Tuesday, 20 February 2018

Pensions Regulator Comes Under Fire over Carillion

The case of Carillion has made for a number of posts here in Financial Regulation Matters, ranging from the commencement of the crisis to the fallout, both in regards to the effect upon the sector and also the effect upon the pension fund and the protective framework that exists to protect pension holders from these sorts of crises. However, news that broke today concerning the performance of the pensions regulator in the U.K. and, specifically, its performance in the previous few years regarding the ever-deteriorating situation at Carillion has brought the pensions regulator’s performance to the forefront of discussions. In today’s post, we will review this breaking news and further examine the pensions regulator as, one would assume, the crisis continues and associated authorities are dragged further into the mire in relation to this massive collapse.

Rather than restart the examination of Carillion in any great detail, it is best to start with the issue at hand. Today’s news consists of warnings that were put forward by Carillion’s (Pension-related) Trustees, which they must do in relation to the relevant laws contained within the Companies Act of 2006 (section 898). However, whilst it appears that the trustees performed as they should, the news today revolves around the notion that, despite a number of warnings to the pension regulator about underfunding, and a generally poor attitude by company bosses when concerning properly funding the company’s pension schemes, those warnings were not heeded by the regulator. When the warnings were acted upon, details today reveal that the regulator did put pressure on the company to put resources into the pension fund, albeit below the level requested by the trustees. The story goes that the trustees had strongly suggested to the company that it should provide £35 million a year for the fund to be properly maintained, with the company only then offering to pay just £25 million; after this was branded as ‘unacceptable’ by the trustees, the trustees returned with a further warning that contributions totalling £65 million a year over a period of 14 years were what was needed, with the company responding by offering just £33.4 million a year over 15 years. It was at this point that the trustees sought the intervention of the regulator; the regulator has responded by stating that they did intervene, and that their pressure amounted to a ‘significant increase’ in the amount of money that the company were willing to pay into the pension pot. However, with the trustees claiming that the actual deficit in the fund was far larger than Carillion bosses would admit to (it has been revealed now that the likely deficit is just short of £1 billion), the question now revolves around the regulator’s insistence that it applied pressure, despite the fund’s deficit increasing beyond expected levels – the regulator is due to give evidence to Parliamentary Committees next week. Frank Field, who we discussed yesterday, has suggested that he is expecting, or at least hoping, that the pension regulator performs more diligently in the attempted clawing back of some of the money that was paid out in bonuses to company officials, although that comment represented more of a dig at the regulator than an instruction. With the regulator facing questions next week, the issue here is what the future may look like for the regulator once the dust settles from the Carillion crisis.

The regulator’s actions, in presumably applying ‘pressure’ but not taking direct action, fundamentally places the regulator within the conversation concerning the best way to move forward in light of such massive corporate collapses. On the one hand, the regulator does have powers to intervene, but was happy with the reported financial situation at the company (admittedly, backed by auditor’s reports, which raises questions about the role of auditors). However, the obvious issue with this is what is the point of the regulator having these powers to intervene if they are not going to use them? In this scenario, there is clear evidence of trustees raising the red flags, operating according to procedure and taking the issue to the regulator, and then the regulator not acting. Whilst it is not a case of right or wrong, for the most part, it is clear to see that the warnings put forward by the trustees were well founded. Perhaps, this is just the latest example of the pro-business mantra developed by regulators that has come to encapsulate the current era; siding with the business when there is any room for manoeuvre is, apparently, the modus operandi of financial regulators and it is vital that this stops. There is far too much evidence to demonstrate that whilst business needs to be allowed to operate, having a pro-business attitude when regulating financial entities causes substantial social problems, but yet it persists. The issues raised by white-collar crime studies, like the almost absolute absence of prosecution in these matters, are raised time and time again, and one wonders what the breaking point may be to tip the scales, if at all.

Keywords – Carillion, Financial regulation, pensions, Business, Law, Crime, @finregmatters.

Monday, 19 February 2018

Update – Tesco’s takeover of Booker Not Yet a Done Deal

This very brief post provides a small update on a continuing story that has been covered throughout here in Financial Regulation Matters. Tesco has been in the news a lot recently, whether that be on account of aiming to move into the ‘discount supermarket’ marketplace, or on account of a massive amount of job losses as the company goes through a restructuring process, both on the shop floor and across management. However, our focus today will be on providing an update to the ongoing attempted takeover of the wholesale firm Booker.

The proposed takeover of Bookers has been a protracted one, and although the deal has been given the go-ahead, slightly controversially, from competition regulators, there are still a number of hurdles to clear before the deal can be completed. Whilst the approval from the competition regulator was a major hurdle, getting everybody on side is perhaps the largest hurdle and, in that sense, the deal still has some way to go before it can cross the finish line. This was demonstrated towards the end of last week when the advisory firm Institutional Shareholder Services (ISS) advised Booker shareholders to reject the deal as it is being proposed, on account of there being, in their view, ‘limited potential benefit’ for them as Booker shareholders, ultimately concluding that the deal should be rejected in its current form.

This development follows Sandall Asset Management, who themselves hold 1.75% on Booker, also declaring that they are against the current deal, at least in its current form. For them, they believe that the deal undervalues Booker significantly, with their claim being that the company is worth between 255 and 265p per share, not the 205.3p currently on offer from Tesco. To resolve the issue, Sandall Asset Management are calling for the firm’s 2018 profits to be paid out, in full, as part of a closing dividend to its shareholders to account for the envisioned loss; whether or not this becomes a reality is another matter entirely – Tesco is currently only offering 65% of 2018’s profits as a closing dividend.

What this saga does show is the precarious nature of a corporate takeover, and the many elements which must be in place before the takeover is completed. What is likely going to be the case is that Tesco raises their offer ever so slightly, with the offer then being just enough to tempt doubters into taking what they can get over and above what has already been suggested. However, it is worth paying close attention to developments within Tesco in the coming months and years, because their restructuring that was designed to right some of the wrongs committed under previous leaderships i.e. an aggressive global expansion that did not have the desired effects, is well under way and will see the famous store repositioned within the marketplace. If we add to that the effects of the U.K.’s secession from the European Union and the effect that may have upon consumer spending, how Tesco negotiates these choppy waters may determine its future for quite some time.

Keywords: Tesco, Booker, Competition, Takeover, Business, Brexit, Shareholders, Investing, @finregmatters.

“Round Two” – Sir Philip Green and Frank Field set to Renew Hostilities

Here in Financial Regulation Matters we have focused upon Sir Philip Green and his vast business empire on a number of occasions, with most posts assessing the downfall of the British retailer ‘BHS’ and the subsequent fallout that spanned from that. Frank Field MP, who chairs the Parliamentary ‘Work and Pensions Select Committee’ has, by way of the Committee’s mandate, come into direct opposition with Green over the collapse of BHS and the effect on its pension holders, and news today suggests that they are yet again set to resume hostilities over Green’s business plans; so, in this post, we will detail what is at issue this time and look at some of the possible effects that may ensure from this continuation of investigation.

The collapse of BHS, and Green’s involvement in the reduction of its pension schemes beforehand, made for a spectacle that was remarkable, but in reality not surprising. We covered the account of Sir Philip Green taking a daring approach to being questioned by Field’s Committee, with the result being that Green contributed significantly, but not in full, to the pension schemes to bring about some sort of parity after it was systematically reduced by the company’s leaders over a period of years. Whilst questions were raised here regarding the effect of that encounter, particularly in relation to the sentiments that resulted - i.e. Green’s bluster was both demonstrative of a. his belief in his lack of wrongdoing and b. his disregard for the threat posed to him, but also in relation to the sentiments offered for Field, that taking on such a commercial giant can reap the correct rewards – the outcome was to both secure a significant portion of the lost pension funds for the pension holders, but also to bring Green to the stage on account of his business dealings. It has been noted recently that Green’s Arcadia company, that controls many high street chains and has nearly 3,000 stores and 26,000 employees worldwide, is under increasing pressure from online retailers that have forced their way into the marketplace but, of course, with much less operating cost; as a result, news today suggests that Green is considering selling his company to a Chinese firm called Shandong Ruyi. However, for Field, this raises concerns on the back of Green’s performance with BHS, and it is for that reason that he has declared that his Committee will ‘look at the state of Sir Philip Green’s pensions schemes and whether he can sell to whomever he wants…’. Other reports suggest the reason for this concern, with one source stating that it is widely rumoured that Arcadia’s current pension deficit stands at almost £1 billion, which would add weight to Field’s declaration that it is important to ‘find out what the position is’ in relation to the current deficit held by Arcadia before any sale can go through. However, leaving aside the merits of the Chinese company, who have been making a concerted entrance into the European market of late, a question posed by Journalists to Field is of more interest at the moment; Field was asked whether this new investigation might be perceived by Green to be the confirmation of a vendetta against him, with Field responding ‘I hope it doesn’t’. That question from the journalist raises some very questions indeed.

On the one hand, it could look like a politician focusing upon a business leader too much, particularly as the BHS scandal and its fallout was so recent, but this is a particularly poor vision to follow. Another way to examine developments would be a politician, tasked with safeguarding vulnerable pension holders, fulfilling his mandate that he was elected to carry out, and consistently protecting pension holders against what has been demonstrated to be particularly venal behaviour. It is quite illustrative of the problems within modern society that investigating a business leader who has just had to settle to the tune of £350 million to replenish funds that he and his company drained, and who sit on an apparently gigantic pension deficit at the moment, is even potentially considered to be a ‘vendetta’; it is not, and this shaping of the debate lends poorly to the integrity of those who advance such degenerative arguments. In reality, Green should have to declare, at a very early stage, his intentions with regards to the sale and then a formal and thorough investigation should be commenced; it is very unlikely that someone who operates in such a manner will leave the company in great shape for its purchaser, and more importantly its employees. It will be an interesting scene if Green is put in front of the Committee again, because his appalling performance last time will surely not be repeated; this is, however, a logical conclusion to make. The case is that, in reality, if Green is put in front of the Committee again, he will likely be even worse, and this come from his understanding that there is no real deterrent for someone in his position; would Green ever face imprisonment for his actions? We know the answer to that, and at best he faces a slight reduction in his substantial wealth which, for a man in his mid-60s, is no real threat at all. Yet, whilst that is a negative, the positive can be found in Field’s determination to protect those who cannot protect themselves, and his actions in this continuing case need to be the model moving forward. Perhaps the word ‘vendetta’ is correct, but rather it needs to be a vendetta against those who continue to plunder the system in the belief that they will not be pursued.

Keywords: Sir Philip Green; Arcadia, Topshop, Retail, Business, Pensions, Politics, @finregmatters.

Thursday, 15 February 2018

Article Preview – ‘Sustainable Finance Ratings as the latest Symptom of “Rating Addiction” – The Journal of Sustainable Finance & Investment

In today’s post, we will be previewing an article produced by this author that was very recently published in the Journal of Sustainable Finance & Investment (available here). The article is concerned with recent developments within the ‘Principles of Responsible Investment’ (PRI) initiative that is being undertaken by the U.N., with the focus being on the proposed incorporation of the leading credit rating agencies (for the most part) and their products. The emphasis of the article is on explaining the view that, based on the historical development of the credit rating industry, inducting them into the potentially systemic-altering movement carries with it great risk, and it is that risk that is analysed within the article.

The article begins by not explaining the developments within the PRI, but by examining a concept known as ‘rating addiction’. Using the literature to provide context for the concept, an assessment is undertaken to examine how the leading rating agencies have been correctly identified as being central to the Financial Crisis (and many other issues) but have not only survived through these socially-challenging periods, but actually prospered – the article advances the claim that the reason for this phenomenon is ‘rating addiction’ which, as one would likely surmise, relates to the notion that the financial system is addicted to the products and therefore the agencies, which has the effect of protecting the agencies against any meaningful punishment for their actions. The article examines the literature that discusses the concept of ‘ratings reliance’, which is similar concept to ‘rating addiction’ in many ways but focuses more on the regulators’ incorporation of the ratings into their procedures for a number of elements, like bank capital requirements, for example; the effect of this reliance has been, according to the literature, a systemic-level of ‘outsourcing’ of regulatory responsibility to third-parties, so much so that the regulators have come to ‘rely’ on the ratings. However, it is arguable, and the article makes this distinction, that ‘reliance’ and ‘addiction’ are two separate phenomena, because ‘addiction’ carries the connotation of the strong inability to remove oneself from the process – much like a drug (or any other commonly witnessed addictions).

Upon declaring that rating addiction does indeed exist, and is fact prevalent, the article goes on to discuss the technical issue of whether ‘reliance’ and ‘addiction’ are indeed separate, describe the same thing, or are different positions within the same linear causal pattern. It is proposed in the article that rating addiction supersedes everything else because, essentially, it predates the regulatory usage of the products of the agencies. Using business history literature, particularly that developed by Professor Marc Flandreau and his doctoral colleagues, the article presents a picture whereby, due to the economic landscape in antebellum America i.e. before the American Civil War, it was the economy that became addicted to the ratings of the agencies, and not a case whereby, as others have suggested, regulators pushed the ratings onto the marketplace – with the ratings being used to deal with the issues being raised by the expansion of the United States, market participants began to realise that ratings were the most cost-effective way of ensuring (to the greatest extent possible) that credit extended to a person or a company would be repaid. Flandreau discusses this at length across a number of fascinating articles, but the conclusion to be drawn from his research is that, quite simply, the regulators in 1933, and in 1975 (to note two key dates in the regulatory induction of ratings; 1933 saw the Office of the Comptroller of the Currency induct the ratings, and 1973 [later promulgated in 1975] saw the SEC formally induce and protect the rating agencies into the modern marketplace) were responding to the marketplace, not influencing the marketplace; understanding this dynamic is absolutely vital to understanding the reason why agencies managed to prosper despite being widely identified as being key actors in the Financial Crisis.

The above hints at the viewpoint that is it actually investors and bond-offering organisations that lay at the cause of rating addiction, which is to some extent true, and on that basis the article then looks at why this may be. One of the key aspects that the article examines is the concept of ‘agency’ and the related theories, which provide a useful tool with which to examine the relationship between an investor, their institutional investor, and the rating agencies. For example, whilst in the 1840s when the first commercialised  rating agency came into being the system involved lenders providing credit to other marketplace actors in a very commercialised manner, the modern system relies on the constant flow of resources; the clearest example to use is an institutional investor, like a pension fund, whereby the ‘lender’ is made of a large number of dispersed investors with relatively small funds, and partake in a system that has investment managers who take the lead on who to lend to, why, and where. The obvious problem with this scenario is that dispersed fund contributors would find it difficult, and more importantly inefficient, to monitor the actions of their ‘agents’ on a daily basis; the solution, within the modern marketplace at least, has been to define parameters within which the ‘agents’ can act, with easily digestible and identifiable ‘ratings’ being a common choice. On the other hand, to protect the system, regulatory (and legislative) bodies have enforced rules that do the same thing but for different reasons, which is why many institutional investors have their investing ability capped by certain rating levels i.e. AAA, or the top ratings prescribed by the relevant rating agency. Yet, as that is the case, the question is then what does that mean when the investing system itself is changed, or at least being proposed to change?

This issue of changing the investing ‘system’ slightly exaggerates the proposals being put forward by the PRI, but the sentiment is close enough. The initiative, which sees a number of large investment practices come together to promote the increased incorporation of sustainable investment practices, whereby key Environmental, Social, and Governance (ESG) concerns are incorporated into investment practices, is essentially the movement being developed by the PRI. In the article the proposals set forth by the PRI are discussed in detail, but the result of that examination is to assess the proposals currently being considered which set out a plan of action for the rating agencies to a. be inducted into the PRI’s movement, and b. have that induction predicated upon the agencies’ incorporation of ESG concerns into their rating processes. Whilst some have championed this idea, there is a problem that is outstanding which forms the crux of the article; whilst the agencies profess to already incorporate ESG into their rating processes, the facts of this are disputable, and for a number of reasons. Firstly, as discussed in the article, the rating agencies are no exactly clear on the levels of ESG incorporation into their analyses, although all say that it forms a part; the majority of responses revolved around the declaration that, for their part, they see financial data as the key driver of their rating analyses, with ESG components playing not much more than a bit part on their deliberations. Whilst the PRI are, as a result of this understanding, aiming to encourage rating agencies to increase their usage of ESG considerations, the responses of the agencies suggest that operationally, and moreover culturally¸ they are not seriously inclined to do so. Yet, the biggest issue of all is that the agencies are notoriously guarded when it comes to disseminating information related to their methodological processes, and this is for a number of reasons – many of the reasons relate to protecting their position, and others relate to protecting themselves when things go wrong or they act in a transgressive manner. Nevertheless, it is on this basis that the article argues that inducting the agencies, in their current form and with their current culture in mind, into the PRI, is a great risk. Whilst that claim may be sensationalised, to an extent (although this author is clear on the view that agencies need to be treated with great care when it comes to incorporation), there is a technical element which describes that risk more accurately. Using the research of Professor Kern Alexander, there is an argument to be had that if the sustainable investment movement continues and regulators place a value on operating in such a manner, then the linking of, say, sustainable finance credit ratings to something like bank capital requirements, could pose a huge risk in relation to the historical conduct of the rating agencies. In doing so, the sustainable finance movement would, in essence, become the latest credit rating-related vehicle with which the systemic safety of the economy could be placed in jeopardy; then, as always here in Financial Regulation Matters, the obvious question is whether the economy, and society moreover, is healthy enough to withstand another shock so soon after the Financial Crisis. Ultimately then, the aim of the article is to present an account of the recent movements of the agencies, and present an account that is determined to highlight the potential risks of incorporating the rating oligopoly into such a progressive and much needed movement; understanding the historical trajectory of the rating agencies provides the rationale for doing so.

Keywords: credit rating agencies, business, finance, investment, law, regulation, @finregmatters.

Tuesday, 13 February 2018

Article Preview: ‘Scope Ratings: The Viability of a Response’ in European Company Law

Today’s post will preview a recent article by this author that was published by European Company Law, entitled ‘Scope Ratings: The Viability of a Response’ (details here). The short preview will discuss the rationale for the article, some of its aims and achievements, and then the wider picture with respect to the continuing Viability Of articles, with this article representing the fourth in the series.

This article, as mentioned above, represents the fourth edition of the Viability Of series produced by this author, which is a series which aims to examine and assess the growing number of alternatives to the Big Three rating agencies (S&P, Moody’s, and Fitch) that dominate the credit rating marketplace. Details of the first three are available here, here and here (although the titles are different in these last two articles, they are still in the same series) and this current article operates on exactly the same lines. The rationale for these articles is straightforward; the proposed challengers to the hegemony of the Big Three need to be assessed, discussed, and judged within a practical light because, given the nature of this industry, even those with good intentions will likely meet an obstacle they could not have foreseen, or at the least anticipated – the Big Three are well known, but their practices are inherent, as in any oligopoly, and the effect of that is felt within every challenger to their position.

This edition of the series focuses upon Scope Ratings, a German rating agency that is taking a different approach to all the other challengers. The agency is aiming to become a ‘European alternative to the “status quo” for institutional investors’, as well as international investors, and to achieve that aim they are embarking upon a concerted and far-reaching Mergers & Acquisitions strategy that has the potential to provide a real foundation to their development, but is also fraught with great risk within the oligopolistic dynamic that exists within the industry. Starting life in 2002, the firm has gone on to acquire a number of financial service providers from within the E.U. in an effort to consolidate expertise that, at least, allows for investors to consider different options other than what the Big Three provide. A big breakthrough occurred for the firm’s strategy when, in 2011, the firm was officially registered by the European Securities and Markets Authority (ESMA) as a functioning and accredited rating agency; the firm has continued its aggressive M&A strategy ever since, and now counts major companies like BMW, Santander, and UBS as its clients. The article goes on to examine the firm’s recent acquisition (2016) of Feri rating services, and discusses how the acquisition has the ability to increase Scope’s fortunes on account of its new found ability to incorporate significant sovereign bond research into its offerings. Yet, the firm sees an important part of its development within the banking sector, and as such has recently moved to open a London branch headed by a former head of department at Moody’s; how these developments will unfold in the wake of the U.K’s decision to leave the European Union is another matter entirely (a point which is raised in another article that has just been published by this author with the assistance of the European Business Law Review – preview available here).

In terms of setting the structure for the article, it proceeds by counteracting the analysis of the ‘challenger’ with that of the ‘champion’ i.e. the Big Three, in order to demonstrate the task facing Scope Ratings. Upon doing so (it is not worth going into detail here; regular readers will know the views on the Big Three held by this author), the article concludes the ‘champion’ section by discussing the E.U.’s plans to ‘increase competition’ in the marketplace by way of inducing the newer firms further into the investing picture (this point was raised in a recent article published by this author with the assistance of European Company Law – preview available here); the overriding statistic that comes from this analysis is that, at the moment, Scope holds just 0.39% of the market, which makes its progress interesting but not threatening to the Big Three at the moment. However, as the article continues by looking at the ‘tale of the tape’, which aims to examine the reasons why Scope may not make an impact, and the reasons why it may. The concluding section suggests that 0.39% is simply not a factor in the current market, meaning that Scope’s ratings offer an addendum at best to the ratings of the Big Three. Also, if it does grow beyond 0.39%, the likelihood is, at least according to historical trends, that the Big Three will devour the agency and simultaneously protect their oligopoly, as any good oligopoly must. Yet, the article does offer reasons for why Scope may gain more success in the field, and that is mainly due to the structural differences being proposed by the E.U. In the American market, any claims of increasing competition within the rating industry is often nothing more than lip service (as Egan-Jones can attest to), but in the E.U. the sentiment is much stronger; this may be because of the effect of the sovereign debt crisis that saw the agencies at the heart of the unfolding crisis, or just because the U.S.-based agencies have less of an influence in the E.U. to some relative extent. Nevertheless, there is a growing sentiment, whether misplaced or not, to enforce competition on the sector, and that can only go in Scope’s favour. Additionally, Scope is particularly European in its outlook, and that bodes well if the E.U. decides to incorporate protectionist ideals into its regulatory framework moving forward. Also, the specialised nature of Scope’s offerings has drawn in some highly reputable clients, with the hopeful impact being that more will decide to incorporate Scope Ratings’ evaluations in their investment decisions. However, a pragmatic evaluation can only have one outcome: at the moment, Scope is minute compared to the Big Three, and perhaps the only reason why the oligopoly is allowing the small firm to grow is because, at the moment, they need not concern themselves with Scope’s development (one can safely assume they are monitoring their progress, however).

The effect of this article is to present yet another account of the incredible dynamics that exists within this, and a number of other financial service sectors (the same could be said of the auditing field, for example). The presence of the oligopoly outweighs any smaller undertakings, and regulatory intervention, and any political movement against its position, which is why the study of oligopolies and their dynamics is of the utmost importance (see here for a good resource on the matter). By continuing the study of the rating agencies and basing it upon the actualities of the rating agencies themselves, which is something this author calls for in every piece, rather than what one may desire them to be, or what they should be doing theoretically, there stands a chance at affectual change; other than that, we can expect the continuation of a process that sees these private firms entrenched within society without any impactful recourse.

Keywords: Credit Rating Agencies, Scope Ratings, Big Three, E.U., Business, Politics, Law, @finregmatters.

Monday, 12 February 2018

Barclays Charged for Crisis Dealings: A Crisis That is Going Nowhere

In the second post today, we will take a brief look at the latest development from a regulator (loosely termed) that we have looked at many occasions – the Serious Fraud Office (SFO). In responding to actions taken in the midst of the Crisis, news today confirms that the Office has charged Barclays for loans the bank made to Qatar at the same time investors from the Country provided the necessary lifeline which allowed the bank to survive the Crisis without governmental support. The impact of the prospective action could be far-reaching, so in this post the details of the allegations will be examined, as will the potential fallout.

During the Crisis, the British-based bank tapped investors for nearly £21 billion, with almost £4.5 billion coming from Qatar Holding – part of the State’s Sovereign Wealth Fund – and Challenger Universal, the investment vehicle of the former Qatari Prime Minister. Furthermore, the bank acquired more than £7 billion more from the two vehicles, along with leading figures from Abu Dhabi, but the details of the deals prompted scrutiny and ultimately a massive five-year-plus investigation by the SFO; today, the SFO made the latest in a string of moves on the back of that investigation. Last year the bank’s parent company, and four of its leading executives were charged by the SFO, but today the SFO charged the bank, via its operating company this time, for a second time on counts of fraud. The difference in focus means that whilst the executives face criminal charges that carry up to ten years in prison, the focus on the operational company means that ‘the bank could face regulatory penalties, including withdrawals of its banking licences in the UK and other countries’. The fraudulent act in question is a £2.3 billion loan made to Qatar Holdings at the same time it received the injection of capital, with the charge being that the loan was used, ‘either directly, or indirectly, to buy shares in Barclays, which the SFO says is “unlawful financial assistance”’. The job of the SFO now is to prove that the directors knew what the loan was to be used for, but market commentators, and Barclays itself, seem un-phased by the developments with people focusing on the fact that many banks have been charged and penalised for similar offences committed in the Crisis era and have continued operating successfully; however, is that really the extent of the impact of these prospective problems?

The Guardian reports that operations, specifically from a retail point of view, would likely not be affected as new ring-fencing rules come into force, but that the investment banking, corporate lending, and international operation arms would all be affected. Yet, the same media outlet raises the question of the impact upon Barclays’ branches, with the suggestion being that a widespread revoking of licences would see the bank forced to halt retail operations in spite of the ring-fencing protection, although the article ends with the realistic summation that the SFO, and specifically the FCA in being tasked with implementing punishment, are highly unlikely to go to what the article suggests is the ‘nuclear option’. So, in reality, this issue is analogous the other post today concerning RBS – the environment today is dictating to what level, if at all, punishment is given to these transgressive companies.

Ultimately, the impact of this charge is proving to be minimal within the marketplace because market participants realise that there are so many hurdles before the bank is stripped of its operating licences, which raises the question of the effectiveness of the SFO’s approach. The SFO’s approach is correct in terms of it has found illegality, and is proceeding accordingly. However, the reality of the situation is being played out across the headlines; impactful regulation and punishment is simply not an option at the top level of business. The likely situation is that the bank and the charged executives will allocate remarkable resources to their defence, and the case will drag on for many more years; what it does tell us, however, is that the Crisis era and the actions taken within it continue to haunt us still, with the environment today being directly dictated by the actions, and more importantly the sentiments, that were developed during that era. On that basis, the SFO is between a rock and hard place, and with its action being scrutinised by leading political figures, it is likely the SFO will back down in this instance and settlement of some sort being viewed as a victory under these circumstances; that is quite a revealing chain of events all things considered.

Keywords: Barclays, Banking, Fraud, SFO, Politics, Law, Business, Qatar, Financial Crisis, @finregmatters.

RBS and the Government: Good Cop and Bad Cop

In the first of two posts today that focus on the banking sector, we will start by looking at the troubled bank RBS. We have looked at RBS on a large number of occasions here in Financial Regulation Matters, with posts ranging from its incredible losses since the Crisis, the bank trying desperately to keep its high-ranking officials (mostly former) out of the court room, and also its appalling treatment of SMEs. In continuing the first and third areas of focus, news recently adds developments to these stories which detail a bank on its knees. However, by adjoining these analyses with the examination of the Government, its regulators, and also Parliamentary committees, the bank’s future comes into focus and is, seemingly, in a particularly precarious phase for a number of reasons.

Looking first at the issue regarding the bank’s treatment of SMEs, via its notorious ‘Global Restructuring Group’, we are no strangers here in Financial Regulation Matters to the developments in this story, and of the appalling practices of, essentially, running SMEs into the wall and collecting the pieces and the fees – a practice made famous by the ‘rogue’ unit within HBoS. The allegations have come in their thousands, with concerted campaigns aimed at bringing these practices to light, but one can only focus on the ‘alleged’ practices at the bank because, up to this point, the FCA has played its part in protecting the bank by commissioning reports and then heavily censoring them and releasing only snippets. However, after a movement by the Treasury Select Committee, headed by Nicky Morgan, it appears finally that RBS’ practices will come to light so that we can all know, hopefully, exactly what they have been doing – and then, hopefully, see some particularly impactful action taken for this despicable practice. It appears this way because, today, it was announced in the business media that the Treasury Select Committee has won its battle with the FCA to release the full report to them, with Friday being set as the deadline to either publish in full or release the report to the MPs. It is being reported today, however, that the FCA are still attempting to resist these attempts, although MPs are growing considerably exasperated at developments with many now pushing for full publication. The original excerpt released by the FCA stated that it did not believe that RBS deliberately undermined companies for profit, although there was ‘widespread mistreatment of firms’ and that 16% of cases resulted in ‘material financial distress’; the conflicting information has increased the pressure for full publication. Speaking to the Treasury Select Committee last week, RBS bosses were adamant that cases were ‘isolated cases’, although a Labour MP who has the full report stated that these accounts equated to ‘misleading’ the Committee, as the report suggests that this treatment of SMEs was ‘systemic’ in nature. It is this conflict that has led to Morgan demanding that, by Friday, the FCA release the full report because ‘it is unreasonable that, four years since the review was commissioned, and 18 months since the FCA received the final report, such slow progress has been made…’. Yet, today’s headline in The Guardian that the ‘confidential report into RBS small business scandal “to be published” may be a little presumptuous, as the FCA has demonstrated time and time again that it will protect RBS because of one massive reason – the effect of its publication.

Whilst the endeavours of the Treasury Select Committee is, on this occasion, to be applauded, the reality of the situation is that the bank simply cannot afford these details to be published at the moment, and the FCA know this. This should not be a reason to restrict justice, but the bank is facing the prospect of declaring its tenth annual loss and the effects of this scandal, in terms of perception and cost, could prove to be terminal. It is for this reason that the Treasury, as it was reported over the weekend, has been cited as approaching the U.S. Department of Justice to expedite the impending fine coming RBS’ way for its performances in the U.S. market before the Financial Crisis; reports suggest that the Treasury is asking the DoJ to bring forward its fine, which is expected to be more than £5 billion. The suggestion stemming from these meetings is that the fine could be coming in the next few weeks rather than months, but the details mask an underlying sentiment; why are the FCA taking on MPs to protect RBS and why are the Treasury using their political capital to intervene on the bank’s behalf? There are probably many reasons for this, but perhaps the most impactful one is that RBS is simply approaching the point of no return, and the Governmental departments know it. The real question then is (a) will the bank be allowed to fail, and (b) what would the effect of the global banking giant be?

What these developments tell us is fascinating. On one end, there are members of the political elite who are determined to promote justice in the face of the flagrant disregard for good business practices and, in truth, illegality. Yet, the developments tell us that the larger picture is always in focus, and protecting consumers goes out of the window when it comes to protecting the system; consider this – the regulator in charge of protecting consumers (it is even in its name!) is actively preventing consumers from achieving justice, and the Governmental department which is tasked with representing the citizens of the U.K., in fiscal terms, is actively working with other jurisdictional departments to present a more comfortable situation for a bank. The effect of these developments is far-ranging, and particularly enlightening to those who choose to observe a shallower level than the systemic level – RBS is failing because of its incredibly poor performance over the past decades, but it will not be allowed to fail because, with all the uncertainties in the current climate, its failure will cause lasting damage. So, what can we learn from this? One thing we can learn is that the Crisis was a warning that has not been heeded and, ultimately, the problems that caused the crisis still persist; Friday will be a telling day for a whole host of reasons.

Keywords: RBS, Banking, Treasury Select Committee, Politics, Business, Law, FCA, @finregmatters.

Thursday, 8 February 2018

Tesco the latest Company to face questions over unequal pay

In today’s post, the focus will once again be on the massive retailer Tesco, with news this time relating to a potentially record-breaking claim making its way up the legal ladder. We looked on Tuesday at the protracted fraud case involving Tesco executives, which subsequently collapsed, but today the retailer is making the headlines as part of a concerted legal push against a number of the top supermarkets in the U.K., all on the same basis. In this post we will assess the particulars of the claim, and look at the potential effects for the retailer, and the sector moreover.

On a number of occasions here in Financial Regulation Matters, we have assessed the concepts of equality and equal-pay between the genders on a number of occasions, with most posts focusing upon the lack of diversity within companies (see here, here, and here). Today’s post however focuses on the claim from the law firm Leigh Day, acting as a representative for potentially more than 200,000 Tesco staff, that female shop-floor staff earn much less than their male counterparts working in the warehouse/distribution sections of the company; the firm claim that the resolution of this case could cost Tesco more than £4 billion in compensation to those affected. The firm is not only taking action against Tesco, with action against Sainsbury’s and Asda already well under way on the same grounds. Although it may obvious to those who have any connection to anti-discrimination law in the U.K., it is worth noting that the claim is not based upon the suggestion that Tesco has been paying men more than women for exactly the same job (which flout every anti-discrimination law); the case hinges on the concept of ‘equal value’. Essentially, the question for the employment tribunals, where the Sainsbury’s and Asda cases are and where the firm hopes the Tesco case will go, is ‘is the work performed by those on the shop floor of equal value to that of a ‘comparator’ i.e. ‘someone of the opposite sex doing a job perhaps traditionally seen as more physically demanding’. The technicalities will no doubt be difficult to establish, but the claims by many shop-floor workers revolve around the actual aspects of their jobs; they too have to do manual-based work, whilst also performing a customer facing role – for this they receive £8 per hour, whilst their distribution centre counterparts earn up to £11. In the media today, there has been reference to the leading case in this particular field when Birmingham City Council were forced to pay out £1 billion in 2010 on similar claims, but that case has many different aspects to these cases; this case, and the other two against Sainsbury’s and Asda relatively speaking, are at a very early stage with Tesco not even commenting yet, so there will be plenty of twists and turns (and legal ‘strangulation’) left on these particular stories. So what then may be the effects of these cases?

The effect of success on the part of the claimants in this case could indeed be significant, not only on Tesco but the entire sector; for those with distribution arms to their business, the prospect of making sure pay is equal across the sectors will have an immediate effect by way of compensation claims, but then a longer term effect upon one of the two ‘groups’ for want of a better word. If the claim was to be successful, one would surely imagine that distribution centre workers would see their pay decrease, rather than shop-floor employees see their pay increase, which will have a number of effects. However, the impact upon the equal pay movement that is currently engulfing organisations like the BBC could be even more significant, and for the better. As with all movements of this type, there is a need for defined victories, and having the law find in the favour of the claimants here would be a massive and important victory in the long road to the eradication of unequal pay. Yet, whilst these developments should encourage, one should expect these gigantic corporations to defend their position vehemently, meaning the required change may be some way off. Nevertheless, today was a small step in the right direction on a critical journey.

Keywords: Equal Pay, Discrimination, Tesco, Business, society, politics, Asda, Sainsbury’s, Law, @finregmatters.

Tuesday, 6 February 2018

The Protracted Tesco Fraud Case Abandoned: Will the Serious Fraud Office Continue?

Today’s brief post looks at the fraud case concerning three Tesco Executives that has been rumbling on for months at great expense. Today, there was a major development which raises the question as to whether the Serious Fraud Office (SFO) will continue its action against the three Executives, bearing in mind the many different factors that must now be taken into consideration; in this post, those factors will be laid before we assess whether it is (a) worth the SFO continuing its action and (b) what the effects of that decision, either way, may be.

We have looked at this case before, albeit briefly, in Financial Regulation Matters when we looked at the decision of the Financial Reporting Council to discontinue investigations into PricewaterhouseCoopers (PwC) in the wake of the massive accounting scandal that saw the SFO fine Tesco £129 million for the accounting transgression. The current case is concerned with three individuals in particular – Carl Rogberg, John Scouler, and Christopher Bush – and charges against them consisting of fraud by abuse of position and one count of false accounting; today, after almost four months and on account of Rogberg suffering a heart attack last week, the presiding judge ruled that it would not be ‘right and proper’ to continue the trial in the wake of Rogberg’s illness. In dismissing the jury, Judge Taylor gave the SFO the option of continuing its action, with a potential re-trial date of September, setting a deadline of March 2nd for the SFO’s decision; Judge Taylor’s decision, which is surely the right one, is based upon the suggestion that the jury would have been influenced by these developments. Yet, in making this decision there are a number of elements which the SFO will no doubt be considering.

One of the biggest issues is the sheer cost of the trial, particularly when paired to the development of the trial before its abandonment. It has been reported that the case has, so far, cost upwards of £10 million, and the protracted nature of the case so far will weigh heavily on the SFO’s decision making process; is the outlay of resources and time, particularly when one considers the uncertain nature of the outcome, really worth it for the SFO at the current time when it is fighting for its future? Predictably, Rogberg’s legal representatives have spoken of his dismay at the collapse of the trial and his subsequent inability to clear his name, whilst the same will probably said of the other two defendants who both plead ‘not guilty’ alongside Rogberg – Rogberg’s lawyer, for the record, had requested for the trial to continue in Rogberg’s absence. Nevertheless, the options facing the SFO are clear.

The SFO must decide whether they are willing to place their head above the political parapet, because at the moment the SFO is under great political scrutiny because of the concerted campaign waged against it by the Prime Minister, as we have already discussed here in Financial Regulation Matters. There is a plausible exit for the SFO to take, if it so wishes, on account of the collapsing of the trial being put down to external and unforeseeable influences like Rogberg’s heart attack, the Judge falling ill when summing up, and issues with the jury; the question is can this failure to see through a prosecution really be laid at the feet of the SFO? Probably not, although some will try, is the likely answer, but the consequences for ordering a retrial and then failing will be massive for the SFO in its current predicament, so perhaps, regrettably, the SFO will have to take this loss on the chin and move forward. In its favour, this chain of events is unlikely to cast a lasting negative shadow over the work it does, because recently it has been successful on a number of fronts, and these successes can be championed as to why it should not be consumed into the National Crime Agency, as would be Theresa May’s wishes; the decision in March will be a big one for the future of the SFO, potentially.

Keywords: Tesco, Fraud, Law, Business, Politics, Serious Fraud Office, @finregmatters.

Monday, 5 February 2018

Financial Regulation Matters is a Year Old: Some Updates

Yesterday Financial Regulation Matters was a year old and, coincidentally, a number of stories covered throughout the first year of the blog have had some significant developments over the past few days; so, in today’s post, we will have a whistle-stop tour of these developments and ask how the recent developments may impact upon a number of parties concerned with these impactful business stories.

Samsung Heir Released from Prison

On the 25th August 2017, we assessed the impact of the changing political, legal, and business landscape within South Korea with the massive news that Lee Jae-yong, the heir to the massive Samsung empire, was to be imprisoned for five years on counts of bribery, embezzlement, and perjury amongst a whole host of criminal infractions as part of his attempt to consolidate his, and his company’s position as one of the leading ‘chaebols’. The news today, that Lee’s sentence was reduced to a suspended sentence after just a year in prison, should be of no surprise to anybody concerned with the study, or indeed interest in white-collar crime. A South Korean Appeals court today adjudged that Mr Lee’s involvement in the massive political scandal involving Choi Soon-sil amounted to ‘passive compliance to political power’ and, whilst legal experts have stated that the evidence against Mr Lee was circumstantial at best, he has been released from prison with the proviso that he must remain in South Korea on account of being convicted of a number of other charges last February. It is also being reported that Mr Lee fully intends to appeal against the original guilty verdicts in due course, although popular commentary within the country suggests that the reputational damage that these events have caused to Mr Lee will be difficult, if not impossible to repair.

Nevertheless, how this development affects South Korean business and politics is still to be decided with a number of aspects still to be played out. For example, will Samsung (via Mr Lee) now attempt to repair the reputational damage done to it and other chaebols, or will it simply continue down the same path on the back of what has been particularly lenient punishment? The backlash felt against the political and business structures within the country suggests that Samsung must now embark upon a concerted campaign to distance itself from the murky waters of South Korea’s elite, but doing so is much easier said than done. Additionally, any attempts to do so must be genuine and forward-looking, because the consequences for not doing so i.e. conducting a superficial PR campaign in the wake of Mr Lee’s release, may cause lasting damage to the social fabric within the country, such is the importance of the chaebols to South Korea and its make-up.

The Federal Reserve Takes an Unusual Approach to Regulating Wells Fargo

We have looked at the continuing struggles of the American banking giant Wells Fargo on a number of occasions: firstly with the discussion about its attempts to repair the massive reputational damage suffered from the ‘fake accounts’ scandal that has consumed the Bank’s organisational responsibilities; we then looked at the effects of the news that original predictions for the amount of fake accounts created was conservative, with millions more predicted and confirmed. As the Bank continues to struggle, news today from the Federal Reserve (Fed) is having a massive impact upon the bank’s fortunes, with the Fed prohibiting the bank from growing past its $1.95 trillion in assets. This unusual (and, arguably, sensible [although there are clear counterarguments]) approach has caused massive waves within the banking and financial communities, with Wells Fargo CEO stating that the move will cut the bank’s annual profit by almost $300 million, potentially rising to $400 million; whilst this figure is particularly insignificant in terms of losses for an organisation this large, the fear is that to be regulatory restrained within the current climate could lead to massive losses in light of the growing influence and profitability of the bank’s major competitors. The New York Times discussed today how the aim of the move is to hold the bank’s Board accountable, because the prohibition can only be lifted once the company demonstrates that it has created and implemented new and more effective corporate governance controls. Yet, the obvious response to this move was one of panic, relatively speaking, within the marketplace, with its shares plunging almost 8% on the back of the news, and a number of advisory firms downgrading the viability of investment within Wells Fargo shares. However, there are a number of considerations to be had with respect to the Fed’s ‘cease-and-desist’ order today, with the underlying issue being one of sentiment.

The real question is what is the Fed’s sentiment in appropriating the cease-and-desist order, and will it hold under pressure? This is a potential issue because if the sceptics are right, and the bank starts to lose substantial ground to its competitors because of the order, then what happens if the bank starts to fail? The Fed will then be faced with the prospect of either (a) letting the bank fail because of its poor governance standards and lending real legitimacy to its enforcement actions, or (b) caving under the pressure of a colossal failure and, at once, fundamentally legitimising and confirming the presence of ‘too-big-to-fail’. It is worth noting that the superficial sentiment of the Fed’s actions is a positive one, because it will likely force an organisation that has proven to be inadequate in terms of its internal governance procedures to make radical changes, but if the bank and its board calls the Fed’s bluff, the whole scenario could turn into something rather monumental in an instant.

Job Losses as the Result of Positive Sentiment

Very briefly, just a small word on two stories which are from different sectors but interconnected in one very particular way. Beginning in March, we spoke of Tesco’s plans to merge with the wholesaler Booker, with the two firms singing the praises of the deal on the basis that it would be advantageous to them as firms, and also to customers. As a result, the issue was brought up in front of the competitions regulator, the Competitions and Markets Authority, with the emphasis being on ensuring that there was to be limited damage, if any, upon competition in the marketplace and upon consumer protection. With the merger confirmed and to be completed next month, news today that Charles Wilson, Booker’s CEO would be taking over Tesco’s operations, was adjoined to the announcement that up to 250 jobs would be lost in the head office, which comes immediately on the back of news that a change to managerial structure within the company has put up to 1,700 jobs at risk. These cuts are in opposition to positive financial news from the company, declarations that detail the company’s increased profits and underlying growth; even more, Tesco shareholders are expected to receive a dividend of 2p per share for the first time since 2014-15.

Similarly, Lloyds Bank has been forthright in its pronouncements of positive financial data for the organisation, with the bank being heralded as a beacon within the industry after it removed itself from any ties to Governmental support in the middle of last year. Yet, as we know, for those still seeking recompense for the damage caused by HBoS, Lloyds’ financial results mean very little (in fact, they are particularly enraging), and news today that Bank aims to cut over 1,000 jobs adds to this notion that financial data is positive yes, but often used to mask an underlying approach towards an organisations stakeholders. Despite the assurances that the bank will be aiming to add 450 jobs in other areas soon, this move comes on the back of announcements for the widespread closure of branches across the country, and across brands connected to Lloyds. So, what is the effect of these two stories?

One clear effect is that one can extract from these events, and how they have been reported, that the financial data i.e. what you can ‘sell’ or promote, is all important whilst protecting jobs is far from high on the priorities of these socially important organisations. In the current climate, positivity is worth more than almost anything and, in developing this narrative of strong data trumping almost everything, the positive spin is being systemically cultivated. The obvious thing to say on the back of that is that perhaps this has always been the way, but that does not mean that it is correct. In uncertain times, as these surely are, some sense of job security should be aimed for by these massive employers, but quite often the opposite is true; whilst technological advances are indeed making many of the workforce obsolete, the impact of that within the current climate is significant because the safety-net for those removed from the workforce is being constantly deteriorated – a show of support for employees from Governmental entities would be particularly welcome, but it is unlikely.

** As the blog is a year old, I would like to take this opportunity to sincerely thank everybody for their support over the past year; the readers, followers, supporters, and contributors, are all very much valued by the blog and the aim now for year 2 is for the blog to go from strength to strength with your continued support. If there is something that you would like to comment on for the blog, your contribution would be most welcome!

Keywords: Financial Regulation, Samsung, South Korea, Lloyds, Wells Fargo, Tesco, Federal Reserve, Competition, Business, Law, Politics, @finregmatters.

Saturday, 3 February 2018

The Financial Conduct Authority comes in for Criticism: What Does PRIIPS Regulation Tell Us about the FCA’s Focus on Consumer Protection?

In today’s post we will be looking at some stinging criticism that was aimed at the Financial Conduct Authority recently, specifically in relation to its regulation of Packaged Retail and Insurance-Based Investment Products, or PRIIPs. In assessing the context behind the criticism, there exists an opportunity to examine the focus of the FCA in relation to its stated mandate of aiming to ‘make financial markets work well do that consumers get a fair deal’.

A PRIIP is essentially a packaged investment product, and it is a common investment product provided by banks within the E.U. as it offers retail investors an alternative to traditional savings accounts; however, the determination of what constitutes a PRIIP has been intentionally left broad to allow for a range of products to be traded, but for our purposes it is enough to say that the products are publicly marketed, have exposure to underlying assets like stocks and bonds etc., provide a return over time, and have an element of risk contained within them. This umbrella term, designed by the European Commission to make clear that the products caught within it are different to products like investments within pension schemes, direct investments (in companies or sovereign bonds etc.), and investment products for professional (sophisticated) investors, was recently backed-up by a specific set of regulations that was adopted by member states on the 1st of January 2018; it is this regulation, and its implementation, that has proved to be contentious.

When a PRIIP manufacturer develops and promotes its product, it must accompany the product with certain pieces of information, according to the regulations, so that investors have the right amount of knowledge with which to make their decision; this information is included in the ‘key information document’, or ‘KID’. The KID, which can be no longer than 3 pages, has a number of legislatively enforced aims including the requirement to detail risks, performance scenarios, costs, and ultimately must be ‘accurate, fair, clear and not misleading’. However, a number of industry participants raised strong objections to some of the performance scenarios contained within certain PRIIPs manufacturer’s KIDs, with the argument being that they appear far too optimistic and, as such, are misleading to retail investors; some PRIIPs have been quoted as containing the possibility of returns of more than one million per cent. In response to these concerns, the FCA published a statement on the 24th of January declaring its acknowledgement of these concerns and that, as a resolution, ‘where a PRIIP manufacturer is concerned that performance scenarios in their KID are too optimistic, such that they may mislead investors, we are comfortable with them providing explanatory materials to put the calculation in context and to set out their concerns for investors to consider’. The FCA go on to discuss that there may be a number of reasons for this optimistic calculation, like too strong a focus on past performance etc., but that has resulted in an incredible backlash. Philip Warland, a former senior policy advisor, was vociferous in his condemnation of these developments, stating that European Regulators and the FCA are guilty of an ‘absolute dereliction of the duty of care’ to consumers, and that ‘heads should roll’ on the back of what is, according to Warland, ‘the worst piece of financial regulation ever in Europe’. The reason for Warland’s disdain is rather obvious and, as head of asset management regulatory change for KPMG Julie Patterson noted, investors could still be confused as accompanying data may be misunderstood, if noticed at all; what then is the effect of these developments?

The obvious effect is that retail investors who, by their very theoretical nature do not have the retail experience that professional investors have, are being allowed to enter a marketplace within which regulations have been set for a purpose and spirit which is not being experienced in reality; if the PRIIPs regulations were designed to enforce clarity within the marketplace, allowing PRIIPs manufacturers to maintain claims of 1m% returns but with some attached clarification does not meet that stated aim and, in fact, does precisely the opposite. The FCA, for its part, has removed itself from a position of responsibility by declaring that the PRIIPs regulations are ‘directly applicable’ and, as such, leave the FCA with no room for manoeuvre, although industry participants (and influential ones at that) have gone as far to advise people not to rely on the documentation which, when considered in the context of the push by the EU and relevant national authorities to bring these regulations into force so recently, is a remarkable piece of advice to receive.

Ultimately, the effect of this is that one can, potentially, obtain one of two pieces of information from these developments. Either, the regulation is so new that issues like this were to be expected and should be ironed out fairly soon, or rather that the legislative and regulatory framework is designed to facilitate business more than it is designed to protect consumers, even in a field where the only consumers are known to need more protection than usual; where one sits on that spectrum will usually dictate one’s view on the performance of regulators like the FCA, but hamstrung or not, retail investors are in particular danger within this current framework.

Keywords – Financial Conduct Authority, finance, investing, PRIIPs, EU, Business, @finregmatters

Friday, 2 February 2018

Will Contagion in the Private Finance Initiative Marketplace Claim a Massive Casualty?

Here in Financial Regulation Matters we have focused on the Private Finance Initiative (PFI) marketplace on a number of occasions, and we have looked at the conduct of the leading auditors on many occasions too; in today’s post, the focus will be on the relationship between the two, which will provide with an overview of recent turbulent events within the marketplace and the potential, albeit a very slight one, of the contagion within the industry causing either a massive organisation to fail, or more probably their regulator to collapse.

We looked at the concept of the PFI late last year and discussed how the injection of private interest into the public sphere is perhaps the most obvious of examples of how one can, purposefully or otherwise, examine the theory and neglect the reality. Whilst we looked at how the ideology was creeping (although that word perhaps downplays the actual situation) into publically vital sectors like the NHS – Virgin’s recent consolidation in this particular sector, despite recently suing the NHS for a loss of contract is a key case in point – the obvious place to start is with the collapsed PFI powerhouse Carillion. We examined the crisis as it unfolded here in Financial Regulation Matters by looking at the unfolding crisis, the systemic effect of its collapse, and also the impact upon pension holders and the Pension Protection Fund although, as we now know, this was apparently just the start i.e. contagion is spreading within the marketplace. This was confirmed earlier this week with the news that Capita, an incredibly interwoven PFI company, saw its share price collapse by almost 50% after a profit warning from its Chairman who declared that the company had become ‘too complex [and] driven by a short-term focus’. The contagion continued to spread today with the news that Interserve, another interconnected outsourcing company, saw its share price collapse wiping almost £1 billion from its value; a number of other connected firms witnessed significant drops too. So, firstly, what does this mean for the future of PFIs? Initially it is difficult to see past the fact that the Government is, because of its past actions (across parties), fundamentally bound to the success of the companies and whilst Carillion was allowed to collapse, it is likely that the collapse of Capita and/or Interserve may force the Government to reconsider their pledge that these companies are not ‘too big to fail’; Carillion has the potential to become this scenario’s Lehman Brothers. For example, whilst Carillion’s collapse has initiated the stalling of key projects across the country, Capita has a hugely significant role in the organisational capacity of Councils, the operation of the London Congestion system, and the hugely controversial delivery of DWP Disability Tests amongst many other roles; the question then is will this firm, with its interconnection, be allowed to collapse so soon after Carillion? It would be a brave Government, particularly within the current climate, to allow contagion to continue to spread at its current rate. However, there is, regulatory speaking, a much bigger casualty on the horizon.

There exists the potential for one of two major auditing actors to suffer terminal damage because of the PFI contagion, and those two actors are KPMG and the Financial Reporting Council (the industry’s regulator). It should be stated immediately that this author does not believe that KPMG will fall because of these events; it is simply far too large not to be able to withstand the incoming pressure heading its way, but that pressure is considerable. We looked in the middle of last year at KPMG and how they had been fined by U.S. authorities for ‘misinforming investors’ and more recently at the auditor’s connection (and subsequent disconnection) from the Grenfell Tower Inquiry; more recently still, three former KPMG partners were charged with Fraud by US authorities in what is a particularly damaging case for KPMG’s perceived integrity. Yet, in relation to the PFIs, KPMG has had its name plastered across the business headlines because of suggestions that it may have breached rules in connection to its auditing of Carillion, more specifically in relation to recognition of revenue on significant contracts (the raison d’ĂȘtre for a PFI) and also accounting for pensions. The obvious issue here is that a massive firm has just spectacularly collapsed with almost no warning from those who are tasked with providing this information to the marketplace; in March 2017 KPMG gave Carillion a clean bill of health for which it was paid £1.4 million (KPMG was Carillion’s auditor every year since its founding in 1999) – just ten months later the company would go on to collapse. Part of that collapse, or indeed the spark which ignited the collapse, was the declaration that the company assets were overvalued by almost £1 billion, which is something that places KPMG at the centre of the ongoing investigation (along with other auditors like Deloitte); the question then is what does this mean for the regulator who is supposed to be maintaining standards in this most crucial of financial sectors? It was suggested recently in The Telegraph that this particular investigation will ‘make or break the FRC’, and it appears that this particular insight is absolutely correct, for a number of reasons. If the investigation is conducted with enthusiasm – which initial actions suggest is not the case – and results in a particularly impactful resolution for what is, quite clearly, errors at best and transgressions at worst on KPMG’s part, then the FRC may go some way to building a solid foundation upon which it can regulate effectively against the massive regulated bodies under its supervision. However, a forthcoming article by this author in The European Business Law Review assess the FRC within the context of potential CRA regulation and finds, fundamentally, that it is not a particularly well-founded or meaningful regulator (in fact, it is essentially a representative for the regulated bodies, not their regulator). The reality is, then, that the regulator will be revealed to be unable to regulate the large auditors, and therefore unable to both correct the behaviour and enforce increased standards within the sector; so, will this encourage the regulatory framework to be realigned and a new regulatory body placed in charge of ensuring standards in this socially vital sector?

Ultimately, there is a real chance that the FRC will be widely castigated for its regulation of the auditors, but whether or not it is replaced is another question entirely. This is simply because the lobbying influence of these massive multi-billion pound oligopolistic organisations is not only considerable, it is unmistakeable; the question then is what regulator would take on such a role? Does the FCA have the capacity/ability/willingness to do so? Almost certainly not, and the PRA and the Bank of England will not be pushing forward in the queue to add the ‘Big Four’ to its list of regulated entities, so even if the FRC is replaced, it will only be replaced with a similarly lenient and receptive regulator, which means that corporate collapses are never far away; unfortunately, we are told that someone is manning the ‘crow’s nest’, but that is often not the case.

Keywords – Carillion, Capita, PFI, Government, Business, Politics, UK, Regulation, Financial Reporting Council, Accountants, Audit, @finregmatters