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I welcome everyone to the 30th meeting of the Economy, Energy and Tourism Committee in 2009, in the slightly unfamiliar surroundings of committee room 4—we are not usually allowed into this one.
Perfect. If I may, I would like to state in a few words what we have been doing, why we have been doing it and what the outlook is going to be, with a special emphasis on Scotland, because I suppose that that will be most interesting to you here.
Thank you. That is a helpful introduction.
The Commission does not impose anything in relation to how the plan looks in detail; the member state would come to us with a proposal. The parameters have been set out clearly. We look very closely into the business models of the banks, their balance sheets and where the problem has come from to assess whether the plan that has been put on our table addresses our concerns about their long-term viability. We want to know whether the entity that will come out in the end is an entity that will be able to survive and operate in the market without state support.
The Commission does not hold bilateral talks directly with the banks—your discussions are with the banks alongside the member state.
Our interlocutor is normally the member state, which chooses whom to take along. In the case of the UK, the banks always come along; in other cases, only the treasury and, sometimes, the national bank come along. The member states are our official interlocutors but, because member state representatives do not always know in detail how a bank is structured, it makes sense to have the experts there as well.
So the proposals that were announced on 3 November had been through a number of negotiations between the Commission, the member state and the banks before they were finalised. Were they very different from or roughly in line with the initial proposals by the member state?
It is clear that it is the prerogative of the college of commissioners to make the final decision. The Commissioner for Competition alone does not have that power—it is a collegial decision. That is why we must add the caveat that all announcements are conditional on the college's final approval. On 3 November, it was clear that the cornerstones of the agreement were fairly fixed, but there is always the odd detail to be settled. Although the announcements were made, were clear and were negotiated with us, the odd i may need to be dotted before the college makes its final decision.
You mentioned that it will be announced today that the college of commissioners has approved the proposals relating to Lloyds Banking Group but that the proposals for RBS are still under discussion. What issues are still being considered in relation to RBS? When do you expect an announcement to be made?
The discussions relate to the complexity of RBS, which has been part of the asset protection scheme and has, therefore, received asset relief, which Lloyds has not. The valuation of impaired assets is extremely complicated. We have had to ensure that the price that was paid for the APS is okay. It is merely a timing issue—it was not possible to finish that work at the same time as the work on Lloyds Banking Group.
It has been reported that the chief executive of RBS, Stephen Hester, has said that the disposal of Williams & Glyn's was uncontroversial and that he understood the arguments for increasing competition on the high street, but that the other disposals—its insurance interests, for example—were
We look at various elements in considering a restructuring plan, one of which is the organisation's viability. We ask the bank to shed all the areas that have been part of the problem. Another element is the impact on or distortion of competition. If a bank is asked to divest something in its core market where it has a strong market position, that would come under that heading.
In the case of RBS, is there a conflict between having to pay back money as soon as possible and thinking about a business that is broad based?
Being broad based and being viable are two different things. Part of RBS's problem is that it had a very expansionary policy. Sometimes, its decisions to buy companies in Europe might not have been the wisest. Perhaps its decision to expand away from its core business model into other areas might not have been the wisest decision. Would not it be better to get back to the core of the business, concentrate on that and do what one can do best?
Did not the problem arise in investment banking rather than in insurance?
Investment, especially in the United States, is clearly an issue and we are considering it. We are not saying that the problem arose in insurance—that would then have to come under the competition distortion heading; we are saying that we want the bank to pay back money. We are talking about around €45 billion of recapitalisation and around €200 billion or €300 billion of asset relief. That is an enormous sum—indeed, it represents the biggest amount of state aid in the whole crisis in Europe—and it is fair that a certain price is paid for it.
You are attempting to create payback for the banks as the price for gaining viability. When does the European Commission cease to be involved? When does the bank come off the books at the directorate-general for competition?
It will come off once the restructuring is finalised. I hope that we will have the final decision on Lloyds today and the final decision on RBS in the not-too-distant future. A number of commitments will be written into that decision. A technical issue is involved in that we have two procedural possibilities. If we open proceedings formally, we can have a conditional final decision: we can say that we think that something must be done and that if you do not do it we will come after you again. If we do not open proceedings formally, we must ensure that the final decision is unconditional, so that all the necessary commitments come from the member state.
So we can safely say that you will be involved until the companies come off state aid?
Yes.
You have been very helpful in sharing with us the rationale for the requirement to dispose of the insurance operations of RBS. If I understand you correctly, that would fall into the area of burden sharing.
Yes.
Great. In that context, you said that you were keeping RBS's United States assets under review. Can you expand on that?
The problem is that the case is still running, so I cannot go into the detail of the various divestments or beyond what has been in the press. I am sorry about that.
Let me approach the same issue at a strategic level. We are trying to get an understanding of the EU's strategic vision for banking. I note that the European Commissioner for Competition, speaking recently in Amsterdam, said that the European Commission was
It is important to make the point that the Commission is neutral in a number of respects. We are neutral in respect of ownership. It does not matter in the end if a bank is owned by the state behaving like a market investor or privately, as long as no undue state resources are used and decisions are made on economic and not political terms—although that is more of a German problem.
You may not have an implicit business model in your head for banking, but we are trying to understand the rationale for the choices that you have made. It is clear that you are tilting RBS in a certain direction. You could have chosen action on insurance, as you did; action on the bank's US assets; or action on its investment banking operations. Because of the scale of the public resources that are involved in the institution—the public holds 84 per cent of shares and has an economic interest of 70 per cent in RBS—I want to understand your rationale for trying to tilt the burden-sharing element in a certain direction. What is shaping your thinking about those choices now and in the future?
It is difficult to look at the three elements that I have enumerated. If there is already a huge divestment for viability reasons and it brings in money that could help with burden sharing, that may have an impact on how big the burden-sharing element must be. However, you cannot sell one element twice.
Indeed. You suggest that the burden sharing that has emerged was agreed in dialogue with the member state and RBS. In advance of the announcement on 3 November, there was much speculation, with the bank saying that there was a red line around its US assets. The burden sharing that has emerged is on the insurance assets, not the US assets—or at least not most of them. Was the burden-sharing element agreed in dialogue?
The decision is not out yet, so we are speculating a little.
Sure, but does the proposal represent the burden sharing with which the member state was most comfortable?
All we have is an RBS press release. We have to put the issue into perspective. We are not going up front with anything concrete before we have the decision, so we have to wait for the decision. However, to answer your question, we are in negotiation with the member state, with the bank present, and we will have to come to an agreement. Because the decision will have to be unconditional, all the restructuring commitments will have to be spelled out clearly by the UK Government and accepted by us in our final decision. I do not know exactly what you want to find out. Is it the negotiation part that you are worried about?
I just want to know whether the disposals were agreed in dialogue. It is reported in the media that RBS is unhappy with the disposals, but you tell us that they were agreed in dialogue and they were the best of the options on burden sharing. I am trying to understand that.
I can imagine that the bank is unhappy, as are all the banks that are subject to forced downsizing after all the aid that they have received, and I can understand why RBS tells you that it is unhappy. However, we have to put that into the context of the amount of aid that it has received. To be coherent, not only within the UK but within Europe, we must have a consistent policy and equal treatment across all the cases—and there are quite a few. That is why negotiations take longer in some cases than in others.
I have two quick questions on unrelated matters. First, you made it clear that the interlocutor is the member state. The Scottish Government made no representations of any kind to the European Commissioner for Competition on the matter, and it said that it had not done so because you had not opened a formal investigation. If you had received representations from the Scottish Government, would they have been heard or listened to?
We receive both formal and informal letters, complaints and representations, and we take that all into consideration. The issue with informal procedure is that there is always room for parties to appeal if they think that the procedure was not right. I am not suggesting that you do that, but it is open to you. Our normal interlocutor is the Government of the member state concerned, which can choose who it draws into the talks with us. However, evidently, we would consider with interest any representation that a third party makes or any information that it provides. I am not saying that we would not look at it.
An issue that has emerged is the conditions that the EU might want to attach, albeit via the member state, in respect of to whom the assets can be disposed. As you know, there has been some discussion about the issue, particularly with respect to RBS. What conditions have been specified about who will be able to bid for the assets? How have those conditions evolved? There is some concern that the conditions have changed, so it would be helpful if you could take us through them.
Again, I cannot really talk about something that has not been finalised, but our aim in respect of all those aspects is that we do not want an outcome that is less competitive than before.
It may be helpful if you can write to us on where things stand on that.
That concentration is not the result of the Commission's action—we would not want it to be there. One reason why we wanted to look for a divestment that is sufficiently attractive to get new entrants into the market is to address that issue and to have a new competitor enter this very concentrated market.
I put it to you—others may wish to pursue the issue—that the evidence does not demonstrate that the divestment of Williams & Glyn's branches south of the border or, indeed, Lloyds TSB branches north of the border, will tackle the concentration in small business banking in the Scottish market. That issue has puzzled some observers in this marketplace when they have examined the divestment strategy.
I note that, and I understand completely where you are coming from, but what we can do is always limited, too.
I seek final clarification of the point about competition in the market. What level of market does the Commission consider—is it Europe-wide, national or sub-national? Would you consider the market in Europe, the UK or Scotland?
The level is national.
It is UK-wide.
The Lloyds and HBOS merger did not fall within our jurisdiction because the two-thirds rule applied—two thirds of their turnover was in the UK market, so the merger did not fall within our jurisdiction.
So the lack of competition in the SME market in Scotland is not a consideration for the European Commission because the market is not sufficiently large.
Oh—is that what your question was about? I am sorry; I misunderstood.
Sub-national market.
Thank you—I did not know what term I should use. I must be politically correct.
We have received written evidence from the Confederation of British Industry Scotland that said:
First and foremost, our concern is the bank's long-term viability. Otherwise, it will quickly have to request further state support. We must ensure that the outcome is that the bank can stand on its own feet in adverse economic conditions and compete without state aid.
In the case of RBS, its insurance businesses were, and still are, successful and profitable. Selling them off in order to pay back money to the taxpayer might be fine in the short term, but in the longer term the bank will have no continual income from those operations. That is why I query the sustainability and viability of the divestments.
When we look at viability and the bank's business model, we take all that into consideration. Often, there is a bit of a smokescreen behind the arguments. If a bank needed an insurance arm to be successful on the banking side, I would have all sorts of questions about the viability of its business and whether it is using double leverage. One huge problem in the crisis is that banks have used their capital requirements for both operations. We will not let that happen in the future and will insist on an end to double leverage in which a bank operates both businesses. Your argument must be approached with a lot of caution because, if the only way that a bank can stay in the market is through its insurance operations, it has a major problem with viability and should really be looking at restructuring its banking business.
Convener, I have one final question, but I would be grateful if I could ask it later because I have been given the signal to go to the Rural Affairs and Environment Committee to move my amendment to the Marine (Scotland) Bill.
If you are back in time, I will allow you to put your final question.
The written submission that the Commission's directorate-general for competition provided to our committee was quite light and short. Because of the timing, the submission does not refer to the Commission's recent decisions. I make no criticism of that, but it would be useful if the committee could be given a list of the principal measures relating to the decision on Lloyds Banking Group and to what is, at this stage, a proposal about RBS. In addition, it would be good to have the justification for each of those measures and the impact that the Commission thinks they will have. Because of lack of time, I do not propose that we should go through all that today, but could that be provided to the committee? It would be extremely helpful to have that.
I think that we can provide something like that. In any case, once the decision comes out, it will spell things out clearly. We set out the reasoning behind our decisions extensively and clearly because, after all, our views on whether a certain measure is adequate or not can be challenged in court. The fact that a decision has not yet been reached on RBS makes things a bit difficult; Lloyds is another story and I think that we can get out something about that a bit more quickly.
I appreciate that discussions with RBS are on-going, but do you have a target date for reaching a decision?
There will always be hiccups in the procedure, and we try to be as quick as possible, but I do not think that I can say anything about timescales.
I realise that you have answered various members' questions about RBS's insurance division and that, at this stage, what has been suggested is still only a proposal. However, the justification for the decision to sell off the division was what you called burden sharing—in other words, the ability to raise money to repay the state aid. I suppose that it all depends on the sale price, but does the Commission have a view on how much money might be raised by such a sale?
No.
Okay.
It is not really our business. Obviously we know what the sale would mean in terms of income, balance sheet reduction and so on, but it is not up to us to sell the business for the bank.
I appreciate that, but you said that the sale might allow the state aid to be repaid faster. If the insurance market does not grow at the desired speed and the bank is unhappy with the sale price that it might get—you said that it could take up to five years for a sale to go through—is there not a danger that none of that state aid will be repaid for those five years?
Again, I do not want to pre-empt what will be in the decision, but we normally have the safeguard that, if the business is not sold within the divestiture period, a divestiture trustee will be appointed to sell the business for the company.
Is it impossible for RBS to repay the state aid without selling the insurance division?
Given that, as far as state aid is concerned, RBS has received €45 billion in recapitalisations and €281 billion in asset relief, do you think that it is possible? I have my doubts.
Just out of interest, how many banks is your department dealing with Europe-wide?
That question raises broader issues. About 20 banks are in the process of presenting their restructuring plans and there might be others to follow. A number of banks have been part of various guarantee, recapitalisation and impaired asset schemes in member states. At the beginning of the crisis, member states first tried to cope with the problem by introducing guarantee schemes. It then became clear that certain unsound banks had toxic assets on their balance sheets and needed recapitalisation. There were also other banks that, although they were sound and might not otherwise have had a problem, found themselves unable to lend to the real economy because their balance sheets were too tight. As a result, we issued a recapitalisation communication in which we distinguished between sound and non-sound banks and made it clear that the sound banks that would have been able to weather the crisis but needed support to fulfil their role of lending to the real economy would not be subject to restructuring. The others, which needed to recapitalise because of other structural problems, would be subject to restructuring. As time has moved on, some of the banks that claimed to be sound have turned out not to be, and they have become our clients. Some of the banks that come under the schemes and that will draw on guarantees will become our clients; some of them will draw on asset relief.
It is difficult to argue with your comments that part of the Royal Bank of Scotland's problem was that it expanded way beyond its core business. That reflects what your commissioner said recently—that Royal Bank of Scotland was simply
It is awkward for me to comment.
That is understood. Please say what you are free to say.
HBOS's problem lay in its risky lending strategy, which I think has been addressed by taking over the much more cautious lending culture at Lloyds. RBS had an almost aggressive expansion model, which became its problem. There was also an issue of timing. RBS, together with Fortis, had just taken over ABN AMRO, but Fortis had problems at a time when the markets were not very willing, although that was not the only cause of RBS's problems. In a way, Lloyds is in a slightly different position—it took over the problem, but without necessarily having been forced to do so. For it, the problems came from elsewhere.
Clearly, some bad strategies were being pursued, as you describe. Were there also failures of regulation? Does the European Commission have a view on the regulatory practices of member states?
We do have a vision, especially my colleagues in DG internal market, who are preparing further legislation. That has been on the agenda for much longer than there has been a crisis. The aim is to improve crisis and risk management and co-operation on the part of the supervisory authorities. That is why there is a window of opportunity to come to a supervision arrangement that functions better, that provides much more and much better co-operation between the supervisory authorities and which involves the supervisory authorities beefing up their resources so that they can act as an adequate counterpart to the various players. A window of opportunity exists to improve all that, and there have been a number of other initiatives in the same vein. Remuneration policies are not necessarily something that we take into account or would request in a restructuring plan, but it is clear that if a company has a long-term remuneration strategy rather than one that focuses on short-termism, that indicates that the company has long-term viability. We are interested in remuneration policies from that point of view.
That is helpful.
No, but we, too, found that out. I must be fair—I do not know exactly what we received from whom, but I know that we were very much aware of that.
You were very much aware of that, but had you received formal representations from Government bodies on the survey, you would have taken them into consideration in producing your proposals.
Sure. We receive informal complaints by competitors, and that is reflected in the decisions. We try to learn as much as we can on our own account, but any information that we get from third parties, from the market or from institutions is more than welcome.
Would such information be used in preparing proposals such as those that were announced on 3 November?
Absolutely. We have also been in contact with the UK competition authority to get a feeling for the competitive impact of certain measures on the market, so we do not just sit in Brussels doing our thing. We talk to the relevant bodies.
I congratulate you on the lucidity of your presentation and your answers; it compares favourably with the answers of some of the British authorities that we have interviewed.
They were not represented in the delegations. I suppose that there would have been some co-ordination at home, but it is people from the Treasury who form the delegations that come to see us.
Given the enormous change in the powers of the FSA that was contemplated, would it not have been useful to try to interrogate the FSA, because it was the body that represented the financial world in London and was responsible for controlling it? I find that state of affairs baffling and think that many of the problems might have had their origins there.
Yes, but I wonder whether interrogating the FSA would have changed the assessment of where we want to go in order to reinstall liability. Getting to the causes was one thing, and we have been quite thorough in looking into that. We have many teams working on all the various cases so it could well be that there have been contacts with the FSA because we do interact with the national banks and the supervisory authorities, but we cannot prescribe who the British Government puts into its delegation. We do read what is out there and have quite good knowledge of the situation and the problems that have been caused.
If several of the great Munich banks got into difficulties, would you assume that you would go to the Bavarian landesbank while you were making inquiries?
The landesbank issue is different, because they would have been aided by the Land. The state and the treasury would be present, but because the money would have come directly from the Land or the Kommun, those bodies would decide on the membership of the delegation, together with the finance ministry. The structure of the German banking market means that there is a different picture there than here.
This comes out of my regular reading of sensational literature, such as the Financial Times. The speed with which transactions were carried out and strategic decisions taken, particularly in the field of financial instruments such as derivatives and the like, could mean that decisions to change strategy were being taken several times a day. You are dealing with a timespan of possibly five years to try to clean up what resulted from that situation. Meanwhile, the investment bankers who were responsible for much of it will have pocketed their bonuses and cleared off to their tax havens. Will there always be a group of people who are looking for justice and not finding it?
You referred to the timeframe and the legislation on derivatives. That is a different story; there will have to agreement in the European Council and Parliament in order to go through with legislation. What we are doing falls within the exclusive powers of the Commission in relation to state aid decisions.
There are two areas in which one senses a leakage in the notion of bringing the various factors together in a collective way. You have already alluded to the first of those. When you are dealing with the controversial takeover of a firm such as ABN AMRO and you are dealing with Fortis and Santander, you are dealing with three different financial jurisdictions, which is complicated in one sense. However, I want to mention another complication before I fall silent, and that is one that we see in today's FT. The systems that are directed through tax havens have themselves adapted to cope with the checks on them by European and national authorities. The problem probably now lies less in the tax havens than in the trusts from other protected jurisdictions that invest in them.
A lot of work and thought is going into that as well, but it is not within DG competition's remit. We have powerful tools, but tools to act on those issues are not among them. However, I know that other colleagues in the Commission are thinking about such things and trying to find solutions. It is not a new problem. For example, the Parmalat case happened years ago.
We recollect the Bank of Commerce and Credit International, and the man who investigated it, Sir Fred Goodwin.
At that point, we will move on to Marilyn Livingstone.
I have a supplementary question on what you said in response to Christopher Harvie's question. You said that decisions will be taken now and they will not change. It is likely that the college of commissioners will change in the months ahead. Does that rule out a rethinking of the proposals for RBS and Lloyds by any new competition commissioner?
It depends on when the final decision on RBS comes out. The present college of commissioners will be in office until 30 November, after which we will have a caretaker Commission, which can usually act only on current affairs. All the competition cases are current affairs, so there is no limit to what the competition commissioner can propose to the college on those. However, any proposal for new legislation and that sort of thing would certainly not be current affairs. It would not be possible to consider such proposals in this period of dealing with only current affairs, but all the competition cases—including all the state aid cases in the crisis—can be decided under the caretaker Commission.
So you do not think that the change of commissioners will in any way delay the RBS decision.
I think that Commissioner Kroes would like to finish that within her term.
On a different topic, in the past, Senator Obama was an outspoken supporter of repeal of the Glass-Steagall Act in order to separate out retail banking—which we have been discussing—from the more riskier elements. He said:
One positive aspect of the crisis has been the fact that, for the first time, there has been some co-ordination and discussion of the issues at G20 level, which has not happened before. The discussions that are taking place in Europe on a more co-ordinated approach or more co-ordinated supervision would not have been possible before the crisis. Although we always think that the process does not go quickly enough, we have made some headway.
What can be done at EU level about issues such as bank bonuses? There are already squeals from the British financial sector about the UK Government's proposals to tighten regulation and to introduce new rules on bonuses. The sector claims that that will harm its competitive position. You said that the issue relates more to legislation than to competition, but there is a negative competition issue in play. Does the EU have a role to play in ensuring that there is consistency across Europe, to prevent the very large banks that still exist playing the card of claiming that their competitive position will be harmed if regulation is introduced in this country, with the result that regulation does not happen?
My colleagues in DG internal market and services have initiatives on the company law side—on directors' remuneration and so on. The present debate will feed into that. The UK has a code that sets out what the remuneration structure should look like, to which we refer every once in a while when looking at restructuring plans. We can take the code into account in that respect, but we cannot impose it on anyone.
Stuart McMillan has managed to make it back from his other commitments.
The submission that we have received from UK Financial Investments Ltd is interesting, and I am keen to hear your opinion on what it says. Paragraph 8 of the submission states:
What do you mean when you ask what the European Commission did wrong? I just want to understand what exactly you mean.
Sure. Following on from the previous question on light-touch regulation, was the Commission further back in keeping an eye on what was going on in each of the member states, or did the Commission have its finger on the pulse?
The discussions that the Commission launched to improve supervision and the rules of the game have been taking place for a long time now. The financial crisis has given some members a window of opportunity and much more motivation to pursue that goal. Before the crisis, I do not think that member states perceived any need to act. It was very much a time of self-regulation, and the view was that we should not interfere, because the markets know best. That was the mantra that the industry and member states expressed to the Commission. It is true that the Commission, as a political institution, could have been more forthcoming in proposing legislation—one always knows better afterwards—but it would not have been easy to do that in the climate of the time, when light-touch regulation was favoured and better regulation meant less regulation in the minds of member states. The sentiment then was very much, "Go away. We will all do that ourselves. In any case, Brussels, we don't want you. We know best, so go away."
To go back to my earlier question about RBS, it could be claimed that RBS is being punished by being forced to divest. Do you agree with that assessment?
In all the cases that we are looking at, we want to avoid that element of punishment. We are considering the dimension of aid received and putting that into the context of the downsizing that is necessary under the various headings that I spoke about. If a company has received less aid and has not participated in the asset relief scheme, its situation is slightly different from that of a big company that has had a huge amount of recapitalisation and asset relief.
Thank you for participating in this session, Ms Schwimann. It has been a long session, but that is because the information that you have given us has been extremely useful.
Meeting suspended.
On resuming—
On our second panel, we have representatives of UK Financial Investments Ltd, which is the body that represents the taxpayer on the boards of the Royal Bank of Scotland and Lloyds Banking Group.
I am a non-executive director on the board of UKFI. On my left is John Crompton, who heads the market investments team at UKFI, which is responsible for those investments that are not wholly owned. On my right is Sam Woods, who is seconded from the Treasury and is the chief operating officer of UKFI.
Thank you very much for your opening remarks, which are helpful.
UKFI has no regulatory responsibility. As I have said, we are an active and engaged shareholder. We act as a commercial intermediary between the Government and the market in order to realise good value for the taxpayer. As an engaged large institutional shareholder, UKFI would be expected to be aware of and to consult the management of the banks—which are indeed managed by their management and their boards—on issues that have caused problems in the past, such as their strategies, governance and risk management. That is what we do. We do not amplify, supplement or replace anything that is currently the individual or collective responsibility of the tripartite authorities.
I have a small point to add to that. It is a statement of fact that the relationship between the Government and the banks has become more complex through the financial crisis because the Government has taken ownership stakes that it did not previously have. There is also, of course, the relationship with RBS through the asset protection scheme. UKFI was set up to ensure that the shareholder interest and the protection of value for the taxpayer as shareholder did not get lost amid all the other competing interests, regulatory and otherwise, that are in play.
Perhaps that can be expanded on. What happens if there is a conflict between your role in protecting the interests of the shareholder—everyone around this table and everyone else in the country is a shareholder—and proposals by the Treasury, the Bank of England or the FSA on regulating the institutions in which we are the majority shareholder.
Our responsibility would be to discuss that with the ultimate shareholder, which is the Treasury. The Treasury is the leading authority of the tripartite authorities; the other two authorities report to it. We make regular representations to the Treasury on all aspects of the taxpayer's substantial investment in the banking sector.
Ultimately, it is unlikely that there would be such a conflict with the regulatory objective. However, if we found ourselves in a position of extreme conflict, the chancellor could use the power that he reserves to direct UKFI. If that arose, it would be a serious issue and the board would have to consider its position. The whole idea of UKFI is to put a bit of grit in the machine to ensure that the protection of the taxpayer's interest as a shareholder does not get lost.
How does the relationship with the European Commission work? Has UKFI played any part in putting forward the proposals that the Commission has considered on divestments from the major banks?
No. That is the Treasury's responsibility. We have consulted the Treasury and we have informed it about certain aspects of the discussions with the Commission.
In your view, are the proposals that are on the table, particularly in relation to RBS, in the interest of shareholders?
It was interesting to hear your previous witness, Irmfried Schwimann, talk about that process, in which we were not directly engaged. It was clear from listening to her testimony and reflecting on the process as we have seen it that the purpose of the Commission's exercise is not to defend or create shareholder value but to ensure that banks that have received state aid to some degree assessed by the Commission are affected to an appropriate degree as a result. Our concern as a shareholder is that the effects of the disposals in the case of RBS, for example, might be managed in a way that minimises the impact on shareholder value. We hope that the four to five-year timescale that RBS is being given to sell assets will enable it to get a fair price for the assets. If it were asked to dispose of them quickly, it is likely that it would get a less good price. The Commission's findings and rulings around this crisis are not designed to build up shareholder value.
As the majority shareholder of RBS on behalf of the taxpayer, do you think that the deal that is on the table from the European Union is not—or may not be—in the best interests of the shareholders.
It is simply not a deal that has been designed to create shareholder value; it is separate from that. The arrangements that have been put in place around the deal, such as the time that RBS has to execute its side of the agreement, are reasonable.
It is, in effect, one of the costs of the support that the Government has provided. You need to look at it in the round, rather than considering specifically whether the state aid stuff on divestments is good for RBS.
I am just trying to establish whether the divestments that have been required by the European Commission weaken the ability to get the taxpayer's money back.
I think that Mr Hester would tell you that had the Commission not told him to make these divestments he would not have gone out and done so himself. I do not think that I can say any more about it than that.
I am sure that we will ask Mr Hester those questions next week when he comes before us.
I want to ask about your involvement with the Royal Bank of Scotland. RBS has recently been described by Paul Myners, the City minister, as
The entire board of RBS has been reconstituted in the past year. It has been reduced and replaced. New management is in place and the management team below the level of the board has brought capable people into key positions such as risk management. We have engaged with RBS on that and on its strategy and compensation practices. Those practices, not just in RBS but in the industry as a whole, were generally regarded as a contributing factor in some of the poor decisions that were made and the poor practices in the banks in the past few years.
Is the board of RBS any more diverse than its predecessor?
I would have to put the two side by side to address that.
From our perspective as a shareholder, the board of RBS is much more effective as the central point of governance for what is a large and important institution. We are comfortable with that. That goes for the performance of the new chairman and the board that he has assembled. One point that makes it more effective is that it is a smaller board and so can debate issues in a much more intimate way than the previous fairly large board was able to do. It is also a board that has no excuse or reason for complacency whatever about the state of the bank that it manages. It has come in to fix a very troubled situation and, in our view, it is doing an excellent job. It is also a board that combines a significant amount of banking and financial sector expertise with meaningful expertise from elsewhere in the business sector.
A criticism of the previous board was that its non-executive members did not play the role that they might have done in having an overview of RBS's activities. Is the range of backgrounds and experiences of the present directors any different from that of the previous directors?
That is a very fair question. One question that the historians of the RBS episode will no doubt puzzle over for a long time is how a board that, on the face of it, had several highly capable people who had performed well in similar board situations at other companies failed to perform. We do not have a single obvious factor that we can change to ensure that the new board performs better. In our view, the most important point was that a new board was needed. We thought that it would be helpful if it was smaller and that it should have broad-based expertise but include considerable and deep expertise in the financial services sector. Beyond that, we cannot say much more, other than to report to you in our shareholder role that we believe that the board as now assembled is performing well.
In our engagement with the board on new appointments, we have tested that point explicitly. We have considered whether the people who are coming on are the sort of people who will be able to provide challenge. We have focused on that as one of the criteria.
The question is not whether the aggregate qualifications of the outgoing board and the incoming one differ materially. RBS had extremely distinguished and prominent people on a board that failed to provide adequate governance for the company. The question is not who is on the board but what they do when they are on it and the tone that the chairman sets in challenging, probing and questioning and carrying out the fiduciary responsibilities for the shareholders and depositors in the bank. I suspect that the current board is extremely motivated to do things differently from the outgoing board.
Will the measure of that be whether RBS is out of state aid in four years' time, having maintained its position as a major international bank? What will the criteria be?
The criteria will be that RBS is back where it rightly belongs, in the hands of the individual and institutional shareholders, and is fully valued for the enterprise that it will become when the strategy is implemented.
I will be a bit more explicit on the goals. The board has endorsed a set of goals that it expects to be delivered by 2013, which relate to the profitability of the bank, its ability to earn a return on equity in excess of 15 per cent, the capital strength of the bank and various other measures that should translate into a significant creation of value for the taxpayer as shareholder as well as a reinvigoration of a major financial institution and the return of that financial institution to a leading position in the national and global markets in which it competes.
Given those tasks and goals, have you been able to recruit senior management to replace those who were there before who can build to achieve those ends?
We have contributed to, and the RBS board has overseen effectively, the renewal of the management team over the past year. That started in October 2008 with the appointment of Stephen Hester, who has proved to be an energetic and effective chief executive. He, in turn, has recently recruited a new finance director, whom we regard as a world-class finance director with extensive experience. Together, they constitute the executive director component of the board. There has also been quite a lot of change at sub-board level through the management structure, which has been driven by Mr Hester. We regard that, too, as auguring well for the bank's ability to achieve its goals. It is not a case of target setting and hoping; in our view, the board is directing real change in the organisation.
You have been able to recruit world-class players despite the bonus constraints.
The short answer is that, within the framework in which the bank has been allowed to operate, yes, the board has done that.
Earlier we heard interesting testimony from the European Commission that its proposals have been agreed by the member state in the shape of the Treasury. We have heard from you that you are the agent of the Treasury, and we have also received the strategic vision of the RBS board, into which you had some input. In the light of that, it is fair to ask you, as the principal shareholder, about your strategic vision for RBS post-3 November. What sort of bank do you want it to be—retail, investment, home or overseas? What is your vision for the bank?
I will ask Mr Crompton to answer that question more fully. I stress that that is very much something that the RBS board should review—mindful, nevertheless, that the competition authorities have predetermined certain things for it.
As it seeks to build out its business from here, RBS will seek to be a leading global financial institution that is active in a number of different business areas that it believes will provide it with both diversification of earning streams and growth, which it believes—and we agree—will drive shareholder value while, at the same time, providing a degree of safety through diversification of risk.
How do you expect RBS to be a leading global financial institution when you have restricted it to position 5 in the bond market? Surely that hobbles its ability to be an investment bank on the global stage.
The restriction was agreed with the European Commission; it certainly had nothing to do with us.
Your principal shareholder is the Treasury. We have just heard that the member state agreed to the package in its entirety.
We manage the shareholding that the Treasury has given us to manage. Discussion of issues relating to regulation by Brussels is dealt with directly by the Treasury, so we were not party to the agreement. As a former and, perhaps, future participant in the investment banking industry, I do not regard RBS being allowed to retain a top five or top 10 position—it is capped at position 5—in a market that includes a significant number of players as a statement that it must move into the second division in that area. It is a statement that RBS cannot chase the number 1 position as an end in itself and that, although it can be a major player, it must not pursue size for size's sake.
You do not think that the restriction has hobbled in any way RBS's ability to be a global player.
I would not use the term "hobbled". I would say that the restriction is consistent with RBS being able to be a major player in the global markets.
I am mindful of time, but I have a couple of other questions. Who oversees the lending commitments that the Treasury has secured from both Lloyds and RBS—for example, the commitment to lend £26 billion to small businesses?
The Treasury.
RBS indicated last week that it believed that it was time to rethink that lending commitment. What role do you, as principal shareholder, play as intermediary in the process?
We are not an intermediary in either monitoring or setting the lending targets, which are legally binding commitments that have been made by the investee banks, as we call them, to the Treasury to ensure that there is no credit withdrawal from the consumer and small and medium-sized enterprises. When RBS makes comments such as those to which you refer, it is presumably addressing them to the Treasury.
An important point to note about the commitments is that they relate to lending on commercial terms and subject to market demand. There is a genuine question about what is happening with market demand. As you are probably aware, RBS says that its applications from SMEs are down by 37 per cent. In his statement—if that is the statement to which you are referring—Philip Hampton was pointing out that that is an issue. There are on-going discussions with the Treasury on the point.
As a former banker, I have always been slightly puzzled about how the lending commitments could work in practice, given the state into which we had got ourselves a couple of years ago. Because of cheap money and easy credit, the world was greatly overleveraged. That was true of families, households and companies—everything.
There has been much coverage in the Scottish media over the past couple of weeks about the HBOS daily overdraft charges on current accounts, which are now being introduced. Would that be appropriate for board-level discussion at Lloyds Banking Group?
I am not familiar with the exact details of that, but it sounds like the sort of thing that would probably be discussed at board level. We would draw the line at that being an operational matter for the banks. We expect them to treat their customers fairly and ethically, both for good business reasons and for reasons of more general practice. We would leave that to the banks.
In June, when the pay package for the chief executive of RBS was announced, The Scotsman commented that it was "ill-judged, ill-timed, disproportionate". Does UKFI have any regrets about the remuneration package that was agreed for the chief executive of RBS? Has that package been altered in any shape, manner or form by the events that took place subsequent to the announcement in June?
We recognise that Stephen Hester is paid a very large sum of money and that our decision to support the board in giving him that package was extremely controversial. RBS is one of the largest banks in the world and it is going through an incredibly challenging period. He is paid in line with what the bosses of big banks around the world make. You could take the view that people at RBS should be paid less; we would disagree with that. We have tens of billions of pounds tied up in the company, and we cannot afford to allow it to become a place where bankers go if they cannot get a job anywhere else.
Since the package was announced in June, the G20 has met in Pittsburgh and the FSA has made various statements—and there were reports in the press on Monday about the future tearing up of contracts. I am trying to establish whether the package that was agreed in June is insulated from all those changes, or whether since June it has been materially impacted in any way by the changes that have been telegraphed.
We expect the package to be largely in line with the regulatory developments since then. The regulatory debate has moved to where we had got to with RBS and Lloyds in February, particularly when it comes to bonuses and the broad principles of deferral and clawback. I cannot give you an absolute assurance that every single detail of the package will be absolutely unchanged—the FSA might wish to have a look at some things—but I certainly do not expect the contract to be torn up.
The situation that we are in is new to everyone. Given the personal element to all of this—for instance, people might well be made redundant—is anyone on the RBS board a member or representative of a trade union?
I do not think so.
Lord Myners said that RBS was
I do not think that it is necessarily for us to respond to that question, but certainly one has to draw some conclusions from the manifest outcome of the RBS situation. It has been our single largest bank rescue, while other banks have not had to be rescued at all. As a result, one can conclude only that things were not managed at all well there.
There is no question but that it is clearly a very bad management outcome.
I fully accept that, but the fact is that for a long time the bank had a sustainable growth model. It is only in the past two or three years that the bank has failed. What do you think will happen to RBS's reputation as an institution?
Perhaps I should unpack that question a bit. If you were to write the history of the RBS episode with, perhaps, a little bit more perspective than we have today, you would probably find that a very important part would have to be an examination of how its growth model evolved over the past decade. When we looked into the issues that we felt most needed fixing at the bank, we felt that two major strands had gone awry. First, there was in the organisation a very strong cultural bias not towards value creation for the shareholder, but towards growth more or less irrespective of whether it was valuable. That can probably be seen in its acquisitive history—the way that it sought to grow through acquisition—and a culture in which balance sheet expansion was chased for its own sake.
But 10 years ago, RBS was not ranked in the world's top 10 banks.
Certainly not before the NatWest acquisition—you are right.
Speaking as a Scot, I believe that, in Scotland, a resourcefulness founded on a strong education system, a drive and a capability have caused the country significantly to outperform, given its size, internationally and in a number of sectors, including engineering, finance and medicine. However, that activity must be channelled and sensible.
Given the constraints on pay and the league table situation, would it be better for RBS to exit the investment banking business?
The short answer is no. As I said, the league table point perhaps means scaling back what might have been an ambition for global dominance—I am not saying that that is true of the present management, but at least the situation tells them that they cannot aim to go there. For the reasons that I gave, members might imagine that we as shareholders do not see that as a particular problem. For us, untrammelled growth is not necessarily good.
"Investment banking" and "investment bank" are catch-all phrases. Over the years, their definitions have changed. If RBS is a client-focused organisation—I believe that that is the intent for the future—it is important for it to be capable of providing to its wholesale clients services other than just lending off its balance sheet. Consequently, its clients will look to it to trade and hedge their currencies, to secure other risks, such as interest-rate exposure, and to help them to access debt capital markets in which RBS has a strong position. Clients might look to RBS for various other services that are increasingly deemed to be in the investment banking world.
My final question is on shares. In evidence to the Treasury Committee of the House of Commons, John Kingman said that UKFI
No. We do not plan to make any forecast, not least because that might tell the market about our intentions and we would then get a worse deal for the taxpayers we represent.
I think that the implication of the answer to Stuart McMillan's previous question was that, prior to the acquisition of NatWest, the Royal Bank of Scotland was a properly scaled and focused institution that was doing what it did quite well, whereas the purchase of NatWest was the first symptom of an organisational bias towards growth above value creation that led things to go badly wrong. Likewise, some might argue, the Bank of Scotland operated with the appropriate scale and focus before its merger with the Halifax. Should RBS and Lloyds continue to operate in the wide range of areas in which they acquired an interest in recent years, or is some rescaling and reprofiling of the banks necessary for their future health?
John Crompton will deal with the bulk of that question, but let me make just one point. RBS had bulked itself up to having a balance sheet of £2 trillion sterling, which is humungous. Given the capital ratios that are now required or regarded as sensible, that is not a sustainable balance sheet so certain business activities need to be reined in and scaled back. In addition, requirements have also been imposed by the European Commission, as we have just heard. Pre-HBOS, Lloyds was clearly a pretty conservative and sensibly run bank. The contents of the HBOS portfolio probably took even Lloyds by surprise when everything finally unfolded.
Perhaps I should just clarify my position on the first part of the question. It is not our view that RBS's purchase of NatWest was an unwise acquisition. Far from that being the case, NatWest was actually a very sound bank and RBS managed to create a lot of value through the combination of the two banks. I do not think that many people would dispute that.
When was that acquisition made?
Around 2003 or 2004—I may be wrong about that by a year or so, but it was certainly several years before the financial crisis. I just do not want to leave hanging the view that NatWest was not a fine institution and that its purchase by RBS was not a value-creating acquisition.
On the employment implications of that restructuring, there have already been significant job losses in both institutions, and there is concern around some of the more recent announcements. How do you envisage future changes impacting on employment in those banks in the UK?
For somewhat different reasons, both banks have indicated that they will need to reduce costs. The job losses in Lloyds relate to the integration of two quite large businesses and the capture of the cost savings that that can generate. In the case of RBS, it is true to say that, the nickname of the former chief executive notwithstanding, cost control at that bank was not all that it should have been. I think that the new management of RBS believes that some of its operations are simply not as efficient as they should be, and is taking steps to manage that.
You mentioned the employment implications of reduced business. Do you feel that Lloyds and RBS are doing enough business in terms of lending to householders and small and medium-sized enterprises in Scotland and across the United Kingdom?
Our impression is very much that both banks are open for business. Lloyds has opened 60,000 commercial accounts during this year, and its SME lending is up 12 per cent in the year to June. RBS has loaned £29 billion to businesses during the year, and its credit application rate is at 85 per cent, which is the same as it was before the financial crisis. I think that some figures are available for Scotland as well.
I will make one additional point that demonstrates how a more viable institution can serve its customer base and the economy better. The Lloyds Banking Group management will tell you that the HBOS business that they bought had effectively shut down its lending activities almost entirely over the previous few months as HBOS management realised that they were running out of capital and were having an increasingly hard time funding the business, which meant that every new loan made their life harder. The Lloyds Banking Group had the opportunity to switch on the HBOS machine again, which took some months to do. Of course, management wanted to ensure that, when they switched on the machine, they did so using the Lloyds standards of risk management, not the standards of risk management that were employed by the previous management.
I will follow up on a point that Lewis Macdonald raised. First, what role will UKFI take in ensuring that there is consultation with the workforce? If there is no trade union or employee representative on the board, what discussions will be held with the workforce? That is an important issue.
I will kick off on the specifics. Sam Woods might make one or two more general points.
John Crompton is right that we are not here to manage the banks. It is very important that we do not get caught between the boards and management and their workforces, but we take an interest in what the unions have to say. We have had numerous meetings with all the unions involved in all the banks and our door is always open to them.
I take it that you have an interest in the banks' strategy for where the job losses will fall, because that will have an impact on the service.
We are, of course, interested in that from a service point of view, but in general, UKFI does not have a particular geographical bias, with the one exception being that we expect the banks to meet their UK lending targets.
These are very much responsibilities for the management and the boards of the banks as they decide how they want to run the banks in different areas and how efficient they want to be. Having said that, clearly the boards and the management are very mindful of the fact that they have one stonking big shareholder and that everything that they do is therefore very much more in the public domain than usual. If they were considering making a strategic or tactical move on employment, for example, that could result in adverse headlines, it would be reasonable for them at least to take a sounding from their major shareholder. However, it is important that I re-emphasise the point made by Sam Woods and John Crompton that these are management issues.
We hear that SMEs are finding it difficult to access finance and that first-time buyers, in particular, are finding it difficult to get mortgages. If those are issues, surely UKFI should have an interest in them?
Sam Woods has the details, but I do not think that what you say is evidenced by the facts.
On SME lending, the more interesting question is the one about the degree of concentration in the market in Scotland. The committee is understandably interested in that and has been considering it. If I understood Ms Alexander's comments correctly, our information is the same as yours, in that LBG and RBS each have 20 to 30 per cent of the SME market in the UK as a whole, whereas in Scotland, they have 30 to 40 per cent each for start-up businesses and 40 to 50 per cent each for the stock of businesses. As the OFT said to the committee, concentration is not the only competition factor to be considered, but it is legitimate for the committee to consider whether the situation is in the interests of consumers.
A number of matters that are under discussion today are outwith your gift. Divestments are a matter for the EU and member states, and you described lending as a matter for the Treasury and the banks. You said that other matters are for the board, including vision and operational considerations in relation to jobs. With that in mind, what are the key factors that UKFI controls? On what factors will you be judged next year and the year after?
The critical factor is our working with the banks as an engaged shareholder to get them fit for purpose so that they can re-enter life in the private world as opposed to their being substantively publicly owned. We will also be judged on the ultimate outcome that we achieve for the taxpayer from the disposal of their unwilling investments, if you will, through the Government, in the banking sector. We will be judged not only on what we achieve in terms of price, but on the fact that we act without destabilising the financial markets and without creating any undue competition issues. Those are the things that we have to keep an eye on.
Do you think that you are too close to the Treasury?
Absolutely not. [Laughter.]
Physically, yes, in that we are currently within the Treasury building. Frankly, that was a purely pragmatic choice. In November last year, with the financial crisis and the bank recap going on, we had to consider whether we wanted to spend the next three months worrying about information technology and desks. We thought, no—so let us free ride off the parent. However, we are moving out next month.
I accept your point that it is a deal between the Treasury and the banks, but is there scope for the active and engaged shareholder to do or say more about lending commitments? The banks have said publicly, and some have said privately to me, that it will be impossible to meet the lending commitments. The main reason given is lack of demand. Potentially, there is a bad incentive for banks to start lending to riskier ventures so that they can hit the lending target, which is obviously one reason why we got into problems in the first place. Is there scope for you to do and say more about the lending commitments issue?
If we saw any evidence of what you suggest we would be extremely concerned and would certainly engage on it. We do not see such evidence at the moment. The deal between the Treasury and the banks involved lending on commercial terms, and it is subject to market demand. That is what we expect to be delivered and it is consistent with our objectives. The constitutional choice has been made for that to be between the Treasury and the banks. Ultimately, we must respect that.
I think you said, when I was scribbling away, that the most fundamental reforms were on remuneration and bonuses. Is it fair to say that that was what you said?
Yes.
You gave an indication of the clawback for the chief executive, but can a specific percentage be clawed back from other investment bankers and so on? Is it 50 per cent or 100 per cent? Apart from the chief executive, is a timescale applied more widely to others?
It varies by seniority. I do not want to go beyond what we have agreed with the banks about what we will disclose. Leaving aside the most junior staff, the clawback is at least 50 per cent—considerably more in some cases.
There have been suggestions in the financial press that some banks are working round restrictions on remuneration and bonuses by having what they call golden parachutes to attract employees. Have you seen much evidence of that? Would that practice concern you, as a major shareholder?
I think that there is an issue in that if a bank wants to attract someone who works at another bank and has remuneration there that ties them in in some form, it is often the case that the bank will have to offer some sort of quid pro quo if it wants that person. We have been clear that we are not in favour of multi-year guarantees. That is also an important part of the FSA's agenda. If a single-year guarantee can be described as a golden parachute, I do believe that banks are doing that, but I think that it is a function of the phenomenon that I just described.
There has been some comment about this issue, including from competitors of RBS. You will appreciate that we have an interest in RBS being commercially successful. Banking is a highly competitive business and it is fundamentally a talent-based business. It is therefore important that RBS can retain and, where it has gaps, attract the highest-calibre people.
At last week's meeting, Jeremy Peat was sitting in the chair that you are in now. I am afraid that he was extremely pessimistic about RBS ever being a major actor in the Scottish economy again. That was the view of the bank's former chief economist.
I enjoyed that tremendously. I am not quite sure whether I should be recounting
That is good enough for a start.
That was my way of saying that I am not quite sure what you were asking me to answer.
Back in the 1990s, we discussed the notion of a stakeholder economy, which Hutton was identified with. Would it not have been better to go in that direction? And, having got to the Titanic-and-iceberg stage that we have now reached, would it not be better for the Scottish banking and industrial finance sector to go back in that direction in the future? After all, as I read my Financial Times, I am told that the priority is now the manufacturing sector.
One could make the case that 75 per cent of the Scottish economy is service sector based and that the financial services sector constitutes a pretty big chunk of that. An economist might, therefore, debate with you whether there would be an imbalance in looking at one aspect of the economy in isolation. If Scotland has a GDP of just under £100 billion, can it realistically sustain £3.5 trillion, £4 trillion or £5 trillion in financial services assets? That is a broader question and it is clearly not within our remit, although it would be interesting to discuss the matter over a glass of whisky sometime.
If the events were as they were portrayed by "Panorama", that would be unacceptable. We understand that that employee has been suspended.
Frankly, it would be unacceptable for any UK-regulated bank to do that. It is not simply our investment that makes the difference.
I would not regard the Baden-Württemberg region as one of those. I would not compare it with the Bavarian or the WestLB system—it is a different system altogether. I teach economics students when I am in Tübingen, and they are totally disillusioned with what they have been taught in conventional economics, with its Black-Scholes theorems and that sort of thing, which are supposed to govern the structures of derivatives.
One of the sub-points under the heading "Overarching objective" in your framework document is:
Remutualisation is not excluded.
Under the remutualisation model, it would probably take longer to pay back the taxpayer's funding to Northern Rock and Bradford & Bingley. As Michael Kirkwood said, remutualisation has in no sense been excluded from our thinking, but that is the tension that would naturally arise if we took that route.
The question is really relevant only to Northern Rock, which has an operating lending and deposit-taking business. In the case of Bradford & Bingley, the branch system has been sold to Santander. Our ownership relates to the pool of mortgages that it has lent, not to an operating business that could be remutualised.
I have one more question. What would be UKFI's attitude to a bid to take over RBS?
You could say that it would depend on from whom the bid came.
We have a clear remit on the point. No restrictions are placed on the way in which we could sell the assets. If someone were to approach us with a bid for our stake in RBS, we would think seriously about that as an economic proposition. We do not have a mission to sell our stake in any particular way.
That is a clear answer. I thank Sam Woods, Michael Kirkwood and John Crompton for the evidence that they have given us this afternoon. It has been of extreme interest to the committee and given us additional food for thought for our later evidence-taking sessions, especially next week's session with RBS and our later session with Lloyds Banking Group.
Meeting closed at 13:37.