BRITAIN:Regulatory reforms in the UK are still being drawn up but at their core is the aim of bolstering the system should banks collapse, writes MARK HENNESSYLondon Editor

THE ROMAN Empire suffered a banking crisis in AD 33 during the reign of Julius Caesar, prompting the “fall of rank and reputation”, as European Central Bank governor Jean-Claude Trichet put it earlier this year, as private wealth was destroyed. In the end, Caesar ended the crisis by injecting 100 million sesterces into the empire and allowing people to borrow without charge for three years, provided they put up land worth twice the loan as collateral.

In the United Kingdom, the treasury is preparing for the next collapse but praying that it will not happen. Earlier this month, it produced a document detailing the special administrative regime for investment firms that would come into place as soon as a Lehman’s-style collapse is threatened. The Conservative/Liberal Democrat government is readying itself to transfer regulatory powers back into the Bank of England from the Financial Services Authority (FSA).

The existing Insolvency Act 1986, while generally robust and flexible, is insufficiently powerful to cope with a repeat of Lehman’s, which had 240 subsidiaries and a web of interconnecting assets and liabilities, the treasury believes.

Under the proposed Suspicious Activity Reports (SAR) regime, administrators would keep fully detailed lists of a company’s assets and obligations to provide “clarity and direction” without having to run daily to the courts.

Second, it would give a bank’s clients and others tied to the bank’s survival “greater confidence in the administration process and therefore reduce the impact of an investment firm insolvency on the stability of the UK’s financial systems”.

The new powers can be introduced without the need for fresh legislation under provisions previously contained in sections of the UK’s 2009 Banking Act – though that is something that must happen before February next year.

Some of this work is already happening, says Mike Jervis of PricewaterhouseCoopers, who says British banks have been “more co-operative” than their US equivalents towards the idea of so-called corporate “living wills”.

Jervis, a veteran of the Enron collapse and now dealing with Lehman’s legacy, says “living wills” – where the company’s secrets are clearly detailed, along with the identities of directors responsible for each – “would have been fantastic” as people struggle with “the chaos”.

Intent on reversing some of the changes made in 1997 by Labour’s Gordon Brown as chancellor of the exchequer, Conservative George Osborne now intends to return to the Bank of England regulatory powers that were taken away and given to the FSA.

Under the Osborne plan, the FSA would be abolished by the end of 2012, with control of day-to-day banking oversight and regulation given to a new body inside the Bank of England called the Prudential Regulation Authority. Oversight of what are termed “business-conduct issues” are destined to go to a new Consumer Protection and Markets Authority.

To Osborne’s eye, the changes would allow regulators to co-operate more closely as they seek to identify storm clouds ahead, but not all are convinced. Recently, the chairman of the FSA, Lord Adair Turner, said the splitting of functions will cause new problems as regulators seek to ensure banks have enough capital and liquidity to carry out their business properly and sensibly.

“While the new structure will resolve problems created by the present division of responsibilities between the bank and the FSA in the prudential arena, it will inevitably create new problems between the Prudential Regulation Authority and the Consumer Protection and Markets Authority in the several areas where the distinction between prudential and conduct issues is not clear cut,” Turner told a City of London dinner recently.

London School of Economics banking expert Dr Tom Kirchmaier said he had always been a critic of the proposed FSA changes. “They have to show what the benefits will be. Regulation by two parties? What is the regulatory model? If they are different, there is complete confusion. If they are the same but carried out by two different groups of people, then there is chaos.”

Some of the difficulties possible in the future in the UK will have been eased by the international Basel III Agreement, which orders banks and financial institutions to keep much more capital on hand, but Basel III has its flaws. “Basel III is good, but it got watered down in the political process,” said Kirchmaier. “But it is a much better outcome in my eyes, it is not perfect but it is much better to allow banks to have much bigger buffers. Rules and regulations can be circumvented.”

Besides the treasury’s SAR plans and Osborne’s Bank of England plans, the UK financial services industry also awaits the outcome of the Banking Commission report due next year.

This will focus on whether banks should be forced to split their retail and investment banking operations – with the industry already lobbying furiously against such a move, warning that institutions would flee the City of London in retaliation.

Kirchmaier is not alone in believing that the Banking Commission will pull punches, though such an outcome would create difficulties within the Conservative/Liberal Democrat coalition because the junior partners in government – particularly business secretary Vince Cable – have long campaigned for an end to “casino banking”, where investment banks chase super profits on the markets.

“I think it will be kicked into the long grass. My suspicion is that the banking commission will follow the US Volcker rules: no proprietary trading, no investment in private equity or hedge funds, but it will not go further than that.

“The interesting thing for the banks is investment banking, not retail banking. They need the deposits, but they make the money from investment banking.”

Top-level executive changes in HSBC and Barclays, where Stephen Gulliver and Bob Diamond have recently taken over as chief executives of the two respective organisations after running the banks’ investment banking operations, are a clear sign the industry will protect its turf. It will threaten to quit the City of London if they do not get their way, regardless of the opinion elsewhere.

Presenting the interests of the City recently, the City of London Corporation acknowledged that rules had to change, but insisted that the measures could choke off risk-taking if they went too far: “Companies going bust is not capitalism failing; it is capitalism working.”