March 13, 2015

Financial Reform Newsletter – March 13, 2015

Financial Reform Newsletter

March 13, 2015

Might there be accountability of a senior executive at a “too big to fail” bank? First, let’s remember that “too big to fail” is shorthand for too big, too complex, too opaque, too leveraged, too interconnected, too illiquid and too reliant on short term funding, which means that not only are these banks too big to fail, but they are too big to manage, too big to regulate, too big to punish and too big to jail.

Better Markets Senior Fellow Bob Jenkins just detailed what this means for Europe’s largest bank, HSBC, in an op ed in The Financial Times. As is well known, HSBC is a bank embroiled in scandal. In 2013, HSBC settled a criminal complaint with the Justice Department for $1.9 billion over charges that the bank enabled drug cartels in Latin America to launder hundreds of billions of dollars while also violating economic sanctions against Iran, Libya, Sudan and Burma. In 2014, HSBC paid $550 million to settle a civil suit regarding its role in inflating the housing bubble which lead to the financial crash. Most recently, a computer security specialist named Hervé Falciani went on “60 Minutes” to discuss HSBC data that allegedly showed HSBC played an active role in knowingly helping numerous clients illegally evade their taxes. So far none of HSBC’s leadership has faced criminal charges or been held accountable in any meaningful way.

As Mr. Jenkins points out, these and many more of HSBC’s egregious activities happened during Douglas Flint’s tenure. Mr. Flint served as group finance director and HSBC board member in 1995 and is now the banks’ Chairman. According to Mr. Flint’s own admission, the bank’s conduct was in “contravention to our own policies.”

A former senior finance executive himself, Mr. Jenkins points out in the Op Ed that the duties and responsibilities of HSBC management involve more than just setting policies. It involves ensuring that policies are carried out, including preventing illegal behavior. Mr. Jenkins showed why Mr. Flint cannot both be responsible and unaccountable. Mr. Flint must be held accountable, which means he has to go.

Mr. Jenkins’ op ed has ignited a vigorous discussion in the City about the fate of Mr. Flint and about executive accountability at too big to fail banks. As one well-known UK observer remarked in a must-read article, “For all the battering HSBC’s leaders have received at the hands of MPs lately, it is the words of a former regulator, Robert Jenkins, which could prove the most damaging.”

Is the tide of elite global opinion about the too big to fail global banks changing? By at least one key measure it is. The Economist this week highlighted the continued risks posed by too big to fail banks, saying, “badly managed and unrewarding, global banks need a rethink.” As noted in this important editorial, it’s not just HSBC that is running amuck causing damage across the globe. It’s also JPMorgan, Citigroup, Deutsche Bank, and others, who have also faced numerous scandals and their leadership has struggled to supervise, manage and remain accountable over their vast, massive and dangerous operations. While there are many reasons why too big to fail is bad and damaging, a number of market participants (including Goldman Sachs, at least when they are talking about JP Morgan Chase) are adding another one: the scope of their activities is hurting profits and shareholders are no longer making adequate returns on their investments. Better Markets’ President and CEO, Dennis Kelleher, refers to this argument as finding that these banks are “too big to succeed.”

If these global megabanks are too big to fail and too big to succeed (as well as too big to manage, regulate or jail), then the end of an era (or error) may soon be upon us.

It’s almost 7 years since the crash of 2008 (which was the worst financial crash since 1929) and almost 5 years since the financial reform law was passed, but the SEC still hasn’t enacted the most basic rules governing the conduct of Wall Street’s swaps dealers: One of the most important reforms in the Dodd-Frank Wall Street re-regulation law is the comprehensive new framework for overseeing the derivatives markets, including swaps and security-based swaps. And among the key provisions in the law are new business conduct standards for the Wall Street dealers, the handful of largest banks that have dominated the market for years in a regulatory vacuum and virtually unconstrained by rules of the road.

Remember that the financial crash of 2008 was incubated unseen in those derivatives markets, which also acted as conveyor belts to spread derivatives risk throughout the global banking system. Remember also that about 95% of all the almost $300 trillion yearly derivatives trading in the US is done by just five banks. That’s like stacking dynamite a mile high on top of a box of matches right next to your home, job, pension, and life’s savings, all of which suffered when those unregulated derivatives blew up in 2008 and caused the worst economy since the Great Depression of the 1930s.

The good news is that, according to reports, the SEC may finally take action to put those all-important business conduct standards for swaps dealers in place (but the bad news is that the SEC might re-propose the proposed rule, causing yet more delay). As we pointed out in a comment letter to the SEC on their proposed rule in 2011, the rules can and should be written to require those Wall Street dealers in security-based swaps to make complete, understandable, and timely disclosure of all material information that a market participant needs before deciding whether to trade in these complex instruments, and if so, under what terms.

They also must be crafted to ensure that dealers have a duty to act in the best interest of their counterparties whenever they are giving advice about derivatives transactions, especially where a dealer is advising a “Special Entity” such as a municipality or pension plan. And to give the new standards a real chance of putting in place meaningful change in the derivatives marketplace, the independence of Chief Compliance Officers at the dealers must be safeguarded in the rules.

The SEC did a good job regarding the independence of Chief Compliance Officers (CCOs) in their recent final rule for swap data repositories (SDRs). These are the officers who ensure compliance with the rules and regulations put in place by Congress and the SEC to make our financial system safer. One of the most important provisions in the new rules prohibit anyone within the SDR from coercing, misleading, or fraudulently influencing the CCO in the performance of their compliance duties. This means that no employee, no matter how low or high, can lie to the CCO to hide illegal behavior or otherwise interfere with the CCO in an effort to protect their position or the firm’s profits. If they do, they are subject civil charges, including monetary fines. Better Markets’ comment letter on SDRs advocated for these provisions.

The SEC’s original SDR rule was lacking strong business conduct standards, but the final rule was much improved. Similarly, the SEC’s initial proposal on security-based swaps dealers was lacking in many respects. As we pointed out in our comment letter, it contained weak requirements and massive loopholes. We hope that that the SEC does not delay further, does not re-propose the rule and that the final version of the rules substantially strengthens the currently proposed rules.

Better Markets in the News

Saving the Whale, Again: Harpers Magazine by Andrew Cockburn April 2015 Issue

How HSBC chairman Flint can restore accountability at his bank: Financial Times by Robert Jenkins 3/10/2015

Jim Armitage: Jenkins may do for HSBC boss Flint: London Evening Standard by Jim Armitage 3/11/2015

Federal Reserve: Every Bank Passed The Stress Test; Should The Fed Make The Exams Harder?: International Business Times by Owen Davis 3/6/2015

The Biggest Banks Aren’t Ready to Shrink: Bloomberg by Peter Coy 3/5/2015

The Outsider: Elizabeth Warren wants to be the most powerful Democrat in America-without running for president: Politico Magazine by Glenn Thrush and Manu Raju March / April 2015

Articles of Interest:

Cocking up all over the world: The Economist 3/7/2015

Michael Lewis Reflects on His Book Flash Boys, a Year After It Shook Wall Street to Its Core: Vanity Fair by Michael Lewis April 2015 Issue

Commerzbank of Germany to Pay $1.5 Billion in U.S. Case: NYT by Ben Protess 3/12/2015

Strength Is Weakness: NYT by Paul Krugman 3/13/2015