Lord McFall’s speech on the second reading of the Financial Services Bill in the House of Lords.
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My Lords, I am delighted to participate in this debate and to welcome the noble Lord, Lord O’Donnell, to this Chamber. He is an individual with whom I have had many formal and informal dealings. He is a person of the highest integrity, respectful of every individual he meets, irrespective of status, and an exemplary model of a civil servant. It is a model that the Government should ensure they get more of in the years to come as the complexity of the financial services dawns on us. So I welcome the noble Lord, Lord O’Donnell, to this Chamber.
I bring to your Lordships’ attention my entry in the Register of Members’ Interests. Like the noble Baroness, Lady Wheatcroft, I was delighted to be a member of the Joint Committee on the draft Financial Services Bill. A number of areas arose during that committee: first, architecture; secondly, complexity; thirdly, accountability; fourthly, ring-fencing; and, fifthly, and most importantly-a phrase to which we all signed up-that to be successful the reforms will have to change the regulatory culture and philosophy. Those should be the guiding principles.
We all agreed that architecture is of secondary importance. The issues that matter are culture, conduct and communication. These issues were key to what went wrong with the tripartite authority. Alastair Darling’s devastating evidence to the Joint Committee brought that out.
On the issue of complexity, we should note that we are moving from a tripartite to a quadripartite system involving Her Majesty’s Treasury, the Monetary Policy Committee, the Financial Policy Committee and the Prudential Regulation Authority, not to mention the Financial Conduct Authority. We have more interfaces, and therefore a higher degree of complexity. It was the interfaces and the information that fell down between them on the last occasion that caused the problem.
The question that bedevilled the tripartite authority when it came before the then Treasury Committee in the House of Commons was very simple: who is in charge? Everyone said that they did their job properly. However, we had to face one of our biggest crises with a vacuum in the making and no clarity for the Chancellor. The Minister rather boldly said at the Dispatch Box that never again would we ask who was in charge. I suggest that those words could come back to haunt him in years to come if the Government do not get the correct legislation.
As other noble Lords have said, at present we have opaque decision-making structures and still require clarity and explicit guidance and information, either through memorandums of understanding or whatever, on the view of the governor and his key deputies. We should remember that on many occasions the governor and his deputies will have contradictory views as a result of the responsibilities they are given and that the Chancellor must have clarity from them. There has to be no hiding place so that we can answer the question about who is in charge, but at present we cannot do that.
I mentioned the issue of regulated culture and philosophy. Business models are the key to understanding the issues within a company, from the policies followed to the individual behaviour of the executives. Auditors are the key to this. A number of years ago I asked auditors what the point of an audit was. It is presently a backward look at accounts. Auditors are doing everything that is required but not much of what is expected. This was illustrated by Northern Rock. In the first six months of 2007, this small building society was responsible for 20 per cent of all new mortgages in the United Kingdom. The chair of the Audit Committee, and not least the auditors, should have asked why the company was doing so well compared to others. However, that question was not asked.
Auditors therefore need to give a realistic view of the state of a company, taking into consideration the present and the possible future risks. I suggest that auditors should report to the Financial Policy Committee so that it understands both the microeconomic and the company landscape environments in an area of no more sensitivity than risk.
At the moment, risk is a black box. This was illustrated in the comments made by Professor John Kay and Professor Charles Goodhart to the Treasury Committee a number of years ago. When asked whether we could evaluate risk, Professor Goodhart said very clearly, “No”. Professor John Kay said, “I have been teaching at Oxford University for 25 years and I have ripped up my notes on risk”. So risk is a black box, and more regulations and rules alone are not the way forward.
We have to recognise that no regulator in the world spotted the problem. The Governor of the Bank of England said that the regulators were like locusts in Citibank. JPMorgan Chase is the latest example in the City, with the “London Whale” and a loss of £2 billion. Ten regulators were sitting in JPMorgan Chase when it happened. The question that arises out of that is: why did Jamie Dimon, someone supposedly alert and cute, need a call from Bloomberg to tell him that there was a £2 billion loss to his company? Jamie Dimon retorted by saying that it was a “tempest in a tea pot”, but if you put your arm right next to a tea pot, you can get a really bad burn. Maybe he did not realise that.
The situation of JPMorgan Chase and others reflects a systemic breakdown in management and risk control systems. Incidentally, the chief risk officer receives $14 million a year before foreign excises, so I would have thought that the risk officer could take quite a bit of a risk if $14 million is going into a current account as a result. I suggest that the Treasury Committee or other committees of the House should invite Jamie Dimon to explore the concept of risk and ask this question: are the largest banks still too big and complex to be managed safely? Are we now seeing “too big to fail” being followed by “too big to behave” in companies such as this one?
The way forward lies in good corporate governance to tackle these deep-seated problems, not only changing the way people behave but the way they think. We need to promote values and a culture that drives people to do the right thing even when no one-that is, the regulator-is looking. Culture is behaviour and ethics is resolving conflicts of interest. That is what the Government should be promoting. The motto of the City of London is, “My word is my bond”. In a recent survey, over 80% of people working in the City did not realise that. In other words, there is a big repair job to be done in order to restore trust.
I am delighted to see that the departing chief executive of the Financial Services Authority devoted his last speech to culture. That is a small but positive step. If we focus more on these issues, we can hope eventually to realise a market system that is fair to both consumers and businesses, where risk is rewarded, failure punished, and growth and employment are paramount.