The Parliamentary Commission on Banking Standards recently published its report on the failure of HBOS. The commission was clearly appalled by the level of incompetence it had discovered – not only at HBOS itself, but also at the FSA. The title of the report gives an indication of that depth of feeling: An accident waiting to happen: the failure of HBOS.
Ironically the phrase “an accident waiting to happen” was taken from a January 2004 report to the HBOS board by its then Group Finance Director, Mike Ellis. He said that in the view of the FSA, the Group’s growth had outpaced the ability to control risks. The Group’s strong growth, which was markedly different than the position of the peer group, may have given rise to “an accident waiting to happen”.”
Disastrously for all concerned, neither HBOS nor the FSA paid any proper attention to this warning. The accident happened. In September 2008, shortly after the collapse of Lehman Brothers, HBOS failed.
We are still waiting for the FSA’s own report on the failure of HBOS. That delay is in itself a scandal, and is yet another indication of the FSA’s incompetence. In the meantime, we should be grateful to the Parliamentary Commission for its report and the many issues it raises.
Those issues include the incompetence of the HBOS board, and in particular the incompetence of Lord Stevenson, James Crosby and Andy Hornby; the total inadequacy of the FSA; the failure of KPMG, the auditors of HBOS, to spot what was going on; the failure of the FSA to take effective action; knighthoods for incompetence. Then there is the question of whether there should be a Leveson-type inquiry into the collapse of the financial systems in general, including the accountability of the regulators.
True and proper accountability of the regulators has been an issue for years. Note that accountability is not the same thing as having a duty to report on various matters. The Shorter Oxford Dictionary defines “accountable” as being liable to be called to account; responsible (to somebody, for something). And the government is not willing to take responsibility for the regulation of the financial services industry. When the industry was first made subject to regulation in 1988, the system was based on self-regulation. In other words, the various parts of the industry took responsibility for themselves. The task of ensuring that the self-regulatory organisations did a proper job was delegated by the government to the Securities and Investments Board. So the government put two layers of regulators between it and the industry.
Then in 1997 the Chancellor of the Exchequer announced that the system would be changed by combining all the then existing regulators into one: the FSA. The FSA was established by the Financial Services and Markets Act 2000 (“FSMA”) as a body independent of the government, and was “not to be regarded as acting on behalf of the Crown”; and its members, officers and staff were “not to be regarded as Crown servants”. Indeed, except in the case of bad faith, neither the FSA nor its staff could be “liable in damages for anything done or omitted in the discharge, or purported discharge, of [its] functions”. It is difficult to think of a more independent body.
The FCA is the successor to the FSA, and its status as independent of the government and as exempt from liability for damages, except in cases of bad faith, is the same as it was for the FSA. In recent years, much has been said and written to try to persuade the government that the FCA should be made formally accountable to the government, and through the government, to Parliament. All to no avail – despite the evidence of the FSA’s ineffectiveness and incompetence.
There are at least two probable reasons for the government’s refusal to require the FCA to be accountable to it. The first is the simple desire not to be seen to be responsible for things that go wrong. The government was always careful to point out that the FSA was independent, and therefore the government could not be blamed for things that went awry.
The second reason is that if the government were to accept responsibility for a regulator, it would be difficult for it to avoid responsibility for the consequences of a failure of regulation. The Equitable Life case illustrates the point. In about 1999 the FSA became responsible for the Treasury’s regulation of life insurance companies, including Equitable Life. The FSA acted on behalf of the Treasury in that capacity until December 2001, when the FSMA came into force and the FSA acquired its independence. Equitable Life closed to new business in December 2000, due largely to its guaranteed annuity rate liabilities. As the Parliamentary Ombudsman’s investigation showed, the FSA was guilty of maladministration in its prudential regulation of Equitable Life. She recommended that the government should compensate those Equitable Life policyholders whose losses were caused by that maladministration. Eventually, and after much argument in court and Parliament, the government did accept its responsibility and a scheme of compensation was devised and is now being implemented. One of the government’s arguments for not accepting liability for maladministration carried out on its behalf was that it should not have to pay for failures of financial regulation – presumably on the grounds of the potential cost.
It is easy to understand that no government would be happy to accept liability for the serial failures of the FSA since 2001. But surely it is the function of government to regulate those industries whose activities have the potential to cause harm and loss to citizens. And surely the government should stand behind the regulator to make sure that its citizens do not suffer loss up to at least a reasonable limit – as in the cases of bank deposits. It is an incomplete step by the government to set up a system of regulation centred on a regulator which is independent of the government and not generally liable for its failures.
We really are all in this together. The regulators need to be effective, and somebody needs to see to it that the regulators are indeed doing a proper job, and to insist that the regulators, and through them the government, take responsibility for the losses caused by regulatory failure. It goes without saying, of course, that the government should be able to recover those losses from the firms that caused them.
If the Treasury Committee of the House of Commons were to have a formal role in holding the government to account for the performance of the FCA and the other regulators, and if the government were liable for losses caused by regulatory failures, the system of regulation would stand a much better chance of preventing a repeat of the type of serial failures we have seen in the last 25 years. The government would take a much closer interest in developments in financial services, and be more aware of the harm that can be caused by a failure to think things through properly. Misselling would be stopped more quickly. Those who work for the regulators would feel that their jobs were on the line if their failures were to be exposed in public in the way in which the Parliamentary Commission on Banking Standards exposed the failures of Stevenson, Crosby, Hornby and others.
Peter Hamilton is a barrister specialising in financial services at 4 Pump Court and co-founder of moneymatterslegal.co.uk