Tax Research UK

FT.com / UK - FSA on defensive over Lehman failings.

Good to know I got yesterday’s musings on Lehamn right.

As the FT reports:

UK financial regulators said they had no reason to question the so-called “accounting gimmick” used by Lehman Brothers to flatter its results because the investment bank’s UK subsidiary’s reports accurately reflected the transactions.

Why - because they were correctly reportted on balance sheet under UK GAAP here.

But as they also note:

In the UK, the bank was able to get a legal opinion certifying that the transactions qualified as sales . Lawyers not connected to the transactions said the UK’s definition of sale is slightly less restrictive than the relevant law in the US.

The legal opinion made no difference to the Lehman UK subsidiary’s accounts to the FSA because they were made under UK accounting rules, which require both repos and sales to be reported on the balance sheet, the FSA said. But when the UK accounts were consolidated back to the US, under US accounting standards, known as GAAP, the transactions disappeared off Lehman’s balance sheet, the Valukas report said.

“The balance sheet effect referred to in the Lehman report only occurred in the consolidated accounts which were prepared under US GAAP,” Mr Sants [of the FSA] said.

“This is a matter for US financial reporting standards, not . . . for UK supervision,” he said. “This is arbitrage between US accounting rules and UK law.”

This is exactly as I suggsted.

But Hector Sants is wrong because if accounts can be abused in this way of course it is an issue for UK regulators.

So this should be high on the FSA agenda when its continued existence is confirmed after the election.

Richard Murphy Accounting, Auditing, Banking, Regulation

My latest column in Forbes is here, looking at the issue of EU hedge fund regulation.

As I argue:

Like it or not international finance needs rules and they need to be consistent. Creating competitive advantage by manipulating the rules does not mean there are winners or losers as a consequence – it means there is no game and only losers. Rules are not anti-competitive. Even Friedman recognized that they make free competition possible.

Brussels is saying that real people–the people of Greece and maybe the E.U. itself–are losing out right now as a result of lax financial regulations largely set by London and Washington. The two financial capitals are signalling that they don’t care, but they should. Unless regulations are levelled upwards so that international finance is a game all can partake in to mutual benefit, there would be no game at all–and that would be a protectionist disaster.

One that the so called free marketeers seem to desire.

Richard Murphy Regulation

FT.com / UK - Watchdogs need not bark together.

Joe Stiglitz in the FT says:

Countries that proceed [to protect their own citizens with strong domestic regulation] will face threats of the kind already received - a rapid departure offshore. But the parts of the financial system critical to the real economy - those, for example, that lend to businesses - are not so footloose. Any cost-benefit analysis of the loss of the gambling casinos offshore would surely conclude that if some other government wants to risk economic instability and big bills for bail-outs to its taxpayers, so be it - our task is simply to prevent contagion from these under-regulated jurisdictions. No country can fully insulate itself, but the best protection is a good regulatory structure at home. The continuing instability in global financial markets should have made it clear that we need that now.

As usual, he’s right.

Richard Murphy Regulation

FT.com / UK - Sants resignation leaves confusion at FSA.

Hector Sants has resigned as chief executive of the Financial Services Authority, sowing confusion about the direction of financial regulation.

The CEO, who will stay at the FSA until the summer, has been outspoken in his criticism of Conservative proposals to dismantle the agency. He described the Tory plan to give the FSA’s supervisory role to the Bank of England and spin out consumer protection responsibilities to a new agency as a distraction that could lead to a “turf war”.

Regulation is not perfect, we know.

Seeking to undermine it before you reach office is a coup few achieve - but Osborne has.

It’s a sign of the mayhem and incompetence to come.

And let’s be honest - how can a man whose sole work experience is a year at Tory Central Office really be expected to have any management competence?

Richard Murphy Conservatives, Regulation

FT.com / Europe - Portugal near political crisis over debt .

Portugal is facing a debt crisis. Whether justified or not I do not know: I am not an expert on Portugal and won’t claim to be.

But the follwoing is reported:

He [the Prime Minister] said Portugal had taken over from Greece as the main victim of the “animal spirits” of financial markets that were often “irrational”. The concern in the case of Portugal, he said, was not justified.

Now here’t the rub: the markets may well be rational - according to their own highly perverse definition. Undermining states, democracies and currencies is completely rational following the logic of the market. If there’s a financial gain to be had destroying well being is entirely rational according to currency and debt traders.

Which is precisely why they need to be regulated quite differently.

Richard Murphy Banking, Economics, Regulation

The Guardian has noted:

The Dubai government refused to guarantee the huge debts built up by its conglomerate Dubai World, dashing investor hopes that the latest episode in the global financial crisis might be swiftly resolved.

In an interview on local television, the director general of Dubai’s department of finance, Abdulrahman al-Saleh, appeared to suggest that investors only had themselves to blame for the unfolding crisis. "Creditors need to take part of the responsibility for their decision to lend to the companies," he said.

"They think Dubai World is part of the government, which is not correct. Dubai World was established as an independent company; it is true that the government is the owner, but given that the company has various activities and is exposed to various types of risks, the decision, since its establishment, has been that the company is not guaranteed by the [Dubai] government."

Moral hazard describes the phenomena where a party that is insulated from risk behaves differently from the way it would behave if it were fully exposed to that risk.

It is very easy to see in this case that the limited liability status of Dubai World – an entity created and owned by the Dubai government, presumably (although I have not checked this) registered under Dubai law that the Dubai government created – means that the Dubai government can deny responsibility for the risks that it created Dubai World to assume in pursuit of its own economic strategy for which it now denies responsibility. A better example of moral hazard is hard to imagine.

Unless, of course, we consider the case of banks in the UK and elsewhere that also trade with limited liability but in their case with the implicit unlimited guarantee of the taxpayer to back them, creating another form of moral hazard.

In both cases the moral hazard has, of course, been created by a form of asymmetric information: Dubai World knew the risks it was taking and the fact it could not enjoy a state guarantee. those who lent appear (as is the way of the market – so ill informed is it) to have been unaware of the risks they were taking and assumed there was an implicit guarantee.

I am not suggesting as a consequence that we should get rid of limited liability entities: as a matter of fact I suspect that near enough impossible to do, although I know some argue for it.

I am arguing that if we are to have limited liability then there is a special duty of care imposed on those who take advantage of it, which no one is obliged to do. That duty of care is to provide considerable information concerning the beneficial ownership,  true nature of management and financial performance of each and every limited liability entity that exists – anywhere in the world and for whatever purpose it is used. The argument is simply that without this information, including country-by-country reporting. those who engage with a limited liability entity are, without exception, the potential victim of moral hazard of the form now being suffered by the creditors of Dubai World.

That is not acceptable: if markets are to be effective, if unjust enrichment and straightforward fraud is to be avoided, if risk is to be allocated appropriately then the price of limited liability is transparency.

Secrecy jurisdictions promote secrecy: they promote moral hazard, risk, distorted markets, unjust enrichment, fraud and more besides as a consequence.

That is why secrecy jurisdiction undermine the effective operation of all markets.

And opacity undermines markets in exactly the same way.

You cannot support markets and support either opacity or secrecy jurisdictions: they are incompatible.

Dubai should teach us an expensive lesson. It is time it was learned and action taken.

Richard Murphy Accounting, Banking, Economics, Ethics, Regulation, Secrecy jurisdictions

The Walker report on corporate governance in UK banks and other financial industry entities includes the most extraordinary missed opportunity. On page 17 it has the following enigmatic paragraph:

Recommendation 15

Deleted.

What might it have said?

What opportunity has been missed?

Could it have said:

All banks shall be tax compliant: tax compliance is seeking to pay the right amount of tax (but no more) in the right place at the right time where right means that the economic substance of the transactions undertaken coincides with the place and form in which they are reported for taxation purposes?  

Might it have said:

The use of secrecy jurisdictions increases governance risk and the chance that insufficient information on the risks and rewards of banking and other transactions are reported to a board of directors and other users of the financial statements of banks, both internal and external. As such detailed quarterly reporting of the activities of any bank located in secrecy jurisdictions, whether on or off balance sheet, shall take place?

Or was it:

The location of risk within a bank is vital to overall assessment of viability, As such the bank shall report not less than quarterly to the Board on a country-by-country basis?

What a tease Walker is: we’ll never know which of these great opportunities was deleted.

That is a loss to us all. The mystery of recommendation 15 might never be known, but we can be sure we’re worse off without it.

Richard Murphy Banking, Regulation

The world of banking has won two more victories over the rest of society.

The challenge to its right to charge excessive fees to people who make the smallest error in running their bank accounts has been overthrown by the new supreme court. This is regressive tax in all but name: it is now the poorest in our society who will continue to be charged excessive fees to bail out our banks.

And the Walker report on banking reform in the light of the banking crisis has proven to be even weaker than anyone feared. Julia Finch has put it well in the Guardian:

Nine months’ work. One hundred and eighty submissions of information and opinion. A weighty interim report, and 167 pages of final recommendations: so much work for so little. Sir David Walker’s review of the corporate governance of banks, ordered back in February, is a crashing disappointment – an anti-climax of even greater proportions than the anodyne code of practice he drew up for the private equity business in 2007. Here was a chance to rewrite the rulebook in a bid to ensure that there would be no re-run of last year’s crisis when two of Britain’s biggest banks, it has now emerged, needed £62bn of secret Bank of England support to keep their doors open. Instead we have some relatively minor tweaking.

Walker says he is "sympathetic with Guardian types … it is outrageous that we have been left all this debt". But he is an investment banker and an old-school City man. He was never the man for this job.

The question is: why was he ever given it?

Given that for all practical purposes his report changes nothing at all – except disclose the number of employees earning more than £1 million a year – for fear ‘talent might go abroad’ – this is the only relevant question.

We had the stupidity of the Foot report on tax havens – written by a tax haven insider with clear intent to excuse them of all wrongs – and now the Walker report on banking – written by a bank insider with clear intent to excuse them of all wrongs.

In the meantime the abuse goes on. The capture of the state by an elite in banking is becoming more and more apparent. And we are all paying for it.

When will politicians stand up and challenge this?

That question is at the core of the future of democracy – because have no doubt about it, these people don’t believe in democracy. If they did they would not treat it with such contempt. For them the state is just one thing – a mechanism for diverting resources to them for their use. I give them credit: they’re good at doing just that. But the process has to be brought to an end.

Richard Murphy Banking, Economics, Ethics, Regulation

The Telegraph has done a  rather useful summary of highlights from last night’s speech by Mervyn King, Bank of England governor. he said:

On support given to the banking system:

In the UK, in the form of direct or guaranteed loans and equity investment, it is not far short of a trillion (that is, one thousand billion) pounds, close to two-thirds of the annual output of the entire economy.

To paraphrase a great wartime leader, never in the field of financial endeavour has so much money been owed by so few to so many. And, one might add, so far with little real reform.

On the creation of moral hazard:

The massive support extended to the banking sector around the world, while necessary to avert economic disaster, has created possibly the biggest moral hazard in history. The "too important to fail" problem is too important to ignore.

On separating utility and risky banking:

In other industries we separate those functions that are utility in nature - and are regulated - from those that can safely be left to the discipline of the market.There are those who claim that such proposals are impractical. It is hard to see why.

On the current state of banks:

It is important that banks in receipt of public support are not encouraged to try to earn their way out of that support by resuming the very activities that got them into trouble.

On regulating the banks:

Although there are no simple answers, it is our collective interest to reduce the dependence of so many households and businesses on so few institutions that engage in so many risky activities.

To summarise:

1. Banks are in our dent. We should call the shots
2. Banks need to be broken up
3. We must separate investment banking from High Street banking
4. there must be much stronger control of Lloyds and RBS
5. More regulation is needed.

He’s a bit late on the block – some of us have been here for some time – but he’s welcome nonetheless.

This is the time for massive banking reform.

Will Alastair Darling do it before may? I hope so.

Richard Murphy Banking, Regulation

The Cynical Tendency: Libel Laws, Financial Losses, Life & Liberty.

Do English libel laws increase the risk of another financial crisis/

I share the beloief that they do.

If there was a law that needed reform this is it.

Richard Murphy Regulation