Last year, the unexpected discovery of a rogue trader at the Swiss bank UBS, by the name of Kweku Adoboli, who concealed trades that cost its branch in London the sum of $2.3 billion resulting from misselling of loan insurance, was shocking news indeed. As a consequence, UK banks had voluntarily set aside more than $16 billion to compensate consumers after mounting pressure in the media created the perception that as a result of such scams the general public is not adequately protected notwithstanding the overlay of financial and banking regulation. This, and a series of market failures, persuaded the UK authorities to separate regulation from monitoring of banking operations.
To give some background to the story, the UK with its impressive financial services sector had, until recently, a single regulator called the FSA. Unfortunately, due to a number of financial scandals that erupted since the onset of the recession in 2008, one can be excused for blaming the government for not reforming the unitary regulatory structure and maintaining the status quo. Nevertheless, to be fair, the blame cannot be entirely placed on the FSA, which, with its light-touch approach to regulation is now viewed as inadequate. On 1 April, its monolithic structure was split into two entities: the Prudential Regulation Authority (PRA), and the Financial Conduct Authority (FCA).
The Prudential Regulation Authority (PRA) is part of the Bank of England and responsible for the prudential regulation of banks, building societies and credit unions, insurers and major investment firms. As prudential regulator, the PRA will promote the safety and soundness of these firms, seeking to minimise the adverse effects they can have on the stability of the UK financial system; and contribute to ensuring that insurance policyholders are appropriately protected.
The Financial Conduct Authority (FCA) is responsible for ensuring that relevant markets function well, and for the conduct regulation of all financial services firms. It is also responsible for the prudential regulation of those financial services firms not supervised by the PRA, for example asset managers.
A third new body, the Financial Policy Committee, which reports directly to the Bank of England, is able to force banks to cut lending to certain sectors to relieve systemic risks building up in the economy. Starting from last year, the FSA began to split its combined roles to a “Twin-Peaks” model and from 1 April started subjecting banks, insurers and major investment firms to separate regulation for prudential and conduct purposes. Simply put, one can say that the new model involves the split between the aspects of conduct and prudential regulation and created two new supervisors for regulated firms.
Back in Malta, the new Labour government is still in its 100th day (reform mode) and some may argue that this may be an ideal time to contemplate changes in the MFSA regulatory model, as ignoring it will be unsafe and the government cannot continue to ignore important reforms that are occurring overseas. Students of regulatory sciences in Malta may be wondering why MFSA (a single financial regulatory model) has not yet followed the lead taken by FSA in UK considering recent financial mishaps both locally and abroad. In brief, this article will argue the case for gradually 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.
Placing all eggs in one basket comes at a price: just consider how the MFSA has an onerous responsibility for the direct supervision of all regulated entities (including banks, insurance principals and intermediaries, all listed funds, Sicav’s etc). This encompasses overseeing both prudential and conduct of business and at the same time taking remedial and timely enforcement action against licensees where it identifies regulatory failures. One of the main drivers that hasten the way for this reform is that the split authority will be more able to make timely judgments on regulated bodies offering risky financial products, which pose a risk to financial stability or are likely to be of detriment to consumers.
A “twin peak” MFSA can use its supervisory powers to intervene earlier rather than later, as past experience has shown in the La Valette units where local consumers lost millions when the fund was abruptly suspended. One may question why, with all the regular monitoring of banks by MFSA, this sudden collapse could possibly happen and moreover that it took two years of ad hoc investigation to reveal the true picture. Can the solution be for our financial super regulator to borrow a leaf from FSA’s book and methodically 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 has the time be so right as today to atone for past grievances suffered by La Valette bond holders and others who were advised by Bank of Valletta to buy into Lehman Brothers perpetuals (the latter were never compensated).
Observers shower La Valette bond holders with sympathy when, under the leadership of Finco Trust, they pitched a legal battle against unimaginable odds to voice their protest and try to scale the steely bastions of managers cosseted in formidable banking institutions. Privately, they lamented on the feeble protection given by regulators. Many commentators have written in the past about the La Valette Multi Manager Property fund collapse –yet one can remind readers that it went bankrupt and its units abruptly suspended in August 2008. Really and truly, it was a subsidiary of Bank of Valletta (BOV) which invested in high-risk sub property funds that went mysteriously up the creek leaving a black hole of about €50 million even though at the time BOV acted as its custodian and issued a clean bill of health over its four year tenure while reputed to have earned a cool €7 million in custodian fees. The saga was diffused two years ago when Bank of Valetta (without assuming responsibility for any wrongs – none of its Mandarins offered to resign) accepted to pay aggrieved unit holders a percentage of their investment on a take-it-or leave final settlement offer which 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 Paul 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 (recently appointed by the government chairman of Malita spv) are insisting on compensation to be given for interest forfeited on investment aided by the fact that the regulator fined Bank of Valletta for a number of breaches. Particularly, they allege there was insider information that availed of by top BOV staff when they cashed €16 million in bonds weeks before the fund collapsed. The plot thickens when one recalls that the long awaited investigative report that took two years to reach its conclusion was never issued for public scrutiny by MFSA.
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 ranked as high risk? It is perplexing to know that Malta, as a small island, where everyone in the business community knows each other and it is very easy to check whether abuse of misselling takes place it had to be the legal protest by unit holders that alerted the regulator. Incidentally, the same bank was fined €175,000 in respect of regulatory breaches related to Lehman Brothers financial products mentioned earlier.
Finally, MFSA appointed Mazars to examine the list of applicants and classify those who were inexperienced and any such applicants were further compensated capping the total refund at €1 each unit. This begs another question: is investor protection being assured at the highest levels? In our case, a split MFSA would introduce a muscled consumer protection unit ideally headed by a specialist to fend off potential future misselling scandals. In conclusion, in the shadow of the Cyprus banking crisis and to ward off criticism by EU columnists pointing to our inherent weakness of having a large financial services sector compared to GDP (particularly highly leveraged investment and private equity banks), action speaks louder than words. It is clear that keeping the status quo is not an option, but of course while any reform has to be carried out expeditiously there should first be a full consultation process with all stakeholders.
[email protected]
The writer is a partner in PKF an audit and business advisory firm