Archives For FSA

Rosemary Hilary

By Rosemary Hilary FCCA, audit director, TSB

When I started my career I knew I wanted to have a respected qualification that would give me flexibility and choices.  As I was naturally attracted to the world of accountancy, ACCA seemed the number one choice for me.

I developed my early career in insurance (management accounting) and industry (financial accounting) and then I joined a commercial bank first as Internal Auditor then as Treasury Accountant.  From there I joined the Bank of England and that led to a fascinating period in financial services regulation, in a number of senior roles, transitioning to the Financial Services Authority and, briefly, the Financial Conduct Authority. In my last seven years at the FSA/FCA I was the Director of Internal Audit. My ACCA qualification provided an excellent foundation on which to develop the skills required for Internal Audit.

But in 2013, after working through the effects of the financial crisis, I decided it was time to return to my private sector roots in banking.

I joined the executive team at TSB, as Director of Internal Audit, in October 2013. Once again my ACCA qualification was a key factor that qualified me for the role and, on a day-to-day basis, I still draw on the skills and knowledge that I learned during my accountancy training.

TSB is a new challenger bank for Britain, but with a traditional and trusted brand and the capabilities of an established organisation. This sense of continuity and history is central to the new Bank’s culture – TSB is benefiting from the trust and reputation it built up over its long history and also setting out its own agenda as a straightforward and transparent bank pioneering a return to local banking for Britain. We still have a sense of the old TSB community and the essence of its values, but the new TSB provides an exciting opportunity to have a hard think about strategy and shape our role as a challenger bank.

I am now building up the Internal Audit function to the size and scale that we need for our operation in future. I’m doubling the size of the team to 40 internal auditors and will also bring in specialists when necessary. Apart from sheer intellectual ability, I am looking for the team to have the core skills that I feel I developed as part of my ACCA training. Top of the list is good communications skills. You must be able to write down findings clearly and be impactful when talking to colleagues.  Next is good stakeholder management – knowing how to convey messages as a ‘critical friend’ and with gravitas and ‘clout’ and the ability to inspire respect from colleagues across the organisation, including the Board of Directors. Internal Audit gives you a great, 360-degree view of the business-constantly taking the pulse of the organisation.

In addition to my work at TSB I also feel privileged to have been selected, four years ago, to be on the board of Shelter, the national homelessness charity.  As a member of its Audit, Risk and Finance Committee, my ACCA qualification provides the underlying skills and knowledge that I need.


By Paul Moxey, head of corporate governance and risk management

It’s now 20 years since the Cadbury Code was introduced. This is the code adopted by the Listing Authority and the London Stock Exchange to restore trust in the City and in financial reporting and ensure that scandals such as BCCI, Polly Peck and Maxwell could not happen again. It set out 19 best practice principles for corporate governance – few people had heard of the term then. Its provisions, in fewer than 600 words, covered the role and structure of the board, audit and reporting on the company’s position including going concern, board remuneration and internal control.

The Code has grown through the years as it went through several iterations. It is now administered by the FRC and called the UK Corporate Governance Code and its principles and provisions take up around 5,500 words, roughly ten times as many as the original code.

Has the Code done a good job? Most experts think it has. The UK has seen few corporate scandals in the last 20 years and many would say that is thanks to the code and they are probably right. But has governance helped create value? We have had the financial crisis and, for savers and investors, little growth in share prices for the last 10 years.

We have however seen the growth of an industry of governance specialists and advisors and we have seen the failure of several banks and, as a society, we bear the scars. ACCA says that the bank failures were governance failures. Others see things differently and in December 2010 the FSA concluded its first inquiry into the failure of RBS saying it did not find evidence of governance failure on the part of the board. This surprised many people. If a company fails surely that points to governance failure unless the reason for it was clearly not to do with the board. It is hard to think of how the failure of RBS was not to with the board unless we consider they were just victims of circumstances.

Is a board responsible for what goes on or a victim of it? Let’s consider Barclay’s role in fixing LIBOR? The Treasury Committee, in its inquiry this summer, heard that the FSA, in a recent review, had considered Barclay’s governance to be satisfactory. The official conducting the review was reported to have said Barclay’s governance was ‘best in class’. During the same period, others at the FSA were concerned about the culture of Barclay’s at the top. Lord Turner, the FSA Chairman, wrote to the then Barclay’s Chairman about what the FSA saw as behaviour at ‘the aggressive end of interpretation of the relevant rules and regulations’ and about the bank’s ‘tendency to seek advantage from complex structures or favourable regulatory interpretations’. Lawyers call this creative compliance and it sounds a little like Enron.

It illustrates the main problem today with both governance and regulation – there is more to compliance than compliance. The focus with both governance and regulation has been on compliance with provisions -in the case of governance, with the Code’s provisions, where the banks and other companies of course fully comply with the letter. It is much harder to tell if companies follow the spirit of the Code and it seems that essentially no one has been looking at how companies do this. The culture at the top of an organisation and the tone set by the board are crucial to whether or not there is good governance but it is very hard for outsiders to judge. Very few company governance reports convey a real sense of this although there is usually plenty of well-crafted text to tell us everything is just fine.

The FSA is changing its approach to regulation to one where supervisors are allowed to exercise judgement. This will make it easier for them to decide when the spirit of a code or regulation is being followed. It may be harder to get a board to respond appropriately. The Treasury Select Committee Chair interpreted Lord Turner’s letter to Barclay’s as a reading of the Riot Act. The Committee report however makes it clear that neither the CEO nor the Chair of Barclays seemed to get the message although Barclay’s board minutes recorded the seriousness of the matter as it recorded ‘Resolving this was critical to the future of the Group’. The Committee report says that judgement-led regulation will ‘require the regulator to be resolutely clear about its concerns to senior figures in systematically important firms’.

A judgement approach is needed for how everyone else looks at governance for companies – investors and their advisors, the media and regulators – and us. As we hear more and more stories about the tone at the top of organisations such as News Corp and the BBC, and about the minimal amounts of UK tax paid by UK household names such as Amazon and Starbucks, it behoves us all to look more closely at large organisations and how they are governed -not just whether they comply with the rules. We should be asking more questions of our leading corporations and holding them to account.

By Manos Schizas, senior economic analyst, ACCA

The future certainly looks bright for alternative finance providers. The last three years have seen the birth of a plethora of new online (and some offline) platforms allowing businesses to bypass traditional banks and venture capitalists and source various forms of peer-to-peer funding instead. A business can now get peer-to-peer loans, equity, donations, and even fx hedging and insurance online, and who can say what will become available next?

It’s certainly encouraging to see the UK at the forefront of this innovative industry. The typical alternative finance provider (if such a thing exists) is born when some bright sparks, boasting a pool of tremendous and diverse tech and financial know-how between them, decide to leave the world of investment banking or the Big Four behind and pour their life savings into a new way of funding businesses.

It’s heart-warming stuff, but for the industry as a whole there are growing pains as well. The dynamism and diversity of these new industries has caught regulators around the world by surprise and the regulatory reaction could be equally clumsy following a high-profile failure. No two platforms are regulated in exactly the same way, and it’s hard to know how one would be regulated just by looking at their business model. Once you try to think beyond the UK border, the situation becomes almost hopeless.

Then there is uncertainty about the future. For now, for example, the FSA may believe that crowdfunding should be a sophisticated investor’s game, but it’s unlikely to step in to stop Joe Public from investing £10 or even £1,000 in a startup. This could change.

Peer-to-peer and crowdfunding platforms are particularly worth watching. These are industries with relatively low barriers to entry and they’ve been benefitting from the best possible climate over the last three years: mistrust of the banks and the financial system, rock-bottom interest rates, interest from venture capitalists and now government support too. If a recovery finally materialises in a couple of years, not all business models will remain viable. Take p2p loans for instance – like microfinance intermediaries before them, some lenders are boasting relatively low default rates, but this partly reflects the fact that they are young, their market is still unsaturated, and credit takes time to turn sour. Some are preparing for the end of the honeymoon period by providing a level of insurance for participating savers. Others are not.

Other developments are afoot that could change the landscape dramatically. Consider invoice auctioning sites, for instance, such as Marketinvoice or Platform Black. They are innovative, effective and a resounding success overall. Fast forward to ten years from now, when the majority of businesses in the UK will e-invoice each other and consumers, and it may be possible to set up an invoice auction on eBay, or any number of other platforms in seconds. Some invoice auctioning platform will thrive in this new world, but others may not be able to handle the competition.

My point is that sooner or later, the UK will see one of many high-profile failures among the alternative finance providers. This is normal and will probably lead to a healthy shakeout; but the way in which regulators and investors react could define the fortunes of these industries for years to come.

The incumbents know this and are already organising themselves into associations. Their main concern is regulation of the sector – partly out of a genuine concern for their industry’s continued viability and partly, the cynic within me thinks, in order to keep newcomers out. Others will also be watching; if I were in charge of a high-street bank, I’d be waiting for the shakeout so I could buy the surviving platforms from their founders and VC investors for pennies.

In the end, everything will hinge on how these platforms add value. Information, collateral, control and risk – these are the raw materials of access to finance; are the new funding providers sourcing, using or combining them in an innovative way?  If they are, then although individual platforms may perish their industries will live on.

By Manos Schizas, senior economic analyst, ACCA

As I write this post, it’s been a year and a day since the Independent Commission on Banking (ICB) published its report on the future of UK banking regulation. The establishment of the ICB was a response not only to the financial crisis but also to the unique challenge of maintaining the UK’s status as a global financial centre without taking on literally a world of risk.

Since then the Government has published its response to the ICB last December, as well as a white paper on financial stability in June. Within the banks the great groaning wheels of compliance have been set in motion. We’ve got seven years to go now until all UK banks are fully compliant.

Most important among the ICB proposals was the proposed ‘ring-fencing’ of activities crucial to the real economy, namely the taking of deposits and provision of overdrafts. This did not come as a surprise to anyone; many around the world had already called for the separation of retail and investment banking. So did ACCA, back in September 2008. The idea is that, if losses incurred in the world of wholesale finance cannot spill over into retail, then governments can rest easy that they will never have to bail out a bank brought to the brink by excessive risk-taking. Even better, banks that can no longer expect a bailout should adjust their appetites for risk accordingly, making more money available to lend to businesses.

Ring-fencing applies to SME credit in a fairly straightforward way (explained in detail on p. 70 here). In principle, it splits each bank into a ring-fenced and a non-ring-fenced portion, each legally separate from the other and with their own structures for managing risk. Any service likely to impact an SME’s viability if disrupted will have to be provided within the ring-fence. That’s current accounts, deposits and overdrafts by the looks of it, as well as some simple hedging products. SME loans, on the other hand, will have to be provided outside the ring-fence. The ring-fenced bank will be subject to higher capital requirements and can only deal with the non-ring-fenced bank on an arm’s length basis – i.e. on commercial terms as a completely separate entity. Small banks are exempt, but in fairness their current share of SME credit in the UK is tiny.

As a result of this structure, nearly all of the information relevant to an SME loan application will have to be generated within the ring-fence: behavioural scoring, for instance, is only possible on the basis of transactions; bank managers can only exercise discretion if they have a relationship with the client based on face-to-face interaction over time. This is the only proprietary information the banks have, since credit scores and published accounts are easily obtainable by their competitors. So far, there’s nothing threatening about this.

However, upon closer inspection it is clear that to assume any credit risk inside the ring-fence would be extremely difficult. Without capital regulation, business overdrafts could in principle be easily financed from deposits, but the cost of capital imposed by the ICB proposals and CRDIV (the European regulatory package governing capital, liquidity and leverage requirements for banks) would make this very expensive – banks would incur the substantial regulatory costs associated with a small business overdraft (in the form of additional capital and liquidity) even if the customer never used their facility.

Banks could still, of course, operate both within and outside the ring-fence at once, and might even be able to cross-subsidise their business within the ring-fence from what they make elsewhere, though not in real time. For instance, a division of BankCorp called, say, BankCorp Commercial, could provide loans outside the ring-fence and a division called BankCorp Retail could provide overdrafts and current accounts within the ring-fence. The two could be able to share information on a commercial basis, subject to the customer’s permission, and could even be made to appear to offer a seamless service, but would in all other respects have to be separate businesses.

But the question remains: if BankCorp Commercial can’t tap into deposits in order to lend, why would BankCorp want it to permanently cross-subsidise BankCorp Retail? The answer is: it wouldn’t. In fact, people at the Treasury clearly know this:

Banks may face a loss of diversification in the long term as banks will no longer be able to cross-subsidise or cross-sell services between the ring-fenced and non-ring-fenced bank. There will also be upfront transitional costs (such as establishing new subsidiaries) and ongoing costs of operating two entities rather than one (such as operating separate IT platforms).

This model would essentially split all major banks into two parts: a ‘Smart Bank’ (BankCorp Retail) and a ‘Dumb Bank’ (BankCorp Commercial). What makes a ‘Smart Bank’ smart is that it owns proprietary customer information and is therefore able to make informed decisions about their creditworthiness with some hope of a competitive advantage; however, it cannot carry any loans on its balance-sheet. The Dumb Bank has access to the wholesale markets and their cheap(er) funding, lower capital requirements, expertise in managing portfolios of loans and pooled risks, and access to financial engineering on an epic scale; but it cannot decide on the creditworthiness of individual SMEs. Essentially, it’s an investment fund that specialises in business loans.

So far, so good, one might think. Except for that fact that, as we saw earlier, the Smart Bank’s small business operation is almost guaranteed to be unprofitable unless it is able to charge someone a fee or commission for its services – either the customer or the Dumb Bank. This is because the vast majority of small and medium sized enterprises have very few dealings with their bank beyond maintaining a current account and possibly an overdraft. The Smart Bank could, in theory, charge all of its customers a fee for these services. But given the reluctance of most SMEs to pay for this, it would be more likely to make its money out of the few candidates that turn out to be suitable for a loan – either by charging them for the privilege of bringing their case to the Dumb Bank or by charging (gasp!) the Dumb Bank in return for originating loans. Or a bit of both.

Science fiction? Absolutely not. It’s already happening – SME loan funds are paying banks to originate loans for them as we speak. Elsewhere, peer-to-peer lenders are taking advantage of the fact that, as originators, they don’t need to hold on to regulatory capital (and the individuals carrying the risk don’t have to either) in order to undercut the banks. The incentives provided by regulation are as discreetly irresistible as gravity.

But if that’s the case, then why stop there? The Smart Bank could, in theory, originate loans for any Dumb Bank. Similarly, the Dumb Bank could buy loans originated by any Smart Bank, or even non-bank lenders, if the risk and return profiles are good and allow it to build a diversified portfolio offering decent returns. It could even buy securities made up of multiple loans in this way. Some Dumb Banks would have the same risk appetite as today’s high street banks. But newcomers need not.

In the medium term, there could be substantial advantages to this model in concentrated SME banking sectors such as the UK’s. Unlike today’s banks, competitors to the Smart Banks could spring up overnight, and risk carriers (the Dumb Banks) would have to compete aggressively for access to the best SME debt with each other and any other major investor interested in the asset class. Customers could switch easily between originators by simply moving their transaction data (which, I am told, is already possible) and without changing the carrier of existing loans.

Government could intervene in order to resolve market failure in ways that have hitherto been impossible. Its major disadvantage (a lack of know-how in assessing credit risk) would become irrelevant as it would only need to set itself up as another Dumb Bank – the best-capitalised and most cheaply funded of them all. If recent announcements of a British Business Bank ever produce a useful policy tool, it will almost certainly be under this model.

The problem is that this model works in exactly the same way as the ‘originate-to-distribute’ model that failed so spectacularly in the US mortgage market and beyond. The Smart Bank has only a weak incentive, especially in good times, to provide the Dumb Bank with high quality loans; the Dumb Bank has little incentive to perform the kind of expensive due diligence that would address this (theory here). The model also invites all of the problems associated with advisers working on commission that the FSA’s Retail Distribution Review was set up to address.

A government Dumb Bank could distort the UK SME loan market with its cheaper financing, like Fannie Mae and Freddie Mac did for the mortgage market in the US – although thankfully EU State Aid regulations should help rein it in.

But worst of all, the Dumb Banks, lacking access to a retail deposit base, would have to finance all SME loans almost entirely from the wholesale markets. A sudden tightening there, as in 2007, would bring the entire SME loan market crashing down in an instant.

This last point brings us to the heart of the matter. When people ask for retail and investment banking to be kept separate, regulators need to be able to see beyond the simple phrasing and realise that this means keeping the retail and wholesale financial markets from influencing each other. To be fair, they almost certainly do, but are not prepared to deal with the reduction in credit supply this would lead to. That’s one thing. But in the case of SME loans, the ring-fence just might achieve the exact opposite of what was intended. Wouldn’t it be ironic if the regulations enacted in reaction to the financial crisis were to end up producing some of the exact same incentives that contributed to the crisis in the first place?