A quick fix for the failed experiment of FSA financial services
regulation...
AS I WAS READING of yet another spectacular mismatch between
bank managers' competence and their remuneration, and this time at JP Morgan
no less, I realised that there is a simple solution which really could be
implemented, writes Paul Tustain, founder and CEO of BullionVault.
My poor old Dad was what they now call an 'investment banker'. His firm got
it wrong by expanding business into the 1970s' slump, and when it went wrong
the Official Assignee took everything he owned. That was in the days when
partners had joint and several liability, which meant that all the top
management of a firm were personally liable for the entire debts of their
business. In those days the regulator was judicious self-interest, exercised
by the partners themselves.
Joint and several liability quickly weeded out the incompetents, the gamblers
and (which I like to think he was) the unlucky. It made managers look very
carefully at their colleagues' strategies, and concentrated everyone's
efforts on controlling risks, rather than seeking bonus-building nominal
profits.
The approach was discarded in 1986 after 150 years of pretty effective
operation. It wasn't perfect (what is?) but we were all very stupid to think
we could do better by replacing the natural damper of direct personal
liability with a combination of salaried and bonused managers, and sixty
thousand pages of regulations.
I realised this morning that FSA regulation of financial services has become
so onerous and so unsuccessful at loss prevention that joint and several
liability could easily be re-introduced. All it would need would be a
subsidiary FSA set up exclusively for the regulation of investment businesses
run by unlimited liability partnerships.
Lots of reputable financial professionals do not get big bonuses, because
they work competently in the low-risk, low-return areas of the industry. Yet
within FSA there are so many complex rules that even these firms have to
employ more compliance officers than accountants, while at the same time
funding the wretchedly unfair Financial Services Compensation Scheme, which
is a bit like being forced to pay for the car insurance of your drunk next
door neighbour.
They should be given the choice of submitting to FSA or choosing a simpler
system, where they put up as collateral their house, their car, their
holidays and their children's school fees, and – within reason – are left to
get on with managing their business risks as they see fit.
Making management collectively liable for their mistakes has lots of
benefits.
- Because partners all want to be able to understand their
whole business it encourages smaller and less systemically dangerous
organisations – ones which are not 'too big to fail'.
- It encourages business formation, something which has ground
to a halt now, because of the huge cost of setting up an FSA-compliant
organisation.
- It forces revenue generators to be more critical about
risks, rather than leaving it to formulae which pass the rules and get
boxes ticked, but do not work in practice.
- It encourages senior management stability and
accountability, and suppresses the job merry-go-round whereby careers
advance by sweeping problems temporarily out of sight and quickly
changing jobs.
- It directly links remuneration to risk, as well as to performance.
- It keeps all prior remuneration still in the
compensation pot, to be reclaimed in the event of future investor
losses.
Our experiment with rulebooks, regulators and
salaried managers has been a bit of a disaster. Maybe a partial return to the
old ways is not such a bad idea.
