Thursday, 17 August 2017

Companies and Morality: A Prevailing Issue

Usually here in Financial Regulation Matters, the focus of posts is on the world of business and usually its connection with the world around it – business, rather obviously, is part of a much larger societal picture, particularly in this modern era. The focus of the posts is usually upon business and/or regulatory developments, which are then assessed against a broader backdrop. However, today’s post represents a slight departure from that approach in that it responds to the recent wave of headlines praising corporations for taking a stand against the developing situation in the United States regarding President Trump and his views towards outwardly racist groups. For this post there is only one question that is of concern, and that is whether the praise being showered upon companies like Apple, Spotify, and Go Daddy is correct.

The first wave of public, and specifically media praise for companies began after a number of CEO’s left the President’s advisory councils. Before the President officially disbanded the ‘Manufacturing Jobs Initiative’ and the ‘Strategic and Policy Forum’, he had suffered a number of high-profile losses in the form of Kenneth Frazier, the head of pharmaceutical giant Merck, and the CEOs of Under Armour and Intel. According to media reports, the actions of the members of the Strategic and Policy Forum, in informing the administration that the vast majority would be standing down, precipitated the closing of both initiatives. Whilst the President’s reaction of ‘grandstanders should not have gone on’ the initiatives anyway is to be expected, the negative reaction to his failure to repudiate the actions of far-right activists in Charlottesville at the weekend continued unabated, with JP Morgan Chief Jamie Dimon ‘strongly disagreeing’ with the President’s handling of the situation, Apple’s Tim Cook warning the President that ‘hate is a cancer’, and General Electric’s Jeff Immelt leaving the initiative because of the ‘ongoing tone of the discussion’.

Whilst corporate leaders abandoned the President, other corporations were taking action against the far-right. Earlier this week, Go Daddy, the website hosting company, announced that it had given The Daily Stormer, a neo-Nazi website, 24 hours to find another domain provider as a result of its articles concerning the murder of Heather Heyer. Spotify, the music subscription service, has started removing so-called ‘white power music’ from its databases. Facebook and Reddit have sought to ban hate groups, whilst the heads of Google, Apple, Facebook, Go Daddy, and a number of other corporations have pledged million-dollar donations to the Southern Poverty Law Centre (SPLC) and the Anti-defamation League. Spotify stated that ‘illegal content or material that favours hatred or incites violence against race, religion, sexuality or the like is not tolerated by us’, whilst Twitter and LinkedIn has removed accounts related to The Daily Stormer. There is an obvious question that must be asked, and regular followers of Financial Regulation Matters will likely know that what that is; what changed? The answer is perception, which is an all-important concept for corporations.

The despicable murder of Heather Heyer at the weekend has forced deep-rooted issues to the forefront of the public consciousness once more. However, if we take a step back and look at the situation, the situation is damning for corporations. Before the weekend, the content of The Daily Stormer was still illegal as it inspired hate and violence; yet it remained freely available via social media and the internet. The hate-filled songs on Spotify were still available. The leading corporations were not increasing their donations to the SPLC or the Anti-defamation League. Yet, the most damning realisation is that the viewpoints of the President, viewpoints that these business leaders were citing as the reason for their abandoning of him, were not new. Before the weekend, there were so many signs that Donald Trump held the views that he reiterated over the last week, but there was little disgust from business leaders then. There was no disgust when he filled the White House with people like Steve Bannon. The travel-ban on people from Muslim-majority countries caused angst, yet they did not abandon him. His repeated links to far-right and racist groups like the Ku Klux Klan has not deterred their support, whilst historic comments like ‘laziness is a trait in blacks’ have been forgotten about. The reason for this is simple, and calls into question any praise levelled at the actions of corporations. There has been some analysis in the media that looks at the economic effect of Trump’s relationship with these CEOs, and therein lies the problem; these corporations are not people. When they disregard the actions of Donald Trump who, throughout the course of his campaign made no secret of his ambition to sow division and hatred amongst the fabric of America, they do so to maintain influence within the political component of the State – as corporations, they must do this. As corporations, they must seek to look after themselves first before they consider any societal issues, so the theory goes, and that takes the form of lobbying for preferential treatment by way of reductions in tax or subsidies etc. Whilst some who are reading this may believe that this is acceptable, as is their right, we must remember that it is corporations who are preserving Trump’s power and, in reality, are the main reasons for his successes in the first place. Their retrospective disgust for hate and division needs to be contextualised properly, and that will start by considering the pro-corporate headlines of their removal of sites like The Daily Stormer – it should not take the murder of an innocent woman to push corporations to flush out such avenues of hate. It should not take the incredible footage that went all around the world of Nazi flags being paraded through an American city to prompt corporations to do what is right and publically disavow a President who does not disavow those flag carriers. Corporations have a lot to answer for, and stepping down from forums created by the President will not change that.


Keywords – Donald Trump, Corporations, Society, Morality, , Charlottesville, Corporate Culture, @finregmatters

Wednesday, 16 August 2017

Two “Big Four” Auditors Fined for Misconduct: A Persistent Problem Being Met With Persistently Lenient Punishment

Today’s post looks at the news that KPMG has been fined by the U.S. Securities and Exchange Commission (SEC) for ‘misinforming’ investors about the value of a certain company. This follows the news from the U.K. where the Financial Reporting Council (FRC) have fined PricewaterhouseCoopers (PwC) for ‘extensive misconduct’ relating to its audit of a professional services group. This recent flurry of regulatory activity has led some to discuss the ‘growing concerns’ regarding the quality of the Big Four’s output, but in this post we shall see that it is a surprise that this behaviour is not expected of the Big Four, and that the regulatory response should certainly be expected.

Only very recently here in Financial Regulation Matters did we discuss the ever-growing problem of accounting firm quality standards, with it being suggested that Andrew Tyrie may be looking to establish some sort of oversight board to further regulate the accounting industry. These suggestions followed on from what is being imagined as a new regulatory wave coming the accounting industry’s way after Brexit, but recently there have been a number of instances which suggest the Big Four firms – PwC, Deloitte, Ernst & Young, and KPMG – are beginning to lessen their standards on a systemic level (this will always be the case with a financial oligopoly). In May of this year, the FRC handed out its highest ever fine, this time to PwC, to the tune of £5m. This was for serious failings in the auditing of Connaught, a social housing maintenance group, for which the FRC proclaimed that it has ‘severely reprimanded’ PwC, with the Connaught fine coming just a year after the regulator had to fine PwC £3m for the same thing for its audit of Cattles, a financial services group. Yet, rather predictably, that severe reprimanding had little effect, and now just 2 months on from Connaught, the FRC has fined PwC a new record total of £5.1 million for its audit of RSM Tenon, a professional services group that went into administration in 2013. Strangely, the regulator continued with the narrative that the fine represented a ‘severe reprimand’ again, with PwC admitting to five separate instances of misconduct – perhaps the regulator has a new definition for ‘severe reprimand’. This all follows on from fines for PwC for its role in a recent audit of Merrill Lynch, and also the Ukrainian lender PrivatBank; clearly, the reprimands are not working.

The growing concerns regarding the quality of the Big Four’s output have been flagged up in the media because of the recent fine given to KPMG by the SEC, totalling $6.2 million. The fine, which was in relation to the firm’s valuing of Miller Energy Resources (a Tennessee-based oil and gas company), punished the auditor for ‘grossly overstating’ the value of the company, even to a point of overvaluing certain assets by more than 100 times their actual value (!). As part of the fine, the auditor agreed to improve its quality control mechanisms, but the ludicrousness of that statement, coming from a member of the Big Four, beggars belief. Yet, these fines, and the sentiment that is attached to them, provide an excellent demonstration of the problem at hand.

If we look at the companies who the auditors have failed to properly audit, there is a distinct correlation. These ‘financial services’ firms are prime targets for the Big Four’s array of ‘consultancy services’, which serve in the same way the Credit Rating Agencies’ ancillary services do, in that the additional services are worth much more to the auditors than the actual audits themselves. This is a common problem within the world of financial gatekeepers, and one that is widely recognised. Yet, in the decisions of the regulators above, the issue is not addressed at all, and all that we see are nominal fines and throw-away comments like ‘severely reprimanded’. Speaking in the Financial Times, Emeritus Professor Prem Sikka stated that ‘a £5m fine is less than half a day’s work for PwC’, and he is absolutely right – there is simply no way that this can be regarded as a deterrent. So, if the fines cannot be counted as a deterrent, then what are they? In essence, these fines represent a pacifier for the public, and that regulatory must stop as we oscillate away from the Financial Crisis.


In the aftermath of the Crisis, the Big Four were criticised, but that criticism could hardly be heard against the wall of criticism aimed towards the banks, mortgage companies, and rating agencies (and rightly so). It needs to be established more clearly and more often that the auditors had a very important role in facilitating the crisis – this should be a given, given their centrality to the financial marketplace. Yet, this is not really the case, and although the transgressions of the Big Four are steadily creeping back into the public consciousness, where they belong, there is a growing problem on the horizon. New rules which dictate that large firms must put their auditing accounts out to tender every ten years has seen the Big Four switch their focus from the auditing section of their business (which is, by far, the least lucrative) and turn their attentions towards the consultancy side of their business (which is, by far, the most lucrative). This attachment to the firm’s consultancy arms is directly at fault for a number of the failings of the industry, in that it makes sense that the firms would pressure their clients to take consultancy services, or vice versa clients can impart influence upon the threat of taking their business to an oligopolistic competitor. The theoretical deterrent is that the firms would not want to risk either their reputation, or their standing with the regulator, but neither of these apply – the oligopolistic structure protects them from competitive pressure, and the regulators, in levying £5m fines, confirm for the auditors that they will not be punished for transgressing. Simply put, until the regulators join reality and begin to fine the firms excessively, there will be no change in the culture of these societally-vital financial firms.

Keywords – Accounting, Audit Firms, KPMG, PwC, SEC, Financial Reporting Council, Fraud, Financial Regulation, @finregmatters

Saturday, 12 August 2017

The Premier League and Corporate Scandals: How Corporate Scandals May Stem the Premier League’s Unrelenting Growth

Today’s post covers a topic that will be of interest to a lot of people all across the world. According to figures from the last couple of years, the Premier League – the highest football league in the U.K. – is massively popular, and its rates of growth in terms of expansion, income, and transmission across the globe grows year on year. The Premier League, which sells the ability to televise its games to multimedia companies like Sky or BT, is preparing to auction off the rights to televise its product at the end of the year, with the expectation that this round of auction will produce new record amounts of revenue. Whilst that is likely, there are external factors that may affect this incessant growth, and those factors are the focus of today’s post.

Simply put, the ‘Premier League’ has been an incredible success since its inception in 1992. Figures taken from the last few years confirm this, with the Premier League being broadcasted to 156 countries with 4.2 billion fans watching every week. Since the league’s inception in 1992, its development has been synonymous with television rights, and the modern era is no different. In this post we will focus on the British rights mainly, because the dominance of the British marketplace in the business model of the League is demonstrated when we consider the prices that are being paid to broadcast the matches. In 2015, the Premier League auctioned off the rights to broadcast its product, and the traditional frontrunner in the auction was Rupert Murdoch’s Sky brand, one which has been synonymous with the Premier League since it began. The auction of rights are divided into ‘packages’ i.e. certain packages have different classifications of matches, with which the broadcaster can broadcast at peak times etc. (one may notice a slight similarity with the securitisation process!) and in 2015 Sky paid £4.2 billion for five of the seven available TV packages for a period of 3 years, with BT paying £960 million for the other two packages. BT stands as Sky’s only competition within the U.K. in a marketplace which Sky has thoroughly dominated and seen off every competitor so far (Setanta Sports, ESPN), but in difference to their predecessors BT has developed quite an extensive, albeit expensive approach to challenging Sky in this particular market – BT recently acquired the rights from Sky to air the UEFA Champions League and UEFA Europa League for a record price of £1.2 billion (almost £300 million more than what Sky had paid previously). This inclusion of heavy-hitting competition is causing particular problems for Sky – the theory goes that it helps consumers, but there is no evidence for that in reality – as BT continues to bid way over the odds for packages that Sky cannot even contractually bid on; a former Sky executive claims that BT’s strategy is costing them hundreds of millions of pounds and can easily be rectified. This understanding has led to analysts predicting that the next auctions rights will see Sky pay an extra £1.8 billion on top of the £4.2 billion it paid in 2015 just to retain its standing, which of course has the Premier League bosses purring – it is likely that the recent increase in transfer fees witnessed in the Premier League in the past two seasons alone (Paul Pogba for £89 million and Romelu Lukaku for £75 million) will be dwarfed by clubs spending the increased revenues. However, the threat of incoming competition from tech heavyweights Apple and Amazon has seen fears of an explosion in bids during the auctioning phase become palpable within Sky and BT recently, with the fear being that the companies will have to have their influence reduced – Sky are already making noises that they will pull out of some packages and instead focus on their other offerings (Drama offerings like Game of Thrones and Riviera), whilst BT Executives are also downplaying the notion of BT attempting to challenge Sky’s dominance. Whilst it may be that the explosion in costs, particularly in line with waning viewing figures (despite the recent ban on illegal streaming) is proving simply unsustainable, it may be the case that the wider world of business provides a clearer reason for the companies’ hesitance to engage each other.

Starting with BT, we have looked before here in Financial Regulation Matters at the accounting scandal that began in Italy but spread to affect a large part of BT’s business. As a result of the accounting scandal in Italy which saw the company write off more than £530 million, it also paid Deutsche Telekom and Orange £225 million to avert litigation resulting from the fraud, which in turn has led to 42% drop in their profits; simply put, now is not the time for BT executives to wage war with Sky over broadcasting rights to football matches. Sky, on the other hand, are having problems of their own. Rupert Murdoch, whose 21st Century Fox Company owns 39% of Sky now, is in a battle with British politicians and regulators with regards to his attempted takeover of the Sky Company – the claim is that the merger will afford Murdoch too much influence over media in the U.K. owing to his ownership of Fox, Sky, and a number of newspapers. Murdoch’s proposed £11.7 billion takeover demonstrates the willingness for the deal to happen, but also the state of flux that Sky is currently in; it can also not afford to engage in a battle with BT or any of the tech giants. How these corporate issues will develop will determine the future of the Premier League.

In short, the individual business concerns of both Sky and BT mean that whilst this next auction at the end of the year will see the price rise again, the next auction may see that rate of growth decrease. The noises coming from both camps indicate a potential shift in sentiment – the cost of broadcasting the Premier League is, potentially, getting to the point where it no longer makes commercial sense to win the auction for the rights. However, the squabbling between the two companies, which plays right into the narrative of pro-market thinkers who proclaim that competitive forces are better for the end users, is in fact producing absurd results. At the same time the Premier League is recording record rates of income, the end users – the fans of the game – are seeing the prices they pay to watch just some of the matches (not all matches are televised) rise exponentially, the price of match-day tickets rise, the price of associated merchandise rise, and also there is evidence that there is only a very small percentage of that profit being reinvested in the game at grassroots level. When we consider that all this coincides with the public experiencing a recession, it is little wonder that the past few years have seen a number of fan protests against the growing costs. There is an old saying that ‘you can fleece a sheep many times but you can only skin it once’, and it appears the leaders of the Premier League have not heard it – the incessant abuse of the public’s affection for the game of football has lured the Premier League bosses into a belief that that adoration is unconditional – only time will tell if this is the case, but the noises coming from Sky and BT suggest that they are reaching a point of saturation. Then, one of two things will likely happen; both prices and demand will begin to plateau, or competitive forces will encourage a bigger player to enter the marketplace and continue the ever-present rate of growth – the potential inclusion of Amazon and Apple to the marketplace does not sound good for football fans.


Keywords – Sky, BT, Premier League, Football, TV, Accounting, Fraud, Amazon, Apple, #finregmatters

Friday, 11 August 2017

Donald Trump and North Korea: A Necessary Slight-of-Hand

On quite a few occasions here in Financial Regulation Matters we have focused on the growing credit bubble and its potential effects when it collapses. In today’s post, we are going to continue this assessment by looking specifically at the situation in the United States, which will encompass an array of reports and studies that discuss an ever-growing problem that is beginning to set records. As we often do in Financial Regulation Matters, we will position this discussion within a much wider context and discuss how the proximity of this bubble to the last Crisis is particularly worrying, but also we will look at how impotent the system is at actually constraining it, with the result being methodologies that are moving into absurd territories.

We have discussed the rising credit problem on a number of occasions before, but mostly in terms of the warnings posed by British regulators. However, looking at the global picture reveals a much more dangerous situation in that the world’s leading economies are witnessing record levels of debt. In China the current ratio of credit in relation to GDP stands at an incredible 260%, which has led to an influx of analysis that essentially confirms that a bursting of that bubble is almost inevitable, but would cause devastating shockwaves around the world. China’s increasing consumer and governmental debt represents the pinnacle of a growing systemic problem, one which has seen the levels of debt issuance by countries and major supranational organisation almost double since the Financial Crisis, with organisations like the E.U., the Asian Infrastructure Investment Bank and the World Bank all entering the capital markets in an attempt to raise massive amounts of resources for their needs. Yet, if we are looking for a massive pile of debt then we need not look further than the U.S.

It was reported recently that the rate of outstanding consumer credit-card debt (just credit cards) has recently surpassed the record set before the onset of the Financial Crisis by reaching $1.02 trillion. Then, in other news, an analyst from UBS has recently been discussing how there is a $1 trillion bubble of corporate debt in the credit markets that have been fuelled by institutional investors being driven to speculative-grade credit in the wake of decreasing yields from bonds such as Treasury Bonds. Student loans in the U.S. are outstanding at an incredible $1.4 trillion, outstanding loans on auto-loans stand at $1.16 trillion (particularly sub-prime auto-debt), and all of this is operating under the umbrella of the impending impasse concerning the raising of the national debt ceiling in the U.S. – Treasury Secretary Steven Mnuchin has been warning Congress that levels will need to be increased, using the Civil Service Retirement and Disability Fund as the emotional black-mail battering ram to get his way – a debt ceiling that now stands at $19.808 trillion and one that will be renegotiated in September of this year. It is clear then that the U.S., like many modern countries, is addicted to debt; yet, the question of how to reverse this addiction is proving as elusive as ever.  

During the campaign trail Donald Trump proclaimed that he would end the credit-related threat facing the U.S. in 8 years by fixing what he saw as imbalances in trade with other countries (something which he suggested would be facilitated by tax cuts for the rich); whilst we can write that statement off as one of the many statements that have or need to be written off from Trump, the behaviour of Trump is a significant indicator of the chances of finding a solution. The reaction to the highs of the stock market (before the North Korea issue hit the headlines) demonstrated a massive u-turn from his election rhetoric, and also signified the need to make the absolute most of any perceived ‘win’ owing to the turmoil that is consistently attached to his Presidency. However, as the hubris of a booming stock market begins to recede, the reality of the political and economic situation becomes ever clearer, and Trump is left with the reality that the debt levels are rising to obscene and record levels on his watch (amongst an array of other problems). As with most elements of the situation, there has been no inclination that a solution is being sought or considered, so if we take a step back and look at the totality of the situation, we see that the President is deciding to create a diversion rather than deal with the issue at hand, and that ‘diversion’ is North Korea.

Though there is no need for a qualifier here, mainly because followers of Financial Regulation Matters already know that the underlying sentiment within every post makes clear that following the promoted opinion of mainstream media is a fool’s errand, the divisiveness of the North Korea issue should not cloud the reality of the situation. To begin with, the incredible rhetoric we are hearing from a sitting U.S. President is having the desired effect in that the mainstream media’s adoption of his frankly ludicrous rhetoric is resulting in increased levels of fear regarding North Korea and the usage of nuclear weapons more generally. Though the ‘politics of fear’ as a concept should be well known, its usefulness still remains, with Trump relying upon it and especially when his position or abilities are in question. Almost none of Trump’s speeches, or his incredible tweets, have an air of peace or calm, with all outputs being based on fear or division and, with no easy ‘wins’ in sight, it appears that Trump has gone to his, and arguably America’s favourite imperialistic play-book. Trump’s adoption of the invasion and militaristic narrative is one that has served a number of leaders throughout history (not just American history) extremely well, but if we consider the large number of experts who have been emphatic in their analysis that North Korea does not actually pose the threat that it (arguably by way of survival) and Trump (arguably, for the same reason) advertise, then the reality of the situation comes into view. Rex Tillerson, the U.S. Secretary of State has been almost dismissive of Trump’s warmongering, strategically-vital aircraft carriers are in fact leaving the region, and the Brookings Institute confirms that the threat posed by North Korea is certainly not what Trump and his supporters suggest. Whilst one must acknowledge the dangers of North Korea, the elevation in rhetoric in fact paints the U.S. President as the greater threat to world peace, a threat that is based upon levering the might of the U.S. to coerce what are, in effect, third-world countries and in doing so move the global narrative to one that the U.S. President can affect, rather than one that he cannot.

Ultimately, that sentiment of narratives that can be affected is perhaps the most important one to consider when we are being bombarded with the ludicrous sentiments like unleashing ‘fire and fury’ and reminding North Korea that the U.S. is ‘locked and loaded’. These statements are simply not befitting of such an established and revered office, but they are indicative of a desperate attempt to shift the narrative. Yes North Korea needs to be challenged, but stifling the economic lifeblood of the country and then reminding them that their people can be ‘destroyed’ is not only unwise, it is perhaps damaging the position of the American government irreparably. Whilst dialogue with North Korea rather than in increase in militaristic tension is needed, the issue serves as a diversion from the fact that Trump is leading an administration that has no idea of how to address the incredible economic situation threatening America on a daily basis. The ease at which Steven Mnuchin offered up the support of civil-service workers as a sacrificial lamb and bargaining chip against the U.S. Congress is demonstrative of an administration whose answer is simply ‘more debt please’ – the danger for us all, however, is if Trump’s slight-of-hand, which he no doubt considers a safe option, backfires, is evidently clear; the sentiment of ‘buyer’s remorse’ on both sides of the Atlantic is almost palpable.


Keywords – Donald Trump, North Korea, Kim Jong-Un, Nuclear War, Credit Bubble, Politics, #finregmatters

Wednesday, 9 August 2017

Regulatory Budgets in Perspective: The Bank of England Issues Yet Another Warning over Brexit

In today’s financial news, the Deputy Governor of the Bank of England – Sam Woods – said that the Bank would see its regulatory capability stretched in the wake of the U.K.’s secession from the E.U. to a point that would demonstrate a ‘material risk to [the Prudential Regulation Authority]’s objectives’. The basis for Woods’ suggestion is that the potential loss of financial ‘passporting’ in the wake of Brexit would both result in dispersed regulatory entities, and also an influx in companies needing to be regulated due to the removal of the ability to essentially outsource the regulation of an entity to another ‘competent authority’. Whilst this point is worth assessing, and this post will briefly do that, it is also worth taking a broader look at the state of the U.K.’s regulatory framework in terms of its capability.

Sam Woods’ comments regarding the ability of the Prudential Regulation Authority (PRA), the regulatory arm of the Bank of England, were extremely direct. Woods further emphasised that ‘we may have to make some difficult prioritisation decisions’ in the wake of the differing dynamic created by Brexit, which comes as a stark warning if we consider that it is those changing dynamics that may (or, more likely, will) encourage speculation, a reduction in quality controls, and so on. The nature of Woods’ warning is based on the increased risks that would accompany the diversification of financial service providers across Europe (we have spoken before here in Financial Regulation Matters about the movement of sectors of financial service provision across a number of countries) in terms of the reduced ability to hedge risks, but also on the increased confusion that will emanate from contractual confusion, as well as the ‘extra burden’ that may come from the repatriation of a number of companies who are regulated by other financial regulators across Europe. However, one onlooker has described how ‘the only encouraging news’ is that the Bank has requested only an extra £5.4 million for its ‘Annual Funding Requirement’ – as the PRA is funded by the regulated entities – which would take its total funding for 2017/18 to £268.4 million. Yet, a question that could be asked is does this news really count as encouraging?

If we begin by looking at the operating budgets of the other financial regulators in the U.K., it will be possible to obtain an understanding of the tools available for regulators with regards to their mandates to regulate and maintain order in the marketplace. Starting with the Financial Reporting Council (FRC), whose role it is to set standards for auditing firms and also help develop the U.K.’s Corporate Governance Code, the news is hardly ‘encouraging’. The FRC is tasked with regulating the accounting industry, amongst other things, which means that it must aim to insert its dominance in a market that is dominated by four firms that are serial offenders; as of 2015, the FRC faced an oligopoly that had a combined income of over £8.5 billion which, when combined with the pressure of providing regulation for seven major bodies responsible for registration and education standards, and conducting well over 1,000 visits per year, the operating budget for the FRC of £36 million for 2017/18 does not add up.

The Financial Conduct Authority (FCA), which as a regulator is tasked with regulating over 56,000 businesses, 18,000 of which count the FCA as their prudential regulator, has a defined aim of protecting consumers, financial markets, and also to promote competition. Yet, for this vitally important regulator who have a massive task ahead of them, their proposed budget for 2017/18 stands at £475.3 million, representing just a rise of £5 million from the previous year. The Serious Fraud Office, although not technically a ‘financial regulator’ – though, as we know here in Financial Regulation Matters, are an extremely competent body despite the aims of Theresa May – currently has a budget of £54 million, despite garnering over £460 million in fines since 2014. The details of all of these budgetary breakdowns are available through the links provided, and it is worth noting that most of these budgets come from levies on the regulated entities. Yet, there is a glowing issue that seems to be ignored more generally.


These regulators, just in regards to the U.K. alone, are tasked with regulating a marketplace that operates in the billions, if not trillions, of pounds. They are tasked with preventing the pervasive and unethical culture that struck in 2007 from happening again, and must balance this task in relation to a wider picture that is defined by an economic downturn that perseveres over the years (the credit bubble is an excellent example of something ‘external’ that these regulators must account for). They do all of this with a combined budget of just over £800 million a year which, when considered in these aggregated terms, is ludicrous. It is ludicrous because we know, beyond doubt, that markets left to themselves will wreak havoc. It is ludicrous because the effect of lax regulation is in front of us every day when we see the increased use of food banks, increased poverty, illness, and depravity. Yet, the small increase in funding required by one of the most influential regulators in the country is ‘encouraging news’ – it is not. What is required is one of two things, and either will suffice. Firstly, and this option is the most righteous, regulated firms should see the amount they have to contribute increased substantially, and should see this increase enforced by legislation. It is not acceptable to have the companies’ contribution limited whilst the public’s contribution is unlimited. However, the alternative to this is that the public, via government spending, substantially increase the operating budgets of the regulators. Whilst this may sound distasteful, it is a social hazard to have financial regulators underfunded, and the cost of providing this extra funding is far less than the cost of rectifying the damage caused by underfunding - the haphazard bonanza we saw in 2008 is a testament to that. Ultimately, there needs to be a societal shift away from the altar of economics. This discipline is extremely useful to society, but at its heart it discounts the effect of the economy – the detachment involved in theories like ‘the economic man’ is fundamentally constraining societal development, and only when that mode of thinking changes shall we see a reduction in the social harm associated with modern finance. 

Keywords - "Financial Regulation", "Financial Conduct Authority", "Prudential Regulation Authority", "Serious Fraud Office", "Politics, Economics", "Financial Regulation Matters", #finregmatters

Monday, 7 August 2017

A Microcosm of the Credit Rating Agency Problem: An Almost Parasitic Existence

Today’s post focuses on a passing article published in Bloomberg last week regarding the credit rating agencies and how they have survived the post-crisis regulatory era to remain as engrained as ever. As this author specialises in studying the regulation of this particular industry, this post serves as an indulgence, with the aim being to present an example of how the agencies operate and, crucially, why they persist in spite of such awful performance. Whilst some of the issues raised will be specific to the example promoted within the post, the underlying sentiment that rating agencies profit and develop when the economy is in decline is the one developed in this post and, in truth, in all of this author’s other work: when considered in that analytical light, it is an almost parasitic existence led by the leading rating agencies.

The article in question, which presents an introductory account of the complex issue, begins by discussing how there has been a level of shock or confusion regarding the lack of impactful regulation aimed at the rating agencies after their behaviour in relation to the Financial Crisis; the article quotes a research advisor who states that ‘I, like everyone else, thought S&P, Moody’s, and Fitch would fail to exist as companies, as they would blow up in a storm of litigation and no one in the markets would use them again… yet, they seem stronger than ever before’. Furthermore, the article continues by quoting from a recent Securities and Exchange Commission (SEC) report that describes how, almost ten years on from the crash, the rating agencies still maintain breaches in their internal firewalls and inflate their ratings, two of the key components to their agencies’ complicity in the Crisis. Discussing the dominance of the ‘Big Three’, which, in essence, is the ‘Big Two, if we look at the actual market share of S&P and Moody’s, the article concludes that the dominance will continue in the face of opposition because of the industry’s make up and the ‘conservative investment practices’ that call for ratings to be incorporated. It is worth noting that this article certainly is not wrong in any sense, but it is important to note that this understanding is introductory at best and fails to examine some of the key reasons for the agencies’ ability to withstand extreme pressures.

In this author’s book Regulation and the Credit Rating Agencies: Restraining Ancillary Services, due to be published next year, this notion of examining the industry’s ability to withstand pressure is examined from within a very large lens. The reason for this is that the development of the rating industry, when viewed from within silos, presents a limited problem. However, when we assess the history of the agencies as a whole, the purposeful nature of the agencies and their actions becomes clear. Professor Frank Partnoy has written extensively on the development of the rating agencies, and in basing his examination from the 1930s onwards presents the idea that the agencies produce what he terms as ‘regulatory licences’ – the meaning being that regulators allow the ratings of agencies to carry a regulatory weight via delegation, which forces industry participants to the rating agencies. If we look further back, as we can with the assistance of the excellent research conducted by Professor Marc Flandreau and his doctoral colleagues, we can see that this systemic support for the agencies goes as far back as 1900, and arguably before, with the development of what Flandreau terms ‘legal licences’. However, in this working paper, produced by this author, a lineal analysis reveals that the industry has experienced times of great hardship, which in turn has an extraordinary impact upon how the leading firms choose to operate. In the face of mounting legal pressure from the outset of the creation of commercialised rating agencies, we see that the agencies responded with a particular viciousness that became the blueprint for their behaviour – survival at all costs. That sentiment carried over into the turn of the century and the economic upheaval of the 1930s, but the so-called ‘quiet period’ of the 1940s, 50s, and 1960s, combined with the dominance of just one rating entity – the National Credit Office of Dun & Bradstreet - left the largest agencies on the brink of extinction before the crash of Penn Central in 1970. We have discussed these developments before here in Financial Regulation Matters, and they are covered in even more detail in the working paper, but the sentiment of the agencies profiting and expanding at times of economic decline are clear.

Therefore, a deduction that can be made is that there is an incentive for the agencies to do one of two things: either promote an air of negativity in the marketplace, and/or become involved in schemes that inherently increase the risk to the marketplace, with the ensuing result being a positive result for the agencies; as people flock towards anything standardised and easily explained/assimilated in times of economic downturns, the rating agencies arguably have a vested interest in maintaining that dynamic – the sentiment being that they have learned from their past in that ‘quiet periods’ are a direct threat to their existence. With that being said, perhaps it is worth presenting a contemporary example so as to provide support to what may sound like a contentious insinuation but in fact is just a deduction from an analysis extracted from the ‘wider lens’. Recently, Moody’s was fined $864 million by the Department of Justice for its role in the Financial Crisis (loosely, anyway), which would usually signify quite an impactful punishment. Yet, at the end of July Moody’s was given the regulatory clearance by the European Commission to purchase a Dutch business intelligence provider for a massive $3.27 billion. The purchase of Bureau van Dijk represents one of the largest-ever acquisitions by the agency, which follows on from its acquisition of German structured-finance data provider SCDM for an undisclosed amount; the actions are said to have contributed to a massive 22% increase in the value of the agency’s shares this year alone. Yet, this period of growth and prosperity comes at exactly the same time the global economies are struggling, with the agency being the loudest in telling people so.

For example, Moody’s recently raised a number of British banking institutions’ ratings to stable from negative, with the inference being that the banks have an increased resilience to the U.K.’s ‘expected deterioration’. Yet, the agency has been promoting this idea of a massive downturn on the horizon more than most, with recent proclamations stating that: ‘the rating agency expects the UK economy to slow, impacting banks’ revenue and credit quality’; that rising household indebtedness, among other elements, were the ‘key drivers’ in reducing the ratings of most U.K. asset-backed securities; and finally that there is a ‘substantial probability that [Brexit] negotiations will fail and no agreement will be reached’. Whilst it is not the case that the agency is fabricating these opinions, the enthusiasm with which the agency proclaims them, when compared to the absolute lack of information regarding rating methodology changes or the underlying risk of securitised pools, leads one to wonder whether the agencies understand that an increase in systemic uncertainty and worry results in profit for them – it is contested here that they certainly do understand this.


The ability to acquire a company for over $3 billion in the wake of a company-record fine reveals a number of important things. Firstly it shows that the fines were completely ineffectual, to the point where it is questionable why they were even considered. Second, it points to a realisation that the agencies are so embedded, that they are actually impervious to negative economic conditions (some would say, one imagines, that this is to be admired – although when we consider that the agencies were central to causing the current economic malaise, perhaps any admiration should be withheld for the moment). Thirdly, the acquisition of such a company (van Dijk) will either raise concern or comfort, depending upon one’s opinion of the rating agencies: either they are acquiring more services to provide a better overall service to the marketplace, or they are bolstering their position in advance of another onslaught upon the marketplace. All of these considerations will be resolved in due course, but in order to conclude, it is worth looking at the aim of the Bloomberg article one more time. The article aimed to examine why the agencies have survived the post-crisis regulatory era, and put forward the reasons of continued conflicts of interests, an oligopolistic structure that protects them, and a regulatory structure that serves to promote their continuation. It would be foolish to argue with these reasons, mostly because the evidence supporting them is overwhelming but, more abstractly, the agencies survive because they are aware of their predicament more than anyone else is. The agencies realise that they can only survive in the harshest of environments and that if they are to continue to thrive they must either promote negativity, or be part of its creation – a rather incredible deduction, but then again we are talking about a rather incredible industry. 

Sunday, 6 August 2017

The “Global Laundromat” Investigation Turns its Focus onto RBS

In March, here in Financial Regulation Matters, we looked at the developing story of a massive investigation into the laundering of Russian funds by a number of famous financial institutions, including HSBC, Lloyds, Barclays and a host of other institutions. The massive scheme, which runs into the tens of billions of dollars, was brought to the public’s attention in March and detailed a scheme enveloping countries from all over the world, with the obvious consequences being financial institutions coming in for regulatory scrutiny and even (potentially) criminal sanctions, especially with regards to the ongoing situation in the U.S. with the Administration’s alleged connection to Russian officials. However, in this post we shall focus on the most recent development which looks at the role RBS played in the laundering system, with the news coming at a very inopportune time in relation to the bank’s reporting of a £939 million profit for the first 6 months of 2017.

The week began well for RBS, with the bank announcing the £939 million profit for the first 6 months of 2017, a result which led the embattled Chief Executive – Ross McEwan – to announce that ‘the government is getting a much better bank… the core of the bank is delivering’. However, that news representing quite an outlier, because analysts firmly believe that the recent $5.5 billion settlement the bank reached with Federal Housing Finance Agency (the first of two massive penalties) will see the bank post its tenth consecutive yearly loss, whilst the bank confirmed that it has chosen Amsterdam to be its European base post-Brexit. Yet, whilst the Department of Justice’s (DoJ) penalty that is forthcoming is likely to have a hugely negative effect on RBS’s position, the focus of the globalised money-laundering investigation is perhaps the biggest concern for the bank, as the reputational capital that will be lost could be extensive, especially when we consider that RBS does not have much reputational capital to lose anyway.

It was reported on Friday that the Financial Conduct Authority (FCA) had initiated its investigation into the bank’s alleged ‘processing of hundreds of millions of pounds for a Russian money laundering scheme’. We know about the money laundering scheme already, having looked at HSBC’s alleged involvement, but the confirmed involvement of RBS would be particularly damaging as it would represent the latest in a long line of money-laundering charges aimed at the bank. Whilst it is very likely that RBS will be found to have been involved, purely based on the sheer size of the operation and the involvement of 732 banks in 96 countries, the history of the bank’s inability to comply with Anti-money laundering rules (AML) is staggering. In 2002 the Financial Services Authority (FSA) fined RBS £750,000 for failing to implement and act upon adequate ‘Know-Your-Customer’ (KYC) rules. In 2010, the FSA again fined RBS a then-record £5.6 million for processing foreign payments that were potentially in contravention of the HM Treasury sanctions list. In 2012, the FSA then fined Coutts & Co. bank, owned by RBS, a record £8.75 million for precisely the same offence; more recently, the bank has also been fined HK$7m by Hong Kong’s banking regulator for the same offences, mostly related to the bank’s connection to the 1MDB Malaysian political scandal. Whilst a more positive person may be of the opinion that these stories are not connected, it is hard to conclude that the bank has learned from its mistake and were not part of the impending Russian money laundering scandal; the bank has too much form for breaching AML rules.


Ultimately, some of the conclusions that we have arrived at here in Financial Regulation Matters concerning RBS remain just as true in light of these recent developments; it is difficult to see how RBS will make it back to private hands like its competitor Lloyds has recently. The continuation of penalties and investigations makes clear that the culture of the bank was rancid, and that cleaning it to ensure the firm’s future is nothing short of a gargantuan task. Billion-dollar fines, billion-pound settlements with investors, accusations of being part of a massive and politically-incendiary money-laundering network all accumulate into a negative outlook. When we combine this with the suggestion that the bank will report its tenth consecutive yearly loss, it is surprising that the British government is not considering drastic action. The question for the government and the British taxpayer is how long will RBS be allowed to continue? How long will it be acceptable for the British taxpayer to hold on to this loss-making entity? Arguably, in a perfect world, RBS would have already been dismantled and sold for the highest possible price to avoid further losses for the taxpayer, but the loss of RBS from the financial landscape, so soon after the Financial Crisis, would have dramatic effects on the confidence of the marketplace. Ultimately, ‘too-big-to-fail’ is in full effect every time RBS reports another one of its failures.

Keywords - "money laundering", "anti money laundering", "fraud", "politics", "RBS", "Russia", "#finregmatters"