The Tyranny of Numbers

Criminal bankers, interest rate spikes & mythical holidays

I assume we will be seeing bankers in court, as UK Chancellor George Osborne is set to implement a reform suggested by the Parliamentary Commission on Banking Standards, namely introducing a new criminal offence: “reckless misconduct in the management of a bank”. Pandering to populism, it is aimed at capturing bank CEOs and directors.

But should not our new, state-of-the-art regulatory system be in the dock right now? The prosecuting lawyer would surely argue there was “reckless misconduct in the supervision of a bank” when the Co-operative Group’s bank was rescued last month. After all, there were plenty of warning signs when in 2012 the bank plunged to a £674m loss amidst almost £470m in write-downs due to commercial property loans acquired via a takeover in 2009.

And why restrict the accusation to financial services? I can envisage “reckless misconduct in the management of a nation’s health” which would apply to all junk food company CEOs.

The list of company directors accused of “reckless misconduct” could be as endless as it would be pointless.

Watching Quentin Tarantino’s classic Pulp Fiction the other night underlined how anaesthetised we have become to violence. Released in 1994, it was a byword for violence. Now, in 2013, it appears endearingly quaint when compared to the blood-spattered Call of Duty: Black Ops II and other ghastly video games played by teenagers.

In a similar fashion, we in the West have become inured to low interest rates and a negative return on savings. We are assuming a few years of them – witness the market panic when the Federal Reserve suggested mid-June it would soon taper off its stimulus programme of buying government securities.

New UK Governor Mark Carney is expected to give guidance next month to push UK rates lower. Interest rate markets currently estimate the first rate increase for 2015, not late 2016, which was their May forecast.

However, say the US economy accelerates faster than expected and the Fed eases off its quantitative easing in line with new circumstances. Sterling plummets. Might not Carney be forced to raise rates unexpectedly early in order to combat a sterling crisis?

Black Ops II would be nothing compared to the carnage unleashed then.

Leadership is about taking decisions without the evidence to back them up.

At a recent Pi Capital event, Lord John Browne, former Group Chief Executive of oil company BP, voiced concern about the current culture of “evidence-based decisions.” He noted that we live in an age of data overload, which leads to an unhealthy reliance – a decision appears to almost “make itself” based on the facts. Most great leaders have made judgements which appeared irrational at the time, with wartime hero Winston Churchill and steel magnate Andrew Carnegie among classic examples.

German philosopher Friedrich Nietzche was right to warn about the “continual falsification of the world by means of numbers.” His words two centuries ago are even more true today due to what Professor Christopher Coker calls “the unstoppable onwards march of mathematics.” Even when the limitation of numbers is shown up – viz risk systems and the financial crisis – the belief system continues.

Boardrooms are often populated by those who hold unconditional faith in numbers, a delusory substitute for religion, most of which at least admit that God’s plan is a mystery.

Two Prussian military commanders, Carl von Clausewitz and Helmut von Moltke, understood the self-contradictory absurdity of scheduling the movement of divisions and battalions in carefully calibrated master plans. The former admitted that the very nature of interaction is bound to make war unpredictable, while the latter put it in a rather more down to earth way by remarking that “no battle plan survives contact with the enemy”.*

The language of the Boardroom is increasingly financial. Yet the world does not operate according to a mathematical formula. In Non-Executive Searches too much emphasis is placed on all board members having deep financial skills, be this a career in finance or an accounting qualification. This is often at the expense of imaginative, creative thinkers, with careers that probably will not include the initials “CFO”. They are often women. There is no arguing that financial skills are crucial in a number of key roles, such as Chair of the Audit Committee; however a partner in a law firm in charge of Competition and Antitrust, or the head of marketing at a multinational may provide other relevant skills to the team.

Financiers formed the majority of the board of Royal Bank of Scotland in 2008. They were of little use in halting its downfall. Diversity is more than just a politically correct catchphrase.

Conventional wisdom in this country has it that southern Europeans are always on holiday. Discussing the topic recently with various Spanish and Italian compatriots who now live in London, we grasped that this was a myth.

In Spain, holidays consist of a week at Christmas, a week at Easter and a month in August, with a few days off in between for Saint’s days. In London – and even more so in the City – they consist of two weeks at Christmas, half term in February, three weeks at Easter, half term in May, half time over the month of June between all the social events like Glyndebourne, Wimbledon and Henley, a why-don’t- we-deal-with-this-in-September attitude in July followed by the month of August off, and capped by two weeks of half term in October.

Robinson Hambro, as an enterprising Anglo-Spanish boutique, is never on holiday.

*Warrior Geeks by Christopher Coker, a fascinating tour d’horizon on the changing face of war and its philosophical underpinnings.

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Where power now resides

Banks & the three p’s: press, public and political opinion

Guests at the Lorünser Hotel in Zürs pay the equivalent of the value of a “small car” for their stay, in the words of a former senior partner of Freshfields Bruckhaus Deringer, a prestigious international law firm. Yet the hotel, built in 1927 in the Austrian Alps, lacks the glamour associated with the Palace Hotel in Gstaad or the Grand Hotel du Cap in Cap Ferrat.

What distinguishes it is the combination of the gemütlichkeit atmosphere, excellent service and unchanging guests. The same families stay during the same weeks every year; sojourn in the same room; sit at the same table in the dining room. The only variables are due to births, deaths and divorce.

Rumour has it that some guest pregnancies are carefully planned to ensure the birth does not interfere with the traditional room allocation. Undoubtedly the same applies to some divorces. For beware if you cancel, say, your family’s traditional Christmas booking for four rooms. Next Christmas you will find there is no room at the Inn. If you are lucky, two years down the line you are allowed back in to a set of rooms overlooking the road, while your assigned dining table is now in Siberia.

He who pays the piper calls the tune is a saying that does not apply to a number of family-run hotels in the Arlberg region of Austria. Power resides in the third generation owners, not the paying guests.

I could gripe that it wasn’t like this in the days when my grandfather stayed at the hotel. But then power is not static, be it in hotels, geopolitics or finance. The winners are those that adjust to the new regime, rather than moaning about it and harking back to the good old days.

The financial and economic crisis has shifted power in financial services, among other sectors. Here are two issues where this is relevant: sovereign ratings and banks.

Ratings – Reform of the rating industry has foundered, even as opinion is unified in blaming the big three (Standard & Poors, Moody’s and Fitch) for their major contribution to the financial crisis through their misguided AAA ratings of packaged subprime mortgages. An excellent recent Financial Times article however, failed to point out that their power has substantially decreased, most obviously when it comes to the impact of their sovereign ratings.

The UK is under warning from the agencies that it may lose its triple A ratings this year. Chancellor George Osborne has – counter-productively for the Coalition – insisted this matters. In truth, when it likely happens, there may be a blip in government debt prices, but this should be short-lived. France already experienced its downgrade last year, as did the US, which is rated AA+ by S&P. Neither saw interest rates rise. Only a downgrade to junk would be a different matter.

Why? There is a combination of circumstances. Investors are relying more on their own models. Some have lowered their investment criteria from triple A to investment grade, not least because countries with triple A ratings are becoming an ever smaller minority. Long term overseas holders such as the Chinese government or the Norweigan oil fund are becoming more important and they are constrained in their choices of where to place huge funds with ample liquidity.

Banks – Bankers would tell you their license to operate in a country is granted by a regulatory authority, be it the soon-to-be-defunct Financial Services Authority in the UK or, in the US, one of three regulators including the Federal Reserve.

In truth, public opinion and the media have become just as important. In the US, the politicians, the media and the public have moved on from focusing on and blaming the banks. Only 32% of the US public rate banks’ performance as poor, according to a recent global survey on trust. This allowed Goldman Sachs to pay out US bonuses early to minimise tax. Not even a whisper of condemnation was heard.

Yet in the UK, Goldman was lambasted for wanting to pay out bonuses in the next financial year to benefit from a drop in the top rate of income tax to 45% from 50%. It reversed course rapidly following public opprobrium, which was accompanied by Bank of England Governor Mervyn King calling it a “depressing” and “clumsy” move.

Goldman was not the only bank seeking to minimise its employees’ tax bills in this way. The Inland Revenue in the UK expected to lose millions from other financial institutions taking advantage of the decline in the tax rate. It gave guidance that this would be acceptable.

Yet in the UK around 60% of the public rate banks’ performance as poor or very poor, according to the he 2013 Edelman Trust Barometer (Edelman Trust Barometer)

That is what the banks are failing to focus on. What is legal is not necessarily acceptable. Political judgement is missing. Highly paid political and public opinion advisors are being ignored or are simply incompetent – presumably a mix of both, since these public relation disasters continue to occur regularly.

Robinson Hambro has written in the FT on the need for a diversity of experience on bank boards (RH piece in the FT). We believe they should be like football teams, with a mixture of different talents. Crucially, one non-executive director, and one executive director, should have an understanding of the three p’s – press, public and political opinion. That is where power now lies.

The power balance in skiing, which is after all the reason to head to expensive hotels in the Alps, hasn’t really changed. Huge advances in the development of equipment give false comfort to the punters. One should never forget that the mountain is in charge. Avalanches still kill.

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Reputation loss: Rato, Mervyn and Dimon

The growth myth

If raw capitalism is about creative destruction, we have undoubtedly seen a lot of destruction. It is not yet clear how creative it will be.

On the back of the financial crisis there was a first wave of people such as Dick Fuld of Lehman Brothers and Sir Fred Goodwin of Royal Bank of Scotland.

We are now seeing the second wave. Mervyn King has lost his reputation as a competent governor, although he won’t lose his job. The Governor’s consistent refusal to commission a study of what went wrong at the Bank of England; a series of in-depth articles detailing his rejection of dissenting opinions; his antipathy towards the City; his obsession with monetary policy at a time when financial stability should have been high on the list; these have all massively eroded his credibility.

The much-criticised independent Court of Directors has now countenanced three separate studies on the issue, surely an embarasse de richesse. Those who argue the Governor ensured each study has a very limited brief are right, but the fact that they are taking place is itself a most vehement slap in the face.

The destruction of the stellar career of Rodrigo Rato, Spain’s much-lauded Finance Minister in better times and subsequently Managing Director of the International Monetary Fund, is further advanced. It has now imploded with Bankia’s effective bankruptcy. The third largest Spanish bank by deposits was effectively nationalised and its chairman fired. The bank spent many months without a ceo as no banker of note was willing to serve under a man who had never been a banker yet whose views reigned supreme.

Jamie Dimon, the embattled head of JP Morgan Chase, is still in his post following $2bn of declared trading losses at the chief investment office. Market and press estimates put the loss at a probable $7bn. More importantly, this raises doubts about the bank’s risk assessment. Dimon’s fate has yet to be decided, but calling the trades “an isolated event” is surely tempting fate.

Is there a common theme linking these three personalities? None of them have been felled by personal scandals. They are all intelligent and all acted and are acting with the best intentions. They have been justifiably acclaimed for years. But we are living in exceptional times. What they perhaps all lack is the capability to allow strong characters around them, the capacity to accept criticism and the flexibility to change behavior accordingly.

At least what happens to those who fall from grace these days is less violent than in ancient times. Julius Caesar, whose dictatorial tendencies were upsetting his peers in the Roman Republic, was assassinated by Brutus and others. He needed a jester, much beloved of later European monarchs, who was armed with permission to mock and thus keep the ego and ambitions of royalty and others within bounds.

According to Roman historian Suetonius, Caesar’s final words were not the famous “Et tu, Brute?” (And you, Brutus?); rather, he spoke his last words in Greek, the language he used for family and intimates: “Kai su, teknon?”(Even you, my son?).

Caesar was rumoured to be Brutus’s father as his long affair with Brutus’s mother was well-known.

The Financial Services Authority will exist for only a bit longer in its current form. It is now a source of destruction, liberally doling out fines and reputational damage as it seeks to cover its former laissez-faire sins with a tsunami of action.

At Robinson Hambro we quacked with fear at the return address on the envelope that came through the office door: “Unauthorised Business Department, Financial Services Authority”.

Our Board Search boutique looked set to bite the dust. All the hard work – be it finding Chairmen for companies, to hosting high-powered dinner parties, to dealing with Ambassadors and family offices – was to be in vain.

We quacked as we opened the letter. Had we mistakenly told a retailing Chairman that a few more women on his board would be a good thing? Had our Ambassador turned out to be a much-married fraudster with children scattered all over the world? Had the blue of our corporate logo infringed a new regulation?

Once the shaking of the hand that held the letter stopped, it turned out to be a warning that we were being targeted by fraudsters. As the FSA warned, in bold, “Remember: if it sounds too good to be true, it probably is!”

The new conventional wisdom, that growth can be easily combined with austerity is just that: too good to be true. There is worthy growth, based on structural reforms and investment and moderate spending, and bad growth.

Far be it from me to question the wisdom of the International Monetary Fund, which in this week’s report on the UK suggested a further lowering of interest rates from the base rate’s 0.5%. Nevertheless, when you are bumping along the bottom, shaving off half a percentage point makes little difference. Take a look at Japan.

As for its suggestion of infrastructure spending, anyone who has tried to move around London, where traffic is paralysed by road and building works, would think enough is being done. For future spending, with no money in state coffers, it will be tempting to finance increased infrastructure investment via private finance initiatives (PFI) or public private partnerships (PPP). These are often accounting gimmicks to keep government liabilities off-balance sheet. The UK has merrily exported these to the rest of the world.

Additionally, infrastructure spending takes quite a bit of time to make its way through the system.

There is, of course, a more radical solution. As proposed by the Institute of Directors and the Taxpayers’ Alliance, a single income tax rate of 30% would put money in consumer’s pockets. It would lead to a surge of spending. Combine that with another radical measure, the raising of interest rates, and savers would be rewarded after years of being the losers compared to borrowers. This would create enough confidence at a micro level for increased spending.

Simplistic, you say, gentle reader, with no thought for the other implications of such policies? Right you may be, but the IMF prescriptions are no less so. Pushing a cut in interest rates and more quantitative easing, when there is no evidence of what the medium term effects are, leaves a lot to be desired.

Perhaps, though, a new “growth” strategy from the government will be enough to boost confidence, just as perceived austerity took it away. Headlines on new spending are perfectly timed for mid-term. The coalition government’s management of public relations is looking good.

I have my own jester, keeping my feet on the ground. My son’s Norfolk terrier, Sasha, a small golden bundle of fun, pines to be a source of destruction – with no creativity thrown in. He has now taken to dementedly barking at all and sundry, especially larger dogs who could eat him in two easy gulps.

Having tried everything from rolled up newspapers to shouting, it was suggested I try spraying his nose. Armed with a spray bought in Avignon a few summers ago, we set off on our walk. Encountering a German Shepherd, I maniacally spritzed Sasha’s button nose with lavender spray. The smell of many a Provencal summer wafted tranquillity onto me. The little dog continued his snarling and baying for blood. The German Shepherd disdainfully walked on by.

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Bank governance: rejecting the check list

Morality and psychopaths

We all have a guilty secret. Confession is good for the soul, so in this post-Easter period, let me come clean about mine. It happened in the spring of 2008.

Shamsad Akhtar, the outstanding governor of the central bank of Pakistan at the time, was under attack from the government and her reappointment for another three year term looked uncertain. In an attempt to bolster her position, while I was on a visit to Karachi, she insisted I interview her on Pakistan state television. For 40 minutes we were filmed discussing monetary policy, provisions for bad loans, interest rate increases and the like. This was broadcast that very evening in the fifth largest emerging market by population. Villagers in the lawless regions on the frontiers with Afghanistan, the military in their secure compounds and government ministers in their mansions all shared one sentiment only: paralysing tedium.

Shamsad Akhtar’s term was not renewed.

Just as I bored a nation of over 170 million to tears, so I yawned audibly when I picked up the Group of Thirty’s report entitled Toward Effective Governance of Financial Institutions. What could this august body add to the barrage of work on the subject? In fact, it adds wisdom and common sense – the latter a much underrated virtue – in an exceptional report.

Having interviewed thirty six of the world’s largest financial institutions (FIs), plus regulators and supervisors, the G-30 are wary of excess prescription as a solution. This column has obsessively attacked box-ticking and is rather chuffed at having an eminent body corroborate its humble opinions.

Below is a summary of the G-30 conclusions. The italics are my own.

Governance is an ongoing process, not a fixed set of guidelines and procedures. Diversity of governance approaches across FIs is a virtue, not a vice. Each institution operates under unique circumstances. Greater homogeneity would likely lead to poorer governance because the constraints that would have to be introduced to ensure homogeneity would reduce FIs’ freedom to optimise.

To delve deeper and deeper into the details of all parts of the business may be a choice some boards will make, but endless detail is not a prerequisite for board effectiveness. Boards will need to dig deep selectively.

Board independence is not evidenced by the number of times a director says no to management. It is a about a value-additive contribution. Having smaller boards that require greater time commitment from their members is better than having larger boards requiring only modest time commitment. If a risk is too complicated for a well-composed board to understand, it is too complicated to accept. The best board in the world cannot counterbalance a weak internal control and risk management architecture.

Supervisors need a deep and nuanced understanding of each FI and need to broaden their perspectives to include strategy, people and culture. This requires regular interaction among senior people in supervisory agencies and boards and board members. But they must accept that they will at best have an incomplete picture and must not try to do the board’s job.

Any arrangement can fail, but failures are more often caused by undesirable behaviour and values than by bad structures and forms. Values and culture are the bedrock for the effectiveness of a FI’s governance culture.

The only sentence that was fully, and correctly, italicised in the G-30 report was this one: Values and culture drive people to do the right thing even when no one is looking.

In Jonah Lehrer’s How we Decide, a fascinating book on how the brain makes its choices, he undermines the notion that we make our moral decisions based on a rational weighing of competing claims. Instead, neuroscience experiments show that within milliseconds of being confronted with a moral dilemma our unconscious generates an emotional reaction, which we subsequently rationalise.

Psychopaths often have above average IQs and reasoning ability, notes Lehrer. The reason they are dangerous appears to be a broken amygdala, a section of the brain that propagates aversive reactions like fear and anxiety. This helps explain why Norweigan mass murderer Anders Behring Breivik, who is currently on trial, appears incapable of experiencing remorse and horror. For him, murder was a logical choice to further his aims. Psychopaths who are on parole are four times more likely than other prisoners to commit crimes after being released.

The emotional part of the brain helps us distinguish right and wrong by being sensitive to the plight of others, Lehrer explains. These moral circuits can only be found in the most social primates, humans being the most evolved. As Harvard professor Joshua Greene puts it, monkeys don’t understand tax evasion, but they do understand that it is morally wrong to push your buddy off a cliff. This implies that religious rules like the Ten Commandments are simply a codification of existing ethics. Man is by nature a moral creature.

Even in circumstances where amorality is rewarded, the brain’s longstanding moral instincts can override the different expectations. Lehrer illustrates this with an example from World War II, where an army survey showed that less than 20% of American troops shot at the enemy, even when under attack. When faced with a personal moral decision, to kill another human being, these soldiers were incapacitated by their emotions.

Army training was revamped after WWII to increase the shooting rate. In the Korean War, 55% of the troops fired and by the time of the Vietnam War, this was almost 90%.

We have a tendency to believe rational thought is better than an impulsive decision, not least because it is the basis of philosophy stretching back to the Greeks. Lehrer shows us that the emotional component of our brain is just as valid.

Numbers appear to be the ultimate instruments of rationality, which is why we are so often taken in by them. The idea that our complex, uncertain world can be reduced to statistics and algorithms is deeply comforting. And false. Numbers to be adhered to by FIs in the form of leverage ratios and loan exposures are, as the G-30 emphasise, no substitute for values and culture.

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Germany thanks the southerners

Saudi investment opportunities

Angela Merkel today gratefully acknowledged the southern European contribution to the euro. “Without the incorporation of those sunny southerners, the euro would be the deutschmark. It would have reached Swiss franc levels, ruining our exports,” she stated, while munching on sardinas at the opening of the Museum of Greek Siestas & Tax Evasion. “Instead, we have this delightfully devalued deutschmark, which has allowed our trade surplus to reach a three year high.”

As she flicked the tail of her flamenco-inspired suit, she thanked Germany’s fellow members in the EU and the Eurozone for being responsible for nearly two thirds of the country’s foreign trade. “Vielen Dank for being less competitive than us and buying our goods,” said Merkel, as she headed off for a week’s holiday in the newly opened Deutsche Acropolis Hotel in Athens.

In truth, most Germans bristle with resentment at having to bail out a bunch of “lazy” southern Europeans who lack a Teutonic work ethic. Similarly, many English smirk at the continental chaos and cheerily anticipate the collapse of the euro. Both would benefit from a bit of perspective.

UK growth this year is now forecast at 0.7%, down from an earlier 1.7%, on the back of the Eurozone crisis. Britain is already seeing a fall in exports to the Eurozone. At 40% of total exports, the impact of a continental recession will be brutal, let alone the unknown effect of a euro collapse. Additionally, British banks are being forced to increase their provisions for the debt of peripheral countries, adding even more impetus to the existing credit crunch.

The flowering of, respectively, nationalist stereotypes and schadenfreude does a disservice to both nations.

Mario Monti, the technocrat who is due to announce a cabinet which he will lead as prime minister, has had an effect on Italy’s borrowing profile. The spread between German and Italian bonds fell on earlier speculation about his appointment, while on Monday Italy sold €3bn of new five-year bonds at 6.29%, a high rate but one that is below what it would have had to pay if Silvio Berlusconi had still been ensconced.

Spain’s Monti is Jaime Caruana, a former governor of the Bank of Spain and now head of the Bank for International Settlements. The Popular Party, set to win a majority in the election on Sunday (20 November), should appoint him Minister of Economy asap. Spain’s spread would fall 100bp. Appoint him Vice President as well, like Rodrigo Rato was in Aznar’s government, giving him more influence, and it would fall another 50bp.

Admittedly, giving up Swiss franc earnings for euros and a role that will see him turn into a St Sebastian figure, pierced by the arrows of countless critics, does not sound attractive. But money has never been Caruana’s motivator. And the saint was cured by Saint Irene of Rome. (It is true that Sebastian then preached Christianity to Emperor Diocletian and was subsequently clubbed to death, but surely martyrdom is a small price to pay in these apocalyptic times?)

These times are also ones where investors are stumped as to where to invest. Dr Florence Eid, founder of Arabia Monitor, believes Saudi Arabia is one possible answer. The IMF forecasts its economy will grow at 6.5% in 2011.

“The King’s financial support package represented a 23% increase in the budget for 2011. This was on top of an existing and fairly ambitious industrialisation, infrastructure and human resources strategy,” she says. “This implies that over the next five years there will be a gold mine in all sectors. The country will be a construction site.”

The IMF forecasts 6.5% growth in Arabia this year, with high unemployment, housing shortages and inflation as the three main tests facing the economy.

The $136 billion in government funds, announced in February and March, was aimed at preventing the unrest from other Arab countries spreading to Saudi Arabia. Bar a few Shia rallies in the Qatif area, which the Saudis blamed on Iran, the Arab spring did not lead to serious disturbances. Eid and her team at Arabia Monitor believe the stability will continue.

“Saudi Arabia is run by a family that has shown over the years it can deal with challenges, from the Iraqi invasion of Kuwait, to the rising Islamic tide, to the demographic challenge of needing to create opportunities for the 50% of the population that is under 25 years old,” says Eid, whose firm specialises in Middle East and North Africa (MENA) research and advisory services.

A recent Chatham House roundtable, however, concluded that the Arab Spring poses a great threat to Saudi Arabia because it endangers the core patronage network that underpins the state. The foreign affairs institute also forecast major upheavals in the House of Saud when the next generation of princes are considered for succession.

Eid notes that despite foreign criticism of its governance, the royal family has developed a “fairly pronounced and healthy respect for technocratic expertise.” The ministries of finance and health, plus the central bank, are run by technocrats who have been in the same jobs for a number of years. The same criterion does not apply for ministries that are seen as crucial to sovereignty, such as that of foreign affairs.

The IMF points to high unemployment, housing shortages and inflation as the three main tests facing the economy.

Eid argues that the Saudi invasion of Bahrain to support the ruling family and squash demonstrators calling for more rights for the majority Shias and more democracy should be seen within the context of the GCC. “It was reassuring for the international investor community. It showed they had teeth and were open to putting to one side their non-intervention policy when events happen in their backyard,” says Eid.

The Lebanese-born, MIT PhD says analysts are mistaken in assuming that the new Crown Prince Nayef Al-Saud will roll back reform when he becomes king. She believes he will continue on the path of gradualism and “evolution rather than revolution.”

Robinson Hambro, the Board Search firm I co-founded with Rupert Hambro almost a year ago, is evolving too.

Last week we were quoted in the Financial Times on the subject of recruiting women to UK boards: “You don’t need five goalkeepers on a football team, you need a mixture of abilities and positions. There has been a tendency to appoint directors who have run divisions of FTSE companies when most women haven’t done this. Instead, the cleverest women we know, who would add value to boards, tend to have risen in professional services firms and asset management and media.”

Much the same can be said about the Eurozone. Not everyone can run a current account surplus. Or a current account deficit, for that matter. There has to be a balance, just like a team.

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New era regulators and a passionate conversion

How tinkering may ruin bank boards

Take a look at the Financial Times, where Robinson Hambro authored an editorial on the Financial Services Authority and its excessive interference in the running of the boards of banks.

Or read the article in the text below:

The passion of the convert is a frightening thing. Be it former smokers who cast glances of derision at office staff puffing away on the pavement or, more specifically, the regulatory backlash on the back of the financial crisis, converts allow little room for a nuanced approach.

One hopes that the government will allow for a degree of flexibility in the separation of retail and investment banking as set out in the Independent Commission on Banking’s report, which is to be published in a couple of weeks. Recent leaks suggest banks will be allowed a longer time frame in which to apply this major upheaval to their business models.

Conversely, the Financial Services Authority (FSA) has shown a new-found rigidity. The UK regulator, lambasted for its ‘light touch’ regulatory approach, now boasts of its intrusive approach. There is no doubt that its earlier regime was one of the causes of the financial crisis, but it has swung so far the other way that it is causing harm.

This is especially true of its enhanced regime for significant influence functions (SIF). These are positions of responsibility within financial services institutions, namely those that can affect a firm’s risk profile, and range from chief risk officers to top traders and all board members, both executive and independent.

The FSA is rightly trying to tackle the lack of understanding shown by some executives and independent directors when dealing with the business of the financial institutions they were involved in. But its approval process has become a “nightmare” according to a top City lawyer, while existing and potential board members lambast the junior staff interviewing them and the morass of definitional bureaucracy.

Although there are some outstanding individuals at the FSA, it cannot afford to pay private sector salaries to the recruits – nor, for that matter, can the Bank of England, into which much of the regulator will be subsumed.

The FSA expects potential non-executive directors (NEDs) to know the financial institution backwards, despite not yet being on the board and therefore not privy to confidential liquidity ratios and the like. To try and ensure success, financial institutions now need to brief the candidates as thoroughly as possible, and help figure out who the independent members of the interviewing panel are, while guessing how this might affect the questioning.

The regulator deems it a success that around 10% of the candidates withdraw. The City view is that good people are being lost due to the intrusiveness of the process.

What is not being counted in that percentage are the potential non-executives who no longer want their names put forward. To be kept hanging around is unenticing to senior executives with a proven track record, while the indignity of possible rejection looms large. Not least if they are already on a board.

Why does this matter? The pool of non-executives for financial institutions is not a large one. A heavier burden of corporate governance requirements and an awareness of potential liabilities – including on the reputational front – makes the job less appealing than it used to be for outstanding directors who are prime candidates.

Overall, the recruitment process is becoming more expensive and the pool of candidates smaller, with “group think” arguably becoming even more pernicious. The risk to business increases when securing the right people for a board becomes too difficult. The best candidates are not only the (rather obvious) former partners in accountancy firms and the like – hence the current drive to diversify boards. It is questionable how the SIF process tallies with the current attempt to promote more women onto boards.

Interestingly, the intrusiveness of the SIF process also runs counter to some recent studies on board performance and share price. Most recently, a report by law firm Eversheds showed a positive correlation between share price performance and the number of independent directors on boards who had little or no direct sector-specific experience. The law firm focused on 241 of the world’s largest companies, including 50 banks.
A host of approaches are being used to improve governance and risk-taking at financial institutions in order to avoid another systemic financial crisis. There is no doubt that corporate governance at many financial institutions was proved deficient and the FSA is rightly keen to correct this. But it is key that boards have a diversity of complementary experience, recruited from as large a pool as possible.

The regulator’s SIF regime is proving counterproductive and needs adjustment. Regulation should not stifle governance, but improve it.

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