The Financial Services Club's Blog

Is SEPA Happening and Does It Matter?

We had our annual pantomime debate at the Financial Services Club this week, with a classical Oxford style debate about whether SEPA, the Single Euro Payments Area, matters or not.

This year, with the backdrop of the Eurozone implosion, the debate was far livelier than usual, with a lot of spicy discussion about countries defaulting, the euro instability, the lack of political union and more.

In particular, the argument against the Eurozone was stronger than usual and so the pro-SEPA panel was loaded with three speakers:

• Daniel Szmukler, Head of Communications and Corporate Governance at EBA Clearing;
• Ruth Wandhofer, Head of Market Policy and Strategy, EMEA, Global Transaction Services, Citi; and
• Jose Beltran, Director of SEPA, STET.

On the other side was:

• Simon Bailey, Director, Logica
• Johnny Brit, former Chairman, Xenophobank

With the last person being a class act anti-euro plant.

It certainly stirred up the debate a bit.

The Case For SEPA

 On the positive side, the panellists argued that SEPA is good for Europe, European Union, and European business and for European politicians.  In fact, it’s even more critical today than it has ever been as the strains on the Eurozone would fall apart far more easily if SEPA and other aspects of the European Economic & Monetary Union (EMU), the Financial Services Acton Plan (FSAP) and the Directives that go with this were not so firmly established in place.

SEPA has been slow to progress, but it’s a ‘moving target’ and should be seen in context as a complex project that involves 9,000 banks and 27 countries (plus four if you include the Extended Economic Area of Norway, Iceland and Liechtenstein plus Switzerland).

This means that you need to understand that the political complexity in delivering a project like SEPA in banking is just a reflection of the political complexity of getting 27 nations to work together across the Union, and you can see how hard that is from things like the latest EU Treaty, the issues in Greece and the PIIGS and more.

In fact, progress was slowed because you had some countries blocking SEPA whilst others publicly supported the program whilst privately were trying to sabotage it, just as any political issue is dealt with.

The slow progress was also down to the fact that it was seen as a compliance project, which caused issues at the start as the program was given to lawyers rather than infrastructure operators.

This meant it was also seen as threat to banks rather than an opportunity.

Equally, it’s still unfinished and there’s still a lot of work to do, with goal posts changing as more requirements are added each month by regulators and governments, but important steps have been taken in terms of creating:

Good governance, through the European Payments Council (EPC) which took two years (2002-2004);

Good practices, through the development and implementation of the SEPA guidelines (2004-2008); and

Good delivery, by demonstrating that SEPA Credit Transfers are working, with almost a quarter of all credit transfers now in the SCT formats (2008 onwards).

Some countries such as Luxembourg and Cyprus now transact almost all their transfers in SCT format and even large countries, such as France, are seeing migration with 45 million SCT transfers per month today.

Yes, direct debits are more of an issue as everyone claims their direct debit structures are different, but that is also moving.

Eventually, it will be like SCTs with SEPA Direct Debits (SDDs) implemented across all member states.

And look at the benefits.

It now costs virtually nothing to withdraw euros at any Eurozone nation’s ATM network, when just a few years ago it could cost you up to €30 for a simple withdrawal.

And standards are making a difference in all of this.  You cannot underestimate the impact of standardisation through XML for example, which is a foundation for innovation.

The end-dates will also help here, with February 2014 for the Eurozone states and February 2016 for the non-Eurozone nations.

You need to see the end-date as the ‘end of the legacy and start of the new’, which is when SEPA will really kick in.

So it’s going to happen … you just need to be with the programme, recognise it takes time and ‘give us a break’.  After all, Rome wasn’t built in a day, and neither will Europe be.

The Case Against SEPA

The nay-sayers were more vocal, and in some ways backed up what the pro-Europeans were saying.

A key point was that SEPA and the Payment Services Directive (PSD) is no longer important against the backdrop of the Eurozone implosion.

Even if you took that implosion away, it would be less important as regulating the post-crisis world has taken over with things like Basel III, Tier 1 Capital ratios, liquidity risk, the rise of Remnimbi and transaction taxes moving to the top of the agenda.

All of this means that mundane activities like payments infrastructure harmonisation has moved down the table and, for some, completely off the agenda.

Equally, the supporters may say it takes time but it’s already ten years and what do we have?  22.66% of credit transfers in SCT format and just 0.93% of direct debits in SDD format.   That is pathetic.

Then you say it will change with end-dates but what do the end-dates actually mean?

It’s just a political statement again, as there are no threats here.

Where are the sanctions if you don’t meet the end-date?

What’s the threat?

Where’s the punishment?

Is there any reward?

And the real issue is that no-one has mentioned the customer.

Who is bringing the customer along in this dialogue?  The regulators?  The governments?  The banks?

No-one is dealing with the customer aspects or needs, and the benefits are risible rather than visible.

So the euro will be dead by the time we reach an end-date, and that means you can forget about SEPA and move on.

The evening then ended with many questions around the themes outline above and concluded with a vote on two questions:

1. Does SEPA matter? and
2. Is SEPA happening?

The 100-strong audience voted that yes, SEPA matters (65% in support – a stronger showing than in previous years) but it’s not happening (only one hand was raised to say SEPA was progressing well).

Obviously, there’s still a long way to go and, if you’re interested, two members of the audience also blogged about the evening: Ben Poole and Barry Kislingbury.

Thank you to them and to all, particularly our esteemed panellists.

A fun evening all around which, when you think we’re talking about SEPA, the PSD and the Eurozone, is saying something,

 

 Postnote:

This is the third annual "Does SEPA Matter?" debate.  Click on the links for the debates in 2011 and 2010.

 

How to deal with an insolvent bank

Sitting in a conference talking about living wills isn’t how you want to spend your typical day, but it did spark a whole bunch of thoughts in my mind.

The FSA issued their consultative paper 11/16 last summer.

The idea is that every bank with assets over £15 billion must produce a Recovery and Resolution Plan (RRP) by the end of this June.

The RRP = a ‘living will’.

I’m not going to delve into the depths of such matters – you can read all about it on the FSAs website - except to say that the RRP comprises a Recovery Plan and a Resolution Plan.

The Recovery Plan must include a sufficient range of material and credible options to address a range of crisis scenarios, and show how the institution would address these issues to continue operating in a stable way, avoiding capital shortfalls and pressures on liquidity.

The Resolution Plan would show how a firm would wind-down if it failed for any reason, including how it would avoid any impact to taxpayers and the public funds.

All well and good.

Or is it.

Whilst I like the idea of a living will for a zombie bank, it strikes me that we still haven’t gotten to the heart of the matter.

The question is really: what do we do with an insolvent bank that could bring down the economy of our nation?

The answer is not to let a bank become so big that it could bring down the economy of the nation.

So the real answer should actually be more to do with limitations on bank size, structure and asset base leverage, rather than getting it to open up a living will.

To me, this is what the Vickers report separating investment and retail banking, and the Volcker Rule shutting down prop trading is all about.

So the two work in tandem – a bank must shrink its size to be big enough to fail and, if it does, have a clear plan for how to deal with failure.

Yet even then, it doesn’t solve the issues.

For example, the average life of a company in the S&P500 is just 15 years today; most banks have been around for over 100 years.

The reason why banks have been around so long is down to governments regulating and maintaining them, rather than any c0mpetitive forces.

If banks weren’t protected by regulations, they would fail far more often, just as commercial firms do.

And if a large commercial firm fails – Rover, BP or Tesco – they just get acquired or shutdown. 

They don’t bring down the entire economy.

When a bank fails, it brings down the whole economy because the economy runs on finance.

Finance is the oil in commerce – no oil, no commerce.

That’s why banks aren’t allowed to fail.

It’s also why we realise the mistake when they do.

A small bank – a Northern Rock – can fail, but it won’t shake the fabric of the economy of system.,

A large bank – a Citibank or Royal Bank of Scotland – is different.

At the height of the banking crisis, UK bank liabilities were 400% of GDP: £5 trillion against GDP of £1.2 trillion – and the Royal Bank of Scotland alone had more liabilities (£1.8 trillion) than the UK’s GDP.

So now we get into the heart of the matter.

How do you deal with an insolvent bank that could break the economy?

A living will is one piece.

The separation of investment and commercial banking (Vickers) is another.

But the real test would be to go back to the trigger of this crisis: would these regulations have dealt with Lehman Brothers collapse any better?

There are two or three things that come to light in this area.

First, when Lehmans collapsed they had $400 billion of debt on their books.  That debt was linked to global credit default swap derivatives (CDS) and amplified by a factor of 20, according to Barclays Capital.

So for every $1 of debt that Lehmans were exposed to, the markets were exposed to $20 due to their AAA-rating backing derivatives traded through the OTC markets.

Hence, the real exposure of risk the markets felt on September 14^th 2008 was a $8 trillion market collapse, not a small bank folding.

Do living wills, Vickers and Volcker deal with this spaghetti of complexity that each banks’ balance sheet is linked with?

Not yet.

Second, when Lehmans collapsed the company most wrapped up in their web of debt was AIG.  AIG Financial Products in London had been trading CDS to such an extent that most of the market exposure landed on their doorstep and dragged the firm down.

However, AIG Financial Products was also a complex web of structure.

AIG was the largest insurance firm in America, trading in risks through their London office which was registered for European operations in Paris.

So three regulators were meant to track the global risks being traded by one global firm through a web of global offices.

Fail.

Do living wills, Vickers and Volcker deal with this web of globality that each banks’ balance sheet is linked with?

Not yet.

The two points made here are making it clear that the regulators need a global level playing field if their attempts to regulate the markets successfully are going to truly succeed.

But a global level playing field is also impossible, as no country can agree with another on taxation, fiscal and monetary policies.

Just look at the EU right now, and the transaction tax, if you want to see why a global level playing field is not going to work.

Sorry to be a downer Messrs Osbourne, Barnier and Bernanke but, as one speaker said yesterday, “the worst mistake regulators can make is to believe in their own rules”.

Point taken.

 

Postnote: yes, I know that OTC Derivatives regulations with a single data repository is addressing some of the last points made here, but do bear in mind that they haven't yet agreed how to define 'speculative' versus 'commercial' derivatives locally, let alone globally, and you get a sense of why this isn't working yet.

 

Wipe out market makers = best execution

Yesterday I wrote about the concept of banks being barred from betting on the bonds and equities markets.

“Own account” trading disappears and the only folks who can “speculate” are those with their own chips to play in the game: the private equity, sovereign wealth, high net wroth assets and their asset managers who back all punts with collateral and cash.

In other words, the current players who systematically internalise will leave.

Bear in mind that a systemic internaliser is defined as a market maker who regularly trade off their own book of business:

MiFID provides that a firm should be treated as a systematic internaliser if it deals with client orders in shares on an “organised, frequent and systematic basis” from its own business account.  These shares would normally be traded through an exchange or regulated market, but the investment firm is basically holding the shares themselves, waiting for the right price to match.

Some fear such trading is risky and allows banks to buck the price because the banks themselves can trade for their own benefit through such internalisation, known as prop or proprietary trading.

It is this trading that is now being targeted as being unacceptable, according to the American Volcker Rule.

The “Volcker rule”, named after Paul Volcker the former Federal Reserve chairman who proposed it, would restrict the ability of banks trading for their own benefit.

The Volcker Rule, along with others such as Vickers, could push systemic internalising out of the banking sector and, as mentioned yesterday, such that trading is purely operated through funds and asset managers who have the collateral.

So who would this impact?

We mentioned Goldman Sachs and Morgan Stanley in the USA yesterday, but the main European systematic internalisers are BNP Paribas, Citigroup, Credit Suisse, Goldman Sachs, Knight Equity Markets, Nomura, Royal Bank of Scotland N.V. (ABN AMRO as was) and UBS.

Now I know I’m pulling the chain a little here but let’s just say that all these guys trading desks, due to regulations and bonus restrictions, see mass exodus.

What is the future?

What does this mean for investment banks?

It means they purely become platform providers.

A little like the City of London describes itself as the Wimbledon of finance – we have no players, but provide the best courts to play upon – future banks will provide the infrastructure but not play.

So the world’s investment markets purely become technology oriented platforms which players plug into to play.

Kind of like  Betfair, Bet365,Ladbrokes, Paddy Power, William Hill and other online gambling and betting services, investment firms become providers of platforms but they don’t play their platforms.

The market makers and systematic internalisers become technology firms, offering the fastest execution at lowest cost with best price, and the high frequency traders in the hedge funds, private equity firms and others trade.

They may trade on their own account or on behalf of sovereign wealth funds and institutional investors, but they trade with collateral, not with depositors’ savings.

And by offering the platforms to trade effectively, the systems move everyone towards best execution.

Best execution is all about trading at fastest speeds at best price and lowest cost, with a guarantee for the likelihood of settlement.

Somehow I can see the regulators being sorely tempted to follow this line of thinking as best execution has been embodied in European and American regulations for some time.

Mind you, you don’t have to think that this is necessarily going to happen as I’ve just re-read the last write-up of the Volcker Rule in the New York Times:

When Paul Volcker called for new rules in 2009 to curb risk-taking by banks, and thus avoid making taxpayers liable in the future for the kind of reckless speculation that caused the financial crisis and resulting bailout, he outlined his proposal in a three-page letter to the president.

Last year, when the Dodd-Frank Wall Street Reform and Consumer Protection Act went to Congress, the Volcker Rule that it contained took up 10 pages.

Last week, when the proposed regulations for the Volcker Rule finally emerged for public comment, the text had swelled to 298 pages and was accompanied by more than 1,300 questions about 400 topics.

Somehow, as with all regulations, it’ll get messed up on the process, whittled down and weakened until it’s a shadow of its former self.

Ah well.

One can dream.

 

 

Casino capitalism: only for those who can afford the chips

For some time there’s been debate about whether Vickers or Volcker is the right way to go.

Should investment banks be divided from their retailing and commercial siblings by a fence, or completely separated so that one cannot poison the other?

Should banks be allowed to play in the markets off their own account, or should such risky practices be outlawed?

The debate will continue for a while and it’s clear there is a possible revolutionary outcome as, eventually, markets will decide how to behave.

This will be through a mixture of the law of unintended consequences and the law of Darwinism.

For the former, we’ve seen the impact of unintended regulatory consequences before.

When the Markets in Financial Instruments Directive (MiFID) was formulated, everyone believed it would seriously impact the systematic internaliser – the banks that trade mainly off their own account.

It did, but not in the way the regulations intended.

Instead, the regulations opened Europe’s markets to full electronic trading strategies and allowed Chi-X to decimate the traditional equities exchanges’ business.

The systematic internalisers leveraged such facilities, particularly through dark pools, and suddenly the majority of equities trading in European markets flowed through systems rather than people.

It is also why the surge in OTC Derivatives trading arose, some would say, as the human touch in banking moved from trading to creativity.

Now the regulators are trying to rewrite the rules for high frequency operations and OTC Derivatives.

We all know that means that, in the law of unintended consequences, they are again creating a new market structure that they may not foresee.

This is because the Volcker Rule – the rule introduced as part of Dodd-Frank in the USA that bans proprietary trading – means that many of the world’s leading speculators, traders and masters of the universe are already moving out of the banking network and into the investor network.

From Forbes Magazine recently: “The Volcker Rule would impact investment banking giant Goldman Sachs the most followed by Morgan Stanley. The two firms derive 48% and 27% of their total consolidated revenues from principal transactions respectively … Bank of America and JPMorgan Chase see about 9% and 8% of their total consolidated revenue come from such transactions. Citigroup will be the least hit with just 5% of its total revenue at stake.”

No wonder Goldman is seeing a mini-Exodus.

Bloomberg recently reported that Goldman Sachs lost two leaders of its biggest division.  

“Edward K. Eisler, 42, and David B. Heller, 44, are retiring from the company, where they helped lead the securities trading division since February 2008 … Eisler and Heller join about 50 Goldman Sachs partners who left the firm in the past 12 months, according to company filings, internal memos and news reports.”

What is today a mini-Exodus is likely to become a waterfall over time, as banks close down areas of business that the regulators make undesirable or untenable such as proprietary trading, along with restrictions around the level of pay rewards by curtailing bonuses.

For example, the law in the UK has changed such that “the practice of up-front cash bonuses has stopped.  The practice of guaranteed bonuses has been sharply curtailed, at least in the London market.  Bonuses now have to contain a very significant element of deferral.  At least 40% of the bonus for a significant risk taker has to be deferred for a period of at least three years.”

Increasing tax, decreasing bonus levels, a tougher job climate – over 200,000 banking jobs were taken out last year – and a general gloom over investment banking – RBS is closing its investment division – all mean that the world of capital markets is being reinvented.

The reinvention is slow at first, but will become noticeable by 2015 and notable by 2020.

What does it look like?

It’s a guess, but the future looks like one where banks no longer participate in active trading and risk.

The trading risks are taken by those who are willing to lose, and they have to have their own collateral and assets upfront in order to be able to play therefore.

That means private equity, sovereign wealth and the high net worth will be the risk takers and trading speculators.

Institutional investors, pension funds, hedge funds will also be in the game.

But banks will not be able to play.

Their inability to play will be partly due to limitations by law – Volcker, Vickers and the like – but more by the natural market selection for talent.

Real trading talent will no longer be won by the banks, due to their inability to pay and remunerate, and therefore others will hire the big guns.

Banks will be forced to focus away from trading and more toward client acquisition and satisfaction.

Banks will become hugely focused upon corporate relationship management, improving treasury returns and demonstrating real value to their clients’ CFO.

Their focal point will be to gain and retain high value relationships at the top tier of the markets, looking after their corporate client’s needs for risk management and advising them on hedging strategies for the future.

A new world where casino capitalism will only be played by those who can afford the chips.

 

How will the world look post-crisis?

I’ve been debating some future presentations with various folks today, and a little ray of light went off in my head.

The light was triggered by a comment: “can you talk about what impact regulatory change may have on bank to corporate relationships using examples historically?”

The question was really asking about the unintended impact of regulatory change in the past and what it might mean for their future, but it made me think about something else.

Each time we have seen a major bubble burst, the cause has been a coagulation of several forces of change.

Forces for change come from four major directions: Political, Economic, Social and Technological (PEST).

These forces for change are used in many ways, and can be seen in my banking history discussions (and soon to be published book) which talks about many historical periods including the Italian Renaissance, the Great Depression and the Credit Crisis.

In each of these, we can see Political, Economic, Social and Technological forces working together at the same time to drive change.

In the fall of the Renaissance Italians, it was a mixture of change between the break from the Catholic Church with the Protestant and other movements (Political), mixed with the ruin of the Italian banks due to over-extension of credit to overseas Royal Houses (Economic), along with expansion of merchant shipping and colonisation (Technological).

In the Great Depression, we saw the end of the Industrial Revolution (Technological) combined with post-war wrangling over the gold standard (Political and Economic).

Right now, we see a major world of change too.

We have the rebalancing of power between America and Asia/China (Economic) combined with an internet revolution that is connecting everyone on the planet (Technological), leading to changes in society, where a Molly Katchpole can reverse a bank’s policy and an #Occupy movement can change global thinking (Social).

The Political outcome of all of this is what is driving bank regulations right now.

And the outcome of all of this will be a massive change.

A New World Order?

Probably not.

We already have a New World Order as China is expected to be the world’s largest economy by 2018 (ten years ago, it was estimated to be 2047).

But we will see a restructured playing field and one that is not level.

We can see this already as one major economy (America) bans prop trading whilst another (UK) just separates prop trading from retail bank operations.

Even more pronounced are the differences between the US and EU on OTC Derivatives regulations and how to define and regulate Systemically Important Financial Institutions (SiFi).

From CME Group in October 2011:

“In an ideal world, global financial regulators would function something like a team of horses, with policymakers in the United States, Europe, Asia and elsewhere all pulling at once in the same direction, and moving toward a common goal.

“Reality is turning out be far more chaotic, however. Regulators and lawmakers are having a tough time forming a consensus even within their own national borders, let alone across international boundaries. The result is turning out be a patchwork of overlapping and often inconsistent approaches to regulation in the aftermath of the financial crisis that gripped global markets in 2008 and 2009. Many financial experts fear that the inconsistent global regulatory framework will alter the flow of capital around the world, as trades are directed to the cheapest jurisdiction, a process known as regulatory arbitrage.”

So we end up with a world where the politicians are trying to react to the implosion of markets at the end of another revolution – Globalisation – and find that they are seriously lacking consistency, vision, leadership or agreement.

The Eurozone is one of the best illustrations of this, although America and China aren’t guaranteed to come out of this stainless as the American elections will change ground again, as will China’s challenges of a property market bubble and inflationary pressures.

All in all, the PEST approach to the world today says that we are going through a momentous change from all angles – Political, Economic, Social and Technological.

Where will it end up?

Probably in a place no-one expects and one which, on this blog, I’m going to avoid predicting decisively.

From Reuters:

“By 2020, the workforce in western Europe will shrink by 2.4 percent, including a 4.2 percent contraction in Germany, according to a Boston Consulting Group study.

Looking further ahead, HSBC projects that Germany's working population will shrivel by 29 percent by 2050, Russia's by 31 percent and Japan's by 37 percent.

Over the same period, the population of many African countries will double. Nigeria will log a rise of 3 percent a year in its workforce - in contrast to a 1 percent decline in Russia and Japan - and will have as many people as the United States by 2050.

On current projections, Pakistan will be the sixth most-populous nation by the middle of the century. And the Philippines could be the world's 16th-biggest economy, HSBC reckons.”

 

Banker commits murder and gets away with it

A year ago, the FSA issued a short 298-word statement saying that after an extensive 17 month investigation into the collapse of the Royal Bank of Scotland (RBS), no action would be taken against Sir Fred Goodwin or others. There was a general outcry, so much so that after initially dismissing any indepth report, they decided they would write one.

It was released today – all 450 pages of it – although it doesn’t add to much more than what we knew a year ago:

(a)    the market conditions allowed it to happen; but

(b)    it was the CEO Sir Fred Goodwin and his management team that were at fault; and

(c)    the FSA messed up by not challenging them.

The report does however make clear that there is more to what happened than can be generally perceived, and provides some interesting insights about the history, issues and prevailing culture within the bank at the time.

For example and in hindsight, it’s obvious that the megalomaniacal Fred Goodwin was doing too much unchallenged.

How megalomaniacal was he?

Well, he was almost Machiavellian according to many reports.

I still remember the fact that he wanted to rename Scotland’s capital city Fredburgh, and that the corporate HQ at Gogarburn was his testament to history with its own golf course.

The fact that he would override decisions made by his management team, including those of the Chief Risk Officer, if he felt it was the right thing to do.

And the reports that have come to light that he even would go mental if the wrong sort of biscuits were served at meetings, goes to show the lengths he had reached in his boardroom seat.

Then the world collapsed for him as the disastrous ABN AMRO acquisition, plus a catalogue of other errors, meant that the bank’s capital and liquidity position had become over-exposed.

This is all in the FSA report, although not in the terms many would use.

For example, a section of the report is headed: “The ABN AMRO acquisition: an extremely risky deal”.

It was originally titled: “an extremely risky gamble”, but Fred’s lawyers forced the FSA to take out the word gamble as it could be used in a case against him, should one ever come to court.

It won’t be, as there is nothing in the legislation today that says that a bank CEO who screwed his bank can be brought to court.

This is one of the changes recommended by the FSA’s report, which elects to offer either a strict liability or clawback basis for curtailing a bank executive’s bonuses, pensions and more, if he or she causes the bank to fail.

But that’s for the future, not for the past, and hence Fred and his team get off scot-free so to speak.

What really gets me in this report is that the FSA knew he was a rogue CEO as far back as 2003.

I would rewrite it, but today’s Guardian summarises this piece well:

The FSA said that between 2003 and 2006, its supervision team highlighted "chief executive dominance" during meetings with the then RBS chairman Sir George Mathewson and that, with hindsight, more senior regulators should have been involved in a review of the bank at this stage.

The FSA sets out how it attempted to assess the risks posed by Goodwin's dominance. In October 2004 because of a "poor regulatory relationship" and lack of access to non-executive directors, its supervisory team recommended that a "section 166" review be commissioned. These reviews – named after the clause in the FSA's rules – require banks to hire independent firms to conduct a review of certain activities and report back to the FSA.

In the event, the FSA did not commission the review because its supervisors met a group of non-executives in December 2004 who were able to provide examples of where they had challenged Goodwin. One example was when Goodwin had wanted to launch an electronic bank which was rejected by the non-executive directors.

The FSA's report into what went on at RBS concludes that if a section 166 review had been commissioned, as first intended, it "would have sent a strong message to RBS, including its board, and might have provided the FSA with more information on the effectiveness of governance, particularly around the potential dominance of the chief executive".

In the event, the FSA kept reviewing the board structure of the bank until October 2006 when it concluded that the "risks associated with CEO dominance and challenge to him had been mitigated sufficiently that the issue could be closed". It was convinced that the appointment of a new chairman, Sir Tom McKillop, and new finance director would provide a new challenge to Goodwin.

But, with hindsight, it says that a "key missing element" in deciding to close the review about corporate governance was "engagement at the most senior FSA executive level".

"This reflects a more general tendency in the FSA's pre-crisis supervisory approach for key supervisory decisions and responsibilities to be delegated several layers below the FSA's CEO," the report said.

Another area of anger is that we all knew the ABN AMRO acquisition could be disastrous back when it happened.

Back then, it was obvious that a battle with Barclays over ego had taken place, and Fred just wanted to win at whatever the cost, in order to stick two fingers up to John Varley, the Barclay CEO.

He therefore not only outbid Barclays in over-valuing ABN AMRO, but ABN also sold key assets in the USA before the acquisition went through, devaluing the bank.

So the result was an overpayment for a smaller bank than the one Barclays originally bid for, just to satisfy the ego of Fred Goodwin.

This is corroborated in the report, which states that “due diligence was inadequate in scope and depth and hence was inappropriate in light of the nature and scale of the acquisition and the major risks involved”.

It asks:

• “Whether the Board’s mode of operation, including challenge to the executive, was as effective as its composition and formal processes would suggest.
• Whether the CEO’s management style discouraged robust and effective challenge
• Whether RBS was overly focused on revenue, profit and earnings per share rather than on capital, liquidity and asset quality, and whether the Board designed a CEO remuneration package which made it rational to focus on the former.
• Whether RBS’s Board received adequate information to consider the risks associated with strategy proposals, and whether it was sufficiently disciplined in questioning and challenging what was presented to it.
• Whether risk management information enabled the Board adequately to monitor and mitigate the aggregation of risks across the group, and whether it was sufficiently forward-looking to give early warning of emerging risks.”

It’s just a shame that it cannot say that this was the case, but had to wrap it up in whethers and possibles due to the legalese issues, in the same way that it couldn’t call the ABN AMRO deal a gamble, as this is exactly what it was.

The report concludes that there were six factors predominantly at play here, on top of the poor management controls internally, namely:

• “significant weaknesses in RBS’s capital position, as a result of management decisions and permitted by an inadequate global regulatory capital framework;
• over-reliance on risky short-term wholesale funding, which was permitted by an inadequate approach to the regulation of liquidity;
• concerns and uncertainties about RBS’s underlying asset quality, which in turn was subject to little fundamental analysis by the FSA;
• substantial losses in credit trading activities, which eroded market confidence. Both RBS’s strategy and the FSA’s supervisory approach underestimated how bad losses associated with structured credit might be;
• the ABN AMRO acquisition, on which RBS proceeded without appropriate heed to the risks involved and with inadequate due diligence; and
• an overall systemic crisis in which the banks in worse relative positions were extremely vulnerable to failure. RBS was one such bank.”

Well worth the two and a half years of researching and writing such analysis, not!

Meanwhile, fyi, Fred’s back on the prowl  looking for a job in the City … and knowing his ability to avoid shit hitting his fan, he may well find a new fan to fuel for the future.

Just like several other characters I could name.

So Machiavelli is maybe a good comparison after all: “the question whether it is better to be loved rather than feared, or feared rather than loved. It might perhaps be answered that we should wish to be both: but since love and fear can hardly exist together, if we must choose between them, it is far safer to be feared than loved.”

 

 

As my SEPA gently weeps ...

I hosted a dinner last night with a focus upon developments with SEPA and innovation.

What innovations has SEPA introduced?

Long silence.

To be honest, there are some – the ability to cash concentrate direct debits into the most efficient countries using SDDs (SEPA Direct Debits) for example –but the list is real short.

We found the reasons why are multiple.

First, there’s innovation and change in wholesale versus retail, with the former taking much longer than the latter.

Second, there’s cooperative innovation where countries and operators need to work together to agree change and standards, which is why it takes the time.

Third, there’s delivery of a wholesale change across a wide economic area, which is not just eating an elephant but a humongous great Blue Whale.

Nothing is simple in the SEPA game, or end-game.

And is there an end-game?

Sure, we’re talking about end-dates, with a single end-date now mooted for end of 2014.

If 2014 is achieved, then twelve years after the creation of the European Payments Council we might get something implemented … but it’s still ‘early days’ as someone said.

Twelve years and it’s still early days?

Jeez.

Another banker said that “just as we’ve started to deliver innovation with SEPA, it may never happen”.

Hmmm … life is what happens to you whilst you’re busy making other plans, and twelve years after inception, SEPA might be delivering a stillborn infrastructure if the Eurozone implodes, as many appear to be predicting.

If you don’t think they are, then talk to a few banks around the City here and they’ll tell you that they’re seriously planning for a euro breakup, and modelling what that means to their systems, structures and processes.

No wonder when most respected media are now saying we’ve reached crunch time.  From this morning’s Washington Post:

“After two years of failed efforts that world markets have swept aside as inadequate, Europe’s politicians face an increasingly sharp divide in combating their financial crisis: either take the sort of politically difficult steps that would tie their economies more closely together, or prepare for the breakup of the euro currency zone.”

So where are we in reality with SEPA?

The EPC’s latest numbers show that, “as of August 2011, the share of SEPA Credit Transfers (SCTs), as a percentage of the total volume of credit transfers generated by bank customers, amounts to 20.12 percent in the euro area”, whilst “the share of SEPA Direct Debit (SDD), as a percentage of the total volume of direct debits generated by bank customers, amounts to 0.13 percent (ECB SEPA Indicators)”.

SCTs have been around since January 2008 (that’s four years near enough) and SDDs since November 2009 (two years).

The reason for the slow take-up of SDDs is down to incompatibilities between country implementations of SDD, and specifically repudiation and revocation rights which have been compromised due to country opt-outs allowed under the rules (derogations).

So we don’t really have any innovation here yet.

Just a slow-burn.

Oh, one thing that was viewed as innovation in this wholesale space however is ISO20022.

“The ISO 20022 standard provides the financial industry with a common platform for the development of messages using:

• a modelling methodology (based on UML) to capture in a syntax-independent way financial business areas, business transactions and associated message flows;
• a central dictionary of business items used in financial communications;
• a set of XML design rules to convert the messages described in UML into XML schemas, whenever the use of the ISO 20022 XML-based syntax is preferred.”

Yea.

ISO20022.

The Nirvana of financial messaging.

And yes, if SEPA delivers a compliance and move to ISO20022 across the Eurozone’s corporations and banks, then yes, that’s good.

According to those around the room, this has to happen as part of SEPA delivery.

OK.

But I’m not going to place any bets on this happening.

And, as if to prove the point, put “ISO20022 SEPA” into Google and what you get back is a whole bunch of articles … from 2008.

Finally, about 30 entries down the list, you get a link to the EPC’s website where an article from October 2011 states: “the existence already of multiple interpretations of the ISO 20022 message standards; i.e. multiple domestic SEPA formats, threaten to undermine key objectives of the SEPA initiative.”

Maybe it’s just me but I’m thinking that, after ten years of evolution and little revolution, this thing ain’t working.

Anyone want to argue the toss?

 

 

The Future of UK Regulation (FSA Speech)

Margaret Cole, Interim Managing Director, Conduct Business Unit at the Financial Services Authority (FSA), gave a great speech at the Financial Services Club last week. 

Margaret's Conduct Business Unit will become the Financial Conduct Authority in 2013, when the Financial Services Authority splits into two units.

Everyone is interested to know what this means, but the presentation Margaret gave was under the Chatham House Rule so I'm not going to repeat it all here.

Instead, I've stolen another FSA speech in the public domain given at the British Bankers Association's meeting recently, and it covers some of the ground Margaret covered, although she was far more frank and open due to the Rule being in force.

Worth a read regardless ...

Thank you for the invitation to speak today.

I would like to focus my remarks on the changing shape of banking regulation in the UK. The essence of these changes gives the Bank of England overarching responsibility for financial stability through the creation of the Financial Policy Committee and establishes what is known as a ‘twin peaks’ style of firm-specific regulation.

In this structure, as I am sure you know, the prudential oversight of banks and insurers will be provided by a subsidiary of the Bank of England, the Prudential Regulation Authority. The oversight of conduct and markets, along with the prudential regulation of other financial firms, will be delivered by a new independent regulator, the Financial Conduct Authority. The FCA will be the successor body to the FSA. It is the intention that this new structure will become effective in the first half of 2013.

The government’s vision for how the new regulatory structure will work is laid out in its White Paper, published earlier this month. The FSA and the Bank of England have also published documents laying out the approach that the PRA will adopt for the prudential regulation of banks and also insurers. These have been complemented by an FSA publication earlier this week which outlines our initial thinking on the FCA

My intention today is to give you an overview of the approach that the new authorities will take to banking regulation, the detail of which are laid out in this set of publications.

The need for change

My principal message today is to say we must use the opportunity presented by these reforms to force ‘root and branch’ change both by regulators and banks. This root and branch change must affect both the behaviours and the processes of banks and regulators. Unless we all change all aspects of what we do, real change will not be achieved.

The financial crisis has demonstrated that significant change is needed in relation to prudential issues – but I want to remind you that we also need significant change to occur in relation to conduct issues. In the last couple of decades, at least £15bn of redress has been paid out to consumers in response to the conduct failures of firms and if we include PPI this number is likely to exceed £20bn. This is an unacceptable cost to both consumers and bank shareholders and it is also a visible demonstration of why trust has been lost between the users of the financial services marketplace and the firms operating within it.

In addition to making changes to the way in which we all behave and operate, we also need to ensure there is clarity of understanding by society and Parliament as to our collective purposes and accountability framework. This is important not just for the regulators but also, in my view, for the industry.

Before outlining the supervisory approaches of the PRA and FCA, I would like to highlight some of the key issues or perhaps trade offs that society will need to consider when addressing the question of the regulators’ purpose and accountability framework. I touched on these yesterday at the FCA conference, but I think it is worth revisiting these crucial issues.

• Firstly, the trade off between responsibility and suitability. This is primarily a question for the FCA. The key question here that society must answer is: to what degree should individual consumers be held responsible for, and given the freedom to, make their own decisions? Given the known asymmetry of information between the consumer and the manufacturer, it has been generally accepted that a degree of judgement on suitability should be made by the regulator. While the FSA’s approach in the past has been to ensure disclosure of risks and information to consumers, experience has shown that in practice consumers pay scant attention to the material provided to them at the point of sale and in many cases lack the technical skills to evaluate the information. The FCA is likely to make more suitability judgements and thus run the risk of being accused of reducing personal freedom.
• Secondly, the trade off between intervention and innovation and its associated cost. Central to the proposed new model for both authorities is the concept of early intervention. This is likely to be most controversial in respect of the FCA, where early intervention will include banning individual products where the regulator judges that the risk of mis-selling significantly outweighs a product’s utility, and intervention to ban individual firms from selling perfectly useful products where their sales processes look likely to lead to significant mis selling. Clearly the intended benefit of such interventions is to choke off the detriment that the mis-selling would cause. The underlying premise is that the regulator is able to successfully identify that detriment is going to occur. Unfortunately, that will not always be the case and thus undoubtedly at times the intervention itself runs the risk of creating more harm than good. It could be seen to reduce innovation, choice, competition and potentially raise the cost of regulation since the FCA would undoubtedly need more resources than we currently have to enable it to make such judgements.
• Thirdly, a word on transparency and efficiency. Here I am sure the trade off is very obvious. Namely, transparency does in general promote confidence, help equip consumers to make better decisions and is in tune with the expectations of modern society. However, there is a risk that such transparency will hamper the efficiency of the regulator and potentially lead to problems in the marketplace linked to the unintended consequences of consumer actions. This is an issue for both the PRA and FCA – both are committed to more transparency, the question is: how much?
• Fourthly, the trade off between cost and effectiveness, which is relatively straightforward. A more interventionist and proactive regulator offers the prospects of greater success but comes with the risk of extra regulatory costs. In the case of the FCA, it seems likely that the extra capabilities needed to deliver against its expanded mandate will increase its cost relative to the FSA, but your feedback will be invaluable in determining the extent of that change. In the case of the PRA, the FSA has already invested in expanding its prudential capability and thus this should be less of an issue.
• Finally, let me talk about accountability and judgement. The trade off here is that we want both regulators to make difficult, brave and forward-looking judgements and inevitably with hindsight some will prove not to lead to the desired result. Furthermore, if every time this happens politicians and commentators leap to the conclusion, without considering the evidence, that the regulators have failed, it will be more difficult to attract and retain capable individuals for those roles.

Let me now make some remarks on the operating models of the PRA and FCA.

Back to top

The PRA’s objective

Turning first to the PRA. It will be the prudential regulator for just over 1,000 deposit-takers. The PRA will have a single objective – to promote the safety and soundness of regulated firms – and will meet this objective primarily by seeking to minimise any adverse effects of firm failure on the UK financial system and by ensuring that firms carry on their business in a way that avoids adverse effects on the system.

This purpose is fundamentally different from that of previous regulatory regimes and will lead to a material change to the model of supervision which was in use prior to the financial crisis. I will outline this new model for you in a moment, but first I would like to make four points that arise from the PRA’s objective.

• Firstly, it is clear that the purpose of the PRA is to focus on the stability of the system overall, albeit through firm-specific supervision. This will require close coordination with the new FPC whose role it will be to manage the risks in the system as a whole.
• Secondly, in light of this objective there has been much debate about whether a regulator whose purpose is to promote financial stability could do so by focusing only on minimising the consequence of firm failures, rather than minimising the risk of individual firms failing in the first place. In a world without uncertainty it might well be justifiable to state that the regulator should not be obliged to seek to reduce the risk of firm failure. However in practice the inherent uncertainty and complexity of both firms and the overall system mean that this is not a realistic objective. The PRA will thus always seek to reduce the risk of individual firm failure but will give particular focus on ensuring that if failure occurs, it does so in an orderly manner. Furthermore, it needs to be recognised that international regulatory standards are explicit with regard to the need to maintain a baseline of supervisory oversight for major firms, with the intention of reducing the probability of failure.
• Thirdly, the obligation of baseline supervision should not detract from a key strand of the PRA’s approach, namely to ensure that the role of regulators is to complement and promote the disciplines of the marketplace, not to substitute for them. The presumption remains that the ultimate responsibility for managing a firm prudently rests with its management, board and shareholders.
• Finally, the consequence of this approach undoubtedly means that the PRA needs to recognise that if firms fail, society will rightly ask the question of whether that was a regulatory failure. However, failure of firms should be seen as a necessary element of a healthy, innovative system and thus the PRA should not be held accountable for all such failures. Particularly in those cases where the process of failure is an orderly one with minimal impact on the financial system or the firm’s customers.

Turning now to how the PRA will carry out its objective. As I have said before, a supervisor effectively has three types of tools.

• rules and regulations, primarily in the form of capital, liquidity, leverage and governance standards;
• resolution plans; and
• supervisory oversight of management actions and strategies, including recovery plans.

The reviews conducted by the FSA on the recent crisis, including the current one being carried out on RBS, demonstrate that the principal regulatory failure was the capital and liquidity rules which were completely inadequate. There is a view that the risk of firms failing could be eradicated altogether if there were sufficient capital and liquidity buffers. This is theoretically true, but the new capital and liquidity standards will not be set at such a level. This month has seen agreement in Basel on the G-SIB surcharge and thus we now know more about the amount of capital large banks will be required to hold. The Basel III framework will be a significant improvement on the historic position, but it will still require other risk mitigants to be in place.

At other end of the spectrum, it could be argued that so long as we could resolve all firms without material cost to the system, then we need neither capital nor supervisory oversight. This perfect world of resolution is not likely to be achieved. Indeed we are currently some years off being able to offer even reasonable confidence about being able to resolve a complex cross border group.

Given these realities, the PRA’s supervisory approach will be to deploy all three tools.

PRA supervisory approach

I turn now to how the PRA will deliver this supervisory approach. In order to make effective judgements, as I have said before, the PRA must equip itself with:

• high quality, experienced supervisors who are willing to make difficult judgements and command the respect of the firms they supervise;
• high quality analysis of the critical risks in relation to a firm’s soundness, notably: its business model, particularly in relation to risk and profitability, its capital model and its funding model;
• high quality analysis of the effectiveness of a firm’s governance model and the competency of its key executives;
• a clear understanding of the firm’s culture and the implications of that culture on its risk profile;
• a clear understanding of its recovery and resolution capability;
• a clear understanding of the consequence of the failure of that institution on the wider economic system; and
• a clear understanding of informed third parties’ views of the risks that a firm is running.

The PRA’s supervisory approach will be delivered by replacing the FSA’s ARROW process with a new simplified framework for assessing the risks posed by individual firms. This will enable supervisors to identify the core handful of issues which, in their judgement, management should be focusing on. It is of vital importance that our supervisors are able to distil these issues and judgements in a way that can be clearly communicated to a board of a firm.

The PRA’s supervisory assessment framework will capture three key elements:

• the potential impact on the financial system of a firm coming under stress or failing;
• the impact on the viability of a firm’s own business model of the overallexternal risk environment; and
• the firm’s overall safety and soundness.

The PRA will take a forward-looking and judgement-based approach to supervision. Beyond the baseline monitoring I mentioned earlier, the PRA will focus its resources on those firms and prudential issues that have the greatest impact on the stability of the UK financial system.

The PRA will introduce a new Proactive Intervention Framework, or ‘PIF’, with a set of stages, or triggers, that represent points at which regulatory intervention would be required. This is, in part, to formalise resolution arrangements but also to mitigate against the risk of regulatory forbearance. This will not detract from the judgment-based supervisory approach which lies at the core of the PRA philosophy. Supervisors will of course need to use their judgement within the PIF.

The PIF will set out both actions expected to be taken by a firm as its financial position deteriorates as well as the authorities’ actions to prepare for orderly failure or resolution of a firm. The PRA will adopt a high threshold of materiality when mitigating actions are raised with firms. Such actions will be closely linked to the PRA’s assessment of risks and focused on the stability of the UK financial system. In cases where a firm’s viability is under threat, the PRA will take supervisory action at an early stage to reduce the probability of disorderly failure.

The FCA’s objective

That is all I plan to say about the PRA’s operating model. Clearly the PRA is but one element of the future landscape and I will now make a brief comment on the FCA. On Monday this week we published a document outlining our current thinking on how the FCA will operate, and this was supplemented by a dedicated FCA conference yesterday.

The FCA will have responsibility over 27,000 firms. For 24,500 of them it will have both prudential and conduct of business responsibility. The key point for this audience, however, is that it will also have conduct responsibility for the firms falling under the PRA’s scope.

The government proposes to give the FCA a single strategic objective ‘to protect and enhance confidence in the UK financial system’. The FCA will deliver this through three operational objectives, which are:

• to facilitate efficiency and choice in the market for financial services;
• to secure an appropriate degree of protection for consumers; and
• to protect and enhance the integrity of the UK financial system.

In addition, there is a key obligation for the FCA to discharge its general functions in a way which promotes competition.

The FCA’s supervisory approach

It is clearly the government’s intention that in relation to its objectives the FCA will intervene in a more intrusive way, as well as earlier, than was the case for the FSA. To deliver on this intention the FCA will require new powers, particularly in relation to product intervention and financial promotions.

The main elements of the FCA’s supervisory approach will be to:

• deliver a forward-looking, judgement-based approach to regulation, at the core of which will be early intervention both in respect of products and selling processes;
• deliver meaningful choice and effective competition;
• deliver a credible deterrence agenda;
• deliver a more effective redress process;
• ensure consumers have the right information to make informed judgements; and
• act in a more transparent and accountable manner.

The supervisory model, as with the PRA, requires a new supervisory assessment framework to replace ARROW. This will include both firm-based assessments and comprehensive market, sectoral and product chain analysis. Central to its design, however, will be simplicity and a recognition that the approach must be understandable not just to regulatory specialists but to boards as a whole.

A word on the enhanced competition mandate which has already attracted comments and is a key feature of the proposed FCA remit. In the past the FSA understood that within the current regulatory framework competition matters were primarily for the OFT, and in particular that it should not use its powers in relation to fairness to intervene in respect of price. This is a simplification of our historic approach, but suffices for the purposes of my comments today, since the principal point I wish to make is that the new framework makes clear that government now expects the FCA to take a central role in the promotion of competition. The government is not expecting the FCA to become an economic regulator but is expecting it to utilise its powers to make judgements on pricing issues where they relate to fairness. Delivering on this mandate will require a step change relative to the FSA in the FCA’s technical skills and philosophy.

Other issues

That is all I intend to say about how both the FCA and PRA will carry out their activities. I do nevertheless encourage you to read our three publications which are designed to give you greater detail.

However, if the new regulatory architecture is to be successful it will not be enough just for the regulators to reform their own internal processes. To operate effectively, the PRA and FCA must engage with:

• the firms they regulate;
• other regulators both domestically and internationally;
• with the public; and
• those to whom they are accountable, notably Parliament.

On this topic I would just like to highlight three key issues.

• Firstly, coordination between the PRA, FCA and FPC. There needs to be a clear understanding about how the PRA and FCA will interact, particularly in relation to firm-specific supervisory decisions. It is also important to recognise that both the PRA and FCA need to engage closely with the FPC. This will be facilitated by their respective CEOs being on the Committee, but clear processes will need to be established to ensure relevant issues are escalated and discussed.
• Secondly, I have spoken about this many times but I cannot stress enough the importance of the changes to the European regulatory architecture. The PRA and FCA are now operating as an extension of a broader European policy-making framework. Therefore, effective engagement with the European process is paramount to their success. Critically, we need to win the argument in Europe that supervisors need to have firm-specific discretion and that regulations need to be tailored towards local circumstance. If this does not happen, the European framework will become discredited.
• Finally, a word on accountability. As I have said before, it is important that the new regulators are equipped to report on both their successes and failures to Parliament.

Conclusion

In conclusion, I hope my remarks today have given you a clear sense of how the PRA and FCA will operate. I hope it has also stimulated a debate to ensure that the approach is one that is fully understood and supported by society as a whole. However, the most important point I would like to make today is that change in regulation itself will not be sufficient to achieve the improvements which society deserves. This needs significant change in the approach taken by the firms gathered here today. A restoration of trust requires a visible step change by you – the banks. PPI was a missed opportunity to demonstrate your intent. I urge you to take the next one.

Many thanks for listening to me. I look forward to taking your questions.

 

 

Banks wasting billions on inefficient clearing

So the morning continues with the innotribe team discussing digital identities, with contributions from a wide range of folks, including:

• Azeem Azhar, CEO, Peerindex
• Scott David, Partner, K&L Gates LLP
• Tony Fish, Founder/CEO, AMF Ventures
• Mary Hodder, Chair, Personal Data Ecosystem Consortium
• Michael Ouliel, Founder and CEO, Ripples HLS Group
• Drummond Reed, Chairman and Chief Trust Officer, Connect.Me; Co-Chair, OASIS XRI and XDI Technical Committees, Connect.Me
• Doc Searls, Alumnus fellow Berkman Center for Internet and Society, Harvard University
• Kevin Sharp, SVP Sales EMEA, Daon
• Gary Thompson, Co-founder and CEO, CLOUD Inc.

The discussions were interesting, particularly as SWIFT used this session to announce that they have taken the Digital ID project to a new level such that anyone can transact with confidence online.

I enjoyed the session and will blog more about it later, as we have a deep dive into the new infrastructure all through this afternoon.

The real challenge here is that it has been tried many times before, but that is no reason not to try again.

Anyways, after that delicacy, it was off to the next plenary session. 

I was particularly interested in this one as it’s all about the plumbing.

Clearing and settlement, for those who prefer to call it that.

This debate focused upon the post-Crisis Financial Transaction Infrastructure: what will it look like, and what do the changes mean for market participants?, and featured

• Michael Bodson, Chief Operating Officer, Depository Trust and Clearing Corporation
• Werner Steinmueller, Managing Director, Head of Global Transaction Banking and Member of the Group Executive Committee, Deutsche Bank
• Lawrence Sweet, Senior Vice President, Federal Reserve Bank of New York

Ably chaired by Dominic Barton, Worldwide Managing Director, McKinsey & Company.

Larry Sweet kicked off, saying that the “clearing system was a source of strength through this crisis.”

He made some key points, and the line: “we’ve learned what was extreme is now plausible and what is now plausible is increasingly extreme”, is a classic.

His conclusion is that we need “to make sure that the settlement and clearing systems are working coherently and towards the greater good to reinforce each other’s actions between the regulators and the market participants.”

Sweet’s key lines were in this opening, where he stated that, from a regulatory view, “there is no end point, just a beginning and the trick is how far are we towards completing a coherent vision?  This should be the basic principles of safety and efficiency we should be striving to.  This includes the things I’m working  on such as the principles for market infrastructures.  We expect to have that completed early next year, in terms of a vision.  Once that’s out there, think of the process that then has to take place.  The participants first have to embed that vision in their processes.  Then all the clearing and settlement systems have to come to grips hopefully with saying that this is a vision with which they can accept and implement.  Then everyone has to work on getting the system to interoperate with that vision.  This is a long process.

Michael Bodson from the DTCC took this dialogue a step further, saying that he agreed “that we're still at the stage where we are beginning to execute the vision”, and that “LEI is a great example of standardisation.”

He made me smile when he said that "global coordination keeps me awake at night. That and understanding all the regulation.”

Too right.  As I tweeted a question to the panel, which was unanswered, I asked whether global regulation is actually feasible when regulators cannot even agree on the definition of what constitutes a speculative OTC Derivative.

Werner Steinmuller was next, and he opened by saying that he sees “a big trend from bilateral clearing to central clearing to central counterparty clearing.  That is concentration and concentration means huge budgets.”

He asked for more transparency from a regulatory point of view – don’t we need this from the banks? – and that the markets need to tackle the issue of unlimited exposure by limiting counterparty.  Interestingly, Werner said that “there is no risk free system but we are trying to make it better.”

Yep, we’ll always have risk.

A final key point he made, that led to much wider debate, is that "we need to help smaller banks and smaller participants in creating new business models."

 For the rest of the debate, I followed the tweets going to #SibosBID as there were many running key quotes from the session.  Here’s a hand-picked few:

Steinmuller

“We must not open the door to regulatory arbitrage.”

“If a CCP is failing, I want to know how we liquidate it.”

Bodson:

“If I was running a credit default swap house, I would never sleep.”

Sweet:

“No one is going to make the world safer by putting transactions into unsafe central clearing systems.”

Steinmuller:

“From a bank’s point of view, systems are changing and we need regulators therefore to be very clear.  We need sophisticated regulators who have understanding and together come to solutions without overdoing it.  We have to work together in an active dialogue. “

Sweet:

“Fifteen years ago we were discussing how to solve the issue of foreign exchange settlement risks and it led to multiple initiatives around the world which, in its evolution, began with multiple initiatives and eventually ended up with CLS so that now we have $4.6 tn a day being settled with confidence through this crisis.   So when you have a clear vision and everyone working towards it, it can be done.”

Bodson:

“Concentrating the risk is not a bad thing - if it's well managed. Fragmentation is never the right way to work.”

Finally, I wrote down virtually word for word Bodson’s discussions of the costs of clearing and settlement globally.

It went something like this:

“There is going to be a change in the business model. There has to be.  Bu the industry has invested in infrastructure that works very well, in Swift, in the DTCC and more.  We have spent an incredible amount of time and money and effort ton these, but i am not sure they are aligned.  Therefore we need to shift these so they are aligned rather than starting again.  It’s not a question of putting more into investment banks or transaction banks, but how to use us more effectively and efficiently.

“This comes back to Giovannini – how many networks do you need, how many CCPs do you need, how many platforms do you need and so on and so on.  The OTC markets are full of inefficiencies and just last week we saw how things can go awry. 

“This results in cost.  The cost of clearing and settlement is about $10bn for the top 10 banks and another $5-$10 billion for the infrastructure; so we could save a sizeable amount if we just aligned and were more efficient.  And I’ve probably underestimated by a factor of two or three.”

Wow – so much cost in infrastructure and, after all this time, the panel admits it is not aligned or efficient.

Seems a bit of a shame if you ask me.

Ah well, off to lunch.

 

 

The similarities between banks and landmines

Last night I was presenting to the MAG-net group.

MAG-net is the networking group in the City for the Mines Advisory Group, MAG, a charity supported by the Financial Services Club and others that clears areas of mines so that schools, villages and life can continue as it should in post-war territories.

They invited me to speak about anything I wanted, and so I created a new presentation about the similarities between banks and landmines (see UBS today).

The presentation developed around the idea of banks being mines that explode in economic terms, in a similar way in which landmines explode and blow away people and animals in the real world.

My premise was that just as landmines blow the legs away from humans, banks blow the legs off economies.

It’s obviously the case that this is true today, what with the Lehmans collapse with Credit Default Swaps creating the first financial crisis; and now sovereign debt in the Eurozone is developing the second.

How can such economic landmines exist in a world where we should have cleared them by now?

They exist because we allow innovation in financial instruments in an unregulated form.

That innovation is all around derivatives of derivatives.

Untried and untested weapons of financial destruction are being created every day and planted as hidden potentially unexploded bombs across the financial system.

This has been well documented in many books, with F.I.A.S.C.O. cited by many as a great illustration of the issues in a storybook form or, if you prefer the academic version, Infectious Greed, gives you the lowdown.

These two books by Frank Partnoy document the issues of derivatives, which are both good and bad.

They are good in creating leveraged risk which allows commerce to become more capable.   They are good in hedging risk, allowing trades to take place that otherwise could not.  They are good in bringing together mixed asset classes, so that previously unrelated goods and services can now be traded together.  They are good in offsetting future uncertainty, which is why they are used.

They are bad because they are so complex, most traders don’t understand them.  They are bad because they are called ‘exotics’, and are so exotic that they can explode.   They are bad because they allow firms, such as Goldman Sachs, to create a massively web of interlinkage between risk that ensures those in their world can have huge exposures whilst Goldmans themselves avoid such loss.  They are bad because they allow debt to be leveraged so greatly that it becomes unmanageable.

All of the latter are the landmines of economies, and are no better demonstrated than by Lehmans collapse and Europe’s sovereign debt crisis.

I illustrated these two points with two charts.

The first is from June 2008, and shows the notional exposure of Goldman Sachs’ main counterparties just before the collapse of Lehman Brothers (doubleclick image for larger version):  

Oh what a tangled web we weave, when first we practise to deceive! Sir Walter Scott 

Now don’t think I’m Goldman bashing because, as I said last night, they are the most effective bulge bracket player in the world’s markets in creating risk and therefore alpha returns.  That’s why their clients use them.  However, they are also the most effective institutions in the world’s markets in creating risks that can explode in the face of their clients.  That’s why they sell ‘crap’ to their customers (by their own admittance) and are happy to do it.  

The second chart I used to illustrate the landmines that firms such as Goldman Sachs lay in the world’s economies is the European sovereign debt crisis and a data visualisation of which countries are most exposed to whom:

Again, derivatives were used to package sovereign debt in the same way as mortgage debt, and has created this second loss of confidence in the European economies. 

The whole presentation can be seen here (needs the words to make sense probably) ...

The similarities between landmines and banks

View more presentations from Chris Skinner

... and the only positive note is that we can save human limbs by clearing landmines using mice to sniff the mines out.

Let’s get some more mice in the financial markets.

 

Postnote:

 In researching the presentation, I found large numbers of images of people with limbs missing.  Some were graphic, some were funny, some were moving and many were tragic.  Give MAG five minutes of your time http://www.maginternational.org/ to consider supporting them.  And any MAG-net member gets a 20% discount if they join the Financial Services Club so it’s worth supporting them for that reason alone surely?

 

 

Bickers over Vickers: the right stuff?

So the Vickers Report has finally crept out into the wilderness.

All 358 pages of it.

Half of it talks about how to increase the competitiveness of banking and the other half about what to do if a bank fails in another crisis.

The latter has garnered all the news headlines, whist the former has been generally overlooked.

More copy has been written about this report than anything else in banking over the past week or so, with a selection of headlines that makes the mind reel.   Here’s just a few:

• Search for new approach to banking has begun - Financial Times
• The complexity of bank reform cannot be underestimated - The Telegraph
• Ring-fencing will dent growth, says forecaster - The Independent
• ICB to admit its reforms will cost banks billions - The Telegraph
• David Cameron in push to dilute ICB ring-fence reforms - The Telegraph
• Oxford Academic Becomes Key for U.K. Banks - Business Week
• 'Shadow banks' move in amid regulatory push  - Financial Times
• Grab some bargain banking shares while you can - The Telegraph
• The wrong reforms will break the banks - The Telegraph
• Banks 'at risk from devaluations' - BBC

If you want the truth, you can read the full Vickers report, which I’ve been reading this morning and so far have found nothing too surprising, as most has already been leaked.

Here’s a summary of the key points on ring-fencing:

• Ring-fencing is confirmed, where banks separate domestic retail banking services from global wholesale/investment banking.  The commission is vague about whether banking to large companies should be in or outside the ring-fence but it suggests that between one-sixth and a third of the £6 trillion of bank assets should be inside the ring-fence.

• The ICB describes the ring-fence as "high" and said that the ring-fenced part of the bank should have its own board and be legally and operationally separate from the parent bank.

• Ring-fenced banks should have a capital cushion of up to 20% comprising equity of 10%, with an extra amount of other capital such as bonds. The largest ring-fenced banks should have at least 17% of equity and bonds, and a further loss-absorbing buffer of up to 3% if "the supervisor has concerns about their ability to be resolved without cost to the taxpayer".

• Capital could be moved from the ring-fenced bank to the investment bank, as long as the capital ratio of the ring-fenced bank did not fall below the 10% minimum.

And on creating new competition:

• The ICB has backtracked on an idea in its interim report that Lloyds Banking Group be required to sell off more than the 632 branches it currently has on the market to meet EU rules on state aid. It dilutes this, to say that it "recommends that the government seek agreement with Lloyds Banking Group to ensure that the divesture leads to the emergence of a strong challenger bank."

• It should be easier to switch bank accounts and the ICB recommends "the early introduction" of a system that makes it easier to move accounts and that is "free of risk and cost to customers". It rules out number portability — as is used with mobile phones — in favour of this switching service. The amount of interest that customers miss out on by having a current account — known as interest foregone — should also be published on annual statements.

• The industry should be referred for a competition investigation in 2015.

For the most part, I’m disappointed with this report.  It’s not that I’m against bank reform, but what is the right sort of bank reform?

What this report appears to do is tread a fine line between bank anger, government need and public input, and comes out on the side of muddle.

It’s already had plenty of flak for this, but let’s pick on a couple of things.

First, account portability. Why hasn’t the ICB included this, as it makes eminent sense as discussed back in December at the ICB meeting I attended.

What the report actually says about this is as follows:

“The Commission recommends the early introduction of a redirection service for personal and SME current accounts (to make account switching easier) which, among other things, transfers accounts within seven working days, provides seamless redirection for more than a year, and is free of risk and cost to customers. This should boost confidence in the ease of switching and enhance the competitive pressure exerted on banks through customer choice. The Commission has considered recommending account number portability. For now, it appears that its costs and incremental benefits are uncertain relative to redirection, but that may change in the future.”

In other words, the cost of using different account numbers between banks allowing portability is too great.  For example, if might from RBS to Lloyds with account number 75280025, there may already be someone at Lloyds with that account number.  Therefore, to introduce account portability of account numbers, you would probably need to renumber all the bank accounts in Britain with unique ID’s.  That’s why it’s been dropped.

But then the report adds more details to this idea (page 218) and shows it is feasible:

“Under account number portability, a customer’s sort code and account number would not change when the customer changed banks, thereby avoiding the need to change any payment or credit instructions. Evidence to the Commission suggested that the effect of account number portability could be achieved through the creation of an ‘alias database’. This proposal is for a new database to be created with a new code for each account that would be assigned to each sort code and account number: a customer would give the direct debit originators (and creditors) they deal with the new code, which would never change; when the customer moved banks, the sort code and account number assigned to the customer’s code would change and nothing else.”

Later on (page 222), it expands on the risks and opportunities of account portability:

“One significant benefit of account number portability (whether done through making existing  account numbers effectively portable, or through the creation of an alias database) is that it would remove the cost of switching to direct debit originators, as well as those who make automatic payments into customers’ accounts. However, given the importance of the payments system, it would be critical to ensure that the migration to account number portability did not disrupt the flow of payments or introduce greater operational risks into the payments system.”

In light of a need for bank reform, this would have been a worthwhile aspect to develop now, and it is something left in the report for further evaluation so you never know.

Nevertheless, the big question is whether this would improve competition anyway?

Competition is more about the barriers to entry – governance, licensing, capital, technology etc – and hence, these are more mighty areas … that the report also fails to address.

The report mentions competition 414 times, and yet the main recommendations of the interim report:

• “that the divestiture of Lloyds’ assets and liabilities required for EU state aid approval will have a limited effect on competition unless it is substantially enhanced;

• “that it may be possible to introduce greatly improved means of switching at reasonable cost, and to improve transparency; and

• “that the new Financial Conduct Authority (FCA) should have a clear primary duty to promote effective competition”;

... have all been watered down.

Then we move onto ring-fencing, which purely addresses the aspects of what to do if a bank fails.

"Structural separation should make it easier and less costly to resolve banks that get into trouble.  By ‘resolution’ is meant an orderly process to determine which activities of a failing bank are to be continued and how. Depending on the circumstances, different solutions may be appropriate for different activities. For example, some activities might be wound down, some sold to other market participants, and others formed into a ‘bridge bank’ under new management, their shareholders and creditors having been wiped out in whole and/or part.  Orderliness involves averting contagion, avoiding taxpayer liability, and ensuring the continuous provision of necessary retail banking services – as distinct from entire banks – for which customers have no ready alternatives. Separation would allow better-targeted policies towards banks in difficulty, and would minimise the need for support from the taxpayer. One of the key benefits of separation is that it would make it easier for the authorities to require creditors of failing retail banks, failing wholesale/investment banks, or both, if necessary, to bear losses, instead of the taxpayer."

Living wills and all that aside, the proposal to leave banks as integrated universal operators – good for Barclays – by purely creating a delineation between their domestic commercial and retail banking operations versus their global links is a duck out.

Why?

Because it does not address the issue of why banks fail, but just what to do when they fail.  This is a positive thing according to some and yes, sure, it's a good thing to know what to do when a bank fails ... but why not try to deal with the core of failure as, even if we know what to do, a bank failure in its investment arm will still destroy value in its overall operations.  

Northern Rock illustrates this well where, as a pure retail bank, it failed due to securitising its loans and mortgages in the wholesale markets.  Surely these aspects of potential liquidity failure should have been in the report, and how a bank builds an illiquid position that leads to failure, rather than just what to do post the event.

And no, I'm not forgetting that through a ring-fence recommendation increased capitalisation of both the retail and investment operations will help, but an illiquid position is still on the cards and that is surely a point that should have been the core of the reforms, not the post-failure fall out?

Equally as Sir John Vickers has been saying in today's press calls: “the too big to fail problem must not be recast as a too delicate to reform problem”, but is he reforming or just adding insult to injury?

As the action of ring fencing is a unilateral action not being followed by any other major nation right now, it may be the latter.

Renowned former Federal Reserve Chairman Paul Volcker gets to the heart of the matter when he says that he “completely doesn’t understand the British approach, where they can leave all these questions unanswered.  They said they wanted a retail bank in the same holding company as everything else. I don’t know what ‘everything else’ means.  Is that not a bank too?  It’s just a wholesale bank.  Who makes the payment system work – the retail bank or the wholesale bank … the philosophy is you are a group of banks that serve the consumers, the retail customer, and that hold their deposits with the central bank and so forth, does not solve the problem with all the other parts of the financial system.  I also don’t believe in a firewall or Chinese wall between them, as you need a very high ring fence to stop the deer jumping over.”

Sir John may claim the fence is high, but it cannot be high enough.  

When a Barclays investment bank fails, it will still bring down Barclays Bank  as Barclays investment banking operations represents 42% of the bank's total revenues (Royal Bank of Scotland generates a third of all revenues from investment operations; HSBC 27%; and Lloyds Banking Group is unceratin as it has no official investment banking arm).

Meanwhile, the costs are at least £4 billion to implement these reforms and the overall programme has really hammered the value of the UK banking sector in the world's financial markets:

With much of the loss of value this year due to Sir John's committee's actions combined with the Eurozone crisis.

So my key question is that we are living in a world where Basel III, G20 reform, European Union Directives along with American restructuring is creating so much imbalance in the global financial system that adding to such imbalance though unilateral action is questionable.

This is corroborated by the views polled by City AM and Politics Home.

“Among just those working in the banking sector, however, support for the idea has collapsed - and while a small majority of bankers still back a ring-fence, net support have fallen from +46% to +15%. This is surely a reflection of recent rumbling in the press on the dangers of such a scheme to the sector.

Those working in the banking sector, however, thought the idea would make no difference in preventing a repeat of 2008, while thinking it would be actively damaging to promoting UK economic recovery, getting banks lending, as well as keeping HQs in the UK.

All in all, the whole area is a cauldron of trouble and messiness that this report has done little to resolve and, if anything, has fuelled more debate about the UK’s sole stance in the face of global regulatory drives.

So what should we do?

We should ensure that we work in harmony with Wall Street on the capital market reforms whilst implementing domestic policies to lower the barriers to entry for new entrants in banking.

The former may be seen as being difficult, but the #1 objective of the UK should be to maintain UK’s attractiveness as a centre for financial services.

That’s the piece that has been most badly damaged by these proposed reforms.

Luckily, it won’t be implemented until 2019 in order to ensure consistency with the developments of Basel III, so delay was inevitable after all.

A few further comments:

Andrew Gray, UK banking leader, PwC, said: “The report from the ICB today sets out a clear statement of the direction it believes should be followed in order to reduce the risks of banking in the UK, increase competition and ensure globally competitive banking based in the UK.   The measures recommended will have a far-reaching impact on the way in which banks operate in the UK in future. A key question for government to consider will be the trade-off between improved financial stability and facilitating economic growth.  The core proposals revolve around the use of ring fencing of retail banking activities to ensure both the financial stability of the banking sector, but also to ensure the government is not called on to rescue the banking sector in the future. Ring-fencing on its own does not change the risks inherent in banking (except when it comes to resolving failed firms) and the ICB recommends higher capital levels than those proposed by the Basel Committee.  The importance of a strong banking sector as an integral part of the UK economy is clearly recognised, as is the need to ensure the UK remains a globally significant centre for financial services. Overall, these proposals, while not unexpected, will represent a significant change to the UK banking landscape.  These are detailed proposals which will take time to digest and, in doing so, more questions will emerge.  It is too early to assess the real impact on the UK banks and the wider economy.  The real consequences will only become clear once the Government decides what is to be passed into law.”

Michael McKee, Head of Financial Services Regulation at DLA Piper, commenting on the Independent Commission on Banking - Final Report, said:   "The ICB Final Report has stuck to the line set out in the Interim Report. Most interesting is the detail of how the ring fence will operate.  It will focus on deposits of individuals and small businesses - but this is likely to catch a lot of private banking business too. The ring fence looks like it will be quite a "hard" ring fence - a retail bank will have to deal at arms length with other parts of the group and apply large exposure rules. Moreover the ICB sticks to its guns about a minimum level of 10% capital for retail banks and also wants a lower leverage limit than international proposals.  Overall, therefore, the ICB has withstood political pressure from the Liberals but has taken a tough line on the content of its ring fence."

Edward Sankey, Chairman of the Institute of Operational Risk (IOR), said: “We are concerned that the Vickers Commission are proposing economic solutions to what they believe are economic problems. However the IOR believes that the root causes of the financial crisis were failures in people, processes and systems, which are the targets of operational risk management.  The proposals will not on their own do anything much to reduce the possibility that failures by people, processes and systems will not again threaten banks and their clients. Time and again we have seen that more sophisticated regulation and restriction leads to more sophisticated efforts to find ways through them, or even plain evasion.  We have a great opportunity to make lasting reforms that will not only help to ensure a sustainable and profitable UK banking sector, but also strengthen UK economic growth. Unfortunately the Vickers Commission is focusing on the wrong solutions – solutions that will do little to correct the failures in people, processes and systems that preceded the crisis.”

Andrew Wingfield from SJ Berwin’s Financial Institutions Group commented: “The ICB’s proposals totally focus on retail protection and would impose a cost ahead of any bank failure.  The costs of restructuring and higher equity capital levels will place returns under further pressure and the ICB’s proposal will likely be a Herculean task given that people and IT systems are intertwined within banks.  The key recommendation (in our view) is around a clear message to UK banks to ring-fence their operations with the tone of the political debate already showing signs of an irreversible process and the Government committing to immediate steps towards implementation.  Over the next few weeks, it will be interesting to see whether support for the recommendations wanes as the party conference season approaches.  However, the message is softened by a long final implementation deadline of 2019, which is intended to synchronise the timeline with the implementation of new international standards under Basel III.  In our view, all Banking reform measures adopted by the UK authorities need to be carefully analysed in order to ensure that the full consequences on the economy and the recovery of banks’ ability to support customers is understood.”

 

 

 

Release: 2011 Survey on the Health of European Payments

Survey reveals that SEPA and the PSD are progressing but liquidity risk needs addressing

Research finds liquidity risk is a major potential exposure for the future and calls for more automation

The Financial Services Club and Logica revealed the results of their annual research into the state of play in European Payments and the progress of the implementation of the Payment Services Directive (PSD) and Single Euro Payments Area (SEPA).

The report surveyed over 360 global bankers, consultants and technologists and covered five key areas. These included the development of the European Union, the impact of the PSD and SEPA, bank-to-corporate relationships, and liquidity risk.

The survey revealed that two-thirds of banking professionals agree that an integrated payments market is either critical or very important to Europe’s future. When it comes to the PSD, 50% of respondents think it has been successful – a 15% increase from 2010. For SEPA, when asked the same question the results are not as positive – only 30% think it has been a success. Banks are also slightly more optimistic on the progress of SEPA - with 70% believing that the SEPA vision will be realised by 2017 compared to 68% last year.

A key issue highlighted by the survey is concern over liquidity risk. While 73% of banks surveyed know their financial exposure in the case of a liquidity event, only 39% were able to do this through the right technology of which only 17% can do this in real time.

Seven out of ten respondents felt that SEPA was having a positive impact on corporate-to-bank payments processing and 81% found that technology solutions met their requirements, although the majority noted that these developments could be improved.

Research background

The survey ran during between July and August 2011, and was completed by 360 participants across 44 countries.  The largest single group of participants was from the banks with over a third of the respondents from this constituency.  Consultants and technology providers are the next largest groups, also representing over a third of the votes.  Almost three out of ten participants (27%) describe themselves as “middle management”, whilst 40% were senior management or C-level and one in four (26%) were “consultants” or “advisors”.  The full report is available upon request.

Logica and the FS Club will be hosting a free webinar on GT News on 12 September at 3pm BST / 4pm CEST / 10am EDT.

To register, please visit: http://bit.ly/rjN4h9

Download Summary Document for a free copy of the research.

Bribery, corruption and banking

I’m sitting in a restaurant the other day, and hear the following conversation …

Banker One: “So what’s this Bribery Act thingamajig?”

Banker Two: “New Law.  Came into force July 1st.” mnum, yum, mnum.

Banker One: “Yea, I know that”, mnum yum. “I meant what does it mean?”

Banker Two: glug, glug.  “Can’t take a bung anymore.”

Banker One: “You do?” Mouth open, food visible.

Banker Two: “Not anymore ha,ha, ha”. Glug.

Banker One: “So what’s the basics on this?” Mnum.

Banker Two: “Well. Let me tell you …”

The pin-striped gel boy then went into a lengthy overview on the whole thing.

Rather than bore you with all the detail, it can be summarised as a new law that came into force in the UK on July 1^st 2011.

The Bribery Act introduces a new corporate offence for, you guessed it, bribery.

A person is guilty of bribery “if he (or she) offers or gives a financial or other incentive to someone with the intention of getting that person or a third party to perform a function or activity improperly or as a reward for an improper act”.

He or she is also guilty if they know or believe that the offer or payment itself constitutes an improper performance of a relevant function or activity.  There are four ways this might happen:

1. “Active bribery”, where someone purposefully gives another person a financial or other advantage to induce them to perform their duty improperly;
2. “Passive bribery” where you offer, request, receive or accept a bribe;
3. Bribing a foreign government official in order to win or keep business for your company, or to gain a business advantage for your organisation; and
4. An offence if you let someone commit one of the above offences on your or your company’s behalf.

This is old news, but I was amused by how the conversation between the two bankers proceeded.

Banker One: “So what about the Clubs?” mnum, yum, glug.

Banker Two: “No can do, no more.” Gnaw, gnaw, ribs.

Banker One: “Damn, I liked the girls.” Splutter, spit, chew.

Guess you get the idea of how they’re eating, so I’ll just recount the conversation as I heard it from here.

Banker Two: But it does make me wonder.

Banker One: Wonder what?

Banker Two: About the Clubs.

Banker One: We can still go.

Banker Two: Not those Clubs.  I mean, are we bribing someone if we take them to see Chelsea?

Banker One: No way.

Banker Two: In Thailand?

Banker One: You did?  Like the Hangover II?

Banker Two: Better!  She did far more than ping pong.

Banker One: Get outta here. Tell me more …

I’ll leave that bit out, as it got a bit close to the edge, but the conversation remained in Asia.

Banker Two: But we’re gonna find it harder these days, aren’t we?

Banker One: ‘Cos of the banking crisis?

Banker Two: No, ‘cos of this stupid Bribery Act.

Banker One: How so?

Banker Two: well, my main action these days is in China, and you get nowhere in China without a bung here and there.

Banker One: Ah, but taking a bung might get you hung.

Banker Two: Only recently.  For years, those guys got away with all sorts of stuff.

They then went into a list of their favourite Asian films, which was pretty juvenile.  I almost wanted to step in when they were talking about which Lee was better: Christopher, Ang or Jet.

Of course, Ang is not an actor and Jet spells his surname differently, but that's another story.

The conversation finally ended up with further surreal chat …

Banker Two: What about Gaddafi?

Banker One: Yea.  Shame.

Banker Two: Tyrant, I know.

Banker One: No.  I meant losing his account.

Banker Two: You had it?

Banker One: We had it.  He moved all the funds out to HSBC.

Banker Two: Told you Asia is where the action is.

Banker One: At least we’re still trading, unlike the Italian guys who partnered with him.

Banker Two: Whatever.  Any idea where he is these days?

Banker One: What?  The Italian?

Banker Two: No, Gaddafi.  I heard the old lag had already jumped ship. 

Banker One: You know he had a load of investments in London property …

At this point, a person extraordinarily similar in height and stature to Colonel Gaddafi walked past … it couldn’t be, could it?

 

The real rip-off culture ... is not Wonga? Part Two

One of the more outspoken reactions to my post on payday firms came from Wonga.

Not surprising as my original headline was that “Wonga will wrestle with regulators”, and they will as the markets are pretty unregulated today.   A point I made last Friday. 

I also mentioned last Friday that the original reason I wrote this was because of two statements in a Wired Magazine cover on Wonga from May.

The first said that “within a year, Wonga had issued 100,000 loans, worth £20 million, earning about £15 million by charging interest at an eyewatering headline rate.”

The second was a letter from Steve Perry in Wired in June that said:   “When I could no longer repay a Wonga loan, it took 50 days of ringing and emailing to get through – an £800 loan became a £1,700 repayment.” 

Both lines made me angry, and hence led to this debate.

So, just to set the record clear, let’s look at Wonga in depth.

First, what is the Wonga business model?

Their business runs on super flexible, short-term loans, delivered via the internet in minutes.

The offer is made using a simple calculation system on their homepage that lets you put in how much you want to borrow – up to £400 (or £1,000 for repeat customers) – for how long – up to 30 days maximum.

The interest is made clear to you as you enter this information.  For example, £300 over 7 days racks up £26.59p in interest and fees whilst, over 30 days, this would be £95.89p.  Bear in mind that £5.50 of these amounts are the transmission fees to move the money to your bank account in real-time, and the rest is the actual interest rate.

In other words, the real interest rate is around 360% APR or 1% per day average.

Although the APR on the homepage states that it is 4214%, this is purely a number required by law to show how much the loan costs over a year.  As a result, the interest rate is compounded to represent how the Wonga loan period would look if spread across a year, even though the company does not offer annualised loans.  So the fee and interest is compounded and added as a mathematical view of APR, rather than real view.

360% interest rates per annum may seem high, but it’s not competing with those long-term loans.  Wonga doesn’t offer long-term loans although, if they did, it would be at 360% interest rates, which they admit themselves: “Even if we were to launch a year-long loan at the same interest rate we charge now, the APR would be much lower than the current figure, more like 360%, because there would be no artificial compounding involved.”

But Wonga doesn’t offer annual loans. Their maximum lending period is 30 days and, in that context, Wonga’s rates are a fraction of those charged by high street banks for unsecured overdrafts and credit cards, which are the markets they are most interested in taking business from.

So Wonga specialise in short-term loans to give you coverage for a few days when you most need it.

Their team shared some interesting stories with me in this context and it’s generally for people who don’t want a bank loan – as such loans tie you up for a long period of time with amounts that are reasonably fixed – or can’t get one due to poor credit history or a recent change of job or address, or need cash fast and it would take too long in the bank.

A few examples included a customer whose dog needed emergency treatment and they needed cash in minutes, and a guy who had lost his job and needed to buy a car to become a minicab driver but couldn’t buy the car through the bank as he was jobless.  The latter is a Catch 22 – how can I start work if you don’t give me the loan?

The loans are incredibly short – typically  a few days – and are high interest due to the costs of acquisition and processing.

Although the company does not publish public records – they are a private firm with £90 million of venture capital backing [Wonga Company Number is 06374235] – they point to similar firms in the USA such as Cash America and Advance America, who have to provide transparent reporting of returns under SEC filings.

What this shows is that Cash America makes less than 10% net income on revenues of over $1 billion …

… whilst Advance America made a net income of $35.8 million on revenues of more than $600 million

This is because the business costs are high with cost of customer acquisition being the highest, followed by default rates which are also significant.  Wonga say they have theirs under control by using sophisticated technologies to avoid high risk customers, but one US study found that as much as a quarter of a payday firm’s revenues can be attributed to defaults.

This does not even include marketing and processing costs, with the cost of data being a major overhead in the process too. 

For example, Wonga use Experian and other credit agencies to real-time check customers during their online acquisition processing.  That’s all at a cost and many other payday firms don’t use such sources for this reason. A typical payday firm would just ask to see your last salary and bank statements and would then approve.  This is why their default rates are high and Wonga’s are lower.

But it makes the point that this is high risk, high volume, low margin business that is hard to make money unless you’re good.

It is also why Wonga claim they do not target vulnerable customers.

Why would you?

Vulnerable customers are more likely to default and less likely to pay back, so that’s not the market they want.  Wonga make the specific point that, being a private firm backed by venture capital, it’s their money they are putting at stake, so they only want to target the right customers?

Who are the right customers?

Wonga want customers who sit between core bank lending markets and the unbankable markets.

These are often customers who have never used a payday loan firm – 75% of the customers have never used an online payday loan before – and they are often bank customers – every customer has a bank account and access to full banking services.  This means that they also have access to traditional credit products, such as loans and credit cards, but often don’t trust themselves with such products.  They would rather pay high interest on a short-term loan they can manage than lower interest on a long-term loan.  This is because the short-term loan is easy and manageable, rather than escalating and invisible credit on a card or fixed for years on a bank loan.

Here’s a few more facts:

• 59% of Wonga’s customer are male, whilst 41% are female
• They are average wage earners (£22,000 per year) and aged typically between 21 and 40 years
• Most are tech savvy and are regular broadband and mobile users
• 14% of Wonga’s customers use an iPhone
• The average first-time loan is for £160 and the average loan across the customer base is £230
• As long as you demonstrate you are a responsible borrower, you can increase your maximum loan to up to £1,000 over time
• Wonga serviced their first customer in October 2007, and is now estimated to be making more than 100,000 loans per annum
• 3 years after launch Wonga.com had made in excess of 1.5 million loans to customers

These customer demographics prove that the customers aren’t necessarily the vulnerable and needy, but the sophisticated and informed.

They use the internet and mobile connectivity and like the flexibility of a short loan that avoids bank overdraft fees.

From a risk perspective, Wonga ensure the select the right customers, not the vulnerable ones, through their technology analytics and algorithms again, and means that most Wonga customers are actually not the normal payday loans customers.

In fact, as mentioned, the technology is something that impresses.

Not only does it credit check and money transfer in real-time, but it goes further by completing the whole process in under fifteen minutes typically.

That’s why Wonga actually describe themselves as a technology firms that offers financial services, which gives you a clue to their positioning right from the start.

They are also very transparent.  Everything is clear up-front.  For example, they calculate the total amount repayable upfront, showing the figures clearly and including all interest and fees.  You might say that’s better than a bank?

There’s also a good guide to ‘responsible lending’ that’s accessible from their home page .

They also make it clear that “the only way costs can increase is if you fail to honour the agreement.”

So what happens if you fail to honour the agreement, like Steve Perry did?  What’s your maximum liability?

Well, it appears Wonga are also semi-flexible on this point too.  If they get a customer who is in trouble, they don’t just keep hammering them with fees and charges, but will apply penalties to a maximum of 360% interest.

At that point, it stops until some form of agreement or compromise can be made.  For example, in Steve Perry’s case, Wonga waived the outstanding balance with Wonga’s head of communications, John Moorwood, saying to me:

“We lend our own money and we’re completely incentivised to make selective decisions and help people who can afford the service and are likely to repay a loan quickly. A typical loan is around a fortnight and a quarter of our customers repay early every month, which they can do without any catches.

“We decline the majority of first-time applicants and we also decline some returning customers, or limit their access to credit, based on the same checks and prior use of the service. Again, we have nothing to gain from helping someone who can’t afford the loan or is in serious financial difficulties. We don’t claim to be perfect, but we believe we are doing everything we can to make the best decisions possible, which has seen us win a number of respected risk-based awards judged by industry experts.

“The fact we’re achieving this aim of making the best possible decisions is supported by the very low rate of arrears and positive feedback from most customers, whom we survey and speak to regularly.”

Now, I can find loads of other complaints against Wonga that are similar to Steve Perry's from Debt Line, the Review Centre, UK payday reviews and more.

Most of the complaints are down to people who failed to payback on  time, didn’t read the rules or ignored them, have been declined as a repeat customer due to their credit getting worse and related issues.  The worst one is that Wonga charges rollover fees if funds are not in the customer's account on the morning of the due date, even though funds may be in the account later in the day.

Even so, none of these complaints appear to be about Wonga not doing what it says on the tin: we will lend you a short term loan at high interest rates and not charge you excessive fees unless you don’t pay back on time.

If you want more on this part of the operation, read the Payday Loan Master write up on the Wonga Scam from June 2011.

My conclusion on Wonga is that they are hard on customers who don’t play by the rules, but they make the rules clear upfront and it’s down to you to absorb or ignore them.

It's all about transparency.

In fact, Wonga regularly survey their customers on what they think and, in the last survey performed by Populus in January 2011 of 15,200 people, Wonga’s customers thought:

• Wonga is better than a bank overdraft, bank loan, credit card or other payday loan
• 77% thought Wonga’s service easy to use, compared to 7% with the banks
• When asked: “how well or poorly is information communicated when you use Wonga’s service?”, 66% think ‘very well’ and 30% ‘well’ – only 1% rated communications poor
• The Financial Ombudsman Service received 30 complaints in 2010 about Wonga, equivalent to 0.003% of their customer base of a million customers; by comparison, Barclays bank had 276,000 complaints which, with around 14 million customers, equated to 2% of their customer base

If you want to read more about Wonga, here are their documents:

• About Wonga 2011 (400KB)
  
• Wonga.com code of practice (2.7MB)

Finally, I asked Wonga their views on interest rate caps, loan caps, and more qualification of the borrower and their other financial exposures, particularly for repeat customers.

They actually agreed with these recommendations, saying that more payday loan firms should be responsible lenders to ensure they don’t get a bad reputation.  For example, they use Experian and credit scoring to ensure they avoid vulnerable and poor credit based customers.  If every payday loan firm did, then they would all qualify borrowers better.  The fact that most don’t, due to the costs of data access, makes this a vulnerability.

Wonga don’t agree with interest rate caps, as they think competitive market forces rule.  As a result, they promote transparency of overall costs as being the way to go, as per their homepage, rather than regulatory limits on lending.

This is in line with a recent analysis by PriceWaterhouseCoopers of consumer credit – “UK consumer credit in the eye of the storm” – which states on page 19 that: “in the case of payday lending, an APR is fundamentally misleading.  Annualising the interest cost of a product that is only offered as a short-term facility confuses the purpose of the loan and misrepresents the true cost.  It’s similar to suggesting that the typically annual cost of a rental car might be close to £15,000, rather than a daily rate of £40.  The total charge for credit may be a more beneficial measure for the consumer in this instance.”

The report goes on (page 16) to say that “while rate caps could reduce the cost of borrowing for some, there are a number of potential arguments against rate caps that should be considered:

• Reduce access to credit;
• Migration of interest rates towards the rate cap;
• Reduced competition and diversity of products;
• Introduction of, or increase in, ancillary fees and charges; and
• Growth in the unregulated market.”

 

The Office of Fair Trading came to a similar conclusion a year before:

“The OFT has also considered the case for price controls for pawnbroking, payday loans, home credit and rent-to-buy credit and concluded that they will not address the problems identified in the high-cost credit sector, which stem from both limited supply options and consumers' lack of ability to drive competition. The OFT is concerned that such controls may further reduce supply and considers there to be practical problems with their implementation and effectiveness. These problems include the potential for suppliers to recover income lost through price controls by introducing or increasing charges for late payment and default.”

Finally, going back to Wonga, they recognise that payday firms can rip-off customers and cite examples in the USA where some firms would actively try to rollover customers at least four times to ensure they recoup their customer acquisition costs.  Wonga claim they do not do this but, as demonstrated by the Payday Loan Master, the most serious disputes between short-term lenders and their customers are when firms add fees claiming that funds were not in the customer’s account on the due date when the customer claims there were funds.

In this instance, Wonga has a zero tolerance approach to late payments and this is why they do have issues with customers who fail to meet the criteria of making sure they payback on payday.

In summary, I’m sure I’ll come back to this discussion again at some point, but Wonga fill a gap in the market for those who need short-term cash, want to avoid banks for various reasons and understand how the system works.  They have very high customer satisfaction and recommendation levels, depend upon repeat customers, and have no interest in poor credit vulnerable customers as they will not pay back.

The net:net is that Wonga does not see themselves as bad company.  However, they live with bad company in a too lightly regulated part of the financial markets.  Regulation is required therefore, and we both agree that regulation needs to be clear, fair and to ensure that customers are effectively protected.

All in all, a good dialogue and much greater clarity about this market, its challenges and issues.

 

The real rip-off culture? Part One

Further to my write-up about Wonga the other day, I have been contacted by author and campaigner Steve Perry, who has been on the wrong side of the payday loans industry.

Now don’t get me wrong. 

I am NOT against payday loans firms or their operations (I actually admire Wonga's technology ops). 

I AM against the uncapped interest these firms charge on their vulnerable customers.

However, this also needs to be qualified in terms of who are 'vulnerable customers' and who actually charges 'rip-off' rates and how.

For example, Wonga have also contacted me to put their side of the story and made clear that they do not target 'vulnerable' people with 'rip-off' rates.  

Read Monday's blog to see what their take on the world is, particularly as my original piece was kicked off by the Wired magazine coverage of Wonga.

In that coverage were two issues.

First, the line in the article that stated: “within a year, Wonga had issued 100,000 loans, worth £20 million, earning about £15 million by charging interest at an eyewatering headline rate.”

I had a fundamental issue with a firm making those sort of rates of profits on loans, but Wonga tell me their margins are nowhere near these levels and, having met with them, I will take that as fact.

Second, the star letter that followed in Wired the following month saying:   “When I could no longer repay a Wonga loan, it took 50 days of ringing and emailing to get through – an £800 loan became a £1,700 repayment.”  Steve Perry

As mentioned, Steve contacted me following the blog entry and I discovered that he is a person who got into serious trouble using payday loans.  Wonga tell me they are not a payday firm, which again I will explain on Monday.

But let's look at Steve's story.

Steve borrowed £15,000 in a year from payday loan firms.  This led him to be in serious schtuk, and having to pay back £22,000.  In other words, even though he tried hard to manage it, he was being charged extortionate interest rates and, having nowhere else to turn, spiralled into debt by borrowing off one payday firm to pay back another,.

In one instance, he borrowed £1,390.00 from PayDay UK between June 2009 and February 2010; he paid back £2,852.50 over 15 months. 

Due to losing his job and trying to manage his commitments to payback PayDay UK, Steve unfortunately then borrowed from another payday firm to pay back the first payday firm.

In July 2009, he borrowed £160 from Payday Express. By the end of his borrowing with them – October 2010 – he had taken a total of £1,225.00 in payday loans and had to pay back £1,975.00.  This is over 15 months. 

Again, the uncapped interest on payday firm operations is illustrated well as, so far, Steve has borrowed £2,615.00 over 15 months which, with a bank, would incur interest payments of around £650 max but, through payday firms, incurred interest of £2,212.50.

It’s the difference between average APRs of around 19% versus 90%.

One of the points Steve raises is that the payday firms do not take into account your other financial commitments, whereas banks do.  If you have borrowed to the hilt, a bank will take this into account and refuse you a loan.  Payday loan firms do not ask about your commitments and this means that you can borrow off all of the payday firms to pay back each one.  In so doing, you just become more and more of a victim, and that’s what happened to Steve.

He ended up borrowing off other firms to keep up and make the payments to the first.

So then came Lending Stream.

Steve borrowed £200 off Lending Stream in June 2010 and, by November 2010, owed them £1301.10 on borrowings of £640.00.

The interest was more than double the borrowings in just under five months.

He borrowed from several other firms and found each had nuances by which they made more or less money.  

Over a period of 21 months, Steve ended up borrowing from 12 payday loan companies, who made and approved 64 individual loans to him with no knowledge or interest in each other’s activities or his other financial commitments.  The result was that he had to repay £21,707.49 on loans of £14,886.00.

Now Steve admits he was a mess … but he became a much worse mess due to the unregulated state of the UK’s payday loans markets.

As Steve says: “It has been apparent throughout, a fact in which I have never denied, that I am the chief architect of my own demise.  Whilst I felt I had no other avenues to take, the harsh reality is that I chose on each of those occasions to take payday loans and sign agreements stating immediate repayment on the set payment dates.  However, responsibility of borrowing of this magnitude, on this scale cannot possibly lie totally at the feet of the desperate borrower.  A fact that cannot be ignored is that on 64 separate occasions, over the period of just 21 months, a total of 12 different payday loan companies were more than happy to instantly approve loan payments to me, with no questions asked.”

So what should be done about this?

For me, the #1 issue is uncapped interest rates.

Most countries  impose limits on the interest payday loan firms can charge.

• 37 American states allow payday lending, whilst 13 have made it illegal; 
• In those American states where it is legal, there are hard interest rate caps;
• In Canada, any rate of interest charged above 60% per annum is considered a criminal act, according to the Criminal Code of Canada; and
• The Australian states of New South Wales and Queensland have a 48% APR maximum loan rate, including fees and brokerage.

In the UK, 1.2 million people took out 4.1 million loans in 2009, four times the level of 2006,with total lending of £1.2 billion.  The average loan size is around £300, and two-thirds of borrowers have annual incomes below £25,000.

And there are no restrictions on the interest rates payday loan companies charge.

Steve makes many more recommendations which you can read in his 70-page overview of the UK industry (provided on request). 

These include:

• More qualification of the borrower and their other financial exposures, particularly for repeat customers;
• Capping of the amounts that an individual can borrow, not just from a single lender but from across the industry; and
• Better structuring of rollover of interest and transparency so that the vagaries between lenders is clearer.

The net:net is that as Vince Cable talks about the banks' “rip-off culture”, maybe he ought to look here a little too?

Meanwhile, I won't damn the industry completely as Wonga have proof that sets them apart from the payday pack.  That proof shows that they are not one of the bad guys, which I'm pleased to hear as I've watched them from their first days of operation and was surprised to hear they were making eye-watering margins.

They're not.

I will explain more about Wonga's operations on Monday.

Nevertheless, the core debate here is whether these markets are working well and whether customers are being protected from potentially damaging practices by some of these firms.

My view is that they are not in the UK.

This means that these markets need regulating and regulating fast.  

And that is a fact.

 

Postnote:

Follow Steve Perry on Twitter and/or  join his campaign - Say No To Pay Day Loans.

 

Shocker: Skinner thinks EBA stress tests not worthwhile

In my usual quiet way, I was interviewed by Bloomberg last Thursday in anticipation of the European Banking Authority (EBA), previously the Committee of European Bank Supervisors (CEBS), about the forthcoming stress tests released on Friday.

Last year, these tests were quite laughable and this year I expected more of the same.

Here's the whole ten-minute interview and, for those who missed it, I loved this article in the Telegraph:

Europe's bank stress tests as bad as 1979 Irish driving test

Seeing large numbers of his fellow citizens failing their driving tests, Mr Barrett – in a quick bid for votes – declared that anyone who had taken their test twice and not passed would automatically qualify for a licence.

The consequences were predictable. At any one time, about 40pc of the Irish population were allowed to drive on the roads without ever actually having passed a test. Traffic accidents went up and insurance costs followed.

Andrea Enria, the chairman of the European Banking Authority, may not like the comparison, but the limited bank stress test results he unveiled on Friday are born of a similar motivation that led directly to Ireland’s until only very recently dysfunctional driving test system.

Like the Irish government 32 years ago, the EBA and the European Union are under the impression that their power to pass and fail banks will translate directly into making them better at what they do.

The fallacy of this approach is as obvious as the needlessly ruined lives and extortionate insurance premiums that once-blighted Ireland will attest.

 

Volcker versus Vickers, Round One

Paul Volcker’s in town and he’s been everywhere!

He popped up on Bloomberg, and “said the pace of financial-regulatory reform has slowed ‘to the point of ineffectiveness’ because of the complex work needed and resistance of lobby groups.”

He made a few comments on Reuters, and said “there are limits as to how much more (the Federal Reserve) can do within things that are feasible for a central bank” with regards to the debt crisis in the USA.

And he delivered the prestigious Mais Lecture at Cass Business School last night.

I was invited to one of the events he attended at the Official Monetary and Financial Institutions Forum (OMFIF), and it’s ten years since I last bumped into Paul Volcker.

Back in 2000, he joined me on a panel at BAI Retail Delivery.

Back then, he was a highly respected, former Chairman of the Federal Reserve.

Today, he is a highly respected, former Chairman of the Federal Reserve, who has a rule.

The Volcker Rule.

The Volcker Rule is the modern version of Glass-Steagall, and says that banks cannot deal off their own book of business in the investment markets.

In other words, he’s effectively ended the US investment banking operation forever.

It’s been watered down a bit since, but Volcker is adamant that banks gambling in the world’s markets are not good for business.

He’s adamant about a lot of other things too, and here are a few highlights from the session I attended.

Paul began with a comment around China’s $3 trillion of reserves, and the imbalances this creates.  When China has enough dollar reserves to buy a quarter of America’s annual GDP, and America is at the tipping point of a debt crisis, something has gone a bit skewwhiff.

He’s also no fan of derivatives, and said that he has a standard offer to every freshly minted PHD student to prove whether any financial engineering instruments have delivered real improvements in the productivity and efficiency of the economy.

He has yet to receive a submission.

In fact, the instruments have purely lined the pockets of Wall Street as the wealth and income of the typical American family has not improved over the last twenty years.

Meanwhile there was an amazing increase in the concentration of wealth in the top 0.5% of the population.

That’s wrong and creates a world less about the haves and have nots, and more about the have nots and have yachts.

After around 35 minutes, I managed to get my question in about what he thought about Sir John Vickers’ Independent Banking Commission (ICB).

The ICB’s interim report recommends that banks are ring fenced so that, if there is another crisis and the investment bank fails, it can just be closed down.

Volcker would instead have the ruling that the investment bank that trades speculatively just should not exist within the bank.

He said that he “completely doesn’t understand the British approach, where they can leave all these questions unanswered.  They said they wanted a retail bank in the same holding company as everything else. I don’t know what ‘everything else’ means.  Is that not a bank too?  It’s just a wholesale bank.  Who makes the payment system work – the retail bank or the wholesale bank?

“… the philosophy is you are a group of banks that serve the consumers, the retail customer, and that hold their deposits with the central bank and so forth, does not solve the problem with all the other parts of the financial system.  I also don’t believe in a firewall or Chinese wall between them, as you need a very high ring fence to stop the deer jumping over.”

This view was expanded upon in the Cass lecture: “The question will inevitably arise as to the financial and regulatory logic of maintaining a ‘retail bank’ as part of what in most cases would appear a much larger, highly diversified and ‘systemically significant’ organisation … in any event, the nagging overriding question will still arise: how to deal with the imminent or actual failure of such a large, systemically significant, financial institution whether or not it is a ‘bank’.”

Back to the lunchtime meeting, he was asked his views on the European Central Bank (45 minutes), and was just as damning about them too: “It’s odd to have a very strong and very independent central bank without a government.”

On the euro, Paul hopes the euro will survive but the current crisis is “obviously The Test, and it’s a very big test.  Nevertheless, I wonder what would have happened today if you had not had the euro.”  Either way, “Europe will need bold and confident leadership to get through this.”

In terms of this crisis and how fast it will conclude, he said that “we’ve been going through a crisis of excessive debt creation around the world, and that deleveraging will take time … when you have a business crisis coupled with a financial crisis, it always take a long time to recover.  Just look at Japan.”

He said a lot more of course, and you can listen to the whole one hour discussion if you want, although the sound quality is poor …

Paul Volcker from Chris Skinner on Vimeo.

… the discussion opens with a few words from George Milling-Stanley (left), Managing Director of Government Affairs at the World Gold Council and Professor Lord Meghnad Desai (right), Chairman of the OMFIF Advisory Board, and is chaired by David Marsh (second from right), co-Chairman of OMFIF.

It began with nostalgia about the Mexican Financial Crisis, Helmut Schmidt, Walter Wriston and other stuff from the 1970s and 1980s.  Start listening at around 32 minutes if you want to miss the nostalgia.

 

Is this the end of the euro?

For the past two years, we have performed a major survey around the euro and the Eurozone, and how the developments of the infrastructures to support this is changing.

The survey for 2011 is now live and looks at the world after the PSD and SEPA, particularly the implications of the end of the euro, liquidity risk and corporate’s needs as part of this landscape. 

We would love to have your participation in this year’s survey.

Click here to take survey

By taking the survey – it’s only SIXTEEN multiple choice questions and should take no more than 10 minutes to complete – you get the chance to WIN a free one year membership of the Financial Services Club and copies of all my Blog Books!

You also will get a copy of the full results of the survey, which are due for release in early September, so please join in.

Click here to take survey

Meanwhile, I’ve just finished a presentation at the SAP Annual Treasury Conference in Copenhagen today that covered the headlines of our last three research reports related to this area.

You can see the presentation here:

View more presentations from Chris Skinner

And get copies of our previous research survey reports by going to these links:

• The Progress and State of SEPA and the PSD 2009
• The Progress and State of SEPA and the PSD 2010
• The Changing Face of Payments 2011  

Click here to take this year's survey

Robin Hood or Robin Banks?

For a long while now the Tobin Tax, or Robin Hood Tax, has been discussed.

It's been heavily promoted by sympathisers such as Richard Curtis and his luvvies mob, but has yet to gain serious traction in Parliament or amongst the G20.

Nevertheless, it now looks like a Tobin Tax will be a reality as the European Commission President, Jose Manuel Barroso, confirmed last week that he will make a proposal on a financial sector tax after the summer.

This will cause a further fissure amongst the Eurocrats - as if Greece wasn't a big enough one - as the proposal for a Tobin Tax is supported by France and Germany, but opposed by Sweden and other member states.

The UK is divided on the issue, as it is something that is seen to be appropriate but only if it is agreed globally, rather than regionally.

Therefore, in a timely issue, the Institute of Development Studies (IDS) sent me a copy of their report into the viability of such a development.

Their report states that: "applying a 0.005 per cent tax to the foreign exchange market alone might raise US$25 billion annually worldwide and £7.5 billion for the UK."

In these times of austerity measures, cutbacks, budget restrictions, government handcuffing and worse, this deal is surely too good to ignore?

Concluding paragraph of the IDS report:

“Although the evidence is not conclusive on all points, a Financial Transaction Tax is clearly implementable and could make a significant contribution to revenue in the major financial economies. It would be unlikely to stabilise financial markets but, appropriately designed, also unlikely to destabilise them.

“Although a multilateral agreement between the key economies is preferable, it could be implemented unilaterally, at least for a major economy. The incidence of a Tobin tax would be less progressive than some of its proponents claim, but it would be unlikely to be significantly worse than most alternatives.”

Download a summary of the report here (100KB, 2 pages) or the full report here (355KB, 79 pages).

 

Lloyd’s branch sell off … what a load of Verde

I was talking about lots of things yesterday but one conversation sticks in my mind more than any other: who will Lloyds sell their branches to?

This is all wrapped up in a debate with the European Commission dating back to 2008, when the UK government flouted competition rules to approve the emergency merger of Lloyds TSB and HBOS.  This was viewed as anti-competitive by the European Commission, but was approved under the caveat that a restructuring plan was put into play.

The restructuring plan, agreed in November 2009, “contains a divestment package in Lloyds Banking Group's core business of UK retail banking as a measure to limit the impact of the aid on competition. The divested entity will have a 4.6% market share in the personal current account market gained through a network of at least 600 branches.”

The aim of this sell off divestment, called Project Verde by the bank, is aimed at creating a new competitor or to support the growth of a smaller existing competitor in the UK retail banking market.

The Commission argues that this will “remove the distortions of competition created by the aid”.

In other words, it’s a bit like the RBS sell-off of branches to Santander or the ING Direct USA sale to Capital One.  Something that Lloyds, RBS and ING didn’t want to do, but was forced upon them in exchange for their bailouts (slightly different to the American approach to TARP mesays).

Anyways, back to Lloyds.

Eighteen months after the plan was approved by the Commission, the divestment is in play and 632 branches are being organised for sale, equivalent to 22% of the bank’s UK branch network.  Bids will be received by the end of July and will then move into the Phase 2 due diligence process for the shortlisted few.

The details were announced at the end of May with a press release from the bank:

“The Verde business will have around five per cent of the UK personal current account market, over 600 branches and will become the seventh largest bank in the UK. It will bring together the Cheltenham & Gloucester business, Lloyds TSB Scotland and over 250 branches from the Lloyds TSB network in England and Wales.”

Paul Pester is the new Chief Executive Officer of the Verde business.  In the press release:

“I am delighted to be in the position of shaping and growing a new business which will serve over 5 million customers and service over 8 million accounts.   The new bank will be an exciting addition to the UK market and will be focussed on promoting competition and delivering great products and services to its customers.”

Paul’s senior team, most of whom will transition across to the acquisitive firm, will be:

• Darren Pope, Transitional Finance Director
• Helen Rose, Chief Operating Officer
• Neeta Atkar, Risk Director
• Peter Navin, Network Director

Peter is currently the Network Director for the Bank of Scotland and Lloyds TSB Scotland branch networks. He is also the CEO of Lloyds TSB Scotland plc.

The divestment will complete before November 2013, when all the customers and branches will move across to whoever the buyer is.

And there’s the rub: who will buy them?

We have the normal suspects: Virgin and Tesco.

Virgin may have a challenge if they want to buy the Verde business due to the history between Paul Pester and Richard Branson.

Before joining Lloyds in 2005, Paul was CEO of Virgin Money for five years.  He left in a bit of a dispute with Virgin Chief Branson, when the bearded one pulled a leaving package that had been agreed, and left Paul with something that was half of what it would have been.   Something that still grates with Paul, although I’m sure he’s big enough to get over it.  However, it does mean that the deal will be negotiated really hard and, having seen the performance with Northern Rock back in 2008, Virgin never pay over the odds for a business so I think they’ll back off.

Tesco?

Tesco doesn’t need these branches as they have stores in most of the strategic locations they need, so forget them.

National Australia Group, who own Clydesdale and Yorkshire, or a similar smaller existing competitor … not really.    I cannot see any small bank wanting to take on board 632 new branches from a large competitor.

After all, even though the sale is going to make them a big player, how do you check these branches are decent?  Sure, the European Commission ruling stipulates that they must provide full coverage representing the demographics and operations of the bank, and are in decent geographic locations, but that isn’t easy.

The integration of the branches, the staff, the processes, the products, the systems and everything that goes with it won’t be easy.

There’s another wrinkle in the process of the sale here as well, as highlighted by Robert Peston of the BBC:

What makes a disposal close to impossible is that Lloyds has been instructed by the European Commission to sell £68bn of assets, largely mortgages, and customer deposits of nearer £35bn.  So there is what bankers call a funding gap of more than £30bn.  The point is that any buyer would have to pay Lloyds £68bn for the assets, but some £35bn of this would be covered by the £35bn of deposits that are being transferred to the successful bidder. The remaining £33bn has to be raised from investors in the form of regulatory capital and new debt.  Or to put it another way, any successful bidder would have to borrow at least £30bn.

This is why Lloyds went out and got some further £15 billion of funding back in March I guess, but it’s not enough to cover the funding gap Peston highlights.

So a small UK competitor swallowing such a massive divestment won’t be something any of them would want to take on board that easily.

This rules out Metro, Newbank and others too.  After all, imagine taking on 632 branches.  Not only do you need the massive capital funding to cover the deposit base, but you also probably need a further 25% or more of the price to invest in a branch refit and rebranding.

So then you start to look overseas for buyers.

Santander would have been a contender a few years ago, but they won’t buy the sell-off … they’ve already become a mainstream UK branch-based bank through acquisitions from Abbey, Alliance & Leicester, Bradford & Bingley and RBS, so an additional 632 branches won’t help.

Maybe another EU bank? 

BBVA?  Probably not, as they’re not here now and strategically look to Latin America.

Deutsche?  Too busy bailing out Greece.

BNP Paribas?  Un banque francais dans Grande Bretagne? Sur mon corps mort. 

Overall, I would say that Europe has enough domestic issues to warrant zero interest in buying a new UK bank divestment in a zero growth market.

So then we look to further shores.

The USA?

Citi, JPMorgan or Bank of America?

It would be interesting.

A US bank with the American culture of innovation, marketing and service, would be good for the UK.   That’s what Metro Bank are bringing over here.   But Citi, JPMorgan and Bank of America are still grapping with domestic issues too and, as mentioned, buying a new UK bank divestment in a zero growth market is not attractive.

So to Asia.

Asian companies are buying Western firms … but only those that offer strong brands or manufacturing capabilities to sell back into Asia where the growth is.

So buying a Cirrus or Volvo makes sense, but buying a UK bank in a UK market with UK customers and UK growth rates?

No.

So there’s no obvious buyer out there.

Add onto this that the Vickers Independent Commission on Banking (ICB) reforms state that even more branches should be sold than those required under the European Commission ruling – possibly up to 1,000 branches rather than 632 – and you can see a real muddle of challenge here.

If the bank resists this requirement then an antitrust probe could ensue, which would block government plans to begin selling its holdings in the bank next year.

The ICB recommendations are yet to be finalised, but this could be an extra spanner in the works for the Verde divestment plans.

The deadline for the sale of the branches is November 2013.

I won’t be holding my breath and neither are Lloyds, as they’re already talking about having to float this off as a separate business:

“The sale has always been part of what we call a ’dual-track’ process. We are obviously looking for buyers but we can do an initial public offering if we need to.  Clearly, people are showing a great deal of interest in the branch network but we need to ensure that we achieve the maximum value for our customers and our shareholders.”

Nothing simple here then.

Final, final point.

What have branches got to do with competitiveness anyway?

ING Direct USA became one of the largest banks in America without a large branch network.  That's why they're called 'Direct'.

Equally, some would claim branch is past competitiveness whilst direct is future ...

Source: Capital One's presentation on the acquisition of ING Direct USA