Fiscal Charter Hoopla* obscured big concessions to the City

Gareth Harfoot, September 2, 2006

Gareth Harfoot, September 2, 2006

* Hoopla: “speech or writing intended to mislead or to obscure an issue.”

October has been an eventful month. In Britain, politics is back in fashion. After years of Blairite vacuity, the media have juicy political red meat to plunge their teeth into.  The new Labour leader’s announcement that he would not press the nuclear button led to a veritable feeding frenzy. This was exceeded only by alarm verging on hysteria at the Labour Shadow Chancellor’s U-turn on the Fiscal Charter. 

Both Labour politicians and journalists obliged the Conservative government by accepting the Chancellor’s framing of the budget deficit as the key threat facing the nation – while effectively turning a blind eye to potential shocks from more volatile sectors of the economy.

For while the nation and its political leaders were enthralled by the antics surrounding the Fiscal Charter, the Chancellor was in fact busy in a quite different, more secluded part of the political forest. Indeed his activities in that part of the British economy have been almost clandestine. If it were not for the sound reporting of journalists on the Financial Times  the public would not know of the quite momentous decisions the Chancellor and the Bank of England have taken in this same month.

The City of London’s month

To recap, while politicians fretted over the budget deficit, it has been an eventful, and even disturbing time for the unstable but globally integrated finance sector, with all of the world’s biggest banks based in the City of London.  

Early on in the month Deutsche Bank, Germany’s biggest bank, warned of €6bn losses when its third quarter results are announced at the end of October. (Deutsche Bank was earlier in the year fined a record penalty for rigging Libor. These fines included a $775m criminal penalty from the US Department of Justice; $800m civil penalty from the US’s Commodity Futures Trading Commission; $600m regulatory fine from NY State’s Department of Financial Services; $344m regulatory fine from the UK’s Financial Conduct Authority. Later the German regulator found that:

“Deutsche Bank executives failed to notice irregularities, failed to investigate suspiciously large profits, failed to implement appropriate controls, failed to apply controls where they existed. Failed, failed, failed.”)

On the 9th October, the IMF, in its Global Stability Report, warned of the threat of another global crisis, and worried that the world’s public authorities have still not fixed the fundamental flaws that wrecked the financial system and global economy in 2007.

The Financial Times reported a warning from IMF officials that if there were to be a serious credit crunch starting in China,

“worse than that simulated by the IMF, Britain would be at the sharp end of contagion because the Asia exposure of UK-based banks such as HSBC and Standard Chartered make it more vulnerable than most.”

If this was not enough to unsettle the British government, then on the 14th October, there was more bad news: Goldman Sachs’s third quarter earnings fell short of expectations. Bankers blamed “renewed concerns about global growth”.

Coincidentally (sic) on the same day of the Fiscal Charter debate the UK Treasury and Home Office published a report which made clear that the UK's financial sector has billions in corrupt cash flowing through it, and that this rendered the property market vulnerable. According to the Financial Times:

“The assessment highlighted the vulnerability of the property market to money-laundering because of the ease with which ownership could be obscured using offshore holding companies. It said there were known estate agents who were facilitating money-laundering by arranging and negotiating the purchase of property.”

On October, 19th the US government unveiled “its most damning evidence so far” of the rigging of Libor by two ex-Rabobank traders,  including  London-based Anthony Allen, a former global head of Rabobank.

On the same day Morgan Stanley recorded that the company’s third quarter profits had dived by 40%.

Also on the 19th October, solicitors and barristers crammed into the High Court to hear a tsunami of claims against RBS “in what is shaping up to be the most expensive lawsuit in UK history” according to the FT. RBS has already paid £10bn “in regulatory fines, litigation charges and customer redress for its worldwide misconduct and business failings.”  The FT explains further that: “the bank still faces multiple civil lawsuits, not least in the US where it is due to pay US regulators the biggest fine in its history for mis-selling subprime mortgages before the crisis. This could be as high as $13bn, according to a US government agency in a court filing.” RBS is defending the case and its legal fees alone have been estimated at £90m.

The Chancellor’s month in a secluded part of the political forest

This is the backdrop against which to judge the politically-engineered furore around the government’s budget deficit and more recent decisions by the Government, the Chancellor and the nationalized Bank of England.

The first momentous decision relates to the proposal to separate retail banking from the more speculative investment arms of High Street banks.

Readers will recollect that Britain did not emulate the US’s determination to investigate the cause of the 2007-9 financial crisis. It seems US authorities are more anxious about repetitions of these crises than is Britain’s government. That is why in 2009 President Obama set up the Angelides Commission, "to examine the causes, domestic and global, of the current financial and economic crisis in the United States."

By contrast, in 2010 Britain’s Conservative-led Coalition government set up an independent Commission on Banking deliberately not required to delve into the causes of the crisis. Instead, the Chancellor said  the Vickers Commission would:

“look at the structure of banking in the UK, the state of competition in the industry and how customers and taxpayers can be sure of the best deal. The Commission will come to a view. And the Government will decide on the right course of action.” 

So the Vickers Commission was essentially shackled. Furthermore the Commission itself bottled the big issue – the need to separate the retail and speculative investment arms of banks, to protect consumers. However, its members did recommend new rules to force the biggest banks to “ringfence”- if not separate - their retail and investment activities. They recommended that while consumer lending and speculative investment operations could be housed within one institution, these two operations should be separately governed and have separate funded structures – with governance independent of the more risky investment businesses of bankers. The point was to protect consumers from failures in the banks’ speculative activities and from risks in the wider financial system. Under the rule, the Commission argued, taxpayers would never have to bail out a bank again.

The Banking Reform Act of 2013 included these recommendations and duly took effect in March this year. Under the law the government sets out to “separate the branch on the high street from the trading floor in the City… when things go wrong”.

On the 14th October (the day of the massive Hoopla over the “Fiscal Charter” debate, and the very day the Treasury reported on the billions of corrupt cash flowing through the City of London) the Bank of England’s Prudential Regulation Authority (PRA) announced new rules under which, the FT reported:       

“The UK’s largest banks will be allowed to transfer capital from retail operations to other parts of their business under new ringfencing rules, underlining how the regulatory climate is warming to the City.

“The key concession is a boon to the UK’s largest lenders, who have long complained that ringfencing puts them at a competitive disadvantage to their overseas rivals, particularly those with large investment banking divisions.”

“They have taken Vickers back to the limit and gone as far as they could to make life easier for the banks within the framework of the law,” said Barney Reynolds, partner at law firm Shearman & Sterling.” “(My emphasis)

The cross-selling of products and lending within a banking group will also be permitted under the PRA’s proposals. The “transfer of capital from retail operations” – means, according the Prudential Regulation Authority - that ring-fenced banks can “make distributions to group entities” if “reasonable notice has been given to the PRA of the intention to make the distribution.”  The notice is to be “signed-off by an appropriate individual approved by the PRA to perform a Senior Management Function.”

We all know how dismally impotent bank compliance officers were in managing and monitoring the activities of their own bank staff in the period before the Great Financial Crisis. Yet today the PRA and Bank of England are effectively restoring to internal compliance officers of big banks the power to agree transfers (or “distributions) between the retail and investment entities of banks. 

After the announcement, City of London-headquartered bank shares all rose in London trading, with RBS gaining the biggest increase of 1.25 per cent.

On the same day, business secretary Sajid Javid offered another juicy public asset to his friends and ex-colleagues in the City of London. As part of his plan to hand over the Green Investment Bank (GIB) to private investors, the Guardian reported that the government intended to repeal

“legislation (that) gives ministers a veto over any move to change the articles of association of the bank, including the five governing principles that require it to fulfil a green remit.”

The GIB was launched in 2012 with £3.8bn of public sector money on investments including wind farms, biomass and energy efficiency projects. Earlier this year, Zac Goldsmith MP and other ‘Bright Blue’ Tories had condemned the privatization of the Green Investment Bank. Ben Caldecott, associate fellow of Bright Blue, said in a Guardian report:

“I admire the UK Green Investment Bank and what it has achieved so far, but the last thing we need is a publicly supported, but privately owned, asset manager using subsidised capital and jobs to compete with the private sector.”

Again, on the very day of the Fiscal Charter debate, the Treasury slipped out an announcement to the effect that it “has abandoned the “reversal of burden of proof” rule that would have held senior (bank) managers to account for failings on their watch, with the threat of a fine or a ban.” This announcement, as the Financial Times reported, excised “one of the most contentious parts of a tough new accountability regime for top executives in the financial sector…. in a move that will be welcomed by Britain’s banks.”

That these stories slipped under the radar of the major political parties, and of much of the media, cannot be considered coincidental.

The shock that lies ahead?

Back in June this year, the Chancellor of the Exchequer addressed the City of London in his Mansion House speech.  Confident of being part of  “a majority government” the Chancellor set out his vision for the City of London under his watch:

“…..let me be clear. I want Britain to be the best place for European and global bank HQs.

It’s in our national interest to be so.”

Mark Carney, appointed by the Chancellor as governor of the Bank of England shares the Chancellor’s ambitions for the City of London.  Two years ago, in October, 2013 the governor said that:

“By 2050, UK banks’ assets could exceed nine times GDP” (currently bank assets are four times GDP)  “and that is to say nothing of the potentially rapid growth of foreign banking and shadow banking based in London.

“Some would react to this prospect with horror. They would prefer that the UK financial services industry be slimmed down if not shut down. In the aftermath of the crisis, such sentiments have gone largely unchallenged.

But, if organised properly, a vibrant financial sector brings substantial benefits.”

However, just two years later, in a speech at St. Peter’s College, Oxford on Wednesday 21st October, 2015, Mr Carney’ was a little more circumspect:

“More foreign banks operate in the UK than any other EU country, and more than half of the world’s largest financial firms have their European headquarters in the UK. The UK has the largest global share of cross-border bank lending, foreign exchange trading, and OTC interest rate derivatives. It has the world’s third largest insurance industry and its second largest asset management industry. The UK banking sector is four times GDP and non-bank financial institutions are a similar size while financial services accounted for 8% of output and around 3½% of employment in 2012.

From this real and financial openness flow two important consequences for the UK economy and for the Bank’s objectives. …

The flip-side is that openness can change the nature of the unexpected itself, altering the type and scale of shocks hitting the economy.

For example, the complexity of financial linkages can grow and become more opaque, creating new vulnerabilities and more severe shocks.

And openness has the potential to exacerbate existing distortions or inefficiencies.  In times of euphoria, foreign capital can flood in and amplify domestic trends.  The speed of its flight when passion turns to panic can then deepen the bust that follows boom.”

These remarks went largely unreported as the media focused on the governor’s remarks about the European Union.

But these remarks, coupled with alarm bells rung by both the City’s biggest banks and the IMF, must serve as a wake-up call to politicians fixated on the budget deficit.

If our elected representatives and society as a whole, turn a blind eye to Ministers flogging taxpayer-backed assets to speculators in the City, while at the same time slowing down or reversing the re-regulation of the finance sector – then we may soon wake up to another very nasty and costly financial “shock”.

A shock that at the speed of flight can turn passion into panic and deepen the bust that follows the boom.

We have been warned.