Bank Financial City

Hugh Dalton, the Chancellor of the Exchequer, was noted (July 1945) to have said ''We are going to nationalise the Bank [of England]. We don't know how, but we're going to do it. Get the appropriate fellow to draw up the plans.'' The British financial services industry aka 'The City' up to then, and decades afterwards (until perhaps the Big Bang in 1986), was still run like Eton or Harrow and the Bank's governor was its headmaster. As headmaster, it was believed the governor's 'raised eyebrows' were sufficient to get an ex-Oxbridge fellow to toe the line(Atkinson, 2002).

(The Governor's eyebrows and 'old school ties' effectively ruled the City. -:) This club-style regulation continued even after the passage of the Financial Services Act 1986 and the Criminal Justice Act 1987 because many market abusers were still only threatened with 'criminal' prosecution and the Financial Services Authority (FSA) became the 'court' of first instance for market abuse cases; the idea being that those accused would heed to the threats and do the right thing or ''accept behind-closed-doors punishments just like in the old days'' (Atkinson,2002:135). While the SEC in America was carting off fraudsters to federal penitentiaries, the FSA, faced with abusive conduct in a regulated market, was imposing fines or issuing warning letters.
 

A decade and a bit later after the the Big Bang

The Big Bang (see Glossary) on 27 October 1986 opened the door to foreign investment banks changed the old City beyond all recognition. This meant the informal regulation the City enjoyed was becoming increasingly unworkable. After all, after the Big Bang, the alleged fraudster could be anyone – an American, an ex-public schoolboy, an African, a German, a Japanese, anyone. This situation warranted some regulatory reforms. The FSA's private court became a fully-fledged court of first instance. Maximum penalties for insider-dealing or any other 'market abuse' behaviour were now on par with those for grievous bodily harm.

Despite these reforms, the 1990s saw the greatest financial scandals to graze the City in the twentieth century. There was the BCCI scandal leaving a black hole totalling GBP 13 billion; Robert Maxwell stole GBP 450 million from company pension funds; investors all over the UK saw themselves staring at worthless pieces of paper that promised them high returns on 'rock-solid' investments that never actually existed; Lesson, a junior trader at Barings, exposed his employers to GBP 800 million of losses; Hamanaka, not to be outdone by Leeson, costed his employers $2 billion in his attempts to corner the copper market (Atkinson, 2002; Davidson, 2006).

These were cases of outright theft or rogue trading. There were very few convictions; Maxwell downed before he could face his accusers; and only a few implicated in some scandals felt honour-bound to resign their positions. To remedy the situation, the Labour government (in power from 1997) rushed through a series of radical reforms and in November 2001 the Financial Services and Markets Act (FiSMA) came to live and it looked like all regulatory powers were vested in the FSA.#p#分頁標題#e#
 

The FiSMA and the current regime

The FiSMA did not work very well in practice because (aggrieved) firms could protest that FSA's actions were ultra vires and take it to court. (Note that the FSA can only police firms who were FSA members.) There was also confusion as to who actually did what during the FiSMA era. Minor ''paperwork offences'' (Atkinson,2002:144) resulting from sloppiness rather than ill-intent were dealt with directly by the FSA/UKLA; product mis-selling, unauthorised business and confidence-trick activities were the remit of FSA, Office of Fair Trading or Department of Trade and Industry; catchall 'market abuse' offences were covered by the FSA (civil jurisdiction) and/or the Serious Fraud Office, Scotland Yard, City Police fraud squads and a host of other regional and county forces.

On paper, the FiSMA looked fine; in practice, there was frequent frictions amongst the various agencies and market wrongdoers were the ones benefiting from this confusion and enforcement agency squabbles.

The FSA seems to emphasize less its quasi-policing function and focuses, I think, too much on its management consultancy aspect. This is perhaps also a fault of Parliament in that the view seems to be that the FSA's main duty is to guard London's competitive position as a leading world's financial centre. The City can look after its competitive position and the FSA's proper business should be to look after market participants.

To use Levy and Post's football analogy(2005), a referee who focuses too much on a league's position in the world and less on enforcing the rules of the game is bound to have some problems. As Levy and Post note ''financial stability is a collective good'' (p, 123) and market participants' confidence in a market go hand in hand with financial stability.

The current FSA principle-based regime is good in theory but when compared to a rule-based regime it is very deficient (Davidson,2006). Principles ''enable the FSA to present a case more easily against firms than excessive reliance on rules, in which clever lawyers may look for loopholes'' (Davidson, 2006:168). I agree but all other regulatory bodies (SEC, EU directives) are rule-based and as co-operation is paramount in an increasingly global market, perhaps it is time to reconsider the principle-based regime.

The Big Bang and the regulations that came with it were meant to widen share ownership. It is perhaps too early to say if this revolution was a success. Foreign ownership in the UK has risen from under 13% in the late Eighties to 40% at the end of 2006; over the same period, the proportion of UK shares owned by individuals has fallen from just over 20% to under 13% (The Observer, 2007:29). UK citizens, it seems, still only trust large mortgages and not exotic share portfolios.
 

Liquidity Regulation and Moral Hazard#p#分頁標題#e#

Any fractional reserve banking system depends on its ability to maintain confidence and convertibility. This basic principle is eroded if risks (in particularly systemic risk) are not properly mitigated (Levy and Post, 2005). Let's consider the cash ratio. It is clear that the smaller the cash ratio, the greater the size of the credit multiplier and the greater the volume of bank deposits created on a given cash base, and vice versa. In most countries, the commercial banks are required by law to maintain a minimum cash ratio, although no maximum is established.

For example, the minimum cash ratio in the US is fixed by the Federal Reserve and has legal force. In Britain there is no legally determined minimum, but by long convention the commercial banks work to a minimum cash ratio of eight per cent. Note that these differences did not stop runs on banks in both countries: Bear Stearns in the US and Northern Rock in Britain.

The manner in which both runs were handled was very different. In the US, the Federal Reserve – avoiding a disorderly closure of Stearns - simply facilitated the its purchase by JPMorgan Chase, while in Britain, the old problem of who should do what resurfaced and dragged on for a while and the Rock was eventually nationalised.

As a Northern Rock shareholder I am still waiting a letter from the government about my shareholding and I don't think it'll come through anytime soon. As a taxpayer, I have effectively been hit twice and I therefore agree with Persaud(2008) that the current model which celebrates ''...expropriation of gains by bankers and socialization of costs by taxpayers'' isn't working and is a dangerous one! The vexing thing about the Rock debacle is that its 'risky' business plan was known to the Bank of England and the FSA. Persaud(2008) seems to be advocating only a tweaking of the risk model.

I disagree here. The risk model also has many limitations. I note that Equitable Life, one of the world's oldsest assurance companies, became insolvent because of miscalculations regarding 'guaranteed' payouts on packaged products which triggered a legal battle after which investors starting withdrawing their money and ignoring steep penalty clauses. On the FSA's risk radar, Equitable Life was rated very low risk, if it appeared at all! My point is market participants should only be made aware of the risks they are running dealing with banks or other market participants, no bailouts whatsoever.

Northern Rock should have been allowed to hit the fan. Many businesses do, why not financial institutions? Even my beloved Birmingham City FC would not be playing top flight football next season. Am I bitter, yes of course but I won't support any endeavour which would allow club chairmen to take extravagant risks. I support only two government interventions: (i) the assurance that the rules of the game are being enforced and market participants are following the rules – nothing more; and (ii) a free programme to educate investors.#p#分頁標題#e#

I next look at additional changes I'll make.

Jury or no jury in 'complicated' white-collar cases?

This is an issue that has been raging on the UK political scene for a while. My gut feeling is that I'll go with a jury in all situations but then some cases could take years. So I am going to sit on the fence on this decision and say that a judge given the facts of the case should decide whether or not a jury is necessary.

Rewarding informants and using wiretaps?

Rewarding informants carry a certain amount of risk: neighbours spying on neighbours; work colleagues spying on work colleagues etc is never a good situation for any society to be in. History tells us that this quickly leads to an unhealthy society. So I won't advocate rewarding informants; instead I'll support the creation of compliance officers (see below).

De facto wiretapping definitely out because it would be opened to abuse. But wiretaps authorised by a judge, yes.

How about anonymous witnesses?

This is another one I'll leave to the judge to decide on a case by case basis. I won't support a blanket use of anonymous witnesses because this leaves too wide a window for overzealous law enforcers to abuse.

Market compliance officer at every institution?

This is an idea borrowed from Health and Safety. Why is every financial institution not forced to have one?

What to do with the conduct of business rules?

The Markets in Financial Instruments Directive (MiFID) came into force across the EU in November 2007. It has this one odd rule: if for example a UK incorporated firm setup shop in Germany and then does cross-border business, this will be subject to UK conduct of business rules. How is this business supervised? At the moment there is no simple answer.
 

References

Atkinson, D. (2002) Complete Guide to the Financial Markets (London: Business Books, Random House Group Ltd)

Davidson, A. (2006) How the City Really Works (London: Kogan Page Limited, 2006)

Persaud, A. (2008) 'The inappropriateness of financial regulation' [online] Available from: https://elearning.uol.ohecampus.com/webapps/portal/frameset.jsp?tab=courses&url=/bin/common/course.pl?course_id=_23557_1

(Accessed: 3 July 2008)

The Observer(2007), The Observer Book of Money (Observer Books 2007)