§ Motion made, and Question proposed, That this House do now adjourn.—[Mr. Kirkhope.].
§ 10 pm
§ Mr. Austin Mitchell (Great Grimsby)
I rise to such an enthusiastic leaving of the audience to call, in this brief Adjournment debate, for a separation of roles between fund management and dealing in currency trading so that fund managers in currency trading are not required to trade in-house where they are at the mercy of the in-house dealers. I ask this so that we can protect the consumer and preserve the integrity of the financial markets.
The particular instance that I wish to outline arises from information brought to my attention by a young man, Evan Souliotis, former manager of the American Express bank international currency fund and its discretionary management programme. The first fund started with $18 million, but when he took it over, it had dwindled to $8 million, and the second was a new fund, which he created, with $2 million at its disposal.
Souliotis found when he took over the fund and began the new fund that, as the manager charged with the responsibility of getting the best deal for the clients of the fund, he not only had to do his dealings in-house but, in a situation that amounted to playing poker, the opponents in the game—the spot dealers in the currency trading room —knew his hand, and knew his expectations from the technical information that he had to produce each day.
Therefore, the dealers had the advantage over the fund manager, and they were dealing with him in a monopoly situation. They did not have to compete for his business: he had to go to them, and they could give him the prices that suited them, rather than the keener prices that would have been obtainable had he been able to deal outside where the spreads were wider.
Furthermore, the dealers could use him to generate profits for themselves. They were required to take two points off every trade for their own trading accounts, a requirement which the customers were not told. In addition, they could hypothetically take points for themselves, and it looked from the history of the fund, the records, as though that had been happening. That was a monopoly in which the fund manager was required to deal through in-house dealers and could not go outside for better prices, and exploitation was possible, theoretically and in practical terms.
We are dealing with huge sums. Let us take a $10 million trade, which is levied two points in and two points out, and add a hypothetical five points each way for the dealer. That is 14 points going astray on the trade, which would generate $10,000 a day in points subtracted from it. That is the equivalent of 22 per cent. interest for that fund over the whole year—all lost to the customers of that fund, and all pretty well untraceable. There are voice tapes, which are kept for two to three months, but they do not show the comparative prices outside. There is also an audit trail, but it is difficult to trace anything—not least, what competitive prices were at the time that a trade was made. In a monopoly, there was no opportunity to go outside—as American Express itself did, when currency trading, in going outside its own dealing room.
118 The situation was open to exploitation and to the churning of customers' accounts. That churning clearly went on before Souliotis took over, which is why the fund dwindled from $18 million to $8 million.
Having quickly assessed the situation, Souliotis restructured the fund. He lessened its exposure to the markets and cut the number of trades to stop the churning. He also kept a close eye on the dealing room, going in to secure better terms and narrower spreads for his customers. He made himself a nuisance, but the fund's performance improved. Its share price rose month by month and was profitable for the fund's customers over the six months that Souliotis ran it. That profitability, however, was at the expense of the bank, which ceased to make the previous easy profits from churning and points on each trade. Eventually, Souliotis was kept out of the dealing room, and then was fired.
Not unnaturally, Souliotis went to the regulators, and must have stumbled with sheer delight into that thick—in every sense—and dense undergrowth of regulatory structures that we call self-regulation. We should all be grateful for Souliotis's perseverance and for his attempts to bring the situation to light. Rarely do we find out what is happening in the City, particularly in dealing rooms. It is a fairly closed freemasonry, whose secrecy is paralleled by the profits involved in maintaining that secrecy.
We know little of that closed culture other than when we see on our television screens flashing lights and people shouting at each other. The real nature of those dealings is a closed book for most of us. We should be grateful to Souliotis for telling us what happened in this case.
The Securities and Futures Authority agreed thatopportunities for such malpractice appear to be many.It agreed also that the audit trail that is typically produced makes the detection of such abuse altogether more difficult. It added, "Sorry, it's not our business—it's for the Bank of England." The Bank of England adopts a rather Nelsonian attitude to regulation. At first it said, "It's not our business, either." Later it said, "This complaint comes from a disgruntled employee and should be treated as such."
When the former Member for Birmingham, Selly Oak —Mr. Beaumont-Dark—and I took the matter up with the Bank of England, it assured us that it had inquired thoroughly into the matter. However, the bank's solicitors stated:To the best of our client's knowledge no investigation is current or was carried out by the Bank of England.So much for its thorough inquiry.
That was hardly surprising, for when we met Eddie George, then deputy Governor, he did not appear to me to understand commercial dealing rooms. He had spent a lot of time in the Bank of England's own dealing room, but that must be like a gentleman's club compared with the realities of commercial dealing rooms. Mr. George appeared to believe that such dealing rooms behaved like boy scouts—that one only had to tell them what to do, order them to be good and instruct them to operate at arm's length and they would immediately do so. He seemed to assume that they were honourable people.
I felt some disappointment after treading through this country's regulatory structures. The oversight committees of the United States Congress took a much keener interest in the evidence that came to light and that I was able to 119 send them than did our own regulators. The American committees cannot do much, but their interest is considerably greater than it is in this country.
All the regulators—from Andrew Large to Eddie George—agree that the situation is open to abuse. All were clearly embarrassed at being told that abuses could have occurred, but they would rather not know—and would rather not do anything about it.
The issue arises because one manager of two funds has one dealing room. It is possible that that dealing room is a different or peculiar culture. It is equally possible that it is typical of other dealing rooms across the City. It is possible, too, that its practices are common to other markets—gilts, commodities, equities and futures—but I am dealing only with financial markets tonight.
The sums involved are enormous, because the trades are huge. At times of rapid price movements, currencies can shift 200 to 300 points in a short period. It is not difficult, in such a burst of massive trading, to skim off five, 10, 15 or 20 points into treasuries, trading accounts or accounts of friends or of people with whom an organisation might wish to do a special deal. Indeed, Souliotis was told to do exactly that by a senior American Express treasury manager.
That money can be shifted on the points basis pretty well without trace. We think of the City as a network of honourable men whose word is their bond, but since big bang, although the change was already under way, that has not been the nature of the City or our financial institutions. It is not a network of gentlemanly capitalism of the kind that built up the commercial ties of empire. That is the old image and attitude. These are dealers: they are sharpies —barrow boys without barrows, who are living on their wits in a pretty tough jungle. How do we know that they are behaving with the integrity that is clearly required in those markets? How can we tell unless we take the obvious and, to me, essential step of imposing the necessary safeguard of requiring dealings in financial markets to be out of house?
It is fair to say that, when I put that solution to the Bank and the SFA, they gave it very brief consideration but an absolute, final and pretty unequivocal rejection. The reasons for the rejection seemed confused and wrong. It is argued—indeed, the Economic Secretary has advanced the argument to me in a letter—that it would be more expensive to require dealings to be out of house, but that is not so. It would certainly be more competitive, and whose interests are we thinking of? Surely we must think of the interests of the clients—the customers of a fund—and of the fund manager's responsibility to get the best possible deal for them.
To require dealers to be out of house so that a fund manager can have a range of prices at his disposal and can use his knowledge to exploit markets and discover who will give him the best deal is surely more sensible than making him subject to monopoly control by an in-house market whose dealers know his position and can exploit it. He cannot best serve his customers if he is subject to such monopoly control.
If we require dealings to be out of house, it allows a fund manager to use his skills, and it makes dealers work. That is the important point: rather than milking a captive market, dealers would be required to work to get better 120 deals and would have to compete. It is true that the bad, lazy and inefficient dealing rooms might go under, but the good, competitive, able and dynamic dealing rooms would survive and prosper, because they would be giving competitive quotes and fighting for business.
Unless they take that step, the Government are effectively saying that they do not believe in competition, because a requirement to go out of house mobilises competition, for the benefit of the consumer—for the people who invest in funds. Competition must be to their advantage, especially if it removes the monopoly.
What, therefore, is wrong with such a simple, obvious and necessary way of protecting the consumer in the financial markets, and at the same time securing the integrity of those markets? What is wrong with making the City and the dealers mobilise their skills that they constantly tell us they have on behalf of the consumers and clients, those people whose business they want to win for London, rather than merely exploiting a captive market, which is easy to do?
If the Economic Secretary will forgive me, I believe that the main interest of the debate will be to learn what excuses, and how many, he can mobilise to avoid doing that which it is so obviously his duty to do.
§ The Economic Secretary to the Treasury (Mr. Anthony Nelson)
The hon. Member for Great Grimsby (Mr. Mitchell) is assiduous and persistent, and I congratulate him on securing this Adjournment debate and on the way in which he has pursued the issue. I have no doubt that he is motivated by a keen desire to secure investor protection, fairness in the markets and the best deal for those who use the markets.
I know from long experience in the House and in Committee that the hon. Gentleman has an outstanding record in this regard. Indeed, he has from time to time supported me when I have moved amendments to toughen investor deposit protection laws, so I am conscious of the fact that I owe him one—although I am not sure that I can deliver what he wants this evening. However, I acknowledge the sincerity of his motives, and many of the sentiments that he has expressed.
When the hon. Gentleman raised this issue with me, I was very keen to meet the gentleman to whom he referred. He may know that the hon. Member for Durham, North (Mr. Radice) came to see me, and I listened to what he had to say. The hon. Gentleman may also be aware that, in a former existence, I was an investment fund manager, with the job of passing chits to the share dealing room and the foreign exchange dealing room.
I am therefore aware of the potential for collusion, of the potential for not dealing on the finest terms for investment clients of particular banks and of the extent to which improper practices may arise if there is inadequate supervision or if the integrity of the concern is not held uppermost. I therefore take very seriously the hon. Gentleman's complaints, and I pursued inquiries on a bona fide basis to try to ascertain whether there was any substance in them.
Having looked into the matter very carefully, having written to the hon. Gentleman, and having discussed the matter again with the Governor of the Bank of England only this afternoon, I am personally sure that it would not be the right approach to engage in either the separation of 121 fund management as he suggests or necessarily to embark on audit trail procedures beyond those already provided. I shall explain why.
The hon. Gentleman spoke in some detail about one aspect of the way in which the foreign exchange markets operate in this country. The markets are, of course, one of the many financial sectors in which London has a leading position in the world. London's position has been won by the City being able to provide customers and participants with high-quality and competitively priced services without their fear of being exploited by underhand practices.
Those who use these services have demonstrated their confidence in our markets by the enormous flows across our exchanges every day. The hon. Gentleman may, for example, know that the daily foreign exchange turnover in London alone amounts to something like $300 billion.
That confidence is not misplaced, and the authorities attach the highest importance to maintaining the reputation of all those who operate in the market. That is why, when the hon. Gentleman first brought his concerns to me, I was keen to ensure that his points were properly examined and that the information he was able to provide was made available to the Bank of England so that it could be formally and fully investigated.
That has now been done and, as he knows, the Bank's findings have been put before the Board of Banking Supervision, so that its outside members could judge whether the Bank had done all that it should in this case. The unanimous conclusion was the it had, but, if the hon. Gentleman has any new evidence that he wishes to pass to the Bank, it will of course be considered. I understand that the upshot of that process is that the Governor and the hon. Gentleman have now agreed to differ about the merits of introducing a ban on in-house dealing by banks who manage foreign exchange funds for their customers.
I would just say as an aside about the Governor, Mr. Eddie George, to whom the hon. Gentleman referred, that I can assure him that Mr. George is fully conversant with commercial banks' practices. Few, if any, people I know are more aware of and conversant with what goes on in the commercial banking world. He enjoys my fullest confidence, and that of the rest of my hon. and right hon. Friends on the Treasury Bench.
Before I go any further, I should say that, although the hon. Gentleman first raised the issue as a result of a specific case, he has since been pursuing his concerns as ones of principle. I am sure that he is right to do so, and I should make it clear that anything I say tonight is to be interpreted in the same way. My remarks are not to be taken to refer to one specific bank or any specific funds or individuals.
To return to the central issue, a ban on in-house dealing sounds superficially attractive. It undoubtedly would prevent some dealers from skewing prices against their clients, although there is no conclusive evidence of that happening. It would, however, have other consequences too, which are far less desirable. As in so many walks of life, we have to strike a balance.
I think that we can all agree that banning motor cars would reduce the number of traffic accidents, but the social and economic consequences of doing so would massively outweigh the benefits, so we have a Highway Code instead. Just as banning cars would not stop all road accidents, so a ban on in-house dealing would not remove all possibility of abuse. It would not, for example, rule out collusion with a third party.
122 An argument that is sometimes heard is that such a ban would force managers to shop around for the best price —the point that the hon. Gentleman made this evening. Perhaps. In the real world, however, all banks need to offer a competitive product to their customers or they will soon start to lose business.
What happens when the in-house dealer can offer the best price to a fund, for example, by obtaining economies of scale and reduced costs by putting together an internal customer's business with dealing for the bank itself? Why should the customer not be able to benefit from that? In cases such as that, the hon. Gentleman's proposal would prevent the customer from receiving the best price in the market. That is a form of investor protection that, in my view, we can well do without.
In all markets, not just financial ones, prices vary with the nature of the transaction. Large deals often receive a different rate from small ones. Wholesale deals, or those with regular counterparties with which a firm has a wider business relationship, may take place on better terms than those which are more generally available.
In the foreign exchange markets, customers are normally quoted two-way prices, with spreads to private customers typically wider than those which banks offer one another. For small transactions, those spreads can be very large—as anyone who has bought currency or travellers' cheques at a bureau de change will readily testify.
For all those reasons, it is misleading to talk objectively about the right price for a particular foreign exchange transaction, and in the absence of such objective information I am far from convinced that the hon. Member has demonstrated that a simple ban on in-house dealing would be in the interests of investors.
I should just mention, with regard to the spreads that he quoted, two pips additional spread on, let us say, a five pip —that is to say, a four basis point spread as opposed to a three basis point spread on a deal—is not unusual as a differential between the basis on which a charge is made to a corporate client and the basis on which money is exchanged on the interbank market.
It is quite normal for the interbank market, where the average amount would be perhaps $5 million or upwards, to be on a three basis points arrangement, but for it to be a four basis points arrangement if it was dealt direct with the customer. That is because there are relationships with other banks in the interbank market; one knows the counterparty; reciprocal business is conducted; and it is not surprising that an additional margin is put on where a fund deals, even if it is an in-house fund concerned.
I believe that, in a free and increasingly international market, financial institutions should be able to compete freely in the type of product that they offer their customers. Some, wishing to attract those who share the hon. Gentleman's concerns, will choose to offer a structure in which no deals are carried out in-house. Others will opt for structures in which all deals are in-house, in the belief that they will tend over time to provide a better and cheaper service. Others will give their managers the freedom to deal either in-house or with third parties, depending on what seems most attractive at the time.
The hon. Gentleman has pointed out that segregation between dealer and fund manager is not a regulatory requirement in these or other financial markets. It is my view, and that of the Bank of England and the financial services regulators, that, so long as those offering such 123 products make the basis of the arrangement clear and have the controls to satisfy regulatory requirements, separation of dealing and fund management is unnecessary.
The hon. Gentleman also talked about the need for a clear audit trail. I am still not entirely clear, from his correspondence or from his speech tonight, what he has in mind here. The practices and integrity of dealings in the wholesale currency markets and commodity futures markets are matters for the Bank of England and the Securities and Investments Board. Firms regulated under the Banking and Financial Services Act 1986 must have adequate systems to control their business, including an adequate audit trail. Where these controls are inadequate, the regulators will take appropriate action. They will also investigate any evidence of fraud or malpractice.
As technology improves, firms are increasingly able to record not only the exact time and price of their transactons but the prices that were current elsewhere in the market at that time. But the fact is that, at any moment, there is a range of prices and of sizes in foreign exchange dealings, and there is a limit to what is possible in validating prices to the nearest 100th of 1 per cent. in a market where prices can move by 20 or 30 times that amount every second.
Unnecessary interference with market practices risks driving foreign exchange business—by its very nature, one of the most international of markets—out of London to our competitors overseas. I am sure that the hon. Gentleman would not advocate that.
This can also be expensive for customers: regulation does not come free. It costs time and money. In fast-moving markets such as foreign exchanges, a requirement to check with a specified number of dealers, for instance, before putting a deal through could easily mean that the price had moved against the customer before the deal could be executed.
To try to find evidence of a best price by looking at brokers' screens can also be spurious. Such prices are often no more than indicative, or are good only for a matter of seconds, and they may not be available once a comprehensive market search has been carried out and the deal comes to be done.
When business such as foreign exchange falls under section 43 of the Financial Services Act 1986, and is thus without the ambit of the Act, it is picked up under the 124 Banking Act and is covered by the so-called grey paper and the London code of conduct. This constitutes an annex to the regulation of the wholesale markets in sterling, foreign exchange and bullion, published by the Bank of England. It sets out the manner in which the bank intends to supervise the London wholesale markets in sterling, foreign exchange and bullion.
Central to the regulatory framework is a list of institutions which act as market makers or brokers or which have been accepted by the Bank as fit and proper. The statutory authority for this regime is section 43 of the Financial Services Act 1986.
The London code of conduct states that managers of participantsmust ensure that the fiduciary and other obligations imposed on them by the general law are observed … As a general rule, deals at non-market rates should not be undertaken.Any breaches of the code by banks will be "viewed most seriously" by the Bank of England andmay be reflected in their assessment of the fitness and propriety of these institutions.
I therefore do not believe that this is an area of unregulated activity. I accept that the nature of the market makes it difficult to fit it into the conduct-of-business rules that apply to investment concerns. Possibly, one could not prevent every transaction that might not be entirely to the benefit of investors.
They may occasionally be disadvantaged, but in such a competitive market, in which the integrity of the banks is at stake and the business they do is up for grabs, some of the largest institutions, which enjoy a high reputation for their activities in London and elsewhere—American Express, for instance—have a much greater self-interest in observing the rules of the London code of conduct.
Based on my dealings with the Bank of England, I am satisfied that the rules are most carefully enforced by everyone, from the Governor down. When necessary, investigations are undertaken and remedial measures are sought and imposed by the Bank of England.
I accept what the hon. Gentleman said about the case in question, and I understand his concerns, but I hope that my remarks will give him some reassurance. My keen assessment is that the Bank is doing a good job in this difficult area. Rules do apply, and, where necessary, lessons have been learnt.
§ Question put and agreed to.
§ Adjourned accordingly at half-past Ten o'clock.