August is traditionally a summer month when our regulators and policymakers take up their buckets and spades and head for the beach. This month was a little different in that the controversial issues such as LIBOR rigging kept on running and our their buckets and spades were needed to clear away a mess. Meanwhile Standard Chartered fell foul of the relatively new New York Department of Financial Services. And in London the FSA decided to call time on the promotion of unregulated collective investment schemes (“UCIS”)
Act in haste, repent at leisure
The Treasury Committee’s report into Liborgate was their hardest hitting report since reformation in 2010. They seem exasperated and rightly so. Even aiming off for a certain amount of parliamentary show boating, (actually there was not much) there remain some enormous issues for the Government to ponder which will simply fester way if workable solutions are not found now.
The first major issue is the role of the Governor of the Bank of England and the Bank’s accountability once it has assumed responsibility for prudential regulation. The Committee was concerned about the ability of the Governor and the chairman of the FSA to squeeze out Bob Diamond with a simple phone call. In the near future those two posts merge for prudential supervision so all power will be concentrated in one office at one institution. There was nothing wrong with the content of the action, (if Barclays could not see which heads should roll they would have to be told). But this same Governor has been resisting greater accountability and stronger governance at the Bank to countervail the concentration of power. No one wants to see insipid regulators acting to slowly and to weakly (that was partly the cause of Diamond and an inappropriate culture being in place in the first place). But if the system is to include the Governor flexing his eyebrows from time to time then he will have to explain himself when he does.
Second is the way criminal prosecutions are handled. The Committee rightly deplores the apparent inability of the FSA Enforcement Division and the SFO to appear joined up in the question of deciding whether or not to press criminal charges. In 2010 the plan to break up the FSA included much more wide ranging proposals that included creating an Economic Crime Agency (“ECA”). The potential donor organisations fought a successful rearguard action and this proposal quietly disappeared. The evidence of Liborgate is that the current dispersed arrangements are not working very well. This is a difficult question because whichever way prosecution is handled a major advantage of the other method is lost. Create an ECA and the close working and understanding between supervisors, investigators and prosecutors will be lost. Leave things as they are and the various agencies lose time and effectiveness liaising (and disagreeing) with one another. The answer is not easy but the evidence of Liborgate is that “something must be done”. Whatever it is, the resulting arrangements must include a major effort to address whichever flank is left open.
Last, the Committee spots that there was no encouragement for Barclays or any financial institution to confess its sins. The FSA has been pre-occupied with “credible deterrence” for too long, apparently oblivious to its reciprocal: that there is every incentive to try to tough it out. The FSA has a very modest discount on fines for an early settlement but has been ramping up the fines so fast that the value of the discount was perceived to have fallen to zero. Plea bargaining can look and feel morally very unattractive in some jurisdictions. But financial services regulation is about mitigating market failure: it does not have a moral dimension. As far as possible the criminal law should be kept out of market failure regulation. It should be reserved for those cases where moral turpitude is present, typically the supposed victimless crime where, plainly, deceit has caused gain at the expense of another.
The Financial Services Bill is still before the House. We doubt the Government will want to see it delayed while significant improvements are made in the fabric of the new regulatory regime. That would be a pity.
Don’t do like I say but if you don’t you are guilty anyway
It does not stretch the imagination too much to suppose that a word more vivid than incandescent would be needed to express the rage felt in the Standard Chartered board when it realised that a state regulator on the make had jumped the gun on purpose to make a name for his organisation at their expense.
The US has had an ambivalent position on Iran sanctions for some years. On the one hand it wants to bring Iran to the negotiating table on its nuclear programme. On the other it wants all oil trades globally to continue to be transacted in US dollars. Failure to do so would jeopardise a currency already bearing up under the strain of apparently unsustainable international borrowing. Thus Iran, through its Middle East friends, and the US have each other by the throat. A fairly typical diplomatic situation. So cue the State Department which invites the Treasury and Justice Departments to tread carefully on the question of applying sanctions to bank operations around Iranian Oil. Whether StanChart’s code stripping went beyond the tacit understanding is not clear and we will probably never know.
So where did StanChart go wrong given that their balance sheet is $340m plus legal expenses smaller and their share price has not yet recovered? First, it is a risky business making money out of ambiguous relationships between various governmental authorities: it really is supping with the devil and maximum vigilance is called for. Under the patchwork system between state and federal jurisdictions StanChart’s banking licence is issued by New York regulators so they have a stake in the action. Moreover, they have a track record of stealing the lime light with foreign corrupt practices style language to make their entrance on stage. Thus a perfect storm begins to build up and it seems StanChart failed to spot that dealing with the more measured federal authorities left them exposed. Were they asleep at the wheel? It seems a hard view to take but it pays to understand the foibles of the American Constitution. And accountability at board level is a tough ask. The money has been paid away regardless of the merits. NEDs have an impossible task and are often underpaid. The lesson, if there is one, is to ask for a hold harmless letter from the authorities you are dealing with. If that is not forthcoming in acceptable language you know where you stand and must make your dispositions accordingly.
You know what you can do with your nuts!
The FSA’s decision to consult on banning financial promotion of UCIS was well-telegraphed in advance. However, it promoted divergent views amongst commentators. In the same edition of the FT Lex wrote against the proposal and a column writer wrote in favour of it. It is good to see such editorial freedom still exists but the causes of the divergence are perhaps worth a moment’s thought. (We leave out of account the strange notion that a collective investment scheme can be unregulated: no wonder consumers get confused.)
The FSA has been careful not to ban sales of UCIS outright. That is wise since they are a broad church. At one extreme the FT columnist had a point that investing in a crop of nuts in South America is a form of commodities trading not likely to be suitable to a small retail investor. But investing in anomalies in classic car prices and in the general appreciation in fine wine prices could be a good move for a high net worth investor searching for yield and risk diversification. Indeed, Lex pointed out that wine had done quite well as an asset class over the past decade compared with equities and the FSA is not against investing in equities…yet.
To get to the bottom of this we need to examine the common denominator conduct risk issues and the broader public policy stance of successive governments. The conduct risk issues are essentially to do with suitability and attitude to risk and whether the advisers are fully aware themselves of the liquidity risks inherent in asset classes not easily tradable in highly liquid markets. Here it seems the FSA has a strong case. Some advisory practice appears to fall well short of the clients’ best interests rule. And life settlement funds based on too few lives are highly likely to hit the rocks. It might be better, however, if the FSA treated these shortcomings as they are rather than taking the rather lazy approach of banning every financial promotion good and bad. The FSA will no doubt say that financial promotions are skewed to the mass market so they are approximately in the right place but the risk with a blanket ban is that it creates liquidity risk of itself as investors rush for the exits. There is a Pareto style analysis to be done.
More broadly, Lex asks the very fair question why public policy seeks to ban investing in wine, and other esoteric asset classes, but allows gambling where losses are virtually guaranteed? The odd answer seems to be that a gambler has no liquidity worries, the bookmaker always pays out promptly. What seems to be overlooked is that the bookmaker is cash rich because the punter has lost his money to him. Worse still, gambling might be regarded as addictive whilst few would pretend that retirement saving and protection were addictive purchases. The irony is somewhat over-powering. Because consumers are weak demanders of savings and protection there is a substantial conduct risk issue that requires heavy regulatory intervention. But because they more readily demand gambling in all its forms, this market is judged to work better. In whose interests does it work better?
It is a funny old world!
The Regulatory Consulting Team