The stench of regulatory failure in the finance sector is everywhere. It has to be an election issue.
The £2.9 billion Woodford Equity Income fund, which suspended withdrawals in June 2019 but continued to charge investors management fees, is finally closing.
Here was the problem: the Woodford Fund treated securities listed on Guernsey’s stock exchange as liquid assets. Such assets could not be turned into cash as investors sought to withdraw their savings. The Financial Conduct Authority (FCA), UK’s financial regulator, had been aware of liquidity problems at least since February 2018, but did little to deal with the problems.
There is scandal everywhere. The outcome of an inquiry into the collapse of London Capital & Finance (LC&F) is awaited. It was authorised by the FCA and offered bonds packaged as Individual Savings Accounts (ISAs) to people. The company was in no position to deliver the promised eight per cent returns.
Some of its loans to third parties were also dubious. The company had three separate auditors, including PricewaterhouseCoopers and Ernst & Young, and all deemed the company to be a going concern. On a number of occasions, LC&F delayed publication of its annual accounts, but that apparently did not ring any alarm bells at the FCA.
And the the decade long saga of fraud at RBS and its arm Global Restructuring Group (GRG) is no nearer resolution even though the House of Commons Treasury Committee said: “The treatment of vast numbers of SME customers placed in RBS’s Global Restructuring Group was nothing short of scandalous. The actions of GRG staff heaped untold misery on hard working business owners, recklessly destroying livelihoods in pursuit of profit.”
Following inertia of regulators in dealing with frauds of £1bn at HBOS, the Thames Valley Police and Crime Commissioner Anthony Stansfeld prosecuted six financiers, including a senior ex-HBOS banker, and they were jailed for 47 years. But Stansfeld explained that regulators do not want to clean-up the City: “I am convinced the cover-up goes right up to Cabinet level. And to the top of the City.”
This is the state of affairs in parts of the finance industry which are supposedly regulated. There are vast tracts which are either lightly regulated or not regulated at all.
Shadow banking is another elephant in the room and can bring down the global economy. The 2007-08 financial crash was not caused by mass withdrawals of savings from retail banks, but by irresponsible speculative activity of shadow banks. The inability of Lehman Brothers and Bear Stearns to meet their obligations infected other institutions and intensified the crisis.
The term ‘shadow banking’ refers to financial intermediaries creating credit across the global financial system. It includes hedge funds, private equity, unlisted financial instruments, credit default swaps and peer-to-peer lending between individuals and businesses.
Even art dealers like Sotheby’s have become shadow banks lending money to customers. Shadow banks secure resources from retail banks, insurance companies, pension funds and wealthy individuals and their activities affect every sector and citizen.
Shadow banks pose major risks to the economy. They are not subject to minimum capital requirements or other prudential rules and tend to be highly leveraged.
They generally borrow short-term and lend long-term, a practice called “maturity intermediation” that doomed Lehman Brothers. They are not structured to deal with periods of low liquidity and heavy withdrawals as demonstrated by the demise of the Woodford Fund. And they lack earnings diversification and can’t easily withstand shocks from a deteriorating market.
The size of the shadow banks is hard to know and one estimate is that it controls assets of around $117 trillion. Little is known about the size of the UK shadow banks though one estimate puts that at around £2.2 trillion. The global GDP of $85 trillion and UK GDP of $2.9 trillion are in no position to contain the domino effects of crisis arising from this unregulated sector.
Time to rein them in
The UK finance industry and regulators have presided over the plundering of people’s savings, investments and pensions.
Regulators have been ineffective and all too often do the bidding of the finance industry rather than protecting citizens from frauds and malpractices. The shadow banks can bring the whole economy down but remain unregulated as the government is wedded to deregulation.
The Labour Party’s promised public inquiry into the entire finance industry is an opportunity to clean-up the industry and bring its unregulated parts under control.
It’s time for a new regulatory structure – one which puts citizens in control, with rights to appoint a Supervisory Board. That will go a long way towards checking the inertia of regulators and their slavish obedience of City grandees.
Prem Sikka is Professor of Accounting at University of Sheffield and Emeritus Professor of Accounting at University of Essex. He is a Contributing Editor to LFF and tweets here.
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