Context

Economic

UK economic growth during 2003 was supported by continued buoyant consumer spending and low interest rates, low unemployment and a strong housing market.i In contrast, performance in the manufacturing sector was generally quite weak. The outlook for 2004 is currently more positive, with an improved forecast for economic growth - particularly in the business sector. However, with household borrowing now at record levels, a significant increase in interest rates could depress future economic growth and increase credit risk. In view of this, The Co-operative Bank has, for the last two years, adopted a cautious lending policy. Asset growth has been carefully targeted to maintain or improve credit quality; for example, by increasing the proportion of secured lending, and by the application of strict credit criteria to both personal and corporate business.

The manner in which people access their bank accounts continues to change significantly. The number of personal accounts accessible in the UK by computer and telephone now stands at more than 17 million and 32 million respectively, compared with 0.4 million and 9.5 million in 1993. The bank and smile have been at the forefront of these developments, which have been credited as contributory factors in improving customer convenience and available leisure time.ii

The UK equity market (stock market), in common with all other major equity markets, fell further and sharply in the early part of 2003 - and at one stage it fell to its lowest point since 1997. However, as evidence emerged of a recovery in the global economy, these markets recovered some of their earlier losses and generally continued to rise during the rest of the year. As a result, for the first time in four years, equities performed better than any other asset class invested in by CIS. The total growth return over the year for the UK equity market was 20.8%, and for overseas markets the FTSE World (excluding UK) Index provided a total sterling return of 20.7%. The property market continued to perform well, producing an estimated return of 11.3%; however, UK gilts and bonds were relatively disappointing, with longer-dated government securities only showing returns of around 1.2%.

Regulatory

In 2003, newspaper headlines made repeated reference to the significant 'savings gap' in the UK, inadequate pension savings, stock market under-performance and several mis-selling scandals. The UK's Financial Services Authority (FSA) continued, quite rightly in CFS' view, to strengthen insurance regulation during 2003 and issued over 50 consultation and discussion papers.

• The Sandler Review of medium and long-term retail savings has recommended a simplified suite of savings and investment products and a simplified regulatory regime to cover their sale to consumers. Different ways of ensuring simplicity, control and investment risks are still under review by the Treasury and the FSA. CIS has been helping the FSA with its consumer testing.
• Depolarisation The FSA developed further proposals on the current regime of the tied and Independent Financial Advice sectors of retail financial services. During 2004 and 2005, CIS expects to see a 'freer' market unfold in which distributors and providers will be more easily able to sell each others' products.
• With-profits review Recognising the continuing demand for long-term savings products that offer some protection from market volatility, but incorporate increased transparency and better governance, the Treasury and the FSA have suggested reforms aimed at rebuilding market confidence in such funds. In 2004, with-profits fund providers must produce a Principles and Practices of Financial Management (PPFM) statement for their funds, to show policyholders how they determine payouts and set annual and final bonuses.iii
• The FSA continued to develop its Integrated Prudential Sourcebook, which will provide a single, coherent and up-to-date set of prudential requirements, based on the risks a business runs. The new FSA Sourcebook will also facilitate the introduction of the new international standards as their requirements become operational over the next few years. During 2003, the FSA published additional proposals and, in parallel, refined the existing regulatory regime to incorporate up-to-date thinking on risk evaluation - in particular, the welcomed 'realistic' approach to life fund solvency calculations.

Ethics and sustainability

Business on both sides of the Atlantic has undergone something of a crisis of confidence in recent years. Even before the much-publicised travails of Equitable Life, Enron, Parmalat and others, public trust in business was already low. Research by MORI iv has found that the proportion of the UK public who feel that industry and commerce does not pay enough attention to its social responsibilities has increased from 68% in 1997 to 70% in 2003; and that the proportion of people able or willing to name any company that is particularly environmentally or ethically responsible is less than a third of those asked. Furthermore, compared with six years ago, the proportion of consumers saying that corporate responsibility is very important in their purchasing has increased significantly, from 24% in 1997 to 38% in 2003. Research published by The Co-operative Bank, as part of the Ethical Purchasing Index,v shows that the total value of ethical consumption in the UK is now worth almost £20 billion. Recorded sales of ethical goods grew by 13% in 2002, at a time when the UK economy grew by just 1.7%. Closer to home, customers of the bank reinforce, year after year, the value they place on good conduct; 'ethics' being the most frequently cited reason given for joining and remaining with the bank. More details of the bank's ethical and sustainability positioning are available here. The financial services sector has recently emerged as an increasingly important driver for improved corporate responsibility. One in every nine dollars under professional management in the USA was part of a socially responsible portfolio in 2003 - some US $2.2 trillion. In the UK, CIS added an important dimension to the Socially responsible investment agenda in 2002 when it became the first insurance business to disclose its complete UK investment voting record on its website.vi This lead is now being followed by others in the UK. One area where the groundswell of activism amongst institutional investors is having a positive impact, together with the threat of legislation, is sustainability reporting. In 2003, 132 of FTSE 250 companies reported on at least one area of social responsibility, up from 105 in 2002. Although, as before, there remain some real problems with quality; just 45 had independent verification and 56 were rated as "producing no information of substance".vii

i  Total mortgage lending in the UK in 2002 rose by an annual record of £78bn. Banking Business (2003). British Bankers' Association.
ii  The Guardian (31.3.2004).
iii www.cis.co.uk
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iv www.mori.com
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v www.co-operativebank.co.uk/ethics/ethicalpolicy_consumerism.html
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vi  www.cis.co.uk/pages/why_CIS/why003_1_1.asp
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vii  Directions #3 - Trends in CSR Reporting 2002-2003.
 Context at Salter Baxter.