Friday, 18 October 2013

Throwing Sand in Somebody Else's Sandbox

As if it isn't difficult enough making headway in financial markets against the uneven playing field that had been created by Tory and Labor financial nomenklatura favouring the US team in UK financial markets, now we effectively have the US team fining the competition (most notably in the selective pursuit of the Libor-rigging scandal) so they are hampered in sending any players onto the field, even if they had the wherewithal to do so. 

The issue here is not two specific cases (Libor-rigging & the London Whale) but a chain of events which has culminated in these two specific events. First we had the Americanisation of the UK and international capital markets then we have the US claiming that it is first in line to prosecute and fine (irrespective of jurisdiction)... and fine it does... but now it is widely suspected that there is a bias in the "pursuit of truth justice and the American way" which falls heavily on City institutions (whether UK- or European-owned) and tips the scales in the favour of US banks and investment banks. 

Jamie and the Whale....

The most recent example of US judicial over-reaching (for that is the only word for what has happened) was the evocatively-named London Whale. It may seem arcane to the outsider and even to the City insiders, but the activities concerned are definitely niche preoccupations for the bulk of the City that deals in equities, bonds/loans and commodities and transaction like M&A. 

In essence the London Whale was a matter entirely internal to employees of J.P. Morgan Chase who had falsified data fed to supervisors (and by implication, beyond to regulators) to cover a series of highly complex trades that had gone bad.. It supposedly had implications for some customers, but who they are and where they are based has never been identified. What is also clear though is that massive market distortion was indulged in with the effect that other market players were impacted.

Back in the old days, the Bank of England used to have a rather amorphous policy of casting to the outer darkness individuals deemed to not be "fit and proper persons". The question is whether Jamie Dimon would have passed muster as such a person back in the good old days when the City codes cast out those that had brought the City into disrepute. While he might be Teflon-coated in the US, why is he regarded in the same light here? Truman had a sign on his desk that read "The buck stops here", seemingly at JP Morgan Chase the only buck that stops at the leader's desk is his pay cheque. 

Frankly the London Whale crisis would have been the end of other mere mortals in the financial space but in this case not. We won't go into who was specifically to blame but the party that was collectively at fault was the US bank itself with lax controls and a dubious culture of mendacity and deceit. 

In April and May 2012, large trading losses occurred at JPMorgan's Chief Investment Office, based on transactions booked through its London branch. The unit was run by the bank's Chief Investment Officer, who has since stepped down. A series of derivative translations involving credit default swaps (CDS) were entered, reportedly as part of the bank's "hedging" strategy. A trader, nicknamed in the marketplace as the London Whale, accumulated outsized CDS positions in the market. An estimated trading loss of US$2 billion was announced, with the actual loss suspected to be substantially larger. The Wall Street Journal in mid-September 2013 posited the loss was closer to US$6.2 billion. As the size of the loss was only gradually revealed and augmented the shock to the financial system was a lot less than if the full extent of the loss had been known at the beginning. These events gave rise to a number of investigations to examine the firm's risk management systems and internal controls.

The bank agreed in September 2012 to pay at least US$920 million in penalties and admit wrongdoing as part of a broad regulatory settlement over its handling of the matter. Regulators (that is US regulators) went for blood in pursuing lower level flunkies despite the fact that the individuals were EU-citizens and had been UK-based at the time of the "crime". It was revealed in October that the bank would pay a further US$100mn in fines to US regulators in relation with the matter.

The Daily Telegraph reported (19th of September) that the US bank was fined £138m by the Financial Conduct Authority (FCA) for what regulators said were “serious failings” in its Chief Investment Office. In addition to the UK fine, the US Federal Reserve, Securities and Exchange Commission, and the Office of the Comptroller of the Currency imposed further penalties of $200m, $200m and $300m respectively, taking the total fine to $920m.

Now the intriguing thing to us is exactly what part of the bank is paying the fines and what are the fiscal implications for the UK. Let us just imagine that the whole amount of these fines are being levied on the UK subsidiary of the US bank. This has some interesting implications. This would generate a tax loss of the order of a billion dollars. With the corporate tax rate at 23%, the UK revenue authorities would be facing a reduction of over $230mn in the amount of revenues it might expect to collect on 2013 (and later years) on net revenues of Chase's business units incorporated in the UK. Meanwhile for a crime that was perpetrated on UK shores, the US government would be collecting around US$800 million dollars (total fines minus the widow's mite the FCA gleaned) from Chase's UK subsidiary. All the UK taxpayer gets from this bonanza is the £138m fine. 

Who knows what other sweetheart tax side-deals Chase was offered by the US authorities to expedite this act of financial prestidigitation....

The sole consolation is that the gross incompetence by the bank resulted in $6.2bn in losses for the bank, implying a similar amount in profits for the "smarter guys in the room". 

If Chase's UK subsidiary had gone belly-up in the UK (as the subsidiaries of Bear Stearns and Lehman Brothers had done before) then UK tax-payers and regulators might have been left to clean up the mess, then surely if the bank survived, and was called to account, then the financial penalties should have been in favour of the UK side not providing a mega-payday for the voracious US regulators (who had so singularly failed to supervise one of their largest banks). 

The lessons here are that some financial institutions act cavalierly in international capital markets and then the US plays sheriff and collects the fines on the miscreants casting a wide net using laws that have no pertinence in the London or non-US markets to shake down the players to its own benefit. In doing so, it cooks deals which are in the best interest of the US (and in the interest of US miscreant institutions) or even worse acts in a fashion that weakens parties (as is strongly suspected in the Libor-rigging scandal) that compete against US institutions in pursuing asymmetrically the perceived malefactors.

It is time that the US was told to mind its own business in the City. The regulators of the City are accountable to the government and the government is currently made up of ourselves and the Conservative party. In a day and age when austerity has been the watchword and services have been brutally cut to pay for a financial crisis in 2008, that had its epicentre and root cause US profligacy, then why are we allowing US regulators to strip fines (i.e. profits) out of UK subsidiaries and ship the funds to Washington with a mere consolation prize of an FCA fine being left on the table in the UK. The total of fines should belong to the UK and the Exchequer. 

A policy should be put in place to not only ensure that financial crimes perpetrated in the UK (and EU) are the exclusive jurisdiction of the UK (or EU) but also that individuals involved in the transactions are only subject to UK (or EU) criminal proceedings. Its time to draw a line in the sandbox and keep the playground bully out.

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