Shocking news in the UK has caught regulators with their pants down with the sudden discovery of a rogue trader Kweku Adoboli, who hid trades that cost the Swiss bank UBS in London the sum of $2.3 billion resulting from improper sales of loan insurance. As a consequence of this scam, UK banks have voluntarily set aside more than $16 billion to compensate consumers. This comes hot on the heels of recent claims that the financial regulator does not adequately protect the consumer.

Students of regulatory sciences in Malta may be wondering why MFSA (a single financial regulatory model) is still in existence when, as a result of recent financial mishaps both locally and more so overseas, governments have pushed for reform.

In brief, the article will present a case for splitting the MFSA into two authorities –one harnessing the prudential regulatory function and another entity having separate management to oversee the financial conduct of regulated bodies. Having all the eggs in one basket comes at a price. Just consider the onerous responsibility the MFSA has for the direct supervision of all regulated firms (including banks, insurance and SICAVs). This includes both prudential and conduct of business purposes and, at the same time, have the duty to take remedial and timely enforcement action against firms where it identifies regulatory failures. One of the main drivers which push the way for this reform is that the split authorities will be more willing to make judgments over whether banks’ or listed funds’ business models or financial products pose a risk to financial stability or are likely to cause consumer detriment.

The split MFSA can use its supervisory powers to intervene early. For example, in the UK, with its mighty financial industry sector, had until recently boasted a single regulator − the so-called FSA. Unfortunately, due to a number of financial scandals that have surfaced since 2008, one can be excused for blaming the government and to point fingers to a delayed reform of the single regulator. Nevertheless, the blame cannot completely fall on the FSA, which, with its light-touch approach to regulation is now viewed as inadequate and the coalition government took a decision to change its structure. The monolithic structure is to be unceremoniously split into two entities: the Prudential Regulatory Authority (PRA) and the Financial Service Authority will be rebranded as the Financial Conduct Authority (FCA) with three areas of responsibility. The first is conduct of business supervision of banks, insurers and major investment firms followed by prudential and conduct of business and markets supervision of all regulated firms not falling within the remit of the PRA, and finally the enforcement (although it is important to note that the PRA will have the same powers as the FCA to impose penalties and fines for regulatory breaches).

As from April this year, the FSA began to replicate the proposed roles of the Prudential Regulatory Authority and the Financial Conduct Authority; the two agencies set to replace it next year. It will subject banks, insurers and major investment firms to separate regulation for prudential and conduct purposes. The new regulatory structure intends to accelerate its move towards a bolder, more proactive and intrusive approach to regulation. The Financial Services Authority (FSA) will soon cease to exist as the UK’s sole financial services regulator. The so-called “twin peaks” model to be adopted, referring to the split between conduct and prudential regulation, will create two new supervisors for regulated firms.

Now that the government in Malta is in caretaker mode, it is not the ideal time to contemplate any major changes in the regulatory model, but again we cannot hide our heads in the sand and ignore important reforms that are taking place overseas.

During the three-month period until the election on 9 March next year, political parties ought to strengthen the financial services industry by including such a reform in their manifesto. It is opportune to look deeper into how our consumer protection unit within MFSA can improve its services particularly in the light of the La Valette property fund debacle (among others). In such an occurrence, local consumers lost millions when the fund collapsed. One may question how, with all the regular monitoring of banks by MFSA, this scandal could possibly happen and took two years of ad hoc investigation to reveal the true picture. Can the solution be that our financial super regulator humbly borrows a leaf from FSA’s book and split itself into two autonomous parts. One part to focus on regulated business and another as a separate independent entity responsible for consumer protection. Never was the time so ripe than today to redeem past grievances suffered by La Valette bondholders and others who were lured by BOV to buy into Lehman Brothers perpetuals. Observers shower them with sympathy when they pitched battle against unimaginable odds to voice their meagre protest to scale the steely bastions of managers cosseted in formidable banking institutions. Silently they lamented about the feeble protection given by regulators.

To give a brief background on the La Valette Multi Manager Property fund collapse, one can remind readers that it went bankrupt and its units unceremoniously suspended in August 2008. Really and truly it was a subsidiary of Bank of Valetta which invested in high-risk sub property funds that went mysteriously up the creek leaving a black hole of about €50 million. BOV acted as its custodian and issued clean bill of health on its four year tenure while reputed to have earned a cool €7 million in fees.

Early last year, Bank of Valetta (without assuming responsibility for any wrongdoing) accepted to pay aggrieved unit holders a percentage of their investment on a take-it-or-leave-it final offer (this was grudgingly accepted by the majority). This change of heart by BOV resulted mainly after court action was instigated by investors helped by their leader Mr Bonello, himself a managing director of Finco Trust Group (a licensed investment adviser). Following a partial settlement of their losses investors aided by Mr Bonello are insisting for an explanation to be given on how the regulator reached his conclusions when investigating the collapse. Particularly, they allege there was insider information used by top BOV staff when they cashed €16 million in bonds weeks before the fund collapse. The plot thickens when one recalls that the long awaited investigative report took two years to reach its conclusion and was never published by MFSA. It is a paradox how the bank had knowledge of its conclusions and promptly declared triumphantly that its staff was exonerated of using confidential information to redeem their holdings in the property fund before it was suspended. None offered to resign. Finco insisted that, although the regulator investigated BOV staff and people connected to them, it did not adequately probe redemptions made by “favoured clients” who may have been allegedly tipped off by bank officials.

All this begs the question − is the consumer adequately protected by MFSA when there are alleged rumours that ordinary investors with no financial experience were persuaded to buy sophisticated financial products of high risk. It is a paradox how in a small island where everyone in the business community knows each other and it is very easy to check whether abuse of miss-selling took place yet the regulator’s report on this aspect took ages to be finalised.

Back to the issue of insider knowledge, one discovers that a board director at La Valette Sicav admitted having prior knowledge and redeemed over 75,000 units ahead of closure date and was reprimanded. Recently, the bank was again fined €175,000 in respect of regulatory breaches related to Lehman Brothers financial products which it sold .The final investigation is being conducted by local audit firm Mazars (directly appointed by MFSA without a tender) which is checking applications for any incorrect selling of the fund to inexperienced investors.

Is investor protection being assured at the highest levels? Perhaps it is not ostentatious to copy the UK prime minister proposing the splitting of the FSA to assure better surveillance especially where banks and funds industry are concerned. A split MFSA branching into a muscled consumer protection unit could be headed by a specialist (not unlike the expatriate who’s running Air Malta) in a pragmatic way to fend off potential future miss-selling scandals.

It comes as no surprise that reform in Malta is sorely needed to weed out inherent weaknesses in investment banking regulation. This is not a revolution but an evolution which can see new faces (please not regurgitate the usual muzzled political appointees with multiple conflicts of interest) but fresh blood that will start anew to face the challenging times that regulated bodies and their investment arms are facing.

It is clear that splitting MFSA into two regulatory bodies will be pro-active, faster and tougher in their regulatory approach. However, it remains to be seen whether the rhetoric used when describing these aims and intentions will be reflected in manifesto of political parties eagerly vying for votes next year.

A Merry Christmas to all readers.

The writer is a partner in PKF an audit and business advisory firm

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