The FinanSer

Can regulators really make markets more stable?

I found myself sceptically smiling when reading that the Financial Stability Forum is going to make the banking world safer by:

• Strengthening prudential oversight of capital, liquidity and risk management;
• Enhancing transparency and valuation;
• Changing the role and uses of credit ratings;
• Strengthening the authorities’ responsiveness to risks; and
• Ensuring there are robust arrangements for dealing with stress in the financial system.

You can read the full report of what they proposed to G7 ministers here.

Why was I smiling sceptically?

Because regulators do not make the markets safer.  If anything, regulators make financial markets less safe.

Read more ...

FSA fines outsourcing firm a million dollars

Under our radar, as it is in the pensions markets, but something very noteworthy occurred last week.  The FSA attacked the outsourcing and Third Party Administration Markets by fining Liberata over a million dollars for failures in its systems and controls for managing and issuing pensions policies.

Margaret Cole, Director of Enforcement at the FSA and who I quoted last week as someone keen to make a mark, said:

"The failings by Liberata were particularly serious because they put policyholders at risk of not receiving important information about their savings and pensions products. This resulted in customers not being treated fairly.

"The fine we have imposed on Liberata acts as a clear signal to firms to ensure that there are appropriate systems and controls around processes and, where there are problems, that such problems are identified and resolved swiftly. Firms which fail to do this should be in no doubt that they run the risk of enforcement action."

The fine represents a substantial chunk of Liberata's £5.9 million of profits in 2007.

Just goes to show that the services and technology community are just as exposed to the FSA's radar as the financial community, especially if you are running a bank's or insurer's back office.

Watch out, there's a fine about.

Post-MiFID, the challenge is Clearing and Settlement

Today's Financial Times has a report on algo trading, with the following line in the middle: "Last week Chi-X, an upstart platform majority-owned by Instinet Europe, marked its first anniversary by capturing almost 15 per cent of total trading in LSE-listed shares at one point during the day. A trade executed on its system takes a mere two milliseconds."

The article goes on to point out that the Chi-x example is a realisation of the MiFID dream.

Equally, I spoke on a panel the other day about the impact of MiFID six months on, and realised that as well as Chi-x we now have MarkitBOAT, Turquoise, Rainbow, SmartPool, Virt-x, PLUSMarkets, Liquidnet, Millennium, BATS Trading, Equiduct ... the list goes on and gets longer by the day.  And this is all thanks to the changes inspired by MiFID opening the markets and removing the concentration rules.

So yes, MiFID is here, transposed, implemented and up and running.  That sorts out pre-trade and trading but, as the FT article points out,the issue is now clearing and settlement.

Clearing and settlement is still aligned with national operations: Euroclear, Clearstream, LCH.Clearnet and all that stuff, along with Central Securities Depositories (CSDs) and their Central Counterparty (CCP) mates, all clogging up the process. 

This is where the Commission is now focused with David Wright, Director of Financial Services Policy and Financial Markets at the European Commission, telling me last year that "there have been a large number of requests – 40 or more from one organisation – for interoperability.  It’s now critical to the EC that this results in flows of business to increase competition and to drive down prices and commission.  The Commission will monitor this space carefully, and we have made it plain that we will not tolerate any anti-competitive blocking of any form."

In fact, he's adamant that this is a critical priority for the Commission.

Equally, the ECB now has an open forum to debate Target2 for Securities which will force the issue.  Then there are the agreements amongst clearers, announced this week.  Then there's the LSE, who gained a clearer through the acquisition of Borse Italiana, and now there's the DTCC who gained approval for their EuroCCP this week from the FSA.  Their clearing operation has already been selected by Turquoise.

This hopefully means that we are rapidly moving from a world where pre-trade now guarantees best execution and transparency with low latency thanks to MiFID, through to streamlined, transparent and competitive CSDs and CCPs which also guarantee free and open choices.

With all of these changes of execution and trading venues, and now clearing and settlement, whoever thinks that MiFID is yesterday's news is missing the point.

'Immunity from prosecution' a major FSA weapon

It almost passed under the radar but, in light of the HBOS share drop of the other day, Alastair Darling - the UK Chancellor - announced on Thursday that anyone who snitches on their mates to the FSA about colleagues who try to manipulate share prices, will be immune from prosecution themselves.   This is seen as a powerful weapon for the FSA, as investment bankers have been reticent to say anything about such practices in the fear of getting caught out themselves. 

Now then, that Jeremy in the banking equities desk has been stopping me from getting a seven-figure bonus this year ... maybe I'll mention that to my new FSA mates down at Canary Wharf?

Causes of the Credit Crash, Part Three: the Governors

Having had a nice Easter break, this was going to be a short entry about the regulators role in the credit crash ... but it's really, really long.  Sorry.  But it does start to get to the heart of the matter.

So, what’s the real problem here?

Is it the machines, the humans?  The banks, the citizens?  Or the regulators?

Well, the regulators do have a lot to answer for, as they create the conditions in which the market operates. 

As Jeff Jacoby points out in the Boston Globe, the Community Reinvestment Act (CRA) of 1977 created the credit focus amongst the US banks, as it prohibited banks from only targeting wealthier areas.  This targeting was a practice known as ‘redlining’ and, under the CRA, banks were graded on their attentiveness to the ‘credit needs’ of poorer areas.  As a result, banks were viewed as being more community oriented, and graded higher accordingly, if they focused upon offering riskier loans to poorer folks.

This maybe one reason for the time bomb of mortgage debt, as Jeff concludes with the line: "And all of it thanks to the government, which was sure it understood the credit industry better than the free market did, and confidently created the conditions that made disaster unavoidable."

Equally, we could say the same in the UK, as the situation that created today’s issues could be viewed as being sown through the seeds of deregulation back in the 1980’s.

In 1986, the UK government deregulated the Building Societies.  In 2007, the firms being viewed as most at risk – Northern Rock, HBOS (Halifax), Alliance & Leicester and Bradford & Bingley – are all converted building societies.  These firms also all have leveraged mortgage books.  For example, when Northern Rock hit rock bottom last September, here were the loans to deposits ratios of each bank:

                                   Deposits      Loans         Deposit to Loan
                                     (£ bns)       (£bns)              Ratio
Northern Rock                   26.7             86.7          £1 - £3.25
HBOS                             211.9          376.8          £1 - £1.78
Bradford & Bingley             22.2            36.1           £1 - £1.63
Alliance & Leicester          29.6             46.4          £1 - £1.57
Lloyds TSB                      139.3          188.3          £1 - £1.35
RBOS                             384.2           446.9          £1 - £1.16
Barclays                          256.7           282.3          £1 - £1.10
HSBC                             442.4           428.2          £1 - £0.97

As can be seen, the banks with the greatest exposure were the ones that were originally buildings societies who converted. 

Before the Building Societies Act (BSA) of 1986, these societies focused upon mortgages based upon coverage by deposits. Now, as proprietary banks, they were seeking to increase returns to shareholders and lower cost-income ratio by doing the opposite: as in promoting mortgages based upon a leveraged loan book.  The fact they could leverage that loan book using cheap access to credit in the interbank markets was also part of the bubble that burst in 2007, some might say. 

Both Acts – the CRA and the BSA – could account for some of the seeds of this crisis therefore and, whatever your view, the fact is that we sit here today with market conditions that allowed banks to create a loans crisis of over $1.5 trillion and that is now being bailed out by the Central Banks and taxpayers.

The governors must take some blame here therefore, as they are meant to govern the markets.

The Governors are all those in power who are meant to manage the markets: the politicians, the lawmakers, the law enforcers, the regulators, the policymakers and so on.  A disparate bunch with little consistency.  And yet, critically, this disparate bunch of governors are meant to protect the hard-earned savings, pensions and investments of Mr. Jack and Mrs. Jill, the citizens.  And they do not seem to be doing very well at it.

After all, you would think that where you see an economy 'fuelled by consumer demand' based upon 'rapidly rising debt' and supported by 'house price inflation' that someone would say, hold on a minute.  It's the emperor's new clothes.

For example, the Economist's main story this week is about the Wall Street crisis, and quotes research from Canadian firm BCA Research. This research identified that America’s financial services industry grew from 10% of all of America’s corporate profits in 1980 to 40% last year.  Its stock market value grew from 6% of all American equity to 19% during the same period.  Yet, financial services only accounted for 5% of jobs in the private sector, and only 15% of corporate gross value-added.

What should have stopped such growth was the dotcom bubble bursting, which meant that consequent American corporate growth slowed.  Instead, financial markets carried on careering over the hill, happily making billions whilst everything else stagnated.

This was because the continued, unabated profiteering in the financial markets was being secured by debt, with financial sector debt rising from a tenth of the size of non-financial debt in 1980 to half of all debt today.  In other words, financial markets were bubbling over with wealth fuelled by debt.  Goldman Sachs’ $40 billion of equity allowed them to leverage $1.1 trillion of assets, whilst Merrill Lynch’s $30 billion of equity pumped $1 trillion of assets around the markets.  This leveraged gearing is like a magic carpet during good times but, someone pulls the rug away, then the drop is sudden. 

The emperor’s new clothes: look we’re all making money!  But look, it’s all based upon borrowing, so there’s no real money there.

Suddenly, the tide turns, the borrowing isn’t there and everything drops faster than Colin Farrell’s underwear.  And the fact that no-one kept this in check means that the governors must take some, or even most, of the blame.

Part of this is because of the fragmentation and lack of coordination of the governors; and part of this is that regulators no longer understand what they are regulating.  This was admitted by the Bank of England in light of the Northern Rock collapse, and appears to be admitted by the Federal Reserve in light of the Bear Stearns debacle. 

First, the UK demonstrated a critical regulatory faux pas with Northern Rock. 

This was a situation created by a triumvirate of buck passing between the Bank of England, the Treasury and Financial Services Authority (FSA), where each could hand-off and blame the other for missing things between the cracks of their authority. 

The Northern Rock example is an interesting one because they lent on the basis of the risk model being one where the UK housing market might collapse.  As a result of looking at this risk, they estimated they had to cover only 40% of their total borrowings: the amount of a correction in the UK housing market in worst case scenario, forecasted by their risk analytic models.  The fact that they never took into account the tightening of the lending markets, particularly short-term lending, was their fundamental flaw.  This is why, when they went belly-up, Northern Rock had lent £3.25 for every £1 on deposit whilst only having £1.5 billion of ‘liquidity insurance’ against their £90 billion mortgage portfolio.  A recipe for disaster as it turned out.

Yet Northern Rock was applauded as a great UK bank with the best cost-income ratio for years.  How come no-one spotted this risk? Because no-one thought credit would dry up? 

Well, the FSA and Bank of England showed some concern in early 2007, but the fact that no-one foresaw a squeeze on interbank lending just shows a basically mistaken hypothesis.   

The fact that the FSA, Bank of England and Treasury all acted independently meant that, when Northern Rock entered into crisis mode, no-one acted in a coordinated manner.  The FSA tried to broker a deal for the bank to be acquired with Lloyds TSB, but the Bank of England felt they could not allow this.  They then went public with their need to be lender of last resort for Northern Rock which meant the bank’s security became questionable.  The Bank of England blamed this on EU disclosure rules, which was incorrect, and the Treasury were made to look like idiots as it resulted in the first UK bank run for decades.

The Bank of England blamed this on EU disclosure rules, which was incorrect, and the Treasury were made to look like idiots.

The real issue, as disclosed later by the Bank of England, is that they didn't understand the markets.  CDOs, SIVs, Credit Default Swaps, Hedge Funds and all this leveraged, global debt and risk was beyond the ability of their little grey cells to understand.  Equally, the FSA seems culpable of the same basic views of the markets, with little real knowledge of the depths underneath, as demonstrated by their reaction to the most recent rogue trader scandal.

So this is the crux of the regulator’s issue: how to keep up with markets that are changing rapidly, are linked globally, and have products that are so complex only rocket scientists can understand them?

Which brings us to the governors of Bear Stearns.

For a long time, everyone thought the SEC had cleaned up Wall Street, thanks to their lightning rod leader: the New York State Attorney, Eliot Spitzer.  Rod being the operative word as it turns out.  Nevertheless, under Spitzer, everyone thought Wall Street had been cleaned up. Not really.

Now, in a post-Bear Stearns market, you have people like Barney Frank, who chairs the Senate's financial services committee, saying: “To the extent that anybody is creating credit, they ought to be subject to the same type of prudential supervision that now applies only to banks”, with the Federal Reserve empowered to act as the regulator.

Some might wonder why credit firms aren't subject to the same prudential supervision as the banks, which brings us to the same point as the Northern Rock issue. The USA has a regulatory market split between the Treasury, the Federal Reserve and the SEC, just like the UK was split between the Treasury, the Bank of England and the FSA.  Again, many are now saying that this is a recipe for regulatory disaster.

This is why the U.S. Treasury is saying that there will be broad changes to the regulatory structure in the near and short term, in light of the subprime credit crisis and, particularly, in light of Bear Stearns.

What happened to Bear Stearns is a similar case in point to Northern Rock.  Again, Bear Stearns were exposed because of their huge exposure to the Structured Investment Vehicles (SIVs) and mortgage books of the subprime American markets, and now Merrill Lynch and others have also been challenged. 

Investors lost confidence, removed funds in droves and started another bank meltdown that was averted from total explosion by the bailout by JP Morgan at the last minute ... thanks to the Fed’s $30 billion line of credit providing a step in to support JPM’s bid.  It was this last piece that changed things fundamentally in the US, as governments do not prop up the banks and have not done so since the Great Depression of 1929 which resulted in the Glass-Steagall Act ... funnily enough, an Act that was meant to separate brokers, dealers and investment houses from insurance and general banking.

Now, it appears that the Federal Reserve have determined that the SEC cannot manage the investment markets, as investment markets are so intertwined with retail and insurance.  After all:

Your mortgage bones are connected to your derivatives bones,
Your derivatives bones are connected to your investment bank bones,
Your investment bank bones are connected to your monoline insurer bones,
Oh, hear the word of the Fed.

The bottom-line is that regulators are too fragmented, uncoordinated, with little or no real knowledge of the markets they are meant to be regulating.  This is why they have made a strong contribution to the issues arising in the markets today, especially as many think they can control the markets ... often only in hindsight however.   

The overall view therefore, is that regulators are fragmented, uncoordinated and have no knowledge of the markets they are meant to be regulating.  This is a recipe for disaster, and a strong contribution to why we have seen the issues arising in the markets.  

The result is that we shall see a swathe of new regulations coming downstream in light of the market crisis of 2007-08 (note: good news for all tech firms – new regs always means new systems sales!).

Already, the Federal Reserve and Treasury are working closely with Wall Street, around the SEC.  This new regime will probably not come in until the current administration moves out, but when George W hands over to whoever then there will be change in 2009.

The UK has also proposed major structural changes to the banking regulatory environment in January, with the British Banker’s Association responding in March, and draft legislation likely to be released during the next Quarter.

Equally, Europe has agreed to improve the regulatory structures beyond today's multitude of Directives through four principles which will:

• improve transparency with respect to banks' exposures relating to securitisation and off-balance sheet items;
• upgrade valuation standards to respond to any problems arising from the valuation of illiquid assets;
• strengthen the prudential framework for the banking sector, including the treatment of large exposures, banks' capital requirements for securitisation, and liquidity risk management; and
• investigate structural market issues, such as the role played by credit rating agencies and the 'originate and distribute' model.

Therefore, the regulators will change regulatory regimes as a result of the credit crisis, but will never solve the issues.  Why?  Because:

(a) they will create risks in the market that will only come to light much later on in hindsight, such as the issues of today that date back to the 1970’s and 1980’s regulatory structures;

(b) there are too many gaps between regulatory offices and not enough integration or ‘joined up’ thinking;

(c) regulators do not understand what they are regulating anymore anyway, as CDOs, SIVs and Credit Default Swaps were way beyond them ... who knows what they would make of algorithmic quant analytics; and

(d) the most fundamental issue: they are domestic.

Domestic regulators cannot regulate global markets.  Global markets need global regulation and, today, there is no ability to globally regulate.  In fact, we cannot even regulate effectively across Europe.

When we live in global markets, with risks being moved between firms, across geographies, instantaneously and in real-time, to have regulators who cannot even regulate effectively domestically means that we have to rely on market self-regulation.  And the issue with self-regulation is that, when times are good and markets are running away with profiteering, who the hell cares about giving up their millions just to keep the governors happy? 

 

Regulators teach grandma to suck eggs

I just read the FSA publication, Market Watch 25, which focused on the systems and controls trading banks should implement in light of Societe Generale's rogue trader incident.      

Apparently, since the SocGen incident, the FSA has had cosy little chats with about fifty trading banks around London.  The conclusion is that firms should:   

• ensure “appropriate segregation of front office staff from middle and back office functions” ... this means keep the wolves, lions and other beasts involved in trading away from the poor administrators who book this stuff (a lesson learned from 1995);
• encourage traders to take their holidays ... this means that traders should have a break before they burn out and, if they don’t take it, there’s probably something fishy; and
• “elementary IT precautions, such as whether access to systems is password dependent” ... in other words, the biggest exposure is that staff can just go willy-nilly booking orders and deals that don’t exist because they can just access systems without a bye your leave.

Now, come on.  Surely it’s a bit basic to think that we have systems that do not even require a password to book an order.

Surely?   

Well, maybe true, as the FSA adds that companies should review their access controls to make sure they limit the potential for malicious activity by one unauthorised trader; that traders should not be able to access systems beyond  their levels of authority; and that front-office employees should be unable to logon from back-office computers.   

In other words, the FSA asks firms to separate front-office from back-office, and add a little bit of basic security to their IT apps.   

This seems so darned basic that it’s like trying to tell grandma how to suck eggs ... and yet ma grand mere’s ouefs need instruction according to the example of Jerome Kerviel, who is supposed to have nicked computer passwords, sent fake e-mails and illegally accessed the bank's computers to exceed trading limits. Anyone would think he thought this was just virtual money!

Having said that, he claims that everyone knew.  In fact, last week came the revelation that "an assistant on his trading desk conducted at least one large fictitious transaction last spring on their boss's own computer - as the boss himself looked on." 

All very dodgy ... le mauvais d'odeur de poissons et, pour la vraie vérité sur Jerome en français, clic ici. 

The real deal is maybe to lock up and separate systems using something better than a password written on a post-it note, stored in the top right hand drawer of a trader's execution desk. 

Maybe it means using something like a biometric?  Now how complicated can that be? 

This one ain’t gonna go away.

Chi-x is now seven percent of LSE's volumes

Seeing this story about the impact that MarkitBOAT is having upon traditional data reporting, I received a heads-up from Chi-x, the alternative exchange launched by Instinet in April last year, that they traded 7% of equity volumes of the LSE yesterday. 

Q4 trading stats show that Chi-x's number of trades were 2,401,856, up 121%; share volume was 1,850,602,948, up 177%; and turnover was €34,614,579,690 , up 71%.

Not bad for a one year old exchange who enjoy blowing their own trumpet.

FSA's data hypocrisy

I had a fascinating conversation with a group of information security professionals yesterday. 

We were talking around the issues of data leakage and covered a wide variety of subjects from accidental leakage to deliberate theft, from human frailties to ISO27001 standards, from the challenges of ensuring users find it easy to get the information they need to the issue of blocking unauthorised access and implementing layers of security, and so on.   To be honest, we could have debated for days rather than an hour and a half.

During the conversation, there was one moment that really surprised me.   

One of the banks had been severely beaten up by the UK’s regulator, the Financial Services Authority (FSA), over their lackadaisical approach to data security.  As a result, this firm has really tightened up their policies.  They don't allow any laptops or systems on or off the premises without security checks, all PC's and laptops have their USB ports blocked to stop any data leakage through memory sticks, and all email is sent using secure servers and high levels of encryption.

The email systems they use, in fact, are based upon PGPU, the PGP Universal Gateway.  If you're not familiar with PGPU here's the write up from their website:

"Unprotected email poses a critical risk to an enterprise’s most sensitive data: customer information, financial data, trade secrets, and other proprietary information. Exposure of this information can result in financial loss, legal ramifications, and brand damage.  PGP Universal Gateway Email provides centrally managed, standards-based email encryption to secure email communications with customers and partners. By encrypting data at the gateway, PGP Universal Gateway Email ensures data is protected from unauthorized access in transit over the public Internet and at rest on a recipient’s mail server. With PGP Universal Gateway Email, organizations can minimize the risk of a data breach and comply with partner and regulatory mandates for information security and privacy."

Excellent. 

After all, the biggest exposure for data loss is surely as you move files of information around between organisations?

Trouble is that the FSA cannot receive PGPU emails because their systems aren't up-to-date enough to allow such emails through their internal mail servers. 

So the bank set up a bank-hosted secure server which could hold their FSA directed emails.  The idea being that FSA staff could access the bank’s server to download emails.  However, that didn't work because the FSA's firewall blocked staff from accessing the bank's secure server!

I thought this couldn't be true, but the story was backed up by other banks in the room who use PGPU encrypted email systems.

In other words, the FSA beats up these banks about their tardy internal data security standards, so the banks overhaul everything to conform and kowtow, only to find they can't tell the FSA about what they've done because the FSA is unable to communicate with their newly secure bank servers.

Smacks a bit of regulatory hypocrisy if you ask me.  Mind you, with so many data leaks from government departments, is it that surprising?

Maybe the FSA should give themselves a fine.

Buddy, can you spare a dime?

A whole raft of headlines over the weekend to cheer up the weary investment banker.

First, there's the news that BNP and Credit Agricole are going to fight over ownership of SocGen, after the French bank declared almost $10 billion in losses from rogue traders and subprime.

Then another saying that Massachusetts' regulators are accusing Merrill Lynch of fraud, for selling securities to the City of Springfield that were backed by subprime mortgages.

Then the news that Goldman Sachs are ramping up their debt exposures by creating a mezzanine debt fund with $12.5 billion in capital and another $7-$9 billion in borrowed money.

This flies in the face of everyone else who can't raise a bean for the life of them as the subprime meltdown continues. Companies reported losses so far include:

• Citigroup:                    $18.0 billion
• UBS:                          $13.5 billion 
• Morgan Stanley:             $9.4 billion
• Merrill Lynch:                 $8.0 billion 
• HSBC:                           $3.4 billion 
• Bear Stearns:                 $3.2 billion 
• Deutsche Bank:              $3.2 billion 
• Bank of America:             $3.0 billion 
• Barclays:                       $2.6 billion 
• Royal Bank of Scotland:    $2.6 billion 
• IKB:                              $2.6 billion
• ShocGen                        $2.0 billion
• Freddie Mac:                  $2.0 billion 
• Credit Suisse:                 $1.0 billion 
• Wachovia:                     $1.1 billion

Source: Company reports

This lot, edited from the BBC's website, totals $75.6 billion declared losses to date.  This misses smaller losses, such as BNP Paribas, Bank of Tokyo-Mitsubishi UFJ and others, many of whom are reporting $500 milllion or more losses.

Finally, there's the knock-on impact of the subprime as it rolls into the insurance communities of America.  A good example is Ambac Financial, who can't find anyone to invest in a bailout due to their exposure to subprime risk.  As a result, there was the news that the banks are bailing out the monoline insurer in a $15 billion plan.  The banks involved are Citigroup, Wachovia, Barclays, Royal Bank of Scotland, Société Générale, BNP Paribas, UBS and Dresdner. 

Why? 

Because these are the banks most exposed to their subprime debts and Ambac can't find anyone else to help them out due to the risk.  Bit of a vicious circle that one, isn't it?

It also intrigued me that Ambac Financial's "About Us" section of their website says:

"Ambac Financial Group, Inc., headquartered in New York City, is a holding company whose affiliates provide financial guarantees and financial services to clients in both the public and private sectors around the world. Ambac's principal operating subsidiary, Ambac Assurance Corporation, a leading guarantor of public finance and structured finance obligations, has earned triple-A ratings from Moody's Investors Service, Inc, Standard & Poor's Ratings Services and Fitch, Inc ..."

Really?  Not sure I'd invest in the leading guarantor of structured finance obligations.  Maybe that's why the next line is:

"... Moody's has placed Ambac's triple-A rating on review for possible downgrade. Standard & Poor's has placed Ambac's triple-A rating on "negative outlook." Fitch has placed Ambac's triple-A rating on "rating watch negative." Ambac Financial Group, Inc. common stock is listed on the New York Stock Exchange (ticker symbol ABK)."

Ah well, thanks for the credit rating agencies in being so fast to alert us to these potential problems.  I guess they had to wait until after Ambac announced fourth quarter net losses of $3.2 billion  to realise there was an issue, didn't they?

Meanwhile, whilst Goldmans leverage debt for good investments, everyone else is scrabbling around to try and work out how much debt exposure and related systemic risk really exists in the markets.

Some say that the overall subprime losses are expected to be around $200 billion, best case.  Others say that if you add in all the monoline insurers and other knock-on effects, such as corporate defaults due to lack of access to capital, and worst case is expected to be up to $500 billion.

No wonder millionaires are stuffing their savings back under the mattress. 

Buddy, can you spare a dime?

Bankers are overpaid, greedy pigs

After my doom and gloom week, I thought this was a good title for a blog entry although this is not me talking ... rather it seems to be a campaign with a certain associate editor and chief economics commentator at the Financial Times named Martin Wolf.

The campaign began a while ago, with a column entitled "Why banking remains an accident waiting to happen" in November last year.  Martin's column begins:

"Why does banking generate such turmoil, with the crisis over securitised lending the latest example? Why is the industry so profitable? Why are the people it employs so well paid? The answer to these three questions is the same: banking takes high risks. But the public sector subsidises this risk-taking. It does so because banks provide a utility. What the banks give in return, however, is gung-ho speculation."

In other words, bankers take high risks, but suffer no consequences as they are underwritten by governments.  Certainly, with the example of Northern Rock in the UK, some may say this is true.   

Then Martin picks up on another FT columnist from a week ago.  The article was by Raghuram Rajan, a professor of finance at the Graduate School of Business at the University of Chicago and former chief economist at the International Monetary Fund. Raghuram writes an insightful piece entitled "Bankers’ pay is deeply flawed", with an opening line that gives away it's point: "Morgan Stanley announced a $9.4bn  charge-off in the fourth quarter and at the same time increased  its bonus pool by 18 per cent."

Finally, we get another column by Mr. Wolf on Tuesday entitled "Regulators should intervene in bankers’ pay", and this one's a real doozy.  A few choice snippets include:

"The world has witnessed well over 100 significant banking crises over the past three decades ... no industry has a comparable talent for privatising gains and socialising losses ... they know that as long as they make the same mistakes together – as “sound bankers” do – the official sector must ride to the rescue. Bankers are able to take the economy and so the voting public hostage. Governments have no choice but to respond."

This is followed by: "That is so for three fundamental reasons: first, these are virtually the only businesses able to devastate entire economies; second, in no other industry is uncertainty so pervasive; and, finally, in no other industry is it as hard for outsiders to judge the quality of decision-making, at least in the short run. This industry is, in consequence, exceptional in the extent of both regulation and subsidisation. Yet this combination can hardly be deemed a success. The present crisis in the world’s most sophisticated financial system demonstrates that."

Followed by lots of other good stuff.

So Mr. Wolf is on a personal tirade to expose the fact that bankers are overpaid, greedy pigs who feed at the trough of society and are never held accountable as, when their excesses are untangled, all the other farm animals have to pay. 

It starts to sound like something out of an Orwellian Animal Farm, with the farmers being Bush, Bernanke, Brown, Barosso and all the other politico's.  The governators of the world have to tax the workers to fund these capitalist pig-dogs.

Oh, I'm sorry.  Am I getting a bit too worked up here.  Am I in danger of biting the hand what feeds me?

Bear in mind, it is not my voice here, but that of the Financial Times: the journo of the bankers and for whom I sometimes provide input.

My own view is that some bankers are overpaid ... I mean even David Beckham might balk at the idea of being paid $160 million for being the man who led his team to relegation and lost the championship, and yet Merrill Lynch's Stan O'Neal had no such qualms.  But this is only in certain parts of the market. So yes, in some areas, they are not compensated on the risks they are personally taking, but on the risks they are taking with other people's money.  And many banks and bankers do blindly follow each other around the markets because they cannot bother to think for themselves.

Sure, this is true.  After all, a seasoned investment banker told me years ago that bankers are lemmings, rather than pigs.  They follow each other in packs and fall off cliffs, only to turn and hope they can avoid the drop at the last minute.  Some do and some don't, and right now there are a number of banks tettering on that cliff-drop.   

The bottom-line here is not that bankers are feeding at the trough of society as overpaid capitalist pig-dogs, but that they have made a fundamental error of judgement.  And the fact that they do this again, and again, and again (1985, 1987, 1998, 2000, 2007 ...) with increasing frequency is going to put them in the public eye and open to this sort of questioning.

The fact that we have another day of reckoning just means that the media is enjoying every single moment, because most of these journo's earn less than one-hundreth of the remuneration that these masters of the universe enjoy.

Me?  I'm going down the pub.

Five firm predictions for 2008

Welcome to 2008 folks, and I hope you all had a wonderful holiday break. I did ... but what goes on at Xmas, stays in Xmas as they say (hic!).

Anyways, a year ago, I made a bunch of forecasts for the year 2007.  This year, I'll go a step further and make some concrete predictions.  However, before doing that, I was looking back at last year's forecasts and they weren’t far off, although I tend to over-estimate the speed of change and under-estimate the impact.  For example, I hoped that 2007 would be the year of Web 2.0 for retail banks. A year later, I hope that 2008 will be the year of Web 2.0 for retail banks.  It didn’t happen last year.  2007, as mentioned before Christmas, was the year some banks woke up to Web 2.0, but most were still fixating upon branch transformations.  Nothing wrong with that, but things are moving at such a pace in our socially networked world that many are going to miss a trick.

So, here’s a bit of wishy-washy forecasting for 2008 and then five firm predictions that will definitely happen before 31st December 2008.

First to the wishy-washy. 

2008 will be the year of the customer. 

Wow!  What a surprise.  Did we forget the customer in 2007?  Nope, not really.  However, 2008 will be the year of the customer because the banks will start to deliver what the customer really wants.

In investment banking, this means best execution and transparency.  That is what MiFID, RegNMS and a host of other global regulations is trying to force into the market but it doesn’t need regulation to make this happen.  It just needs customers – fund and asset managers in the institutional investment firms in this instance – to demand it.  And they have been and are making those demands.  Those demands, combined with the regulatory regime, will mean that the bankers who try and duck the customers’ scrutiny will get caught out.  So yes, there will be an investment bank that gets hauled over the coals for failing to deliver best execution in 2008.

In payments, delivering what the customer wants is all about the dialogue banks were having through 2007 around supply chains.  Supply chain management is the bankers’ focal point for turning around their internal scrutiny on bankers processes and trying to understand their customer’s processes.  Why is this important?  Because banks want to demonstrate their true value to their customers before their customers chuck them out.  Therefore, 2008 will be all about how to create real-time, value-adding, corporate information services into the financial processes that support the supply chains of bank’s customers.  That will be a critical dialogue.

And, as mentioned already, for retail banks it will be a rush back to the internet to focus upon social networking.  2007 was all about branch transformation strategies being delivered.  2007 was all about creating branch experiences and turning tellers into sellers.  2008 will now be around how to leverage the branch experience with a consistent and complementary electronic experience using social networking as the underpinning.  Again, it will be about giving the customer what they want face-to-face locally and electronically remotely.

So, as can be seen, all aspects of banking will be focusing upon giving the customer what they want, whether that is best execution and transparency in investment operations, real-time information services in supply chains, or experiences that exceed expectations locally or remotely, online or offline.

In other word, 2008 will be the year of the customer.

OK, that’s the wishy-washy stuff out of the way.  Now to the real meat of 2008 – what’s really going to happen?

Here are five predictions  … and yes, I am playing safe but you would not expect a wild and wacky view here would you?  OK you might, but as you’ll pick these up in January 2009 I think it’s better to be safe.  Also, these predictions are all about banking, as predicting that Barrack or Hilary would be in the White House in a year, or I love Huckabee is not part of this ritual.

So here we go.

 

Prediction #1: A Top 10 US Bank will be majority-owned by a foreigner

It was interesting over the winter break that the business editors at The Times commented on Warren Buffet’s investments, and how he’s totally avoided supporting US domestic banks during the credit crunch crisis.  In fact, he’s gone into low-tech industrial services instead with a major investment in Marmon, who make railway tankers, plumbing materials and household wiring.  Meanwhile, the dollar-bleeding subprime casualties of Bear Stearns, Countrywide Financial, Citigroup, Morgan Stanley, UBS and Merrill Lynch have all been ignored by Warren.   Instead they’re being propped up by saviours from Asia and the Middle East in the form of Sovereign Wealth Funds.

Therefore, I reckon there will be a major storm mid-2008 as a Sovereign Wealth Fund from China, India or the United Arab Emirates – what?! – gains a 51% or higher stake in a major US bank.  This will then form the source of a major debate in the middle of the presidential battle, with the likes of Michael Bloomberg and Steve Forbes jumping to support the Obama and Huckabee campaigns.  The fight will be wonderful to watch as quiet diplomatic support meets hell and brimstone outrage, and presidential candidates fight over the loss of American leadership in the financial markets.

Why is this prediction likely?  Well there were already forays into American banking from China last year with Blackstone, the leading US private equity manager, is now 10% owned by the Chinese, as is Bear Stearns.  Over the course of 2008, Sovereign Wealth Funds will stretch their muscles even further and, with the dollar weak and the economy teetering into a recession, American financial firms will look like a cheap target throughout the year.

 

Prediction #2: A bank will be fined over $1 million for non-compliance with MiFID 

We all know that MiFID has been implemented in a fairly roundabout fashion, with some countries still to transpose. However, certain markets have been very proactive and vigorous in getting MiFID in place to demonstrate best practice, with the FSA in the UK being the first to get their teeth into the implementation.  As a result, the FSA will also be the first to find and set an example of a bank that is undermining the spirit of MiFID’s best execution policies. 

The test case will occur towards the end of 2008, by which time they will believe that most banks have had more than enough time to get used to MiFID’s requirements, nuances and policies and hence will be viewing any non-compliance as flagrant disregard.  The worst offender will be picked out and heavily wrist-slapped with a fine that will be viewed as one of the highest of 2008 but, in comparison to earnings and profitability, will actually mean diddly-squat in practice. 

Why is this prediction likely?  Because it will demonstrate to the European Union that the London markets are once again at the forefront of leading the charge towards transparency and a level playing field, whilst maintaining London’s and the FSA’s integrity, and pushing the markets to view the City as one of the world’s best trading grounds therefore.

 

Prediction #3: PayPal reaches 200 million users, Facebook 100 million and a major bank launches a social network for consumers

In November 2007, PayPal claimed 164 million user accounts in almost 200 markets and 17 currencies worldwide.  PayPal’s rise and continued rise staggers.  In March 2007, for example, they had 133 million accounts in 103 countries, 100 million in February 2006 in 55 countries, and only 16 million back in May 2002.

Facebook’s rise is equally dramatic, claiming 2 million new users each week and over 50 million users worldwide in December 2007, of which 10 million are in the UK.  Compare that with 7.5 million users in July 2006 rising to 18 million in February 2007 and you can see the phenomena in action.

The network is in action and dramatic social interaction at that.  The power of the network is such that each time someone is added to it, they multiply the number of people communicating and hence fuel the rapid rise of communication.  This is why “If 100,000 people join my group, my wife will call our second child Spiderpig” gained 100,000 members on Facebook during the summer ... in days.  This is why “Stop the HSBC Graduate Rip-Off” stopped the HSBC graduate rip-off by gathering over 6,000 members on Facebook in a fortnight.

This is also why Zopa, Propser, Boober, Smava and many other social finance sites are starting to build new models of investing and borrowing.  Therefore, 2008 will be the year that banks start experimenting with social lending and social finance.

Why is this prediction likely?  The idea is already on the rise, with Fortis and Bank Of America building business community sites, but no bank has really got into trialling these ideas in a retail context.  Why would they as it undermines their business model?  The Zopa style low margin platform is totally at odds with a bank’s credit-debit offset model.  But I feel a bank will try to bring in more social connections in their retail operations, even if it’s just a bit of blogging around your bank statement online.  Watch this space closely in 2008.  After all, banks cannot ignore markets that grow from nothing to 100 million or more users in under two years.

 

Prediction #4: There will be another major European merger of banking goliaths

You thought the Royal Bank of Scotland, Fortis, Santander fight with Barclays for ABN AMRO was a humdinger in 2007?  Think again.  There will be another one in 2008.   In fact, there will be lots of little sparks of merger as demonstrated by the fact that Santander has already been trying to woo Alliance & Leicester, but this one will be a major ding-dong in mainland Europe.  No names mentioned, but it wouldn’t surprise me if there may even be a non-European bank playing an instrumental role in the battle.

Why is this prediction likely?  Well, what the hell is the point of what Charlie McCreevy is doing with SEPA and MiFID and the rest, if it’s not meant to move Europe towards a more harmonised, rationalised and efficient market.  And right now, Europe is far from that as 9,500 banks is an awful lot for a territory that can only sustain about 3,000 long-term.

 

Prediction #5: Green Computing becomes a hot topic

It’s funny that I spoke about green computing over a year ago and was met by blank stares.  Then a couple of banks, Dutch ones being at the forefront, started telling me that they were willing to refresh their technology on a three-year cycle rather than four years, if it could demonstrably reduce carbon emissions and power outage.  In 2008, I reckon a lot of other banks will get this message if, for no other reason, than to look good.  Many banks this year will therefore start talking about their green credentials and will ask technology providers to do the same, as demonstrated by the most recent Finextra headlines.

Why is this prediction likely?  Come on, everyone wants to be green these days, especially after Al Gore won a goddam Peace Prize for harping on about it.  So you gotta show you’ve got a green finger or greensleeves these days haven’t you?  Thing is though, most of us don’t actually give a stuff.  I mean, I’m all for green but cancel my holiday to Barbados?  Get outta here. 

This is the view of most of the investment banks I talk to: green is of zero interest.  Their only focus is on power and latency and their issue is being hampered by space.  They cannot actually get all the processing power they want into the office space that’s available. However, what you will see this year, is lots of processing power going into banks, and core technology refreshment to exploit speed, power, mips ... all under the label of green.  This looks good from a marketing viewpoint and you never know, it just might win us the FT’s Sustainable Banking Award in 2009! 

 

So there you go folks, five predictions for 2008:

1. A Top 10 US Bank will be majority-owned by a foreigner
2. A bank will be fined over $1 million for non-compliance with MiFID 
3. PayPal reaches 200 million users, Facebook 100 million and a major bank launches      a social network for consumers
4. There will be another major European merger of banking goliaths
5. Green Computing becomes a hot topic

These are all safe bets, and there are many more I could cover but I thought they were too obvious.  For example, a bank will have a payments problem due to SEPA or a bank will find fraudulent activities rise rapidly due to their trials with mobile and contactless payments. These are valid but I wanted to stick to the top five that were slightly off radar, which are above.  And a top six or top seven doesn't sound as good as five.

Meantime, my forecast of Microsoft's demise has been followed up with Bill Gates crashing and burning at CES this week. Sorry guys. This is not a campaign, just a lament.

My other predictions?  Well, I had a few wilder ones such as a bank implodes due to their technology exploding, but decided to stick with safe and sound.  However, just in case, here’s ten more for those who wanted the weird and wacky:

#1: Britney Spears will enter rehab

#2: Britney Spears will leave rehab

#3: Britney Spears and Lindsay Lohan will enter and leave rehab together

#4: Paris Hilton will marry Kevin Federline, with Britney and Lindsay as bridesmaids

#5: Celebrity Big Brother will merge formats with I’m a Celebrity … get me out of here and Strictly Come Dancing to form I’m a Dancing Celebrity’s Brother

#6: The Doors will reform to cash in on the latest mega-group band reunions wave, with Jim Morrison’s vocals performed by Robbie Williams

#7: Hilary Clinton will be found in the Oval Office with Barrack Obama

#8: José Manuel Barossa will be found in The Hague with Angela Merkel

#9: David Cameron will be found in the Houses of Parliament with Michael Portillo

#10: This year’s Christmas #1 download will be the YouTube clip of Chris Skinner being arrested for spreading false rumours.

Here’s to a great 2008 and a Happy New Year to all of you.

 

2007 in review: will Capital Markets survive?

The end of the year is nigh and not a day too soon for some investment bankers.  Some say, with the $500 billion of subprime losses this year, this has been a major downer for the markets long-term.  Others say

that $500 billion is what the stock markets can lose in a day, so don't worry about the credit crunch of 2007 ... it's only a blip.

I blogged about the ups and downs of the credit crunch, the bonus season, algorithmic trading going through strange hiccups and all sorts of other stuff.  It's a bit of a far cry from the start of year, where the discussion was all about the search for alpha and how brokers would start using complex algo to bridge across multi-asset strategies. That is not to say they are not doing this, just that they will be doing it with far more risk management focus than ever before. 

After all, in the investment markets, it has been quite a year.  In particular, the summer's turmoil in the financial markets, the like of which has not been seen for over two decades, meant that Citigroup, Merrill Lynch and others posted major losses and ousted CEO’s.  Meanwhile, we had one of the most shocking runs on a UK bank, Northern Rock, for years.  Some people thought for hundreds of years but actually a similar event occured less than twenty years ago with Town & Country Building Society in 1991, a small UK community-style bank.

With all of these upsets, and half a trillion dollars thrown down the tubes, we all wonder what is going on.  Has the world gone mad or did someone just pull the plug on the financial stabilisers we learned to live with in recent memory? 

No, nothing has gone mad.  We just happen to be seeing one of the major explosions erupting in financial markets that occur on a fairly regular basis.   

After all, think back a few years and we had a bad few days in 2001 when the internet investment boom ended and many lost millions.   Equally, America has had a subprime style mortgage crisis before in the 1980s.  In fact, the financial markets seem to boom and bust on a fairly cyclical basis, and some would say that you should view it this way, e.g. investment banks boom and then bust and then boom and then bust.   

What does this mean for all of us today?  It means being circumspect and thoughtful.  It means thinking very carefully about the knock-on effects of what we do and how we invest. 

For example, the credit crunch and subprime crisis was incredibly obvious in the way it brewed ... just that no-one was watching the kettle.  What was so obvious?  Well, lending to people who could ill-afford to pay back on the basis of a piece of collateral called a house.  Now, the house price was rising, but only because of al the irresponsible lending. All of this lending was then wrapped up in complex derivatives in the investment banking operations and laid off to the capital markets through structured investment vehicles (SIVs) and collateralised debt obligations (CDOs).  The fact that the debt had collateral that was worth half of its book value, inflated through the very SIVs and CDOs that funded it, was never known or considered.   

So the point is this.  You create an artificial bubble through bank processes that, on the one hand, inflate the market through unsubstantiated loans and borrowings whilst, on the other, offset the risk through wrap-around products that hide the true credit risk laying underneath, is something the markets and regulators and governments never want to see again. 

And how do you avoid this ever happening again?   

Through an enterprise risk view of course.  Sounds easy, but this is very hard to deliver in practice.  What this means is that for each risk you lend against, you clearly understand the underlying picture and exposure it creates for the bank.  This is sound economic and investment theory but it was thrown aside in recent times, as clearly demonstrated by the credit crunch financial crisis.  Only by managing total risk from the end borrower or investor through to the collective investment vehicles used in the investment operations, can a bank truly manage its enterprise risk.  That is the real point: enterprise risk.   

Show me a bank who can manage the totality and I’ll show you a sound bank. Now, there’s aren’t a large number of those around these days, are there?

Meanwhile, from the technology perspectives, this year has been all about low latency, high throughput. We've seen increasing moves to manage latency and make this a differentation, with my favourite story of the year being the bank that moved their routing for Tokyo deals that originally went from London via servers through New York to using servers through Moscow, as it saved them 25 milliseconds.   Will wonders never cease?

Another technology that keeps evolving is the algo stuff.  Last year, it was simple black box algo trading starting to get a bit sexier with cross-asset class instruments.  Equally, the idea of simluated trading strategies and real-time illustration through graphics of the success or failure of the trading strategy.

This year, the hot topic has been news algorithmics and the idea of embedding any news related to a stock ticker into the real-time trading arena through automated reference data is becoming a hot topic.  It doeesn't mean humans ever go away, but it does mean that we see a market that is very different in structure and volume and value thanks to low latency, highly sophisticated, algo-automated markets.

Finally, we can't forget that 2007 was the year of MiFID. It's here and we're all going yippee, aren't we?  Some analysts who aren't that familiar with the markets think it involved hardly any issue or impact, whilst the markets have worked with me to write a book about the subject, and seem to be saying it's been quite an upheaval.

This is why we have new exchanges like Turquoise, Chi-x, Equiduct, Virt-x, Smartpool and company.  Then add the existing and newer dark pool and algo systems, e.g. Goldman Sachs Sigma, JPM's Aqua and Arid, Credit Suisse's Crossfinder etc, and you can see we have many new trading venues across Europe to interface, integrate, work with and deal with.

The MiFID monologues are well mantained on Finextra and now I just look forward to the first Best Execution trial of 2008.  More on this next year.

Anyways, back to the question: will capital markets survive?  Of course they will.   I think they've seen more volatility and change this year than in the past five years, but change is good.  It makes us move on. Meanwhile, as the economist Paul Samuelson stated, stock markets with all of their ingrained volatility are not the best recessionary indicator as, if you'd followed their advisory trends, they predicted nine out of the past five recessions.

Back here tomorrow for a review of Retail Banking 2007.

 

 

 

EU love-in between politicians, bankers and regulators

After eighteen months, the European Parliament once again opened their doors to a dialogue about the state of European financial services.  With a series of presentations and top-notch speakers, we review:

• “The implications for EU integration of globalised financial services”
• “Can the EU legislative framework cope with cross-border developments, worldwide competition and market strains?”
• “Perspectives and Priorities for the EU Banking and Financial Services Industry”
• “What focus for EU securities infrastructure in today’s globalised financial markets?”
• “What are the key challenges and trends for Europe’s retail payment systems?”
• “SEPA: for a sustainable and balanced business case”

and so on. 

Strangely enough, SEPA does not spell “Sustainable And Balanced Business Case” (SABBS?), so maybe that last session should have been called “SEPA: for a Single Euro Payment Already” as it is about to start in less than a month.   On that subject, I’ve just finished editing 35 chapters all about Europe after SEPA for a book coming out in March 2008 … watch this space.

Anyways, back to the European Parliamentary debate.  Speakers included:

• Charlie McCreevy, European Commissioner for the Internal Market and Services
• Neelie Kross, European Commissioner for Competition
• David Wright, Director, DG Internal Market and Services, European Commission
• David Vegara, Spanish Secretary of State for Economic Affairs
• Fernando Teixeira dos Santos, Portuguese Minster of Finance
• Tommaso Padoa-Schioppa, Italian Minister of Economy and Finance
• Henri de Castries, Chairman and CEO of AXA Group
• Elizabeth Corley, CEO, Allianz Global Investors Europe
• Georges Pauget, CEO, Credit Agricole
• Jean-Claude Trichet, President of the ECB
• William Cruger, Managing Director, JPMorgan
• Jean-Francois Theodore, Deputy CEO, NYSE Euronext

… you get the idea.

It is pretty heavy duty stuff and will form the basis of this week's blogging so - for those who have no interest in Basel II, Solvency II, the PSD and SEPA, MiFID, Multilateral Interchange Fees and such like - I'm sorry.  This week's blog will be pretty dull, although I'm sure I'll be able to find ways to liven it up.  For example, the question from the Italian consultant to the French politician: " 'Ow coma, yua never implementeded alla of zee laws of competition? " to which the French politician replied, "Qu'est-ce vous direz?  Je ne comprend pas."  (loosely translates to "Stop talking rubbish and get lost").

So I was pleased to see they included a repeat of the session: “Should Europe have a single regulator”. 

This year, they increased the panel from six speakers to eleven.  It just shows what a critical question this is.  So the panel comprised keynotes from Tommaso Padoa-Schioppa, Italian Minister of Economy and Finance, and Jean-Claude Trichet, President of the ECB. 

This was followed by a debate with:

• Edmond Alphandery, Chairman, CNP Assurances;
• Jorgen Homquist, Director General, DG Internal Market and Services, European Commission;
• Sir Callum McCarthy, Chairman, the Financial Services Authority (FSA);
• Daniele Nouy, Chairwoman, Committee of European Banking Supervisors (CEBS);
• Michel Pebereau, Chairman, BNP Paribas;
• Thomas Steffen, Chairman, Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS); and last, but not least,
• Eddy Wymeersch, Chairman, Committee of European Securities Regulators (CESR).

Three of the key Lamfalussy European supervisory bodies in attendance: CEBS, CESR and CEIOPS, meant that this would be a strong debate … or so I thought.

Instead, what came about was more of a love-in than a punch-up.  I guess the shell-shocked markets of Europe, recovering from the US sub-prime credit crisis, feel more inclined towards stronger regulation than ever before, although that was not what was being called for.

In fact, it was more to do with convergence of regulatory and supervisory bodies through cooperation and coordination.

For example, the first keynote from the Italian Minster of Economy and Finance, Tommaso, began with the opening lines:

 

“Tomorrow, I join the committee looking at the effectiveness of the Lamfalussy process for better regulation, as it has been seven years since its launch in 2000.   Our conclusion should be a simple one.  I am going to recommend the European Commission to instruct the relevant committees to deliver over a short-term horizon, as in during 2008’s French presidency), two results:

1. to reach the point of having a single manual of rules applicable to all supervised institutions in the EU; and
2. to have an integrated supervision for institutions that are in more than one EU member state.

“This is the spirit of Lamfalussy, although it does require some changes to EU national laws.  We need these two results urgently because multinational European institutions are subject to a very heavy regulatory burden, which is far heavier than if there were a single manual of rules.  Also, this manual of rules regarding transparency and investor protection has failed, because of the fragmentation and diversity across countries. 

 

“The result is that we have paid a very high price for a very poor outcome.”

Tommaso was followed by Jean-Claude Trichet of the ECB who had two basic messages and three recommendations for the future. 

His two basic messages were:

1.   The EU regulatory and supervisory framework needs to promote more movement to a single market whilst ensuring stability of the core system.  The Eurosystem is convinced the EU framework will meet these challenges only if the requirements for local practices are reduced to the minimum, in other words nothing.
2. There needs to be an adequate institution to manage greater integration of regulation and implementation and this needs cross-border coordination at a centralised level for convergence to occur.

And Jean-Claude’s three recommendations were:

 

1. Reinforce the role and operating mechanisms of the Committee of European Banking Supervisors (CEBS).  The current regime of a consortium of national supervisors does not work, and CEBS needs to be bolstered to be a full part of the L3 committees (the Committee of European Insurance and Occupational Pensions Supervisors, CEIOPS, and the Committee of European Securities Regulators, CESR) to create greater EU cross-border convergence and cooperation.
2. Improve the level of regulatory convergence as progress is a key issue, especially in the banking sector where most EU rules, apart from the Capital Requirements Directive (CRD), were adopted before the Lamfalussy process started.  Even then, the CRD has a lot of differences in each member state and progress needs to be made towards more consistent EU banking rules.   Regulatory convergence should be further enhanced through supervisory convergence via CEBS.
3. The arrangements for cross-border information sharing and cooperation for banks in the EU should be further enhanced.  The cross-border cooperation between supervisors and National Central Banks (NCBs) should be further strengthened in preparedness for any further financial crisis. 

After these two keynotes was a long-ranging two and a half hour discussion amongst the other panellists.  I think Callum McCarthy gave the most succinct summary of this debate:

“Here are the things upon which I think all the speakers can agree.  First, regulation imposes costs on firms in the financial industry, so the regulation should be properly targeted, effectively administrated and that avoids duplication.  We don’t currently achieve that.  Second, supervisors managing cross-border institutions need to collaborate as much as possible to control risk and avoid costs.  Third, we need regulatory structures that support convergence.  Fourth, the Lamfalussy process today does need improvement.”

 

On the last point, this is why there’s a Lamfalussy in-depth review taking place right now ... this is the one that Tommaso referred to in his opening words.

 

What became clear during the discussions is that there are still very conflicting views as to what is required, with three different sorts of European regulatory regime envisaged.

First, there is a view of a central policymaker at European Commission level with national regulators acting as administrators and policing the policies.  This is the one that liaises with the SEC in the USA, as well as Japan, China, India and others.  This is the one name-checked in the EC presentation last week, where the Commission made it clear that they are working with the G7 and SEC to allow mutual recognition for firms to passport operations into each other’s geographies under the host regulator acting at a regional operational level.  For example, Bank of America’s investment operations may be managed under a home regulator, the SEC, with host supervision through the European Commission’s CESR or other body.  However, this does not work because some countries have more at stake than others.  For example, 80% of European UCITS are sold through Luxembourg and Ireland; equities are primarily traded through three exchanges; and so forth.  Therefore, you should naturally turn to the regulator with the most experience and knowledge of the financial market.

Therefore, a second view is that there should be lead regulators, who are the lead regulator of the operators’ home state. This is the approach being taken by CESR for MiFID but, as Callum McCarthy pointed out, you can then end up with 27 lead regulators and equally, some nations do not like the idea of being secondary to a lead.  So what do you do?   Well you go for the third view, and this is the one that everyone seems to have agreed to follow.   

The third view says that you work together in a consensual fashion, with lots of convergence through committee based upon majority voting. Where a nation’s regulator wants to follow a different course of action to that agreed by the majority they have to publicly explain why.  If their explanation is not solid or justified, then they are publicly named and shamed. 

This final example is the one that CEBS, CESR and CEIOPS appear to agree upon, as does the ECB and EC, so this is the one they are going to follow.

It basically says there’s central rule-making but local application.  The focus is on the principles-based spirit of what is trying to be achieved, with a focus upon the outcomes – the market practices and operations – rather than the detail and the application.  In other words, you can have local market differences but only to the extent that they do not materially alter the spirit of what is being required.

On that note, the best question of the day had to be from the audience member from the Bank of Italy (the Italians win for me every time), who asked: “Could the panel please tell me what they are converging towards, how they define moral hazard in this context and how their efforts will ensure we manage moral hazard out of the markets?”

This was the best question because (a) it cuts to the heart of why committee-based consensus does not work, (b) no-one on the panel wanted to answer it, and (c) everyone gets nervous when an Italian starts talking about moral hazards.

A month after MiFID and 'nothing happened' - who says?

OK so it's not quite a month since MiFID came into force on 1st November, and I got a flurry of emails over a statement made by one of the research firms* that, "It's been remarkably quiet. I don't think there've been any big issues ... I think everyone can be pleased that they've complied." 

Now, to be honest and fair, I think this firm is trying to indicate that the big explosion, the big bang, the major revolution has not happened.  So I'll agree with that.  Most of us refer to MiFID as the long moan rather than the big bang.

As a long moan though, a lot has happened. 

We have many new market players in trading (Chi-x, Equiduct, Smartpool, PlusMarkets, Turquoise …) and trade reporting (Omgeo, Boat, ICMA’s TRAX2, as well as new systems from LSE, Deutsche Bourse and Reuters).

We have had issues with LSE's new systems reached breaking point shortly after MiFID's launch.  That was a shock and, in part, relates to the fact that trade reporting issues, which were never fully resolved, are creating duplicate reports and false flags.  The result is that there is confusion about what was traded with whom and where. As is the fact that there are now over 190 execution venues trading across Europe creating a data bubble.

We also had the Property Investment Market suspending business because they could not get a license from the FSA as an MTF, as reported by John Cant the other day.

I don't think "everyone can be pleased that they've complied" is quite true however, as I hear lots of firms are non-compliant, including some of those involved in the big projects. 

For example, the fact that the firms publish their “best price” but that those prices aren’t firm is, in my view, non-compliance.  These prices are not firm as, by the time the retail investor tries to get in there, the price has changed.  This price change happens to be due to delays between pre- and post- trade reporting systems.  The delay allows the directly connected professional investor to get best price, but retail investors connected to retail service providers do not. 

Now these delays may be purposefully built into those systems of course, and I am told that this is ok because the FSA has ruled that such prices are allowed to pass through as the “negotiated price”, so that’s ok.

To me, this is non-compliance.

Equally, the fact that no-one has been taken to task yet is primarily because no-one has been tested for compliance yet.  The FSA and European Commission are instead watching very carefully to see how firms are behaving and which are misbehaving.  Those caught in flagrant disregard, watch out.  Around April 1st, you will be made to look like fools for your in flagrante delicto disregard.

For example, I just attended a nice presentation this morning from the European Commission giving an update on MiFID.  Their comments included:

“We have continued infringement proceedings against those who have failed to transpose which currently focuses upon four member states: Czech Republic, Spain, Hungary and Poland.  Spain is voting today to transpose level 1 of MiFID by mid-December, and Hungary did so last week.  But we will be naming and shaming those countries that fail to implement and the Commissioner is regularly on the telephone to their finance ministers as a result.”

In this update, they also mentioned that in Q1 2008 the Commission will make rulings around bond markets and other non-equities markets and their coverage under MiFID, and Q4 2008 a statement on commodities markets.

Equally, they will be updating transparency rules to cover delay tables and the availability of execution data quality, as well as bringing back telephone recording as a requirement of reconstituting trades.

Watch this space.  MiFID is by far and away unfinished.  More to come later.

 

* one of my friends has it in for this firm so I promised not to mention that it was Gartner again.

How many bankers does it take to change a lightbulb?

Eight of course.

One to change the lightbulb.

A second to assess the risk of the light bulb changing process.

A third to ensure the light bulb changing process adheres to the internal compliance regime for health and safety during light bulb changes.

A fourth to ensure that the internal purchase order procedures have been adhered with for light bulb change orders.

A fifth to audit the supply of the light bulb following the internal purchase order procedure.

A sixth to report back to the compliance and risk functions that the supply and audit divisions had complied with the light bulb change risk and compliance procedures.

A seventh to monitor that the light bulb was changed by a member of staff who was cleared by the banking union to be authorised with light bulb changing management.

And an eighth of course.

This person is responsible for costing the light bulb changing process and being creative enough to incorporate the pricing of the eight people into the customers' monthly billing statement without the customer noticing.

That's processes folks ...