Vericool Finance

In John Buchan’s The Thirty Nine Steps, the hero, Richard Hannay, attempts to piece together a mysterious assassination plot that leads him to seek refuge in Scotland. Given recent events there, it might be unwise to head north of the border if you’re a banker. But now Sir David Walker – a stalwart of Morgan Stanley – has proposed his own 39 steps to better bank governance in the hope of averting future disasters on the scale of the collapse of Royal Bank of Scotland.  Has he pulled it off?

Hopes weren’t high.  Walker was dismissed by many as a City old boy who would never turn on his own. But what he has to say is both sensible and useful.  He proposes beefing up boards to counter over-powerful executives by putting non-executives in charge of new shareholders with pressure from regulators id they fail to exercise proper stewardship.

Pragmatic, certainly, but the most striking thing about this report is that so banal a set of recommendations were necessary.  It’s all great in principle, but there are big cultural barriers to practical application.  The risk function in most banks is so low status, for example, that it is hard to imagine even the best practitioners stomping around in hobnail boots when the chief executive comes up with a whizzy M&A transaction.  You can hear the next lot in front of the Treasury Select Committee already.  “Well, our head of risk said, go right ahead…”

Given the British public’s one-point agenda to punish the banksters, it’s not surprising that Walker’s most controversial proposals centre on bonuses. Some senior bankers claim the move to defer half the pot for three, or even five years, could prove as damaging to London’s competitiveness as the Sarbanes-Oxley reforms were to Wall Street.

And Walker was surely playing to the public gallery by calling for compulsory disclosure of the biggest packages which has nothing to do with  improving corporate governance or preventing future crisis.  In fact, given the failure of past voluntary governance initiates, there’s every reason to be cynical that the new reforms will make a lasting difference. The history of remuneration reform is littered with the corpses of do-gooders… steamrollered by market forces or bypassed by cunning advisors.

At least Sir David tried.  But the real onus is on governments to push for higher standards internationally – and then enforce them at home.

Even on Wall Street, the land of six-and-seven-figure incomes, jaws dropped at the news.  During one of the worst six-month periods in the history of finance, Goldman Sachs squirreled away $11.4bn to pay its staff and has just posted the richest quarterly profit in history.

At that rate, bank staff could earn an average $770,000 this year, with packages for senior executives and bankers running well in to the high millions.  It would be easy to forget there’s a financial crisis still going on, but Goldman should expect renewed political and public anger.  It might insist it has to pay to keep the brightest and best, but it would be foolhardy to believe these arguments will placate a restive public.

Slurp – the great vampire squid strikes again!.  It takes some sucking power to extract $3.4bn of quarterly net income within a year of a full-throated banking crisis. So how did they do it? The vast bulk of the cash came from plain vanilla stuff, like helping companies raise money from share issues, and Goldman has undoubtedly profited from the fact that so many competitors have either died or retrenched.

But are these huge profits a one-time wonder? Beneath Goldman’s gleaming mantle is cephalopod swimming with one powerful arm.  The huge spring boom in client trading was no more business as usual than the events of last autumn; and Goldman’s other arms remain weak.  And with $171bn in excess liquidity now in its coffers, the government could yet opt to cut this sucker down to size.

Goldman attracts admiration and loathing in equal measure: no bank seems better capable at looking after its own interests. But if more capital is required to make the banking system safer, returns are bound to fall.  The goose that laid the Goldman egg could yet be killed by regulation, but the behaviour of survivors like Goldman suggests the opposite. They are hiring staff on salaries and bonus packages that make sense only if the days of mega-profits have returned permanently.

The question for governments is whether they are prepared to tolerate this state of affairs indefinitely.  It’s time to ask whether exceptional profits deserve exceptional rates of taxation. If we, the taxpayers, are obliged to underwrite the banking system, it is surely right to extract a fair price for that guarantee.  That’s how pricing power works – as Goldman would presumably understand.

After a difficult gestation, the Government’s blueprint for regulating the City finally emerged blinking into the cold light of day. Observers anticipated few surprises in the White Paper, much of which is based on the relatively uncontroversial proposal put forward by Lord Turner, chairman of the FSA, in March.

As expected, the Chancellor made clear that he did not favour splitting up big and complex global banks, dubbing such proposals “simplistic”.  Instead, they will be forced to hold more capital to absorb losses and to have greater liquid assets to guard against a run on deposits.  The riskier a bank’s operations are deemed to be, the more capital they will have to hold. There will also be a new “backstop” power to prevent them borrowing too much.

The initial reaction from the City was broadly positive.  As well it might be. Investment banks, including Barclays Capital, are already inventing schemes to reduce the capital cost of risky assets on balance sheets to a practice BarCap calls smart securitisation.  Some will see this as a sign that financial boffins have already found a way to run rings around rules on capital designed to make banks safer.

Certainly signs of life in the securitisations market should serve as a warning to regulators: the plan to impose higher capital thresholds will only succeed if the riskiness of the derivative products can be accurately monitored. What does the White Paper say on that?  Not much. Little detail was given on how macro-prudential oversight is to work, or who will be in charge. As such, the Chancellor’s proposals are a wholly inadequate response to the banking crisis.

The bottom line is that Alistair Darling has plumped for fudge. Perhaps the biggest dollop is the new Council for Financial Stability, which is actually just a rechristened version of the old tripartite system, comprising the Treasury, the FSA and the Bank of England. The old trio failed miserably, largely because they couldn’t communicate effectively and things fell through the cracks.

In future, both the bank and the FSA will have slightly broader powers and the Council - chaired by the Chancellor - will be more transparent.  But these are mere tweaks.  The Chancellor has also deferred the important questions of exactly how counter-cyclical measures, such as jacking up capital ratios, will be applied.

Getting the details right is clearly important, but so is getting things done.  There is some good stuff in this White Paper, but unless momentum is maintained, the Government could end up wasting a good crisis.

There’s a new buzzword doing the rounds in the born again City – BAB.  It stands for Bonuses are Back and its arrival in the lexicon is evidence that bankers are once again looking forward to bumper payouts, just eight months after the sector faces meltdown.

Goldman Sachs staff are now looking forward to the biggest payout in the bank’s 140-year history.  Many other investment banks are anticipating stellar profits in no small part as a result of the chaos caused by their previous activities.  Bond markets are hectic as a result of governments’ needs to finance their deficits, while economic problems have created (profitable) volatility in foreign exchange markets.

When even majority government-owned banks, like RBS, join the party, you know the system is rotten. RBS chief Stephen Hester’s £9.6m bonus shows that bankers haven’t changed.  Indeed, there is growing suspicion that this lethal breed is going back to business as usual, although the financial crisis remains unresolved – frightening prospect for taxpayers everywhere.

Fading political will to secure a strong regulatory response – and a good deal of sustained lobbying – would appear to have let banks off the hook.  That is dangerous, particularly against a background of unresolved global imbalances.  There must be a possibility that, with bankers once again at play, the financial system will return to chaos in the not too distant future.

What should be done?  Bank of England Governor, Mervyn King, argues that investment and retail banking should be separated, along the lines of the old US Glass-Steagall act. His reasoning is that it is too risky for high street banks to continue playing in the casino of investment banking.  The problem, though, is that shrinking banks so dramatically would generate a big chill just as the markets are beginning to unfreeze.

Without its investment banking division, Barclays would have joined RBS and Lloyds as a burden on the taxpayer.  It would be better to follow the FSA’s strategy of making banks reserve more capital the banks warn that even a tamer crackdown could stifle recovery, because the more capital and liquidity a bank has to hold, the less they are able to lend.

That’s a valid point.  The crucial thing now is to get enough money into the system to get the taxpayer off the hook, keep good businesses alive, and convince jittery foreigners to find the Government’s truly extraordinary borrowing requirements.  The niceties of financial regulation can wait.

Ever since the fall of Northern Rock, a cold war has been waged between the Treasury and the Bank of England.  Last week we witnessed the equivalent of the Cuban Missile Crisis.  The setting was the gilded banqueting hall of mansion house, and the level of brinkmanship and tensions, as Alistair Darling and Mervyn King faced each other down, was palpable.

Darling delivered a lacklustre speech on regulation, setting things up nicely for the Governor’s putsch.  King is making a power grab:  not only does he want to put the Bank in charge of spotting squelching future threats to financial stability; given the chance, he’d break up Britain’s biggest banks, too.  The Treasury is opposed to both measures; the Tories broadly sympathetic.

The financial crisis has descended into a tedious soap opera.  Alistair and Mervyn have fallen out again.  The guv’nor is getting matier with David and George… It’s all so trivial.  Instead of arguing about who should be sheriff, we should begin with the broader question of what sort of financial system we actually want.

Yet the sheriff question is key.  The tripartite system of joint regulation (between the Bank, the FSA and the Treasury) which Darling defends in such lukewarm fashion clearly hasn’t worked.  The tatters of the British financial system are testament to its failures. Indeed, in continuing to champion it, Darling has cast himself outside consensus.

A key measure of President Obama’s regulatory blueprint is to put the US FED into the cockpit.  King’s wise proposal echoes that.  The FSA should be left to deal with consumer protection and the solvency of individual banks, leaving the Bank to safeguard against systemic risk.

There are regulatory battles everywhere.  This week’s tussle between Gordon Brown and Brussels over fiscal independence was a more significant encounter than the Darling-King scrap.  Who would you prefer to, make judgements about the UK banking system, Mervyn King or the European Central Bank? The PM, fortunately, secured an opt-out.

Clearly, the posse of global regulators is breaking up as national interests assert themselves, and, given the confusions, that’s all the more reasons why Darling is right not to rush reform.  The FSA chairman, Lord Turned, fears that the will to reform… could weaken as recovery takes hold.  Perhaps, but until you know what new levers you want to give the regulators, you can’t really decide who should pull them.  Darling is right to take his time.  We need to get this one right.

There is a distinct whiff of cordite in the air.  Investors at this year’s AGMs have been expressing rage at the wholesale destruction of value.  Eggs were thrown at the directors of Allied Irish Bank; protestors singing the Marseillaise stormed the stage at Belgian bank Fortis; and there have been confrontations over pay at BP, Provident Financial and Amec.

This has been the biggest backlash yet.  In one of the most significant investor rebellions in years, 59% of Royal Dutch Shell shareholders voted to reject the company’s executive pay plan – evidence of the mounting anger over remuneration and bonuses.

Shell had it coming:  the behaviour of the non-executive directors on the company’s remuneration committee was outrageous.  According to their own rules, bonuses would be due if Shell came third or better in a league of five oil majors ranked by total shareholder return.  When the company finished fourth, directors brazenly declared that the race was so close that fourth was as good as third. Shell moved the goalposts.  But there are plenty of other cases where the goalposts were simply set in the wrong place, with shareholders’ approval, making it ridiculously easy for executives to claim huge payouts for mediocre performances.

That fact, one suspects, partly explains the sudden outbreak of rebellion.  Investors are finally realising that the wool has been pulled over their eyes for years. Stock markets are back where they were a decade ago, dividends are being slashed, but boardroom pay has gone to the moon.

In boardrooms, in clubs – and at certain flower shows one might mention – you will hear much huffing and puffing from some directors about having their hands tied.  Others will feel they can shrug off shareholder votes, which are non-binding, even when they’re made on the scale we saw at Shell.  But Shell’s remuneration committee, led by Sir Peter Job, has taken shareholders for granted for the last time.

Other directors take note:  next time, the protest could get personal. If that is what it takes to remind self-interested executives who really owns their firms, so be it.  The crunch has highlighted a crisis of ownership.

Supine institutional shareholders, such as pension funds, were the handmaidens of recklessness, greed, corruption and destruction- and they allowed it to happen with our money.  Regulation is only part of the answer:  we need to move from a culture of entitlement to a culture of responsible ownership.  Executives, like politicians, must be forced to realise that they work for us.