December 31, 2009
The Strangely Silent Supervisor
Announcing bad news on the day before a public holiday is a favored ploy of grubby governments and politicians. Now banks are doing it too!
On the last full working day before Christmas and the long summer holidays, the biggest Australian banks, known collectively as the Four Pillars, announced that their New Zealand subsidiaries had agreed with the NZ tax authorities to pay some A$1.7 billion to settle a dispute over transactions used by the banks to reduce their tax liabilities. The settlement came after an appeal by Westpac had been conclusively rejected in October by the New Zealand High Court, who concurred with the NZ Commissioner for Inland Revenue that the 'structured finance' transactions were 'tax avoidance arrangements entered into for a purpose of avoiding tax'.
Like spoilt teenagers, the banks claimed that someone else had encouraged them to do it; in this case, their lawyers.
Legal or not, in what bizarre, parallel moral universe could such business activities be considered even remotely acceptable?
Not content with making excess profits due to their domination of the NZ banking market, through local subsidiaries, the four banks attempted to generate even more money by picking the pockets of the New Zealand taxpayer. This is just pure, unadulterated greed.
In yet another example of the hubris that has become the hallmark of Australia's largest bank, Westpac even attempted to turn this disaster to its advantage by crowing that they had overstated the possible settlement in their last annual accounts, and would be able to 'write-back' some A$190 million next year. This is like a thief who steals your car then, taking pity, gives you your bus fare home - in the great scheme of things, hardly praise worthy?
But what is the Australian banking regulator, APRA, doing as regards the settlement?
Keeping very quiet, so far.
With some justification, APRA has received much praise for its part in keeping the Australian (and, by extension, New Zealand) banking system relatively safe during the Global Financial Crisis (GFC). Pleased with itself, APRA has been trumpeting its particular form of muscular 'meta-regulation'. Obviously, being accused of being asleep at the wheel as regards these unethical transactions would severely tarnish this newly won reputation.
In regulatory terms, the huge losses incurred in this settlement should be classified as an 'Operational Risk' event under new Basel II regulations. In a similar, but smaller, operational risk event in the FX department of the National Australia Bank (NAB) in 2004, APRA acted quickly: setting up an independent enquiry; engineering, or at least hastening, the ouster of the Chairman, CEO and several managers; and generally taking a big stick to NAB's internal risk management procedures. APRA gained a lot of kudos within the regulatory community for the promptness and effectiveness of these actions.
But where are the prompt actions in this case? APRA has had plenty of time to consider its response to any such settlement, since it has been anticipated for months. If they were not aware of it in advance, on the other hand, that would indicate a much more serious problem in their regulatory oversight. Nor can APRA slither into the murky jurisdictional crevices between itself and the NZ banking regulator, the local Reserve Bank, since, under new Basel II rules, regulators are supposed to 'exchange information on issues of interest' under so-called 'home host' provisions.
For a start, where is the much-vaunted improvement in corporate governance that was supposed to follow criticisms in the judicial inquiry into the spectacular failure of HIH Insurance in 2001? So far, not one of the directors of the four banks, or their subsidiaries, has had the courage to resign for failing to properly execute their oversight responsibilities. Obviously, for these over-paid glove puppets, accountability is merely a word in the dictionary somewhere between abuse and avarice. If they do not do so of their own volition, APRA should, at a minimum, insist that the chair of each bank's audit committee resigns for failing to protect their company's ethical reputation.
Was there no one in a position of authority in any of these large corporations who would ask the most basic question: 'we know it may be profitable, but is this the right thing to do'? While there is anecdotal evidence that some staff were uneasy about the legality/morality of these transactions, the banks, acting as a pack, just lost their moral compass.
In the words of Barack Obama - 'these bankers still don't get it'.
One bank CEO reportedly went so far as to claim that 'the length of the trial, clearly demonstrated the complexity of issues'. Far from it, all of the banks' arguments were comprehensively rejected by various courts and the prolonged trial reflects the fact that there appeared to be no limit to the amount of shareholders' funds that the banks were prepared to expend to cover their tracks. Not content with stealing (let's call it what it is) from the New Zealand taxpayer, the bankers wasted hundreds of millions of dollars of Australian pensioners' investment income in a vain attempt to hide their misdeeds.
But where is the outrage in the Australian investment community?
Is it merely a coincidence that the cynical PR exercise of burying the announcement of settlement happened just after the annual bank reporting season and while the parliaments were in summer recess.
While searching for scapegoats might prove an interesting blood sport, the activities of the banks in this case comprise a serious industry-wide breakdown of good ethical behaviour. The banks behaved like bullies and acted as they did just because they thought they could get away with it.
In the fall-out from the GFC, APRA, along with other regulators, are proposing new rules on bankers' remuneration, in particular, introducing mechanisms for deferring or even 'clawing back' bonuses paid on activities that subsequently went sour. If ever there was such a situation, this is surely it.
APRA should, immediately, direct each bank to set up an internal inquiry that first gets to the bottom of why this particular moral failure occurred within their firm and then makes specific proposals on this year's remuneration for the business lines involved. Having learned why firms committed such egregious ethical lapses, APRA can then make industry wide recommendations to remedy the situation to make sure it doesn't happen again.
If banks and regulators do not come clean, the clear message to all bank staff and customers will be that any type of unethical behaviour is acceptable, just provided you don't get caught!
Finally, it must be remembered that banking regulation is an arm of government and ultimately politicians must bear some responsibility. The Australian Prime Minister, Kevin Rudd, has recently published some cogent insights on the moral failures at the heart of the global financial crisis. Since this is much closer to home than the US subprime crisis, the government should recognize the regulatory failures and make an apology to the victims - the tax-paying public of their nearest neighbour.
There is an old proverb that 'Success has a 100 fathers, but failure is an orphan'.
Despite some success during the financial crisis, underpinned remember by taxpayer guarantees, someone in the Australian banking industry should have the guts to take responsibility for this completely unacceptable behaviour.
In any case, APRA cannot remain silent for long and must act to ensure that proper lessons are learned and that ethics are improved across the industry.
Posted by pjmcconnell at 04:21 AM
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December 18, 2009
FSA - FSAin't!
Bart Simpson: "I shouldn't let this bother me. It's my job to be repetitive. My job. My job. Repetitiveness is my job".
On the bus home from the Compulsive Obsessive Disorder (COD) clinic recently, I re-read the business news and noticed that the UK banking regulator FSA (Financial Services Authority), had just slapped a fine of some 7 million pounds on Toronto Dominion (TD), the second largest bank in Canada.
Margaret Cole, the FSA director of enforcement and financial crime, thundered that: "This is one of our largest fines and it underlines the seriousness with which the FSA views repeat offences". Wow - go girl!
This fine, some C$12 million, which was the fourth largest ever by the FSA, follows an earlier fine of almost C$850,000 on TD for similar offences. The FSA really showed them that they mean business this time!
The FSA levied the fine because "Toronto Dominion failed to effectively use its existing systems and controls over what was a complex business dealing in sophisticated and often illiquid financial products. As a result, Toronto Dominion failed to price certain positions held by the Trader accurately and failed to prevent or detect these pricing issues in a timely manner."
Does that sound familiar?
Hint: Barings, AIB, NAB, Societe Generale, and etc. etc. etc. etc. (as a compulsive obsessive might say).
Obviously, FSA's stern action is working really well! Not!
To put the TD 'fine' in some sort of context: C$12 million is only one eighth of the C96 million that TD had to write-down when it detected the failure. And it is only 1% of the C$1 billion that TD reported for the latest quarter alone! No difficulty paying the fine out of petty cash, then?
[By the way, TD, and by extension the FSA, only found out about the problems when the trader involved was made redundant and someone else looked at his books! Nice work, Sherlock]
The litany of pitiful fines by the FSA just grows and grows, outstripped only by the increasing pride that the FSA takes in justifying such gnat bites.
Under the laughable 'home host' provisions of Basel II, the Canadian banking regulator, the Office of the Superintendent of Financial Institutions (OSFI), should also be getting involved. So far, the OSFI has been noticeably quiet, as silent as sleeping, snow goose in a snowstorm. Can someone south of the border please wake them up?
As argued in an earlier case, the head of the FSA, Adair Turner, has no option but to resign since it is untenable to continue to threaten banks with sanctions and then fine them a pittance if they transgress. "Unless, of course, you want to encourage regulatory arbitrage to get more banks to settle in London?"
But Britain always does its own thing, its own way. On the subject of the differences between the UK and other countries, Marge Simpson sagely said, "Remember, in England, an elevator is called a lift, a mile is called a kilometer, and botulism is called steak and kidney pie." And, she might well have added, "Blancmange is called banking regulation"
Posted by pjmcconnell at 01:25 AM
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December 12, 2009
Basel to go High Tech?
'A journey of a thousand miles begins with a single (mis)step' Chinese philosopher Lao Tzu (abridged).
My spies tell me that, in their big Christmas announcement, the Basel Committee will unveil a new high-tech approach to 21st century regulation.
The Global Positioning System (GPS) has become a must-have gadget for tech-heads everywhere and, like the coffee mug-holder, has become standard equipment on all new cars.
There is something exciting about getting into a new car, switching on the GPS, keying in your destination and then listening to the GPS voice giving timely and accurate advice on the journey: 'Turn left at 200 yards', she purrs.
GPS voices are, for some reason, almost always female: reassuring, comforting and non-threatening. They are mesmerizing. For example, the latest Journal of American Psychiatric Regulation has a peer-reviewed paper that identifies the emergence of a new 'Auto Erotic Disorder', where lonely men will get into their cars and cruise, often for hundreds of miles around their cities at night, just to hear a gentle, sympathetic female voice. It is estimated that GPS alone accounts for some 100 million of tons of additional CO2 emissions per year.
GPS can, however, be problematic. Police have not confirmed, but it is widely believed that Tiger Woods recently had installed a specially customized GPS with a voice resembling a Las Vegas cocktail waitress. Rumor has it that the GPS became jealous of the birdies that Tiger was scoring and (conveniently) forgot to warn him of the large tree directly in front of his car. Hell has no fury like a GPS scorned!
But, I digress.
In a bomb-proof bunker deep under the Matterhorn, Swiss scientists, under the direction of the Basel Secretariat, are developing a new device for regulating global markets, to be known as CPS or Capital Positioning System. Details are beginning to emerge on Facebook.
The concept of a CPS is similar to that of a GPS, and is designed to sit neatly on a bank CEO's desk, or on the dashboard of their Rolls Royce. A CPS will receive information from three sources: (1) market data from Reuters and Bloomberg; (2) risk data from a bank's systems; and (3) capital control signals from the new Basel III satellite.
Like a GPS, the new device will warn a CEO of impending danger, for example: 'Only 14 billion until your next Tier 1 capital raising'; 'Reverse at the next counter cyclical roundabout'; 'Stop - you are about to hit a liquidity buffer'; and so on.
If, in future, regulators decide to change leverage ratios - no need to consult, just upload to the satellite and all banks will be warned immediately.
The device is currently in beta testing for Swiss banks, but the voice, that of a Swiss yodeling champion, has been criticized as being too strident and unintelligible. It is rumored, however, that Maria Bartiromo, CNBC's 'Money Honey', is being approached to appeal to Wall Street types. Originally, Lou Dobbs was asked to be the voice of CPS in the US, but this was abandoned when the device got stuck on 'Don't turn Left, Turn Right, Turn Right!'
The new CPS device will retail around $599 but will cost more for a mock crocodile casing. We are already booking our place in the WalMart queue for the first day sale.
After a two day meeting in early December, the Basel Committee announced that it was about to release new proposals that will radically change the rules on capital adequacy.
Forget Pillar 1!
The new Basel (yet to be named/numbered) looks like a hotchpotch of all the ideas that have been floated about capital in the last year. The final proposals appear to be mainly about multiplying by whatever you first thought of by a new, very large factor, which is yet to be defined. [Incidentally, one of the key causes of the crashes (an over-reliance on what turned out to be wildly incorrect credit ratings) appears to have been put back into the too-hard basket].
Having crashed driving Basel II, maybe these novices should retain their L-plates for a few more years before they are let loose on the road again.
On the next leg of the Basel journey into the future, I am reminded of the sage words of the Irish regulator, CBFSAI, 'Wherever it is you are going, you just can't get there from here!'
Posted by pjmcconnell at 05:31 AM
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December 08, 2009
How much is a Risk Manager worth?
In the wash up of the Global Financial Crisis, the Australian Prudential Regulation Authority (APRA) has become one of the first prudential regulators to formally announce new rules on the governance of risk and remuneration for the directors and management of banks and insurance companies. APRA's new rules require that financial institutions have a 'Remuneration Policy [which must be approved by the Board] that aligns remuneration and risk management'.
APRA leads the supervisory field by demanding that regulated banks ensure that 'the performance-based components of remuneration must be designed to align remuneration with prudent risk-taking'. [Note the emphasis on 'prudent', how will that be measured?]
Under the new rules, performance-based components of risk-takers' remuneration must incorporate 'adjustments' to reflect not only the risks taken, actual outcomes and the time for risk outcomes to emerge, but also 'the cost of the associated capital'. In effect there must be some form of 'Risk Adjusted Performance Measurement' (RAPM), such as RAROC (Risk Adjusted Return on Capital).
Without detailing in any way how risk-adjusted performance is to be measured, APRA requires that remuneration policies must cover senior management and risk takers, whose 'activities, individually or collectively, may affect the financial soundness of the institution'. [In practice a lot of (very powerful) people].
Of interest in this forum, is that the regulator requires that new policies explicitly cover remuneration for 'risk and financial control personnel', ensuring that remuneration of risk management staff does not 'compromise the independence of these personnel in carrying out their functions'. The new rules dictate that the Board Remuneration Committee must have 'free and unfettered access to risk and financial control personnel and other parties (internal and external) in carrying out its duties'.
[Note that for insurers, APRA includes Actuaries in its definition of 'risk and financial control personnel'].
Risk Managers will have, at least, three roles in implementing the new policies.
First, the risk management function, led by the Chief Risk Officer (CRO), will have to take the lead in developing RAPM methodologies and ensuring that they are understood and approved by the Remunerations Committee and senior management, as part of the firm's overall Risk Management Framework.
Secondly, and potentially more treacherous, risk managers will be forced to make judgments on individual business managers as to their risk management behaviors. In practice, normal events, such as risk limit breaches, will gain enormously in importance, as the resolution of such events will impact on the evaluation of a risk-taker's adherence to risk policies. Expect more blowback from business!
Last, risk management professionals will have to be rewarded on a basis that is independent of the performance of the businesses that they serve.
What will be the rules for remunerating risk professionals under new rules?
Obviously the occurrence of a risk event, or not, is not a valid measure. If a risk manager estimates that a firm will probably incur a particular loss once every year, say, and nothing happens: is the risk manager good, bad, or just lucky?
Reward for risk managers, in such a new regime, must be based not only on risk assessment abilities but also on softer skills such as their ability to improve the 'risk culture' of the firm overall. Since risk culture is extremely difficult to measure, influence on changing culture will probably be impossible to measure.
So what makes a good risk manager?
Obviously, 'skill' will be important and that, to a great extent, will be impacted by education and ongoing evaluation. In the new risk reward model, certification, such as the PRM designation, will become increasingly important, and will be necessary, but not sufficient. There must also be ongoing evaluation of a risk practitioner's skill set. I.e. there must be some form of Continuous Professional Education (CPE) for risk managers and potentially gradation in qualifications, such as the attainment of Fellowship status by examination, as in the Actuarial profession.
Professionalism will be important. How risk managers conduct themselves, with clients, colleagues and potential adversaries will be important to any evaluation of their contribution to a firm's risk culture. PRMIA's Standards of Best Practice, Conduct and Ethics, is a good starting point for evaluating adequate levels of professionalism but will probably need expansion going forward.
Lastly, knowledge and experience will be essential. Risk managers gain a 'feel' for risk though exposure to risk making decisions, both good and bad. Difficult to measure but essential to evaluation, experience 'in battle', and the ability to use that experience productively, will become a key determinant of a risk manager's 'worth'.
APRA is the first regulator into print, but one only has to pick up the financial press to see that similar rules are on their way, everywhere!
Who will Boards turn to when the issue of risk-adjusted performance is tabled? The first port of call will be Human Resources, of course, but Risk will not be far behind.
What will the risk profession do when the question is asked?
I suggest that 'don't know' will not be a satisfactory answer!
There is a need for risk professionals to think about these issues as a matter of some urgency and one of the first questions to tackle is
'How much is a Risk Manager worth?'
Posted by pjmcconnell at 04:05 AM
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