Photo: uair01 on www.flickr.com
Welcome back to the banking blog. Today we have someone in a vital yet little-known and understood area in investment banking: risk and compliance. These are the people employed by a bank to stop its bankers from breaking the rules or taking excessive risks.Let’s call him Mark. A veteran of several decades in the City, he is a true idealist and is coming into the threads below over the next 72 hours to answer questions and discuss his views. Can I encourage in particular others in risk and compliance to join the conversation?
You can read the full transcript of Mark’s words here. His best quote (IMHO): “The thing with risk and control is that it’s impossible to put a number on a loss you averted by saying ‘no’ to something. Meanwhile when a deal goes through, the trader can put a number on the profit generated.”
This is one of the big questions in finance these days; how do you get “front office” traders to obey the risk and compliance “middle-office” when it’s the traders who make the money that pays for the salaries of the compliance people? Indeed, the implicit hierarchy between the two seems neatly encapsulated in the terms “front” versus “middle” (the “back” office settles the digital paperwork).
For a long time Mark sat on the trading floor. The divide in treatment of trading (“front”) and support functions (“middle”) is immense, he said. “A telling anecdote: We would go play football, traders and support, after work. One time we were late, so we took taxis. The traders could claim that through expenses without a second thought, but we couldn’t. It was only a few pounds, obviously, so it was all about the symbolism. We refused to pay causing a huge headache for various managers who had to blame each other for the need to enforce this petty rule. This went on for weeks before we paid up.”
Finance is hugely diverse and Mark was specialised in equity derivatives. From how he describes it, its social utility isn’t immediately apparent:
“Most money made in the 90s was from ‘tax and dividend arbitrage’. Example: the Italian government wanted to encourage foreigners buying Italian shares. So they said, if you are a foreigner you get 140% of that share’s dividend, effectively a subsidy. At the same time Italian nationals would get only 80% of that dividend, a withholding tax.
“A trader will look at this and say: right, I can arbitrage this. I will get a foreigner to buy the share, then effectively sell it to an Italian national via a derivative. Out of the 60% difference in dividend receipts, the foreigner gets 20%, the Italian gets 20%, and my bank gets 20%.
“Sounds great, doesn’t it? Except of course for the Italian government. So what happens when the government catches on: they create a massive backlog for any tax claims by processing them extremely slowly. That way inflation eats away at any gains. The bank is left with a tax credit on its balance sheet which is in effect worthless. The only winner is the trader, who pocketed his bonus when the trade went through and who probably moved on to another bank years ago.”
How does the 2008 financial crisis look from a risk and compliance point of view? “What happened is simple: banks provided cheap credit to individuals and governments, and kept doing that by packaging the debts as Collateralised Debt Obligations (CDOs). It looked too good to be true and it was. Banks worked out what rating agencies wanted and manipulated their models until they fit and the agencies declared all that cheap credit super safe. The rating agencies deserve a huge portion of the blame.”
What should have happened? “We should have let more of the banks fail. We should have let the insurance companies who bought the CDOs fail. We should have let people who borrowed too much lose their homes – a home they couldn’t afford in the first place. This is how people learn what risk is.”
Some may think that bankers are all the same, and that they are in it together – against us outsiders. Mark’s words suggest once again there are allies on the inside. “We need to punish and humiliate key figures [in finance],” he says. “This applies across the industry. Some of the CEOs are like criminals who got off on a technicality. We should have chucked a few in jail, make an example out of them. You need to make these people’s social standing go down and then the rest will be much more worried than just losing their job and retiring with a few million in their bank account.”
And don’t stop at the investment bankers, he added: “I hope the next big scandal is exposing the fund manager industry. Their fee structure is completely opaque. I reviewed my own pension returns and discovered it had grown only very modestly over the last two decades. Not because the markets went down but because so much went in fees. Fund managers are worse than investment bankers.”
Anyway, Mark concludes, do let’s see things in perspective: “The hardship in western economies, no matter how bad, is nothing compared to life for the poor in a place such as India.”
Read the rest of the interview here, with very provocative passages on the changing nature of the City: “Far less honour and far more diversity.” There is also good stuff on who exactly benefits from short-selling, and on why a sentence like “this bank’s balance sheet is the size of the UK’s GDP” is comparing apples and pears.
In particular, if you think about leaving a comment, please read the entire interview first.
• This banking blog features interviews with insiders across the industry. Here is a guide to help you find your way. So far there have been two others interviews with people in risk and compliance. This veteran looked at “sovereign risk” and says :”The sector as a whole has become relentlessly focused on profit, and out to screw the customer.”
This female risk and compliance officer truly hated her job because front-office bankers “see us as football players might look at linesmen; losers running back and forth along a line, stopping players from scoring or doing great things”.
This article originally appeared on guardian.co.uk