Where next for regulation?
In advance of the International Banking Forum's conference, The Future of Wealth, on 27 June, international regulatory expert, Dr Oonagh McDonald spoke to James Mews.
DR McDonald is coming to speak at the Future of Wealth conference in a session covering financial stability, risks and opportunities as a result of regulation. The discussion will feature other high-powered speakers and will be chaired by Geoff Davies of the Bank of England.
Dr McDonald has previously sat as a director of the key UK regulator, the Financial Services Authority, and as a Member of Parliament. She now lives and advises globally from a base in Washington DC. Her recent book on the fixing of the LIBOR rate, called Holding Bankers to Account, has won plaudits.
What positive steps have been taken in corporate governance since the financial crisis?
Sir David Walker pointed out in the preface to his Review of Corporate Governance that the fact that banks in such very different circumstances in every way, led to such very different outcomes, can only be fully explained in terms of the differences in the way in which they were run – that is, their corporate governance. The right balance between regulation and supervision is to be found in better corporate governance. Regulation and supervision are vital but corporate governance places the emphasis on the banks themselves and the way in which they are run. My book on the failure of Lehman Brothers found it was due to a large extent on a major failure of corporate governance.
Separation of the role of chief executive and chairman, with the non-executive chairman playing a major role in the development of the bank’s culture and strategy, is essential. The four committees of the board, audit, risk, remuneration and nomination, all have non-executive chairmen, who can be in frequent contact with the chairman. Senior staff such as head of risk management can raise their concerns directly with the chairman or chair of the relevant committee. That would have suited Madelyn Antoncic, who was the head of risk management at Lehman Brothers. When she warned the CEO, Dick Fuld, that the bank was ‘too risky,’ when he constantly overrode the risk limits she set, he sacked and replaced her with a more compliant risk manager with no knowledge or experience of risk management. He also had a supine board, which he was able to control tightly as CEO and chairman. Of course, structure isn’t everything by any means, but it is very significant. It is hard to work effectively without an adequate structure.
What further steps would you like to see implemented?
Having served on a supervisory board in Sweden, and studied the current state of corporate governance here in the USA, I would like to see this kind of corporate governance more widely accepted. But unfortunately, it is not something I expect to see happening very soon. That is only part of it. I think the recent developments in the UK’s Senior Managers Regime is also a vital step forward.
What are the most productive steps you would like to see implemented?
SMR is one of the most important steps forward, given recent developments. SMR has been a tool the regulators in the UK have had for many years but it was not set up in a sufficiently clear way until the FCA and the PRA’s consultations and adoption of the SMR. For example, had it been in place during the years in which LIBOR and other benchmarks were manipulated, senior managers would have been held to account more easily than just going after the traders involved. What the traders were doing was entirely clear from the emails they sent to each other and the electronic chat rooms. They only had to read them!
How essential is the SMR to ensuring bankers have a sense of responsibility.
No doubt many senior bankers, including CEOs have a sense of responsibility, given all that is involved in running a major bank. That is not really the point. It is the knowing that they will be held to account for what happens under their watch, that they have to take responsibility for the bank’s strategy, the risks the bank takes, compliance and the behaviour of the staff, when they are put in charge of a specific area of the bank’s activities. Given that may involve a wide range of activities involving hundreds or maybe thousands of staff in many locations, the most productive next steps could be the development of better management information systems so that senior bankers can take prompt action.
Was there a failure of supervision in the build-up to the financial crisis?
Yes, in the UK certainly, as the reports on the failures of Northern Rock and RBS clearly show.
Have we seen a change in supervision and what additional steps would you like to see taken?
The trouble is that there may be a shift in supervision towards macro supervision and away from what is called micro supervision. Supervisors need to understand the way in which a bank conducts its business and to be aware of the risks arising from for eg the appointment of a new CEO, taking on a new line of business or a merger or acquisition which can change a bank’s risk profile very quickly. All too often it is at the micro-level that the rot sets in and a bank’s capital resources disappear.
What is likely to happen with regard to LIBOR?
Here there is a difference between what is scheduled to happen to LIBOR ie being replaced and what should happen. In my book I set out in detail the way in which LIBOR as a benchmark has been radically transformed. It is now defined as ‘wholesale funding rate anchored in LIBOR panel banks’ unsecured wholesale transactions to the greatest extent possible’ and is based on funding from central banks, multi-lateral development banks and non-bank financial institutions. It has one advantage that the two alternatives do not – it provides a yield curve. LIBOR submissions are now supervised by the FCA and the PRA and the benchmark itself is administered by ICE benchmark administration. All of this is a long way from the days when traders used to shout their requests across the room to the submitters.
What should Parliament do to resolve Brexit?
That is a very tough question and a complicated one. With a leadership election in the Tory party and Labour’s leadership in serious if not terminal difficulties, nothing much can be done until these two issues are resolved. The problem is the posing among the contenders for the leadership with ‘no deal’ being presented without any understanding of the consequences of that. Although many politicians think that the UK is still the fifth largest economy in the world, it isn’t. The total population of the EU is seven times greater than the UK and its GDP is six times greater than the UK’s. Any ‘deal’ is inevitably hard to bring about. So, the dangers of no deal have to be spelt out by MPs – honestly, and supported by facts about what the continuing relationship could be – with the economic consequences of a deal also being spelt out honestly.
That is a tough demand, but actually some of this was achieved for Harold Wilson’s referendum on whether or not to remain.
Much has been made of the outcome of the European Parliamentary elections but the turnout in the UK was 37%, less than Estonia, with Latvia at 34% and other smaller countries ranging from Portugal at 31% to Slovakia at 23%.
There is nothing much to be done until the Tory leadership election is over and the possible reconfiguration of the parties done.
The Future of Wealth event is essential for CEO’s, senior managers, thought leaders, compliance, legal counsel, IT, and innovators. It looks at strategy, regulation and future changes caused by structural reform, the fintech revolution, opportunities and risks such as cyber-security, and asks what does this mean for businesses charged with growing international wealth?
The event takes place on Thursday 27 June at the Royal Yacht Hotel, St Helier, from 8.15am – 5pm. Providing excellent networking opportunities, this event brings together senior industry leaders, regulators and policy-makers from the House of Lords, HMRC, and the Bank of England.