Friday, 17 August 2018

Guest Post - Back on Track or Heading for a Derailment: The British Railway System

In today’s guest post, Jake Richardson discusses the potential future of the British rail network, both in advance of the changes that Brexit may bring, and also based upon the historical trends within the industry.

The British railway system has indeed been through some massive restructuring exercises throughout its history. Post-World War One and the Victorian era of Britain’s steam railway revolution, all private companies were rationalised into the ‘Big Four’ predominant companies under The Railways Act 1921, which included Great Western Railway (GWR), London, Midland and Scottish Railways (LMS), London and North Eastern Railway (LNER) and Southern Railway (SR). However, post-World War Two, the railways were once again run into the ground, meaning post-war nationalisation was inevitable and the British Railways, latterly known as British Rail, came into action through the enactment of The Transport Act 1947. For nearly fifty years the nationalised railway system, which was often associated with inefficiency, industrial strike activities and poor customer service – as embodied through the infamous British Railway sandwich - survived the ever-growing case of privatisation under the Thatcher-led Government during the 1980s. However, privatisation was eventually achieved during the late 1990s through the enactment of The Railways Act 1993. The question to be solved here is how should our railways be run? This, as many would agree, is not as clear cut as one would expect, since many economic, political, and some legal points need to be discussed. Therefore, this post will evaluate whether Britain’s railways should return to the era of the 1920s, if re-nationalisation is the preferred route, considering Labour’s manifesto under Corbyn supports this model, or whether the current system needs to be developed further.

Perhaps a return to the days of the ‘Big Four’ railway companies could be an option available. However, while John Major believed this to be a valuable option, he was nevertheless talked out of it because that model was deemed impractical to recreate; in the sense that each one of the four companies would have to own the rolling stock and infrastructure. We will use Great Western Railway as an example of the reasons why such a system could or could not operate. The profits that Great Western Railway enjoyed were obtained through the creation of a monopoly on certain routes, particularly the Bristol Mainline section. At the time, there were no other railway companies that could compete with GWR, which is still the case today. The only competition GWR faced was that from the Kennet and Avon canal which, most of the time, had water shortages and the slow alternative stage-coach services. Profitability was also enjoyed by GWR because of the lack of health and safety regulation. It was down to GWR to keep their own staff and infrastructure safe but, of course, profits took precedent back then and the infrastructure was not up to scratch, as demonstrated by the bridge collapse over the River Dee in 1847.  However, even in the midst of such issues facing GWR in its early days, it was the only one of the ‘Big Four’ to make a profit between amalgamation and nationalisation period. Yet, these were the days when the motor car and heavy goods vehicle began to take place and offer an alternative means of transportation of goods and people. Therefore, it is difficult to determine whether the 1920s railway system would work. Perhaps, with the increase in passengers and less people commuting to work by car in today’s society meaning that if there were to be a return to the ‘Big Four’ companies, then they would be faced with less competition. Throw in the issue of an ever-growing population, perhaps a return to just four large companies would mean that the issue of profitability would be of less concern and investment would be placed back in the privately owned assets.
Could a return to a nationalised railway, under the banner of British Rail, work? When the railway system was first nationalised, it went through a modernisation plan of around £30 billion in today’s terms. However, this was a missed opportunity because the investment work only sought to replace what already existed, instead of looking ahead and future-proofing the system. By the 1950s, the nationalised system was in decline, partly due to the increase in car usage and the Beeching cuts of the 1960s, which witnessed the cutting of about a third of the railway network. Recently, there has been a drive to have the railway system re-nationalised, with some viewing the current franchise system as being broken. Upon a closer and careful inspection of the franchise system you will notice that many of the train operating companies are foreign state operators, with some including Ariva, Keolis, Govia, and Go Ahead Group. Almost 90 per cent of the 1.73 billion railway journeys taken in the U.K during 2016-2017 were controlled and run by foreign-backed rail operators across Europe, with RMT suggesting that 70% of UK rail operators are now owned by foreign entities.  It seems ironic then that the British government allows for a state run railway so long as it is not British. Yet, the result of this causes fragmentation, with issues over ticketing, coordination, and waste; something which was foretold in 1993. To add insult to injury, the presence of foreign-backed operators running the railway system in the U.K means that the British population are the ones subsidising the state-run railway systems across the continent. Perhaps Britain’s departure from the European Union could ignite reform, meaning that the UK could be released from certain EU rail directives. The bigger question is how much does the railway system make? According to the Office of Rail and Road, the total income was £12.4 billion, which included fares and government subsidisation. As one can see, that is a lot of money. However, closer attention must be given to the government subsidies. In 2013, the University of Manchester published a report that found Welsh and Northern railway operators paid out dividends of £176 million between 2007 and 2011, but such profits would not have existed if it were not for the £2.5 billion in government subsidies. Thus, if the railway system was nationalised once again, government subsidies would not line the pockets of private shareholders. Instead, it would be invested into the publicly-owned railway system to reduce fares and maintain current or future infrastructure projects. In the midst of all this, there is still support for the current system to remain and continue. Railway operators like Chiltern or C2C are seen to have transformed rail services, with Chiltern Railways having invested £130 million of the £320 million cost of the new Oxford to London Marylebone line. Therefore, perhaps the franchise system can be further developed if rail operators have an incentive to invest, which can be achieved through longer periods of franchise agreements so that rail operators have a chance to recover money from such projects. Developing this line of thought could mean that if the rail operators oversaw the infrastructure as well as the rolling stock, with the government creating legislation that operators must abide to, then rail operators would recognise the need to modernise the infrastructure to increase train services and profitability.
What this post has aimed to do is demonstrate the need for the railway system to be reformed. As to how this should be done is different matter altogether, with points raised here open to scrutiny whilst others have not been discussed.  Indeed, there are major problems with the current model, as seen with the InterCity East Coast franchise having been taken into public ownership twice. Through taking back control of the East Coast mainline, the government is demonstrating that public services must be run for the people and not for profit; especially since a nationalised East Coast returned a healthy £209 million profit to the taxpayer. All too often, the British population look towards how other states run their rail services. Looking at how our European neighbours operate their services, one can see that rail travel is cheaper due to the higher rates of public subsidies which, again, raises the case for a publicly-owned system. Those in favour of the privatised rail system often look towards the Japanese model as being the epitome of transport success, because it is entirely privately controlled. Whereas, the British model is a collection of temporary and varying franchises tightly controlled by the government. However, something which is often overlooked is the current state of the British railway infrastructure. While attempts have been made to overhaul and modernise the Victorian model, such as modernisation projects like the Electrification of the Great Western Mainline, many have been hit with catastrophic delays to both the punctuality of train services and the completion of projects. If reform is on the table, then the Government need to decide how it is going to strike a balance between the need to continuously modernise the British railway system, whilst providing a service for its people. So far, this country has been through three models, each with their own strengths and issues. Times do change and perhaps the old saying of ‘what goes around comes back around’ may apply here.

Keywords – Railways, UK, Nationalisation, Trains, Business, @finregmatters

Mr Jake Richardson is an LL.B. student in Aston University. Jake can be contacted via LinkedIn here.

Whistleblowing on the FCA’s Agenda… Again

Previously in Financial Regulation Matters we have discussed the issue of whistleblowing, mostly in relation to the case of Barclay’s CEO Jes Staley (here and here). We know that the FCA faced criticism for not suspending Staley in that case, so today’s news that the regulator are looking into the conduct of Royal Bank of Canada (RBC) has brought the issue to the forefront once more. In today’s post we will review this news and look at what whistleblowing actually means, and its ‘function’ in a much broader sense.

The case with RBC has accelerated after a former trader recently won his case against the bank for unfair dismissal. The claim, relating to the trader’s revelations regarding the ‘box-ticking’ culture that was/is prevalent within the firm, concluded with the judge describing the bank’s conduct as ‘egregious’ and that, ultimately, ‘employers should take better care of whistleblowers even if they find them somewhat enervating’. Whilst the FCA has not confirmed the nature of its enquiries with the firm, it is widely believed that they in relation to claims from whistleblowers that legal and compliance problems have not been dealt with adequately for a number of years. For the FCA, it is clear that the issue of whistleblowing is currently high on its agenda (particularly after the response to its performance with Staley), as its head – Andrew Bailey – recently met with the head of Whistleblowers UK to discuss ‘potentially suspect patters of departures of individuals who have raised compliance issues at a number of banks’. In Wednesday’s post we discussed the concept of a regulator’s ‘role’, and presented the concept that regulators have the role of maintaining the ‘system’, rather than protecting the public. On that basis we shall not discuss the FCA in too much detail in this post, but what is of interest is the relationship between the concept of ‘whistleblowing’ and its importance to the ‘system’.

Within the whistleblowing literature, it is often advanced that ‘whistleblowing can and should be understood as a “pro-social” process’. However, there is a competing dynamic at play that revolves around the concept of ‘loyalty’. Older views on the subject have labelled whistleblowing as being ‘disloyal’ against the firm, although more developed views now consider whistleblowing to be ‘loyal’ to the firm, particularly if the firm has advanced the notion of reporting malpractice for the greater good of the company – the concept here is ‘where an organisation has stated that its staff are expected to report suspected wrongdoing, the failure to do so may be regarded as disloyal’. That understanding would suggest that there are positive developments within the field of whistleblowing, and indeed there are, but the process of whistleblowing is a multi-faceted process. One of the most important aspects of the process is that there is adequate protection for one to blow the whistle, and in that regard there is still plenty of work to be done. It was reported recently that Senior MPs and campaigners ‘are demanding the government overhauls laws around whistleblowing, calling the current legislation “wholly inadequate” and “not fit for purpose”’. These calls are in relation to the number of individuals who ‘blow the whistle’ but then lose their jobs, which is a clear inhibitor for whistleblowing. More worrying still, the article discusses how, perhaps, the greatest impact is within the NHS where doctors are losing their jobs after highlighting malpractice. The effect of a reduction in whistleblowing is tremendously obvious in that particular field, but the reduction of whistleblowing in any area is a clear social problem.

The article in The Independent concluded with the views of Philippa Whitford, the SNP’s health spokeswoman, who states that there ‘has to be some form of enforcement and some form of punishment… when someone has real concerns about how a trust or department is being run or how an individual is behaving, they need to be able to come forward safely…’. Admittedly Whitford is talking in relation to public bodies, which perhaps denotes a slight difference in relation to the public-facing nature of those institutions and the ‘duty’ of those involved, for want of a better term. But, in reality, a private institution is more often than not engaging with the public, and the question is whether their responsibility to a ‘consumer’ should be any different to a public body’s responsibility to a ‘citizen’. Arguably, there should be no difference whatsoever. Another question is what should be done to make the process safer for whistleblowers?

Unfortunately, there is no easy answer to that question. If anonymity becomes an absolute in the process, which would protect whistleblowers, then what would be the impact upon businesses or public bodies? What if the claim against them is unsubstantiated, or is not a genuine claim? This is the underlying issue that dominates the concept of whistleblowing and its development, and it is difficult to foresee a middle ground. In the excellent International Handbook on Whistleblowing Research, there are a number of ‘remedies’ discussed, ranging from the criminal law protections that have been developed in the courts, to those involving the (American) constitutional rights infringements that punishing dissenting opinions theoretically constitute. However, when analysing the comparative legal developments, Fasterling finds that there is plenty of divergence between countries, which perhaps lends itself to ‘social’ foundation of the concept of whistleblowing, which impacts upon how it is protected, and indeed advanced. Fundamentally, it all may boil down to the concept of ‘values’, and what a given ‘system’ values.

If a ‘system’ values the development of its business arena, then how whistleblowing is developed and protected can go one of two ways: it will either be advanced upon the concept of the whistleblower doing right by the company and, ultimately, making the organisation a better entity for it, or it will be repressed upon the basis of protecting the company from a variety of effects, including external investigations, a loss of reputational capital, or a number of other things. This discussion directly relates to the discussion on Wednesday regarding the role of regulators, with the relationship being the concept of the regulator being an enforcer, but for whom? Again, it is dependent upon the viewpoint the regulator takes in relation to its role in the wider arena. Again, we must look at the evidence rather than the ideology, and on that basis it is difficult to foresee the process of whistleblowing being afforded more protection anytime soon. The FCA’s treatment of the Staley case means that, for them, acknowledging a breaking of the whistleblowing rules is punishment enough, but the question on the back of that decision is what effect does that decision have? Does it encourage whistleblowing in the future, when one may consider that their superiors will circumvent rules to identify them but then not suffer any serious consequences? Arguably, it does not. Arguably, even though the Staley case was in relation to a personal connection and then somebody somewhat outside of the organisation, the sentiment is loud and clear – the circumvention of whistleblowing rules is allowed, depending upon the importance of those circumventing the rules. For the FCA, Jes Staley as CEO of Barclays presents an entirely different proposition than the RBC, and therefore we may see more punitive action taken in this current case, if the FCA decides to pursue it. If that is the case, then the sentiment that we can take from those diverging actions is even more worrying – is it the case that some people, and organisations (think RBS), are above the law if they are deemed vital to the national interest? The impending unknown in the UK – Brexit – is defining the future of the UK, and stories such of those demonstrate that the effects could be particularly long-term, and particularly damaging.

Keywords – UK, Whistleblowing, Royal Bank of Canada, Barclays, FCA, Financial Regulation, Business, @finregmatters

Wednesday, 15 August 2018

The FRC Reluctantly Releases a Report on PwC and BHS: Yet another Indicator of Weakness, or is it?

We have reviewed the collapse of BHS here in Financial Regulation Matters, whilst we have also reviewed the performance of the Financial Reporting Council (FRC) here. We also looked at a number of investigations that the FRC were undertaking with regards to the audit sector, with the regulator’s record fine against PwC for its auditing of BHS being one of the more recent actions taken. However, what looks like a victory for the regulator, at first glance, is quickly becoming anything but, and in today’s post we shall look at the sentiment of the regulators actions in this case.

When the announcement was made that PwC would be fined, and one of its partners involved in the audit banned for life, it was suggested by the regulator that they would be releasing an extensive report into what went wrong. However, Sir Philip Green initiated legal proceedings to amend, and essentially delay the report from being published on the grounds that it would negatively affect members of his holding company, Taveta. At the end of June, the High Court ruled against Green and his attempt to impose an injunction, meaning that the FRC were then free to publish the report. Yet, they did not. This quite rightly drew criticism, with Frank Field MP demanding to know when the report would be published. Yet, they still did not release the report. However, in The Sunday Times last weekend, the report was leaked, meaning the FRC had no choice but to release the report.

One would think that would be the end of this particular episode, and that we can now focus on the poor job that PwC did when auditing BHS. The report was released by the FRC on Wednesday, and spans nearly 40 pages. The report goes into detail regarding the lack of supervision undertaken by lead partner Steve Denison, the alarmingly short amount of time that was spent on the audit, and the decisions the board at BHS were allowed to take and have them signed off by PwC. The report is indeed highly critical of Denison, PwC, and the board at BHS, but there is one more twist in the tail. Today in the Financial Times, it is being reported that ‘the report released on Wednesday contains differences to the original document that Sir Philip attempted to block. The FRC declined to comment on what changes were made’. An example provided of the differences between the two versions include the previous report stating that the FRC concluded that the management at BHS had assumptions regarding future losses that ‘were not reasonable’; in the released report, that sentence was changed to the assumptions regarding future losses ‘should have appeared to the respondents to be very optimistic’. This change was that suggested by counsel for Taveta during the application for an injunction, and this has lead Field being forthright in his criticism for the concession. However, does this occurrence tell us something about the reality of the situation between a regulator and the regulated?

It appears that there is a fear that exists within financial regulators, and if we focus on the dynamics of that particular relationship we can perhaps see why. The theory behind the relationship is that regulators operate to protect the public from the iniquities within the marketplace, by way of either disciplining, or setting standards. Yet, the FRC’s actions, when combined with the actions taken by the FCA recently with regards to the releasing of a report into RBS and its GRG unit, suggest that the actual power dynamic within that regulator-regulated relationship is tremendously imbalanced. The regulators are, it appears, fearful of going against what are particularly wealthy and resourceful organisations, with the legal ramifications for the regulators being much higher if they were to enter a legal war with the regulated. There is also the issue of the regulators not wanting to alienate the regulated entities, as it is often prescribed that working with these entities, rather than ordering them is the more beneficial route to take. These points are valid, simply because they make sense. Whilst the regulators represent the state, they do not have the resources to challenge these massive organisations legally. Also, it will be easier to work with people and organisations who you have not alienated. However, if we look at it from the opposing side, there is an entirely different story.

What justice is there for the 11,000 employees of BHS who faced losing everything they had saved (and many will not receive what they are supposed to), or for the many SMEs who were put into a brutal machine within RBS and HBoS, and in the latter instance are continuing to be consistently disrespected by Lloyds in their handling of the case? The answer, it appears, is that the justice they may receive is second to the preservation of order. That sentence may seem conspiratorial, but it answers the question of why so few were imprisoned for criminal conduct in the Financial Crisis, and why so many other scandals are ‘settled’. But, perhaps this is too idealistic. Perhaps, there needs to be a recalibration of the role of the regulator. Do they exist to protect the public, or do they exist to ensure the efficiency of the marketplace? A definition for the word ‘regulator’ is ‘a person or body that supervises a particular industry or business activity’, but that does not describe for what purpose. If we are to ask, then, for what purpose do the regulators operate, it is arguably important to remove ideology from the equation (which would be a difficult exercise in the modern era given the prevalence of ideology over evidence). If we were to remove ideology and replace it with evidence, and historical analysis, then the answer of for who do regulators operate will become abundantly clear – need the answer be written here?

Keywords – FRC, BHS, PwC, Audit, Financial Regulation, @finregmatters

Sunday, 12 August 2018

The Latest Indicator of the Onset of Regulatory Amnesia: Trump Takes Aim at the OFR

We know here in Financial Regulation Matters that there were a number of initiatives set up in the wake of the Financial Crisis, with all of them theoretically designed to guard against a crisis of similar, or even worse proportions. Some have been somewhat of a success, and others less so, but recently the Trump administration took aim at an agency which is purposely designed to guard against another crisis by providing cutting-edge research to regulators. In this post we will examine the Office of Financial Research (OFR) and the news that the agency will soon be experiencing even more job cuts, alongside a further depletion of its resources. The question will be whether this constitutes just the latest in a string of events which suggest the onset of ‘regulatory amnesia’, or the culling of an agency that sounds good in theory, but could never have been effectual in the real world.

As part of the many reforms brought forward by the Dodd Franck Act of 2010, the Office of Financial Research was created, and was designed to support the Financial Stability Oversight Council (FSOC), which itself sits within the Treasury Department. The OFR’s official mandate is to look across ‘the financial system to measure and analyse risks, perform essential research, and collect and standardise financial data’, and to protect it from a myriad of potential influences, it was designed so that it would be funded by assessments taken from financial institutions. The Office also has the power to issue subpoenas to institutions and people who are not forthcoming with the necessary information required. On paper this initiative sounds like it is particularly well placed to furnish the regulatory environment with the up-to-date and critical research it needs to guard against future crises. However, there is an obvious problem with this aim. That problem is that by doing so, there is the potential that the Office will stifle growth in areas which are beneficial to both the financial marketplace, and also politicians who campaigned on the promise of bringing about the end of the recession and long-term economic growth. This has been noticed by commentators, who have suggested that the OFR has been plagued by a number of issues (some internal, many external), ranging from a lack of cohesion amongst regulatory agencies, the lack of discipline that the FSOC can administer, and a reluctance on behalf of the OFR to issue subpoenas.

Yet, it has also been suggested that the OFR has been doomed to fail by the interference from politicians. Reuters reports that the OFR has been under pressure for many years from Republican congressmen and women, who claim that the Office is ‘unproductive, unnecessary, and another form of intrusive government bureaucracy’. According to the Financial Times, Steven Mnuchin (who we know from previous posts) has taken a direct aim at the office, insisting that the Treasury Department take over the OFR’s staffing and budgetary decisions. The fact that the OFR sits within the Treasury is one major problem, and the fact that the OFR is supposed to be autonomous is clearly another problem. Yet, that has not stopped the Trump administration, who have recently announced that the OFR will have its budget cut by 25% to around $76 million, and will see up to 40 positions obliterated – in 2016 there were 208 members of staff, but that is an ever-dwindling number. The Treasury maintains that it is taking such actions to ‘make OFR a more efficient organisation with a stronger workforce and culture to better execute its mission’, but the suggestion from elsewhere is that ‘rather than strengthening the OFR, the Trump administration is undermining it… this is shortsighted’. It is worth noting that it is not just the Treasury taking aim at the OFR, as the SEC took action in 2013 by declaring that some of its reports ‘were too strong in [their] depiction of the industry’s risks’.

Here in Financial Regulation Matters we know full well that there will always be a sharpened opposition to risk-aversion because, essentially, being risk-averse is not profitable. It was reported recently that the banking industry is increasing its lobbying efforts to repeal certain banking laws in the U.S. that will enable them to free themselves from certain capital ratio requirements (the so-called G-SIB Surcharge), and this is not surprising. However, it is relevant to paint a picture of both the desire to free the industry from crisis-era restraints, and also the public body support for that to come to reality. Donald Trump vowed to cut back governmental red-tape throughout his Presidential campaign, and he is doing just that. Perhaps that is fair – he is doing what he said he would do – but the reality is that these calls were made under a false pretence. On many occasions he stated that there was a requirement to cut the red tape to create jobs in the U.S., and in some cases that may come to fruition. But an associated reality that he rarely mentioned when campaigning for office is that this approach disproportionately benefits and emboldens the rich, with particular reference to the financial powerhouses that tower over American, and many other societies. We know that after his massive tax cuts for the rich he proudly declared that he had ‘made his friends rich’, and developments such as these with respect to the OFR only further that cause.

Essentially, we are beginning to move through the certain ‘phases’ which can be traced back for a large number of years. The calls by financial institutions to be freed from restraint, in order to grow and ‘provide jobs’, is not heeded after a crash. However, those calls never stop, and it is institutional support from the state that advances the ‘phases’ so that these calls start developing momentum. Any rational person would surely suggest that, for what is quite a limited budget anyway, the OFR should be supported further so that, once the financial institutions begin to make more moves in the marketplace, the regulators tasked with regulating their activities are provided with as much information as possible. The logical chain of events is that the financial institutions are allowed to take more risk but from within the informed and progressive regulatory arena which monitors and regulates the systemic risk being taken. Yet, there is a push to do exactly the opposite, with politicians now queuing up (on the bank of increased lobbying efforts) to severely damage that regulatory arena. The reason is simple, and it is not related to ‘growth’ or ‘jobs’ – the ‘excess’ that is required to be made to make certain people rich cannot be developed within that regulatory arena. A solid regulatory arena can allow for the development of ‘growth’ and ‘jobs’, but does so within a confined, sustainable, and systemically-safe manner; none of those attributes contribute to the development of excess, and it is that excess that allows Donald Trump and his ‘friends’ to continue their dominance. The cuts to the OFR merely represent just one small strand in what is an ever-unwinding regulatory tapestry. The question then is, and this is a question we have asked a number of times, is a decade of ‘recovery’ enough to provide societal stability if another crash takes hold?

Keywords – Office of Financial Research, Trump, USA, Treasury, Business, Regulatory Amnesia, @finregmatters

Monday, 6 August 2018

House of Fraser Continues to Teeter

House of Fraser, the massive department store that began in 1849, in Glasgow, has been making the business headlines for quite some time. After the collapse of BHS, House of Fraser stands on the brink of being the next massive feature of the British High Street to fold. In this post, we will look at the latest developments as the company battles to stay in existence and survive the hostile environment facing High Street retailers, whilst we will also look at the what these developments many mean for the future of British retailers as we continue to move through the economic cycles.

The news of House of Fraser’s troubles broke earlier in the summer, which came on the back of negative financial results last year which detailed that the company had made a net loss of £37 million, with a £53 million drop in revenue. Those financial troubles led to the need to develop a rescue plan to protect the company from the hostile environment within which they operate, and in June of this year they announced that it would be closing 31 of its 59 stores. As part of that rescue plan, there were two specific elements that needed to be realised, and recently those elements have been played out. Today the company managed to come to a legal arrangement with the landlords of the properties they wish to close, after those landlords had sought to take legal action against the closures as part of the ‘Company Voluntary Arrangement’ (CVA) process that we have discussed before here in Financial Regulation Matters. The terms of the arrangement involve the company being allowed to continue the CVA process without running the risk of further litigation from the landlords, with the landlords stating in response that ‘we are pleased with the outcome and hope that our landmark legal challenge sends a clear message to any other companies considering a CVA, on the importance of transparency and fair treatment for all creditors throughout the CVA process’. It has been suggested that inherent weaknesses within the CVA process are being magnified by the increased usage of them, relatively speaking, and that these issues need to be ‘urgently addressed by the industry and by government’, whilst there is also a number of scholarly investigations on this area taking place at the moment.

The second element of House of Fraser’s rescue plan involves finding an entity to invest in the firm, or better yet take it over. It was suggested yesterday that the removal of the legal hurdle presented by the landlords would advance the rescue of the company, but other news recently has presented the company with much larger hurdles. C.banner, a Chinese firm which also owns the toy store Hamley’s, had been in talks with House of Fraser regarding a takeover and a much-needed injection of £70 million. However, C.banner announced last week that it would not be proceeding with that planned takeover/investment, and this stems from the company’s issuance of a profit warning after its share price plunged. It has been mentioned subsequently that Sports Direct founder, Mike Ashley, may be interested in investing, as too may the Alteri Investors vehicle, but apparently those talks are not at an advanced stage. The question is, however, may there be a longer effect stemming from this current period of turmoil.

It should come as no surprise that economic cycle fluctuations will have a demonstrable effect upon sectors such as the retail sector. We have looked previously at the tremendous effect the economic cycle is having upon the dining sector, and it is obvious that the retail sector would struggle also. As leading names on the High Street struggle (John Lewis reported warnings over its, and Waitrose’s performance recently), one would assume that there would be an almost-natural shift towards the ‘price-aggressive discount retailers’. Yet, the collapse of Poundworld recently perhaps flies in the face of that understanding. There has been plenty of research into the connection between the retail sector and its performance during the changing economic cycles, with it being suggested that economic downturns are prime moments for discount retailers to irreversibly take market share from the more respected retailers. That view seems more than sensible, but the collapse of Poundworld forces us, perhaps, to re-evaluate. What then is the differing factor between that economic research and the reality we see in front of us?

The answer, arguably, is Amazon. The massive online retailer is revolutionising the way in which retail companies operate, and is quickly becoming the focus for targeted research as we begin to seek to understand its scope, its role, and its effect. Amazon made the news recently after reporting a profit of $2 billion for the first time in the second quarter, and also for having paid just £4.6 million in tax within the UK. Predictably, this news has resulted in a number of articles within the business (and wider) media regarding the system of corporate taxation, but for us there is another effect which is worth discussing. Earlier this year a columnist asked ‘is this the end of the UK’s retail boom?’ after referring to slumps in spending over usually busy periods (Christmas, and early year periods). However, perhaps the question should be aimed at the presence of a High Street at all. The British High Street is fundamentally changing, with bank branch closures being performed at an accelerated rate, restaurants struggling to cope with the economic climate, and now constitutive components of the traditional High Street model now disappearing. If House of Fraser were to fall, then the loss of BHS and House of Fraser to the British High Street would be massively noticeable. The existence of Amazon is providing the retailing dynamic with a new stimulus, and the sector is being changed irreversibly. Amazon is forcing society into two particular streams: from a retailer perspective, it is forcing retailers to compete online, but the dominance of Amazon in that field is prevalent. From a customer’s perspective, the need to shop on the High Street is ever-diminishing, with better value and more convenience to be had via online retailers. This revolution started in 1994 but did not gather pace until the Financial Crisis took hold, and that is for a good reason – the economic climate is forcing society into the realm of Amazon, and the deteriorating High Street is the proof of that. What is means for the future of the High Street is uncertain, of course, but it is not outside of the realm of possibility that the concept of a ‘High Street’ will be a thing of the past very soon. What the High Street of the future will look like is another question entirely, because the obvious conclusion to make would be that it would be dominated by discounted stores. But with Poundworld’s demise that may not be the case, whilst it is also possible that an economic upturn (although one is surely not forthcoming anytime soon) could reverse these trends mentioned in this post. Whilst that may apply to consumable items i.e. restaurants, it is difficult to see a way back from the brink for the large department stores, which would mark a sea-change for modern living.

Keywords – Retail, UK, House of Fraser, BHS, Investing, @finregmatters

Wednesday, 1 August 2018

Trust and the Banking Sector: RBS and Lloyds Make the Headlines Again

In Financial Regulation Matters we have covered the story of the disgraced GRG unit within RBS from the moment that the scandal was publicised, and recently that case has taken a particularly disappointing turn. In other news from the Banking sector, Lloyds have been forced to set aside even more money to cover PPI claims made against them, bring the prospective to total to more than £19 billion. In this post, we will assess these stories and examine what they may mean for the continuing lack of trust that the public have in the Banking sector.

Starting with RBS, the bank have been in the midst of a number of legal claims regarding the conduct of its infamous GRG unit, which was set up to ‘help’ Small and Medium Enterprises (SMEs). Last month the bank managed to fend off a claim from a Real Estate group regarding the mis-selling of interest rate swaps and manipulated interest rate benchmarks, and a couple of days ago managed to fend off a claim in the High Court from an SME regarding its treatment via the GRG unit. Yesterday, however, came the news that many affected SMEs were dreading, in that the FCA are to take no disciplinary action against RBS for the conduct of its GRG unit. In explaining the FCA’s decision, CEO Andrew Bailey stated that the regulator lacks the powers to take action, although this was followed by the statement that the lack of action does not condone the actions of the GRG unit. Bailey suggests this based upon the understanding that whilst the FCA does have the power to punish senior management within banking institutions, those powers only came into force in 2016 and could therefore not be used retroactively. This decision falls in line with many other legal conclusions that suggest that whilst the GRG unit was clearly deficient when it came to standards, there was little in the way of overtly illegal action. This is the viewpoint put forward from a number of avenues, despite the damning report that RBS fought to keep from the public, and revelations that include leaked memos that declare that GRG were advising its staff that ‘sometimes you have to let customers hang themselves’ and ‘missed opportunities will mean missed bonuses’.

This has led, understandably, to considerable backlash since the news broke that the FCA would not be taking action. Nicky Morgan, Chair of the Treasury Select Committee, immediately stated that ‘it will be disappointing and bewildering for those who got caught up in GRG’s actions that the FCA is not able to act. This demonstrates the need for a change in how lending for SMEs is regulated’. Affected customers have also been quick to voice their anger at the announcement, with one customer stating that ‘the Government have got to get a grip’. So, whilst RBS celebrate the findings of the High Court and the FCA, the question is what will be the effect of these continuing scandals that are going without punishment?

The actions of RBS are rather remarkable when one takes a moment to look at them. Not only are the bank attempting to close the compensation scheme and cap it at £125 million, despite the investigation into affected customers not being complete (only 10% of customers who may have been affected have come forward), but the bank is continuing the usage of the term ‘legacy’ to distance the bank from its previous actions. Sir Howard Davies, the Chairman of RBS, stated that ‘we await the publication of the FCA’s full account and will reflect carefully on its findings to learn any further lessons from what was a hugely challenging time for the bank, its customers and the wider economy’. The tragedy is that the ‘challenging time’ for the bank was supported by the British taxpayer, and for the victims of GRG and the wider economy, those ‘challenging times’ continue to this day.

The trust that the public have in the banking sector is incredibly low, and this is because the rate of scandals that are emanating from the sector is showing no signs of abating. Over at Lloyds Bank, who are having massive issues with their own version of GRG (albeit via the purchase of HBoS), it was announced today that the bank have put aside another £550 million to cover claims for mis-sold PPI. Although the bank announced this alongside strong financial figures – a pre-tax rise in profits of 23% to £3.1 billion in six months – the figure of £19.2 billion as a prospective figure for PPI compensation is difficult to ignore. It is also worth noting that this figure represents the highest figure for all British banks and the compensation due to customers who were mis-sold PPI, The bank, rather predictably, avoided commenting too much on the extra provision, but it is a damning development for the culture within the bank – although, obviously, the bank will be quick to write this off as ‘legacy issues’.

In reality, these are not ‘legacy issues’. In fact, they are representations of a culture that has persevered throughout one of the largest financial crashes in modern history. Yes the banks are not able to perform in exactly the same manner, but the sentiment the banks still display when treating the victims of their transgressive policies ‘with contempt’ is truly remarkable. It often goes unsaid that banking does not have to be like it is, where the actions of the banking companies are almost adversarial to everybody else but themselves. The trust that the public have in the sector will have been damaged significantly during the Crisis – this we know – but the way in which the banks are dealing with the post-Crisis era is arguably much worse. To transgress is one thing, but to take such an adversarial approach when it has been proven that one did wrong is something which can damage the future relationship between the public and the sector irreversibly. However, there is a counter-argument to this, and that is that relationship between the banking sector and the public is absolutely irrelevant. It is perhaps the case that people would like that relationship to mean something, but from the perspective of the leading banks there is very little to suggest it is the case. One may argue that a breakdown in trust on behalf of certain banks, say RBS, would damage their reputation, but in reality it is riskier to deal with the smaller banks since the Crisis, despite deposit protection schemes. The Crisis taught us all that the larger the bank, the safer it is, so why would the banks care about the relationship with the public? It is worth debating, but it is certainly the case that the ‘regulatory capital’ argument no longer applies – the banks have been called ‘too-big-to-fail’, but perhaps it is more the case that they are ‘too-big-to-care’.

Keywords – Banking, RBS, Lloyds, UK, FCA, Business, @finregmatters.