between not being seen to be scaremongering and how was it the case that everyone thought that it was being seen to present a realistic view of risks. We a good idea that executives be rewarded in this way. have the same problem now in talking about the This is not just Fred Goodwin, it is not just banks, it state of the economy. Every time I give a speech on is compensation in general where the executives at the economy I get a large number of letters from the very top have earned vast amounts of money people who say, “You shouldn’t talk down the beyond the dreams of ordinary people for doing a economy. Your job is to talk it up, not talk it down.” job which it is very hard, I think, to say justifies that Then I come, and you very rightly say, “Wouldn’t it kind of bonus because you can never impose a be better if you gave a realistic view of your own downside. judgement about the balance of risks?” The diYculty at the heart of it is that none of us know. Somehow Q2374 Chairman: As a Committee we are well aware people seem to think that we should know whether of the utility element where in the branches you get house prices are going to go on up or whether they people with 10% of their bonus on salaries of £15,000 will crash or whether share prices will rise, or or £25,000 a year and they deserve that, so we are whether the exchange rate will fall. We cannot do aware of that segmentation element, Governor. that. I think all we can do is talk about the balance Mr King: Exactly. of risks and the limits of our knowledge. Ever since I have been coming to this Committee, which is a long time now, I have always said in answer to many Q2375 Mr Tyrie: Just on Sir Fred, would you be questions “I don’t know” because there are many prepared to just go a small step further, as Governors facts about the future I simply do not know, and we used to do, and raise your eyebrows to the point that have to admit that ignorance and just talk about the you are feeling that he should voluntarily consider a balance of risks. I think my predecessor tried to do response to the criticism? it. Every speech I have made since the inception of Mr King: What I would much rather do is to spend the Monetary Policy Committee has some reference my time here with this Committee trying to work out to the need for the UK economy to rebalance, that how we can reform a system that created something rebalancing would be necessary, but I have no idea where you are drawing attention to only one when that will be or how it will come about and I individual case. You cannot blame one individual could not anticipate that. for the failings of a system and that is what we should focus on. Q2377 Mr Tyrie: In a separate exchange with me Q2376 Mr Tyrie: I agree with that. I think you have your predecessor also said that he did not have the made a number of very thoughtful remarks today. resources to collect the necessary information. This You have talked about the power of words. When I is a point that you have alluded to indirectly with was last on this Committee I asked your predecessor respect to bank liquidity, that you have no power to to use the power of words to do something about the demand that information from banks. He also said developing asset price bubble. This was in the that he did not have enough staV, or he implied that context of the house price boom, which had already he did not have enough staV to collect this stuV. begun and was already 25-30% above its long-run There was a reduction in the number of staV in the trend. This is in 2002–03. I pressed your predecessor Bank dealing with this area. Is that now being vigorously in order to try to persuade him to use the rectified? power of words and I have in front of me what he Mr King: It is but I have always been baZed as to responded: “We are not expecting a boom-bust in why it is that when I come and talk about managing the housing market. That is not what we are areas properly, Members of Parliament say, “Why forecasting. I could envisage circumstances in which don’t you spend more money on it?” I thought most we might forecast that. That is not our judgement at of the time we should be trying to make sure that we this point.” The problem is, is it not, that although run our organisations eYciently. It is not numbers privately there were a number of people in the Bank that matter here. We have well over 100 people who were prepared to talk to me about this, publicly, working in this area of financial stability and always Processed: 25-03-2009 23:45:45 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG14

Ev 316 Treasury Committee: Evidence

26 February 2009 Mr Mervyn King, Mr Paul Tucker, Mr Andy Haldane and Mr Andrew Bailey have had. We have made a change to that by go directly to the heart of the total lending by the increasing the numbers given our new statutory banking system. That is one area. I think that is responsibilities for special resolution framework, for diVerent from asset price bubbles, and I would like regulating payment systems and, over and above to give you an example as to why my predecessor and that, for the work that we will do in monitoring I both share the view that it is quite easy to talk about banks given our statutory objective, but I go back to asset price bubbles but very, very hard to know what it: I do not think adding numbers in itself solves the to do about it. In the early days of the Monetary problem and I do not believe the diYculties we faced Policy Committee there were those who said, “There in the past ten years have anything at all to do with is an asset price bubble dot.com stocks. These prices numbers. The ability to understand whether or not of shares are rising rapidly. This does not look the housing market would crash, whether or not the sustainable. What on earth are these companies? stock market would continue to go up or not is not Where are the assets? Why don’t you raise interest a question . . . You cannot hire an extra 50 people rates to lean against the wind in the bubble in the and say, “Go and find out the answer.” It is not that dot-com market?” Then some other people said, kind of question. “Hang on a minute. There is also an asset price bubble in the exchange rate. Sterling is too high. No- Q2378 Mr Tyrie: Governor, your comments on the one quite understands why sterling is so high against limited utility of both regulation and committees is the euro. It is damaging the export industry. It is not well taken and that is more or less what you are sustainable so we ought to lower interest rates in saying. You made a very interesting speech, and you order to deal with that asset price bubble.” Well, we only have one interest rate. You cannot have have already referred to one of the points, on 20 V V January about how to deal with asset price bubbles di erent interest rates for di erent asset price in the future, in which you talked about the bubbles unless you go back to the system which additional policy instrument to stabilise the growth existed in the old days, with segmented capital of the financial sector balance sheet, which you markets and margin requirements for all those who alluded to a moment ago. But in response to George want to buy stocks and so on. Mudie and others you have not taken that very far forward. I wonder whether you could—not Q2380 Mr Tyrie: You are proposing a second tool. necessarily today—take it forward and commit to Mr King: The second tool is really about credit as a producing an early paper on this which you could whole and not about asset price bubbles, where I submit to the Committee. think it is very hard to be confident that there is an Mr King: Absolutely. asset price bubble, and anyway you only have one instrument. Using interest rates, using the bank rate, Q2379 Mr Tyrie: It would be setting out a number is not, in my view, the appropriate tool to deal with of things, if I could go through the things. First of all, concerns about asset price bubbles or concerns we have to find a way around the international about the growth of credit. I think you can design an problem you have described, that you could be instrument to deal with the growth of credit. I think undermined by another bank abroad deciding to it is harder to do that with asset price bubbles, ignore those levels of capital requirements. Secondly, though I do accept that it may be worth debating. I you have to do something, in my view, and make a do not want to form a judgement on that today but proposal about who is in charge. One of the I know some people have said, given what happened, problems that we have had in this whole area is we maybe we should just put some real obstacles in the have had this tripartite committee without the way of mortgages in excess of 100% loan-to-value public, and the informed public, including the City, ratios being granted. That goes back on the idea of having the confidence that one person is in charge. free and open capital markets and individuals Would you be prepared to come forward with a making their own decisions about how much to proposal on that, setting out what the structure borrow and lend, and it may not be the right thing should be? At the beginning you were reluctant to. to do. In fact, I did not write it down but I think you said something to the eVect that you did not want to get Q2381 Mr Tyrie: But you are going to give us an into too much detail about who should run it—I early paper on this second instrument? think that was the phrase you used. Perhaps you Mr King: We will give you a paper. I do not want to could also reflect on how Basel II has illustrated commit to a date now but we are thinking about some of the weaknesses of trying to get international these issues and we will come back to you on it. I do agreement and how we can go forward with this think this is part of the really important debate that particular proposal, bearing in mind that experience. we have as a country about what kind of financial Mr King: I will be very happy to do that and no system we should have. I do think that one of the doubt in our speeches as well we will be contributing benefits is that we must use this to learn some to the debate, and I am happy to discuss that with lessons. Rapid expansion of what appears to be a you. I want to try to distinguish between some highly profitable industry, paying massive salaries, diVerent areas here. In terms of trying to prevent the was damaging. It sucked in large numbers of young build-up of leverage and the growth of credit in the people from other professions which could not oVer economy,it really is the amount of credit, borrowing, the same kind of compensation, under the illusion— that you need to focus on and that, I think, is a and it has now been seen to be an illusion—that these question of trying to devise instruments which will bonuses could be paid for ever. That will adjust itself Processed: 25-03-2009 23:45:45 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG14

Treasury Committee: Evidence Ev 317

26 February 2009 Mr Mervyn King, Mr Paul Tucker, Mr Andy Haldane and Mr Andrew Bailey of its own accord now. People will go to other the implementation of that tool. Whether that tool careers. The financial sector will not be as big and it is actually in the Bank’s hands I think, as the will not grow as rapidly. So we have time, I think, to Governor has said, is an issue for another day. I try and think through how to prevent our successors think first base is establishing, first of all, that there facing this problem. I do not think you on this is a case for such a tool, and I think the emerging Committee will face this problem again. I do not consensus is that there is; secondly, what operational think I will face this problem again. It will be the next form that tool might take, on which I think there is generation, and we need to leave behind some clear a lot of work to be done to get underneath what institutional memory of what happened and what would be a suitable instrument, and how that lessons we drew, just to give them some ammunition instrument should best be calibrated to achieve its to resist the calls that will inevitably come 15, 20, 25 end objectives; the third question is who does it, and years down the road: “Those fuddy-duddies in 2009, in some ways, for me, it is the least important of the they all got over-excited about financial crises, they three. I think establishing first, that there is a case put blockages in the way of the expansion of the and second, what form that rule should take are financial services industry and we must remove sensible next steps. that.” It is handing on to the next generation some of the lessons that we have learned from this crisis. Q2386 Jim Cousins: That is very interesting. Mr Tucker, I wonder if I could ask you, would you Q2382 Chairman: Governor, I was going to ask you visualise, in the deployment of a future control, yet about the over-dependence on the financial sector to be designed, that control having to apply to a and the rebalancing of the economy. You have made category of enterprises or banks, or could it be statements about that before and I think your deployed in the case of a single bank? That would answer ties into that issue. aVect the design of the sort of control you would Mr King: Yes. have. Mr Tucker: I think it is quite hard to envisage the Q2383 Chairman: As a Committee, we want to look application of controls that have not been designed. at the issue of rebalancing as well. I do not mean that as a cheap shot. Mr King: Well, we are coming back to you in a month’s time. Q2387 Jim Cousins: The decision about whether the Chairman: Exactly, so that will be very helpful. control applies to a category or a single institution will aVect the design. Q2384 Jim Cousins: Mr Haldane, I wonder if I could Mr Tucker: The debate is about categories of take you back to a very interesting point you made institutions, and that goes precisely to the point that right at the beginning, that you saw a distinction the Governor, Andy, and Andrew Tyrie as well, have between assessing risks and imposing a requirement made about the international dimension. Because, to control those risks. You drew a very good clear as the Governor said, sometimes the credit cycles distinction between those two things. Could I ask across the world will not be synchronised but you if you think that they are two diVerent roles for sometimes they will. The short answer: the question regulatory and supervisory authorities to have? is about categories of institutions. The other thing I Mr Haldane: The current institutional apparatus would say, if I may, is that, first of all, I think this is clearly assigns those two distinct roles to two distinct a first order issue and it is absolutely vital that our institutions. That is certainly true. That is to say, it is generation of policymakers nails this. It has been not the Bank that currently exercises control over the around as an issue since the mid-1980s and it comes regulatory apparatus. I think, as the discussion has and goes as an issue. This time I hope it will not slip gone on to second instruments, were regulatory away: that we will resolve this time whether or not policy to have an explicitly systemic or macro it can be operationalised or not. The second point I prudential as distinct from micro prudential would make about it is that it is absolutely vital that dimension, then that begs the question about we, the regulators, and you, do not become fixated whether the macro analysis could not be brought that this is some kind of silver bullet. Financial together in one place with a macro regulatory stability policy is not like monetary policy. Your instrument. I think that would be easier to achieve if successors in 20 years’ time will not be talking about there were this second instrument. one instrument that has been found to solve the problem of financial stability. It is of its essence a Q2385 Jim Cousins: Mr Haldane, let me be clear whole series of levers. Some of them micro about this. That points to the fact that you see the prudential, some of them may be macro prudential, assessment of the risks and the deployment of the to do with the credit cycle. Some of them are to do controls to deal with those risks being dealt with by with the design of the capital markets infrastructure. a single institution. Some of them are to do with accounting rules. Some Mr Haldane: I think that is one potential of them are to do with insolvency law. All of these configuration. I do not think it is in any way, shape things need to be in place in order to ensure the or form the only one that could be made to work. If system is stable. The third thing I would say, if I may, you are to have a tool that is serving a macro is that one of the glaring lessons of this episode is prudential systemic role, it is likely that the Bank, by that when the authorities, domestically or dint of its role in assessing macro risks, would have internationally, identify fault lines in the financial some influence, some judgement to bring to bear on system, things that will matter if very low probability Processed: 25-03-2009 23:45:45 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG14

Ev 318 Treasury Committee: Evidence

26 February 2009 Mr Mervyn King, Mr Paul Tucker, Mr Andy Haldane and Mr Andrew Bailey but very big impact events occur, then it is vital that Bailey has been very close to this because he has been those fault lines are addressed. Examples would be involved. We have not seen the final details. This was mono-line insurers in the United States, money decided last night. market mutual funds, the role of Fannie and Freddie. This episode would have been slightly, Q2390 Mr Cousins: On the understanding that that somewhat better if those fault lines had not existed. is happening, there is this very important issue raised But none of them is to do with the macro prudential by my colleague, Sir Peter. In the case of RBS, a lot instrument that we are discussing. The reason I go of the assets that are going to be protected—in fact, through that is that while we absolutely must pursue probably the great majority of them—are outside what you and Andrew Tyrie and others have been UK jurisdiction so how does the Treasury carry out talking about, and I am extremely keen on that and an audit of assets that are beyond its reach? have talked about it publicly, we absolutely must not Mr Bailey: You have to take what I would describe become fixated with the idea that it is some kind of as a whole bank approach to this, and that is what cure-all. We will have to operate on lots of fronts, the bank’s own auditors have to do. They have to “we” being the plurality of institutions domestically audit the whole bank. The Treasury will not be using and internationally. the bank’s own auditors to do this precisely for the point that the Governor made that this has to be independent but you have to do exactly the same Q2388 Jim Cousins: Governor, do you see future thing. To get RBS to the point where it is stable, its controls that we are now discussing as being future is clear and it can start to undertake the symmetrical in the same way that monetary policy is, lending commitments that it has entered into, you that is to say, that they could involve increasing have to look across the whole balance sheet. You lending at certain points as well as requiring perhaps cannot say,“We are not going to look at that because a reduction of exposure? it is somewhere else in the world.” This is a bank Mr King: Yes, and I think that, in a sort of de facto that, of course, went on a global strategy. I think you way, that is where we are, in that at the same time as will find, from the announcements that the Chief regulators around the world are talking about the Executive has made today that that strategy will of long-run need to raise capital requirements, they are course change but we inherit the assets that we also stressing very clearly that capital requirements inherit and therefore we have to deal with all the now, if anything, should be lower to enable the assets. There is just no choice on that matter. banks to use a buVer between the capital that they have and the minimum that they have to keep as Q2391 Mr Todd: There are lots of uncomfortable available to underpin lending. Anything that is moral messages in this crisis. We highlighted earlier thought of as a countercyclical approach is bound, I the fate of one pensioner. Some other pensioners think, to have an element—not of perfect symmetry who did what would seem the prudential thing of because cycles do not form perfect sign waves but making savings for their retirement, early retirement certainly cases where you would be tightening in some cases, have found themselves losing out capital requirements at one part of the cycle and substantially as interest rates have fallen. They have easing them at other parts of the cycle in order to ended up as rather innocent victims in this. What prevent an unnecessarily large reduction in lending sort of message do we give to people who are taking by the banking system. personal prudential action? Mr King: I have immense sympathy for people who were engaged in saving and acted prudently, which Q2389 Mr Cousins: I just want to ask a question of was everything that we would have wanted them to fact essentially. You will be aware that the do and they, and millions of others—it is not just Committee has had handed round the outline of the savers who have lost; many people who worked for Asset Protection Scheme, and I have not had a Royal Bank of Scotland were not receiving the chance to look at the absolute detail but you made it multi-million pound bonuses that the senior clear that you thought there should be a rigorous management were, they did not decide the strategy, audit of the underlying assets before the Asset but it is their jobs that are going now. There are Protection Scheme kicks in. millions of people who are being aVected by this Mr King: Not quite. What I said was that before the downturn. Some of it you can link to individual details of the actual value of the assets and the price decisions in banks, some of it is the consequences of to be paid for them are determined, this needs to be a very sharp, sudden and serious worldwide done, and that is exactly what is happening, as I downturn. For all of those people I have immense understand it, that the Treasury has started on the sympathy. process of this rigorous audit, they are part of the way through it, they have not yet completed all of it Q2392 Mr Todd: I understand that, but you will but it is still important—and I did stress this—that appreciate the longer-term implications of some of the actual underpinning of the balance sheet you put the moral messages that we are handing out at the in place now, so that the Chancellor has underpinned moment. the balance sheet of the Royal Bank of Scotland, but Mr King: Can I go back to the point I made in the precisely what this will mean in the future depends January speech? I referred there to what I called the on the assessment of the evaluation that will paradox of policy at present. Everything that we are continue to take place over the next few months. Mr doing now in order to stop the downturn and to get Processed: 25-03-2009 23:45:45 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG14

Treasury Committee: Evidence Ev 319

26 February 2009 Mr Mervyn King, Mr Paul Tucker, Mr Andy Haldane and Mr Andrew Bailey back to normal is absolutely opposite to everything the case of Germany, where the banks were in the that we know we should do in the long term. That public sector, even there both the owners and the does not mean to say it is wrong. It means to say we supervisors did not know about the oVshore have to explain to people why it is that collectively, activities of some of the activities of their banks. if we all started to save now, we would be worse oV in the short run. It is important that we get the Q2397 Mr Todd: Would you perhaps concede if economy back on track again and then, at that there is a private sector future for banks that the point, we can turn to implementing the moral corporate governance models of banks will need to messages about the need to save. be redesigned in the circumstances of our current knowledge? Some of the discussion we had, and I do Q2393 Mr Todd: That is a really complicated not know whether you heard it, of the diVerent message. governance models that applied to HSBC, Mr King: It may be complicated but it is crucial. Santander in its governance of Abbey, and the banks that are now causing us the greatest problem Q2394 Mr Todd: I am not saying it is wrong but I am produced interesting diVerences in the way in which just saying it is one that we need to express they chose to govern themselves. Are there consistently and clearly,and I do not think the media experiences that we can seek to apply as a legislative helps us to do that. framework for banks if they are to remain in private Mr King: I will redouble my eVorts to try to explain governance? it, and it is very important that people understand. Mr King: I find it very hard to believe that a In the long run we will all, as a nation, need to save particular process of corporate governance is going more. We need to reduce our borrowing, but if we to guarantee people behaving prudently. now move to that position too quickly, we will merely exacerbate the speed of the downturn. Q2398 Mr Todd: But it may happen. Mr King: It certainly helps, and there is no doubt Q2395 Mr Todd: Agreed. Can I ask about the future that there are elements of corporate governance of banks in private ownership? They are inherently which it is worth reinforcing to make it more diYcult unstable. I think we all accept that and there is an for one or a small number of individuals to engage argument for saying that RBS, with its minority in massive risk taking but in the end what we have to private stake, has a rather confused and complex have is a culture in which people on boards are future ahead of it. Do you take the view that there is willing to stand up and say—take Dennis a long-term future for private-sector ownership of Weatherstone, who ran JP Morgan. He basically banks? said to anybody who worked in JP Morgan, “You’ve Mr King: Banks engage in significant amounts of got 15 minutes to explain this new instrument to me. maturity transformation by borrowing short and If I don’t understand it after 15 minutes, we are not lending long. It is that that creates the instability, not doing it.” It is the willingness to be tough and not to whether they are owned privately or publicly. They get sucked into the culture of saying, “The other would be just as unstable if they were owned banks are doing it. We must take part as well.” That publicly. Of course, knowing that there would be requires great strength of character. some underpinning is important, and that is why, even with privately owned banks, you would have a Q2399 Mr Todd: To take a classic example, which I framework in which the government oVers deposit am sure you will have followed, was the debate insurance to prevent bank runs and provides about risk management within HBOS and the regulation and supervision in such a way as to ensure models that were applied there and the individual that the banks do not take too many risks and appointments that followed from those models. ultimately will have to underpin the banks of those Perhaps we need to look harder at how banks govern that are central to the functioning of the economy. I risk themselves and set clear criteria for how to do not think that is an issue about private versus separate executive and risk functions. public ownership; it is a question about how we can Mr King: That is certainly part of it but I think it ensure banks are able to engage in suYcient maturity goes beyond that. I remember even after August transformation to yield economic benefits without 2007 receiving pretty strident comments from people taking excessive risks. in the industry, and indeed elsewhere, about the importance of not disturbing the distinctively British Q2396 Mr Todd: One of the diYculties of getting a model of banking of wholesale funding. That model consistent picture of asset values is the dispersed of wholesale funding was in large part responsible ownership that is there. The model in Scandinavia for the degree of risk that was incurred, yet, because was easy, of setting up a bad bank, because virtually it was seen as the key to success of the expansion of the entire banking system ended up in the state’s the City of London, large numbers of people hands. thought this was a good idea and woe betide Mr King: I think they had the same problems in anybody who stood up and argued against that many ways as we face now but on a smaller scale. because they were seen as being disloyal to the need Their banks lost enough that they were no longer to see the success of the City of London. It is diYcult viable as institutions without public-sector support. in those circumstances to expect people to stand up They needed a period of restructuring and then they and argue against something which has become were floated back into the private sector. If you take conventional wisdom. Processed: 25-03-2009 23:45:45 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG14

Ev 320 Treasury Committee: Evidence

26 February 2009 Mr Mervyn King, Mr Paul Tucker, Mr Andy Haldane and Mr Andrew Bailey

Q2400 John Thurso: Following on from that, if I Mr King: I think you have summarised the nature of may, Governor, because you have said some very the problem well, and I think the diYculty is that if interesting things today, earlier on you told us that you try to legislate to have two kinds of banks, you we need to be focusing on credit and burrowing and cannot legislate to have culture A in one type of bank leverage as an important indicator. You talked about and culture B in the other. All you can do is try to risk and the balance of risk and you talked—and this define it by types of activity. Instinctively, I find the is something you and I have discussed before— narrow bank idea very attractive but the argument about remuneration and how inappropriate it has that is put against it, which I have reluctantly over been. You have also talked about the diYculty of the years come to accept has some real validity, is finding regulatory levers for all of this, which brings that if you try to restrict deposit protection and one back really to whether this is not a question of regulation to the narrow banks and say to people culture and philosophy. The problem is that the City that if you put your money into a narrow bank it is thought of itself as the masters rather than the safe whereas if you put your money into a wider servants of commerce, and that we have actually bank, you take your own pot luck, the problem is moved from the old-fashioned, traditional British that the wider banks, precisely because they are not banking model of 20 or 30 years ago to taking in a regulated, will be able for most of the period to oVer great deal of the American model, that greed is good higher returns, and many depositors will not be and short-termism, and above all we need a return to strong enough to say to themselves “I don’t think a culture which is more of the old and traditional and this is really prudent in the very long run. I will stick less of the new. Is that not a fundamental part of the with my narrow bank.” They will switch their problem? deposits to the wider bank, those banks will be less Mr King: The one thing I would pick out from that well regulated, they will expand much more rapidly that I think is very important is short-termism. I than the narrow banking sector, and indeed, they think the nature of banking is bound to change over will become so big that when the crisis does come, time as the world economy develops and evolves, the government will be forced to step in for concern about what will happen to the economy through a and banks are very diVerent institutions now than a collapse of these big institutions. hundred years ago but what is very important is that I think this pressure, this incessant pressure to achieve quarter on quarter increases in profits Q2402 John Thurso: Following that through, a point cannot possibly make sense in an economy which that is often made—and I remember we discussed it itself is inevitably somewhat volatile. What it does in June—is that we do not want to stifle innovation. do is to undermine the ability of managements to put As they say in Scotland, “I hae my doots about that in place credible long-term strategies for building up one,” because innovation has got us where we are, business. It is no accident that many of the one might argue. There is a view that a certain companies outside the financial sector that I meet amount of innovation is actually quite good but when I go around the country that impress me most there is an element within the whole financial market are those that are not subject to the so-called that you do want to act in that way.At the same time, discipline of quarterly reporting to the City and the that whole element of trust and confidence which is judgement of analysts on that. I do think that you so important is required for the everyday banking. have to have some method of accountability of Should we be saying that if you wish to engage in the managers to the owners of the company. It is not an taking of deposits, you will be regulated on your easy system to devise and make work but the short- leverage at a far higher degree than if you wish to termist response I think has been damaging. forego that and actually operate in the other areas? In other words, can we disaggregate, as we have so often said here, the money utility from the casino? Q2401 John Thurso: Can I put a point to you, and it Mr King: I think is worth having a serious debate goes from culture into the whole concept of what is about this. My concern is not about the objective or being called narrow banking and the Glass-Steagall. the desirability of doing it. My concern is about the This is something we have discussed and I put it feasibility of doing it, because I think that what you yesterday to Lord Turner. It seems that there are call the casino type institutions will eventually find it quite a lot of very intelligent commentators and quite easy to create deposit accounts into which witnesses who favour a return in that direction. He people will find it very attractive to put money and said himself that whilst he saw the validity of the it will be very hard to stop that. That has been the argument, he was not convinced by it at the moment. nature of the problem so far, that where you have Is not the problem that, if you go back to risk, risk two types of institution—in a sense, we have been itself is not bad? Zero risk equals zero return. Taking through this for a very long time. If we go back to the measured risk, and it is the measure bit that is 1970s, there were licensed deposit takers, there were important. The culture that is required in the whole unlicensed, there were some kinds of banks and investment banking side is a riskier culture, giving second-tier banks. We have always struggled with greater rewards. The culture that should be in these boundaries and in the end the trouble is that clearing, retail banking is a culture that is more the bit that is not regulated very much always grows prudent, and the problem is that it is the joining of very rapidly because it can oVer higher returns, and the two cultures rather than any institutional in the end enough people have their savings in those problem that is really at the heart of the problem institutions that you and other parliamentarians feel there. What are your views on that argument? we cannot just abandon them to their fate, because Processed: 25-03-2009 23:45:45 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG14

Treasury Committee: Evidence Ev 321

26 February 2009 Mr Mervyn King, Mr Paul Tucker, Mr Andy Haldane and Mr Andrew Bailey they did not decide what the risks were in these problem and not the nation’s, and allowing a institutions. They were not really knowledgeable number of large institutions and a system to take about what was going on, and these institutions are some catastrophic errors of decision which actually so important that, for systemic reasons, we have to bring the country down? There is surely a diVerence rescue them. That is the problem, I think, and it between the two. certainly goes to the heart of the danger of having Mr King: There is but of course, one of the most too big institutions. remarkable things about this crisis—and let me take Citibank as perhaps the best example here, the Q2403 John Thurso: It is not just about investment biggest bank in the world. When we went to New bankers at one end and retail bankers at the other. In York four or five years ago all the banks in New the middle there are these guys who are playing York were saying “We will probably have to follow roulette with weird instruments. If you look at long- the Citibank model.” “That is the question: do we term capital management and its collapse in 1998, it follow the Citibank model?” Who were the people was basically all the arbitrage guys, who had made running Citibank? Some of the cleverest and all the money, who then lost it, and of course, that brightest people you can imagine, with a wealth of was headed by the same team as the guy who was experience in Wall Street, in government, in booted out of Salomon in 1992 for having done investment banking, in academia and in emerging exactly the same thing. How do we get that lot out market debt crises. They knew a lot about what had of the rest? Does it actually perform any function? happened in the past. It was not in their interests to Mr King: I am not sure if that would solve all the take risks that would turn catastrophic later on. problems because there are plenty of imprudent and They did not set out to destroy Citibank but they risky decisions that banks make which are not of the were as aware as any regulator of what they were kind that require a degree in higher mathematics. doing and what the risks were, yet the outcome was Indeed, as someone said not so long ago, it is a disaster for the bank. They did not intend it, and it amazing that banks go to such trouble to find new is very hard in this situation for those kinds of ways of losing money when the old ones seem to be institutions ever to guarantee that you can avoid doing perfectly well, thank you. Look at all the what, once in a generation, looks like a catastrophic losses in HBOS on commercial property lending. It outcome. That is the challenge we are facing. How takes us right back to the late 1980s/early 1990s, do you decide the infrastructure and legislation when a lot of money was also lost on commercial around institutions to trade oV their ability to property lending. I think very high leverage innovate and create new financial instruments and to inevitably entails significant risks. That is why banks avoid the catastrophic risks that can occur when are risky institutions. things go badly wrong? I do not think it is easy to do that. I think we have to try. We have to learn the lessons from this and try to improve the system but, Q2404 John Thurso: So what we are back to is that as I said in that speech in 2007, are we really so much we just legislate and say, “That’s it. You can’t wiser than the financiers of the past? Do we really leverage that much. End of story.” think that we are going to come up with the answer Mr King: I think it is diYcult to say there is one that will prevent hundreds of years of banking crises, simple answer which means, if implemented, we can suddenly come to a halt? No, we are not going to be go away and forget about the problem. That will able to that. We can try to make it less likely, we can never be the case. When you get to a period in try to diminish the damage, we can try to get into a which—whether you call it the word culture or position where we can deal with the consequences whether you call it the prevailing degree of animal more easily, but these are really fundamental spirits, that people are willing to take risks, then questions about the nature of risk-taking in a market there are likely to be problems, and it is diYcult to economy. know whether you should stop them in terms of legislation or whether you should try to advise people and draw their attention to the risks. What Q2406 Mr Love: Governor, can I come to the Asset would you have said, for example, to the young Protection Scheme? There has been some concern woman I saw on television some years ago saying, “I expressed by the banks that to pay the insurance fees have decided to give up my company pension fund related to the protection scheme will either cause because shares go down in value and I have taken further significant dilution of their shareholdings or out a 100% mortgage to put all my money into a buy- lead to—and the words that are used are—“creeping to-let flat because houses only ever go up in price”? nationalisation.” Are you concerned about that? That is a very risky decision. Do you want to Mr King: I do not think in first order I am legislate to say that someone cannot do that of their particularly concerned about that. I think the banks own free will if they want to, or do you try to find a need to have this protection scheme and I think the way of advising them not to, or do you in the end say taxpayer is entitled to take their share of the returns that they have to accept the consequences of their if they put in money to underwrite the balance sheet. own actions? These are not easy questions. The person who has been working most closely with the Treasury on the design of this is Mr Bailey, so Q2405 John Thurso: That is a good point. Is there perhaps he can comment. not a significant diVerence between allowing one Mr Bailey: I would just echo the Governor’s point person, whether it be me or the lady on television, to that I think the taxpayer is entitled to expect that make a catastrophic error of judgement, which is my when the banks come out of this situation—which Processed: 25-03-2009 23:45:45 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG14

Ev 322 Treasury Committee: Evidence

26 February 2009 Mr Mervyn King, Mr Paul Tucker, Mr Andy Haldane and Mr Andrew Bailey they should and will—when they recover, the money and take shares, has the great merit of trying taxpayer will be able to recover the amount of public to make clear to everybody, particularly in the rest of money that has been put in. the world, that nobody thinks that the Government should be involved in running these banks Q2407 Mr Love: Can I interrupt you? I do apologise. indefinitely and that the shares will be put back on to In relation to the Royal Bank of Scotland, it was the private market and the banks will be back in the widely trailed that the level of fees would be 4%. It private sector. I think avoiding the actual process of has turned out to be 2%. Are you surprised at that formal nationalisation has great merit from that decision? point of view but the economic substance is clear: the Mr Bailey: There are a number of variables in the taxpayer has had to put in so much money to ensure equation by which you arrive at the overall outcome, the viability of these banks that it is now of which the level of fees is one, and the so-called contributing a majority of the equity capital as well attachment point, which is the level of the first loss as a vast amount of public support in terms of that the bank bears and the level of loss beyond that lending to the banking system. that the government shares with the bank, but in a ratio that is heavily towards the government, so you Q2410 Mr Love: Can I just quote briefly from the have to look at the whole thing to get the essentials press release, because it comes to a point that you of that. raised earlier, I think in a response to Mr Cousins. It says, “In determining the pool of assets, banks will Q2408 Mr Love: Let me look at the whole thing. be subject to extensive due diligence on the identified According to the scheme, they are taking on what assets.” I would interpret that as meaning that we are the public certainly think—I do not know what the at the start of the process rather than either halfway Bank thinks—are very high-risk assets: through or near completion. We do not want to get collateralised debt obligations, collateralised loan into semantics about that but are there any concerns obligations, and included within this, the first loss, that the due diligence process will take so long when according to the RBS, is roughly 6% of the overall we really need to get on with re-establishing trust in assets included. The residual exposure is 9% so the the banking system? total bank exposure is 15% of the assets. That leaves Mr King: No, but the point I have been making very a potential maximum of 85% for the public purse. strongly to the Chancellor now is that you have to Clearly, that will not all materialise but are you take the time to do the due diligence. The fact that concerned about the balance that seems to be being we need to do something to shore up the balance struck in this deal? sheet of the banking system—and that has to be Mr Bailey: The balance that is being struck is the one done quickly, I accept—is not a reason for not that has to be struck to get the bank to a position starting the process of due diligence. You have to where it is stabilised. Let me be clear. The amount of start it at some point in order ever to complete it. We the pool of assets that has been announced is £325 have to do that. It will take time. They have already billion. We do not expect £325 billion of assets to go started it and have got some way down the road. bad. The whole exercise—and it is subject to the This is a continuation of a process that has already point the Governor and I made earlier about the begun, but it is vital, as you suggest, that the need to do this very thorough due diligence over the underpinning of that balance be put in place now, coming period—is to isolate those pools of assets without any ambiguity, so that anyone that is where the losses are most likely to be. thinking of lending to a bank will be able to do so secure in the knowledge that the capital position of Q2409 Mr Love: Can I stop you there because I want that bank is completely secure, underwritten by the to come to the due diligence point in a moment. Government, and that the bank has access to the According to the scheme, the Government will credit guarantee scheme to fund its lending. Only in charge £6.5 billion. It is providing an additional £13 that state can we possibly expect banks to start billion of further capital and a potential further £6 lending again. billion. That is £25.5 billion potentially of additional capital. Does that not mean that in eVect RBS has Q2411 Mr Love: Can I take you a step further? been nationalised? Governor, I would like your Although bad banks have been rather cast in a views on this. shadow because of the real diYculty of pricing the Mr King: I am not going to comment on the details assets at this particular time, there is a lot of people because we did not get them until quarter to nine this that think that the insurance scheme, which is being morning. What I will comment on is the principle of replicated, I think, in other parts of the world, is only this, which is that most of the major banks do need a a first step towards a bad bank. What is your view on very significant support, and in the case of RBS and that matter? Lloyds, that support essentially amounts to the Mr King: I think the Chancellor has been clear on Government putting in a majority of the base equity that and wishes of range of options. The important capital that is needed. In that sense, the Government thing to do at this stage was to start the process, owns more than 50% of the equity of the bank and which had already begun, and began before today,of it can make its decisions accordingly. I do not see a examining the balance sheet, underpinning the significant diVerence between that and outright capital position of the bank. Once we know what the nationalisation, except in the sense that the system balance sheet is like, then it is possible to think about we have now, which is that the Government puts in how you would price assets, whether you want to Processed: 25-03-2009 23:45:45 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG14

Treasury Committee: Evidence Ev 323

26 February 2009 Mr Mervyn King, Mr Paul Tucker, Mr Andy Haldane and Mr Andrew Bailey split the bank into good bank, bad bank. There are performance-related pay, and this is related not to a range of options that will become available at that financial performance but to very clearly defined point but you cannot wait until that point; you objectives, set for each member of staV at the cannot do nothing; you have to underpin the balance beginning of the year. We pay something like 7% of sheet now. A split between good bank/bad bank is the total compensation in the form of a bonus. The certainly a feasible option down the road. That same scheme applies to everybody apart from the remains to be seen. The diVerences between that and Governor and two Deputy Governors, for whom insuring assets are a matter of degree; they are not there is no bonus at all. qualitatively diVerent. Q2416 Chairman: Why is it you can get out of your Q2412 Mr Love: From the sound of things, you are bed in the morning without a bonus and the rest of attracted by the idea that when we get further down the banking industry cannot, without getting ten or the road, when we know better what the shape of 20 times their basic salary? these assets is, a bad bank purchase scheme may be Mr King: You would have to ask them. the sensible way to go. Mr King: I am not sure if I am keen on the taxpayer rushing in to buy assets without knowing what the Q2417 Chairman: You are quite happy to get out of price is. That is why we have to wait for the end of your bed in the morning for a basic salary? the process. At the end of it, I am certainly attracted Mr King: I am extremely well paid and I get out by a process that cleans up and restructures the because I love the world of public policy and I bank’s balance sheet. That is absolutely vital. That enjoy it. was the lesson from earlier banking crises. We have got to get to grips with this and realise that balance Q2418 Chairman: The issue of bonuses, certainly sheets have to be cleaned up, and only at that point from the evidence we have received so far, is that will you have a good bank that people will have there is a recklessness about the situation, because confidence in and can return to normal. The sooner they are dealing in the short term, dealing with other that happens, the better but we have to be prepared people’s money but, irrespective of success or failure, to take the time to do the forensic analysis of the they are rewarded. balance sheet first. Mr King: I think there are jobs and jobs. One of the things I found somewhat distressing about the lives Q2413 Chairman: Thank you. Paul Tucker, with of many people who worked in the City was that so regard to the financial stability responsibilities, how many of them thought that the purpose of a bonus many extra staV have you taken on or are you and compensation was to give them a chance to leave taking on? the City, to do something they really wanted to do, Mr Tucker: We are taking on just over 20 staV to run having built up enough money to give them the the special resolution regime and half a dozen to financial independence to do it. I think that is rather support the payment system oversight function, sad because actually, there is nothing more because that is being put on a statutory footing. That rewarding. I am well paid, make no doubt about it, is where the increase in resources is being focused and so are most people at the Bank compared with so far. many ordinary people around the country. Having more money is not going to motivate us. We enjoy the job. We are privileged to have this position. It is Q2414 Chairman: Are you content with those that which motivates people to work. That is why arrangements? people in the Bank worked all night and all weekend Mr Tucker: In terms of the new statutory functions, when Bradford & Bingley was resolved without any I am content. Andy’s area has expanded somewhat overtime payments. over the past year beyond that but, as I said in my written evidence to you and in my confirmation hearing, this is something that I shall want to look at Q2419 Chairman: Governor, the Financial Times with the Governor and with Andy, Andrew and this morning said that you were going to announce other colleagues, as I get my feet under the desk. at our Committee the contents of your letter to the Mr King: The financial stability area has already Chancellor requesting permission to start increased by around 20 people over the past year. We quantitative easing. I have not heard anything of have done that already in large part. that so far. Mr King: No, I have not read the Financial Times yet. I must find out. I always find it helpful to follow Q2415 Chairman: Governor, just on the bonus the media to know what we are going to be doing. aspect, is there a bonus or performance-related pay structure within the Bank and are the lower paid staV on the same scheme, with the same conditions as the Q2420 Chairman: Can we await that shortly then? senior staV? Mr King: Yes, I think you can expect that there will Mr King: Yes, some years ago the Court of the Bank be an exchange of letters and that we will be able to decided that it wanted to increase the proportion of explain that to you in more detail when we come remuneration that was oVered in the form of back again in March. Processed: 25-03-2009 23:45:45 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG14

Ev 324 Treasury Committee: Evidence

26 February 2009 Mr Mervyn King, Mr Paul Tucker, Mr Andy Haldane and Mr Andrew Bailey

Q2421 Chairman: Good. Lastly, Governor, the we were in Japan in October and the message there genesis of the present crisis: how much do you put was that you have got to take the public and the that down to the major imbalances within the global consumer with you. I think there is a lot yet to do in economy, how much are they receding and what that area. prospect is there for re-balancing? Mr King: We are very conscious of that. If there was Mr King: I think that was a major factor in making an area where we would really have to improve and this possible and I think it is very important that we work harder, it is undoubtedly in the area of are not just diverted into fields of regulation and the communications. That is easier said than done. I do behaviour of banks and incentives. They are not think we shall be popping up all the time on the undoubtedly important but it is not the sole thing. regular programmes but we need to be able to The financial imbalances I believe generated capital explain clearly and simply what we think the flows which were the underlying cause of all these problems are and what we are doing to put them problems, and what we are going through now in the right. If I could take the opportunity now: we will world downturn is leading to changes in those come through this. There have been downturns and imbalances, undoubtedly. What we do not have is an financial crises in the past. Undoubtedly we will international monetary system that will prevent come through this. It will not go on for ever. It will those imbalances from being created again, and that be painful but we will come through it and I think we is what is so important now. will have learned some painful lessons but lessons that will enable us to improve the system. Chairman: Governor, we have given you notice of Q2422 Chairman: In terms of our inquiry, Governor, that. Maybe you could do some fresh thinking for we hope to come out with a report within a month us. We have found your evidence and that of your or so but we are following that up with the colleagues at the beginning of this inquiry very international dimension, which is very important, helpful in helping to formulate our policy. That just and if we can receive any evidence from you on that, leaves me to wish Mr Paul Tucker every success in but also on the issue of public confidence, because your new job. Thank you very much. Processed: 25-03-2009 23:58:58 Page Layout: COENEW [SO] PPSysB Job: 416782 Unit: PG15

Treasury Committee: Evidence Ev 325

Tuesday 3 March 2009

Members present

John McFall, in the Chair

Nick Ainger Mr George Mudie Mr Graham Brady John Thurso Mr Michael Fallon Mr Mark Todd Ms Sally Keeble Mr Andrew Tyrie Mr Andrew Love Sir Peter Viggers John Mann

Witnesses: Mr Glen Moreno, Acting Chairman, and Mr John Kingman, Chief Executive, UK Financial Investments Limited (UKFI), gave evidence.

Q2423 Chairman: Good morning, and welcome to Mr Kingman: I said that I do not have those figures the Committee. Mr Moreno, could you identify and we would be very happy to ask the banks yourself please. whether they would be willing to disclose those Mr Moreno: Yes, my name is Glen Moreno and I am figures.1 Chairman of Pearson and Acting Chairman of UKFI. Q2430 Mr Mudie: But you were asked on Friday to Mr Kingman: I am John Kingman. I am Chief get them. Why do you turn up in this sort of smug Executive of UKFI on secondment from the ‘never mind the Committee’ way? The Chairman Treasury. sent through word that he wanted these figures. Mr Kingman: I am afraid, I do not have those Q2424 Chairman: Now, just as a matter to get on to figures. the public record, how many staV at each of RBS, Lloyds Banking Group, Northern Rock and Q2431 Chairman: But, Mr Kingman, are you going Bradford & Bingley were paid more than £100,000 to be a serious body here? You are standing behind in 2008? hundreds of billions of pounds of taxpayers’ money Mr Kingman: I do not have that figure available, I and, in the interest of the taxpayer, you got a simple am afraid. request on Friday and you do not even seem apologetic that you do not have it. Mr Moreno, Q2425 Chairman: Could you send those precise come on, give us a break here. details to us? Mr Moreno: Chairman, my understanding is the Mr Kingman: I will certainly ask the banks. following: that we had, in the original RBS proposal, a breakdown of various degrees of bonuses, sort of broad categories. Those were knocked back and Q2426 Chairman: So how many staV at each of the they were subject to a great deal of negotiation, as four firms received bonuses, in cash and shares you know, over the last couple of weeks. My own combined, greater than £100,000 and £1 million in understanding, and correct me if I am wrong, John, 2008? is that the discretionary bonuses actually have not Mr Kingman: Again, we do not have those figures. been awarded yet. The aggregate amounts have been We can ask the banks whether they wish to disclose negotiated for the bank, but I understood that those those figures. were to be awarded in March.

Q2427 Chairman: Well, actually the Committee staV Q2432 Chairman: But, Mr Kingman, why did you phoned you on Friday to brief you specifically on my not come back to the Committee before today and question and that is why I thought you would have say, “We can’t give you that information”? I think it it on the record today. is highly discourteous of you. Mr Kingman: I am afraid, I do not have those Mr Kingman: Well, I apologise, Mr Chairman, if you figures, but we, as I say, would be very happy to ask feel it is discourteous. I do not have that the banks— information. We would be very happy to ask the banks whether they are willing to provide that information. Q2428 Chairman: But we phoned you on Friday for them. Mr Kingman: Well, I am afraid, I do not have Q2433 Chairman: Given that I had asked you on those figures. RBS, Lloyds Banking Group, Northern Rock and Bradford & Bingley,did you contact these individual companies and ask for that information? Q2429 Mr Mudie: Can you say again what you said to the Chairman? 1 HC (2008–09) 144–III, Ev 593 Processed: 25-03-2009 23:58:58 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG15

Ev 326 Treasury Committee: Evidence

3 March 2009 Mr Glen Moreno and Mr John Kingham

Mr Kingman: No. Mr Kingman: Would it help, Mr Chairman, if I Chairman: Is it worth going on with this session! Mr started by setting out the facts as I understand them Moreno, this is terrible. about this issue, if that would be helpful. I should say that I personally was not involved in the relevant Q2434 Mr Mudie: So why not? Why, when you were discussions and UKFI did not exist, but on 19 asked to prepare yourselves and come with this February UKFI became aware that Fred Goodwin’s information, did you not even ask the banks for this pension arrangement, which we had always information? understood to be an unavoidable legal commitment, Mr Kingman: Mr Chairman, I apologise if there was was in fact partly discretionary. The reason it is any misunderstanding. discretionary is that his entitlement to an undiscounted pension from the age of 50 stemmed Q2435 Chairman: There was no misunderstanding. from the decision of RBS that he should be treated Mr Kingman: Well, there is a misunderstanding on as retiring at the request of the employer. Had those my part. concerned decided instead simply to terminate the contract, as RBS could have chosen to do, with 12 Q2436 Chairman: No, there is not. months’ notice, the right to an undiscounted pension Mr Kingman: Well, I am afraid, there is, which is that would not have applied. The consequence of this we were briefed on a number of broad areas we decision was roughly to double the value of Fred expected the Committee to ask and I had not Goodwin’s pension pot. UKFI immediately took understood that there was a specific request to ask legal advice because this decision does seem to us the banks for this information. We are happy to ask extraordinary and it remains unexplained. We are them whether they are willing to provide that investigating whether the committees of the RBS information. Board involved in taking the decision did so with the full knowledge of the alternatives. I understand that Q2437 Chairman: The Clerk is telling me that you the Government was informed at the time of the were phoned on Friday and asked specifically. rough size of the pension pot that resulted from the Mr Kingman: Well, I apologise. That message decision. What the Government was not told was certainly had not reached me with that clarity and I that this payment was in any way discretionary. We apologise for that. have clear evidence that the Government repeatedly made clear to RBS that weekend that it expected to Q2438 Chairman: Well, I think that is scandalous, see no reward for failure and all payments to quite honestly, and I think it is a bad start for UKFI outgoing directors were to be minimised, subject because, when we look on your website, there is a only to unavoidable legal commitments. The paucity of information anyway and that was the principle of no reward for failure was repeated in the reason we asked for it. If you are a serious body terms of the recap agreements signed between RBS looking after the interests of taxpayers, then you and the Government at the end of that weekend and have got to show that there is a seriousness about it was also a key part of the terms of reference of you and, frankly, we are all appalled at this this RBS’s own Remuneration Committee. The morning. arrangement put in place for Sir Fred Goodwin was Mr Moreno: I cannot respond to your question on clearly inconsistent with these principles, and our individual bonus awards at RBS. I can say that view is that criticism should be directed at those who UKFI has been very heavily involved over the last took the decision. We are, as you know, vigorously few weeks in negotiating RBS’s original bonus exploring with the company all possible legal proposals and, frankly, pushing them down and avenues of redress. To come to your question, Mr pushing them out and making them payable in Chairman, the decision was clearly taken by RBS. It deferred debt paid by the bank over three years, was not approved or endorsed by the Government, starting in 2010, so, in John’s defence and in UKFI’s though the Government was informed of the size of defence, they have been very heavily focused on the pension pot, but the impression received by the reducing, where they could, the discretionary part of Government, consistent with the principles that the the bonuses. Government had stressed, was that this was an unavoidable legal commitment. It turns out that that Q2439 Chairman: So you would say, as Acting was only the case because of the decision that had Chairman, that it is appropriate to respond to a been taken which was discretionary. request of the Select Committee and you take it seriously enough? Q2441 Chairman: So was the decision that Sir Fred Mr Moreno: Of course I do and I know John would Goodwin had to go taken by the entire Board? as well. I was not aware of this request. Mr Kingman: My understanding is that that decision was taken first by the non-executives meeting alone Q2440 Chairman: The Fred Goodwin issue, I want on the Friday and was subsequently endorsed by the to get that out of the way at the moment, but that is Nominations Committee of the Board later on the not the biggest issue and there are lots of questions Friday. we want to ask you about, but that one first of all, to get it out of the way. I am interested in the time-line on this information. Who ultimately approved the Q2442 Chairman: Did the full Board have the full deal on Fred Goodwin’s pension? facts and when did they have them? Processed: 25-03-2009 23:58:58 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG15

Treasury Committee: Evidence Ev 327

3 March 2009 Mr Glen Moreno and Mr John Kingham

Mr Kingman: We are exploring that question and I is hard to know, if you are not in a boardroom, what do not feel we have got to the bottom of that went wrong. Certainly, these were people of integrity question. We know that there was a Remuneration and experience. Committee meeting that endorsed a proposal from the then Chairman and the then senior independent director to handle Sir Fred’s exit in the manner I Q2447 Chairman: Of course, but you have been a have described, ie, as an early retirement. That was director of a board for many years and lifelong in the subsequently endorsed by a meeting of the industry. What would a director need to do to a company to become fireable? Chairman’s Committee of the full Board at which V the executive directors and Stephen Hester were not Mr Moreno: Well, he would normally be thrown o present, which took place at 1.30am on the Monday a board, I would have thought, if he were not— morning. Mr Kingman: I think there is an important point which is that, as we understand it, Sir Fred Goodwin had 12 months’ notice, so the Board could simply Q2443 Chairman: At the end of the day, who is to be have decided to terminate his contract with 12 held responsible for the decision on that pension? months’ notice without having to identify a cause. Mr Kingman: Clearly, this was a decision taken by They could simply have given him 12 months’ notice RBS and my understanding is that the two key and, plainly, the cost of that would have been a good decision-takers were the then Chairman and the then deal less than the pension outcome that we now Chairman of the Remuneration Committee, who know followed from their decision, and I think that was also the senior independent director. is the crucial point. Mr Moreno: I think it goes beyond that. There is a Q2444 Chairman: That was Bob Scott and Tom tendency for boards to take legal advice and the legal McKillop, so those two? advice is, “You can’t do anything about this”. Look, Mr Kingman: Correct. if somebody destroys the value of a longstanding institution on that scale not through any sinister motive, but just by inadequate management, there is Q2445 Chairman: Your assessment, Mr Moreno, of a point at which the Board has to say, “We’re sorry, good governance at RBS? You have got you’ll have to stand down on the basis of your longstanding experience in this. performance”. If that leads to legal claims Mr Moreno: On this issue, I have to say that I regard subsequently, that is something a board has to deal this as completely reward for failure and what in with, but that is a decision for boards, not for America is called a “golden parachute” I think it was lawyers, I think. wrong. I do not think the Remuneration Committee or the Board of RBS should have eVectively increased, doubled, I guess, a pension benefit in that Q2448 Chairman: Is the relationship between Sir situation. I also have to say that I do not think there Fred and the Royal Bank of Scotland completely was any great attempt to make that very clear to terminated? Is there any access he is getting to any people. As I recall, this Committee probed, properly, benefits at the moment? Sir Fred on his pension benefit and his answer was Mr Kingman: I am not in a position to give a full along the lines that, “I’m a member of the full answer to that. There may well be lingering things retirement scheme, like everyone else in the under various contracts, but I am not in a position company”, and neither of them pointed out the fact to say. I can certainly get information on that, if that that this very significant change had been made, so I would be helpful. do not suppose that at any point in the process that was disclosed to either the institutional shareholders Q2449 Chairman: There are a whole range of things or anybody else. and we are possibly talking about security or whatever else, lawyers’ fees or whatever, so could Q2446 Chairman: There are suggestions in the press you look at that and write to us on that particular that there will be 20,000 job losses in RBS, and I issue? would presume that not every employee who is made Mr Kingman: Yes, I would be happy to.2 redundant will get the same terms as Sir Fred in that, if they retired at 50, there will be no actuarial Q2450 Chairman: Lastly, can I say that we got the discount. Framework Document this morning and that was Mr Moreno: I do not know the answer to that not enough time for us to read everything, so I think question, but I am sure the pots will not be it has been a bad start for you. comparable. I do think on the broader governance Mr Moreno: We only got it yesterday. issue, and it is obvious in the case of RBS, but it is a Chairman: Let us hope that, as time goes on, we will very important point of the entire issue that this get more friendly, so a couple of hours later. Committee has been reviewing over the last few months, that we clearly had a massive governance breakdown in the banking system and it has caused Q2451 Mr Fallon: John Kingman, you said you were not only huge damage to the banks, but it has caused not involved in this Goodwin aVair, but your biog on a body blow to the prospects of others because the UKFI says that you led the negotiations with RBS. economy and the economic downturn, I believe, are a direct result of the failure of the banking system. It 2 HC (2008–09) 144–III, Ev 593 Processed: 25-03-2009 23:58:58 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG15

Ev 328 Treasury Committee: Evidence

3 March 2009 Mr Glen Moreno and Mr John Kingham

Mr Kingman: It is absolutely correct that I led diVerent, and that fact was not, so far as we can oYcial negotiations on the recapitalisation of the establish, shared with anyone in Government until banks, but, as it happens, I had no involvement 19 February. personally in, what I might call, the ‘people aspects’ of the decisions that were taken that weekend. Those Q2461 Mr Fallon: Was nobody in Government were handled politically. aware of the 2007 RBS Annual Report, which says, “The RBS fund allows all members who retire early Q2452 Mr Fallon: Did a Treasury oYcial accompany at the request of their employers to receive a pension Lord Myners and the lawyer? based on accrued service with no discount applied Mr Kingman: No. for early retirement”? Mr Kingman: I think what we were not aware of was Q2453 Mr Fallon: So there is no note of these that the Board had chosen to take a route which had meetings? the eVect of doubling the pension pot. Mr Kingman: There is a note which was taken by the lawyer. Q2462 Mr Fallon: But Lord Myners told the House of Lords last night that it was a few days later in Q2454 Mr Fallon: Can that be made available to us? October that he was advised of the sum of the Mr Kingman: I do not see any reason why not. I will pension, so he must have known the total pot. have to check with the lawyer, but I am not aware of Mr Kingman: I do not know exactly at what point any reason why it cannot be shared with you.3 that weekend that the number was known, but I do know that the number was known to the Q2455 Mr Fallon: Lord Myners tells us that the Government that weekend. pension was first discussed on the Saturday, which was October 11. Q2463 Mr Fallon: So, if the sum of the pot of the Mr Kingman: Yes. pension was known in October, why did it take until last week for UKFI to act? Q2456 Mr Fallon: So he must have been aware, Mr Kingman: Well, UKFI acted immediately on therefore, of the initial Board decision the previous discovering that this had in fact been discretionary, day to terminate Fred Goodwin? contrary to the impression that had been given at Mr Kingman: Yes. the time.

Q2457 Mr Fallon: He was aware of that? Q2464 Mr Fallon: The final decision on this pension Mr Kingman: Yes. appears to have been taken, you have just told us, by the Remuneration Committee and then the Q2458 Mr Fallon: So why did he accept an assurance Chairman’s Committee at the end of the weekend, that the pension reflected 30 years of service when he that is, the Sunday night or very early on the knew that Sir Fred had only joined the bank ten Monday morning, so Lord Myners could in fact years earlier? have prevented this decision? Mr Kingman: I am not in a position to answer that Mr Kingman: I have no idea whether he could. It question. He may well have assumed that previous seems to me an entirely hypothetical question pensions were transferred in, but I am not in a whether he could have prevented the decision. I do position to answer that question, I am afraid. not see how he could have prevented it when he was not told very material facts that, clearly, he ought to Q2459 Mr Fallon: Why did he say in his letter that have been told. In any event, it was not his decision he only became aware that the Board decision may to take, it was a Board decision and necessarily a have involved a discretionary choice? Board decision. Mr Kingman: I think nobody in government was aware of that until 19 February, as far as I know, Q2465 Mr Fallon: But it had not been taken at that which was the point at which we discovered that point. He is an experienced director, he has served on there was an element of discretionary choice, and remuneration committees, so, had he asked the right that is the key fact which, it appears to me, should question on the Saturday, this decision could have have been made available to Lord Myners that been very diVerent on the Monday morning, could weekend, but was not. it not? Mr Kingman: It is factually the case that, as I Q2460 Mr Fallon: But, if it was a Board decision, it understand it, the compromise agreement was must have been a discretionary choice, by definition, signed in the early hours of Monday morning. must it not? Otherwise, it would not have gone to the Board. Q2466 Mr Fallon: Yes, but what we are trying to Mr Kingman: Well, I think any decision, any establish is whether this was a nod-and-a-wink, settlement with Sir Fred would invariably have had banker-to-banker deal between Lord Myners and or would certainly have had to be approved by a Fred Goodwin or whether this was just sheer committee of the Board at any rate, but the key point bungling incompetence. Which do you think it was? is that the terms on which he left could have been Mr Kingman: I think that it is not reasonable to expect a minister to have known about the fine detail 3 HC (2008–09) 144–III, Ev 593 of the entitlements of Fred Goodwin under the RBS Processed: 25-03-2009 23:58:58 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG15

Treasury Committee: Evidence Ev 329

3 March 2009 Mr Glen Moreno and Mr John Kingham pension scheme such as to know that the Board was Mr Kingman: I can confirm that there are UKFI staV not sharing with him material facts that it ought to who have eligibility for bonuses. Could I set out have shared with him, given that the arrangement the facts? they were putting in place was clearly inconsistent with the principles that Lord Myners had set out to Q2474 Nick Ainger: Yes, please. him, and we have clear records that he did set out Mr Kingman: We are not planning City-style those principles. Those were no rewards for failure bonuses, to be clear. We will be a very small and that any payment should be minimised, subject organisation. The total cost of running UKFI we only to legal entitlement. expect to be in the lowish, single-figure millions. We currently have 11 staV and we expect to be something Q2467 Mr Fallon: So you do not think it is of the order of 15 or 16 staV when we are fully reasonable to have expected Lord Myners to have complemented. That includes a number of civil asked whether or not Fred Goodwin was being servants on secondment who are eligible, like all civil terminated or given notice? You do not think that is servants, for modest bonuses, and I am myself a reasonable? seconded civil servant on a standard Civil Service Mr Kingman: I do not think it is reasonable to have contract. We have at the moment two employees expected Lord Myners to have had suYcient from the financial services sector. I am not proposing detailed understanding of the rules of the RBS to disclose their exact terms, they are not members pension scheme to have known that the Board was of our Board, but they are earning very substantially not sharing material facts with him. less than they earned outside and that they could earn outside, even in the present circumstances. Q2468 Mr Fallon: But, given that the right to take These are people who have taken huge pay cuts and early retirement was in the Annual Report, surely the bonuses for which they are eligible will not be Lord Myners should have known that? City-style bonuses, they will be fractions of salary Mr Kingman: I have no reason to know that Lord rather than multiples of salary, and, if we were to pay Myners was told that he was being asked to take out the maximum bonus eligibility across our early retirement. I think Lord Myners was simply organisation, we would expect that to be no more told that Fred was going and I think the clear than 15 to 20% of our total staV costs. My view is impression he had was that Sir Fred was going with that we are very lucky to be able to attract these sorts his minimum entitlement. It now turns out that that of people. They have taken enormous pay cuts. I do was not the case. not think we could do our job professionally without it and I also do not think it is wrong that some part of Q2469 Mr Fallon: But he knew within a few days of people’s pay should be related to performance; that that weekend that the pension pot had been seems to be a good principle. diVerent. Mr Kingman: He knew that the pension pot was Q2475 Nick Ainger: But what are the objectives built very large. into this bonus scheme? How will the performance- related pay be calculated? Q2470 Mr Fallon: So he did not ask the obvious Mr Kingman: Bonuses will be entirely at the question on the Saturday or the Sunday as to the discretion of the UKFI Remuneration Committee circumstances of the pension entitlement. based on individuals’ performance against their Mr Kingman: It is not obvious to me that it was objectives which will be set by me. obvious that there had been a change. Clearly, that is easy to say with the benefit of hindsight. Q2476 Nick Ainger: We had evidence from the Governor last week and there has been a whole Q2471 Mr Fallon: It was clearly a mistake, was it range of people commenting on the bonus culture not? and that this was a major factor in why we have Mr Kingman: I believe the mistake here was made by ended up with the credit crisis that we have. Are you the RBS Board and those on that Board who took not, by going along with a bonus culture, admittedly this decision, which was clearly inconsistent with the diVerent from those that we have seen the worst principles that they had discussed with Lord examples of, but are you not actually perpetuating Myners. the bonus culture by agreeing that there will be bonuses paid? After all, senior people, as the Q2472 Mr Fallon: No, I am asking you about Lord Governor told us, throughout the Bank of England Myners. Lord Myners made a mistake, did he not? just work for their salary and they get up in the He did not ask the obvious question that weekend. morning perfectly happy to do that job. Why are Mr Kingman: I am not willing to criticise Lord your staV not prepared to work on those terms? Myners; I do not think it is reasonable. This was not Mr Kingman: My Chairman may want to comment, his decision and I do not see how he could have but I really do not believe so, and I would observe known very important facts that, I feel, those who that we have pushed through the most radical did take the decision ought to have shared with him. change in bonus culture of any large bank in the world at RBS. I do not believe there is any large bank Q2473 Nick Ainger: Mr Kingman, can you confirm in the world that has made changes remotely whether UKFI will be running a bonus scheme this comparable to what we have secured at RBS. The year? key point that people are making about the bonus Processed: 25-03-2009 23:58:58 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG15

Ev 330 Treasury Committee: Evidence

3 March 2009 Mr Glen Moreno and Mr John Kingham culture in banks is that in banking it is very easy to consulted. I think shareholders have every right to a make your work look good in the short term, but view, and we have a strong view, about the approach leave all sorts of problems for the longer term, and boards take to failure. that is a very diVerent kind of operation, when you are paying bonuses that are many multiples of Q2481 John Mann: Well, my legal advice is not that people’s salaries, from people doing a job in UKFI there is a legal obligation, but that there may be a where a small proportion of the salary will be paid in legal obligation in this case to have consulted a way that is related to performance. shareholders. What is your legal advice? Mr Moreno: I do not know about the legal advice of UKFI, but, in general, the Best Practice Guidelines Q2477 Nick Ainger: But, to come back to this for Institutional Investors stress the fact that question about performance, how are you going to remuneration committees should particularly judge their performance? disclose to institutional investors decisions about Mr Kingman: The judgments will be made and I will departing directors which may cause controversy, if make a judgment on their performance against their I remember it correctly. objectives and that will inform the decisions of the UKFI Remuneration Committee about whether any bonus should be paid. Q2482 John Mann: And they did not do so? Mr Moreno: No.

Q2478 Nick Ainger: So it will have nothing to do Q2483 John Mann: And, therefore, there is with the ultimate disposal of the shares in these potentially a question mark about their actions, a banks? It will not be based on that? legal question mark, possibly under the Companies Mr Kingman: Well, I have not set some formulaic Act 2006? thing for the organisation, but we have a very clear Mr Kingman: We are exploring every legal avenue central mission which is to manage these that might provide any form of recourse in this shareholdings in such a way as to maximise their situation. value and to extract ourselves over time. For example, if I were to say that bonuses will be paid Q2484 John Mann: Why did you wait until depending on exit, staV would have a perverse February 19? incentive to sell at whatever the price, and I do not Mr Kingman: I do not believe we waited until think that is a healthy incentive for them to have. My February 19. February 19 was the point at which it staV will have personal objectives which are set by became clear to us that this decision, which we had me and their performance will be judged in the light understood to be non-discretionary, was in fact of those personal objectives, and I fully expect that discretionary. we will obviously be publishing aggregate staV costs and I fully expect to have to defend them in front of Q2485 John Mann: But, when you launched on 3 this Committee. November, point 4 in the press release, your remit is, including other things, to “restrict the potential for Q2479 John Mann: I have a question for you, Mr rewarding failure”, so that pension could have been V Moreno, but before I come to that I have some paid in less tax or, rather, a pay-o , not a pension. A questions for Mr Kingman because I think it would contractual ending could have been paid as a lump be fair to say that you were there at the beginning of sum, in which case the taxpayer, whom you UKFI, in fact you were there before the beginning, represent, would have got 40%. and I know you will not want to mislead the Mr Kingman: I do not believe there is any way that Committee in any of your answers in the way that UKFI could have stopped the decision because the Mr Goodwin did when asked about his pension. Is decision was taken by the Board of RBS on the Mr Goodwin’s pension entirely and fully funded out Monday morning well before UKFI existed. We of the RBS pension fund? have been having extensive discussions with our Mr Kingman: I am not sure that I know the answer boards about their approach to remuneration, to that question. He certainly had pensions from including rewards for failure going forward, and I previous employment and I am not sure what has see that as an important part of our mission. We are happened to those pensions. discovering facts about the past, some of which may be able to give us rights to take legal action, which will be in our interest as shareholders, and that is an Q2480 John Mann: Twelve months’ notice, the important thing. We have asked the boards of both contract. You said a few minutes ago that it was of the large banks in which we have invested to necessarily a Board decision, but that is not undertake major reviews of everything that went necessarily the case, is it? There is a question mark wrong at RBS and HBOS to establish whether there about whether shareholders should have been are any opportunities for taking legal recourse in consulted over this decision. There is a legal question those banks. mark, is there not, about whether shareholders should have been consulted? Q2486 John Mann: But, since you came into the job Mr Kingman: I do not think there is any legal on 3 November with that remit, to “restrict the obligation on boards to consult shareholders and I potential for rewarding failure”, there is, and there do not believe that shareholders would normally be always was, a question mark about the legal Processed: 25-03-2009 23:58:58 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG15

Treasury Committee: Evidence Ev 331

3 March 2009 Mr Glen Moreno and Mr John Kingham entitlement and particularly when you are could be provided, and I would not expect you to representing the Revenue, ie, the taxpayer. Why did have that in your head now, I would find that very you not look into this from 3 November? useful. Mr Kingman: Well, I can only say that we did not. Mr Moreno: I have no idea, but I can look at that.4 We have had a lot to do, these are large banks, and we have been focused principally on reshaping the Q2493 Chairman: Are you okay providing that? way these banks work for the future as opposed to Mr Moreno: As far as I know, they are usually in the the past. We are, however, pressing our banks, and banks’ annual reports in huge detail, but we will they have agreed to undertake full reviews of what certainly ask the banks for them, so we will answer happened in the past, to identify what opportunities those questions. there are for legal redress. Q2494 Chairman: But, given again that press stories Q2487 John Mann: In answering the Chairman, you are saying that a lot of the assets that the Royal Bank said you were not sure whether there were other such of Scotland has are overseas and that has brought cases that would come to light, and what are you about the problem, I think we need a clarity and a doing to see whether there are and what should be transparency to this situation with the banks, and I done about them? think that is behind John Mann’s question. Mr Kingman: Well, I think the principal issue on Mr Moreno: I think RBS has pretty good disclosures which we are focused, other than the well-publicised on the geographic location of their portfolios and issues around Sir Fred, is that we have agreed with that sort of thing in their full report, which is out Lloyds that Lloyds conduct an exercise to assure soon, I assume, but not yet published. themselves that the departing executives of HBOS Mr Kingman: We are very happy to ask the banks were paid no more than was legally necessary. We what information they can provide on that. were assured at the time by HBOS that that was the basis on which they were working, but we have agreed with Lloyds that Lloyds should undertake an Q2495 Mr Brady: Mr Moreno, at what point did you exercise, an exercise which has been under way for decide not to seek the permanent chairmanship of some time, to assure themselves and us that no more UKFI? was paid than necessary in those cases. Mr Moreno: I never sought the permanent chairmanship of UKFI and it was never discussed with me. Q2488 John Mann: Do you have the legal advice now on Mr Goodwin’s pension? Q2496 Mr Brady: And that was clear right from Mr Kingman: Extensive legal advice. the start? Mr Moreno: Yes. What happened was that I Q2489 John Mann: And do you intend to act? volunteered to serve as UKFI non-exec, for obvious Mr Kingman: We intend to take any opportunity and reasons, because I think this is the worst financial it would either be for us to act or the Board of RBS crisis we will ever face and, if we blow it, we are going to act, and that is a very live issue. to lose a generation of prosperity, and I have had a lot of experience of prior banking crises and Q2490 John Mann: What is the timescale on that downturns. What happened was Philip Hampton action? went to RBS, and I was with my wife on a brief Mr Kingman: Well, it depends. To the extent that any holiday in Malta and I got a phone call, saying, “Will potential for legal action derives from an analysis of you do this?” and of course I said yes. There was no all the events of the past, possibly relating to Sir Fred discussion of my doing it on a permanent basis at or possibly relating to other actors in the drama of any time, it just was not discussed and, I have to tell you, based on the amount of time I am spending on RBS and HBOS, I would expect that to take weeks Y rather than days because there is a lot of past to go it right now, it would be very di cult, so it was never through. proposed to me as a permanent assignment. In fact, my understanding was that there is a process that the public sector has to go through to make those kinds Q2491 John Mann: Is that weeks rather than of appointments anyway. months? Mr Kingman: I would hope so, but these are exercises Q2497 Mr Brady: When you joined the Board of led by the boards of the banks because that is what UKFI and became Acting Chairman, was there any they have. discussion at all about your prior involvement with Liechtenstein Global Trust? Q2492 John Mann: Mr Moreno, I think this would Mr Moreno: It was in all the documents and be easier to put in writing to the Committee, if you conversations with the executive search firm and would be prepared to do so, but I have been keen to documents provided when I talked to, I suppose, the get on the record what the assets are of the various interview committee. Remember, our first meeting banks, in which you now have a holding on behalf as a Board was on a Sunday night and I had become of the taxpayer, in UK dependent territories and UK Acting Chairman 24 hours before, so that was not overseas territories broken down by the precise investments or even liabilities that are there. If that 4 HC (2008–09) 144–III, Ev 593 Processed: 25-03-2009 23:58:58 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG15

Ev 332 Treasury Committee: Evidence

3 March 2009 Mr Glen Moreno and Mr John Kingham the focus at that point. It is a public fact, whatever Q2501 Mr Brady: So you have concerns about it, but people think of it, and I do not intend in any way to you think it is a matter for Government, not for hide it. individuals? Mr Moreno: I have concerns about the specific actions I mentioned to you. The Swiss bank secrecy Q2498 Mr Brady: Your assumption would be that law is hardly a surprise to me or anybody else who ministers were aware of it at the time you joined? has been a banker for the last 50 years; this is the Mr Moreno: I assumed so. The only conversation I basis of Swiss banking. had, and I have had three conversations with ministers, I met with the Treasurer and we spent a Q2502 Mr Brady: John Kingman, if I can turn to very intensive 40 minutes or so talking about the you, I had an answer to a written question to the banking crisis— Treasury on 29 January, a number of questions, where I sought some detailed information about Q2499 Chairman: Sorry, who? UKFI’s staV, payments to staV, and so on, and I Mr Moreno: Sorry, the Chancellor, and we talked received the answer that UKFI’s Board would about the banking crisis and, frankly, I found him produce by the end of February, and recommend to informed, concerned and totally focused on the Treasury, a budget and funding plan financial stability over the next couple of months. “appropriate to ensure the fulfilment of UKFI’s We did not talk about LGT, we did not talk about remit”. Have you done that? Citibank, we did not talk about Man Group or Mr Kingman: We are in discussions with the anything else, but we talked about the crisis. Treasury about our budget and we have indeed made a proposal which we are negotiating with them, and I said to your colleague earlier that my expectation Q2500 Mr Brady: Do you personally have concerns is that the total cost of running UKFI, when we are about Liechtenstein and its presence since 2000 on fully up to speed, will be lowish single-figure millions the OECD blacklist? a year. Mr Moreno: Well, I understand the OECD blacklist and it is a perfectly legitimate issue, and the blacklist Q2503 Mr Brady: And when will that budget and should not be limited to the blacklist, as you know. funding plan be complete and agreed by the Switzerland is not on the blacklist, that is the biggest Treasury? joke in the world and everybody knows it, but Mr Kingman: Well, I am not sure, it depends how the Switzerland is a big country, though it is coming on, negotiations go, but I would intend to publish the I gather, through Obama and Gordon Brown and Annual Report with the full facts before the summer. others. I was concerned that Liechtenstein at one point was being criticised by the OECD under the Q2504 Mr Brady: But we are not talking here about anti-money-laundering conditions and that the Annual Report, we are talking about a budget situation changed dramatically and Liechtenstein and funding plan which was due to be submitted put in very strict money-laundering controls, as did before the end of February. Switzerland. That is a separate issue. The real issue Mr Kingman: Indeed. I am just saying that I do not that applies to Liechtenstein, and obviously it is know when that will be resolved because we have a much larger than Switzerland, is its bank secrecy negotiation to have with the Treasury who are our laws. Now, these are laws which have been single client and funder. embedded in statute for generations and they are the basis of banking in those countries, I have to say, including the very large banking operations of major Q2505 Mr Brady: But this will be done before the UK banks and major US banks as well as UBS and Annual Report is produced? Credit Suisse. That is the law and that is the basis Mr Kingman: I would hope so. upon which the intergovernmental dispute about tax revenues and tax havens is based. Liechtenstein Q2506 Mr Brady: You could not produce your came into the spotlight, LGT, because an employee Annual Report without having done that. stole client data and sold it and it was passed around Mr Kingman: Indeed. to various authorities. I have to say that the one Mr Moreno: Mr Brady, the Board has reviewed the aspect of that which disappointed me and surprised draft business plan and approved it, which was me was the allegation in a very few cases that some submitted to the Treasury. By the end of February, employees of a Liechtenstein trust subsidiary may we had done that. have assisted US or US-connected taxpayers in constructing trusts in such a way that they could Q2507 Mr Brady: So it has gone to the Treasury? exploit loopholes in US reporting requirements. Mr Kingman: Yes, but it has not been approved by That apparently was not against the law either in the Treasury. Liechtenstein or the US, but, frankly, I find it commercially foolish and I find it ethically unsound, Q2508 Mr Brady: When it is approved, will it be and I was not at all happy about that, but in the published? broader sense I think the Liechtenstein/Swiss bank Mr Kingman: I do not think we have taken a decision secrecy issue is an intergovernmental issue and it is about that. I would envisage publishing the Annual going to be very much on the agenda, as you know Report which will set out the full facts on the costs from recent developments in the States. of running UKFI, staV costs and so on. Processed: 25-03-2009 23:58:58 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG15

Treasury Committee: Evidence Ev 333

3 March 2009 Mr Glen Moreno and Mr John Kingham

Q2509 Mr Brady: Is there any reason why you Q2514 Mr Brady: But it is not in your Framework cannot publish the budget and funding plan? Document? Mr Kingman: I would have to reflect on that. No Mr Kingman: No, there is nothing covered in it. decision has been taken on that. Q2515 Chairman: Mr Moreno, the image you gave Q2510 Mr Brady: When you have reflected, will you there of UKFI is a sort of hole-in-the-wall operation let the Committee know what your conclusion is? and here it is, standing behind hundreds of millions Mr Kingman: Certainly. of pounds, so give us a break; it is a very important Mr Moreno: If I may oVer a perspective on this, I organisation. think it is important to understand that UKFI is a Mr Moreno: No, I was not asking for a break. I just very small company. I think it has 12 employees did not want the wrong impression to arise. today and its maximum size is planned to be about 16 people. The entire company operates in a room which is probably smaller than the average bank Q2516 Chairman: But you are giving the wrong boardroom and smaller than the average bank impression if you say that this guy is getting less than CEO’s oYce. Its Chief Executive makes less, if the John Thain is paying his chauVeur. press is correct, than John Thain’s chauVeur did last Mr Moreno: No, not at all. First of all, I have to say, year, so I just want to make the point that I believe I am extraordinarily impressed with the people who there is real value for money for the shareholder have come from the Treasury. They are very good here, and the former point is scandalous, by the way. people, very, very good people, highly professional I believe that all of these things should be perfectly and hard-working. I am impressed with the two transparent, but it is not going to be a big, rich external hires we have made, both of whom have quango kind of deal. extensive and very relevant experience of what we are doing, John Compton in capital markets and Tim Sykes in analysis and figuring out how we are Q2511 Mr Brady: I fully accept that, Mr Moreno, going to earn taxpayers’ money back. It is just that and I would like to make it clear that I do not think its style is not flashy. People work literally adjacent I or other members of the Committee have got it in to each other at work stations without any dividers for UKFI to catch you out, but what we do have is between us, and that is fine; I think that is a healthy a duty to scrutinise. environment. Mr Moreno: Absolutely, and you should see the business plan and the funding plan, absolutely, yes. Q2517 Chairman: We call that ‘open plan’. Mr Moreno: That is right. Q2512 Mr Brady: And to bring that into the public domain. If I can just ask one other question, picking up on the earlier exchanges regarding Sir Fred Q2518 Chairman: On the issue of the pension fund Goodwin’s pension, it is clear from Lord Myners’ of RBS, press reports say that the RBS pension fund letter to Sir Fred where he says, “Once we became is said to be in deficit to the tune of something like £2 aware of this issue, UKFI has, on behalf of the billion. Will the taxpayer be required to bail that out? Government, been vigorously pursuing . . .”, but Mr Kingman: Not directly. That is entirely a matter does that not rather make a nonsense of the arm’s for the company. The position of the pension fund length arrangement between UKFI and the was certainly one of the issues taken into account Government? Is it not making it clear that you do when establishing the various recapitalisations of what it tells you to do? the bank, but it is an issue for the bank. It is a legal Mr Kingman: No, and one of the reasons that we obligation of the bank. published the Framework Agreement in such detail was that I wanted to be very, very clear with the world, and particularly with other investors, about Q2519 Chairman: Yes, but, given that the public precisely who was taking what decisions. The reason have got an economic stake of 84% in this company, we are pursuing the Fred Goodwin issue is because it is a very legitimate question, is it not? we think it is in our interest, as shareholder on behalf Mr Kingman: We have a huge economic interest in of the taxpayer, to do so, and that seems entirely anything RBS do or have to do, absolutely. appropriate to me. Mr Moreno: As you know, with the pension policy at the moment, there is a trend towards saying that the company is going to have to meet those Q2513 Mr Brady: It is clear from the Framework obligations before they fund dividends. Document that you have a responsibility for the Chairman: Well, keep us informed because I think it future remuneration packages in the banks. Where is a good point. in the Framework Document is the specific item which gives you authority to act over pensions of former staV? Q2520 Mr Mudie: I would just like to get on record Mr Kingman: There is none, but the point I would some of the stuV that we have touched on because make is that the reason we are pursuing every legal you are a very shadowy organisation and we know avenue open to us is clearly, if it is possible to secure nothing about it from what we read in the papers, legal recourse, that will benefit the bank and, and your website is not the best. Your funding— therefore, our investment. single-million figures? Processed: 25-03-2009 23:58:58 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG15

Ev 334 Treasury Committee: Evidence

3 March 2009 Mr Glen Moreno and Mr John Kingham

Mr Kingman: Yes. Mr Kingman: I think that is the wrong impression, if I gave that impression. We have agreed with the Q2521 Mr Mudie: Well, I understand that and I Treasury how we would operate before a full understand you have put a business plan to the business plan was put in place, including discussing Treasury and I understand that you will have estimates month by month of what we would spend. negotiations, but what have you spent to date and on That has been approved by the Treasury month by what basis has that funding been spent? month and, as I say, I am very happy to send you a Mr Kingman: I do not have that number personally note with those figures in it. to hand, but I am very happy to do a note with that number in it.5 Q2530 Mr Mudie: That would be good. Now, let us talk about this little room you are working in. I am Q2522 Mr Mudie: So you have just had a blank going to send Health & Safety round, as a good trade cheque while you have been working, for the four unionist, as you have got 11 in a room, I hear! I know months while you have been working? the Treasury rooms are big, but 11 in a room— Mr Kingman: We are being funded by the Treasury Mr Kingman: It is, strictly speaking, two rooms. and the Treasury review that monthly, as you would expect. Q2531 Mr Mudie: But one of those will be yours, will it not, as Chief Executive? Q2523 Mr Mudie: But we all accept that you are still Mr Kingman: No, absolutely not. in the public sector. Mr Kingman: Yes. Q2532 Mr Mudie: So two rooms in the Treasury? Mr Kingman: Yes. Q2524 Mr Mudie: So you have not been given a budget, you have just been told to get on with it? Q2533 Mr Mudie: Are you planning to stay in the Mr Kingman: In advance of putting the proper Treasury? business plan in place, we have discussed with the Mr Kingman: I do not think we have taken any long- Treasury, and agreed, an approach for funding us in term decision about that. The Treasury happen to the interim, and clearly they have approved month have oVered us an extremely reasonable deal. There by month the cost of running UKFI. is actually a serious economy point which is that we are a very small company, we do not want to have Q2525 Mr Mudie: Well, what have you agreed with our own overheads, such as an HR person or an IT the Treasury month by month? person, a press person and so on, so we are to some Mr Kingman: Well, I literally do not have to hand the extent, as it were, working on the back of Treasury exact figure for the amount we have spent today, but systems, which is an economy. I am more than happy to send you a note with that in it. Q2534 Mr Mudie: But, according to one of the press reports, somebody is camped in the personnel Q2526 Mr Mudie: You are still shadowy, John. department. Mr Kingman: I literally do not have that number Mr Kingman: That is incorrect. to hand. Q2535 Mr Mudie: Where are you parked then? Q2527 Mr Mudie: John, are you anticipating going Mr Kingman: We are on the ground floor of the back to the Treasury? Treasury building. Mr Kingman: I have no idea. They may not have me. Chairman: But you are hoping to get an invite. Q2536 Mr Mudie: Now, your Board. At one stage, it was described as having three private sector and Q2528 Mr Mudie: It is simply that you are sort three public sector, but the business document demob happy in front of us today and I am suggests it is now slightly more in favour of the wondering: is this the John Kingman we have known private sector. and loved for the last few years? Mr Kingman: The Board of UKFI will be three Mr Kingman: I have to tell you, I do not feel in any independent non-executive directors, one— way demob happy; this is probably the most stressful and demanding thing I have ever done. Mr Moreno: Perhaps I could just add that the Q2537 Mr Mudie: Did you say “will be”? It is, is it intention is that the Treasury will fund our costs. not? Mr Kingman: I am sorry, you are quite correct, yes, it is three independent non-executive directors, one Q2529 Mr Mudie: We have a lot of questions and a Chairman, two government directors and myself. lot of people to ask them, so I do not want to get into a philosophical discussion, but it is interesting that the Treasury have given you a blank cheque while Q2538 Mr Mudie: That will be Philip Remnant. Is he you have been operating in the last few months. regarded as— Mr Kingman: He is one of the government directors 5 HC (2008–09) 144–III, Ev 594 and he is Chairman of the Shareholder Executive. Processed: 25-03-2009 23:58:58 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG15

Treasury Committee: Evidence Ev 335

3 March 2009 Mr Glen Moreno and Mr John Kingham

Q2539 Mr Mudie: And Louise? Q2548 Mr Mudie: There is talk in all the deals that Mr Kingman: Yes, she is the Treasury’s Finance have been done that Credit Suisse, Deutsche Bank, Director. Citigroup have all been participating in one way or another. Are they doing it for £200,000? Mr Kingman: Those firms have been employed by Q2540 Mr Mudie: It is not a personal reflection on the Treasury to run the Asset Protection Scheme. her in any way, but it seems to be a strange corner of the Treasury to recruit someone from where she has come from. Is that the only place where we could find Q2549 Mr Mudie: But they are nothing to do with someone who would actually go and be allowed to your organisation? go in these troubled times, procurement and Mr Kingman: No. We are making some use of operations? Credit Suisse. Mr Kingman: Louise is the Treasury’s Finance Director and we thought it important to have a Q2550 Mr Mudie: And are you paying for that? qualified finance director on our Board. Mr Kingman: At the moment, we are not paying Mr Moreno: She is going to chair the Audit for it. Committee as well to make sure we have a control of the finances. Q2551 Mr Mudie: Very good. Well, you should watch what they do because a bank that does Q2541 Mr Mudie: StaV—you are reputed to have 15 something for nothing is up to something! staV and you have said you have got 11. Mr Kingman: But I should warn that, as and when Mr Kingman: At the moment, we have 11. we do major transactions, there will be significant transaction costs. I think that is inevitable. Q2542 Mr Mudie: These three characters who are in the document, Crompton, Woods and Sykes, is that Q2552 Mr Mudie: Have you included that in your how you are doing it, three divisions? draft budget? Mr Kingman: No, there will be three senior roles, Mr Kingman: No. and— Q2553 Mr Mudie: That is just a warning to Alistair to look at it. Your Chairman said that he was Q2543 Mr Mudie: So that is the three senior roles? surprised he got the job and that the public sector Mr Kingman: No. One is John Crompton, one is process is under way. Is it under way for your Sam Woods, and we are likely to recruit a third appointments? senior person who will manage the investments in Mr Kingman: The Treasury have that process in Northern Rock and Bradford & Bingley, whom we hand. have not yet taken on and we will be taking on in the coming months. Q2554 Mr Mudie: Are they advertising? Mr Kingman: That is a decision the Treasury will Q2544 Mr Mudie: Of the 11 you have appointed, are have to make and I do not know what they will they all chiefs, as we understand it? Are they all decide. senior staV? Mr Kingman: No. That includes, for example, two Q2555 Mr Mudie: And you are not being consulted? PAs, a compliance person and so on. Mr Kingman: No.

Q2545 Mr Mudie: What are the salaries for the 11 Q2556 Mr Mudie: Again, you seem demob happy. staV? What do you mean “no”? You are the Chief Mr Kingman: Well, as I said— Executive? Mr Kingman: I do not think the Treasury think it Q2546 Mr Mudie: John Crompton is, supposedly,on appropriate to consult the Chief Executive on the £200,000 a year. appointment of my own Chairman. Mr Kingman: I do not propose to publish salaries for staV who are not on our Board, but they are not Q2557 Mr Mudie: Well, how many of all the outlandish salaries and they are an enormous characters we have mentioned were done through discount on what those people have earned, and the public process, interviews, et cetera? could earn, outside. Mr Kingman: Well, all of the independent members of the Board were appointed through the— Q2547 Mr Mudie: Yes, I accept that, but why is it secret? I have seen £200,000 which, as you say, Q2558 Mr Mudie: The network. reflects well on John if he is prepared to take that Mr Kingman: No, through public advertising and small salary and do something of a public service. the process. Why are you not proud to announce that? Mr Kingman: These are individuals who are not on Q2559 Mr Mudie: Were they? our Board and it does not seem appropriate to have Mr Kingman: Yes, the independent non-executive to publish them. directors. Processed: 25-03-2009 23:58:58 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG15

Ev 336 Treasury Committee: Evidence

3 March 2009 Mr Glen Moreno and Mr John Kingham

Q2560 Mr Mudie: So John— at Northern Rock was developed by the Board of Mr Kingman: No, the independent non-executive Northern Rock and about which they are actually directors. very enthusiastic.

Q2561 Mr Mudie: So Peter Gibbs, Michael Q2568 Sir Peter Viggers: Looking at the overall Kirkwood, all applied for a job that was advertised strategy for your company, is it your role to enforce in the press? the Government’s will in respect of the taxpayers’ Mr Kingman: Yes. investments or is it to decide on the best course of action? In other words, who is calling the shots? Q2562 Mr Mudie: And you will give us copies of Mr Kingman: Well, the Framework Agreement those adverts of course. makes clear that we will operate under both the Mr Kingman: If you wish. Framework Agreement itself and an investment mandate which we will agree with the Treasury and Q2563 Mr Mudie: Well, we are responsible for we will operate within that, and that will provide a checking that you are spending public money broad framework, but the Framework Agreement is properly, John. All your stuV will be covered, as you also very clear that we are to operate commercially, are a public company, with freedom of information, that we are to use our discretion to use all the I take it? functions of a shareholder, so voting, interaction Mr Kingman: Yes. Of course, there are exemptions with the boards and so on, at arm’s length from the relating to commercial confidentiality which, I Treasury. suspect, will be quite germane to quite a lot of the information we handle. Q2569 Sir Peter Viggers: All the banks which get involved in the Asset Protection Scheme face Q2564 Sir Peter Viggers: I was surprised that Lord interference from the Government, not just those in Myners went walkabout without a civil servant which UKFI hold shares. Will it be UKFI or the accompanying him to an important decision- Treasury which would decide, for instance, and making meeting relating to Fred Goodwin’s involve itself with Barclays, should it decide to use pension. Is it no longer the absolutely unvaried rule the scheme? that Treasury ministers are always accompanied by Mr Kingman: The conditions that are attached to the a civil servant in order to avoid misunderstanding Asset Protection Scheme are entirely a matter for the and to record decisions? Treasury. We had some role in brokering some Mr Kingman: I do not know whether it has ever been aspects, for example, on the RBS remuneration an unvaried rule that ministers cannot move without decisions, but the conditions are set by the Treasury, a civil servant with them, but I can tell you that no and that is appropriate. These were enormous sums civil servant was present, but a lawyer was present. of taxpayers’ money that were being put in and the Treasury decided what conditions to attach, and that Q2565 Sir Peter Viggers: Is it your experience from would be the case were any other bank to want to a long time in the Treasury that it is normal for participate in the scheme. ministers to attend decision-making meetings without a civil servant? Q2570 Sir Peter Viggers: The directors of banks in Mr Kingman: Well, I do not know whether, strictly which you have shares have responsibility to their speaking, I would call it a “decision-taking meeting” shareholders, which is laid down in statute. How do since the decision was for the RBS Board, but I expect the dialogue to go if you approach them and would say it is not that unusual under either this ask them to carry out duties which they feel are administration or the last for ministers sometimes to inconsistent with their duty to their shareholders? wish to operate without civil servants present. I have Mr Kingman: I think that is a very important point certainly known many examples of that from both relating to our holdings in RBS and Lloyds, that, this administration and the last. however large the Government’s holding short of 100%, directors do have duties to all shareholders, Q2566 Sir Peter Viggers: Mr Sandler took up his and, knowing them to be robust people, were role with Northern Rock on the basis that the bank hypothetically we or the Government to say, “We would be run at arm’s length from the Treasury. Is wish you to behave uncommercially”, I would fully that still the case? expect them to have quite robust views about that. Mr Kingman: Yes, I should emphasise that we have not taken on responsibility for Northern Rock and Q2571 Sir Peter Viggers: They will be seeking to will not do so for some months, but that is my strengthen their balance sheets, yet you, as the understanding, absolutely. conduit of government involvement, will be pressing them to advance money to small business and by Q2567 Sir Peter Viggers: What does “arm’s length” way of mortgage. mean to you? Northern Rock’s lending strategy Mr Kingman: Well, I think that the key point is that appears to have been completely reversed. the Government, in setting conditions on lending, Mr Kingman: My understanding, and again I has made it very clear to the banks that it does not emphasise that this is not something with which I want them to engage in uncommercial lending, and was closely involved or for which I am responsible, the RBS statement the other day was very, very clear but my understanding is that the new business plan indeed about that, as was the Government’s Processed: 25-03-2009 23:58:58 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG15

Treasury Committee: Evidence Ev 337

3 March 2009 Mr Glen Moreno and Mr John Kingham statement. The banks have told the Government Q2575 Ms Keeble: But you cannot define that they believe they can meet these conditions “expeditiously”? whilst lending commercially and, therefore, I do not Mr Kingman: I am not able to say to you that there believe there is a tension or contradiction between is an agreement with the Treasury that we must do it the value role and the conditions which have been by X date because there is not, but I do think we imposed by the Government. should get it in place quickly, and it would be helpful to me to get it in place quickly. The people with whom we are negotiating are obviously also busy Q2572 Ms Keeble: I wanted to ask some more about saving the world and negotiating asset protection the investment mandate which you referred to just schemes and so on. now which is in your Framework Document. When do you expect that actually to be agreed? Mr Kingman: I do not know. It is something we will Q2576 Ms Keeble: In your Framework Document, now turn to. Having got the Framework Agreement you have got two particular priorities for your in place, and, as Glen said, that was approved by the mandate. One is about the overarching objective, Chancellor yesterday morning and immediately which is quite long, and the other bit is paragraph 7.1 published, we will now turn to discussing with the which talks about company independence. Do you Treasury the investment mandate. not see a tension between those two and how do you intend to resolve them? Mr Kingman: I do not believe there is a tension. I Q2573 Ms Keeble: But, given that that is supposed to suppose the philosophy that runs through the guide your investment strategy, you must have some Framework Agreement and through the timeframe for it. Chancellor’s announcement last autumn about Mr Kingman: Well, there is no timeframe set out in setting us up was a belief that the best way of getting the Agreement, but I would certainly want to do it these banks back on their feet and back into the expeditiously. The general point I would make private sector properly was for them to be run though, standing back, is that we, the Treasury and commercially by proper independent boards and for the banks are very much still in a kind of crisis mode those boards to be running the banks and not for the at the moment, so, for example, what the investment Government to be running the banks or indeed for mandate sets down in terms of our approach to UKFI to be running the banks. I see our role as disposing of the investments I would expect to be managing the shareholdings, and I do see a very more of a medium-term set of issues, frankly, but I important part of that as having all the dialogue you do think it would be good to get the investment would expect a serious shareholder to have around mandate in place expeditiously, and that is what we management, strategy, performance, capital, risk are going to turn to now. management, all of those issues, but we are not Mr Moreno: John makes a very important point. running the banks and I do not believe that, were we The reality of UKFI’s involvement is really two- running the banks, we would get the quick exit that phased. The first phase has been assisting in financial the Government wants to see and we want to see. stability, and that is critical, both at the time of bank recapitalisation and now in the Asset Protection Scheme. I believe that the arrangement of the APS Q2577 Ms Keeble: When you were set up last with RBS has now provided a stable basis for that autumn, there was also a bit in the letter that came bank to move forward and to focus on restructuring to our Chairman, saying that you would oversee, in the bank’s business and recapturing value for us particular, the maintenance of the 2007 levels. How through a return to its core profitability, and I hope high up on your priority list is that and how do you the same process is happening at Lloyds. When the intend to oversee it? financial stability eVort is finished, and I hope that is Mr Kingman: Well, that role has changed with the in the next few days, we can then turn our attention announcement yesterday, ie, we will not be very much to the classic role of an institutional responsible for that any longer and the reason for investor, which is to get the taxpayers’ money back that is that the Government is setting completely over the next several years, and that is where, I think, new lending conditions relating to the Asset the investment mandate will be king. Protection Scheme, we have no role in relation to the Asset Protection Scheme, and it is thought, and I think it is sensible, that we should not be running lots Q2574 Ms Keeble: Your Framework Document, as of diVerent conditions and monitoring in lots of you say, was actually published yesterday morning. diVerent bits of government, so the Treasury is going It seems to put quite a deal of emphasis on the to be monitoring all lending conditions in all these importance of the investment mandate and I am banks going forward. quite surprised that you do not have any sort of time-line for agreeing it, given the importance of it Q2578 Ms Keeble: So all of that bit has gone for financial stability and for the interests of the UK completely? taxpayer, so can I ask you again, have you got an end Mr Kingman: Correct. date for it? Mr Kingman: No, we do not have an end date as in a date that we have agreed with the Treasury that we Q2579 Ms Keeble: So how much oversight do you must have this done by, but I do think we should do have because you also referred earlier to your role in it expeditiously, and I would want to do that. reshaping the future for these banks? How active is Processed: 25-03-2009 23:58:58 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG15

Ev 338 Treasury Committee: Evidence

3 March 2009 Mr Glen Moreno and Mr John Kingham that in terms of RBS, for example, dropping its run the business down, they were missing Project Finance Section and various banks reporting commercial opportunities and I think they have been this morning that it is pulling out of PFI deals? making that point to government for some time. Mr Kingman: I suppose we would start with the board. As you will know, we have agreed with Philip Q2584 Mr Tyrie: So, when the Government was Hampton a very substantial reshaping of that board, imposing on them a policy of accelerating mortgage which is the first place to start. We then had a series redemptions the Northern Rock board and of discussions with them around all the issues you presumably you, although you did not have a direct would expect to care about, the management responsibility, thought that was the wrong policy. strategy, performance and so on. As part of that we Mr Kingman: I was involved because I handled the had in-depth conversations with Stephen Hester Northern Rock situation up until the point at which about the strategy that he published last week. We it was taken into public ownership. The priority at were closely involved in those discussions. We are that time was very much to get the taxpayers’ money supportive of the strategy.I think there are quite a lot back and I think that that was understandable. The of issues that have yet to be finally resolved as he world has moved on, the economy has moved on and develops the strategy. We will similarly be involved the mortgage lending market has moved on. If there in that. We will be approaching those questions from are commercial opportunities to be had genuinely on a shareholder value perspective, which is what we are the basis of commercial credit scoring and mandated to do. commercial credit pricing, I do not think it is right to stand in the way of that. Q2580 Ms Keeble: Are you looking in any way at all at the level of lending to the public, which is one of Q2585 Mr Tyrie: You have a very diYcult job. I our big priorities? I have seen—and it is anecdotal think we will have to wait and see how you interpret but it is happening—banks, some of which are ones the mandate to operate commercially as the months for which you are responsible, pulling in some of go by. I hope you also understand that we are going their loans and causing a huge amount of problems to look extremely carefully at that and it is absolutely for the firms that are reliant on them as in they crucial that there be clarity and transparency about cannot draw down facilities for the duration, which the way you are conducting that function. I notice is causing very severe diYculties. that under “Preservation of Investee Company Mr Kingman: We would approach that and any Independence” it says, “The Company will manage lending decisions by the bank as a commercial the Investments on a commercial basis and will not matter and that is the mandate we have been given intervene . . .” It says, incidentally, “. . . including and it derives from a view that that is the best way to with respect to . . . remuneration decisions”. get the banks back on their feet. Mr Kingman: To individual remuneration decisions.

Q2581 Ms Keeble: Hence the dropping of your Q2586 Mr Tyrie: The bracketed section says, “. . . responsibility for the 2007 levels? including with respect to individual lending or Mr Kingman: I would not say that that follows. I remuneration decisions.” But should it read, think the reason that decision was taken was more “including with respect to individual lending or because we did not want to have a messy situation individual remuneration decisions”? where diVerent bits of government were monitoring Mr Kingman: That is certainly what it means. We diVerent lending conditions. have been having, and I think it is very important that we have, quite a lot of discussion with the banks about remuneration policy on the boards and Q2582 Mr Tyrie: Are you entirely happy and elsewhere. The reason I think that is very important comfortable with the Chancellor’s announcement is because one of the lessons of what went wrong in that Northern Rock should help fill the gap in these banks is that the incentives were wrong in these mortgage lending? banks and I think as shareholder we should really Mr Kingman: As I say, I am not responsible for care about that. Northern Rock yet so I am not deeply familiar with its business, but my understanding is that this Q2587 Mr Tyrie: I think you would agree that public strategy was developed by the Northern Rock board confidence in what you are doing is absolutely and put to the Chancellor and approved by the crucial. You have been asked a series of questions Chancellor. I have not reviewed the strategy. I have about Sir Fred Goodwin’s pension. You have told us no problem with the Northern Rock board that you have taken extensive legal advice, which developing a commercial strategy and if the presumably has been very detailed, and that you Chancellor has approved it I am sure it must be an were exploring every legal avenue with respect to it. excellent one. In response to Mr Mann and the Chairman you seemed unaware of the extent to which diVerent Q2583 Mr Tyrie: Knowing Whitehall as you do, do parts of his pension might be funded diVerently. I you really believe this all originated with the find those two responses from you diYcult to Northern Rock board? reconcile. Mr Kingman: As a matter of fact, I do. I think that Mr Kingman: The legal advice we have got and are the Northern Rock board felt that with the original getting covers a whole range of issues. My remit they had been given, which was very much to understanding is, to the extent that there is an issue Processed: 25-03-2009 23:58:58 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG15

Treasury Committee: Evidence Ev 339

3 March 2009 Mr Glen Moreno and Mr John Kingham about the accumulated pension entitlement, leaving certainly not going to say that the tripartite aside this question of what he got from age 50, that successfully identified every problem that might it derives from a decision taken ten years ago, at the arise because it clearly did not. point at which he was recruited. I think it likely that there is very little that we or the RBS board can do Q2596 Mr Tyrie: It failed, did it not? about a decision taken ten years ago, but I am not Mr Kingman: I think it has been abundantly clear going to rule out any legal options. that— Q2588 Mr Tyrie: Surely you have looked at how that pension is going to be funded going forward. Q2597 Mr Tyrie: Why are you so reluctant to just be Mr Kingman: I do not think that the question of how frank about it and say it failed? the pension is funded is the central legal issue. Mr Kingman: Sorry, I do not think I am. If your suggestion is the tripartite should have foreseen Q2589 Mr Tyrie: It is certainly an issue. everything that has happened, it plainly failed. Mr Kingman: I think the key issue is what exactly the contractual entitlement was, what exactly the board Q2598 Mr Tyrie: Did it succeed? Would you say it decision was and the issues around that. Then there was a success? is a wider question, which is whether the board or Mr Kingman: I would say it achieved a lot. Was it a anyone else has grounds for claims against Sir Fred full success? Plainly not. or any of the other players in RBS in relation to past events which had nothing to do with the pension. Q2599 Mr Love: I want to go back to this issue of Q2590 Mr Tyrie: We have explored those questions pensions. RBS is looking to make considerable already. I am exploring with you another question. I savings. Have you had any discussions with them am not going to persist with it very long. I just want about the prospect of closing their defined benefits to be clear whether or not you have a firm grip on the scheme and perhaps moving to a defined sources from which his pension will be paid. contributions scheme? Mr Kingman: We are exploring every avenue. I do Mr Kingman: Not to my knowledge, no. not myself believe that is going to be the most fruitful source of legal enquiry, but I may be wrong. Q2600 Mr Love: You are not aware of any discussions at this stage about the pension fund? Q2591 Mr Tyrie: Do you understand that that does Mr Kingman: No. not inspire public confidence if, after having taken all this legal advice, this relatively straightforward Q2601 Mr Love: Has UKFI at any time advised the question, even if you do not think it is the most Government to nationalise RBS? crucial question, is one that you are not able to Mr Kingman: No. answer? Mr Moreno: I think it is a good question. The fundamental question is whether his pension Q2602 Mr Love: In your consultations with the entitlement is coming from the broadly defined Treasury this has never come up as a matter for benefit pool of RBS or is it separate. discussion? Mr Kingman: We are not a policy making body. We Q2592 Mr Tyrie: Absolutely. take some assets and manage them for the Mr Moreno: We will have to find that out. Government. We have not advised the Treasury at any point to nationalise anything. Q2593 Mr Tyrie: How long were you on the tripartite committee representing the Chancellor? Q2603 Mr Love: Your objectives are, as you have Mr Kingman: I think I chaired it for nine months. already stated, protecting the public purse, to increase competition and financial stability. Would Q2594 Mr Tyrie: Do you agree with most experts they not be enhanced by the nationalisation of RBS? who have looked at it that the tripartite committee Mr Kingman: I do not believe so at all. That is a was in retrospect a disaster? matter of opinion. It is not our role to make policy Mr Kingman: To be fair to the tripartite committee, on this. That would be entirely a matter for the the point at which I chaired it was not a point at Chancellor and the Government. The key thing I which it was going through crisis. would say about nationalisation is that, firstly, I believe there are serious advantages in having other Q2595 Mr Tyrie: The whole point about the shareholders. I think it helps with the commercial tripartite committee is it is there to prepare for a management of the bank. In particular, and this is crisis; it is not waiting for one. the really important point, whatever the merits of Mr Kingman: I completely agree with that. I think nationalisation, one thing of which you can be the lessons that have emerged around the tripartite absolutely sure is that if you were to nationalise one have been around its performance under stress in of these banks the exit would be significantly more crisis conditions. There probably are also lessons diYcult and significantly more prolonged. I think about the extent to which regulators, the bank and that is unavoidably true and I think that would be a the Treasury successfully anticipated problems. I am negative. Processed: 25-03-2009 23:58:58 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG15

Ev 340 Treasury Committee: Evidence

3 March 2009 Mr Glen Moreno and Mr John Kingham

Q2604 Mr Love: We are dealing with the situation like Barclays. I am sure that there will be losses on now in the present circumstances. While I accept the this insurance scheme for RBS and for the argument you make, that the problem five years or Government, but in one sense those losses come out ten years down the road, depending on when it of one pocket and they go back into the taxpayers’ happens, may be more problematic, it might help other pocket through its shareholding with RBS. now in terms of lending, in terms of stability and in There is sort of a comity of interest. I think it is much terms of increasing the opportunities for the public more diYcult if you are talking about these sorts of to get back the funds that they have invested. schemes for a completely private bank. There is a Mr Moreno: I think on that latter point I am not so certain amount of balance here and I hope the sure. I think you nationalise a bank when there is a taxpayer is going to come out okay. run on the bank. That is the way it works in the US and that is the way it will presumably work here in Q2607 Mr Love: Let me just press that a little bit the future, much more quickly than it did in the case because the press release that was put out at the time of Northern Rock. I do believe that the I interpreted as saying that due diligence was only capitalisation plan and the asset protection scheme starting. So in eVect they have put their hand up at RBS when it is complete will work. This bank now against the wind and chosen a figure, have they not, has an enormous net of resource to meet future because they have no idea how toxic these toxic losses and get back on its feet. I do not see the assets are? advantage of a complete nationalisation when we Mr Kingman: The payments that are made under the have the advantage of public listing and public scheme will obviously be subject to very extensive shareholders. I believe a huge number of due diligence and that is a process that is well shareholders in RBS and Lloyds Group are small under way. shareholders. I do not see any particular public benefit in wiping them out by nationalising the bank. Q2608 Mr Love: What happens if after due diligence The important thing is to get the bank sorted, retain it comes out that the first loss should be £30 billion? a listing and then begin to move the bank back into Do you think we will renegotiate it? the private sector, where I think we all agree it Mr Kingman: The shape of the scheme is clear. That belongs or many believe it belongs. scheme was put in place in order to stabilise the bank. Q2605 Mr Love: The asset protection scheme announcement last week for RBS was generally Q2609 Mr Love: There has been some surprise that welcomed by the markets but they thought they got Lloyds TSB has not announced an asset protection a very easy ride. Is that correct? scheme. Can you give us any indications why the Mr Kingman: I do not believe so. I think that the negotiations are so tortuous at the present time? APS announcement stabilised the bank. If the bank Mr Kingman: I really cannot comment on that had been given an incredibly easy ride what you situation. We are not a principal in that negotiation. would have expected to see would be the share price It is a negotiation between Lloyds and the shooting up and the share price went up by a small Government. It is a phenomenally sensitive amount [and has gone up a small amount] and has situation. stabilised since. I think that suggests that this was probably quite a sensible deal. Q2610 Mr Love: The Chief Executive of RBS has suggested that they will move towards a Q2606 Mr Love: The first loss amounts to 6% of the privatisation of RBS in a time-frame of three to five £325 billion of toxic assets that include collateralised years. Do you think that is achievable? debt obligations and all the other things that people Mr Kingman: What I understood him to say and are very worried about. Does that not seem a rather what he said to me is that he sees that as the timescale small amount to you? for the full turnaround of the bank. I think that is not Mr Kingman: If the choice that the Government had necessarily the same thing as the timescale for our was to stabilise the bank and the private sector exit. I think our exit will depend very much on the through the asset protections scheme or to return of investor confidence, which could well nationalise the bank, the reality is the taxpayer precede the full flowering of everything that Stephen would have had those liabilities in either scenario. is trying to deliver. I would also say that I would Actually, by having the private shareholders in the expect, most likely, that our exit is something that Government is provided with a degree of economic would happen through a series of transactions over protection which is captured in the arrangements of time probably, rather than one big-bang simply the APS where the Government is not taking 100% because the scale of our investment is so large. I find of any of the losses. Clearly the Government has had it very diYcult at this point with so much uncertainty to do extraordinary things in order to stabilise this to make any meaningful prediction, but I would not enormous bank and that has the potential to have necessarily presume that it is bounded by Stephen’s significant impacts and costs to the taxpayer, but the three to five years. Government was unavoidably trading a set of very Mr Moreno: I agree with that. I think that at some diYcult choices. point investors will become convinced, if Mr Moreno: One thing that is important to think management is convincing, that there is an about and why RBS was an important first step in underlying core profitability in these banks—we the APS scheme is that RBS is diVerent from a bank have an estimate of what it might be but it is very Processed: 25-03-2009 23:58:58 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG15

Treasury Committee: Evidence Ev 341

3 March 2009 Mr Glen Moreno and Mr John Kingham early days—and that that will start to determine the Mr Moreno: If the compromise agreement was value of the share price of the bank and at that point signed between midnight and 3.00 am on 13 October one can start thinking about exit, but it could 2009, that is not the way remuneration committees happen before the turnaround. normally work, at least not mine. I suppose it would have been very diYcult to take somebody’s pension that they had already accrued. I think this was an Q2611 Mr Love: How sensitive is that investor golden parachute, as I said, and I think it was wrong. confidence to our return to growth in the economy? Mr Kingman: I think we do take the view that it The projections at the moment are that, although would have been significantly cheaper for RBS and there will be a relatively deep recession, we will turn therefore the taxpayer as an involuntary investor in around relatively quickly. If that was to change over RBS had the contract been terminated without him the next year or so do you think that would aVect getting the undiscounted pension. We have yet to investor confidence? have any explanation of why that decision was taken Mr Kingman: I think it is very dependent on investor perception of the economy and not just in the UK or why that decision was in the company’s interest. because, remember, RBS is a global bank and therefore the world economy and perhaps Q2614 Mr Fallon: Why did Lord Myners not ask for particularly the US economy are very relevant too. that to be done? There is a lively debate about whether banks’ share Mr Kingman: Because he was not informed that that prices anticipate what investors are thinking the was the choice that had been made. economy is going to do or whether they move at the same time or whether they move after and diVerent people in the City have very diVerent views on that. Q2615 John Thurso: Anyone who has served on a I find it hard to be sure. We are going to have to see remuneration committee and terminated an how it pans out. executive knows full well that the end outcome is a compromise agreement. A compromise agreement is so that you do not get sued by the executive Q2612 Chairman: I wrote to The Royal Bank of afterwards; in fact, it works in both directions. This Scotland on Friday and asked them to provide me letter informs us that Lord Myners was informed by with answers to a number of questions. This Sir Tom McKillop and Bob Scott that there was to morning they have written back to me and here is a be a compromise agreement and, according to this, copy of that letter for you. Perhaps I could take up they took him through the broad terms of it prior to paragraph 1 because in answer to John Mann you its signature. Lord Myners, as somebody well said that Fred Goodwin’s pension arrangements practised in the City, would have known that the were dealt with at the outset of his employment, but moment that compromise agreement was signed it paragraph 1 from RBS makes clear that the terms would become wholly legally binding on both were recorded in letters to Sir Fred dated 24 March parties. Is that not correct? 2003, 26 April 2004, 21 December 2007 and 13 Mr Moreno: I suppose so. I really have no October 2008. It says in paragraph 1, “The terms, as knowledge of what was going on. This was not a they would apply on Sir Fred’s departure from the normal situation at RBS. It was a massive break Company, were subsequently recorded in a down and one of the world’s greatest banks was Compromise Agreement which was signed between about to go bust. It is possible to take the position midnight and 3.00 am on 13 October 2009.” Do you in that situation and say, “Fred, this has clearly not want to clarify your earlier remarks? Mr Kingman: I have no reason to believe that worked out, it is a disaster. You have to go,” with no anything said here is untrue. The point I was making compensation. He might have had the opportunity to Mr Mann was that, to the extent that there is an to sue the bank, but that seems to me a much better issue about the basis on which Sir Fred was able to position to be in than where we are today. translate earlier pension entitlements into RBS pension entitlements, I have been informed by the Q2616 John Thurso: I agree with you. That is what I company that that was decided at the point at which think the directors should have done and they did he was hired, which was roughly ten years ago, but not. I want to turn from there onto the current that is all I am able to tell you. remuneration of RBS. As a body you are eVectively Chairman: Further enquiries need to be made in that almost like a private equity owner of RBS in that you area. That letter is a matter of public record and will have nearly three-quarters of the equity in it. What be available to the press afterwards. discussions will you have or are you having with RBS on its remuneration policies, including Q2613 Ms Keeble: In paragraph 7 of that letter it bonuses, long-term plans, et cetera, going forward? says that if he had been dismissed instead of having Mr Moreno: I do not think we are like a private the early retirement package which he had the equity owner at RBS. We are an institutional pension payable now would have been £416,000 a investor that has a mandate from the owner, which is year, which is still a phenomenal amount of money. the Treasury, to manage these investments. It is more Glen Moreno, given the remarks you made about like managing a pension fund’s assets. Somebody governance and so on and the decision taking, do has referred to UKFI as “Fidelity with nuclear you think that would have been a more sensible weapons”. I think that is a bit over the top. Clearly course of action? we have more involvement than a normal Processed: 25-03-2009 23:58:58 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG15

Ev 342 Treasury Committee: Evidence

3 March 2009 Mr Glen Moreno and Mr John Kingham institutional fund manager, but we are not really in UK remuneration in banks. The Governor was here that direct ownership relationship of a private last week and again reiterated his view that there has equity investor. been too much greed and not enough done for the money paid. You have an opportunity to be part of Q2617 John Thurso: Forgive me, but is that not a formulating a more appropriate future reward copout? When you own 70% of something, whether structure for everybody in the banking industry. it is you as the managing arm or whether it is the Mr Kingman: I do agree with that. I believe that, if Government as the beneficial owner, one of you you take the case of RBS, the changes that were owns it and one of you needs to be having a look at agreed very much with our very close involvement what that means. Are you saying that it is not within are the most radical shift in the approach to your remit to act as the owner, so those kind of investment banking remuneration anywhere in the policy decisions are all with ministers, or is it within world. There is no other bank that is going for 100% your remit? deferral, the extent of claw back that we have put in Mr Kingman: We own a very large stake in this bank. place and payment in capital rather than in cash. The way we exercise our rights in relation to that will These are very big changes. What you do have to be massively publicly scrutinised and rightly so. It is juggle there is you have to strike a balance between not quite the same as being a 100% owner. If you are getting the incentives right and getting remuneration a 100% owner you are a natural insider and you get structures that are perceived to be fair with the fact management information in a way that external that these banks are in a competitive marketplace for shareholders do not. If you take the issue of board people and bear in mind their ability to hire people remuneration, which was your question— as you reform these structures going forward. I expect the banks in which we invest to be at the forefront of changing these practices going forward. Q2618 John Thurso: I am talking about the entire I am not in any doubt about that. remuneration policy. Mr Kingman: We are taking a very close interest in remuneration both on the board and below for the Q2620 John Thurso: There was a suggestion that reason I gave earlier, which is that we believe that loans will be made in lieu of cash bonuses. getting the incentives right in this bank is desperately Mr Kingman: The discretionary bonuses that will be important to us as shareholder and that is a hugely paid at RBS will be paid in the form of subordinated important lesson of everything that has gone wrong debt. The key point about that is that it means it does both in this bank and other banks in the course of the not deplete the capital that the Government has put last few years. RBS have made clear that they are in. If the bonuses were paid in cash the Government would be putting in cash at one end and cash would fundamentally reviewing their remuneration policy V going forward. We have strongly supported them in be coming out of the other and going to sta . This is the bank issuing new debt and issuing that over time doing that. We will be closely involved in those V questions. The decisions will be taken by the board in a deferred way, over three years, to sta subject to of the bank, but I know they will want our views and claw back. they will want to assure us that our interests alongside other shareholders are being taken into Q2621 John Thurso: That subordinated debt is account. I really do think that both on the board and suYciently subordinated and everybody else gets below getting the incentives right matters. That is repaid first. Where does it rank? not at odds with necessarily paying quite large sums Mr Kingman: It is subordinated. for serious people to work in these banks and I think that is necessary. Q2622 John Thurso: But not that subordinated. Mr Moreno: In a private equity firm we would not Mr Kingman: No. be interacting with their board and the executives who are responsible and having this polite, if intense, Q2623 John Thurso: Perhaps you would be kind conversation. We put people on the board and we tell enough to let us have more detail once that is them, “Fire those people. Cut his pay. Close that formulated. oYce.” That is the way I see private equity as Mr Kingman: Certainly.6 operating quite eVectively sometimes. We are acting more like a very engaged shareholder with a board Q2624 John Thurso: I want to turn to the question that is independent. of board appointments and your influence there. Am I right in thinking that all of the board Q2619 John Thurso: That is actually at the heart of appointments, including executives, would be made what I am asking you about because I think to a by the nominations committee of the board? certain extent you are really describing a worst of all Mr Kingman: The way this works is that we have worlds position, which is that you have got all the influence at two levels. Firstly, we have the general ownership, all the risk and all the problems and you right as a large shareholder to discuss with the are not able to exercise any of the influence. You said chairman and the nominations committee the board earlier that you are not an instrument of policy structure and the board composition going forward making, but I hope you would accept that the and I think that goes well beyond those directors decisions you make have a major impact on policy. over which we have direct rights. We also have direct Clearly in the case of remuneration, decisions you make will have a much wider influence on the whole 6 HC (2008–09) 144–III, Ev 594 Processed: 25-03-2009 23:58:58 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG15

Treasury Committee: Evidence Ev 343

3 March 2009 Mr Glen Moreno and Mr John Kingham rights to approve the appointment of three directors Q2633 Sir Peter Viggers: In John Thurso’s at RBS and two at Lloyds Banking Group and the questioning I think there was reference to the right two have been appointed. The way that works is that that you have to agree with the board’s appointment in order to be appointed the person must be of new non-executive directors. Did you say you acceptable both to us and to the nominations have made two appointments so far? committee of the bank and that seems to us a Mr Kingman: Correct. At Lloyds there have been sensible arrangement and it has worked quite well. two new appointments who are Tony Watson and Tim Ryan and they were appointments that were Q2625 John Thurso: You would expect them to go very well received. At RBS we have overseen along through their normal due diligence process and with Philip Hampton what could be the most come up with a nomination which would be put fundamental restructuring of a board in British forward to you, would you? economic history of a company of this size, which is Mr Kingman: No. The actual process that we have the departure of a very large number of existing non- operated and agreed with both banks is that we agree executive directors, a new chairman and a process is quite a long shortlist that we are comfortable with now in hand to appoint three new non-executive and the bank is comfortable with. Then we both directors, all of whom will be appointed with our interview the candidates and then we get together agreement. with, in practice, the chairman and we mutually decide who is acceptable to us. Q2634 Sir Peter Viggers: When do you expect that to happen? Q2626 John Thurso: RBS has recently appointed Mr Kingman: In the coming weeks. Nathan Bostock as Head of Restructuring and Risk. Is that a board appointment? Q2635 Chairman: How does your approach to Mr Kingman: No. shareholding diVer from that of a private investor? Mr Moreno: We are a large institutional shareholder Q2627 John Thurso: Do you have any say in and I think we will be much more engaged. The appointments below board level? obligations of institutional shareholders are often Mr Kingman: I was aware of that appointment talked about, but when they reach a certain size there before it was made. is just no way that you can avoid them. So I expect us to be heavily engaged with these bank boards on Q2628 John Thurso: Was he not in charge of RBS’s key elements in terms of taxpayer value, strategy, risk management until 2001? board appointments and remuneration and any Mr Kingman: I believe he was, yes. other area where we think that the value of these banks for taxpayers over time is going to be seriously Q2629 John Thurso: Does that make him aVected. We have been extremely engaged over the appropriate to come back or not? In other words, last six weeks with or without an investment was it his good work that was undone after 2001 or mandate, much more so than is obvious from was he the architect of the problems? discussions in the press, especially in sorting the old Mr Kingman: I believe on the information available RBS board and I think that will continue. At the end to me this was a very good appointment. of the day our biggest job is to get good boards and good management who can sort these banks out. Q2630 Mr Fallon: The Permanent Secretary told us in the autumn that you were being set up at arm’s Q2636 Chairman: What engagement have you had length from the Treasury. Is that right? with other private shareholders of Lloyds Banking Mr Kingman: Yes. Group and RBS? Mr Kingman: I think it is very important that we do Q2631 Mr Fallon: But the document says that the have a lot of dialogue with other institutional Treasury can give you directions of a specific nature shareholders and we have had some. We have been and that the board of your company will comply slightly constrained by the fact that, in relation to with such directions or resign. RBS, we have been insiders in relation to the Mr Kingman: Yes. development of Stephen Hester’s strategy and that was a choice that he made to bring us in and we made to be insiders and that meant that we could not have Q2632 Mr Fallon: How is that arm’s length? discussions with institutional investors. We have Mr Kingman: I think we would all see the now set up a series of meetings with all the large Government giving us directions as something that investors in both of those banks and we very much would happen in abnormal circumstances. I think want to hear their perspective because they have the Government has every right, given that these are been studying these banks for a lot longer than we massive taxpayer investments, to ask for a backstop have. power. If it thinks that UKFI has in some sense lost its senses and is doing something that it fundamentally disagrees with, it can overrule us and Q2637 Chairman: As a dominant shareholder in the board of UKFI would have to decide how it some of the biggest financial institutions, will you be responded to that direction. I would see directions as looking to revise the structures of corporate being an extremely unusual event. governance currently in place, Mr Moreno? Processed: 25-03-2009 23:58:58 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG15

Ev 344 Treasury Committee: Evidence

3 March 2009 Mr Glen Moreno and Mr John Kingham

Mr Moreno: I am not sure whether it is a question usually takes half a generation for bankers to go of structure; it is a question of eVectiveness. In other back to their foolish ways so I think this will last for words, certainly our message to those banks will be, a while! I have lived through a couple of disasters. “Look, we don’t want to go back into the old system where you had a former chief executive as chairman. The non-execs were good people to talk about world Q2641 Mr Tyrie: You spoke about the need to aVairs but they did not know anything about protect the minority shareholders and I think that banking and they were there not to really engage point will be well taken outside this room. I think it with us.” I think the governance issue is that non- would be helpful if you could give us reassurance execs particularly have got to get engaged and they that that may require speaking up and defending have got to be given the opportunity to say, “That’s them against the majority shareholder, which is the crazy. Don’t buy that bank. Stop lending so much Government, and that you, Mr Moreno, will be mortgage money in the United States. This doesn’t prepared to do that in no uncertain terms, if make any sense.” necessary. Mr Kingman: There are lots of lessons from Mr Moreno: I certainly will and I am sure my particularly the RBS saga, but one of the lessons is successor will. I think it is very important for a there were real issues about information flows to the couple of reasons. First of all, these people have board and the involvement of the board in risk perspectives that we do not have as the largest management. One of the things we have done is go shareholder which are very valuable. I think that and have discussions with the heads of risk some of our consultation with Scottish institutions management at both RBS and Lloyds, and one of that are doing some of the RBS board manoeuvres are very helpful. Secondly, ultimately the share price those people said to me this was the first time a V shareholder had ever asked to come and see them. I in these banks is much a ected by people’s view of think reforming that is important. The second thing how they are going to be treated. This very small I would say is obviously you have got the David group in share terms of shareholders have a lot to do Walker exercise and we will want our banks to be at with what is happening to the marginal price of the the forefront of engaging with that and responding shares and I think they have value to add. Also, they to it. help us in our mission of keeping an arm’s length commercial relationship here with the Government because their interests can be diVerent. Q2638 Chairman: You talked about information flow problems to the board. Can you expand on that? Q2642 Mr Mudie: Mr Moreno, I think you have said Mr Kingman: I think there are real questions about some very interesting things. One of the interesting the extent to which the board had the kind of things was that when you were speaking about information you would expect them to need about compromise agreements you said they are management of the balance sheet and about risk compromise agreements, they are negotiations to particularly. I do not claim to have conducted a stop the executive who is going suing the company, massive audit but certainly, after looking and a messy departure. Let us say I am the minister and discussing with RBS, as we have done in a structured you are the chairman and I say, “We’re going to way, the important lessons that they have learnt so rescue this bank but this fellow has got to go,” and far, this issue about information flows to the board you say, “Fine, but it will be messy, minister. We will has loomed quite large. have to do some negotiation.” I say, “Fine. On you go.” The phone rings 24 hours later and you say, “It’s going well. I think we have got agreement.” I Q2639 Chairman: We have got Peter Sutherland on say, “Right. Tell me. That is very good.” You say, the board of RBS, a former EU commissioner, and “He is not going to sue. He is going to go quietly. He we have Steve Robson, the number two at the has given up £1.5 million in salary and the shares.” Treasury.These guys are pretty bright. There must be That just does not ring true. I would say back to you, some systemic reason for the problems. “And? What the hell have you given up?” That is just Mr Kingman: I do agree with that. I think a straightforward negotiation for an old trade union information flows is almost certainly part of the oYcial to use. I have put you in to negotiate our way answer. out of a very messy situation. You may be a lovely negotiator who can stop a fellow from suing us by letting him give up a £1.5 million salary. I have got Q2640 Chairman: Are you adequately equipped to to say to you, “What the hell have you given up?” Is capitalise on this unique opportunity to lead the that not fair? banking sector into significant lasting improvements Mr Moreno: I have to say that trade union oYcials in the way in which it is governed or will the banks tend to be a bit tougher than remuneration revert to their old ways once UKFI exits? committees. I do not know. May I just say a word Mr Moreno: I think we can play a significant role in about Lord Myners? remuneration and in governance. There are other people at work on these issues, obviously. I think the entire FRC approach of looking very heavily at the Q2643 Mr Mudie: No. Mr Kingman said a minister composition of boards and committees and that sort cannot be on top of all the details. What details? I of thing needs to focus more on the substance, on have asked you to negotiate a settlement to stop him what happens in boards, that is very important. It suing us and you end up taking £1.5 million from Processed: 25-03-2009 23:58:58 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG15

Treasury Committee: Evidence Ev 345

3 March 2009 Mr Glen Moreno and Mr John Kingham him and you ask me as a minister to believe that he crisis and went right at the bankers. I know that has not put a demand on the table that you have met because I was the other one. We were in a very tiny that we have got a settlement for. minority in saying, “You guys are walking into huge Mr Moreno: Certainly in my own case, if I were Fred trouble.” It just seems inconsistent to me what we are I just would have walked and not demanded pay on talking about, but I do not know. this thing. There are a lot of people who have done Mr Kingman: I was not present, but I have read very that because they are embarrassed or they are detailed notes about some of these conversations ashamed or because things went very badly. I think and I do not recognise the picture you paint, which the board was still in denial at that time and resentful is, “Look, we have got to do a deal with this guy to about the government assistance so I guess the avoid him suing us.” That does not come across at atmosphere was diVerent. This guy has been paid a all. What comes across is that Lord Myners went in lot of money for what he did over the years. Basically and said, “Look, the Government is willing to act in you say, “You have failed on this. I am sorry. We are support. Some people decisions have to follow.” He all going to have to stand down,” and you walk. was then immediately assured that the bank had already decided that Fred needed to go. Myners said, Q2644 Mr Mudie: I do not think you are being as “Okay. We don’t want to see any rewards for straightforward as you have been all meeting. failure,” and he was very clear about that and he was Mr Moreno: I am. recorded several times as saying, “All payments to outgoing directors must be minimised subject only Q2645 Mr Mudie: In this day and age, if I sent you to what is legally necessary. What are you going to in to negotiate to stop the fellow suing us and you do?” He was told what they were going to do and persuaded him to give up £1.5 million, I would have essentially what happened was that the bank did not to ask you what the other part of the deal was. share the fact that actually it had made a choice Mr Moreno: I think Fred should have and would which was not consistent with what Myners had said have walked. He is the kind of guy I would have to them and I think they ought to have done. thought would have said, “I am leaving. Goodbye.” The pension thing is just too complicated. I do not know what they were told. Q2650 Mr Mudie: But then I would have asked you about that and the minute you said it is £697,000 a year I would have said, “Bloody hell! How do we get Q2646 Mr Mudie: Would you have followed it up out of this?” because I certainly would as a minister? Mr Moreno: On a remuneration committee— Mr Kingman: It is not news that Fred Goodwin’s remuneration arrangements were incredibly generous. Q2647 Mr Mudie: We are not asking you that. We are asking you about this three person situation where I am a minister, the Government is putting Q2651 Mr Mudie: It is £703,000 with inflation. You money in and we say to you that he has got to go and would ask. You would press. I would press. That is you say back to me, as you would, as anybody who not an acceptable figure. That is not a normal figure. has done this knows, “It could be messy” or “We will You would say, “That is obscene. We cannot let have to reach an agreement.” You reach an this go.” agreement. Get into negotiations. I am just a Mr Kingman: It is not news that Fred Goodwin minister. You come back and you say, “We have alongside other senior executives had reached agreement. He has given up £1.5 million and extraordinarily generous remuneration he will not sue us.” Commonsense and every instinct arrangements. I do not think that one can expect as the minister would lead me to say, “Glen, tell us Lord Myners to have known the fine detail of the the rest.” It just does not make sense. RBS pension scheme in order to know that what he Mr Moreno: I do not know if anything makes sense was being told was not consistent with what he had when you have been in your job for three days and said. you are trying to get rid of these guys and save the Mr Mudie: If you had said to Lord Myners or banking system. anybody else it is a £703,000 pension you mean to say he would have said, “Okay”? He would not have Q2648 Mr Mudie: Who has been in the job three said, “Are you sure this is right?” It looks as though days? there are other questions to ask. Mr Moreno: Paul Myners had just got there, had he not? Q2652 Sir Peter Viggers: In response to a question Q2649 Mr Mudie: Yes, but he has been in the from me you said that you thought that it was not banking industry all his life. He has been at a senior unusual for ministers to attend meetings and to take level. You are again equivocating. You are being decisions without the accompaniment of a civil too loyal. servant. I put it to you, based on a long time ago, two Mr Moreno: I am not. I am being driven by years in the Treasury as a PPS, that ministers never something that I know and that is, I have sat in took decisions without civil servants being present. chairmen’s dinners and meetings and small sessions If what you say is correct, it must be that this is a in this city for the last three years and Paul Myners systemic fault that Government has become so was one of the few guys who spotted the banking casual that this sort of thing can happen. Processed: 25-03-2009 23:58:58 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG15

Ev 346 Treasury Committee: Evidence

3 March 2009 Mr Glen Moreno and Mr John Kingham

Mr Kingman: I suppose I am simply making a Mr Kingman: I can assure you, the phones are being factual statement, which is that my own experience answered. both under this administration and the last is that it Chairman: I think we would characterise your is not by any means unheard of for ministers to have approach to the Committee as maybe dozy at the meetings without civil servants present. I am not sure beginning. We want you brighter and alert. You can that is a constitutional outrage. I think it is the case be sure, Mr Kingman and Mr Moreno, that we are that such meetings do sometimes happen. It is also going to invite you back. We will look forward to a the case that that weekend was extraordinarily more enlightened communications strategy. pressured because we were doing an exceptionally large series of transactions. Q2655 Mr Mudie: Is the advert for your position Q2653 Chairman: There may be more questions to out now? tie you down on the ministerial side and also the Mr Kingman: No. It is a matter for the Treasury to non-execs as well. I think you would agree with that. decide how it wants to take that forward. Mr Kingman: I would. Mr Mudie: Are you not taking advantage of the fact he is doing it for nothing? Q2654 Chairman: I notice that two of your staV, Chairman: Your evidence has been hugely helpful to Sam Woods and Tim Sykes, are here. Given the hole us and our report. Thank you very much. Obviously in the wall operation, who is left to answer the we wish you well given you are the custodian of the phone? taxpayers’ interest. Processed: 26-03-2009 00:27:11 Page Layout: COENEW [SO] PPSysB Job: 416782 Unit: PG16

Treasury Committee: Evidence Ev 347

Tuesday 17 March 2009

Members present

John McFall, in the Chair

Nick Ainger Mr Andrew Love Mr Graham Brady John Mann Mr Colin Breed Mr George Mudie Jim Cousins Mr Mark Todd Mr Michael Fallon Mr Andrew Tyrie Ms Sally Keeble Sir Peter Viggers

Witnesses: Lord Myners CBE, a Member of the House of Lords, Financial Services Secretary to the Treasury, Ms Mridul Hegde, Director of Financial Services, and Mr Nikhil Rathi, Team Leader, Financial Stability Team, HM Treasury, gave evidence.

Q2656 Chairman: Lord Myners, welcome to the Q2659 Chairman: The issue of Sir Fred Goodwin’s Banking Crisis Inquiry of the Treasury Committee. pension has obviously been a big issue over the past Can you introduce yourself and your colleagues for few weeks and you would be surprised if we did not the shorthand writer, please? ask you about it this morning. You come as a Lord Myners: Good morning, Chairman. I am Paul pension fund manager from the aggressive and Myners and I am Financial Services Secretary to the unsentimental environment of the City where detail Treasury. On my right is Mridul Hegde, Director, is king. Is it not the case that you have dropped the Financial Services, from the Treasury and on my left ball here; that detail is king and you have not looked is Nikhil Rathi, Head of the Financial Stability at it, and you were either negligent or you were Team, from the Treasury. misled, it can only be one or the other? Lord Myners: Mr Fallon oVered me the choice of choosing between a nod and wink with another Q2657 Chairman: Good morning. The Financial banker or negligence. I plead guilty to neither. I am Services Secretary post is a new post. What is grateful to the Committee for the opportunity to set distinctive about that post? Why did it need to be out what I know about RBS’s decision in respect of established? Sir Fred Goodwin’s pension. By way of background, Lord Myners: I think it is a new post in the sense that during the weekend of 11 and 12 October, I was it was an additional oYce created in the Treasury, heavily engaged in the task of supporting a number although many of the functions for which I am of major UK financial institutions which were responsible were previously carried out by other essential to the financial stability of the UK Ministers; before me by Kitty Ussher, and before her economy. These meetings were at the Treasury and by Ed Balls. I think the increased demands on the they took place round the clock, from the Friday financial services side of the Treasury, particularly as a consequence of the diYculties being experienced in evening through to the early hours of the Monday the financial sector, persuaded the Prime Minister morning. It was in this context that I met with and the Chancellor that they wanted to create an representatives of RBS on the evening of Saturday additional ministerial position. 11 October. I was informed that the directors had already decided on the previous day to replace Sir Fred Goodwin as Chief Executive; in their own Q2658 Chairman: Lord Turner has stated to us in the words “he needed to go.” The following evening I Committee that the FSA is not yet fit for purpose. was telephoned by a director of RBS, Mr Robert When do you think it will be fit for purpose and what Scott, and during the course of that conversation process has it to undergo to achieve that aim? was told of the then estimated transfer value of Sir Lord Myners: Like members of the Committee I am Fred Goodwin’s pension. At no stage prior to sure, I am looking forward to Lord Turner’s review, February of this year was I, or anyone else in the which will be published later this week. I think it will Government, as far as I know, made aware that in be a very thorough piece of work which will look at the process of replacing Sir Fred Goodwin RBS had issues around the monitoring of capital and liquidity, exercised a discretion which allowed him to take his behaviours, supervision, accounting, and the nexus full, undiscounted pension from the age of 50 and between boards and management and shareholders. thereby nearly doubled the value of his pension. This also will fit neatly with the work which we are Quite the contrary; I was very clear with RBS and expecting Sir David Walker to do in his review of with the other banks that I met over the weekend bank governance. How long will it take? I think we about the principles which the Government must wait to see what Lord Turner says and the expected them to follow in dealing with departing debates that follow that. As the Prime Minister has executives. I developed a script for these meetings said, the complexity of financial services has and I set out these principles in the following terms: increased quite significantly over the last 10 years there should be no rewards for failure; payments to and it is possible that global regulation failed to keep departing executives should be minimised; and up with the pace of innovation in the financial sector. executives should be required to mitigate loss of Processed: 26-03-2009 00:27:11 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG16

Ev 348 Treasury Committee: Evidence

17 March 2009 Lord Myners CBE, Ms Mridul Hegde and Mr Nikhil Rathi oYce costs wherever possible, but we would not Philip Hampton. Members of the Committee will expect the banks to abrogate existing contractual appreciate, no doubt, that there are limits to what I commitments. The two directors of the Royal Bank can say further given the fact that there is the of Scotland with whom I met to have this discussion possibility of legal action being taken. I am grateful about Sir Fred Goodwin—that is Sir Tom McKillop to you, Chairman, for allowing me to make rather a and Mr Robert Scott—expressed no issues at all full statement, but I felt that it might set the context with these principles, although it has subsequently and then provide the Committee with a good become clear that they were already embarked upon opportunity to cross-examine me on what I have a decision process which was contrary to those said. principles. It is beyond my comprehension that RBS could have then exercised a discretion that very substantially increased the cost of funding Sir Fred Q2660 Chairman: In continuing our inquiry into the Goodwin’s pension. Perhaps I could mention the banking crisis we are going to be looking at the role key terms of RBS’s pension scheme, as I understand of non-executives in our consumer confidence focus them. Under the pension scheme, a member of the and we will be having them back on that. You scheme retiring early at RBS’s request—these words mentioned the issue of principles. Outlining general being very important—has the right to receive a principles is not the same as engaging in proper pension based on accrued service with no discount checks as to what is going on. Did you demand to see applied for early retirement. This is set out clearly in the relevant documentation? If not, why not? the company’s Annual Report and Accounts, but Lord Myners: I think, Chairman, in the context of this right only applies for someone who is asked to the negotiations which were taking place with eight retire and chooses to do so, such a person choosing major financial institutions throughout that long voluntary redundancy and having the right to make weekend, which led to a commitment in principle of such a choice, that is to say, they could decline the up to £50 billion of equity capital support, a direct invitation to retire early. It was clear from my commitment of £37 billion, plus the launch of a new, understanding of the discussions with RBS, and an complex, innovative Credit Guarantee Scheme of examination of RBS papers that I have seen, that the £250 billion, and an extended Special Liquidity board had reached a view that Sir Fred Goodwin Scheme, there was a limit to how much we could do, needed to go. There was no question of Sir Fred but, quite clearly, this was a responsibility that the Goodwin being able to decline the oVer of early directors of the Royal Bank of Scotland owed to all retirement and, as such, I do not think it met the tests shareholders. The responsibility of directors under that the scheme set. Someone who leaves the company law is very clear as to the members of the company without having an option to stay is not company current and prospective, and this was a automatically entitled to his pension treatment. Sir duty which fell to the board of the Royal Bank of Fred Goodwin did not have the option of staying. Scotland, as they clearly understood themselves in The board had decided that he must go. Someone their terms of reference, and yet in their papers to the within RBS took the decision to treat him more nominations committee, which you have seen, the favourably than required. This decision is remuneration committee and the Chairman’s completely at odds with the principles that the committee, they consistently misdirected themselves Government made clear to RBS and expected them in saying that Sir Fred’s pension reflected his to follow. I believe that the role of government as a contractual entitlement. It simply did not reflect his prospective shareholder and provider of financial contractual entitlement, only the interpretation that support was to make clear the principles it expected they had allowed to be placed upon it by virtue of the to be followed in respect of remuneration. This is the fact that they had requested that he retire rather than same approach that other engaged and informed required that he retire, which was clearly, in my view, institutional shareholders would take in similar what they had actually done. In order that he could circumstances. When directors fail to act in the get a better pension, they had framed this in terms of interests of shareholders they should be held to a request, but I repeat my view that it was a request account. It is not the job of the government minister which clearly Sir Fred was not going to be able to to negotiate or settle the details of individual decline. May I also add that they were advised very transactions that the banks enter into, including seriously by Watson Wyatt, a reputable firm in this termination arrangements for departing executives. area, that this would have adverse consequences and I did not negotiate, settle or approve Sir Fred their shareholders would not approve of this Goodwin’s departure terms. All these issues were decision. That said, the board still continued with handled by RBS. The new board of RBS, like the their actions. I think it is the board to whom these Government, is very concerned to understand how questions should be directed, not a Minister. people within the company could have made this quite extraordinary decision, clearly at odds with the principles that the Government had laid out, and Q2661 Mr Fallon: But you were the Minister exactly who made that decision, a decision which responsible and what you have not told the was also clearly contrary to the terms of reference of Committee this morning is what you told the House the remuneration committee of the Royal Bank of of Lords on 5 March, namely: “I discussed Sir Fred Scotland. This is now a matter of legal investigation Goodwin’s pension on the evening of Saturday 11 which is being carried out under the guidance of the October.” What was there to discuss about his new Chairman of the Royal Bank of Scotland, Sir pension? Processed: 26-03-2009 00:27:11 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG16

Treasury Committee: Evidence Ev 349

17 March 2009 Lord Myners CBE, Ms Mridul Hegde and Mr Nikhil Rathi

Lord Myners: In expanding upon the principles and decline the request. There was clearly no such option in my discussions with Sir Tom McKillop and Mr so it did not fulfil the wording which you are reading Bob Scott, I talked about a number of aspects of the to me. I apologise for giving long answers; I will try arrangements for Sir Fred’s departure. In respect of to be briefer. the pension, Mr Scott said, “The pension will be enormous; you know that”, and I acknowledged that because Sir Fred had been an extremely well- Q2666 Mr Fallon: Are you aware that RBS’s paid person. He had been paid £11 million over the evidence to this Committee on 2 March said the previous three years. What I was not told was that decision was taken the previous day. They decided Sir Fred’s pension was in the course of being doubled this would best be accomplished by treating Sir Fred in value by the members of the remuneration Goodwin as leaving at the request of the company committee. In challenging Mr Scott, who was the and not being dismissed. That decision had been most active member in these discussions, about the taken the previous day. need to ensure that failure was not rewarded—and Lord Myners: And Sir Tom McKillop advised me— let us be clear, this bank had seriously failed, this bank, as we now know, had lost close on £30 Q2667 Mr Fallon: So you knew that? billion—I challenged Mr Scott on this issue, and he Lord Myners: Yes I did, I have been very clear. was very clear, and I remember the words well, as indeed does the partner from Slaughter & May who was present, that Sir Fred Goodwin is a man who Q2668 Mr Fallon: You knew that he was leaving at absolutely insists upon his contractual entitlement, the request of the company? and his pension was a matter of contract. As I said Lord Myners: I knew that he was leaving. earlier, I did not believe that we could abrogate contract. What was clear with hindsight, Mr Fallon, Q2669 Mr Fallon: But this says he was leaving at the is that I was not told the full story. request of the company. Chairman: We have half a dozen members wanting Lord Myners: I knew that he was leaving. I did not to come in on questions, so if you can give us some know the basis on which he was leaving. shorter answers it will help.

Q2662 Mr Fallon: Sir Fred Goodwin in his letter said Q2670 Mr Fallon: You did not ask? that you indicated you were aware of his entitlement. Lord Myners: Sir Tom McKillop told me that the Were you aware of the RBS pension fund rule that board had decided, or more precisely the non- allowed any member retiring early at the request of executive directors of either the nominations or the the company to receive a pension without any governance committee had by a telephone call on the discount for early retirement? previous day decided that there needed to be a Lord Myners: The RBS pension fund rules run to change. over 200 pages. I had not studied the full document. Q2671 Mr Fallon: So you did not ask. You have been Q2663 Mr Fallon: But the rule is specified in RBS’s a director of many companies. You have served on Annual Report, I have it here at page 109, which is remuneration committees. In fact, you were on the the last Annual Report available to you. NatWest board when Sir Derek Wanless was pushed Lord Myners: I do not think that is actually a rule of out as Chief Executive with an early retirement the pension scheme, Mr Fallon. package of around £3 million, which has become known in the City ever since as “doing a Wanless”. I Q2664 Mr Fallon: I will quote it to you Lord put it to you that either you were party to some very Myners: “The RBS fund rules allow all members expensive piece of back-scratching and it was only who retire early at the request of their employer to later when the Prime Minister found out about it receive a pension with no discount applied for early that you pretended that you had not approved the retirement.” That is in the Annual Report. Were you full details, or you simply failed in your duty to aware of that? protect the taxpayer and you allowed Sir Fred to Lord Myners: I was not aware of that at the time. walk away with a pension of £700,000 a year for life. Which is it? Q2665 Mr Fallon: Why were you not aware of that? Lord Myners: It is neither. The decision on the Lord Myners: Because of the situation which we pension was made by the board or directors of the were handling when there was a global financial Royal Bank of Scotland. I made no decision; my crisis which was bearing down heavily on UK banks, approval was not sought; I was given no and on which we were taking steps to ensure that the information; I sought no information. What I did banking system was in a position to operate do, Mr Fallon, was to set out very clearly the eVectively on the Monday morning. I think, more principles. Those principles accorded closely with importantly, Mr Fallon, the situation of Sir Fred the policies of the Royal Bank of Scotland and Goodwin did not fulfil the condition of that rule. He indeed accorded with the principles set out by was not requested to retire in the sense in which agencies such as the Association of British Insurers. lawyers approach this, and there is case law to No rewards for failure; minimise the cost of support this whereby a request can only be defined departure; mitigate against any costs that can be as qualifying as a request if there is an option to avoided; but do not abrogate legal requirements. Processed: 26-03-2009 00:27:11 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG16

Ev 350 Treasury Committee: Evidence

17 March 2009 Lord Myners CBE, Ms Mridul Hegde and Mr Nikhil Rathi

Q2672 Sir Peter Viggers: Is it normal for Ministers his pension until the age of 60. That was changed at from the Treasury to go to meetings without the some point on the Saturday morning, under accompaniment of a civil servant to record the instruction, I believe, from Mr Roden and Miss events and to avoid uncertainty? Sloan of the Royal Bank, who were taking Lord Myners: Sir Peter, if I can try to give you a instructions from Sir Tom McKillop and Bob Scott. picture of what— They were the people who made the decisions, not the lawyer from Slaughter & May and not myself. Q2673 Sir Peter Viggers: It is yes or no really, is it not? Q2677 Sir Peter Viggers: Any lawyer, whether or not Lord Myners: I am a relatively new Minister but from Slaughter & May,must have been present at the what I did do was to take advice from oYcials, and meeting to advise you on the law, and clearly they we concluded that the sensitive nature of the failed. discussions that I was going to have with Sir Tom Lord Myners: No, quite the contrary, we were McKillop and Mr Scott, and with Lord Stevenson talking about the principles on which executives and Mr Andy Hornby of HBOS, were best would depart. We were not talking about the details conducted not in the large meetings which we were of individual contracts. That is a matter under having with the banks, in which there might have company law for the directors of the company. been as many as 20 or 25 people, but in smaller groups. In consultation with oYcials, we agreed that I should be accompanied at those meetings by a Q2678 Mr Mudie: I do not think you can have it lawyer from Slaughter & May to maintain a note. both ways, Lord Myners. You have just finished up talking about company law. In line with the Government, you set out the principle of no reward Q2674 Sir Peter Viggers: Did that lawyer know that for failure, but you did interfere in the discussions your guiding principle was that there should be not because in early November you went back and dealt rewards for failure? with a share option, so you did actually negotiate Lord Myners: Yes, we agreed that before the and you did settle things. I can understand the busy meeting. weekend and the huge decisions that you had to take, but you did slip up by not asking some Q2675 Sir Peter Viggers: So why did he not alert you questions about the pension when you saw the to the fact that the package which was being amount of it. proposed was going beyond his contractual Lord Myners: Mr Mudie, with all respect, I do not entitlement? Can you not simply take Fred think I slipped up. Goodwin’s pension out of Slaughter & May’s indemnity policy? Lord Myners: The responsibility for fully informing Q2679 Mr Mudie: That usually means “with no me on these matters lay with Sir Tom McKillop and respect”! Mr Bob Scott. They were the only people who knew Lord Myners: No, with considerable respect for you the thinking of the remuneration committee, or and the Committee. I have watched this Committee members of that committee, at the Royal Bank of at work over many years. I have contributed written Scotland. The lawyer from Slaughter & May was evidence to this Committee and I believe, without acting on behalf of the Treasury,not acting on behalf sounding sycophantic, that you have done much of the Royal Bank of Scotland. good work in terms of exposing some quite complex and tricky issues, and we have benefited from your work, so I say that with all sincerity and candour. I Q2676 Sir Peter Viggers: If he knew that there were do not think that I slipped up. I think the right to be no rewards for failure, what was he doing? approach was one based around principles. Indeed, Lord Myners: He knew that there would be no that is what the Combined Code and the report of Sir rewards for failure and, furthermore, he heard me Derek Higgs expects shareholders to do. very clearly state in both my meetings with HBOS and the Royal Bank of Scotland that that was the case, Sir Peter, and he noted that no dissent was Q2680 Mr Mudie: Shareholders were not involved raised, nothing was said at that meeting by either Sir here or, rather, you were the representative of the Tom McKillop or by Mr Scott along the lines of, shareholders in terms of the Government. We were “Well, actually, Minister, what we are minded to do putting billions in. You were told that this was an is be rather generous to Fred because he has served exceptional pension. Bob Scott told you. I can us well, and we would like to double the value of his understand that you were preoccupied with the pension, as a result of which we are going to create bigger picture, but you cannot then take refuge and an elaborate ruse under which it appears that he is say that you did not negotiate, it is was not your requested to retire, and he accepts that request.” decision. You were there as a Minister to make sure That was not explained to me. It was clear from the that there was no reward for failure. Fred Goodwin instructions that had been given to Linklaters on the walked away with a pension that was almost Saturday afternoon to draft his compromise doubled, so he was rewarded for failure, and you are agreement that a decision along those lines had been the individual, you are the Minister who handled reached because earlier in the morning on the that business. If you said that you were pre-occupied Saturday the compromise agreement drafted by by the bigger picture, people would understand, but Linklaters had assumed that Sir Fred would not take you cannot say it was nothing to do with you. You Processed: 26-03-2009 00:27:11 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG16

Treasury Committee: Evidence Ev 351

17 March 2009 Lord Myners CBE, Ms Mridul Hegde and Mr Nikhil Rathi set the parameters; you actually interfered in the Lord Myners: Yes. details. You have conceded that, you have accepted that. Why can you not accept that you slipped up? Q2686 Nick Ainger: And, as you want to see, and I Lord Myners: I set very clear parameters and am sure all members of this Committee want to see, principles, which I believe was the right approach to and certainly the British public want to see, that Sir adopt. In November, in the course of reviewing the Fred Goodwin pays a substantial part of this draft listing particulars in connection with the oVer pension back because, clearly, he has been rewarded of securities to the Government, it became clear that for failure. My calculation is that if he lives until 80 the board of the Royal Bank of Scotland had he will receive £21 million. If he had taken his allowed Sir Fred to retain certain share options. contractual arrangements, he would only have got When my attention was drawn to this, I think I £9.6 million. Therefore, he has received over £11 telephoned Mr Scott and said I thought this was not million as a reward for failure. Can I take you back consistent with the principles. to what the remuneration committee did and what its minutes tell us. I have got the minutes here and Q2681 Mr Mudie: Why did you do not that with this was the meeting that started at 5 pm on Sunday the pension? 12, and it states: “It was noted that the departure Lord Myners: Because the discretionary aspect to terms which had been considered by the Committee the pension was not disclosed at that time. represented Sir Fred Goodwin’s contractual entitlement. Mr Roden reported that discussions Q2682 Mr Mudie: Let me ask you finally— with Sir Fred Goodwin were on-going and that a Lord Myners: The discretionary element of the compromise agreement was being prepared which pension was not disclosed, Mr Mudie, until stated that the termination date was subject to February. mutual agreement.” Then the resolution of the committee is by the general council and group Q2683 Mr Mudie: It is almost like the Chancellor secretary and directors, Mr Roden be authorised to slipping up over the Budget over an individual thing take whatever actions are required to implement the and saying, “I was preoccupied by the bigger arrangement for Mr Hester and Sir Fred Goodwin. picture.” You cannot get away with that. Just let me Therefore the remuneration committee did not agree ask you: with hindsight, would you have referred this the package that Sir Fred Goodwin accepted; is pension to your oYcials to look at in view of the that correct? huge amount? I can forgive someone for making a Lord Myners: I think constitutionally under the mistake; I cannot forgive anybody for not learning terms of reference of the remuneration committee— from a mistake. In hindsight, would you have asked, and Mr Fallon, as chairman of a remuneration as I would have expected a busy Minister to do in the committee at Tullett Prebon, will no doubt have middle of negotiations, “Somebody better look at insights into this as well—acts as a sub-committee of this”? the board and the full decisions are taken by the Lord Myners: I am afraid that Mandy Rice-Davies board. would probably anticipate my answer, but I have looked very carefully in my own mind about this Q2687 Nick Ainger: Let us just be clear. From that issue, Mr Mudie. I have asked myself, as I think minute, and I think you have got it in front of you, many of us would do, did I do something wrong, the remuneration committee did not agree the should I have done something diVerently in the severance package for Fred Goodwin. circumstances. I am not claiming as a defence that I Lord Myners: I believe that this Committee agreed was in some way overworked or pre-occupied by terms that they would recommend to the board and other matters, but I have asked myself should I have that that decision was taken in the early hours of done something diVerently, and I have concluded Monday 13 October. that it was right to adopt an approach of setting up very clearly with no hesitation and no qualification Q2688 Nick Ainger: But the minute says that: “Mr the principles and then expecting the Royal Bank of Roden reported that discussions with Sir Fred were Scotland board and the HBOS board to take actions on-going and that a compromise agreement was consistent with those principles, or to explain why being prepared.” they were not doing so. Lord Myners: I believe that a compromise agreement was handed to Sir Fred Goodwin on the afternoon Q2684 Mr Mudie: It is one thing to set principles but of Saturday 11 October. These minutes relate to a it is naive not to check that the principles are adhered meeting held on Sunday 12 October. There is an to. This is where we are in this banking crisis—light- inconsistency between those two dates, and that is touch regulation and principles-based—and the one of the areas which I am sure the board of RBS reality is if you do not check, people do funny things. will be investigating. Lord Myners: I think that question, Mr Mudie, should be directed to the directors of the Royal Bank Q2689 Nick Ainger: Indeed, because further on in of Scotland. They are the people who are legally the Chairman’s board meeting, which took place at responsible to the owners of the business. 1.30 on the morning of Monday 13 October, it says: “Finally, the committee noted that the remuneration Q2685 Nick Ainger: Lord Myners, I think what we arrangements in respect of Mr Hester and Sir Fred’s would be looking for is some way out of this mess. departure had been considered at a meeting of the Processed: 26-03-2009 00:27:11 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG16

Ev 352 Treasury Committee: Evidence

17 March 2009 Lord Myners CBE, Ms Mridul Hegde and Mr Nikhil Rathi remuneration committee held on 12 October. The Q2691 John Mann: Did you know that he had been directors approved the arrangement, details of kept on in January? which are contained within the remuneration Lord Myners: I knew because they announced on committee minutes.” There are no details in the Monday 13 October that Sir Fred Goodwin would remuneration committee minutes. Therefore, in be departing as soon as a new Chief Executive was your experience, how on earth could that full board appointed. At that time Mr Stephen Hester was come to a decision on Sir Fred’s deal? Chief Executive of British Land and he had to secure Lord Myners: Mr Ainger, I do find this his departure from there. The board of the Royal extraordinary. If I can stick with the paragraph from Bank had concluded that Sir Fred’s continuing which you were quoting which says, “It was noted presence was critical over the three-month period, that the departure terms which had been considered but thereby hangs another tale. by the committee represented Sir Fred’s contractual entitlement.” They simply did not reflect his Q2692 John Mann: What had you concluded? Did contractual entitlement, and the board was you believe that his continued presence was a good misdirecting itself on that particular point. It is also thing or did you tell them to get rid of him straight very clear that there is not a single number in this away? paper. These directors took their decision on the Lord Myners: I do not think from the perspective of pension without a single point of data in terms of sitting outside the company it is possible to form a cost. There is no articulation of the alternatives that view on the internal dynamic and the roles of the the board had. The board clearly had choices. The board. I was aware that in Mr Gordon Pell there was board could have terminated with cause. The board an extremely accomplished and distinguished could have terminated without cause. The board banker in the Royal Bank, but the view of the Royal could have terminated with garden leave. The board Bank of Scotland, and I believe their financial could have invited Sir Fred Goodwin to retire and advisers Merrill Lynch and UBS, was that Sir Fred’s give him the option. They constructed this continued employment was critical to the next arrangement in accordance with the last of those three months. routes, which was the most generous that they could have done from the perspective of Sir Fred, which led to this quite extraordinary settlement. You will Q2693 John Mann: But you represent the interests of also notice that they give Sir Fred the choice of either the taxpayer not the interests of a failed bank with taking his full pension at 50 or his full pension at 60. failed advisers and a failed board, so why was he I think one would have to have been a monkey in allowed to continue on in January? that situation to have spent a great deal of time Lord Myners: I believe that he was allowed to carry deciding on which of those choices to take. It does on because it was concluded by the board of the give an overall picture of a board of directors, or at Royal Bank and by their financial advisers that his least some directors, bending over backwards to be presence was absolutely critical to the capital-raising generous to Sir Fred. There was a real sense of and management of the bank until Mr Hester’s denial, in my view, about the Royal Bank of arrival, but he would depart almost as soon as Mr Hester arrived. You may remember— Scotland during this period of time. When I had a second meeting with Mr Scott, after my first meeting with Sir Tom McKillop and Mr Scott, Mr Scott was Q2694 John Mann: Why did you not just insist that most insistent that if the board insisted on Sir Tom he was sacked? McKillop leaving that the non-executive directors Lord Myners: Because it was not for the had the previous day agreed that they would all Government to do that. We were not a shareholder resign in protest because they felt this would have in the bank. This was a decision to be taken by the been harsh and outrageous treatment of Sir Tom directors of the Royal Bank of Scotland. Remember McKillop. I was dealing with people who, quite these are distinguished people. Sir Tom McKillop, frankly, for the first time, in my view, on that evening the former Chief Executive— were realising the serious state of aVairs in which this bank had been taken and yet they had already taken decisions in principle to treat Sir Fred Goodwin in a Q2695 John Mann: Distinguished people? most extraordinary and generous manner. I still Distinguished people who have cost the taxpayers tremendous risks. Let us look at the future. Have hope there is an opportunity for Sir Fred to do the you had a chance to discuss with Harriet Harman right thing and either return some of his pension or her proposals on retrospective legislation? make a very, very substantial and long-term Lord Myners: I have not discussed Ms Harman’s commitment to charity, both of money and of his proposals. undoubted energy and resources. Sir Fred can mitigate even at this stage. Q2696 John Mann: So we can dismiss that then as purely hot air. Who is the legal action going to be Q2690 John Mann: I would not want to risk a charity against, the board of directors of the Royal Bank of in my area. How come you kept him on in January? Scotland or Mr Goodwin? Lord Myners: Mr Mann, the board of the Royal Lord Myners: I cannot anticipate that until the Bank of Scotland kept him on. advice is provided to the Royal Bank of Scotland. Processed: 26-03-2009 00:27:11 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG16

Treasury Committee: Evidence Ev 353

17 March 2009 Lord Myners CBE, Ms Mridul Hegde and Mr Nikhil Rathi

Q2697 John Mann: I know that you have been a Q2704 Mr Tyrie: Did it occur to you that it might be politician for six months but a politician’s answer is a matter of some public interest? not good enough on that. Is the thought about Lord Myners: I believe that large pensions and large directing action against Mr Goodwin or against the remuneration are a matter of considerable public directors? interest, and issues on which I have previously Lord Myners: I think we have to await the advice of expressed views, but bear in mind that Sir Fred the leading QC who is advising the Royal Bank on Goodwin’s pension pot was not larger than Mr John this matter. Varley’s at Barclays. It was considerably smaller than Lord Browne’s at BP or Mr Garnier’s at Q2698 John Mann: Come on. When you are taking SmithKline Beecham. It was of similar size to two legal advice, you give them a brief to come back to directors at BAT, of which until which recently the you on. Is the intention to try and take action against shadow Secretary of State for Business was a non- Mr Goodwin or against the directors? executive director, so these large sums, Mr Tyrie, are Lord Myners: As I understand it, the brief that has ones which reflect the reality of the way executive been given to the solicitor and leading counsel is to directors had been allowed to be rewarded in investigate a wide range of matters in the conduct of recent years. the board of the Royal Bank of Scotland. Q2705 Mr Tyrie: But since you had not asked you Q2699 John Mann: So the taxpayer is paying for did not know whether it was a large sum or not, advice on a wide range of matters. It is pretty simple: did you? either there can be action taken against Goodwin or Lord Myners: I was told it was a large sum. there can be action taken against the directors. There is no other party that legal action can be against. I Q2706 Mr Tyrie: I see. And when you were told that cannot see how it could be against Goodwin, so is you did not say, “Roughly how much?” the action against the directors for their Lord Myners: I did not ask roughly how much, and incompetence and breaches of various Acts? Mr Scott oVered no further information at that time, Lord Myners: As a non-legally qualified person I am and indeed when he spoke to me on the Sunday simply not going to anticipate the legal advice that evening he was quite confused in the way that he might be received. The Chairman said earlier on that explained the pension, and even raised the these were matters of detail and I think this detail is possibility that it would not be disclosed appropriately directed by legal advice. immediately but could be spread over a couple of years in order to deflect adverse comment. Q2700 John Mann: They are matters of policy and principle as well. Has anyone been able to suggest to Q2707 Mr Tyrie: So you knew that it would be you any potential legal remedy against Fred politically sensitive, you had been told it was going Goodwin? to be large, but it just did not occur to you to ask Lord Myners: I believe that legal remedies against roughly how much? You are really asking us to Sir Fred Goodwin are under contemplation in accept that as the reasonable action of a competent certain respects. minister? Lord Myners: It is for others to form the view Q2701 John Mann: But has anyone— whether I am reasonable or competent. I certainly Lord Myners: Mr Mann, with all respect, I have endeavour to be both to the best of my ability. I answered your question. You are behaving as recognise that I am new to the world of government though I have not. and politics, but I do bring some relevant experience.

Q2702 John Mann: You are not answering the Q2708 Mr Tyrie: Were you relying on the fact that question. The question is quite simple, and we have these were “distinguished” people who were taking had this for some time that there might be some legal this decision? Do you feel let down by these advice being given. I have taken legal advice. distinguished people? Goodwin has accepted the money and I cannot see Lord Myners: I regret using the word that there is any case legally against Mr Goodwin. It “distinguished”, which I think I might have done to seems to me that any legal case is against the Mr Mann earlier on. I think I would prefer to say— directors for breach of fiduciary duty in various ways. How can there be any specific legal case Q2709 Mr Tyrie: Undistinguished? against Fred Goodwin, who has been given a Lord Myners: Experienced, Mr Tyrie. Do I feel let package and has signed oV that package? down? I feel the shareholders of the Royal Bank of Lord Myners: I think, Mr Mann, you are basing Scotland have a right to feel let down. I feel that your observations on the pension alone. pensioners have a right to feel let down. I think it is Chairman: Mr Tyrie? quite outrageous that a departing executive, a man who led a bank into the largest banking failure ever, Q2703 Mr Tyrie: In this meeting with Slaughter & a bank which depends upon public support, should May at your elbow did you ask roughly the size of be drawing a weekly pension of £13,000, which the pension? compares to the national state pension of £92 for a Lord Myners: No, I did not. I was told by Mr Scott single person or £150 or so for a married couple. This the pension will of course be enormous. is quite unacceptable. Processed: 26-03-2009 00:27:11 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG16

Ev 354 Treasury Committee: Evidence

17 March 2009 Lord Myners CBE, Ms Mridul Hegde and Mr Nikhil Rathi

Q2710 Mr Tyrie: You have said that you are new to impropriety because I was myself the beneficiary of politics. Do you think that had something to do with an RBS pension. I do not have an RBS pension, and the fact that you did not ask the obvious question, I have never had an RBS pension. I hope, Mr Tyrie, which is roughly how much is his package? you will accept that and possibly apologise for any Lord Myners: No, I think I asked appropriate suggestion in your question that I was in some way questions, but in particular I adopted an approach compromised, because I certainly was not. which is based around a clear articulation of principles, and I would repeat there was no dissent expressed by Sir Tom McKillop or Mr Scott. They Q2715 Mr Tyrie: A NatWest pension? did not say, “Wait a minute, Minister, we have Lord Myners: I do not have a NatWest pension. Do actually already decided that we are going to double you want to carry on? the value of his pension.” Mr Tyrie: No!

Q2711 Mr Tyrie: But you have already told us that Q2716 Chairman: I think our heads are full of you went into that meeting having failed to secure pensions so let us get on. The letter from Miller proper advice about the scale of the pension and you McLean to me dated 11 March, I do not know if you V further said that you made no e ort in following it have a copy of that—the letters that RBS and, through to ensure that those principles were put in indeed, HBOS have sent to me will be available for place and were acted on. the press and public after this meeting—in the third Lord Myners: I do not think that I said that I had page at the bottom it says: “In discussions between failed to take proper advice. I said that I adopted the Philip Hampton and Sir Fred, RBS has suggested to correct approach which was a principle-based Sir Fred that he waive his election to commute a cash approach. lump sum from his pension which will be reinstated to its non-commuted form. Sir Fred was happy to Q2712 Mr Tyrie: Do you think it is conceivable that consent to this in principle and appropriate an elected politician could have behaved in the way arrangements are accordingly being put in place. that you did in that meeting that day. RBS would like to thank Sir Fred for his assistance”. Lord Myners: I would like to believe that I behaved I do not fully understand what that means. Can you correctly; and I believe that elected politicians would explain it? behave correctly as well—particularly you, Mr Lord Myners: Sir Fred’s pension was quite Tyrie. extraordinary in a number of respects, and it does not reflect well on institutional investors that these Q2713 Mr Tyrie: You think no elected politicians were matters of record because his contract was open would have found themselves in a position of for inspection but no questions had been asked. wanting to ask the question: roughly how much is Indeed, the major voting recommendation services the package we are giving Sir Fred Goodwin? had consistently recommended voting in support of Lord Myners: I think an elected politician would the RBS remuneration policy. I mean by this the have looked to Sir Tom McKillop and Mr Bob Scott, agencies known as ABI and RREV. The third people of considerable experience—McKillop at agency, PIRC, was distinguished by the fact that AstraZeneca and Lloyds TSB, on the Board of BP, a they had recommended voting against the colleague from BP also on the Board with him; Scott remuneration report. Sir Fred’s pension was unusual previously from CGU—who would have been able to understand those principles very clearly and to in a number of respects. Firstly, he was deemed, on have interpreted what they meant and to have taken joining the scheme at the approximate age of 40, to the necessary actions. It was not for me to seek to have joined at the age of 20. He was credited with 20 micromanage. years’ of service. To the best of my knowledge he did not contribute into the pension scheme his pensions earned previously at Deloitte and Clydesdale; they Q2714 Mr Tyrie: Do you think it is possible that the were kept outside the scheme. He was allowed to fact you took what I think most elected politicians would consider a pretty relaxed approach to the size choose his highest 12 months’ earnings in the of this pension derived from the fact that you previous 10-year period, which I also think is a quite yourself are the beneficiary of a very large pension extraordinary structure in a pension scheme. from RBS? For the record it might be helpful, could Because his pension benefits exceeded the pensions you tell us what is the capital value of your own cap set by Parliament, they were largely provided pension from RBS? through a FURBS—a Funded Un-approved Lord Myners: I can tell you absolutely. I would not Retirement Benefit Scheme. A FURBS is not normally believe it was appropriate to disclose allowed to provide a tax-free lump sum. details about one’s personal information but I am Accordingly, in December 2007, I believe, the Board happy to tell you, Mr Tyrie, that the capital value of of RBS decided that if Sir Fred took a lump sum my pension from the Royal Bank of Scotland is from his FURBS (which he has now done, just under approximately zero. Mr Alan Duncan made a £3 million, I believe) that he would be compensated statement of correction, an apology, to the House of for the fact that this would be taxable, whereas it Commons last Thursday in which he said that he had would not have been taxable if it had come from the been incorrect in the assertion that he had made the RBS scheme—of which, as I have previously previous week that in some way I was guilty of explained, I am not a member. Processed: 26-03-2009 00:27:11 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG16

Treasury Committee: Evidence Ev 355

17 March 2009 Lord Myners CBE, Ms Mridul Hegde and Mr Nikhil Rathi

Q2717 Chairman: Are you saying to me that RBS are Q2722 Chairman: You have left me with the thought paying his tax bill? that you admire Sir Fred’s dexterity,but at the end of Lord Myners: RBS are going to pay his tax. This was the day it is the taxpayer who is the bloody mug here? not disclosed to the shareholders. This was a Lord Myners: Yes, and I was very careful to say that significant amendment to Sir Fred Goodwin’s I did not approve. Just to complete what I was contract of employment in, I believe, December saying—he gave up his entitlement to 12 months’ 2007. It is a matter of judgement as to whether it notice, but he actually then accelerated the receipt of should have been disclosed; but in my view, on the his pension from October to February, and he basis of my experience, it would have been proper to carried on earning until the end of January. As a have advised the shareholders. consequence what he gave as a gesture of giving back actually cost him nothing, because he earned for three months and he took his pension nine months Q2718 Chairman: Can you assure us today that the earlier. Again, the Board of Royal Bank seemed to taxpayers will not be liable for a further contribution be very slow in appreciating what was going on, and here, if my reading of this correct? that does raise serious questions about their overall Lord Myners: Chairman, I have to go back to my performance. earlier observation about not abrogating legal agreements, and I think this is a legal agreement. Q2723 Mr Brady: First of all, just picking up one However, Sir Fred said that in principle he is point from an earlier exchange, in response to John prepared to repay the lump sum but in turn, Mann you said that he was basing his view that Sir obviously, take a larger pension. Fred Goodwin could not be pursued on the pension issue alone. Could I ask you just to be more specific: what other legal avenues are being explored? Q2719 Chairman: You go back and consult RBS and Lord Myners: I am advised, Mr Brady, that it would send us that information. be inappropriate for me to go into further details as Lord Myners: I will very happily, on behalf of the that might in some way compromise the options that Committee, through UKFI, communicate with Sir could be open to the Bank on behalf of its Philip Hampton and seek the information. shareholders. I apologise for not being able to be fuller in my response; but I believe that it would be Q2720 Chairman: We need that quick. We need that appropriate for me to take the advice I have been information back within a few days. given. Lord Myners: I do think it is to Sir Fred’s credit that, in principle, he has indicated a willingness to do Q2724 Mr Brady: But other avenues are being something here. explored as a way of seeking recompense for the Bank, for the taxpayer? Lord Myners: A wide range of issues are being Q2721 Chairman: We want to know if there is a reviewed. further contribution from the taxpayer. Finally, on this point, you said that Bob Scott was quite Q2725 Mr Brady: When the issue of Sir Fred confused when he spoke to you about these Goodwin’s pension came to light you wrote a letter, arrangements. In my mind, given the track record of Lord Myners, in which you said once you became these people and what they did and how they failed aware of this issue “UKFI has, on behalf of the this worldwide institution, why did you trust them? Government, been vigorously pursuing it”. Can you Mr Fallon’s point to you about not scrutinising the tell the Committee please, Lord Myners, under what Y annual report, you should have these o cials power UKFI has been doing so, given that it has working away like beavers look at this annual terms of reference that relate to future remuneration report. Really the truth after this discussion is that if packages but none relating to remuneration and Fred’s agreement is watertight then you can do contracts pre-existing? nothing at all, and he is out of the trap with a clean Lord Myners: UKFI has responsibilities as the body pair of heels and he has really left the Government which holds these shares on behalf of the UK people, flatfooted. That is a summation of it. and in so doing it is charged to perform as an Lord Myners: I think one has to admire in a non- engaged, informed, responsible shareholder. I approving sense the dexterity of Sir Fred Goodwin believe that Mr Kingman, Mr Moreno and the team in respect of his own contract; because you may that they have assembled are setting new standards remember that one of the things I persuaded Sir Fred of how shareholders should perform. As I said to do was to give up his 12-month compensation for earlier, there were issues around Sir Fred Goodwin’s loss of oYce payment. Incidentally, how could he be pension, and indeed around compensation across a paid 12 months’ compensation for being fired on the wide range of banks, which in my view shareholders one hand, and yet also a pension as though he had should have been more alert to and more challenging been requested to retire on the either? Either the man about than they were. I hope that UKFI will raise was fired or he was not fired. When it suited him he the standard of institutional engagement. was fired; when it did not suit him he was not. These are the questions I believe the Royal Bank need to Q2726 Mr Brady: You have obviously been involved answer. With all respect, it is not for the Minister to in drafting the terms of reference in the framework answer those questions. document for UKFI in its conduct in handling those Processed: 26-03-2009 00:27:11 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG16

Ev 356 Treasury Committee: Evidence

17 March 2009 Lord Myners CBE, Ms Mridul Hegde and Mr Nikhil Rathi investments for the taxpayer. Can you point to the meeting where we met a lot of very angry, very item in the terms of reference of the framework worried employees of HBOS who are worried they document that give it those powers? might lose their jobs in a town which clearly depends Lord Myners: I was not involved in drafting the very much on that one source of employment. Is any terms of reference in the framework document, and of that a legitimate public interest concern for I do not have a copy of the document with me. I UKFI, or not? would be very happy to do that, but they are a Lord Myners: I think that we must not lose sight of shareholder and shareholders need to take these the fact that these are public companies and they issues seriously. have a responsibility to all shareholders; but within that context it is entirely appropriate for UKFI as a Q2727 Mr Brady: I appreciate that and I now want large shareholder to engage with the banks and ask to return to that. When I put this question to John them questions about these issues, and to form a Kingman quite specifically he responded, “There is view on whether the banks are making good and none”; and I came back to it very specifically about well-informed decisions on matters such as V the framework document, “No, there is nothing outsourcing, tax planning, o shore trust activities covered in it”. The reason I am asking this question et cetera. is not that I disagree with you that it is a reasonable position for a shareholder to take, but because I Q2730 Mr Brady: Good and well-informed purely want to explore a little further some of the other from the question of the financial performance of the reasonable interests that a shareholder might take institution, or with the wider public interest in mind? and the public interest questions that arise from it. In Lord Myners: I think companies should have a soul; looking perhaps at the framework document when it they should have a moral purpose; and good refers to the “overarching regard for financial companies are very conscious of their community stability, financial or economic policy”, would that obligations. extend to UKFI having an interest in the banks in which it is a major shareholder seeking to maintain the UK’s skills base in financial services? Q2731 Mr Brady: Thank you. Could I just ask one Lord Myners: I do not think that that would fall final question, which really is to look at the situation within the terms of reference of UKFI. of any other banks that are not currently in receipt of support from the taxpayer, but which might come to the Government in the future for support. Would Q2728 Mr Brady: Even though clearly it is the same rules that have been applied relating to important for financial stability and the future remuneration, bonuses and pensions be expected of, financial economic policy of the United Kingdom? for example, Barclays Bank if it were to have Lord Myners: I think it is to manage the recourse to Government support? Government’s investments in these institutions in a Lord Myners: A very wide number of banks are manner which is consistent with a much more benefiting from Government support through balanced view than the very narrow financial matrix liquidity, funding guarantees, loan guarantees, so I that lies at the heart of some of the problems that we think your question is directed at the Asset have experienced in the financial sector over recent Protection Scheme; and the principles that lie behind years. You did not quite allow me to finish my the Asset Protection Scheme were spelt out quite previous answer and that is probably because I am clearly on 19 January, and those are ubiquitous and being long-winded, but I find it quite extraordinary would, therefore, apply to any other bank that might that until very recently not a single institutional apply to APS. Of course, the FSA has now published shareholder had raised any questions about the a code on remuneration, and the Turner Review, I terms of Sir Fred Goodwin’s departure, or the suspect, will say more about this tomorrow. departure of Mr Cameron, or the departure of Mr Fish, who went on an even bigger pension. We have talked a lot about Sir Fred Goodwin, but Sir Fred Q2732 Mr Tyrie: We had an exchange earlier about Goodwin actually failed to be the top dog as far as the size of your pension. I asked you whether you pensions were concerned and these issues have not thought that what appeared to be your relaxed been pursued. attitude about the size of this award, which you had been told was large, might have been related to the fact that you yourself were a beneficiary of a large Q2729 Mr Brady: I am grateful for that, Lord pension. You told me that you did not have one from Myners, but because our Chairman is very keen on RBS; you did not have one from NatWest; do you keeping us to time if you get all of that on the record have one from anywhere? I will not be able to ask any questions. Can I return Lord Myners: I do. to this point, I want to explore really where the boundaries are of the public interest role as far as UKFI is concerned as the major shareholder in some Q2733 Mr Tyrie: Would you be prepared now to of these banks. Concerns have been raised, for answer the question: what is the capital value of that instance, particularly by some of the staV at the large pension? banks about the question of outsourcing, and Lord Myners: I fully declared my financial interests whether services are being put to outsourcing to the Cabinet OYce, to the Permanent Secretary at contracts in India, for instance. Also last week a the Treasury, to the House of Lords and to number of us went to Halifax and attended a public Parliament. Processed: 26-03-2009 00:27:11 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG16

Treasury Committee: Evidence Ev 357

17 March 2009 Lord Myners CBE, Ms Mridul Hegde and Mr Nikhil Rathi

Mr Tyrie: I am looking at an annual report here that entitled to 12 months’ compensation. I do not think gives me a rough idea. It is in the public domain; I am there was any question of that being subject to legal not asking you to say something that is top secret. I challenge; any question of concealing information. am just asking you to give us a rough estimate of the It would have been a quite straightforward and capital value—and I will give the figure, it is roughly simple thing to have done, and also to have placed a £100,000 a year pension from Gartmore. an obligation on him to mitigate by seeking earlier employment elsewhere as quickly as possible, which Q2734 Chairman: That is a NatWest account from would have brought to the end the monthly last year. payments he was receiving. Lord Myners: That is the figure which was disclosed in the NatWest accounts from 1999. I also have a Q2738 Mr Breed: The threat of dismissal did not pension in respect of 11 years’ of service with N M pose any financial penalty on him at all, you do Rothschild & Sons, which I am not drawing. I have not believe? no pension entitlement as a consequence of my Lord Myners: I think the Board could quite easily employment as a schoolteacher by the Inner London have concluded that the conduct of a man who was Education Authority. taking his bank towards a reported loss of £30 billion probably met the test of no longer enjoying the Q2735 Mr Tyrie: What is the capital value, broadly confidence of the owners of the business and the speaking, of your accrued pension entitlements, board of directors, and in those circumstances they roughly? could simply have terminated his contract. Lord Myners: I do not know the capital value. Q2739 Mr Breed: Turning now to these complex Q2736 Mr Tyrie: That is roughly the question we financial instruments, Jon Moulton told this were expecting you to ask about Sir Fred Goodwin, Committee that regulators simply cannot keep pace was it not, earlier? with financial innovation by the banks; and it is Lord Myners: I simply do not believe that that is impossible for them to properly regulate them in information which my family and I should be their currently configured way. Do you agree with required to share publicly. I am receiving a pension; that? I am not drawing any ministerial salary at all; I am Lord Myners: I think it is a real challenge for V living o my pension and my accrued past earnings; regulators to keep up to pace with the innovation of and I do not believe that it is necessary or the financial sector, but I believe that relief is at hand; appropriate for me to have to disclose details of my because these activities, firstly, were clearly nothing personal finances, except to the Permanent Secretary like as profitable as originally believed. If Lord Y and the Cabinet O ce, which I have done in Turner and other regulators require more capital to considerable detail, Mr Tyrie. be held in support of those activities in the future, and clearly the financial stability forum is minded to Q2737 Mr Breed: Just before we get on to another do that as well, then they will become less prominent subject in respect of the regulation of complex in banking in the future. Banking will simply become financial instruments, I have been listening to the simpler, Mr Breed; the sort of banking that you and exchanges and it is hard not to come to the I know from Cornwall, which was a good honest conclusion that Sir Fred Goodwin could have left branch bank, which took your deposits and lent the company in three ways: he could have money and did not engage in CDO2 et cetera. voluntarily retired; he could have resigned; or he could have been dismissed. In the compromise Q2740 Mr Breed: Often nostalgia does not provide agreement it seems fairly unlikely that he was going the tools for the future, Lord Myners; that is the to resign; he might well have been challenged to be problem. You do not believe the banks should in any dismissed, but he might well have decided to fight way be reconfigured in order to be able to make them that on an unfair dismissal charge; therefore the more easily regulated and supervised? voluntary compromise agreement, which was so Lord Myners: I think the regulators need to ensure favourable to him, was in part at least to ensure that that they are able to fulfil their regulatory went quietly; that he did not expose all the responsibilities; and if they see a gap between their incompetence and weaknesses not only of the Board abilities, competencies and legal powers and what is but perhaps of the auditors and everything else; and happening then they need to address that gap. I do it was felt that perhaps this would be a more simple not think we can allow a situation where there is a way; hopefully it would all go away; he would go regulatory gap which is not being addressed. away with a very large sum—not perhaps as large as even some others, but it would be a means of actually shutting him up so that he would not, in being Q2741 Mr Love: Can I really follow on on the issue dismissed, really spill all the beans. Do you recognise of the future of UK banking. You have got a great that as a possibility? deal of experience in the City. There is a lot of Lord Myners: I do not really, because I think clause discussion about the very diVerent cultures that 21(b) of Sir Fred Goodwin’s original employment make up retail, banking and investment banking. contract, the one of 21 December 2004 (I mentioned First of all, do you agree there are very diVerent that there must have been one before that), is very cultures; and, if you do, should those cultures be clear that if Sir Fred Goodwin is dismissed he is existing within the same organisation? Processed: 26-03-2009 00:27:11 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG16

Ev 358 Treasury Committee: Evidence

17 March 2009 Lord Myners CBE, Ms Mridul Hegde and Mr Nikhil Rathi

Lord Myners: I agree, there are diVerent cultures, Q2744 Mr Love: I understand that. I understand and I think it is quite a challenge to manage them. why the public debate is all about that, but you do What we have seen in many banks globally is that not see any need to separate out in any way—there the dominant culture of investment banking has has been a lot of debate about this; indeed, political infused into the rest of the bank. The investment parties are dining out on some concerns about the bankers in broad-based banks have tended to mixing of investment banking with commercial or become the key decision-makers and the highest retail banking—you do not see the need for any rewarded. We must not lose sight of the fact that Government action to limit the sorts of risks that are most people in banks are paid quite moderately. The borne in banks that have very large numbers of small average retiree from the Royal Bank of Scotland depositors, as do retail banks? pension scheme was on a salary of £21,000. Lord Myners: I think it is worthy of consideration, but there is a danger we may be concealing some core Q2742 Mr Love: I understand that. Of course, there issues. Firstly, simple banks continue to contract with complex banks; and simple banks, like are many millions of people who have their very Y small savings deposited with retail banks, and very Northern Rock, got into di culty because of some of their contracts with complex instruments. We few who have the very large sums of money that are V required for investment banking. Is there not a should also recognise that banks su ered huge losses consumer interest in ensuring that the small from very straightforward banking. The big losses depositor in a retail bank is protected against the we have seen from Royal Bank of Scotland are not much riskier activities that go on in investment exclusively limited to exotic instruments; they are banks? largely arising from loans made to people who have Lord Myners: Mr Love, firstly, I would remind the not repaid. committee that no UK retail depositor in a British bank has lost any money at all as a result of the crisis. Q2745 Mr Todd: I was slightly surprised in your list I think the issues you are inviting me to comment on of things that need to be fixed that you did not list the are around narrow banks versus broad banks, and governance of the institutions themselves. You have around Glass-Steagall. I think it is interesting to note highlighted the problems of relying on a charmed that quite narrowish banks, like Northern Rock, circle of people who have great experience in these Bradford & Bingley, Freddie Mac, Fannie Mae and matters. I would have thought one of the things you IndyMac got into trouble just as much as non- have learnt from these unpleasant experiences is that commercial banks like Bear Stearns and Lehman’s. that has got to change? So I do not think there is a simple solution around Lord Myners: I think, Mr Todd, I have mentioned the reintroduction, into America, and the governance a number of times in my replies: I think introduction here of Glass-Steagall-like legislation. it is absolutely core in everything which we have been The key thing I think is around better supervision, talking about in connection with Sir Fred Goodwin. better regulation, more capital, and particularly I wrote an article for the Financial Times— around liquidity requirements, which were lacking in the Basel. Concordat. Q2746 Mr Todd: Let me stop you there, bearing in mind I have heard what you have said. The Walker Q2743 Mr Love: I take your point about the need for Review is being set up and one of the things that it better regulation, and the points that you have made will be looking at is risk management in these but some people think the structures are quite institutions. There are a number of models that important as well. You mentioned about whether or could be applied. We have had evidence from Abbey V not it would be appropriate to introduce a strict Santander on the very di erent approach to risk separation between retail investment banking along management that they adopt there. Does that model the lines of Glass-Steagall. Most informed opinion or something like it commend itself to you? does not seem to think that is really a runner in 2010. Lord Myners: I think the Abbey Santander model is What is a runner? Is there any separation you would particularly attractive because they have non-pro- like to see; or should we just go ahead and continue cyclical capital reserving policies. in the way we have done? Lord Myners: I think the separation will be achieved Q2747 Mr Todd: They have got that because of the by significantly increased capital requirements. Lord policy of the Spanish authorities, but they have their Turner has spoken about an increase in capital for own policy on the entire separation of a risk function investment banking-type activities of multiples, within the bank, brought in separately to the non- rather than percentages. I would remind the executive team? Committee, that bonuses and profits in banks have Lord Myners: I was not familiar that was the at times been on the basis of what have transpired to arrangement at Santander, but in a speech last be illusory profits. One of the problems for the Thursday in Edinburgh I gave a number of pointers banking industry was an acceleration of front-end of what I thought Sir David Walker could do: one loading of revenue from new products and structures was to say that the risk line should have a direct which allowed fairly immediate calculation of report to the board of directors. I also talked about bonuses on a product or a facility the true outcome the need to up-skill the non-executive component on of which would not be known for many, many years. boards of directors; because it has been quite This was a shortcoming in governance; a apparent to me, through my meetings with the chairs shortcoming in remuneration policy. of the audit committees of our major banks, that Processed: 26-03-2009 00:27:11 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG16

Treasury Committee: Evidence Ev 359

17 March 2009 Lord Myners CBE, Ms Mridul Hegde and Mr Nikhil Rathi there are some shortcomings in their understanding exercised to apply the care and attention that is of the complex instruments that their banks are necessary to behave in a manner consistent with funding themselves through or are holding as assets. ownership responsibility.

Q2748 Mr Todd: Not just in their skills, but also in Q2753 Mr Todd: We have also had evidence here the resources they may have available to them to particularly from HSBC for example, a rather more scrutinise the information that is provided to them? conservatively run bank, that they had been under Lord Myners: Mr Todd, I spoke about encouraging pressure from institutional investors to increase Sir David Walker to look at the case for audit leverage, take more risks and so on. Really we have committees having independent advisors to guide to look at how that community can be better tooled the committee; to ensure that they are up to speed on up to live up to the responsibilities they have—which new products; to work with the external auditors; are to look after the investments of blameless and to shape the development of the work of the taxpayers, who are seeking to protect their pensions committee. I think it is an idea worthy of further very often. review. Lord Myners: I think we have to ask ourselves whether we have been too devout in our worshipping Q2749 Mr Todd: Are there not just some products of the god of shareholder value, as measured in which carry so much risk that we should not let our short-term shareholder performance. I submitted a financial institutions dabble in them altogether? Is paper to this Committee in June last year in there an argument for actually simply saying, “That connection with private equity; I was not a minister is not something we permit to see traded”? then; I alerted the Committee to my grave concerns Lord Myners: If you do not understand it you should about the build-up of credit risk; the fact that we not do it. were in an unsustainable bubble; and I highlighted the fact that this was placing at risk the sound Q2750 Mr Todd: I agree that is a good moral management of good companies. One of the message, but is it something that we should place problems we have now, Mr Todd, is that we have into a statutory framework? good companies with inappropriate capital Lord Myners: I think any board of directors where it structures, part of which has been foisted on them by could be proven that they were engaged in things innovative bankers, and the private equity industry. which they did not fully understand may well be Chairman: You mention private equity and you have exposed to shareholder action. appointed Sir David Walker, and this is only a comment from me, but given that he had this private Q2751 Mr Todd: That does not suggest that the equity report, silent in taxation, vague in Government is actually seeking to take any action communication with employers, nothing on on this; it suggests that the existing law already executive remuneration et cetera, what are we going provides for action to be taken. Is that what your to get out of Sir David? Okay, leave it! view is? Lord Myners: I floated two other ideas in Edinburgh: one was that we could consider putting Q2754 John Mann: Adair Turner is already drip- a statutory duty on the boards of banks to have feeding his proposals, which is rather extraordinary regard to the impact of their decisions on financial behaviour for a regulator, and perhaps stability. Recognising that banks are essentially unprecedented for a regulator. As he increasingly ultimately underwritten by the public, should asserts the independent role of the FSA, what directors be required to have regard to the financial mechanisms are you going to use to ensure that the stability consequences? I have also suggested that we FSA is doing what it should be doing to fill what you should consider putting a legal obligation around describe as the “potential regulatory gap which we the responsibilities of fiduciaries, fund managers, cannot allow”? assurance companies, to pursue good governance. Lord Myners: I have regular meetings with Mr Hector Sants to discuss issues relating to the FSA; but the FSA is an independent entity; has its own Q2752 Mr Todd: Exactly the point I am going to board of directors, accountable to the Treasury and turn to. Another member will ask you about the to Parliament. I also attend some of the meetings of rather woeful performance of the institutional the tripartite and through that forum I am also able investor community in this area. Looking to the to engage with the FSA. I think Adair Turner, quite future, what mechanisms might be applied which rightly in his Economist speech a couple of months will enhance the performance of their function in ago, set out the broad direction of his thinking in holding these institutions to account on behalf of order to invite responses prior to tabling his final those who invest with them? report, which I believe is going to be presented to the Lord Myners: I think there are some very serious Chancellor in the next couple of days. questions which institutional investors should be invited to answer; because we have ended up in a situation where it appears that we have to some Q2755 John Mann: The question of oV-shoring to extent ownerless corporations. The ownership of the Caicos islands today in turmoil; government our major firms, not just banks, is now so widely intervention; where is the financial regulation in held across a number of institutions, none of whom relation to this? Who is going to ensure that the own more than 2% or 3%, that nobody is much oVshore UK dependencies are properly regulated? Processed: 26-03-2009 00:27:11 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG16

Ev 360 Treasury Committee: Evidence

17 March 2009 Lord Myners CBE, Ms Mridul Hegde and Mr Nikhil Rathi

Lord Myners: When I referred earlier on to “oV- Mr Rathi: Whether we go for an Asset Protection shoring”, I think in answer to a question from Mr Scheme or a formal bad bank, the key first task is to Brady, I was talking about the removal of jobs and identify what the impaired assets are and to functions, such as call centres oVshore. You are understand those on an asset-by-asset basis and to talking about oVshore banking. The Chancellor and do that as quickly as we can. We have built in I are both very exercised about oVshore centres. The suYcient flexibility in the Scheme through step-in Chancellor raised this, I think, in response to a rights for the Government in defined circumstances question previously in front of this Committee and to be able to move to a bad bank concept at some will perhaps comment on it later this week. We have point in the future, if that is what we consider asked Mr Michael Foot to carry out a review into necessary. On the complex instruments, we have oVshore centres and crown dependencies. I think done a certain amount of diligence on the assets that very significant progress was made at the G20 have been put forward by the two banks where we meeting over the weekend. We have seen a dropping have reached in principle agreements. In the case of of the protective curtain behind which a number of Lloyds there is a very limited number of complex oVshore centres have operated. Let us be clear, very instruments—a very small number to bring forward. substantial amounts of tax are at the moment being V avoided through o shore centres, and we need to Q2761 Ms Keeble: What percentage, roughly? look at that. We will look into how these state- V Mr Rathi: In the case of Lloyds it is very low indeed, invested banks conduct their activities in o shore close to negligible. In the case of RBS there is more centres. work ongoing. I would say it is in the region of 10%–20% of the assets they are putting forward. Q2756 John Mann: My final question: I am sure you get the Sunday Times, this Sunday’s Sunday Times has: investment sense £100,000 prize draw; up to 5% Q2762 Ms Keeble: Okay. If we can come back to tax free yield. This is from Hargreaves Lansdown what Lloyds has got covered. 83% of its covered where, in the small print it says, “Oh, please assets are in fact from the HBOS bad book. Would remember investments can fall as well as rise in it not have been preferable and perhaps cheaper to value”. Are we just getting back into the same old have dealt with HBOS separately, rather than to cycle: money for nothing; prize draw—get your have encouraged, as the Government did, the application in before April 5 to qualify for the prize merger? draw. Is this not business as usual; money for Lord Myners: The decision by Lloyds Bank to nothing? Is this not the kind of thing you ought to be acquire HBOS was made, Ms Keeble, by the Board sorting out? of Lloyds TSB and supported by their shareholders Lord Myners: I think you raise some interesting with alacrity. points. Q2763 Ms Keeble: But previously there was Q2757 Ms Keeble: I wanted to ask about the way discussion about the encouragement by the forward with some issues around the Asset Government of that merger? Protection Scheme. There has been a lot of Lord Myners: I am not aware that the Government discussion about bad banks/good banks and I am encouraged the merger; but I was not a Government sure you have seen that. To what extent do you think minister at the time. What I do know is the that the Asset Protection Scheme is an alternative government enabled the waiver of a competition perhaps to a bad bank, or that it is a precursor to a obligation which they subserviated to the needs of bad bank? financial stability. Lord Myners: I wonder if I could invite Ms Hegde to lead on that question. Q2764 Ms Keeble: If we go back to the assets which are included in the scheme, Lloyds actually put out Q2758 Ms Keeble: I have got a lot of other questions a list of the percentage of its assets it would cover I want to ask. that came into diVerent categories, and it did not Lord Myners: I feel I have dominated things! actually follow the categorisation which the Chancellor gave. I wonder if you are going to go Q2759 Ms Keeble: Let me ask some of the other ones back and scrutinise the figure that Lloyds gave to than. Looking at the construction of the Asset make absolutely sure about what is covered by the Protection Scheme, the Chancellor set out very scheme? clearly three categories of components to it. You Mr Rathi: Certainly. We set out a fairly broad range yourself, Lord Myners, referred to the CDO2—what of criteria for eligibility in the scheme. We are in the percentage of the assets likely to be covered in the process of an asset-by-asset diligence and will Scheme are of those riskier products? publish, when the final contracts are signed, more Mr Rathi: On your first question about the bad bank details about exactly what assets will be covered by and whether this is a precursor to it, I think there are the scheme; and any assets that do not meet the a number of similarities— eligibility criteria will not be accepted into the scheme. Q2760 Ms Keeble: No, as I say, I have got quite a Lord Myners: I also think CDO2 and CDO3 are number of other questions, so just go on and deal unlikely to apply for cover because they have with the second one. embedded equity characteristics. Processed: 26-03-2009 00:27:11 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG16

Treasury Committee: Evidence Ev 361

17 March 2009 Lord Myners CBE, Ms Mridul Hegde and Mr Nikhil Rathi

Q2765 Ms Keeble: Part of the quid pro quo for this loans? There has to be some balance between the was that the banks maintained liquidity at 2007 approach that is taken to the existing loan book as levels, which originally was supposed to be the well as maintaining levels of new lending? responsibility of UKFI to monitor, but most recently Ms Hegde: I think the art of achieving our public UKFI told us here that in fact it was the Treasury policy objective here will be about achieving a that was monitoring that. Who in the Treasury? balance between increasing lending to the Which Minister has got responsibility for it? How is economy—which is the overall public policy it going to be reported? objective and which we have made concrete in terms Ms Hegde: I think you may be conflating two of the specific agreements we have with Lloyds and diVerent sorts of lending commitments. The RBS—and also actually permitting the banks to commitment by banks which participated in the continue to make commercial decisions on the recapitalisation in October was to maintain lending ground at branch level, which individual decisions at 2007 levels, and that was the obligation which was we cannot monitor or hope to monitor. initially placed with UKFI to monitor. Subsequently, when the APS was announced, and it Q2770 Ms Keeble: Because the insurance scheme is was agreed that some lending commitments and oV balance sheet, what kinds of studies have been commitments on remuneration would be part of the done of the likely cost to the public purse once the deal on the APS, it was clear that there was going to losses crystallise? You must have done some be a further lot of monitoring of those lending projections going forward? commitments. Since the APS is not something that Lord Myners: The projections will depend upon the is suitable to be monitored by UKFI it made sense economic outcome. If you look at HBOS, for for the Treasury to do it. The APS is a significant instance, because so much of that book is dependent commitment of public spending on behalf of the on UK residential and commercial property values, Treasury, and it is ultimately the Chancellor’s the extent of any claims under the Asset Protection responsibility to account for that. Scheme will be a consequence of how values move there. Remember, there is a very large first loss Q2766 Ms Keeble: Okay, but the lending levels, we requirement; there is a very substantial premium were specifically told by UKFI when they came here being paid; and there is a continuing 10% vertical last time that that was being left over? quota share participation that HBOS or Lloyds will Ms Hegde: That is right. So that reverts to the have in the ongoing protected book. Calculating the Treasury too. All monitoring of lending will be dealt likely claims is diYcult; but as the Chancellor has with by the Treasury. said in another place, experience elsewhere of such schemes has suggested that the costs are often a lot Q2767 Ms Keeble: Which ministerial hat are they less than people originally anticipate. A recovery of coming under? confidence, an improvement in economic Ms Hegde: That is the Chancellor’s responsibility. performance and strongly recapitalised banks will mean that the claims on these schemes will be a lot Q2768 Ms Keeble: That is going to be the less. Chancellor, okay. In addition to looking at the new lending, is there going to be scrutiny of what the Q2771 Ms Keeble: Yes, but you must have some best banks are doing about their existing loan books; case/worst case. There is going to be more probably because certainly there is a certain amount of than Fred Goodman’s pension? evidence that the banks in scrutinising some of their Ms Hegde: Could I just make a factual point. I do existing loan books are bearing down very heavily not think it is quite right to describe the APS as being on existing small businesses? “oV balance sheet”. The possible losses that might Ms Hegde: I think inevitably there has to be scrutiny arise from the APS are contingent liabilities in the of existing loan books, because the lending language of public expenditure. Those will have to commitments only make sense if you understand be shown in some way in the Treasury’s Annual where you are starting from. For example, part of Report and Accounts. They will be reported on in the commitment of banks participating in the APS is that way. that, in the case of RBS for example, there will be an increase of an additional £25 billion of lending—£9 Q2772 Ms Keeble: Have you got any estimates of billion of which will be for mortgages and £16 billion them, of what it is likely to mean to the taxpayer and for business; and in the case of Lloyds it is an what it is likely to mean in terms of future decisions? additional £14 billion—and that breaks down as £3 Ms Hegde: At the point where contracts are struck, billion for mortgages and £11 billion for businesses. which is the point we are working towards at the Part of the process that is going on now is base-lining moment, at the moment Nikhil has mentioned that where those banks are at the moment in order that we are in an extensive process of diligencing the we can make sure that the lending is indeed assets; that will give us the information that will additional. enable us to build a bottom-up picture of what we think the likely losses are likely to be. Q2769 Ms Keeble: Sure, but you understand the Mr Rathi: Part of the reason for the Scheme is the point that there is not much point about being huge uncertainty that exists around these assets and punitive about people with existing loans and then their value and how they are going to perform in saying they have to be generous about extending new diVerent economic scenarios going forward. Much Processed: 26-03-2009 00:27:11 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG16

Ev 362 Treasury Committee: Evidence

17 March 2009 Lord Myners CBE, Ms Mridul Hegde and Mr Nikhil Rathi of the work we are doing at the moment is on an Q2777 Jim Cousins: Let us be clear about the asset-by-asset basis to get some understanding implications of what you have just said. If it is the precisely of the risk transfer that has been passed to Government’s policy not to insure against the the taxpayer. In judging how we price the Scheme, exchange rate risk, then it means the exchange rate we are working to making sure there are appropriate risk, which is plainly there if more than half the protections for the taxpayer, as the Minister has said, assets are outside the United Kingdom, are being through a fee, through the first loss, through the 10% directly borne by the Treasury? share of any second loss. Also a point which is not Ms Hegde: I think that is correct but in the sense that fully understood, if at any point the first loss is burnt we do not bet on sterling and the Treasury bears that through, 90% of the recoveries that come from these risk anyway—that is the status quo. assets over time, and many of these assets will Lord Myners: I think that is consistent with mature over several years, they come to the Government policy over many governments. taxpayers’ account first. We will benefit from the upside of these assets as they recover. Obviously also Q2778 Jim Cousins: Again to be clear about this: the big imponderable is, at some point the that means that the Asset Protection Scheme has got Government will exit its equity stakes at some point a further degree of exposure beyond its own in the future, and exactly what value we will get from boundaries because the assets being protected are that is unclear at this point. outside the UK and there is an element of exchange Lord Myners: I think this is not much diVerent from rate risk about them? the Equitas case at Lloyds, with a very similar Ms Hegde: Correct. approach being adopted. Q2779 Jim Cousins: We are visualising that these Q2773 Jim Cousins: I wonder if I could ask you what relationships, through the Asset Protection Scheme, proportion of the assets are located in the United will not be relationships for today and tomorrow; Kingdom, in Britain? they could last decades, could they not? Ms Hegde: I will ask Nikhil to answer that. Lord Myners: I think it is unlikely that they will last decades, Mr Cousins, but they will have to match the tenure of the assets that are placed in the Scheme but Q2774 Jim Cousins: I am here talking about the they will run-oV. The average and median maturity assets that are being protected in the Asset of the Scheme will be a lot shorter obviously than the Protection Scheme. final maturity of the longer-standing asset. Ms Hegde: In the case of Lloyds, most of them I believe; in the case of RBS, a large proportion of them. I think Nikhil has probably got the precise Q2780 Jim Cousins: Do you have any figure for that numbers. median maturity? Mr Rathi: In the case of Lloyds practically all their Lord Myners: We will do as part of the assets are UK-based assets. In the case of RBS, the documentation for the final agreement. This will be majority of assets are UK-owned, but many of the worked through into enormous granularity. We will UK-owned assets are based on collateral which is need to fully understand every aspect of the risk overseas. I would say the majority of the underlying portfolio that we are underwriting. We will be collateral is overseas in the case of RBS. adopting the very best practices of insurance. Ms Hegde: The other thing to take into account, I think, would be the fact that there must be the Q2775 Jim Cousins: Let us be clear about this: RBS opportunity for participants in the Scheme to exit, in because they are so huge, £300 billion have been put the same way as you would be able to exit an into the Asset Protection Scheme, and of that the insurance contract. majority is outside the UK. Who is bearing the exchange rate risk on that? Q2781 Jim Cousins: Lord Myners, Mr Rathi gave us Lord Myners: The Treasury has concluded at this an alternative form of exit from these arrangements, stage that it will bear the exchange rate risk; but as which is that the Government might decide to we get closer to finalisation of the Scheme I imagine, actually break oV these protective assets and park Mr Cousins, that that will receive more scrutiny. them somewhere in a so-called “bad bank”. Has the Government already prepared a set of criteria for the Q2776 Jim Cousins: Let us be clear about this: on situations that would give rise to that? top of the risks of the Asset Protection Scheme itself Lord Myners: One of the things I found when I because, certainly in the case of RBS, the majority of became a Government minister was the ability of the assets are outside the United Kingdom, there is people in Treasury and the huge amount of forward an exchange rate risk as well, and we have not yet planning that had been done. A lot of forward clearly decided who is going to meet that? planning has been done around options about how Ms Hegde: It is generally not the Government’s we would manage assets on which claims were made, policy to insure itself against exchange rate risk—as on which we then became eVectively the 90% equity a sovereign we do not do that. That is where the holder. Wrapping them up into a bad bank, decision is at the moment. While it is true that the packaging them to sell them on to other people, are majority of RBS’s assets are outside the UK, the options that are available to us; as is the option of benefits from the Scheme will of course flow back to continuing to support the bank in the workout of the UK. those impaired assets—which of course we are Processed: 26-03-2009 00:27:11 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG16

Treasury Committee: Evidence Ev 363

17 March 2009 Lord Myners CBE, Ms Mridul Hegde and Mr Nikhil Rathi encouraging the banks to do by giving them a Q2786 Sir Peter Viggers: Following that, Sir David continuing 10% responsibility, liability incentive Walker is carrying out a study of corporate through the vertical structure of the quota share. governance because he has the City in his DNA (and I have very high regard for him) as do you. Is he the Q2782 Jim Cousins: What are the situations that right person to carry out the study and are you the could give rise to a forced sale or a break-up and right person to consider it? separation of the assets from the rest of the banks? Lord Myners: It is for others to decide whether I am Lord Myners: It is diYcult to speculate with any the right person to receive his report, but you can rest specificity at this point, but simply to say that if that with some ease because he is reporting to the made good sense for the Government it would be Chancellor and the Secretary of State for Business done. and Enterprise and they undoubtedly are the right people for him to report to; I am just a junior player Q2783 Jim Cousins: So, for example, in the case of in this. As for whether Sir David Walker is the right RBS a fall in the value of the currency against some person, I think he is. He brings valuable experience of the key locations where the assets being protected of being a director of the Bank of England and a were might trigger such a situation? chairman of the SIB. He sat on a number of boards. Lord Myners: I think it would be unwise to be drawn He is wise and he is reflective, he is measured and into something which is hypothetical; but simply to moderate in his approach, but he does not pull his say that this programme will need quite intensive punches. and resource-heavy management. We are taking on Chairman: An insider’s insider. very substantial contingent liabilities into the public sector; those cannot be managed without the appropriate resources, highly professional people, a combination of Treasury oYcials, of whom I have Q2787 Nick Ainger: When we took evidence from already spoken highly, and people drawn from the the FSA earlier in this inquiry they told us that they insurance, actuarial and other legal professions. were reassessing the criteria for approving individuals as “fit and proper”. How do you think Q2784 Jim Cousins: Is the build-up of this situation the process of appointing bank directors and key over a number of years within RBS part of the wide people, such as the head of risk management, for range of issues that you say you have referred to example, can be improved, bearing in mind the lawyers? record of distinguished directors at RBS, for Lord Myners: I would rather not be drawn on that example? issue, not least of all because the instruction to Lord Myners: I did, Mr Ainger, withdraw my lawyers has come from RBS and not from descriptor of “distinguished”. This is an issue which Government. I imagine Lord Turner is going to address in his report later this week. I think you were earlier told Q2785 Sir Peter Viggers: Do you think that the that the FSA rarely look for criminal convictions. recent banking crisis demonstrates that the model of That does not seem to me to be setting the bar at an having non-executive directors in banks is a model appropriate level. One of the things I would like which is really eVective? What more could be done institutional shareholders to do is to have much to make sure that non-executives fulfil their role? more engagement with non-executive directors, to Lord Myners: I think, Sir Peter, there needs to be a sit with the non-executive directors, to talk about the wider debate here, not only in this country but also issues, to form a view on their competence, to elsewhere. I wrote an article for the Financial Times understand what is going on in their minds—what in the summer of last year, again before I became a are they worried about at the moment? From my Minister, pointing out the lamentable state of experience of contact with some of the non-executive independent director performance on banks of directors of some of the banks where we have directors. I cited Citibank who had recently placed intervened it is quite illuminating to know what is on an advertisement for non-executive directors in their minds and, perhaps more interesting, what is which they said “Some financial experience would be not on their minds. helpful”. I have talked about cultures which are not suYciently inquiring and I have spoken more recently about the need to ensure that non-executive directors are suYciently well-informed. Whether it is Q2788 Nick Ainger: Some of the evidence we have a part-time job must be a matter for debate. The idea had, particularly in relation to HBOS and the that you turn up once a month to a meeting and the appointment of an individual there as the head of occasional committee meeting may fall short of the risk management who it would appear had no direct expectations we have now placed on non-executive experience of risk management, is that it is not just directors, but again that has implications also for the the executive directors; it is key people within these community from which non-executive directors are organisations. Do you think the FSA should have a drawn, which on the whole is far too narrow. If you direct role in not just checking that they have not got invite people who read the same newspapers, went to a criminal record but that they do have the the same universities and schools and have the same competence, the experience and possibly the prejudices and views to sit round a board table you qualifications to carry out the role that they have do not get diversity of view and input. been appointed to carry out? Processed: 26-03-2009 00:27:11 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG16

Ev 364 Treasury Committee: Evidence

17 March 2009 Lord Myners CBE, Ms Mridul Hegde and Mr Nikhil Rathi

Lord Myners: I believe that there are certain oYcials express views and why employees, either directly or in a financial organisation who do have to be through trade unions, should not also have an approved by the FSA—the heads of audit and opportunity to input their views—not to make the compliance and risk. Perhaps that needs to go decision; that must be made by the directors. further. Q2793 Mr Mudie: Following your speech to the Q2789 Mr Mudie: How do we align rewards more National Association of Pension Funds on closely to the long-term sustainability of firms? shareholder failure, what reforms do you have in When you are dealing with that would you pass mind yourself? comment on where you see rewards ending up after Lord Myners: I think I am calling on institutions to this present period? In other words, I think the reflect on how they have seen such huge losses public are very critical of the level of rewards to accumulate in their clients’ portfolios and what it is certain people in the financial sector. Do you think that they should have done which they did not do. I we will go back to that level or that some note, for instance, that institutions, as I said earlier, commonsense will be shown? voted in support of acquisitions which were value Lord Myners: There are several questions there, destructive. I think there is case for looking at the Mr Mudie. Takeover Code. The Takeover Code is a bit like the British guns in Singapore—it is pointing in the Q2790 Mr Mudie: The Chairman is very tight on wrong direction. It protects the shareholders in the time so he has asked me to ask them and you have target company but not in the oVeree company, even got to answer them. though we know from experience of academic Lord Myners: Setting objectives and performance research that the oVerees suVer the greatest damage. goals which are clearly around short-term share I think the institutions need to wake up. It is very price movement I think must be highly questionable, interesting that RBS had a number of insurance and that is at the core of many of the problems that companies in its group. The ABI’s policy on we face. As for proportionality and appropriateness pensions—back to Sir Fred Goodwin for one of remuneration, I think we need to break the grip of moment—says that undiscounted pensions should the benefit consultants. I think we need to open up not be permitted and yet here we have a bank which reporting on the whole culture of remuneration in a owns an insurance company which is a member of company and to introduce internal comparators, the ABI and which pursues policies which are that is, to express the chief executive’s remuneration inconsistent with the principles articulated by its in relation to other people within the company, to own trade association. There is a clear need here, Mr explain why this gap has got bigger and bigger. The Mudie, for institutional investors to wake up to the issue of the right levels of bonuses is very diYcult. I responsibilities of ownership. imagine that Mr Fallon must have grappled with this. He is chairman of the remuneration committee Q2794 Mr Mudie: Those are words though. Apart of Tullett Prebon which paid a bonus of £4 million to from selling up, what powers do they have? Have its chief executive in 2007 that was even higher than they suYcient powers or should they be given new the bonus paid to Sir Fred Goodwin for a company powers to ensure that the board listens to them? which is probably only 5% of the size of Royal Bank Lord Myners: Investors in UK companies have very of Scotland, but I defer to Mr Fallon for his wise substantial powers. They have amongst the most advice on how you reach decisions on fair and significant powers of investors anywhere in the appropriate remuneration. world. The ability to convene meetings to remove directors is not embodied in company law in the Q2791 Mr Mudie: You do get even quickly, do you United States of America in most states and it is not not? I dread to think what you are going to say next. common practice in Europe. It is not a question that Lord Myners: I have been visiting Leeds recently, they do not have the powers, Mr Mudie; it is that George. they have not exercised them.

Q2792 Mr Mudie: You have mentioned the Q2795 Mr Mudie: When we were talking about Sir deficiencies of remuneration consultants. The ABI Fred, Legal & General claimed the year before that suggested a code of ethics. You, for example, they had demanded of the board that Sir Fred be suggested in a recent speech that they should seek removed. If they have got all these powers is it just views from investors, employees, and I have put the fact that these powers are there but the code of “trade unions” but you have put “their the City means they are not used? representatives”. I suppose that was a step too far for Lord Myners: I read with great interest the Legal & New Labour, consulting trade unions. Can you General evidence to the Committee and I thought in explain your thinking in this role? the end they just ran into sand, did they not? They Lord Myners: I think that remuneration committees just gave up. I hope that others will learn from that need to have a wide range of inputs and it would lesson. You cannot give up. You are the owners. You seem to me entirely proper and would lead to better have a responsibility to unit trust investors and decisions if they took advice from more than just the pension policyholders and insurance policyholders benefit consultants, the people that Mr Warren to act in their very best interests. You cannot just BuVett describes as “Ratchet, Ratchet & Ratchet”. I stop when you see things happening of which you do see no reason therefore why investors should not not approve. Processed: 26-03-2009 00:27:11 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG16

Treasury Committee: Evidence Ev 365

17 March 2009 Lord Myners CBE, Ms Mridul Hegde and Mr Nikhil Rathi

Q2796 Mr Mudie: Is there a recent example of these and you have got £40 billion there. Lord Turner said powers being used? that he could not understand them at the end of the Lord Myners: They are used modestly. day although he made a valiant attempt. The chief auditor of KPMG said he could not look through Q2797 Mr Mudie: By whom? Do you have an these annual accounts and at the end of the night feel example? he could understand them. Given the issue of tax Lord Myners: I am stretching to find a recent and avoidance and schemes and other issues here, this is a big issue and one thing we want you to take back is relevant example, which I think probably supports to look at these issues and get these banks to simplify the contention that lies behind your question. them. Otherwise, the notion out there is that they are hiding things. Q2798 Chairman: Lord Myners, if you had read the Lord Myners: Agreed. transcripts of our Committee previously you would Chairman: You agree; thank you. On that note of have noted that both myself and Mr Fallon brought agreement can we thank you and your colleagues for to witnesses’ attention pages 102 and 103 of your attendance this morning. We did overrun but it Barclays’ annual accounts which had been sent to was a very worthwhile session for us and hopefully them. They are totally and utterly incomprehensible for yourself. Processed: 26-03-2009 00:31:08 Page Layout: COENEW [SE] PPSysB Job: 416782 Unit: PG17

Ev 366 Treasury Committee: Evidence

Thursday 19 March 2009

Members present

Mr John McFall, in the Chair

Nick Ainger John Mann Mr Graham Brady Mr George Mudie Mr Colin Breed John Thurso Jim Cousins Mr Mark Todd Mr Michael Fallon Mr Andrew Tyrie Ms Sally Keeble Sir Peter Viggers Mr Andrew Love

Witnesses: Rt Hon Alistair Darling, MP, Chancellor of the Exchequer, Mr Dave Ramsden, Chief Economist, Mr Tom Scholar, Managing Director, International and Finance, and Mr Nikhil Rathi, Team Leader, Financial Stability, HM Treasury, gave evidence.

Q2799 Chairman: Chancellor, good afternoon, there were many people who came to believe that welcome to this last session on the banking crisis. somehow this could just go on and on. I think clearly Can you introduce yourselves for the shorthand mistakes were made at the supervisory and writer, please. regulatory regime and, frankly, it is interesting, if Mr Darling: Yes, of course. I have with me Dave you read the debates which took place when we put Ramsden, who you know is the Government’s chief through the Financial Services and Markets Act, at economic adviser; Tom Scholar, who has also been the end of the last decade in the late 1990s, it was before the Committee before, who is the managing striking if you read contributions on both sides of director responsible for financial services in the the House, almost without exception, people were Treasury and Nikhil Rathi, who I think again you then nearer where they saw regulation as being, I have seen before, who is the team leader responsible suppose the characteristic was light touch. I think as for financial stability. If you would allow me, Adair Turner and others said, I have said this before, Chairman, can I take the opportunity of telling the I think there are many lessons to be learned in the Committee that in relation to the Monetary Policy way in which institutions are regulated. Then, of Committee, I have announced today that I am course, there were other matters which distorted appointing David Miles to replace Danny behaviour. We have talked about and continue to Blanchflower. That appointment will take eVect talk about the incentives that encouraged behaviour from 1 June, obviously that will give you ample time that proved very damaging to banks in terms of to carry out your hearings. Separately, Tim Besley people at senior levels. I think there are lessons to be has told me that he will not be seeking learned. The key thing is to make sure that we can reappointment to the Committee, so he will leave at learn from what happened in the past and we can the end of August. We will readvertise his position, build a supervisory and regulatory regime that is following the new procedure which I announced last more robust. As you know, I asked Adair Turner to year. I thought I ought to tell you that since it is report to me, and that report will form a lot of what probably not for today but it is something you will we do in the White Paper, which I am proposing to want to return to. publish at the time of the Budget. We have already made some changes like, for example, the Banking Act 2009, which is now on the Statute Book, which Q2800 Chairman: Good. We know David well, he gives the Bank of England statutory responsibility has been an adviser to us. Sorry seems to be the for financial stability as well as monetary stability. fashionable word, Chancellor. If you are not going There will be other measures which will no doubt be to indulge in that, could you tell us what the necessary. I do not think there is a country in the Treasury’s gravest mistake has been in not world where you can point to a regulatory regime, or preventing the financial crisis? anything else, and say it was perfect, there were not Mr Darling: As I said before this Committee and on lessons to be learned. The important thing is that we many occasions, I think there are many lessons to be do learn those lessons and we implement them. learned in relation to the origins of the present problems and the developments thereafter. Actually, the summary provided by Adair Turner in his report, Q2801 Mr Fallon: Chancellor, you have spoken which was published yesterday, provides a very good commendably of the need to have humility in these account of what happened, not just here but what circumstances, and you have repeated that again happened in other countries across the world, which today. Why do you think it is proving so diYcult for is basically a combination of matters. Firstly, an the Prime Minister to oVer a full apology for the awful lot of credit came in to the world economy failure of banking supervision? particularly from the newly emerging economies, Mr Darling: The Prime Minister and I have said like China, in to developed economies, like the exactly the same thing. The Prime Minister said at United States, and that credit chased a limited the weekend, and again earlier this week, exactly amount of assets which put up their prices. I think what I have been saying to you just now, I think all Processed: 26-03-2009 00:31:08 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG17

Treasury Committee: Evidence Ev 367

19 March 2009 Rt Hon Alistair Darling, MP, Mr Dave Ramsden, Mr Tom Scholar and Mr Nikhil Rathi of us have to learn from what has happened in the Mr Darling: Look, without labouring the point yet past and we need to improve upon it. I do not think again, and I refer you to my interview in the Daily there is anyone in this room, perhaps dare I say you Telegraph about two or three weeks ago when I set yourself, Mr Fallon, at some stage or other, we do out my position quite clearly, and if we were an have to show some humility. American court I would say let the record show whatever was in that, it refers you to that, I think Q2802 Mr Fallon: But I did not set up this system of that inevitably when you set up a regulatory system banking supervision, did I? Yesterday, for example, there are some things that work well: ending self- you heard the Prime Minister apologise for the regulation, bringing the regulators together, I think failures in the NHS StaVordshire Trust but we have that was the right thing to do. Without doubt, not had a full apology from him for the failures of whether it was here, America, Europe, the Far East, banking supervision which he set up. Why is that? you name it, there is not a regulatory system in the world where you can say, “In that country they were Mr Darling: What I said in answer to the Chairman, V and I say again in answer to you, I think if you look not a ected”. Even in countries like Spain where, for at what happened in this country and just about example, they had quite high requirements on banks every other country in the world over the last few to maintain a certain level of capital, Spain has not years, it is clear that mistakes were made, we need to escaped the consequences of what is happening at learn from them and we need to put them right. I the moment. The problem we have got, in the past think some things that we put in place were right at very often what you had was a crisis in the wider the time. For example, I think that bringing together economy hit the banking system, this time we have all the regulators, ending the system of self- got a banking system that has caused a real problem regulation which we had, as you will recall from the in the economy which is feeding back in to the time when you were a minister in the 1980s and banking system again. Trying to break that 1990s, bringing them together in to one body was the potentially damaging spiral is what we really need to right thing to do. I think many of the problems we be concentrating upon. had at that time were addressed by the fact that you did not allow institutions to fall between the various Q2804 Mr Fallon: All right. Now quantitative regulatory stools, if you like, but what happened, easing, £75 million so far, who established that especially in the earlier part of this decade, was that figure? I do not think regulators, whilst they were Mr Darling: I did in that I authorised the Bank of concentrating on what was going on in their own England to buy assets and I set the limit. You have back yard, were as alert as perhaps they should have seen the exchange of letters between me and the been to the big pressures that were building up Bank of England. The overall figure of 150 is the one underneath all of them across the globe. As I say, that I set. The 75 was the figure that the MPC—the there was this huge build up of credit. Also, as Adair Monetary Policy Committee—decided would be Turner has recognised, I think the FSA itself did not their initial scale of purchase at their meeting a week concentrate as much on issues like liquidity, the lack ago. The overall strategy and the conditions are set of liquidity, it assumed that liquidity would always by me as Chancellor, the operationalising of that be there and like many other institutions did not remit is done by the Monetary Policy Committee. contemplate a situation where you could not sell things where the market would actually go. There Q2805 Mr Fallon: How do you know the £150 are lots of lessons to be learned. Without labouring billion total will be enough? the point, because I think it is important, it does not Mr Darling: We had discussions with the Bank, we matter where you sit in the House of Commons or discussed it ourselves and we thought that was where you sit generally, if you need to learn lessons, appropriate. Like a lot of what we are doing at the if you need to show a bit of humility, yes you do that moment, because we are in extraordinary but what people want to know is, okay, this has circumstances, in many cases we are in uncharted happened, what are you going to do about it, how waters, we need to do whatever is necessary to make are you going to fix it, how are you going to try and sure that we support businesses and support people. make sure this does not happen again. That is what That is what quantitative easing is about; it is about I am focused on, that is what the further changes putting money into the economy.I said initially there which need to be made to the regulatory system will is £150 billion, the Bank of England said, “Let us see focus on and Adair Turner for his part, and Mervyn what the £75 billion does as a first stage”. As you King separately, you will know that he delivered a know last night the US Fed made an announcement speech on Tuesday night, both of them set out how in relation to its plans that are similar, the Swiss in respect of the Bank of England and the FSA they Central Bank has been doing it, the Japanese Central intend to put in place measures to try and deal with Bank has been doing something similar as well. A lot the problems that we have encountered over the last of countries are doing things that in normal times couple of years or so. they would not contemplate but these are extraordinary times and I think what people want to Q2803 Mr Fallon: Okay but it was the then know from us, in those times do you have a plan, can Chancellor who was in overall charge of the financial you ensure that you can try and get us through system and it was the then Chancellor who has ended recession out into recovery so we can prepare for the up leaving us all this debt. Would it not make your world in the future, what do you need to do and if job easier if he apologised? there are steps that need to be taken then we will take Processed: 26-03-2009 00:31:08 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG17

Ev 368 Treasury Committee: Evidence

19 March 2009 Rt Hon Alistair Darling, MP, Mr Dave Ramsden, Mr Tom Scholar and Mr Nikhil Rathi them. Of course we will do it in a prudent way, of Mr Darling: Two things, firstly my position in course we will look at these things but I believe it is November and my position right from the start has absolutely necessary for us to do this, as indeed the been consistent. The decision to start merger Governor has said. discussions was taken by those two banks. They did it on a commercial basis. True, HBOS was probably Q2806 Mr Fallon: But the 150 sounds a bit of a an equal partner but also Lloyds was interested in guess, does it not, how will we know when it is HBOS. There was nothing the Government could working? have done to have made that merger go ahead if the Mr Darling: The Governor of the Bank of England shareholders had not wanted it. was asked this on the day that he announced that he would implement the scheme and he said that it Q2810 John Thurso: Equally, Chancellor, the would take time to develop. It is rather like the way Government could have stopped it if it had not the MPC looks at its monthly interest rates, it has to legislated to allow it to happen. take a view as to what is going to happen in the Mr Darling: We could have done but at that time, as economy, it has to take a view on what eVect raising I said on a number of occasions, the issues in relation or lowering interest rates take and it continually to financial stability I thought took precedence over keeps that under review. Exactly the same the question of competition. Now, you are right that considerations will apply to the question of putting about three or four weeks after that we had to money in through quantitative easing. recapitalise all the banks so that the landscape changed and it would have been open, as you know, Q2807 John Thurso: Can I return to the question of to the shareholders of either HBOS or Lloyds to the Lloyds/HBOS merger. Eric Daniels in his have voted against it. Now they did not, in fact the evidence to us told us that had that merger not gone vote was overwhelmingly in favour. ahead, had Lloyds been a stand alone bank, it would not have needed taxpayers’ capital. Do you agree Q2811 John Thurso: I seem to remember that the with him? mood music was, “if you do not vote for this, Mr Darling: The FSA would have had to have nobody will get helped out, it is your only option”. carried out an assessment of that. You may recall Mr Darling: No, we have never said that and nor that last October when we recapitalised the banks, could we. My priority right the way back to when we the FSA carried out an exercise in respect of all the were discussing Northern Rock has been to do banks concerned, the big half a dozen banks in this whatever it takes to maintain the stability of the country, and it treated HBOS and Lloyds as one banking system. I said that on countless occasions entity for this purpose, although it did allocate in because that is what we have been focused on. Why general terms how much capital it needed for the are we doing that, because that is essential to protect Lloyds’ side and the HBOS side but the assumption savers’ money, it is essential to make sure there is at that time was that the merger would go ahead. It money in the system to support businesses and to was a month after it was announced and yes, right support people. It was absolutely essential that we enough, there were probably another two months to did that. As I said to you, when we had to address the go before the shareholders finally confirmed that, question of Lloyds/HBOS coming to us and saying, but the FSA actually fixed the amount of capital that “Look, we are considering merging, will you waive Lloyds would require. The question of whether or or suspend the competition regime” as I said to you not to do a strictly separate assessment for HBOS just now and said to you last November, I thought and for Lloyds is something they did not do because that was right. You will recall that much of the in the event, as you know, the merger went ahead. discussion at the end of last year was from various people saying, “Look HBOS might have a future on Q2808 John Thurso: But Eric Daniels, as the Chief its own”. I think people now know that HBOS’s Executive, would know and he says that it would not position was extremely diYcult but, at the end of the have needed it. Do you think he is wrong? day, the decision to merge was one that was taken by Mr Darling: The FSA would have had to have a vote of the shareholders and only they could have carried out an assessment. The FSA would have voted this through or voted it down as they saw fit. come to a view as to whether or not it was needed or not. Clearly now I am not in a position to tell you Q2812 John Thurso: Mr Daniels also told us that the that; in any event, any judgment any of us brought amount of due diligence they were able to perform in to bear would be one that was done with the benefit the time was very considerably less than they would of hindsight. normally have expected to undertake for a transaction of that size. You have just told us that Q2809 John Thurso: Carrying on with the benefit of the FSA looked at the two entities as merged entities. hindsight, I put it to you when you came before us Would it be fair to say that the Treasury was unable on 3 November that in the light of the fact that you to do a suYcient level of due diligence on that deal? had announced a general rescue of the banks it Mr Darling: No. Firstly, in relation to Eric Daniels’ would be appropriate to revisit that merger and look point—and I read what he said about that—that again as to whether it was in the best interests of all essentially at that time when he was just Chief concerned. Having had an opportunity to look at it Executive of Lloyds, that was a matter for Lloyds, with hindsight, do you really think that merger was they had to decide how much diligence they were in the best interest of all concerned? going to do because apart from anything else they Processed: 26-03-2009 00:31:08 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG17

Treasury Committee: Evidence Ev 369

19 March 2009 Rt Hon Alistair Darling, MP, Mr Dave Ramsden, Mr Tom Scholar and Mr Nikhil Rathi had to put a prospectus forward to their demonstrate how diYcult it can be sometimes to shareholders. In relation to the FSA assessment, place a value on bank’s assets, it can take an awful which was carried out in October, firstly, that had to lot longer than people think. be done fairly quickly. We were at the point in October where we had the serious risk of the banking Q2814 Nick Ainger: Chancellor, you are on record as system collapsing. I have said it before, the expressing your concern about the bonus culture and Governor has said it before, we were not the only the levels of remuneration in the financial services country in this position but we had to do something sector. President Obama has announced that he and we had to do it quickly. Of course it was widely plans to impose a half a million dollar cap on the supported at the time. In order to calculate how salaries of executives in banks and companies that much capital was required by each bank, the FSA are in receipt of exceptional assistance from had to do an assessment, it had to do it fairly quickly. American taxpayers. Why does the UK If you look, for example, at RBS, as you know we Government not intend to carry out a similar policy have had to put additional capital into RBS. Why on remuneration in banks that are in receipt of huge has that happened, well partly because especially amounts of taxpayers’ funds? since the new management have gone in to RBS we Mr Darling: We have. You may recall a month ago, know a lot more about RBS and some of its as part of the conditions of us supporting RBS and exposures. The other thing, and this is very the Lloyds group, especially in the case of RBS there important, as you look at these things, is that we was a very great restructuring of the way in which it have not been operating in this country or any other remunerates people. We had to deal with what you country against a static background. By that I mean, might call the inheritance problem where you have if you had dealt with a single bank collapse, suppose contractual obligations in relation to some people we had been talking five years ago, everything in the but we made it very clear that there would be economy looked fine, one single collapse, basically restrictions on what the board could get, they will conditions were not changing, well you could not be getting bonus payments in relation to pay,and V probably do a valuation, you could probably do it also large numbers of sta even where they did have fairly accurately and you could sort it. What we have contractual obligations they have been deferred and had to do is to do an assessment in relation to capital there are claw back provisions. That goes far, far in October and then in the case of RBS and Lloyds, further than what they are doing in the United as they join the Asset Protection Scheme, we have States. The United States initially announced a restriction on how much board members could earn, been doing it against a background where the this goes an awful lot further. The people we have economy has been deteriorating here and across the been trying to protect—and I think it is important world very sharply indeed. Indeed, the sheer scale of that the distinction is made—there are an awful lot the downturn at the back end of 2008 is significantly of people who work for banks who are not terribly worse than many people anticipated. We were not well paid, and I do not think anyone in this room doing it against a static background. I am sorry it is should argue that somehow it was all their fault, it a long answer but I think you deserve justice to your certainly was not, and we have tried to protect that. question. What we have tried to do is accept the fact that there are some inheritance problems, deals that were agreed by the previous managements, but going Q2813 John Thurso: I do not think anybody would forward we have been very clear there has to be a argue that it was a very fast moving situation, it still structure that does not reward failure, that focuses is, with very big numbers, a great deal of complexity people on things that will improve the conduct of the and it would be very understandable if people took bank and at the same time protect the interests of decisions which a month or six weeks or two months those people at the lower end of the pay scale. Now later needed to be reviewed. The point I have we have done that for RBS, we have done that in consistently tried to put to you is that this merger has relation to Lloyds, and I have made it clear that actually been a disaster for Lloyds TSB shareholders needs to apply to any other body that comes in to and is likely to remain that for many years to come these new lending schemes. and it is questionable in the light of the developments that you have pointed out to me that it Q2815 Nick Ainger: They are in relation to the bonus is going to be in the national interest in the long term. packages, what about the actual salary, the level of Mr Darling: The point I was making to you is that remuneration that people still feel are completely out the decision to go ahead with this merger was made of kilter with the rest of the economy? Do you not after consideration by the shareholders of both those think that you should be setting an example, as banks. I do not think it is the position of the Chief President Obama tried to do, of trying to reduce the Executive of Lloyds bank that he does not think in level of salaries that are paid, and quite frankly the long run that he will not be able to make people feel are not justified, particularly when these something of this merger. Now that is a decision that banks have failed and are now dependent upon the they reached. In relation to the other part of the British taxpayer to bail them out? banking system, you are right we have at times had Mr Darling: I think, firstly, if you look at the bank to do things fairly quickly but if we did not do it the remuneration generally, although it is not exclusive uncertainty would be far more damaging. If you to banks, over the last few years, over the last 20 look at the United States just now, they perhaps years, a situation has developed where people at the Processed: 26-03-2009 00:31:08 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG17

Ev 370 Treasury Committee: Evidence

19 March 2009 Rt Hon Alistair Darling, MP, Mr Dave Ramsden, Mr Tom Scholar and Mr Nikhil Rathi top are getting paid more and more both in salary, pay package—and what the troops who in many bonuses and pension provision and so on, which as cases keep the thing going get. There was quite a big you say at times seems very out of line with the diVerence. performance of what the institutions have done. I do think that people should pay sums that are realistic, Q2818 Nick Ainger: I accept that but Adair Turner that represent a reward for good work, do not suggests that in the longer term this is an issue that reward people when they make mistakes. If you look regulators should now be looking at. at the bank remuneration generally,we have to make Mr Darling: Absolutely. sure also we are in a situation where we do not end up with a situation where other banks start Q2819 Nick Ainger: And is proposing a code. You attracting people who are key to make RBS and the are giving an indication that when the White Paper Lloyds group work in the future. The overall is published that code will be enshrined in the White objective here is that of course there are immediate Paper or will you leave it up to the regulator to concerns that we have to deal with, you are right to enforce their own code? How will it be done? raise issues like pay but, at the end of the day, there Mr Darling: I think the code is pretty important. I are two things we need to do with these banks, one mentioned it last September when I was speaking at is to get lending going but, at the end of the day, I our party conference speech, I said I thought the V want to get these banks back, o Government hands code was pretty important. There is no doubt, and so we can get our money back, so we do not have to there was no doubt then, that some of the incentives be guaranteeing these assets, that will take time. We were geared to making people take unacceptable have to bear in mind that is our objective and risks. I think, as Adair Turner says, and as I have whatever we do we have to make sure we manage said, that a code in relation to how remuneration is these banks in such a way, they will not be in the structured is absolutely essential. If you look at same shape and form that they are just now, RBS for Adair Turner’s report, he does look at things in a V example I think will look quite di erent, but we have very coherent overall way and there is no one part of got to get them back in to the commercial sector. I it which you can pick out. What he does do, he do not think anyone, it is hard to say anyone, there highlights a number of areas where I think action will be one or two but I think most people in the needs to be taken, especially a thing like a bank, House would not wish us to be running banks where it is not just the bank that we are bothered forever and a day. Believe me, it is fraught with about it, it is the systemic risk, the eVect on the rest diYculties. of us that we are extremely bothered about.

Q2816 Nick Ainger: I appreciate that but Lord Q2820 Nick Ainger: Just a final point, the Centre for Turner in his report of yesterday says, “The first and Economic and Business Research estimate that this short term issue . . . ” this is about remuneration “ year £3.6 billion is going to be paid out in the . . . concerns the total level of remuneration paid to financial services sector in bonuses. Would you executives in banks which are receiving taxpayer expect next year to see that figure substantially support”. Total level of remuneration. This is a reduced as a result of the code of practice and as a legitimate issue for public concern and one where result of what has happened? Government as a significant shareholder has a Mr Darling: I expect the revenue from bonuses to crucial role to play. fall, although I have to say to you, Mr Ainger, it is a Mr Darling: Absolutely. double edged thing. I do not know if we are going to get on to discuss broader issues of public finances but one of the reasons that our finances are down at Q2817 Nick Ainger: What I am getting at is not the the moment is because about 25% of our corporate bonus culture, I understand that and I understand tax take used to come from the financial sector, what you are doing in terms of RBS and the Lloyds about 12% of tax and national insurance, and it Group, but there is this issue of the total level of follows if people are not paying bonuses then less is remuneration which is being paid and, with respect, coming in to the revenue. On balance I think it is a addressing the bonus issue does not address the total good thing that we ensure that the excesses in the remuneration. banking industry are brought to an end, however it Mr Darling: I agree with you and I did also say in does mean that our revenues do suVer as a result. February, when we were dealing with these, we wanted the new management of these banks to Q2821 Ms Keeble: I want to ask about the Asset develop a remuneration policy going forward that Protection Scheme. To what extent do you think it takes account of the very points that Adair Turner could be seen as an alternative to or a precursor to a makes in his report. As I said earlier, in reply to a bad bank? question from Mr Fallon, largely I accept much of Mr Darling: I would say that there is a choice and I what Adair Turner has to say. I will respond in more do not think necessarily you would say one is better detail when we do the White Paper, indeed next week than the other. I have always been clear that I think actually, but I accept a lot of what he says and you need a menu of options. If you stand back and making sure the remuneration policy properly ask why you are doing this, what is it that is holding reflects people’s eVorts but does not create this great back banks from lending at the moment? It is not gulf between what some people were getting at the because they are all sitting there saying, “We are not top—and as I say, you do need to look at the overall going to lend”. It is simply because a number of Processed: 26-03-2009 00:31:08 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG17

Treasury Committee: Evidence Ev 371

19 March 2009 Rt Hon Alistair Darling, MP, Mr Dave Ramsden, Mr Tom Scholar and Mr Nikhil Rathi banks have on their books assets for which there is Q2826 Ms Keeble: He said something in the last either no market or where the value has fallen session. substantially. Therefore, they want to husband their Mr Darling: He may not want to say something but resources and keep their capital against those losses; he certainly said something then. I announced this therefore, there is less to lend. The objective here is on 19 January originally and a number of people to get more lending going and so you have a choice. said, “Why has it taken so long before the You can separate banks into a good bank and a bad announcement in February?”. That is because we bank, and we have done a bit of this; we did it in needed to look at the assets, we needed to do due relation to Bradford & Bingley, for example, where, diligence and to understand what they were. Of as you know, we separated oV the deposit-taking course, we need to go through a lot of the small print side which Bank Santander bought from us and the before we can finally do the deal. I judged it better remaining part is being operated but basically it will though, and I think people have accepted this be run down as the mortgages get redeemed and so because, when I look at other countries who have on. In relation to the insurance scheme, the not done this, the more you can get certainty, advantage to us is that it stays on balance sheet but accepting that you are doing this against a shifting we do insure it. As you know, we have signed background, as I was saying to John Thurso, the agreements now with both RBS and the Lloyds better it is for the institution and therefore for us all. Group in return for which there is a lending agreement which will see £25 billion extra this next Q2827 Ms Keeble: You said just now that you year from RBS, £14 billion from Lloyds. I do not needed to get the valuations before you could finalise think one is better than the other and, interestingly, the deal. Does that mean that it is not finally agreed? if you look at other countries in the world, they too When do you expect to know how much is being are adopting a menu. America is, for example. insured? Mr Darling: I expect the figures to be of that order of magnitude. Obviously, we need to go through the Q2822 Ms Keeble: In relation to this side of the detail, and you would expect that, but it is like any scheme, you have already insured something like other big contract of this nature. It is not uncommon £600 billion worth of assets, which must make it one in a commercial contract for heads of agreement to of the biggest bank cheques in history. How many be reached, a general outline and the rest of it, but more banks do you expect to join and how large then you have to go through the detail. The would you expect the scheme to become? alternative would have been to maintain radio Mr Darling: So far the RBS assets are £325 billion silence for a long time and in countries where they and Lloyds £260 billion. have attempted to do that it has proved to be very diYcult. Q2823 Ms Keeble: That is close on £600 billion. Mr Darling: That is right, but those are the actual Q2828 Ms Keeble: Do you expect Barclays to join? figures, if it helps the Committee. That is guaranteed Mr Darling: Barclays have said publicly that they are assets. The first loss is taken by the banks. considering the options available to them.

Q2829 Ms Keeble: Do you know about the size that Q2824 Ms Keeble: But it is diVerent amounts for they have put in? There has been £80 billion talked each bank, is it not? about. Mr Darling: That is right. Perhaps I could illustrate Mr Darling: Barclays have said they are considering it to you if it is helpful. The first loss in relation to it but, as with any other discussions that we have RBS gross is £42 billion; the figure on Lloyds is £35 with anyone who may approach us, we will respect billion. There is a fee paid of about £6.5 billion from their wish to observe the confidentiality of that until RBS and about £15.5 billion in relation to Lloyds. we are in a position where we can make an Yes, they are diVerent because, like any insurance announcement. Barclays have simply said so far, and policy, if you and I went along to an insurance that remains their position, that they are considering company we might get quoted diVerent rates because their options. of our diVerent circumstances. There is a fee paid and we take 90% of the next loss, they take 10% of the remaining loss, but the object of the exercise is to Q2830 Ms Keeble: You said just now that you want get lending going again. That is why we have put it to talk about some of the wider public sector funding in place. issues. Have you done scenario planning for what happens if some of these losses crystallise? Have you looked at the timescales and what the kind of impact Q2825 Ms Keeble: With most insurance schemes you on the public sector finances might be? value the assets before you do the insurance but in Mr Darling: Of course you have to consider that. this instance you are still doing the valuations. When do you think the valuations will be completed and Q2831 Ms Keeble: So what does it look like? have you got any idea as to what you are actually Mr Darling: Like any insurance contract, it is very insuring? diYcult to make an assessment as to what the Mr Darling: It will take, I suspect, and Nikhil may position will be because we do not know how long it want to say something further about this, a few will take for us to get through this. We do not know weeks. to what extent the eVect on these asset prices is Processed: 26-03-2009 00:31:08 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG17

Ev 372 Treasury Committee: Evidence

19 March 2009 Rt Hon Alistair Darling, MP, Mr Dave Ramsden, Mr Tom Scholar and Mr Nikhil Rathi permanent and how much is temporary. In Sweden, on a level playing field with other institutions, in for example, they did a similar thing, as you know, other words, not oVering something that is hugely in the early 1990s, and on one view when they came preferential, I am hopeful that that will be okay. out of it the Swedish government ended up on the better side of it rather than the worst side of it. At the Q2838 Jim Cousins: So the state aid issues are still present time it is very diYcult because it depends on not resolved? so many diVerent variables. Mr Darling: State aid takes ages to resolve. Even in steady state, even when things are going fine, it is not Q2832 Ms Keeble: Is the fee that you have spoken uncommon to take a couple of years to sort out state about that is being charged on the banks a one-oV or aid things. We are doing it a lot more quickly this is that going to be renewed in the future? Is it going time because I think Commissioner Kroes in the to be annual or what? Commission has been exceptionally helpful in Mr Darling: It is the fee they paid for operating it. recognising that governments are having to do things very quickly, but, obviously, they need to be satisfied, and they are not just dealing with us Q2833 Ms Keeble: So it is an entry fee, is it? because, despite what you sometimes read, there are Mr Darling: My recollection is that it is 2% of the a lot of other countries who have got state aid issues total amount. that need to be cleared as well.

Q2834 Ms Keeble: But that is an entry fee or an Q2839 Jim Cousins: But does that mean the new annual fee? lending cannot start until the state aid approval has Mr Darling: It is the entry fee. been given? Mr Darling: No, I understand it can start. Q2835 Ms Keeble: Can I come back to you again on the valuations because I have asked about this Q2840 Jim Cousins: It can start? repeatedly and I keep on being told, “It is being Mr Darling: Yes. done”, “It is being done”. When do you expect to know the valuation? You have said you expect it to Q2841 Jim Cousins: Can you give the Committee an be in the order of the amounts that have been assurance that you will not seek to merge Northern announced. Have you got any idea about what the Rock with the rump of Bradford & Bingley? upper limit might be or have you put a cap to the Mr Darling: I would make this general comment, scheme? that to make any broad-based or even specific Mr Darling: What we announced in February was comment like this at a time when things are changing the agreement and I have told you the figures in so rapidly might be unwise, so whether it is Northern broad order of magnitude, and that is more or less Rock, Bradford & Bingley or any other institution where I expect them to be. However, as I said to you, you care to name, I think I would be better just it will take some weeks to get the detail finalised and making the point that I will do whatever is necessary. that is what we are working on at the moment. There are two things I want to see happen. I want lending to increase but I also have to have regard to Q2836 Ms Keeble: Do you know when you will stability, and I also have to have regard to the overall expect a response from Barclays or when you will be expenditure. As you know, all we have done to allow able to say anything about Barclays? Northern Rock to carry on the lending is that we are Mr Darling: No, the ball is in Barclays’ court. eVectively splitting the bank so that you have the deposit-taking new lending in one part of it and you Q2837 Jim Cousins: Chancellor, you announced a have got the existing book in the other, but we will decision that Northern Rock would be able to continue to do what we think is best, of course, in the undertake £14 billion of new mortgage lending. Was public interest. It does not matter what institution that your decision and will it extend the period of you care to mention to me; I have to consider these public ownership for Northern Rock? things against a background that frankly is Mr Darling: Yes, it was my decision because only I constantly changing. That does not mean we are could agree to it, as you know. The original plan was about to do something or not about to do to hold on to Northern Rock, to run down its book something. I would just be reluctant to commit and to gradually repay the loan. The loan has come myself in a way that I do not think would be wise. down. I think the last figure I saw was just under £9 billion. It is down from about £27 billion, I think, Q2842 Jim Cousins: In Bradford & Bingley already, originally, so that is ahead of what we thought at the and you have just referred to the fact that you are time. As the circumstances changed my view doing much the same with Northern Rock, you are developed that, especially this time, it would be splitting the old book from the new book, from the wrong to take more capacity out. That is why we new lending. have allowed Northern Rock to expand the amount Mr Darling: There is not a new book in Bradford & of lending that it is doing. We have got to get state Bingley. What we split was the deposit-taking side aid approval. We have been talking to the European of it. Commission and they understand what we are doing, and I think broadly speaking, as long as they Q2843 Jim Cousins: The old book has been are satisfied that Northern Rock will be competing separated? Processed: 26-03-2009 00:31:08 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG17

Treasury Committee: Evidence Ev 373

19 March 2009 Rt Hon Alistair Darling, MP, Mr Dave Ramsden, Mr Tom Scholar and Mr Nikhil Rathi

Mr Darling: That is right. biggest banks in the world. It is now on one view the biggest bank in the world precisely because it has Q2844 Jim Cousins: But when we come to the Asset global operations. We have to start from the Protection Scheme, which we were talking about situation that we are in. We have this bank and if we earlier, and your team very helpfully on Tuesday want to get lending going again in this country we have got to ensure that we take the necessary steps made it clear to us that in the case of RBS the old Y book, if I can put it like that, the old lending that is to insure su cient assets to reduce that risk and being supported, more than half of it is outside the therefore they will lend into the British economy. UK. We are not protecting British savers and British That is absolutely essential. depositors and British lenders. We are protecting property developers right across the world. That is Q2846 Jim Cousins: Chancellor, if you are going to the old book. lead us into this temple of doom I think the British Mr Darling: No, it is not. That is not quite the people will be looking to you to behave a little bit position. In relation to RBS you will be aware that more like Indiana Jones. when they published their annual results in February Mr Darling: SuYce it to say, Mr Cousins, that I just Stephen Hester, the new Chief Executive, identified do not agree with your conclusion. that part of RBS which he saw as being core to what they are doing in the future and for which he believes Q2847 Mr Brady: Chancellor, have you agreed the there is a good future. He also identified parts of the budget and funding plan for UKFI? bank which he was not proposing to sell or attempt Mr Darling: We have agreed its framework to sell immediately, but he thought that in the future agreement, which I think you discussed with John they would be run separately but still both be RBS. Kingman when he was here, and as part of the It was not, if you like, a pure good bank/bad bank normal discussions that we have as we come into the split in the sense that I was talking to Sally Keeble financial year we will agree its budget. about because a lot of the non-core business could be fine in the future but it is not central to what they Q2848 Mr Brady: But you have not agreed it yet? think is going to be part of RBS. In relation to the Mr Darling: As you know, it is still being staVed up, point you are making about assets that are overseas but we know generally the position. Tom will tell you and in the Asset Protection Scheme, the reason that more about it if you want but, as I think John we are doing this is that we want to ensure that there Kingman said to you, it will be a fairly small is increased lending in the United Kingdom. If we organisation of about 15 individuals because of the did not insure assets that may be abroad or may be very specialist role that it is carrying out. on a book abroad, whether they are here or not, that would mean that it would still prevent RBS from Q2849 Mr Brady: So there are no particular sticking being able to lend, for the reasons that I set out to points. We were told also by John Kingman that Sally Keeble, that is, if RBS or any other bank has UKFI is eVectively camping in spare rooms in the assets, no matter where they are in the world, that are Treasury, that it is sharing human resources, IT and impaired to one degree or another it will curtail its press teams with the Treasury. It is obviously lending. If you decided not to insure lending because commendable that it is saving public money by it was abroad you would not achieve the objective, doing so, but can anybody seriously believe that it is which is to get increased lending. Our objective here truly independent of the Treasury in those is to get more lending into the UK; that is why we circumstances? have got the lending agreement with them, and that Mr Darling: I understand what you are saying. I was is why the insurance scheme is more widely drawn. just thinking as you were speaking, suppose I said In the case of Lloyds, there is a lot less overseas that they had taken a lease on a very fine oYce simply because Lloyds is a much smaller operation. somewhere, that they had not just got 15 people but RBS is the biggest bank in the world and we own it. four press oYcers, X number of people to do HR and the rest of it. You would quite rightly say, Q2845 Jim Cousins: But have we not engineered a “Could you not have achieved some economies of situation in which it is not the Government that has scale?”, so you cannot win. That is the nature of taken over the banks but the banks that have taken things. I am not saying in the future that it will not over the Government, and it is British spending and be housed somewhere else but what we wanted to do, British lending which is being cramped in order to and it comes back to the point I was making earlier, support the interests of property developers is that there are immediate things we are going to throughout the world? have to be dealing with on a day-to-day basis which, Mr Darling: No. I think just is simply not right. As of necessity, UKFI have been involved in, like the I said to you, if we took the decision (and in RBS’s remuneration structure in these banks and so on. At case we will only insure whatever is in the United the end of the day we must get ourselves into a Kingdom), you could do that and then you would position as we get through this and we deal with find that RBS would say, “We still cannot lend some of these important issues where we manage because we have got all these doubts about other these banks in such a way that we can return them to things we have got on our books”. You could take a the private sector operating commercially and that view one way or another as to what RBS might have for the taxpayer, which has legitimate and done in the past because the nature of the bank is understandable interest in this (as does the that a lot of what it did is overseas. It was one of the Committee and elsewhere), we have to make sure Processed: 26-03-2009 00:31:08 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG17

Ev 374 Treasury Committee: Evidence

19 March 2009 Rt Hon Alistair Darling, MP, Mr Dave Ramsden, Mr Tom Scholar and Mr Nikhil Rathi that we get our money back at some stage and we get Government owns. Most of us around this table can this risk away. That means that this is going to be remember the days when the Government owned the tough for governments, for MPs. We have to just steel industry and ship building. It was always decide where we need to apply intense ministerial diYcult to say, “What is a legitimate interest for engagement, political engagement, if you like, and Parliament to have?”. where, for example, in the question of normal commercial judgments on loans, frankly, we say that Q2853 Mr Brady: But do you see my point, this is for the bank concerned; it is not for Chancellor, that on the evidence so far the governments. Government has shown that it is willing to use UKFI as a cat’s paw to take political action when a Q2850 Mr Brady: But, Chancellor, as you know, pension arrangement, for instance, already agreed UKFI has already acted on behalf of the Treasury in proves to be unpopular with the public? relation to Sir Fred Goodwin’s pension even though Mr Darling: It is quite clear that it is a legitimate they admit they do not have any formal powers to do interest of a shareholder, and UKFI represents us in so in the framework document. that, to take an interest in remuneration policies, Mr Darling: We are in something of a transitional but, in relation to remuneration, at the end of the period at the moment. That is inevitably the case. day it still comes back to ministers and it comes back to me in particular. Q2851 Mr Brady: But if they can act in regard to Fred Goodwin’s pension without having the powers Q2854 Mr Brady: So what guidance have you given to do so, how can you tell us that they are not going to UKFI regarding issues such as outsourcing and to act in similar regard in relation to other jobs tax planning and the input they should have into the maintained in Halifax, in Edinburgh, regarding banks that they largely own in those regards? outsourcing and without having the powers to do Mr Darling: What I think you have seen, and if you so either? have not you will very shortly see it, is the framework Mr Darling: On the remuneration side that is a agreement which sets out what UKFI is supposed to legitimate question that can be raised by do. What I am saying to you is that inevitably— shareholders, and we patently are the largest institutional shareholder, if you like, so it is not Q2855 Mr Brady: No, sorry, I was asking what unusual for a shareholder or a representative of a specific guidance you have given to UKFI. shareholder to engage in remuneration practices. Mr Darling: I have not given them specific guidance You are right: diYcult issues will come up in relation on these issues, and remember we have not owned to how these banks are organised, employment banks in this country—I suppose TSB was probably issues and so on; they already have. As you know, the last one that we owned—for some time. RBS has already announced quite significant job V losses in di erent parts of the country. Q2856 Chairman: Chancellor, in terms of UKFI, what is the purpose of it? What is it there for? It has Q2852 Mr Brady: But on Tuesday Lord Myners told been wrangling for the past few months about me, “I think companies should have a soul, they getting the banks to do lending and that should have a moral purpose, and good companies prevarication has gone on. Why does the are very conscious of their community obligations”, Government not just do it itself? Is UKFI just there and he had already said that it was legitimate for as a shield for the Government? UKFI to take an interest in matters such as Mr Darling: No, and I saw the exchanges you had outsourcing, tax planning, oVshore trust activities, with John Kingman and Glen Moreno. The shares et cetera, but he said on the other hand it was not need to be held by someone and I see UKFI as being legitimate for them to have regard to the extremely useful to the Government, especially as we maintenance of the UK skills base. Do you agree move into the medium term, where you do need to with his list of proper responsibilities? have your shares managed because at the end of the Mr Darling: I think Lord Myners is raising a broader day where we want to get to is to get these banks oV philosophic point about companies in general as our books and back into the commercial sector well as banks in particular. Of course, banks’ properly supervised and regulated, and it will be a shareholders are entitled to take a view on diVerent world from the one they have operated in in remuneration policies, they are certainly entitled to the past, but that must be our long term objective take a view on ethical issues. As I said the other day, and we must not lose sight of that. Inevitably, if we I think in relation to banks, especially ones that we look at the immediate problems we have, and you own in relation to their tax, that they should do what have mentioned the lending agreements, whilst they are supposed to do. Shareholders can take an initially the general agreement we reached when we interest in this but you do highlight an issue that is recapitalised might have been managed by UKFI, going to be with us for some time because I think we my judgment is that, because it is needing quite a lot are going to have these banks for a while yet, and of day-to-day management and, yes, there is a lot of that is what is something in which Parliament has a politics in it because these decisions are political; it is legitimate interest, say, and you have to say in terms a political judgment as to whether or not you have a of these institutions, what is a proper commercial lending agreement or we are managing these directly, decision to take? We have this in the Royal Mail. The and, as you know, we have set up the lending panel Royal Mail is one of the large institutions that the and we meet the lenders generally. We have got more Processed: 26-03-2009 00:31:08 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG17

Treasury Committee: Evidence Ev 375

19 March 2009 Rt Hon Alistair Darling, MP, Mr Dave Ramsden, Mr Tom Scholar and Mr Nikhil Rathi specific agreements with the two other banks. To my Q2861 Chairman: Whatever. You have had had the mind, I am afraid—and I know it can be trying at papers. times—you are in comparatively new territory both Mr Darling: I will see if I can get it on iPod. in the general economic environment in which we are operating but certainly in terms of us owning substantially two very large banks. It is something Q2862 Mr Todd: Clearly not such a sad soul! What that I do not think anyone around this table would is the proportion of the UK retail banking market have contemplated five years ago. which is now in taxpayer hands? Mr Darling: I am not sure I can give you that. I do not want to give you a figure that is not right but, Q2857 Chairman: Chancellor, we have not been too quite obviously, we own quite a substantial amount impressed with the rationale for UKFI to date, as of it at the moment. Lloyds is a third, from you will see from the evidence session, and it seems recollection, and RBS is about 40% in total, I am to us at the moment that you are taking a circuitous told. route rather than a straight route. We are going to be examining UKFI much more closely and there are a lot of answers that you have to give us yet. Q2863 Mr Todd: I perfectly understand the wish to Mr Darling: Of course, and, indeed, one of the issues be hesitant about giving precise answers but it which you have alighted upon is that you have asked perhaps indicates why this line of questioning is UKFI for quite detailed information in relation to being followed. We now have in the taxpayer’s these banks, and I think John Kingman has written hands a very large proportion of UK banking. The back pointing out the Government’s policy shareholding is being governed by 10 folk in the back generally is that institutions we own should disclose oYces of the Treasury. There is no business plan what they should be disclosing, and this is a for UKFI? discussion we probably need to have with you, which Mr Darling: As I said, there is a framework is just how much you put in the public domain, document. We are about to start the first full having regard to the fact that these banks have to financial year. It is very important that not just us compete with other banks. I think none of us wants but you and Parliament know what we are doing to be in a position where we do something that ends with public money, and you will. My point with Mr up with a situation where we have these banks and McFall is that at some stage, and maybe there is an because they have not been operating as much as agreement to be struck here, we will have to strike a they possibly can on a commercial basis then they balance between what is quite legitimate and entirely will remain on the Government’s books for far in the public domain and what causes problems for longer than anyone would want. It is in all of our commercial competition and so on. interests to get through this incredibly diYcult period where, yes, there will be cases where you will Q2864 Mr Todd: Not very surprisingly, most MPs try something and it may not work so you may try a are now going to get queries about individual issues slightly diVerent approach. I make no apology for relating to the banks that are in public hands. that whatsoever. What is important is to get it right Defining the diVerence between the state as a and to get it right long term. regulator, the state as a shareholder and parliamentarians as representatives of customers is Q2858 Chairman: In that case you are talking about going to be really hard, is it not, and one of the key we gave them pre-notice on the Friday and we still things that is going to need to be done is to define did not get the answers. These are simple questions very clearly the definition of what UKFI is for? and we should have that information, and the reason Otherwise, expectations are going to be ridiculously is that the taxpayer is standing behind these banks to high and we have already seen some of that. Do you the tune of hundreds of billions of pounds, so I think accept that a lot more work needs to be done both at we do need that negotiation, Chancellor, and the the philosophical end of defining what I have just answer is inadequate to date, maybe from them and said and the diVerence between various functions? yourselves. Mr Darling: Absolutely. That is what I have been Mr Darling: Hold on a moment. As you well know, endeavouring to say over the last few minutes. Mr McFall, I am very happy to talk to you and I do on a number of occasions. Q2865 Mr Todd: It would help if we had more of this really rather rapidly, so is this an institution which Q2859 Chairman: You do. should be pursuing governance issues? Should it be Y Mr Darling: If you think you are having di culties dealing with remuneration? It has already been with anything that I am responsible for I am happy drawn into that. Should it be dealing with tax to discuss it with you, as you well know. activities in the various banks along with The Guardian campaign, because it will be blown around Q2860 Chairman: Chancellor, if you had looked at with the wind, will it not? the television on the parliamentary channel you Mr Darling: I agree with you that you do need to be would have seen we have had terrible diYculties very clear as to what the regulatory bodies do, and with UKFI. that is established primarily in statute but in other Mr Darling: I cannot pretend to watch the ways as well. Earlier on in this hearing we were parliamentary channel every day. talking about how that might develop in the future. Processed: 26-03-2009 00:31:08 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG17

Ev 376 Treasury Committee: Evidence

19 March 2009 Rt Hon Alistair Darling, MP, Mr Dave Ramsden, Mr Tom Scholar and Mr Nikhil Rathi

You also need to be sure what UKFI’s job is, which debt levels we have just now, which have, of course, is essentially to manage our shareholding. In relation increased because of the current economic situation, to lending, I would make the point— and if you look at the last published figures that we have, our position is a lot better than many of the Q2866 Mr Todd: But shareholders have a wide other G7 countries. Obviously,—and I am not variety of interests, as you have just said. making any forecasts; I will get my retaliation in Mr Darling: They do, and it may be from time to first: my next forecast will be made on 22 April, not time that things that shareholders take an interest in today—the situation, as I said, I think, in reply to may change. I am pretty clear in my mind, and my John Thurso, had deteriorated quite markedly at the view has changed since last October, that the actual back end of 2008, but if you look at our debt levels management and supervision of lending agreements at the moment we are better placed than many other is rather better done in the Treasury and the countries. Department of Business and Enterprise than by a body that is essentially there to look at long-term Q2869 Sir Peter Viggers: You gave an extended shareholder interests. You are right that people need interview in the New Statesman last month. To quote to know that, MPs need to know that. The point I from it, “What people want at a time like this is for was making to Mr McFall and others was that this elected politicians to level with them”. Bearing in is a situation where we have acquired these banks mind that the pound has fallen 31% against the and we had to do it rather quickly. A lot has dollar and 17% against the euro, and that is happened in the last five months. Inevitably there yesterday’s figure and it has fallen since, can I ask will be some things which we may need to adapt and you to again visit the same question? Do you really I do not think we should be ashamed of it if we do think that you were right in saying that “Britain is adapt them. better placed than other economies to withstand the slowdown in the global economy”, with the benefit Q2867 Mr Todd: Just to bring to a conclusion what of hindsight? I am going to ask you, there is clearly a conflict of Mr Darling: I have answered that and I said yes. In interest in the Government’s role as a shareholder relation to the currencies, which you raised the last and as representative of the customer base in the time I was here, there has been self-evidently over the UK. Those interests are not identical and some last couple of years a lot of volatility in the currency explanation will have to be required as to how you markets. We do not provide a running commentary diVerentiate between those functions. on that. Successive governments have wisely decided Mr Darling: You are absolutely right and, sadly, not to do that, but there is no doubt that we are, like unlike other organisations, the Government many other countries, facing a very turbulent frequently finds itself with a conflict of interest. You period. However, if you look at the position at the are right: there are two things that we are telling moment, provided we maintain our support for the banks to do. One is to rebuild their capital base, economy, as I set out in the Pre-Budget Report last because that is absolutely essential. We are also year, and provided too, as I also made clear in the saying, “We would like you to lend into the Pre-Budget Report, that in the medium term all economy”. How do you reconcile them? It is partly countries have to live within their means, I believe we because both things are necessary but we have to can get through this. I was just saying to you that if reconcile two things like the recapitalisation when you look at the IMF report which is being published, only the Government could put money into these probably even as we speak, and it is not the growth two institutions, like the Asset Protection Scheme, forecast one which was in the papers the last couple because that is the only way to make sure that of days; that is not coming out until some time in lending is going. The other thing we should not lose April, they do say that we and America and one or sight of, because it is important, is that this is two other countries entered this from a position happening and similar things are happening all over where we could support our economies, and that is the world, and one of the things that was blindingly why I have done it and I think it is very important obvious in the meeting we had with the finance that other countries continue to do that. I know it is ministers of the G20 at the weekend was that unless not a universally held view in the House of countries do this all over the world it will be like Commons because there is a divide between the trying to fight something with one hand tied behind Government and the Opposition on this, but I think your back because we can sort out our problems but it is right that we should take steps to do it because if the American banks are not functioning normally the costs of not doing it would be absolutely or the European banks are not functioning normally, colossal. given the global nature of trade and everything else, it will be very diYcult. Q2870 Sir Peter Viggers: It is not your fault, of course, that we are so badly prepared. It is your Q2868 Sir Peter Viggers: Chancellor, in your Budget predecessor’s. Who was that? a year ago you said, “Britain is better placed than Mr Darling: If you do not know who were the other economies to withstand the slowdown in the Chancellors of even some years back I would be global economy”. Was that right or wrong? surprised. Mr Darling: I think it was right; that is why I said it. If you look back, we had come just oV the back of 10 Q2871 Sir Peter Viggers: We have a Prime Minister years’ steady growth, and indeed, if you look at the of whom Ministers dare not speak his name. Processed: 26-03-2009 00:31:08 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG17

Treasury Committee: Evidence Ev 377

19 March 2009 Rt Hon Alistair Darling, MP, Mr Dave Ramsden, Mr Tom Scholar and Mr Nikhil Rathi

Mr Darling: If you are going to refer me to my article Q2874 Sir Peter Viggers: You have referred to the in the New Statesman, refer again to the article in conflict of interests in the banks between The Daily Telegraph a couple of weeks ago. I am recapitalising and building their balance sheets and very clear: whatever the Government does we have lending. In retrospect, do you think that you drove a collective responsibility for it and I have been a too hard a bargain when banks such as Lloyds TSB member of this Government since 1997. came to you asking for support? Mr Darling: Lloyds? Q2872 Sir Peter Viggers: We have pressed you in diVerent ways about making investment in the banks Q2875 Sir Peter Viggers: Yes, I use the example of without carrying out due diligence and the fact that Lloyds TSB. Do you think you were too hard in banks have been criticised for making acquisitions driving your bargain with them? without due diligence, but how much worse for the Mr Darling: On the APS? Which transaction had Government to use good taxpayers’ money to make you in mind? acquisitions without due diligence. You have always said that you did not have time, but surely you have Q2876 Sir Peter Viggers: When first they came to had since August 2007 to appraise the situation. you? Mr Darling: No, I do not agree with you at all. In the Mr Darling: Over the question of the merger? back half of 2007 there were many people that took the view that Northern Rock was our problem, for example. I think the scale and extent of the problems Q2877 Sir Peter Viggers: Yes. that began to aVect the rest of the banking system Mr Darling: No, I do not think so. What we did was started to manifest themselves probably about the we agreed to waive the competition rules which I am turn of 2007–08 when there was a growing concern not sure had all-Party support but had very that banks had on their balance sheets assets that substantial cross-Party support. I think if you are were severely impaired. Whether they were referring to the APS, it was a perfectly fair American or ours, they were there. We did not own agreement. any of these banks at that time, and indeed throughout the summer it was not clear that banks Q2878 Sir Peter Viggers: Do you have a clear exit were going to be in a position where they would need strategy for the investments which have been made to be recapitalised either by the Government or by and how should we assess whether your investments raising money themselves. What really precipitated in banks have ultimately been a success or a failure? the problems was the collapse of Lehman Brothers Mr Darling: That is something that we have been in September. That is when not just our banks but touching on throughout this hearing. My objective other banks really got into a position where it was is to return these banks to private sector ownership quite clear they could not carry on without major so that they can be commercially managed, albeit help, so I do not accept your analysis that somehow much better supervised and regulated. That is our all this was foreseen months before that. strategy. At the present time, as we are dealing with a situation which is still developing, where we have got to firstly make sure that we can restore these Q2873 Sir Peter Viggers: It is the fact though, is it banks to health and then at the same time we have not, that we do not know exactly what our to ensure that we get lending going into the system, obligations are to the banks that we have acquired? and I think this will take time to work through. This Mr Darling: As I was saying to John Thurso, when is one of these things where we do need to have a we acquired shares in some of the banks last October clear objective, a clear plan, which at the end of the we had to carry out an examination very quickly day, as I say,is to take the banks oV our books, if you because we were facing, as I said, the imminent like, and be able to withdraw the various guarantees collapse of the banking system, so we had to act very and support that we have oVered. However, we can quickly. Since then it is not as though things have only do that consistent with ensuring at the same been static and even if you had carried out a time that our economy recovers, so we will have to thorough examination culminating on 13 October, manage this in such a way as to make sure that we do nothing would have changed. Since then an awful lot not set back the recovery when it starts to develop. It has changed, not just in this country but in other is very, very important that what we do supports the countries, too. You just have to look around the general economic recovery,which will come. There is world. The banking system throughout the world a lot of money being put into the economy. We are has been aVected, to a greater or lesser extent, partly doing a lot to support banks, we have got lower because of problems originally in the banking system interest rates, we have got other measures being put and partly, of course, because as the wider economy in in support, but it will take time to work its way is aVected that feeds back and aVects adversely through. There is no quick-fix for this. banks. That is why you are seeing problems developing now in the emerging economies, which is Q2879 Mr Breed: Chancellor, I think it has become why again we need to sort this problem out, not just clear that in the UK you will not allow a major bank nationally but globally as well. It really does need to fail. Given that the banks benefit from that global co-ordination and that is why the summit on implicit backstop in a way, is it not reasonable to 2 April is so important. require them not to engage in risky activities like Processed: 26-03-2009 00:31:08 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG17

Ev 378 Treasury Committee: Evidence

19 March 2009 Rt Hon Alistair Darling, MP, Mr Dave Ramsden, Mr Tom Scholar and Mr Nikhil Rathi proprietary trading and such, because at the end of happened when Lehman’s went down. It was the the day ultimately of course they are risking thing that started this avalanche thereafter. I just taxpayers’ money? think that you need to look long and hard at a Mr Darling: I think all banks, whether we own them solution that was neat and may have fitted the or not, need to exercise a degree of prudence. It is American banking world of the 1930s as to whether diYcult to legislate (with a small “l”) as to what is you can translate it, even suitably adapted, into what risky and what is not risky. For example, you may we have just now. That said, I am very careful to say say that in normal times there is not much risk in that in the current climate I think it would be very domestic lending, but at the present time there may foolish to say to somebody no. These are ideas and be quite a lot of risk in it. In terms of proprietary you need to look at the pros and cons of them. I tend trading, there is nothing wrong with it provided it is more to the Turner view at the moment than I do to properly regulated and provided, as it says in the the view of those of who say this is the answer for Turner Report, you make sure that banks are the future. suYciently capitalised to do it. Q2883 Mr Breed: Including the Governor of the Q2880 Mr Breed: But banks have engaged in Bank of England? proportionate risk all their lives, that is their Mr Darling: The Governor of the Bank of England business. It is the fact that they have engaged now in takes a similar view. I do not think he is advocating way beyond proportionate risk, and rather than the splitting of the banking system. He highlights, relying upon the fact that they may well fail, they and I have highlighted in the past, the problems that now know of course they are not going to fail so they proprietary trading can get you into. Supposing you may therefore push the envelope far further. are a company and you bank with a narrow bank Mr Darling: There are two separate issues here. One and you want them to underwrite some sort of is if you look at things now, I have had made it clear, flotation, at what point do they have to say, “I am and I think most governments have made it clear, sorry, you need to go and see somebody else about that we will not allow the banking system to fail, for that”? patently obvious reasons. I do not know anyone who would argue the contrary. Looking ahead, we do need to make sure that banks organise themselves Q2884 Mr Breed: I accept the point entirely about and take decisions where they fully understand the deposits as well. Finally, going back to UKFI, did risks to which they are exposed and, if they have you agree with or did you influence in any way the risks, that they have got a fall-back position. At the fact that the FSA are not going to regulate UKFI? end of the day that has to be a decision taken by their Mr Darling: I think whether they regulate it would boards. That is an issue that I keep coming back to: depend entirely on what is in the Financial Services board responsibility for running any organisation, and Markets Act of 1988, which specifies what they banks included, is very, very important. regulate and what they do not.

Q2881 Mr Breed: But their fall-back position of Q2885 Mr Breed: I understand that they have taken course is the taxpayer. What sympathy do you have a decision not to regulate UKFI. for the so-called concept of narrow banks? In other Mr Darling: They would have applied the law as it words, the separation of retail banking and stands as to whether or not they would need to investment banking? regulate it. Mr Darling: It is an interesting discussion. I was asked this in the House of Commons on Monday. I think it is a matter that will be discussed and it is Q2886 Mr Breed: And you are happy about that? touched on in the Turner Report as well. Mr Darling: I am very happy they applying the law. It is a jolly good thing that they do! Q2882 Mr Breed: Lord Turner seems to rather be pouring cold water on the idea. Q2887 Mr Breed: Are you happy that they are not Mr Darling: He comes to the view that I tend to, regulating UKFI? frankly, at the moment, and that is that I am not so Mr Darling: They are not a deposit-taking sure that what matters is the physical split between a institution, for example. conventional bank and one that might do more investment banking. What he says, and I think this is important, is that if you have banks that are Q2888 Mr Breed: They do not only regulate deposit- undertaking more risky activities, you might require taking institutions. them to have a bigger capital buVer than other Mr Darling: No, they do not. I firmly believe that if banks. The reason I come to that conclusion is two- you lay down the law and you tell the FSA, “Here is fold. Firstly, if you look at the banks that have got your remit; you decide,” then it is best they should into the trouble, like Northern Rock and Bradford decide these things. I would not say it any more than and Bingley, they are narrow banks, but they are I would say they ought to be regulating any other narrow banks that failed. If you look at some of the financial institution. I can think of one in particular investment banks that failed in America, like Bear where you collectively may have expressed an Stearns and Lehman’s, which did not take deposits, interest. they were systemically very important. Look what Mr Breed: Thank you. Processed: 26-03-2009 00:31:08 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG17

Treasury Committee: Evidence Ev 379

19 March 2009 Rt Hon Alistair Darling, MP, Mr Dave Ramsden, Mr Tom Scholar and Mr Nikhil Rathi

Q2889 Mr Tyrie: Both Lord Turner and Hector problem for successive Governments, whether Tory Sants have set out in great detail what they think the Governments or Labour Governments. We had a cause of the crisis was. I think it helps Government long period of economic growth, one of the longest credibility enormously if they are able to be clear and periods on record. The thing that has caused us the frank about what they think the origins are. Hector most diYculty at the moment, and if it was a Sants gave a speech on 12 March referring problem in just one country it would have been particularly to the US but also to other countries. He relatively easy to fix— said that one of the main drivers of the crisis was “a drive by governments, finance ministries and central Q2893 Mr Tyrie: We are agreed on that. bankers to encourage a credit boom for the benefit of Mr Darling: I am glad we agree on that. consumers. A cultural driver was the view that credit was good for votes and that somehow or other it would be possible for the authorities to avoid a Q2894 Mr Tyrie: I am just asking if you recognise boom/bust culture.” Do you recognise any of that this as part of our problem, Chancellor. being applicable to the UK? Mr Darling: It is Hector Sants’ speech, it is his Mr Darling: As I said in reply to the questions to words. I have said on a number of occasions this Michael Fallon earlier on, there are lessons for all of afternoon and on previous occasions, that there are us to learn here. For the sake of completeness, I clearly lessons to be learned and the most important think Adair Turner did say that similar calls had thing, and the thing that most people would do is to been made by governments and oppositions, and he ask us, okay, this is what happened in the past; these was very bipartisan about these things. Obviously,as are the lessons you need to learn; what are you going I was saying a while ago, one of the problems we to do to stop it happening again? That is what I think have had, if you look at the system overall, is that you need to concentrate on. there was an extraordinary increase in the amount of credit, and when that chases a fixed number of assets Q2895 Mr Tyrie: Let us look again at how we deal there is a consequence of that. with this. It is unfortunate that you appear in denial about the fact that it was a terrible mistake to say Q2890 Mr Tyrie: Yes, but he is referring specifically that you had put an end to boom and bust. Do you to government encouragement. He is specifically agree with Lord Turner that principles-based saying “a belief that somehow or other it would be regulation has been dropped now and that “light- possible for the authorities to avoid a boom/bust touch regulation is dead”? I am quoting Lord Turner culture”. Is that something that you recognise might in the second part of my question. apply to the UK? Mr Darling: I have always thought it was a rather Mr Darling: No, what I would say to you, which is false dichotomy to say that you could have either what I have been saying earlier, in relation to credit light touch or presumably the corollary is heavy- in the system is that is one of the reasons that handed. Lord Turner says that principles have their underpins my belief that the authorities, whether it place. What he is arguing for, if you like, is a rather is the FSA or the Bank, do need to have powers, more intrusive form of regulation where— when it is appropriate, to require banks to build up more resources in the good times, and that acts as a Q2896 Mr Tyrie: He is quoted in the Telegraph as check, if you like, to excess money in the system. I saying: “Light-touch regulation is dead. The also think that the regulators (probably the FSA but regulator will no longer hold the view that markets there may be a discussion to be had on that) need to are in general self-correcting.” have the power to stop banks from over-reaching Mr Darling: You were talking about principles- themselves, either to their detriment or to the based and that is what I was talking about, which is detriment of the wider economy. adiVerent issue. I have never been an advocate of light-touch regulation. However, I accept there were Q2891 Mr Tyrie: You began that answer, many people in the House of Commons who were Chancellor, by saying no. Do you not see that many and they articulated it during the passage of the people will consider that to be eVectively still a Financial Services Act on many, many occasions. denial, when you have a Chancellor for 10 years who is now Prime Minister who has said over 100 times Q2897 Mr Love: Name names! in the House of Commons alone that “we have Mr Darling: Mr Tyrie, I am as happy and as capable abolished boom and bust”? as anyone around this table to engage in a party Mr Darling: I can see what you are trying to get at. political exchange, but I think on this occasion it is important that we recognise that there are things in Q2892 Mr Tyrie: If I may say so, do you not think the regulatory system and the style of the regulatory also, Chancellor, that if you say you have abolished approach which need to change. Adair Turner is boom and bust that it might be rather more diYcult quite right: it does need to be more intrusive; it does to spot the next one when it comes? mean that regulators have to question whether or Mr Darling: What we tried to do, and I think what not business models are right; and they do need to to a large extent we succeeded in doing, was getting ask serious questions of those which they regulate rid of the home-grown domestic problems that because the stakes are too high for them not to. That successive governments had faced in this country. does need to change and, yes, there were people 10 Whether we had boom or bust or stop-go, it was a years ago, indeed there were some rather more Processed: 26-03-2009 00:31:08 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG17

Ev 380 Treasury Committee: Evidence

19 March 2009 Rt Hon Alistair Darling, MP, Mr Dave Ramsden, Mr Tom Scholar and Mr Nikhil Rathi recently I can remember, who were arguing for Mr Darling: I think what will help all of us, and further deregulation or what you might call light importantly the people of this country, is if we put touch. That has not been my view. forward measures that will strengthen and improve our regulatory regime and measures that will help us get through this downturn and through to recovery Q2898 Mr Tyrie: Yes and one of them was the as quickly as possible, and that is what I propose to Chancellor of the Exchequer in his Mansion House do, both at the Budget and at the time when I publish speech in 2006 when he said that he wanted an the White Paper. “enhanced light-touch regulatory environment”. You have not really been prepared to say that this regulatory system is fundamentally wrong, but some Q2901 Mr Mudie: I think you lead us to an of your ministerial colleagues have. Do you disagree interesting point which is when Lord Turner came in with Lord Mandelson when he said: “What we got front of us he said that what he was going to have in wrong was the regulatory system we put in place in this report would be revolutionary. It has not proved this country”? to be the case. Hector said he would be Mr Darling: No. “frightening”. I have not met anybody who is frightened of Hector. They all talk tough but when it comes to the crunch they do not seem to be. One of Q2899 Mr Tyrie: Is the answer to that no as well? the things you said to Nick and Mark was that you Mr Darling: I do not think that represents the had two objectives: get the banks back lending; and complete view that Lord Mandelson holds because I get government money back. Is there not a third have spoken to him about this on a number of thing, and that is what Mark, and Nick to some occasions. As I said earlier, I think the decision that extent was pressing on remuneration, which is do we we took to set up the FSA and to end self-regulation, want the same sort of banks back operating in the which was a manifest failure, and to get rid of a V same way but just with tougher regulators, or do we situation where we had seven or eight di erent want to put our imprint on the banks, not only on regulators, and to bring them together, was remuneration above all on transparency, which absolutely right. That system dealt with many of the would have helped to avoid what we went through? problems we had in the 1980s and 1990s and it put Do we want that or is it just a question of let us get them right. It is common ground that during the through this crisis and then we all forget about it? course of this decade there were a number of They tough words were to please the public whilst problems that arose. As Adair Turner rightly they were going through the hard times, but now we recognises, some of them were big, global problems, are all friends together? such as flows of credit. There were some problems in Mr Darling: No, I do not think that you can go back relation to the views that the regulators took, the to what you might describe as business as usual. As I attitude they struck, and we saw it in Northern Rock have said, the regulatory regime/supervisory regime for example where the FSA recognised that it had does need to be strengthened. We need to recognise slipped up, and clearly there are things that we need where there were weaknesses in the system and we to learn from that. Again the point is okay, what do need to deal with them. To some extent, we have we do about it? There are serious arguments to be talked about that earlier this afternoon. Inevitably, had here as to the right balance where you let people banking is about risk, it is about management of run their businesses, if you like, and where the risk, and it is the management of risk and the regulators have got a quite legitimate interest to say, management side of it in particular that we need to “That model is too risky,” or “You are lending too be concentrating on. That need to change. Banking much,” or, “Your bonus structure, your payment has been with us for hundreds and hundreds of years structure is skewing behaviour.” That is a real issue in one shape or form. which we need to explore and we need to get it right and we need to get it right quickly. Q2902 Mr Mudie: But not in this form. Mr Darling: It is far more extensive and far more Q2900 Mr Tyrie: You are producing a White Paper extended now than it was, but the essential principles in a week. One last point: do you not think that it will of banking have been the same for some time. The help with the credibility of what you say about how key thing, though, is to make sure that we manage to sort this out—and I agree with you that that is the risk and make sure that people actually where the emphasis has to be—if the Government understand the risks to which they have become shows a much greater degree of candour, starting exposed. That means dealing with a whole host of with the Prime Minister, about the scale of the problems, many of which you have just mentioned. mistakes, which are absolutely gigantic and which go to the heart of the whole regulatory regime that we have had in this country, and which were Q2903 Mr Mudie: But to understand the risk you vigorously fuelled by the now Prime Minister, then have got to have the knowledge. You have just said Chancellor of the Exchequer, in four successive that the regulators will have to look at things much Mansion House speeches. In 2004 he said: “I want to more closely. Do you really mean that, Chancellor, do even more to encourage the risk takers.” He is so that you expect the regulators to be more intrusive, up to his ears in this. Do you not think it will help the to be in their face, to be in their premises, to be like Government’s credibility if a more concrete the SEC or the IRS in the States which take no admission is made of the scale of the mistakes? prisoners and have a job to do? Do you really mean Processed: 26-03-2009 00:31:08 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG17

Treasury Committee: Evidence Ev 381

19 March 2009 Rt Hon Alistair Darling, MP, Mr Dave Ramsden, Mr Tom Scholar and Mr Nikhil Rathi that or is this just tough talk, like Lord Turner, a more intrusive, to be even “frightening” with revolutionary last week and a gentle liberal this Barclays and actually be down at Canary Wharf week? finding out what on earth is going on? Mr Darling: I would be wary about saying that the Mr Darling: The FSA’s job is to supervise Barclays, American system sorted everything out because I as you know, and it is doing a diVerent job to HMRC think there is some view that it did not, and I think whose job it is to make sure that money that is due the Americans themselves recognise that it needs to to government through taxes is actually collected. be changed. Indeed, I think it is the present As you know, I cannot discuss individual taxpayers, administration’s policy still to bring together their individuals or corporate— regulators rather in the way that we have done it. As I said to you, and I used my words deliberately, I Q2909 Mr Mudie: That is the cop-out that HMRC think the supervisory system does need to ask more have and that is why we are in this situation where questions and it does need to be more intrusive. you do not know what is going on Chancellor, Those are my words and I think that is appropriate. Barclays’ profits come from that unit. This is what In relation to Lord Turner’s Report, I do think in has happened and this is where we are. The banks terms of analysis and in terms of many of the areas were making so much money that nobody felt able where he identifies we need to take action, that is to or wanted to question how they were making that. quite a sound basis. You yourselves collectively may Mr Darling: If you let me get a word in. come up with other things which we will want to look at. Q2910 Mr Mudie: I will. Mr Darling: HMRC’s job is to collect taxes and Q2904 Mr Mudie: I just found it strange right from HMRC has got powers and it has the law to back it the start that we asked the head of a regulatory body up, but its job is to make sure that anything that is that failed to do a review. Maybe that accounts for due to the Exchequer is collected for the Exchequer. him putting on 280 staV at £80 million additional My preamble to what I was about to say was I cost before his report is out because he is writing cannot discuss individual taxpayers’ aVairs because the report. it would really be very wrong for ministers to do that. Mr Darling: I appointed Adair Turner last October, so he was new to the FSA, and I asked him to Q2911 Mr Mudie: Yes. conduct a review. The White Paper when it comes Mr Darling: But in relation to this over a number of will be the Government’s view. years where we have seen loopholes that can be closed we have closed them and we will continue to Q2905 Mr Mudie: That is going to be very quickly, do that. In relation to making sure that money owed is it not? is paid to us, that is what HMRC is there to do. Mr Darling: It is going to be about the time of the Budget. Q2912 Mr Mudie: That is not good enough. HMRC have proved over the years, they have even admitted, Q2906 Mr Mudie: I hope that you will join me in in fact the senior tax lad, ex-HMRC in The Guardian congratulating The Guardian on its run of articles on said, “They don’t tell us anything. They don’t tax avoidance. Have you been reading The Guardian volunteer anything. They gave us as little recently? You are looking puzzled. information as they could but if we persisted they Mr Darling: IdoreadThe Guardian. sent vanloads of papers to us and we couldn’t handle it.” That is how we are regulating and taxing the big Q2907 Mr Mudie: And you would join me in corporations and they are taking advantage of it. congratulating them because in the present state of When you are in this room saying you are in favour the media to put resources like this into this of stronger regulation, dealing with transparency, subject— and we raise the situation in Barclays, you will not Mr Darling: I am sure you will get a mention in The congratulate The Guardian for making it public Guardian, George! (which I think is commendable). The only time it has happened before was in America and you got double-dipping stopped because of a series of press Q2908 Mr Mudie: I am not after that. Because they articles. The Guardian do the same here and you pointed out in their articles that we are losing cannot raise yourself to congratulate them, even between £4 billion and £14 billion of tax from thank them. You are saying you are going to regulate companies that should be paying tax. You can hard but you do not think that you can intrude into challenge that, but they pointed out and proved the Barclays’ aVairs. lack of transparency that allows this to happen. To Mr Darling: Come on, I did not say anything of bring it home, this week has been about Barclays and the sort. this unit headed by a lad who will not go on the board because that would mean that he would have tell the public his salary and it is reputed to be Q2913 Mr Mudie: Are you going to? between £40 and £75 million a year. What is he doing Mr Darling: HMRC’s job is to make sure— for that and what is Barclays doing? The Guardian raises the question, and I think it is a good question, Q2914 Mr Mudie: No, I am speaking about the have you asked HMRC or the FSA to actually be regulator. Processed: 26-03-2009 00:31:08 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG17

Ev 382 Treasury Committee: Evidence

19 March 2009 Rt Hon Alistair Darling, MP, Mr Dave Ramsden, Mr Tom Scholar and Mr Nikhil Rathi

Mr Darling: Let me answer the question. Q2925 Mr Mudie: You cannot smear The Guardian and not back it up. They had the courage to print it. Q2915 Mr Mudie: I am asking you about the Mr Darling: All I am saying to you is that HMRC do regulator, Chancellor. We are speaking about have powers to investigate these things. If they think regulation, we are speaking about transparency. they have insuYcient powers I will happily look at Mr Darling: You seem to be talking about both. giving them more, which will have to be agreed by Parliament at the end of the day, but it is important, Q2916 Mr Mudie: You said to us that you are going and you would expect the Chancellor to be to be tougher. Tell us how that demonstrates extremely interested in collecting every single penny toughness? that is due to us, especially at the present time. Mr Darling: There are two separate issues. I said that I thought the regulators, the FSA in this case, needed to be asking more searching questions and that it Q2926 Mr Mudie: Chancellor, have you asked the needed to be more intrusive. The second issue you HMRC about the articles and about their powers raised is in relation to the tax aVairs of companies. and whether they need any additional powers? If you The HMRC, equally, if it is not getting the answers are so hard up for tax and these companies are not it wants or has not got the information it wants, it paying tax, if I were in your shoes I would want to needs to be intrusive too. If it has not got the power know what the hell they were doing not to pay tax. to do that or if we need to change the law then, as we Mr Darling: I have many discussions with the have done in the past, we will do it again in the HMRC about a whole range of matters. future. Q2927 Chairman: Chancellor, there is an issue here Q2917 Mr Mudie: You are going to do a Code of in terms of the complexity of annual accounts. We Practice? had the chief auditor of KPMG in and when I asked Mr Darling: Indeed. him if he could look at HSBC’s annual accounts, over 500 pages, study it for the night and understand Q2918 Mr Mudie: Will that strengthen the powers of it, he said no. There are lots of things hidden here the FSA to actually— and there is a real need to get transparency into these Mr Darling: That is HMRC not the FSA. accounts. Maybe that is one issue that you could take back from this Committee. Q2919 Mr Mudie: So are they going to enforce it? Mr Darling: I think it is a fair point and one which This is not an FSA enforcement? has exercised successive governments. It was last Mr Darling: Look at what I said on Monday, I was debated when the Companies Act of 2006 was going talking about HMRC not the FSA in regard to the through the House, when at that time, of course, Code of Practice. many people were saying that we should not be having that degree of openness, but it is something Q2920 Mr Mudie: This is a diVerent Code of which obviously we need to look at. Practice, this was dealing with tax? Chairman: Fair enough. Andy? Mr Darling: Tax, which is HMRC.

Q2921 Mr Mudie: So they are going to enforce it? Q2928 Mr Love: Chancellor, as part of our inquiry Mr Darling: Yes. we visited Belfast and Edinburgh, your home city, and Halifax. One of the messages that came out Q2922 Mr Mudie: Are you going to give them any clearly from the public meetings that we had was the additional powers? Did they ask for any additional widespread belief that those responsible for this powers? banking crisis have been treated somewhat Mr Darling: If they need additional powers then we diVerently from everybody else, many of the people will make sure they have them. in these cities having been directly aVected by this. We tried to answer that question. What is your Q2923 Mr Mudie: Chancellor, The Guardian went answer to it? through company after company that is not paying Mr Darling: I think you will find throughout the any tax because they are moving money about so country, and not just in places where these banks quickly in so many countries. You have got the operated, yes, not just people who work for the examples. The Guardian has done it. Day after day banks but other people as well, are very angry at after day the HMRC obviously cannot handle it. what has happened, and that is entirely They obviously either do not have the will or they understandable. I think, too, they recognise that it need more powers. Did they ask you for more was necessary for us to take action to stop people powers? losing money and to stop the banking system from Mr Darling: You are making a number of allegations collapsing, because that would have hurt everyone in and you are referring to a number of things that the country and not just some. As I said, again, we appeared in the newspaper. need to make sure that we deal with these problems and that we make sure that we try reduce that risk in Q2924 Mr Mudie: So The Guardian is wrong? the future, and certainly in terms of excessive Mr Darling: I am not passing any judgment on what behaviour, as I have said before, there needs to be a is in the Guardian. culture change. Processed: 26-03-2009 00:31:08 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG17

Treasury Committee: Evidence Ev 383

19 March 2009 Rt Hon Alistair Darling, MP, Mr Dave Ramsden, Mr Tom Scholar and Mr Nikhil Rathi

Q2929 Mr Love: Do you think you could have “paradox of policy”, which is that in the longer term assisted that culture change if perhaps you had we need people to save more, for obvious reasons, spoken out more critically about what has happened but in the short term we need them to continue to and who was responsible for it? consume. How do we get that complicated message Mr Darling: Certainly over the last couple of years I across and how do we persuade them that the time have been very critical about what was happening in has come when saving needs to start? the banking system. Certainly my experience—and, Mr Darling: At the moment we are putting a lot of as you rightly say, I represent one of the Edinburgh money into the economy one way or another. Low constituencies and I probably represent more people interest rates, for example, will help an awful lot of than many who work for both RBS and HBOS—is individuals. However, in the longer term you do need that my constituents are angry about what has to encourage people to save. Mervyn King is quite happened, but they are much more keen that we right, there is a paradox here, just as there is a should try and sort these problems out as quickly as paradox in saying strengthen the banks’ balance possible. They are also very keen that the sheets and lend more. I think what is necessary at the Government should continue to do what it can to moment, both in terms of the banking system and in help them and their families to get through this terms of supporting spending, is it is necessary for us recession, and that is very important too. to do everything we can to get the economy through the recession because if we do not do that then it is Q2930 Mr Love: Should we have been more robust going to be longer and far more painful than about what we expect from those responsible for the otherwise would be the case. That is why it is banking crisis? I am thinking about the contrast that important that we do keep up with things and put has been drawn between what has been said in the money into the economy. The basic rate of tax will United States and what has been said in this come down for basic rate taxpayers from 1 April. We country? Most of that contrast, interestingly, are increasing the amount of money going to families between Parliament and Congress rather than and to pensioners. We are bringing forward between Governments. A lot of people say that the infrastructure projects which will support further Americans are far more robust in saying what it is jobs. These things are very, very important. That is V that the people responsible ought to do to put it actually what will make a di erence to people. As I right. Do you think there is more that we could have say, it will take time to work its way through but it is done there? necessary to do that. Mr Darling: My own view is that people are more interested in not what you say but what you Q2933 Mr Love: Let me take you to another actually do. paradox, in a sense, and that is we are asking, and the Government has very specifically asked, that they Q2931 Mr Love: Do you think there is more that we maintain lending levels at 2007 levels. could have done to indicate that we were on the side Mr Darling: That is the banks we have re- of the public? We have talked a lot about the need to capitalised, yes. maintain mortgages, the need to provide money for small businesses, to maintain employment, but do Q2934 Mr Love: The banks you have re-capitalised, you think those messages have got through? People yes, and that message has gone out more widely, yet do seem to think that we are favouring those all those banks and indeed the industry itself are responsible rather than doing what is necessary. saying that they do not want to go back to those sort What more could we do? of levels of irresponsible lending. What do we settle Mr Darling: Gauging these things can sometimes be for? diYcult, but certainly from my own experience as a Mr Darling: There are two diVerent issues there. constituency MP I think people recognise that this Firstly, in relation to the banks which we have re- problem is a global one. They recognise that there capitalised, which are basically Lloyds and RBS, the are lessons to be learned. They recognise that at a same ones which have the lending agreements, we time like this when people are worried about losing wanted them to increase the level of lending and we their jobs, that governments should do everything have quite detailed agreements with RBS and with they can to help people who do lose their jobs, but the Lloyds Group, but I do not think anybody that they should also take steps to make sure that thought, “By extension you therefore lend willy-nilly they help families, whether it is through business whatever the risk is”. One of the many lessons to be support, through the various tax measures that I learnt over the last few years is that perhaps people have announced. What people want to know is what did get money in terms of lending which they could you are going to do, and that is why I think it is not pay back and therefore the asset on which the important that governments make it clear they are lending was secured simply was not worth what prepared to do something, they are prepared to act people thought it was. So we do need more prudent and not just stand back and let the recession take its lending. I have to say in some ways it is simplified toll. If that is the point you are getting at, I agree good, old fashioned lending; that we understand to with you. what it is you become exposed.

Q2932 Mr Love: Let me take you to one particular Q2935 Mr Love: Clearly from the evidence and the issue that was highlighted to us by the Governor of monitoring you are undertaking, those banks we the Bank of England when he came. He called it the have substantial shareholdings in appear to be Processed: 26-03-2009 00:31:08 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG17

Ev 384 Treasury Committee: Evidence

19 March 2009 Rt Hon Alistair Darling, MP, Mr Dave Ramsden, Mr Tom Scholar and Mr Nikhil Rathi lending not just at the levels but indeed they have with—I think it is—the Department of Trade and increased in some cases where that has been Industry or the DTI in Northern Ireland, obviously requested, however there is a huge gap in the market; if it were a bank, then it should have been reported as all the foreign banks have disappeared, the such and it would have been regulated by the FSA. I securitisations which used to take place have come think we need to get to the bottom of that and to find to an end. How do we ensure that we increase out what the problems are. I hope that can be done lending to a suYcient extent to take up that slack as quickly as possible consistent with ascertaining where foreign banks have disappeared and the facts. I am very aware of this; I know it is causing securitisation is no longer available? a lot of concern in Northern Ireland. Mr Darling: Again, it is not a standard situation, since the ratio of supply and demand will be Q2937 John Mann: Chancellor, you have told us changing throughout that period but we have got several times, “I will do whatever is necessary”. You lending agreements. The hope of the RBS was to get give the Department for Communities and Local more lending and other banks may come in. Other Government hundreds of millions of pounds for the banks, for example HSBC, have increased their Local Economic Business Growth Initiative money, lending although it is not in any of the government and that money sits in local authorities—several schemes. The more complex question is, how do you hundred million pounds are sat today unused in get back, say,the securitised lending? The one thing I local authorities—and they can spend it on would say is that if it comes back, it needs to be more anything. One I know is spending it on job tightly controlled than it was in the past. In the Pre- evaluation in its next year’s budget. You could Budget Report I said we were looking at an asset- change that today and have that money made backed scheme which might help there, although at available this week for local businesses across the the present time, since more banks are using the country, particularly small businesses, which would credit guarantee scheme, the absence of the make a big impact. additional funding which will come is perhaps not as Mr Darling: Like all these things, we continue to acute as it might have been, but we will still press look at them and if and when we change our policy ahead on that. The more diYcult one is the Icelandic then I will make the appropriate announcement. I banks have gone, the Irish banks have scaled back would be interested in looking at the particular thing what they are doing, and indeed if you have a you raise. conversation with any finance minister in any of the big economies they all say, “The problem is the Q2938 John Mann: That is another government foreign banks have gone away” because some of our department’s policy of not making the local banks have taken their money out of Germany, for authorities use it, you could in reality override them. example. This is a problem. It is where you get into It is all hands to the pump. the unintended eVects of encouraging lending in Mr Darling: Whatever a department is doing, it is all your own home state. It is something we discussed at part of the same Government. the weekend, and it is something we have to be very, very careful about, because it could have a very Q2939 John Mann: So you will take that back— unintended and perverse consequence. Mr Darling: It is a collective policy.

Q2936 Chairman: Chancellor, Andy mentioned Q2940 John Mann: You will take that back and look about the Committee going to Belfast, Edinburgh, et at that? cetera, when we were in Belfast we were told about Mr Darling: I would be interested in the example you the serious hardships people were facing with the raise with me. Presbyterian Mutual Society, indeed the Moderator of the Presbyterian Church wants to meet me to Q2941 John Mann: On job centres, decisions were further press that case next week. We accept that made by your department about where they should regulation is a devolved issue but what message can I be at times when unemployment had been falling give him that the Government is taking this seriously and repeatedly falling, we are now in new times. Will which can give confidence that the savers there who you take that back and reconsider the find themselves out of pocket, not as a result of any reconfiguration of where those giving advice to the actions they have taken, could be re-compensated unemployed are based and will actually be in those once the various legal issues relating to the Society areas that are seeing people moving— are resolved? Mr Darling: You are talking about the configuration Mr Darling: I have a great deal of sympathy with of Job Centre Plus, the network? many people who put their money into what was thought to be an industrial provident society and are Q2942 John Mann: Yes. in a situation where they are extremely worried Mr Darling: I have no doubt you raised that with about their savings. As you know, the Financial James Purnell, the Secretary of State. I do think I Services Authority is carrying out an investigation should make the general observation that bringing into seeing whether or not this institution at some the Employment Service and the old Benefits stage became a bank in terms of taking deposits and Agency together was a very good step. I also think making lending. I think they do need to conduct that the fact we have spent very substantial sums on that investigation. If it was an industrial provident to make Job Centres the place where you can go society, as I understand it, it would be registered rather than the terrible places some of them were in Processed: 26-03-2009 00:31:08 Page Layout: COENEW [O] PPSysB Job: 416782 Unit: PG17

Treasury Committee: Evidence Ev 385

19 March 2009 Rt Hon Alistair Darling, MP, Mr Dave Ramsden, Mr Tom Scholar and Mr Nikhil Rathi the 1970s and 1980s and even the 1990s, that was the reluctance of the FSA to get stuck in on the money well spent. But in relation to actually where micro-examples which influence the behaviour of the the oYces are, obviously you will have taken that up financial bodies? with James Purnell but, if you have not, if you have Mr Darling: There are two things you need to do. particular concerns I will take it up with him. One is you need to make sure there is suYcient, if you like, micro-prudential supervision; suYcient Q2943 John Mann: I have but I am happy to hear supervision of the overall risk to which a bank or you will as well. Excellent. building society is exposed, to look at all the things Mr Darling: On a day-to-day basis he actually runs which drive those risks and underpin those risks. the Job Centre Plus. I have not done so for some There is a separate issue in relation to what you time. might loosely call “conduct of business”, more micro-management if you like, which Adair Turner Q2944 John Mann: In terms of the Halifax, will you addresses in the fourth part of his report. He does consider remutualising the Halifax Building Society? not come to conclusions; he calls them issues for Mr Darling: It does not exist at the moment. As you discussion. If you take, for example, the sale of know, it is part of the Lloyds Group. The Lloyds mortgages, one of the reasons that the American Group are working on how they intend to structure sub-prime market problems arose is that their their operations in the future. Although we do have market was very much less regulated than ours was, a 65% shareholding in the Lloyds Group, the Halifax and even at that time in 2005 there were people is not really a distinguishable part. calling for less regulation of mortgages here because they said it would only aVect the institutions and not the individuals, which I think was plain daft as we Q2945 John Mann: At the moment but, would you can now see. The point you make about individuals agree with me, that the confidence that would give in who take out a loan, a mortgage say, and then take the High Street, seeing the Halifax Building Society out a second mortgage, then maybe get something recreated, while only one small part of a solution, secured on the house because of personal loans and would boost consumer confidence in Government so on, that is precisely what you want to avoid, but, more important, in the banking sector? where somebody just gets more and more into debt Mr Darling: I think there is a general debate to be and takes far more than they can ever repay and we had as to whether or not we will see the return of really have to stop that. That is why I do think the large mutuals. As you know, every single conduct of business rules, if you like the more micro- demutualised building society has either been taken management side of things, is equally important. over or has failed, and the question is whether or not Striking the right balance between the two is always there are mutual bodies in the future. The Halifax going to be a matter for debate. I think all the was a very big one. Apart from the Nationwide, evidence we have had, particularly looking at what which is a very substantial organisation, most happened in America where there just simply was mutuals are fairly small. There have been one or two not that supervision, is that there are disastrous mutuals which have been taken over because of the consequences. current circumstances. I think mutuals are very good, whether or not it is right for a particular institution is something we would need to reflect on, Q2947 Chairman: Chancellor, I just want to finalise but I think there will be a debate as to whether or not on the Icelandic situation with a couple of questions. the re-introduction of mutuals is a good thing and it To what extent do you think the actions of the UK could be that you see them. In relation to specific Government, both by using the anti-terror institutions, I am not in a position to say it would legislation and making public statements, increased definitely happen or not. pressure on the remaining Icelandic bank, Kaupthing, which the Icelandic authorities Q2946 John Mann: Lord Turner’s Review gives themselves seemed to believe could survive? macro-interventions and lots of them in terms of Mr Darling: I just think anyone looking objectively regulation, rather than the Law Society’s model of at the Icelandic banks would find it diYcult to come regulation which is micro-interventions. You to that conclusion. Indeed the present Icelandic comment on Lord Turner’s Review next week so I do Government takes a slightly diVerent view from the not want you to do that now, but on the question of previous Icelandic Government, with which we were mortgages, he is suggesting some macro-powers in dealing last year. The thing that triggered the failure relation to what the overall system should be. He of these banks is that the FSA came to the raises as well the question of second charges on conclusion they did not meet the threshold mortgages, what he does not do—and every single conditions and, as you know, this is a responsibility case I see does do this—is look at multiple unsecured of the FSA, it has to decide whether or not an loans which in fact are the trigger to the problems of institution can carry on trading. If you take repossessions. That requires not looking at the Landsbanki, which is the bank which we attached products which are individual decisions for the FSA, the order against, the chronology was that the FSA and he wants more of, but looking at the behaviour said it could not carry on, I took action really to which has led to a person being so geared that in protect people in this country because I did not want essence they cannot balance credit, debit cards, to find that the assets which were here were being unsecured loans and a mortgage. Will you look at shipped back to Iceland, especially when at the time, this balance between those micro-interventions and following a conversation I had with the then finance Processed: 26-03-2009 00:31:08 Page Layout: COENEW [E] PPSysB Job: 416782 Unit: PG17

Ev 386 Treasury Committee: Evidence

19 March 2009 Rt Hon Alistair Darling, MP, Mr Dave Ramsden, Mr Tom Scholar and Mr Nikhil Rathi minister, we suggested Iceland was at that time Q2949 Chairman: Have you discussed with the trying to do something for its own Icelandic relevant authorities in the Isle of Man and Guernsey depositors it was not able to do for British whether the UK Government could provide a loan depositors, which is why we have had to underwrite to ensure the rapid payment of aVected depositors, them. As for the legislation concerned, it is a piece of even if only to £50,000? legislation which deals with anti-terrorism but Mr Darling: I would need to check, Mr McFall, but actually it is designed to deal with a situation where I am not sure that a request of that nature has been there would be an economic harm done to the made to us. I am not saying it may not have been country, and that is why I did it. If I had not done it, discussed at some level but certainly I do not the question which would have been asked is, “How recollect any request being made of such a nature come you allowed all this money to be taken out?” that we would treat as a formal request. If you think There is another issue to be raised too, which again that is material to your enquiries, I will need to come back to you. Turner touches on, and that is this business of allowing people from outside the EEA to passport Q2950 Chairman: That is a reasonable answer. The themselves into the European Union without us last point is the old moral hazard issue. Bailing out being able to have some control over the regulation, banks and ensuring no depositor has lost a penny of and that has to stop. their savings has been the aim of the Government, but in that process the cherished concept of moral hazard has been left to wither away. I imagine you Q2948 Chairman: Under the rules of the European regret that as Chancellor but, if you do, how Economic Area, is there any legal requirement for important is it that we have the restoration of moral the Icelandic Government to compensate British hazard as a functioning market discipline in bringing depositors to the same degree they are compensating about the reasonable financial discipline that we Icelandic depositors? would all like to see? Mr Darling: We think they have obligations. The Mr Darling: I think it is important. You cannot have view of the previous Icelandic Government was that a situation where basically there is no risk for you. If they were not certain about that. We have tried to you are a bank, there has to be a situation where, if engage with the present Icelandic Government and there is a reward, there has to be a penalty if you fail. they have shown themselves to be willing to talk to That is what went pretty badly wrong in a lot of the us about trying to resolve these things. The tragedy banking system. In relation to savers, for perfectly here is that we have had to use our British taxpayers’ obvious reasons in the current climate I think it is necessary to make it very clear to savers we will do money to support UK investors in these UK everything we can to look after their savings. If we branches, and we should not have been exposed to a did not do that, the situation would be very, very situation where you have an EEA member who can diYcult. I think most developed countries are in that come and set up here without the safeguards you same position. would expect. What really brought down the Icelandic banks was not anything we did here but, as Q2951 Chairman: Okay. We said we would let you is self-evident from an examination of what away by a quarter past three, we are two minutes to happened at those banks in Iceland, the problems the good. Thank you very much for your time. were, I am afraid, as ever home grown. Mr Darling: Thank you very much.

Printed in the United Kingdom by The Stationery OYce Limited 4/2009 416782 19585