Regulatory Consulting’s Insight & Foresight Newsletter - July Review 2012
July was not dominated by the usual practice of the authorities in London and Brussels issuing various documents to clear their desks before going on holiday, thus leaving us with holiday reading of the most tedious kind. Rather it was dominated by the LIBOR fiasco. And in Brussels the Parliament failed to deal with the Solvency 2 Directive. So this month we deal with the ramifications of these two stories, both very serious in their own ways.
The price of money and the price of failure
Liborgate has so many implications it is difficult to know where to start. Expert commentators appear so stunned by the enormity of the conspiracy at the same time as the simple grinding incompetence of the system that they have failed to get to grips with the salient issues. The same goes for the MPs on the Treasury Committee who struggled to pin point the killer question in evidence hearings. Here is our take.
The system for setting LIBOR (and EURIBOR) beggars belief in the age of powerful information processing tools. A trade body collected data from a panel of banks, crunched some numbers and produced some averages. No investment has ever been attempted to produce a real time system using actual trades in the market. It was too easy to trick the system. Moreover, the competition authorities appear to have been insouciant to what is essentially a restrictive trade practice.
The system was so imprecise that the Bank of England believed it would be perfectly valid to substitute one set of figures for another to help ease Barclays through the worst part of the crisis. Did it not occur to them that convenient though this was in the short term, it was full of risk? And if they could seek to influence LIBOR for policy reasons did it not occur to them that a panel bank acting singly or with others could influence it for commercial reasons? The Bank was not a regulator at the time but will soon become one again. Does it have so little appreciation of the risks in a system with so little control built into it?
Plainly, the culture at Barclays requires attention of a fairly drastic kind. If the FSA did not care for cut of Mr Diamond's jib they had a perfect opportunity to deal with it when he was proposed for the CEO role. It seems they did have misgivings but did not seize the opportunity every experienced regulator will say is the moment for action. Change of control, authorisations, variations of permissions and changes of significant influence functions are the key gatekeeper moments for effective action. The FSA was not effective. Moreover, it continued not to be effective. Sending the board of Barclays a ferocious letter is part of the process of supervision but the key parts are always face to face. Good supervision requires good laws and rules but they are necessary rather than sufficient. Sufficiency comes from hiring regulators who have the imagination and resolution to use the powers given them in a determined and decisive way. The FSA did not do that. Splitting the FSA in two will not do that either. What is required is a cadre of regulators who put their foot down and force culture change where they believe it is the right thing to do. Wailing about inadequate powers is an excuse by regulators, making organisational changes to the regulators is merely shifting deckchairs around by politicians. We need both to improve their game in a way that would raise not one penny piece in fines. And there is the problem, the FSA used up too much energy fining people after the event and too little supervising robustly and keeping inappropriate candidates away from key positions.
For the future, this story will run for years. It will make lawyers wealthier than they would have been and act as a drag on the resources of our banks. This outcome is a key justification for our regulators being tougher on culture and fit and proper issues. Whether Barclays survives is not really in question. Whether their shareholders get to keep any of their value is more doubtful. In time a bail out may be required to pay for the litigation costs.
Another kind of Euro crisis
While the currency crisis drags on from one failed solution to another, the European Parliament has got the Solvency 2 Directive round its neck. More precisely it has the Omnibus 2 Directive round its neck but since this provides the transitional provisions for Solvency 2 it puts the entire edifice in jeopardy. By failing to agree a timetable before the summer break, the delayed start of the S2 regime on 1.1.14 will now be put back even further, presumably to 1.1.15 to make sense for the annual reporting cycle.
Some of the politicians seem to have made a good job of understanding what is the most complex material they will ever have to address. What they may not have grasped is the cost of delay for the insurance industry and the difficulty it will cause. In the UK, as we are prone to do, we set off at full speed and completed much of our S2 work for the original 1.1.13 start date. The Lloyd's market seems determined to convert to S2 for 1.1.13 despite the delay. There is a practical reason for that decision which is that once the systems are designed they will decay if not brought into immediate use and years of parallel running is simply very expensive. Which brings us to the FSA. They have been placed in a fairly impossible position by the European Parliament. But their view is that the current requirements are the ones in force and to move unilaterally to rules that are not yet enshrined in law is itself unlawful.
Sadly, this is stuff and nonsense and the FSA should be bold and pragmatic. On a purposive view Solvency 2 must be better than Solvency 1 or else why make the change . The UK has already gold plated Solvency 1 to produce a forerunner to Solvency 2. It can simply gold plate it some more and move to Solvency 2 earlier than the rest of Europe. This will save an interminable amount of parallel running. The authorities owe that to an industry that has paid a small fortune to develop Solvency 2 systems and played the game with quiet dignity. It deserves better treatment than this from the European Parliament, the European Commission and the FSA.
Time to reflect
As we sit on the beach this August there is one thing to reflect upon. Our regulators have let us down pretty badly. It is not an easy job, not least because it is about trying to achieve an optimal solution; Goldilocks porridge had to be not too hot and not too cold. Failure, in degrees is pretty much assured. But there is a common denominator in most of the criticism the regulator attracts. it is not that it has the wrong form of organisation, or that it lacks powers. Rather, it lacks the imagination and the courage to do the right thing quickly enough and to allow pragmatism to guide it towards an effective performance. The Financial Services Bill still before Parliament will not deliver that.
The Regulatory Consulting Team