Tuesday, 30 July 2019

Can Boeing Rely on their Place in the Duopoly to Overcome the 737 Max-8 Crisis?

In today’s post the focus will be on the continuing crisis at Boeing, which started when two planes fell from the sky killing 346 people in total. In the business press recently, it has been suggested that Boeing may need to move to a ‘Plan B’ very soon before this crisis envelops the company, with a number of possible alternatives being put forward. However, in this post we will focus on the duopoly in the large jet airliner industry and seek to understand just how secure it is.

In October 2018 a Lion Air Boeing 737 Max airplane crashed into the Java Sea shortly after taking off from Jakarta, killing 189 people. On the 10th March 2019, a 737 Max plane flying under Ethiopian Airline colours crashed shortly after take off from Addis Ababa, killing all 157 people on board. Following the two crashes, that were connected by a failure of the Manoeuvring Characteristics Augmentation System (MCAS), all 737 Max planes were grounded and remain grounded to this day. Boeing initially announced that the planes would be back in the sky by June 2019, then that was November 2019, and now it has been announced that it will be ‘sometime next year’. The initial thought process was that the MCAS system needed to be overhauled, but recently there have been revelations of further issues with the planes that have contributed to the continued grounding of the fleet. The headline-grabbing issue however is the MCAS system, which was a technological response to an issue created by seeking greater fuel efficiency from the engines. The Boeing 737, as a model of airplane, stretches back to 1967 with the plane building on the designs of the 707 and 727. The plane has been redesigned a number of times since then, with the suggestion being that redesigns were deemed better for the business rather than a new plane, because of the competition provided by the European-based Airbus, the second member of the duopoly. The current iteration of the 737, the Max-8, has heavier engines to increase fuel efficiency. However, the result of this is that the increased weight and positioning of the engine now forced the nose of the aircraft up slightly. This could potentially force the aircraft to stall and crash, so Boeing introduced the MCAS system which would force the nose of the plane downwards to compensate for the increased weight of the engines. However, that system relies on data from one of two sensors to calculate the position of the nose – in the two cases above, that data was incorrect. Acting on incorrect data, the MACS system forced the nose downwards incorrectly. In response, the pilots pulled the nose of the aircraft upwards to compensate for the nosedive. However, the MACS system then received data that the aircraft’s nose was above level, and continued forcing the nose of the aircraft downwards – the result being that the planes were forced into the ground by the repetitive nosedive instigated by the MACS system.

Since the crashes the entire fleet has been grounded and recently Boeing announced a net loss of $2.94 billion for the second quarter of this year, and an after-tax charge of $4.9 billion to compensate the airlines who cannot use the aircraft. Despite President Trump claiming he could fix the problems at Boeing, mostly be ‘rebranding’ the planes – the airline, remarkably, has already tried to do this – there is no solution in sight (consumers are being made aware of how to identify the planes, with engineers stating that neither they nor their families will fly on one ever again). It was suggested in the Financial Times that one potential solution would be to scrap the idea of the 737 Max becoming a commercial aircraft once it is cleared to fly, and instead move the aircraft into the freight sector instead (with the sentiment being that it will be easier to get freight pilots on board rather than commercial consumers). This is probably the best case scenario at this point for Boeing, but there are much larger questions and issues that this current period for the company raises.

Former employees at Boeing have been quoted in the media as stating that the investment into the 737 Max was not adequate, and that this related to ‘the culture [being] very cost centred, incredibly pressurised’. It is being suggested that the push for cost-savings lead to the narrative being promoted that any changes from the last version of the 737 to this were ‘minor’, thereby reducing the need for new and costly certification and increased training – the pilots for the new 737 were, essentially, not up-to-speed with the new MCAS system. Boeing have countered this claim with a statement declaring that technological updates get the same scrutiny as an all-new aircraft, although the suggestion from employees is that ‘there was a lot of interest and pressure on the certification and analysis engineers in particular, to look at any changes to the Max as minor changes’. There are a number of reasons for why Boeing may have taken this approach. The company has long since been established as the market leader, with one commentator arguing that overconfidence was to blame. Peter Atwater argues that there were three particular issues. First, there was extreme overconfidence within and surrounding Boeing, with the firm increasing profits year on year and Wall Street analysts and the associated media describing Boeing as ‘killing it’. This overconfidence can and probably did lead to a lack of scrutiny, both internally and externally (from regulators). Second, the negative effect of this crisis is exacerbated by an inherent confidence dynamic within the industry: back-to-back crashes have caused consumer confidence in Boeing to plunge, and it is questionable whether they can regain that consumer loyalty, although Atwater makes the point that consumer do not really have a say in what plane they fly (unless they are particularly cautious and invested). Last, whilst consumer confidence in airline travel is at a high currently, any sort of a recession will diminish this confidence and therefore airlines will not need the aircrafts – this potentially leads to Boeing having a large number of aircraft that they cannot sell. These issues, and then attempting to guard against these issues, can result in massive inefficiencies which, in the aircraft industry, can result in tragic consequences. Yet, is there a claim that the duopoly will save Boeing and that everything, once the aircraft is cleared to fly again, will go back to normal?

It is widely agreed that the aircraft industry, in relation to large jet aircraft, is dominated by Boeing and Airbus (here, here, here, and here). In 2018, Airbus delivered 800 planes whilst Boeing delivered 806 although in reality Airbus is a way off the size and clout of Boeing – in 2018 Boeing recorded revenues of $101 billion against Airbus’ $71 billion, with Boeing recording $10.4 billion against Airbus’ $5.68 billion in profit. Competition in the marketplace is being actively reduced by the duopoly, with Airbus acquiring a controlling stake in Bombardier’s C-series, and Boeing forming a joint venture with the Brazilian company Embraer this year. However, it is being suggested that a smaller player in the marketplace – Chinese company Comac – represents a genuine threat to the duopoly. It is being suggested that Comac, with the sponsorship of the Chinese Government, have received more than $7 billion in public funding already and have more than 1,000 order from Chinese airlines and could spread into the BRICs nations and other emerging marketplaces.

The impact of this is that Boeing may have more trouble on its hands than it expects and will need a solution to the 737 Max problem very soon. Atwater’s suggestion of moving the aircrafts into the freight sector is probably their best option, although they will continued to be buoyed by US subsidies and exclusive access to the non-public US marketplace. It is will be fascinating to see whether an increasingly aware public will be able to influence the direction of the duopoly, but the reality is that the consistency of Airbus and the impending threat of Chinese manufacturers has put Boeing under pressure and, essentially, it cracked. A lot of people lost their lives due to this however, and the noises coming from the press about the continuing investigation into Boeing’s conduct regarding the certification process is hardly inspiring – whilst it may be unprecedented and a number of subpoenas have been issued, the fact that the Federal Aviation Administration (FAA) would likely be implicated too for delegating the certification process to Being itself, means that any chance of there being anything close to substantial punishment for this chain of events is staggeringly low.


Keywords – Boeing, Aircraft, Airbus, Duopoly, Business, @finregmatters

Monday, 29 July 2019

The EU Provides a Small Reminder to non-EU Countries on ‘Equivalence’

In this post, we will review a recent action by the EU that takes into account credit rating regulation, as well as Brexit. It was only last week when we reviewed the most recent regulatory manoeuvrings in relation to credit rating agency regulation, and yesterday it was announced in the business media that the EU have taken another step. However, whilst that step is having very little effect, it is being seen as a direct warning shot to the British as the new British Prime Minister, Boris Johnson, continues to reiterate that the UK will be leaving the EU on the 31st October, with or without a negotiated exit deal.

Rather than regulatory amendments, the EU has taken the unprecedented step of stripping five particular countries of its market rights. On the basis that the EU has warned Canada, Brazil, Singapore, Argentina, and Australia that, for the past 6 years, the rigour of its regulation of credit rating agencies is not equivalent to that of the EU’s regulation of the industry, the EU has decided to withdraw equivalence provisions. The technical impact of this is that European clients can no longer utilise the ratings of agencies based in those particular countries. A vice-president of the Commission, former Latvian Prime Minister Valdis Dombrovskis, stated that the decision set ‘some kind of precedence for monitoring adherence’ and that ‘if they, during several years, chose not to update their legislation, then we had to take the decision to withdraw equivalence’. However, the reality of the EU’s rules have been made clear by those affected, with the ‘endorsement’ regime seemingly coming to the rescue. The endorsement regime allows agencies stationed within the EU to vouch for the ratings of a satellite agency. With credit rating agencies being spread across the globe, the effect therefore is minimal, if not non-existent. Canadian rating agency DBRS stated that the decision ‘will have no impact on our business’, because they will ‘continue to issue ratings from our US and Canadian credit rating agencies that can be endorsed by our EU registered CRAs and therefore used for regulatory purposes in the EU’. In the immediate aftermath of the decision, the exact same sentiment can be seen coming from those within Singapore’s marketplace as well. This is because, seemingly paradoxically, the targeted countries are still seen as meeting the criteria to endorse credit ratings for regulatory usage, although does consist of a different process.

So, the effect is minimal at best. Onlookers such as Professor Lawrence Loh of National University Singapore, have stated that the real effect is that the rulings have two consequences. The first is that it is a warning shot to third-party countries that, with a new EU Parliament forming, there will be plenty of new rules being developed and that the bloc expects adherence in exchange for access. The second, and related point, is that this action may be seen as a warning shot to the UK, with Loh suggesting that the ongoing Brexit saga is vitally important in relation to the concept of ‘equivalence’. The Financial Times seemingly agrees, suggesting that an equivalence deal ‘may be the best the City can get’ from any negotiations between the two parties. There is an obvious downside for the British party in this process in that, under the equivalence regime, the EU can remove it at a moment’s notice. Bloomberg suggests that this system is all that will be offered by the EU and that, in the face of such a precarious threat, British firms are well ahead with plans to move more than $1 trillion into the Eurozone and thereby safeguard their assets. Dombrovskis has moved to calm these fears, arguing that whilst the UK will only be offered the equivalence regime in a negotiation, the reality suggests that the EU are extremely cautious in removing equivalence rights, with it being noted that 6 years elapsed since the EU raised these regulatory issues with the third-parties targeted this week.

The reality is important here however. On one side the EU is, quite rightly, seeking to protect itself from what may become a predatory race-to-the-bottom financial centre sitting right on its doorstep in the wake of a no-deal Brexit. With the British political establishment seemingly marching into the arms of a waiting President Trump, the EU must seek to protect itself. For the UK, the story is very different. There is a belief since Boris Johnson came to power that the EU has no choice but to give into the UK’s demands as they want the money that will be owed in the so-called ‘divorce bill’ – this is not true. The reality is that the EU holds the upper hand in these negotiations and the UK faces either a. having to accept the equivalence regime for entry, which makes a mockery of the claims that Brexit will mean a re-establishment of ‘British Sovereignty’, or b. leave without a deal and subject itself to, potentially, one of the largest instance of capital flight the modern would have seen. For business, there is no loyalty to a jurisdiction – at all. They serve the ideal of profit, and that ideal will see, and is seeing, businesses flock to Europe in order to protect their access to what is a much larger and more significant marketplace than the British economy. This move looks unsubstantial at first, but it is a clear reminder to the British – the penalty for becoming a regulatory cesspit in the wake of Brexit will be severe.


Keywords – Brexit, EU, credit rating agencies, regulation, @finregmatters

Thursday, 25 July 2019

The EU Takes a Pragmatic Approach to Regulating Credit Rating Agencies’ Connection to Sustainable Finance

The two elements of today’s post are common subjects here in Financial Regulation Matters. There are a variety of posts concerning credit rating agencies, on account of it being this author’s specialism, whilst there are also a number of posts concerning sustainable finance, and the incorporation of Environmental, Social, and Governance (ESG) concerns into the financial process. In the author’s most recent book The Role of Credit Rating Agencies in Responsible Finance, the continued and concerted entry of the leading CRAs into the growing field of sustainable finance was analysed, with one of the overarching sentiments being that regulatory oversight would be needed, and be needed soon. The EU has attempted to rise to that challenge and recently responded to orders from the EU Commission to put together a regulatory agenda in this field with their ‘Technical Advice’ on the matter. In this post we will look at these developments.

Released on the 18th July, The European Securities and Markets Authority (ESMA) presented their response to the orders contained within the Action Plan for Sustainable Finance, officially disseminated in March 2018. The Action Plan aimed to build upon a report developed by an expert group earlier in 2018 that suggested that sustainable finance ‘is about two urgent imperatives’. First, there was a need to ‘improve the contribution of finance to sustainable and inclusive growth’, and second there was a need to strengthen financial stability by incorporating ESG factors into investment decision making. In Action 6 of the Plan, the Commission stated that it would engage with all relevant stakeholders ‘to explore the merits of amending the Credit Rating Agency Regulations to mandate credit rating agencies to explicitly integrate sustainability factors into their assessments’. They also ordered ESMA to ‘assess current practices in the credit market’ specifically in relation to the extent to which ESG factors are taken into account. There was also an aim to encourage sustainability ratings and market research.

The headlines surrounding the release of ESMA’s response read like ‘ESMA urges ESG transparency for credit ratings but no requirement’. The Head of ESMA, Steven Maijoor, stated that market regulation needed to reflect the ‘reality’ of climate change and that there is a ‘need for vigilance on the levels of investor protection’. Yet, in the eyes of ESMA, this is not to be achieved by mandating the methodologies of the rating agencies which, as we know, is an area of their business which CRAs defend above else. The reason for ESMA’s conclusion is rather predictable, as it is the same as every other investigation. The PRI’s polling of its signatory agencies (the very same agencies for the most part), suggested that CRAs do factor in ESG considerations, but that it is either a. difficult to determine when and to what standard because it varies, and b. the usefulness of incorporating any one of the three elements, or even more than just one, will depend upon the issuer or product that the agencies are rating. For the past few years since the agencies have been making purposeful moves into the sustainable finance marketplace, they have all been saying exactly the same thing: we have always incorporated ESG into our analysis. This makes absolute sense, because it would only serve to improve the usefulness and worth of their rating, not detract from it. But, the agencies are clear that, as an abstract concept, one cannot quantify how ESG is incorporated – they argue it is just ‘part of a larger process’. The arguments often put forward are that they become relevant depending on the sector. For example, ‘S’ocial and ‘G’overnance may impact a sovereign rating more than a coal-mining company’s rating, with that rating tending to focus more on the ‘E’nvironmental and the ‘G’overnance angles. It worth stating here that the call from the marketplace, in terms of altering the rating agencies’ methodologies, is that they should not be as focused on the financial elements of the rating, and should incorporate ESG more. The million-dollar question is ‘how does one mandate that?’

For ESMA, one cannot. It is for this reason that they state that it would be ‘inadvisable’ to alter the regulations. They do however suggest that it may be better to update the CRA Regulations’ disclosure provisions, which ESMA have noted as being a particularly important issue. In their Final Report: Guidelines on Disclosure Requirements Applicable to Credit Ratings, it is declared that there is an inconsistency amongst agencies in relation to how they are disclosing their methodologies (and the impact of ESG within those methodologies). As a result ESMA will be pushing ahead with the development of a single set of good practice, in order to increase the informational value and consistency of the agencies’ press releases and reports.

The resulting sentiment that one can take from this is extraordinarily similar to a host of other regulatory investigations since the Financial Crisis (and, in truth, long before). The aims of the EU Commission are wildly out of step with the reality of the marketplace, and ESMA have essentially made that point to the Commission. Attempting to affect elements such as methodologies and competition within the marketplace are dead-ends in the credit rating arena. This is because the oligopolistic structure is what determines developments, not regulation and legislation. The sooner legislators and regulators learn this the better. That is not to say, of course, that the rating agencies should be given free reign, because that is certainly not optimal given that we are now living with the consequences of what happens when they are given that freedom. No, instead the probable best course of action is that suggested by ESMA, in that it is the sustainable financial products, and how they are created, assimilated, and dispersed across the financial system, which need to be regulated. This is an incredibly prudent regulatory agenda, and one that should be solidified within the EU’s future plans. With the sustainable finance field growing and growing, there will be the temptation to link aspects such as a bank’s capital reserves to the amount of sustainably-positive financial products it is holding (as just one very crude example), and regulators must be incredibly wary of doing this. The result would be to incentivise the gamification of this new financial field, which would bring in the biggest players – as it is already doing – which often leads to the very same result. However, the development of sustainable finance is, arguably, societally positive, so it really ought to be protected. It is positive to see ESMA fight their corner and take a pragmatic approach to regulating this regulatory ever-so-difficult industry and its impact on the marketplace.


Keywords – Credit Rating Agencies, EU, Sustainable Finance, Business, @finregmatters

Wednesday, 24 July 2019

Sajid Javid: The Chancellor from Deutsche Bank (?)

There is a risk in writing and publishing this post before 4pm GMT because as we await news of Britain’s new Prime Minister’s new cabinet, suggestions from the press may have guess wrongly. The strong rumour is that, as Boris Johnson begins to form his new Cabinet, which is likely to include such figures as the disgraced Priti Patel, current Home Secretary is in line to become Britain’s new Chancellor of the Exchequer. The reason for this post is based upon a theme that is currently being played out across the media, in that the past of a number of candidates are being reduced to mere footnotes in favour of a list of compliments regarding their past performances and this is being linked to ideas of what they will do in their new roles. This applies particularly to Sajid Javid who, whilst he is a son of a Pakistani bus driver and represents a ‘rags-to-riches’ story, also went to play a vital role in Deutsche Bank’s structured finance gluttonous uptake that both contributed to the Financial Crisis and has continued to haunt the bank – it is not difficult to make a connection between the actions of those in charge in the pre-Crisis era and the news that 18,000 jobs will be going at the bank. So, in this post, we will attempt to get to know the potential Chancellor in a more robust way than the media is allowing.

Javid’s early life has been well documented. The story of his Father, Abdul Ghani, settling in Rochdale and working in a cotton mill, before becoming a bus driver, is well established within the media. Other outlets discuss how Javid then moved to Bristol, where his Mother had a market shop selling clothes that she made, before opening a shop in the city. The young Javid studied at a comprehensive school before reading for his Economics and Politics degree at Exeter University; Javid was the first member of his family to study at University. In the media there is also repeated reference to his connection to the Conservative Party, with Javid attending his first Party Conference in his early twenties and revering Margaret Thatcher. However, the majority of the mainstream media’s analysis of Javid’s life now takes the same approach in that they make a remarkable leap past a massively important phase in Javid’s life. One onlooker states ‘at 25, Javid became the youngest vice-President at Chase Manhattan Bank. His reputation for success led him to be headhunted by Deutsche Bank where, as the head of credit trading, he earned £3m’. Remarkably, that is all that the author mentions, and perhaps only the author would know why this is the case, but the same issue is repeated almost across the board. The Evening Standard states ‘after a successful career where he was a director at Deutsche Bank, he was elected as an MP in 2010 for Bromsgrove in Worcestershire’. The Guardian, in a biography of Javid, say ‘Javid came into politics have been the former head of credit trading at Deutsche Bank, which the Evening Standard once estimated had required him to take a 98% pay cut. The job put him at the heart of the credit rating business that precipitated the financial crash…’ This theme is common, but why? Are the authors of these pieces suggesting that the phase of Javid’s life where he made the vast majority of his wealth and sat in a position to heavily influence the decisions of a leading global bank, in an area that brought society to its knees, is not relevant? Or are the authors merely attempting to focus on his politics, with the sentiment being that one can understand him better if one understands his politics? Whatever the reason, the sentiment in this post is that understanding that period in Javid’s life is probably more important than any other in understanding the man that may, today, become the Chancellor of the Exchequer.

Leaving aside claims that Javid was funnelling his wealth through tax havens for one moment, the suggestion is that towards the end of his 18 years in the banking industry, Javid was earning around £3.4 million a year at Deutsche Bank. However, this has been questioned and more realistic and detailed estimates suggest that Javid was earning a total of £2.4 million towards the end of his banking career. There have been suggestions from Javid’s former colleagues that he was worth every penny, with it being argued that he was ‘very creative, very energetic, and a very likable guy’, whilst he was also noted for being good at ‘crisis situations’. Yet, this picture of a cheery docile investment banker is countered by others who claim that, in opposition to the claim by his former boss that he was not involved with the creation or selling of Collateralised Debt Obligations (CDOs) whilst in Deutsche Bank’s London office, he was in fact a structured credit trader at the heart of Deutsche Bank’s involvement in the system that precipitated the Financial Crisis. Having joined Deutsche Bank in 2000, it was not until 2006 that he joined the Asia (ex Japan) division as its head of global credit trading, meaning that for the 6 years prior to this Javid was centrally placed to be involved in Deutsche’s massive uptake of structured products. Javid personally led on the sale of a Collateralised Loan Obligation product called Craft EM CLO 2006-1, and despite stating that ‘as long as investors understand the risk-rewards of an emerging-market CDO, they are very appropriate’, the CLO would go on to be massively downgraded by Moody’s and would go on to see massive defaults within the underlying pool that depleted large parts of the subordination available for junior notes. This led to Arco Capital bringing a case against Deutsche in 2012, although the case was dismissed only on the basis of the expiration of the five-year statute of limitations. Arco had claimed that Deutsche had purposefully inserted ineligible loans into the product that resulted in a 14% loss rate, although Deutsche simply blamed the Financial Crisis for the losses. Predictably, Javid is a vocal supporter of the banking sector, stating that ‘I don’t see “parasites”, I don’t see a problem that needs solving’; rather, he sees ‘talented, hard-working, dedicated men and women at the top of their game’ and that, ultimately, the industry deserves public praise and support. Moreover, the banking sector and Capitalism in general must be praised, because ‘what you know is more important than who you know, and it doesn’t matter if you’ve got a funny-sounding name, it doesn’t matter if your skin’s not white, because capitalism is colour blind’.

The reality is somewhat different however. Whether it is banks statistically being twice as likely to deny refunds for victims of fraud if the victim is not white, non-white businesses being four times as likely to be refused finance by banking institutions, women having a ‘double glass ceiling’ in the sector, there is clearly an issue that Javid is overlooking because of his own experiences. Further evidence of this societal issue is demonstrated in initiatives being adopted across the sector to increase diversity within the banking sector’s workforce – Lloyds, as just one example, has committed to ensuring that 8% of its senior management jobs are filled by people from a BAME background by 2020, aiming to increase the current total of just 5.6% of its workforce. Other studies have found that ethnic diversity in the top boardrooms across the British economy is reducing since 2014, not increasing. What does this tell us? It tells us that a. Javid’s assertion that ‘it doesn’t matter if you have a funny-sounding name, it doesn’t matter if your skin’s not white’, is nonsense, and b. that this man will potentially be bringing in this anti-progressive bias into one of the leading financially-concerned political roles in the country. It will come as no surprise to regular readers that the incoming Boris Johnson led Government is something that this author is not looking forward to, but the point of this post is that the media, academic onlookers, and general commentators have a vital responsibility to talk about the whole truth – attributing 2 sentences to 18 years of somebody’s career is not good enough, especially when it concerned leading a major bank’s involvement in the very process that caused the Financial Crisis and the subsequent period of austerity that continues to ravage the UK (and other countries, of course) politically, economically, and most importantly in the health of the citizenry. Javid must be held to account.


Keywords – Sajid Javid, Politics, Business, UK, @finregmatters

Friday, 19 July 2019

Ross McEwan in Focus: Former RBS CEO Heads to Australia

RBS has taken up a large amount of space here in Financial Regulation Matters since the blog began, and also column inch after column inch in the business media. Financial Crisis-era transgressions, headline-catching financial penalties (whether large enough or not), a return to profitability, sell-offs that represent losses for the taxpayer, and also running businesses into the wall are all aspects that plague the recent and current era of the massive bank. However, now that Ross McEwan has made his move back to Australia after resigning in April, it is worth taking a closer look at the man that led the bank through one of the most difficult periods in its nearly 300-year history.

The post-Crisis era for RBS has been, and arguably continues to be turbulent (despite returning to profitability). Going through those post-Crisis era developments is worthwhile, but we shall do that through the prism of understanding Ross McEwan more. Born in 1957 in New Zealand and educated at Hastings Boys’ High School – a leading sporting High School in New Zealand – McEwan went on to study Business Studies and Human Resources at Massey University, despite failing an accounting module twice. After this, McEwan went to the US, where he read for his M.B.A. in Harvard Business School. After starting his career as a Human Resources manager at Unilever in New Zealand, McEwan became one of the youngest CEOs in New Zealand when he ran the local operations of French Insurer Axa. After holding a leading role in a New Zealand stockbroking firm (First NZ Capital Securities), McEwan moved into banking with Commonwealth Bank in Australia as CEO of the retail banking arm. It would be in the same sector of banking that McEwan would make his move to the UK, as the boss of the retail arm. In 2013, with Stephen Hester stepping down, RBS were rebuffed in their approaches to external candidates like BlackRock’s Mark McCombe, leaving the internal favourite Ross McEwan free to take the reins of the bank. When McEwan started as CEO, he began with a ‘gesture’ of refusing to take his bonus for the first two years, as he wanted to avoid ‘the drama’ of taking bonus payments whilst the bank was performing so poorly. Whilst the bank did hand out more than £2.5 million in bonuses to its executive team in 2015, McEwan continued to waive his cut, although he did receive the final tranche of the £3 million in shares he was given when joining the firm.

Whilst executive pay continued to dominate the headlines in 2015, McEwan was busier dealing with fines for the bank. In 2014 the bank began setting aside hundreds of millions of pounds for Forex Rigging and PPI-related issues, and in 2018 the big news came that the bank had settled with the US Department of Justice for a total of $4.9 billion, in order to end an investigation into its sales of financial products in the lead-up to the Crisis. This news was met with cheer by the British Government, as the sale of tranches of shares that the government owned was eagerly planned. McEwan declared that it was a milestone movement and a ‘stark reminder of past behaviours of this bank that we should never forget’. Yet, whilst the bank returned to profitability in late 2018/early 2019 and McEwan felt comfortable enough to take his bonuses of £3.8 million in 2016 (despite recording a £2 billion loss), £3.5 million in 2017, and £3.58 million in 2018, there was a looming issue that would cast a long shadow over McEwan’s legacy.

In 2013 McEwan stated that the allegation that RBS were running small and medium-sized enterprises into the wall to collect the debris were not true, declaring that ‘no evidence has been provided for that allegation to the bank’. RBS Chairman, Sir Philip Hampton, called the allegations ‘unsubstantiated’ and ‘anecdotal’. Nevertheless, with a small number of politicians maintaining pressure on the bank, the bank set up a £3-400 million compensation fund for SMEs affected by the practices of the now-infamous Global Restructuring Group (GRG) – the unit within RBS that was tasked with helping SMEs. With politicians demanding that a bigger compensation fund was put together, McEwan was criticised not for his involvement (as the issues within RBS had happened before his arrival), but for having the ‘wrong attitude’ in stating that he was ‘tired of small businesses “badmouthing” the bank’. The result was an all-enveloping drama that may still bring the Financial Conduct Authority to its knees, with the supposed publication of a report into the GRG. Though the FCA originally stated that the report would be made public, it eventually released the report with major sections removed. After pressure from the public and the Treasury Select Committee in particular, the FCA released the report that confirmed that the Unit had indeed been running the firms into the wall for profit, although it did not go as far to attribute absolute criminality. Later revelations have included the remarkable fact that the UK Treasury department was in fact imparting significant pressure and influence to perform such awful practices, which means this saga is nowhere near concluding.

Yet, in April 2019 McEwan announced that he would be leaving the bank, and has this week been announced as the head of National Australia Bank, the country’s fourth-largest bank by assets. McEwan has stated that ‘it is a privilege to return to Australia and lead NAB at a crucial time for the bank, its customers, employees, shareholders and the broader community’. Clearly, he has been brought in to repeat his performance at RBS. However, the question is, looking back, how will McEwan be remembered? The likelihood is that he will be remembered in a number of polarised ways. He was the person at the helm when the bank returned to profitability and the British Government began selling their shares in the once-stricken bank (albeit at a loss on every occasion). Yet, he was also the person at the helm when the truth came to light regarding the despicable practices of the GRG, along with the influence of the Treasury, and his performance during that period was less-than-stellar. Acting negatively towards genuine victims of the bank he represented will not be forgotten, and nor should it be. It is important that a bank is not controlled just as a financial institution because it is not, it is much more than that – in this sense, there is a stain on McEwan’s legacy in that the victims of the GRG need not have been treated, retrospectively, as they were. Getting to know McEwan more has been very much worthwhile, but the larger story of RBS is much more important to understand. We have covered the topic on a number of occasions here in Financial Regulation Matters (here, here, and here) and will no doubt continue to do so. Also, if you would like a massively insightful examination of the bank, you need not look further than Shredded: Inside RBS, The Bank That Broke Britain by Ian Fraser, who can be found on Twitter @Ian_Fraser – which has only recently been updated.


Keywords – RBS, Ross McEwan, Banking, Britain, Business, @finregmatters

Wednesday, 17 July 2019

Potential Railway Reforms Raise Issues

The issue of the British Railway system has taken up a few posts here in Financial Regulation Matters, with the majority being concerned with developments with the HS2 project. However, in relation to yesterday’s post on the concept of ‘capture’, this post will examine a suite of potential reforms that are heading towards the British Railway. In examining the proposals put forward to Government recently, we will look at this potential issue of developing an ‘arms-length’ body or entity, and also the effect of the proposals, which has been to completely ignore the question of nationalisation.

The Government have commissioned a review of the rail system, to be undertaken by former British Airways CEO Keith Williams. This week the first signs of the reform proposals have been released and there are a number of issues the Williams’ Review intends to tackle. The main issue that has been picked up by the media is that a ‘Fat Controller type figure would be key for regaining public trust’. The sentiment is that the public needs to see that there is accountability within the system, with the suggestion that a body needs to be created that may be similar to the Strategic Rail Authority that existed in the early 2000s. Williams has identified that the Department for Transport (DfT) is too involved in the rail network system, so much so that the DfT has been specifying which trains stop at which stations. To fix this and other issues, Williams has focused on five key areas, including ‘a new passenger office, simplified fares and ticketing, a new industry structure, a new commercial model, and a range of proposals on leadership and skills diversity’. The Government has suggested these proposals will lead to the ‘most significant [review] since privatisation’, although Unions have been quick to make the point that the review has ‘ducked the issue of public ownership’, and that Britain is in urgent need of a railway that ‘delivers reliable, affordable and environmentally sound transport to communities across the country’. The Unions also suggest that support for Nationalisation is increasing, and that is based upon statistical evidence that suggests that ‘punctuality across Britain sank to a 13-year low in 2018, with one in seven trains delayed by at least five minutes’. With it being the case on a number of routes that it is cheaper to fly than travel on the rail system, it is not surprising that nationalisation is looking more appealing. This is on top of the fact that companies (Virgin) have been complaining about the tendering processes for a number of key routes, which in effect puts the DfT at the centre of the rail system’s issues once more.

The reality is that the DfT has created such ‘quangos’ before, with little effect. The claim is that such elements were the foundation for future evolutions towards an arms-length entity, but it is questionable whether that would even work. The potential for capture increases, whilst the penalties for underperforming have not been suggested – it is all well and good creating accountability, but to what end? There is also the obvious question of whether a full nationalisation of the system i.e. a return to ‘British Rail’ is the best way forward. Whilst bringing the train companies under governmental rule may sound appealing, the question then comes of whether the appropriate amount of funding would be directed towards the system, or whether competing pressures would take precedence, like education. It remains to be seen whether the establishment of an arms-length body would work, both in terms of effectiveness and maintaining an independence from Government, but it is clear that reforms are needed.


Keywords – Railways, UK, Business, @finregmatters

Tuesday, 16 July 2019

The Economic Crime Strategic Board and the Concept of “Marasmus”

Here in Financial Regulation Matters we have covered the concept of ‘capture’ from a number of different angles, including the audit, banking, and tobacco industries through to the concept of ‘public private partnerships’. Additionally, we have also looked at issues relating to money laundering, and economic crime more generally. It is for those reasons that the recent news that the British Government have put in place a number of plans to tackle the systemic issue of economic crime within the country – with London being consistently rated as one of the world’s leading economic crime ‘hotspots’ – is worth examining. Yet, rather than this being the headline, there is a glaring issue that the media have been quick to focus upon. The Independent’s headline neatly sums up the story: “Government criticised for giving banks key oversight role over fraud and money laundering”. So, in this post we shall examine these developments and analyse the theory of ‘capture’ a little more.

The Economic Crime Strategic Board was established by the British Government in January 2019 and exists to ‘set priorities, direct resources and scrutinise performance against the economic crime threat, which is set out in the Serious and Organised Crime Strategy’. Sajid Javid stated that ‘we need to take action on all fronts to target the corrupt fraudsters’, whilst Philip Hammond declared that ‘the UK is leading the world in the fight against illicit finance, preventing fraudsters from stealing billions from the public each year’. That claim is easily countered by the fact that London is a laundering hotspot on the global scene, and also that the Government itself admits that economic crime costs the British citizenry at least £14.4 billion a year (which will be a remarkably low estimate in reality). To counter this global and multi-billion pound threat, the Government has allotted just £48 million over 2019 and 2020, which it suggests will ‘further ramp up law enforcement capabilities to specifically tackle illicit finance’. Bob Wigley, the Chair of UK Finance – the country’s leading financial lobbyist – stated that the ‘private sector can’t tackle [the issue] alone’ and was therefore grateful of the governmental assistance. Whilst the stated aims of the governmental ministers can be easily recognised as what they are – lip service – the media’s focus is worth considering also.

The media have chosen to focus on the inclusion of HSBC, RBS, Barclays, Morgan Stanley, and UK Finance on the Board, citing Conservative MP Kevin Hollinrake who stated that ‘it is also worrying that the members of the body charged with the responsibility for this… includes the CEOs of the major banks’. The first point to deal with is that the Government were clear on their approach, with the announcement including the line in the first paragraph that ‘The Home Secretary and Chancellor will… jointly chair a new government taskforce which will work with senior figures from the UK financial sector to tackle economic crime’. So, whilst the accusations of ‘corporate capture’ are correct, they are not a secret. Furthermore, whilst interested onlookers have commented that ‘it portrays the banks effectively as victims rather than potential perpetrators of economic crime. Clearly, they are both’, the reality is that there have been very little suggestions of alternative solutions being offered, just criticism. It is surprising that a. people expect the Conservative Government to do anything other than work directly alongside private interest whatever the cost, but also b. that there is a suggestion that anything else can work. It would be interesting to ask these same people what they suggest would be the best way forward in terms of personnel. Yet, there is a concept in the literature that makes another point and which transforms the discussion.

In discussing the genealogical history of the study of ‘capture’, Professor William J. Novak tells us of how the famous proponents of the concept – scholarly giants such as George J. Stigler – have their base in the theories developed by Samuel P. Huntington, a young Harvard Government instructor advising the Interstate Commerce Commission in the 1950s. In relation to railroad intervention within ICC policies, Huntington described a story of agency decline and ‘marasmus’, which Novak tells us is a ‘biological pathology featuring a gradual and continuous wasting away of the body from a morbid cause’. It is important to note this ‘morbid cause’, because the decline is therefore not a naturally occurring instance, as Novak continues ‘Morbid cause was key here, for it was not just time or desuetude or inertia that contributed to this peculiar regulatory disease. Rather, Huntington proffered a more distinct and direct cause, that is, the infectious influence of pervasive railroad interest in almost every aspect of ICC policymaking’. Huntington’s suggestion was that a regulator must be independent, and if that objectivity is no longer there, then there is little point having a regulator. Novak discusses how the field that is interested in regulatory theories and their effects essentially came to a conclusion that little could be done, and it is difficult to move that line of reasoning forward. We know that institutions like this Strategic Board are primed for capture, and we currently exist within an environment where Governments are not even discreet with the fact they are captured. Interestingly though, onlookers have also bemoaned the lack of development in terms of corporate liability, with the antiquated notion that a ‘directing mind’ needs to be evidenced in order to criminally charge a company and/or person being targeted as proof of a lack of will to really challenge economic crime – proponents of this argument suggest that a ‘failure to prevent’, like that seen in bribery and tax evasion cases, should be expanded to more economic crimes. Which leads to another issue – are we focusing on the entirely wrong aspect of the fight against white-collar crime?

It seems that ‘we’ are, and that ‘we’ represents the general consensus. It is not, by a long way, the universal view. In fact, many have already confined regulators like the FCA, the FRC, this new Board, and many other regulators to the classification of ‘captured’. Under Huntington’s thesis, they should technically be wrapped up and discarded, as they clearly no longer serve their original mandates – the FCA’s behaviour regarding RBS and the GRG unit is a clear example of this. However, if we discard regulators, it will be pointless replacing them with more regulators. Perhaps then the key lies in the equalling of penalty for Blue and White-collar crimes. By increasing the capability to charge and prosecute individuals within companies, and then penalising them to the same extent that ‘normal’ criminals are penalised, would serve to alter corporate behaviour. If a CEO of a bank, let us say, was pushing poor practices in the pursuit of short-term gains and executive compensation for example, but the potential penalty was 15, 20, or 25 years in Prison, would the banking CEOs be so bashful in their pursuit of profits? Certainly not. What that does, however, is raise the question of why this currently is not the system. Is it because those in positions of power are usually from privileged backgrounds? Is it because they tend to come from the same backgrounds as the political and legal elite? Is it because, essentially, the political, legal, and business elite are all the same people generally speaking? If the answer is ‘yes’ to any of those questions, then there is no solution on the horizon. Understanding that makes the headlines regarding ‘corporate capture’ as empty as the statements regarding the need to battle economic crime, unfortunately.


Keywords – economic crime, capture, banks, business, UK, @finregmatters

Tuesday, 9 July 2019

The National Trust Becomes the Latest to Ditch Fossil Fuels

The National Trust, the UK and Europe’s largest conservation-based Charity, has this month declared that it will be divesting from all of its fossil fuel investment positions. Even though the investing in these positions is an important part of the Trust’s investment strategy, it has decided that the Oil, Gas, and Coal industries’ movement into greener technologies has not been quick enough, nor extensive enough. In this post we shall look at the Trust and its investment strategy a little closer, and position this recent movement against the backdrop of an increasing shift away from fossil fuel investment.

Founded in 1895 and given statutory powers by the National Trust Act 1907, the National Trust has a number of clear mandates. According to the 1907 Act, which has been updated several times since, the Trust exists to promote ‘the permanent preservation for the benefit of nation of lands and tenements, including buildings, of beauty or historic interest, and as regards lands for the preservation, so far as practicable, of their natural aspect, features and animal and plant life’. This societally vital aim has led to the Trust becoming the leading conservation-based charity in the UK and Europe, and sees it conserving nearly 800 miles of coastline, nearly 250,000 hectares of land, over 500 historic houses, castles, ancient monuments, parks and nature reserves, and close to one million objects and works of art. With more than 5 million members, the Trust has grew into a financial powerhouse with its decisions carrying great weight within the investment arena.

As a result, its £1 billion investment portfolio and the way it is invested, makes the headlines. Last year, The Guardian reported that the Trust, despite its conservation-based mandate, had invested more than £30 million into companies such as BP and Shell. This past week, however, the Trust has declared that it is starting a period of divestment from the fossil fuel industries, with the vast majority of that divestment plan expecting to be completed within 12 months and the entirety of the plan to be completed within 3 years. Whilst recognising the need to grow the investment pot in order to provide the resources required to meet its mandate, the Director General of the Trust, Hilary McGrady, stated that ‘the impacts of climate change pose the biggest long-term threat to the land and properties we care for, and tackling this is a huge challenge for the whole nation’. In line with this aim, the Trust announced that it was making a renewed push in investing in Green start-ups and portfolios that benefitted nature. The Trust’s Chief Financial Officer did acknowledge that fossil fuel companies were investing in renewable energy, but that ‘after decades’ worth of lobbying not enough has been done by the oil and gas companies, and for that reason we’re looking to withdraw our investment’. The divestment is notable in that it is the Country’s largest conservation-based charity that is divesting but, in reality, the Trust only holds less than £50 million in investments within the sector.

However, this is just one more part of a growing movement. In 2015 the Church of England and its Ethical Investment Advisory Group began divesting from the sector, while earlier this year Norway’s massive $1 trillion sovereign wealth fund announced that it would be moving towards investing in renewables rather than Oil and Gas. According to The Independent, Insurers are making real waves in the sector having pulled more than $3 trillion in recent years, with further Insurers lining up not only to pull their own investments, but to stop the underwriting of fossil fuel-related projects, such as coal-fired plants. Couple this with the developments within the PRI (Principles for Responsible Investment) and the recent adoption of the Poseidon Principles, as was discussed recently here in Financial Regulation Matters, then the picture of the near future is an increasingly green one. It would be extraordinarily premature to suggest that such a powerful and well-resourced industry is likely to disappear anytime soon, or even bow to the pressure and make a concerted move into the renewable marketplace, but the tide is ever-so-slowly turning. As for the National Trust, it is positive that it seeks to align itself with its mandate, but also the general will of its membership. The Trust signifies a crucial element within society, in that it is vital that we preserve both the wildlife and nature that we have been afforded, but also the history of the country and the many beautiful and fascinating objects and monuments that are in the UK. Whilst preserving the investment pot in order to allow the Trust to do that is important, reducing the negative impact that climate change will have on that same wildlife and cultural history is far more important.


Keywords – National Trust, Investment, Business, UK, @finregmatters