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Good decision from the Federal Court today in regards to the case brought by ASIC against Citigroup. This was the one where ASIC regarded Citi’s prop trading in Patrick while advising on the (failed) Toll / Patrick deal in 2005 as a breach of the duty that Citi owed to Toll as their clients.
The court threw the case out on the clear grounds that Citi had no fiduciary duty to Toll despite the client relationship. Additionally, it looks like the court regarded the Chinese walls in operation as good enough to prevent leakages of price-sensitive information.
The consequences of ASIC’s action being successful really did not bear thinking about (at least if you are an investment bank) as it would mean that simultaneously both advising a client and prop trading in any party to a deal would be out. The odd outcome from this would be that, as soon as a bank was engaged to advise on a deal they would have to stop trading in the shares – meaning that the Chinese walls would have to come down at least a little. I would imagine the consequences in a conversation between a trader and the compliance officer:
Compliance: Mate, dealing in Companies X, Y and Z must all stop now.
Trader: WTF? I have large open short positions.
C: I don’t care. You may not deal.
T: Why?
C: I cannot say, but dealing in Companies X, Y and Z must all stop now.
T: Ahhh, right – I understand. Excuse me, I think I need to go for a smoke with a mate of mine.
All of a sudden everyone on that trading floor knows that a deal is in the wind – even the juniors. The more people know about it, the less chance a Chinese wall will hold. Even if the trading floor itself does not leak the lack of trade flow may well alert others in the market that a deal was on and that the banks that are not trading in the shares are doing the advising.
Liquidity in the shares of the parties to the deal would also drop, by itself a signal that something was up.
Oddly, the ASIC website is silent on this. They are normally very quick with a press release. Thanks to the FT Asia for this story.
Update
ASIC have now put out their press release on this one – putting, as you would expect, about the best possible spin on it – not dwelling on the loss, talking about how these “clarifications will assist ASIC” and then going on to talk about their successes in insider trading prosecutions. Would have been nice, but unexpected, for them to say “look, we were wrong – sorry” but regulators do not say that, do they?
Reading the decision further, and also the commentary in today’s AFR, the judge really worked them over. Essentially it took him 5 minutes to say “no case to answer” and ask everyone to leave. Ouch.
Short speech that Nout Wellink of the Netherlands Central Bank will be making later today in Paris has just popped up on the BIS website. It makes a few good points around how the risk management practices being improved through Basel II will improve the resilience of financial institutions and the system generally. Might not be worth a full read, unless you like that sort of thing but a few points bear repeating.
Nout was clear on the importance of the Pillar III disclosures – “Pillar 3 will become more important because of increasing intermediation of risk through the capital markets.” In the context of the draft Pillar III disclosures that APRA released in the new APS 330 I can only repeat what I said at the time – they are inadequate. Banks and other ADIs going standardised and seeking cheaper funding would be well advised to make fuller disclosure than required.
The US regulators (hello – that is you FDIC) –
A regulatory framework based on a simple risk weight scheme has become less and less effective in assessing an appropriate level of regulatory capital against these new, complex risk exposures.
To extend the point beyond Nout’s – the old ways of calculating risk exposures do not work. Trying to impose them in this context is simply wrong. Financial institutions need to be able to fail. Trying to make sure they cannot, as the FDIC seems to be trying to do is merely a recipe for the whole sector to become a moribund wasteland of zombies, too afraid to do anything new. Not an attractive prospect.
This post over at John Quiggin’s blog reminded me of my first job in a back office. In short, the job was to replace an ad-hoc, paper based settlements “process” with one based on computers – with no budget. The solution ended up being an Access database that not only managed the settlements process but also did full online reporting. It also, in a large part, removed the need to print anything out – saving a lot of paper.
As with a couple of the commenters on that thread, I now print out very little – confining it to large documents I reference regularly and those I need to sit down and read carefully.
Bank regulation, though, often mandates printed documents. In Australia, for example, every time a bank or other financial firm licensed to provide advice, provides that advice or sells you a product, they need to give you what amounts to a mountain of paper, signatures everywhere and normally also a few printed documents. None of this, in most cases, will ever be read again and (in my case at least) normally ends up in the bin as I know I can always get a copy if I really need it off a website somewhere.
Another good example is the need to send a copy of annual reports to all shareholders under the various listing rules.
APRA have just made an important step in allowing the quarterly disclosures under pillar 3 of the Accord to be made simply by posting them on the banks’ websites (discussed here). The use of online form submission to APRA by regulated entities is also very good.
Any other ideas for reducing the amount of paper we have to use – particularly those forced on us by regulation?
Just browsing through the latest edition of the Global Risk Regulator and I came across a discussion on a speech given by Martin Gruenberg of the FDIC on Basel II. It does not say much that Sheila Bair has not said before – but he does try to answer some of the critisism that has been directed at the FDIC for its attitude on this.
Regular readers of this blog will be familiar with my attitude towards the FDIC’s position – but if you need a summary, I think it is at best misguided. For a full discussion, look at the category.
I was, to say the least, disappointed with the weakness of some of his points, but this one was a real howler:
The dollar amount of excess capital that would be available to foreign banks as a result of Basel II is expected to be substantially less than the current market capitalization of any of the largest U.S. banks, thereby limiting the possibility that Basel II capital reductions will induce foreign acquisitions of U.S. banks.
From my reading of this he is saying that because you will not be able to fund a purchase in its entirety of a US bank from any reduction in regulatory capital it is less likely to happen. If I have read this correctly it is arrant nonsense. All you need is to get some advantage from the regulatory capital reduction – not fund it entirely. The next point was worse:
Finally, foreign acquirers of U.S. banking organizations would gain no immediate regulatory capital benefit for the newly formed banking subsidiary in the United States since the subsidiary would remain subject to U.S. capital and prompt corrective action rules, including the leverage ratio. This would reduce, if not eliminate, acquisitions with an economic purpose of capital arbitrage.
Ummm – ever heard of home / host? There would be an immediate capital benefit where the US bank has foreign operations (i.e. all those going Advanced) as the home regulator would no longer be one imposing the highly questionable (I will run out of weasel words soon) US regulations.
The observation he has made that more capital does not mean lower profits is right – but the linkage he uses is weak. As he notes elsewhere, defaults are at low levels – so this has led to increased profitability. Does that mean that all that additional capital was needed or even useful? I fail to see the link.
The rest of the speech is similarly disappointing. The FDIC is continuing to try to justify using a risk-insensitive approach to banking capital; to use Basel II as a stick to beat the US banks to both improve risk management and to hold unjustifiably high capital levels; and to generally use double-speak around risk-sensitivity.
Simple message, FDIC. Basel II is meant to give more risk-sensitive capital outcomes. If the banks modify their behaviour to reduce risks is this not a good outcome? Slavish adherence to a capital number that was not in the first place based on any real science beyond “hmmm – it looks right” is not a good substitute for a truly risk based approach.
Just a brief post on Mike Smith’s appointment to head the ANZ. It is good that they have acted early to replace McFarlane, but there must be at least a few disappointed internal candidates. Headhunting externally is normally a sign that either an organisation is in crisis and / or internal succession planning has failed. It may also (more rarely) mean that there is a compelling case for a particular person.
As the ANZ does not appear to be in crisis then it means that either the internal candidates were considered not up to it or that Mike Smith brought something special. Either way, look for an exodus of senior people at the ANZ over the next few months as they gradually find jobs elsewhere.
APRA today (or was it yesterday now) released what is probably very close to their last words on how Basel II Advanced methodologies will look in Australia. The good news is that they seem to have taken on board most of the input from the submissions and other discussions they have been having since the release of the drafts of the new prudential standards. The bad news? I have not found much yet.
In the words of one of the guys I respect most in this process “this looks like one of the best papers out of APRA on the subject of Basel II.”
The only real bad news in here seems to be that the nonsensical 20% LGD floor, imposed a few months ago by letter (and covered here), will remain for the time being – although it is not being added into APS 113.
Fuller coverage is over the fold for those interested. Read the rest of this entry »
This piece in Bobsguide is a touch self-serving (it was inserted by Algorithmics), but it makes a valid point.
Much of the press coverage concerning the ‘subprime meltdown’ has focused on the products themselves and the credit risk involved. They have variously been characterized as too risky, unsuitable or designed to appeal to unsophisticated buyers by offering cheap teaser interest rates.
However many of the subprime mortgage product cases appearing in Algorithmics’ FIRST database of loss events involve an element of insufficient operational risk processes; primary among these processes is lax underwriting, which often involves insufficient background checks, inadequate documentation and a failure to train and supervise front-line personnel. Eighty three per cent of the cases can be attributed to relationship risk, including mis-selling, suitability issues, contract obligations and regulatory and compliance violations.
Much of the bad lending that gets done is not simply lending that goes bad after being written – they are loans that probably should not have been written in the first place. If the loan is written in contravention of established procedures, or was written due to fraud, that is not a credit risk loss but an operational risk loss. The difference is crucial when it comes to finding a solution.
Credit risk can properly be regarded as something that happens as part of the business of writing loans – some of them will go bad. If too many go bad, then you need to update your policies and procedures and maybe find some additional capital. If loans are being written in contravention of policies and procedures, however, then a different solution is needed. This may include retraining, counselling, targeted redundancies (i.e. sackings) and probably some management changes.
If you identify the problem incorrectly, the proposed solution will also be wrong.
With just over 6 months to go APRA have today released their draft of the standard giving the market disclosures needed under Basel II.
In short, and as expected, they have largely followed the disclosures under Pillar III of the accord for the banks going Advanced – with the bulk of the disclosures copied (sensibly) word for word. As with any of these, APRA needed to make some changes (discussed below). The real interest is in how scanty the disclosures will need to be for the ADIs (authorised deposit taking institutions) going standardised. For these guys the disclosures are (very) little more than they have to make now.
The other interesting point is in how you may disclose these – release to the website (para 18)! There is no need to formally publish the results in hard copy. Good move.
Many of the changes are simply textual – just making the disclosures work with the previously released standards. I will confine my discussion at this point to the substantial changes from Pillar III. Read the rest of this entry »
Through the whole Basel II experience there has been continuing questions raised about the viability of the smaller institutions (in Australia these are mutuals like the Credit Unions / Credit Societies and the Building Societies – not all of them mutually owned) . They will only get minor capital relief, if any, and this was felt to be likely to put them at a disadvantage to the bigger banks.
A couple of points can easily be made against this argument. Not the higher capital part – that is virtually indisputable. The banks using the more advanced methodologies will have lower capital requirements than those institutions going standardised – which, to be blunt, is the way it should be. The amount of likely disadvantage, though, is disputable.
As this media release makes plain customers like the smaller institutions. They consider they get a better deal through them – perhaps not in pricing (though this is disputable) but certainly through customer care. While this continues the customers will stay with them and they may well attract new ones.
The trick for the smaller banks is to weed out the customers that are costing them too much money to service and either get rid of them or charge them more. If they manage that then I see no reason why the smaller institutions should not continue for a long time to come.
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